Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No.

PEROMANCE AUDIT REPORT

MOROCCO

YIsT BOUSlMG LOAN TO CREDIT IMDBIIIER ET HOTELIER - CIM(LOAN 2245-VOR)

AND

PILOT PROJECT FOR THE COMUAL INFRASTRUCTURE FORD - FEC(LOAN 2272-MDR)

JUNE 30, 1993

MICROGRAPHICS

Report No: 12168Type: PPAR

Operations Evaluation Department

'lls document has a restricted distrbHmion and may be used by adl only in the performance oftheir ofieil dulles. Its contents may not otherwise be disclosed WOid Bank uthordzation.

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Currency Unit: Dirham (DE)

Anual Averages

1.2 IM I 1983 19l4 1985 1986 1987 1"S 1989 1990 12213.90 4.30 6.00 8.06 9.55 9.62 8.71 7.80 8.21 8.12 8.04 8.15

GLOSSARY OF ACRONYMS

BCP Popular Central Bank(Banque Central. Populaire)

BDCL Local Commune Development Bank(Banque de D6veloppement des Collectivit6s Locales)

BEDS National Economic Development Bank(Banque Natioaale pour le D6veloppement Economique)

CDG (GOM's) Savings Management Fund(Caisse de D6p6t et de Gestion)

CGI (CDG's) General Real Estate Company(Compagnie G6nrale Imobilibre)

CIR Real Estate and Hotel Finance Bank(Cr&dit Imobilier et Hotelier)

DGCL General Directorate for Local Authorities(Direction Gn6rale des Collectivit6s Locales)

DIC Development Finance CompanyERAC Regional Planning and Construction Agency

(Etablissement R&gional d'Amfnagement du Territoire)FEC Communal Infrastructure Fund

(Fonds d'Equipement Communal)CO Government of MoroccoHBM Low-cost housing

(Habitation a Ion March)MAT Ministry of Housing and Urban Planning (latterly MO)

(Ministbre de l'Kabitat et de l'Am6nagement du Territoire)

HOF Ministry of Finance(Minist6re des Finances)

NO Ministry of Housing (formerly MEAT)(Minist6re de l'Habitat)

MOI Ministry of Interior(Ministre de 1'Int6rieure)

OED Operations Evaluation DepartmentONE National Drinking Water Bureau

(Office Nationale de l'Eau Potable)PAR Performance Audit Report

PCR Project Completion ReportPR President's ReportVAT Value-added taxWDR World Development Report

FISCAL YFAR OF BORROWER

January 1 - December 31

FOR OFFICIAL USE ONLY

THE WORLD BANKWashington, D.C. 20433

U.SA

Mutc of Drectoi.Gene0a4Operatione 8valastia

June 30, 1993

*lA U TO =IlK EXEMMiE =IE ORS AND THE PRESIDENT

SUBJECTs Performance Audit Report on MoroccoFirst Housing Loan to Credit Immobilier et Hotelier -CIA (Loan 2245-OR), andPilot Project for the Communal Infrastructure Fund -FEC (Loan 2272-Mp).

Attached is the *Performance Audit Report on Morocco - First HousingLoan to Credit Iamobilier et Hotelier - CIE (Loan 2245-MOR), and Pilot Projectfor the Communal Infrastructure Fund - PEC (Loan 2272-MOR)O prepared by theOperations Evaluation Department.

The two projects audited in this report provided lines of credit toCIE for a housing program and to FEC to Invest in eligible infrastructure sub-projects in local communes throughout the country; in contrast, several earlierurban projects were specifi physical Investments. Both projects were preparedand approved in 1983, at a time when Morocco's economic prospects were notpromising. Thus the funding provided through these two loans was essential toboth organizations at the time of project launch.

The CIE project provided funding for some 251 of the total housingunits financed by CIE during the 1983-90 period. The focus of the Bank fundedpart of the program was on the low cost housingi its Implementation faced fewproblems, except land titling uncertainties in a small number of cases. The F&Cproject, a pilot operation, provided funding for local infrastructure andequipment sub-projectes markets, water supply and sanitation, and urban transportwere the most significant. Although the project achieved its physical targetsits financial and institutional development was limited. The project, howevergset in motion a process of further institutional development which allowed theBank eventually to prepare a follow-on operation with F&C.

Overall, the Audit rates the CIN project as satisfactory, itsinstitutional development as partial, and the sustainability of project benefitsas likely. The PCR-based rating Is the same for overall performance, substantialfor institutional development, and uncertain for sustainability. The FECprojects outcome is rated as marginally satisfactory, its institutionaldevelopment as partial, and the sustainability of Its benefits as uncertain. ThePCR-based ratings weres outcome satisfactory, institutional developmeutsubstantial, and sustainability likely.

This docm*ent has a restricted distribution am my i used by recipients only in the perfore nQ oftheir offioial daies. Its contents may not othervise be disclosed without ortd eank euthoriztion.

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日X。 �司暱低凶瀘 胡 馴扛叮 觀開颼 甚划國幼 偽 卻網n 劍玆劇閱盧 名馴n 瀘

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Zále of C~ Olft (Cont.) Oalte zo.

2. CIE - Tochnical Assistance ........... 3330 IMC 34

D. Sust~ bility ......... 3510 CIE 352. CDGIFZC ............ 36

IV. MEER POIMS Op SPECIAL IMMST ..................... 37

A. Poverty Impact 37Ie CIE 00444 404 37

2* IMC 38

3. For Borrovere 9 Loon Am~te vers Inel~ lesat 0 0 0 0 0 0 0 0 4 0 0 0 0 0 39

C. luctitutional Appraleal In U~ of Credit Operatiom .......... 40

D. Role of Subproject Appraisal In FZC Project Dooielon M~ ... 41

9. Inadequate ~ toring In terms of Proj eet Obj ectives 42

10 Zaviror^tal Impact ............... 43

V. FOMMCE op BORROM AM BM 44

A* Experionces of Borrover &ad Zxecuti" Agencies 44

10 CIE 44

2. CDGIIMC ........... 44

ze 1010 Of th* Zaak 44

1. CTE Project ........ 45

2. FEC Project ............. 45

VT. CONCLUSIONS AllD LESSONS 1r2 46

A. CIE Project o ...... 47

3. TBC Project 47

AMM 1

Com~te from tba Borrover 49

MOROCCO

FIRST HOUSING LOAN TO CREDIT IMMOBILIZR ET HOTELIER - CIS(LOAN 2245-HOR)

ANDPILOT PROJECT FOR THE COMMUNAL INFRASTRUCTURE FUND - FEC

(LOAN 2272-M0=)

1. This document is a Performance Audit report (PAR) on two lines ofcredit operations in the urban sector in Morocco. The First Housing Loan toCr6dit Iamobilier et Hotelier was approved by the Board of Directors on March 15,1983, and partly financed by Loan 2245-MOR in the amount of US$60 million, whichwas fully disbursed. The Pilot Project for the Commnal Infrastructure Fund -FEC Vnf, approved by the Board on April 26, 1983, and partly financed by Loan2272-MOR In the amount of US$16 million, which was also fully disbursed.

2* The PAR consists of an Evaluation Sumary and a Performance AuditReport prepared by the Operations Evaluation Department (OED). ProjectCompletion Reports (PCRs) pre.pared by the Infrastructure Operations Division offormer Country Department II tf the former Burope, Middle East and North AfricaRegion (EMA) were previously submitted to the Board of Executive Directors asReports No. 10154 dated November 27, 1991 (CIR), and No. 10075 dated November 14,1991 (FEC).

3. The PCRs provide general accounts of the project experiences andindicate their successes and failures. In order to give a wider and more recentperspective, the Audit provides additional Information about the projects, theirhistory, eventual outcome, the issues raised, and the principal lessons learned.The PAR is based on the PCRs, the Staff Appraisal Reports (SARs), the President'.Reports, project legal documents, project files, legal files, a transcript of theExecutive Directors' discusions at Board presentation and other relevantmaterial. It also draws on Interviews with Bank operational staff and withMoroccan Goverrment Officials and management and staff of CIN and FEC inCasablanca and Rabat, as well as field visits to project sites, during the auditmission to Morocco in June 1992.

4. The Audit agrees with the CIE Project's PCR In some respects, buttakes a different view of the project's achievements and in particular of theimpact on the sector and low-income population. In the case of the FEC Project,the Audit"s analysis of a broader data base has lead to somewhat lower ratingsthan presented in the respective PCR.

S. Following standard ORD procedures, copies of the draft PAR were sentto the Borrower and Executing Agencies for comments on March 26, 1993. Commentsand clarifications received from the Ministry of Finance, CIE and CDG, arereflected in, and attached to the report as Annex 1.

I

zuzMC AMD

11R8T 101US1EG LOAN TO CREDIT nlmDBILIER ET RO'ELIER(LOAN 22454M4R)

nASIC DATA SEERT

EET PROJECT DATA

Actual or Aotuala IAppraLeal Curent of Appasa

Total Projeat Coat kUs$ M) 209.5 105.3 50.0Loen Amount (US$ 9) 60.0 60.0 100.0Economto Rate of Retu~ 12 15 125tnstitutional Perfoman*e: Subøtantial

Appraisal getløate (Us$ M) 60.0Actual (Us$ i) 60.0A*tual sa t of Appraial () 100.0Date of ial Dbur~ements January 29, 1990

Identification 09181Prepration 01/82 05/c2Appratsal 06/82 10/82Negotiation 12/82 01/83board Approval 03/15/83Loean ignture 04/11/83Loa Ef fectivene8 07/83 08/30/83Projeot Copff ton 09130190 05/28/91Loan Clo#1% 12/89 12/31/89

pre~a a 35.9 .1 -- - * -- 3.s.otat 4.', 0.-

lotto" - 5.9 - - - - - - . . . 5.9lson • 4.3 12.0 8.5 22.1 8.9 7.4 4.3 7.3 4.4 0.4 79.6

6.4 11.5 • - . • • • - - • 17.9

£1 As pr æ Imtituti Data as/RportIng system

EMISINATA

Date No. of No. ofMnth/Year .Jms Pergona

Identlfication 09/81Preparation 05/82 24 2Appraisal 10/83 18 5Negottation 04/83 11 2Supervision I 02/84 10 2Supevision II 08/84 10 2Supervision III 03/85 8 2Supevision IV 05/85 8 2Supervision V 10/85 16 1Supervision VI 12/85 5 1Supervision VII 02/86 6 1Supervision VIII 03/86 15 1Supervision IX 10/86 6 2Supervision X 03/87 2 2Supervision XI 10/87 2 1Supervision XII 04/88 5 2Supervision XIII 05/89 2 1Supervision XIV 12/89 4 1Supervision XV 05189 5 3Supervision XVI 12/89 7 1Supervision XVII 02/90 _1 1

Total 253

OTHER PROJECT DATA

Borrøvers Credit Umobiller et Hotelier

ExecutingAgenciøs3 Crodtt Iamobiller et Hoteller

Iv

PILOT PROJECT -OR THE COMMURAL INFRASTR=CTUR FUND - VZ0(LOAN 2272-MOR)

BASIC DATA SOMM

RZY PECT -DATA

Actual or Actual as IAppraisal Current of Appraisal

n Epectation Estimate Etimata

Total Project Cost (US$ a) 31.0 11 N/A

Loan Amount (US$ a) 16.0 16.0 100.0

Economic Rate of Return n.a. n.a. U.a.

Institutional Performance: Substantial

1/ An estimated tine-slice of an ongoing investment program.

CUULATIVE ESTIMATED AND ACTUALDISE

Appraisal Estimate (US$ a) 16.0Actual (US$ a) 16.0Actual as I of Appraisal (2) 100.0Date of Final Disbursements Januav- 29, 1990

Oriinal Atual

Identification 05/80

Preparation 02181

Appraisal 06/82

Negotiation 03/83

Board Approval 04/26/83

Loan Signature 05/23/83

Loan Effectiveness 08/22/83 04102/84

Loan Closing 06/30/89 12/31/89

Preappras t 20.7 30.9 12.4 .2 • • • • • • • 4.2Apprela • •3.0 16.8 • - • 19.8Nesotietain • • • .1 • • • • • • • • .1supervistln • • .1 3.6 6.1 8.7 1.8 2.7 4.8 1.9 16.6 3.6 49.9Other 3.7 .7 .7 9.4 - • • • • 16.5

j1 As per 0E0 Instituttonmt Date Bas/Reporting System

MISSIO DATA

Date No. of No. of~ot 9a 1Dav Peom

Preparation 01181 14 4fteparation 05181 7 1Preparation 06/81 3 5Preppra:bal 03182 14 3Appraisal 07/82 24 3Appraial 02183 4 2Supervision 1 11183 3 1Supervis:Lon II 03184 12 1Supervision III 10/84 8 1SupervloLon IV 03/85 6 2Superviaon V 10/85 5 3Supervision VI 03186 12 4Supervision VII 10/87 12 3SupervLeion VIII 07/88 .2 1

Total 131

OTHER PROJECT DATA

Borrowers Goverrment of morocco

ExecutingAgencies: Caise dc Depot et de Gestion (CD)

Comwunal Inrastucture und (lEC)

v1

MOROCCOs E N CE WITB LINBS OF CREDIT FOR ROUSINGAND URBAN DEVELOPMENT

FIRST HOUSING LOAN TO CREDIT IWMBILIER ST NOTELIER - CIE(LOAN 2245-MOR)

ANDPILOT PROJECT FOR THE COmmUNAL INFRASTRUCTURB FUD - FEC

(LOAN 222-quR)

Introductl n

I . The two projects audited in Improve. There were two consequencesthis report provided lines of credit for the project.: tiLs externalto CIR ("Crddit Immoblier et funding they provided become lessHotelier# - Real Estate and Rotel urgent to the borrower., end localFinance Bank) and FEC ("Fonds resource, for CIE and FEC expanded,d'Equipement Commnal - Comiunal reducing the relative Importance ofInfrastructure Fund) to Invest In the Bank. hare of the total (par.eligible subprojects throughout the 1.03-1.06).country in housing and local commmeinfrastructure, respectively. This 3. Morocco'e 4.32 average annualwas in contrast to the early urban urban population growth made demandprojects in Morocco, which financed for shelter and urban services-'ecific physical investments In Increase rapidly. Currently, 12

selected cities. The project concept million people live in urban area,vae modelled on the development or 48X of the total population.finance company (DFC) approach that UNCHS (N0RTAT) projections indicatethe Bank had previously used to this proportion will grow to 711 byprovide credit for Ind-trial the year 2010. Challenges ofdevelopment, including some urbaniaation In Morocco include rapidoperations in Morocco itself (paras. eansion of "bidonvilles" or1.01-1.02)o squatter settlements of precarious

shacks built Illegally on unserviced2. Both operations were prepared land and growth of "informal"and approved while Morocco's economic housing, similarly Illegal, but of aprospects were not promistg: In higher standard than bidanvilles.1983, the country faced an Sam 20Z of Morocco's urbaninternational payments crisis and the population is estimated to live Inneed for external finance was scute. these two types of housing. TOGross domestic product continued to resettle the residents of thesefall for the first half of project illegal settlements and meet theimplementation until 1985. After growing demands of new urban1986, however, Morocco's households would require the annualmacroeconomic performthae began to provision of at least 151,000 new

vii

housng units. Morocco's formal agreed between CON and the Bank afterhousing sector has, at best, been 19810 The Dank's reluctantable to supply 57,000 units In one recognition of 00*' opposition to.year. The Government of Morocco bidonvilles led sector trategy to(GOM) made considerable efforts to focus on sites and services with coreincrease housing supply, but the housing. The Banka 1982 urbanpublic sector has, at most, been able sector review of Morocco Identified ato deliver only 8,300 units per major role for CIN as a uniqueannum. Thus, the CIR Project'a focs vehicle for promoting a coherenton the private sector, responsible housing policy. The Bank's strategyfor 852 of the formal housing supply, was to take the most successfulwas appropriate (paras. 1.07-1.11). element of the first two urban

projects (i.e.,9 sites and services)4. Rapid urban growth also and stimulate their efficientincreased the pressure for delivery through CIS (paras. 1.16-administrative decentralization in 1.21).Morocco. The Local CommuneOrganization Law of 1976 augmented Mbectives and V2821121102local communes' responsibilities andenhanced their access to financial 6. Under this line of creditresources, but central and provincial approachg CIE made loans to publicgovernment control over local and private developers for housedecision-making remains substantial. construction In the first Instance,Morocco has two tiers of subnational and later as mortgage loans for thegovernment. The first consists of buyers of the houses built. In theprovincial governors and prefet. case of the C Project, modelledwith considerable responsibilities upon the pioneering Cities andfor regional coordination. The Villages Development Bank Projectsecond Is made up of some 859 local (Loan 1826) in Jordan, the finalcommunes, 99 of which are for larger borrowers were local communes andurban areas. The FnC Project sectoral utilities (known as lrftlesfocussed on the local communes, in Morocco). (paros. 2*01-2.04)providing them with loans to financeinfrastructure and equipment. The 7. Project Institutions were keyMinistry of the Interior represents players in their respectiveGCH'. authority for local affairse subsoctors and the financial marketsand is responsible for overseeing of Morocco. CIN is the countryosdecision-making by the communes principal housing bank with asets of(paras. 1.12-1.15). US$1.7 billion in 1990. Majority

ownership of CIEIis held by CDC5. 00M and the Bank have had (Caisse de Ddpat et de Gootion")sdifferences about urban sector policy 00M9o very large savings managementand strategy in Morocco. Under the fund (para 2.06). Bein wel knownfirst two urban projects, sector to the Bank through four earlierdialogue largely revolved around the touriem projects, CIE was recommendedissue of bidonvilles, whether to as the borrower for a housing financeeradicate them (as 0 wished) or to project* Despite its judicial statusupgrade them (as the Bank proposed). as an Independent fund with its ownAlthough upgrading was Included in financ statements, 79C was athe first two urban operations on a department of CDGv subject to thetrial basis, no further projectsincluding bidonville upgrading ae

vill

policy and administrative norms of development policy, to assist localthat Institution (parse. 2.05-2.10). commues In their efforts to meet

their basic infrastructure needs; and8. At appraisal, FEC was a very (U) to asist FEC In formulatingsmall operation with a staff of only operating principles for projectnine. Its job was to lend to local financing, on the basis of rigorouscommes and utilities ("r6tes6) for preparation, appraisal andinfrastructure projects and supervision standards end criteria,acquisition of equipment. The Bank* and Improving the efficiency of itsappraisal report cited a long list of staff in the performance of theirweaknesses of F8Cs no track record or functions." (NEC SAR, par&. 4.01)operational procedures and policy; These objectives were Incorporatedinadequate staffing; and tabalanced into the legal documents through anfinancial structure. Most of these agreement to implement the project inproblems existed because NEC was not accordance with the Statement ofa genuine financial institution, but Policy. (para. 2.37-2.38)simply a department of anotheragency. These uncertainties led the Inlementation ExperienceBank's Legal Department early on torecommend against NEC as a borrower 11. There were practically nofor the proposed project (pares. disbursements of the loan to CIA for2.11-2.17). the first year after loan

effectiveness. CINI's explanation is.9. Objectives of the CIN Project that the Bank underestimated thewere tos (i) encourage private and housing costs necessary to meetpublic developers to produce low-cost official nors, contradicting the ShRhousing schemes affordable to income which stated that the ceiling pricesgroups in the lower half of the urban on which they were based wereIncome distribution (i.e., with identified by CIOs own marketmonthly household incomes below studies. After CIE prevailed on theUS$330 in aid-1982 prices); and (ii) Bank, the ceiling price, were raiseddevelop CIR's ability to apaise successively by 87.5Z (against anlow-cost housing schemes and advise accumulated inflation of 38.42 in DR,private and public developers on all para. 3.03) to a mazimm of DRaspects of low-cost housing design. 150,000 (US$18,720 in 1988) andThe funding mechanism involved disbursements began. The PCRconverting all (three year) mentions that a special upper limitconstruction loans into long-term (up of DR 100000 per unit wasreally to 25 year) mortgage loans. maintained. This limit was notTo meet this obligation, it was observed, however, since 13 of the 43recognised that CIN might have to developer contracts financed by CIEseek additional funds at a later under the projact were for housingdate, since the combined maturity of units in the DR 108,955 - 163,333the loans under this arrangement ois range 0 These inreases ma theup to 28 years, compared with the 17 housing offered under the projectyear term of the Bank Loan. (pares. unaffordable to Its Intended low-2.32-2.36) income beneficiaries NIC PrOJect

disbursements were also slow at the10. The goals of the 7EC Project outset, but this later proved typicalwere: (1) in support of the of municipal development projectscovernment's regional and ommunal where noew policies and procedures

ix

were introduced. As more proposals with the legal agreements. 79C grewwere submitted and PEC staff became even faster than CIR with a smallermore adept at appraising them, Bank financial contribution,disbursements began to accelerate corresponding to just 6.12 of its

(pares. 3.01-3.04). growth in long-term loans. Over the1983-90 Period# PEC did not become an

12. CI*s financial performance autonomous financial Institution.

weakened between 1983 and 1990 while 001 briefly contemplated creating

the project was being Implemented, such an entity, but shelved the plan.

This was even true during the second Roweverg Important groundwork washalf of this period (1987-90) when laid for this to happen In the future

the national economy was picking up. under a follow-on operation that was

For nine of the eleven financial recently approved by the Dank (paras.

indicators reported in the PCR, 3.16-3.24).actual performance was below theforecast. CIR did, however, maintaina positive interest rate spread and asound capital structure. CIR grew 14. The project accounted for

significantly during 1983-90, but the some 252 of all the housing units

Bank contributed only 7.3Z to the financed by CIE during the 1983-90

increase of its long-term loans over period, a significant share of CI's

this period. Two decades and six total sector operations. The funding

Bank loans may have induced "borrower of each of the 15,449 units completed

fatigue" in CIR, whose management under the project involved two

came to see the amount of the housing successive financial operations from

finance loan as insignificant. CIR's CIE"s point of view. The first was

hotel loans worsened during to provide three year construction

Implementation of the project (pars. loans to developers to build the

3.05-3.15). house, and the second was to providelong-term mortgage loans to

13. FEC's financial performance purchasers to buy the unit built.

during 1983-90 was mixed. This is normal housing finance

Profitability declined and losses practice in many countries. In the

were reported in 1988 and 1989 after PCR, however, CIN only counts the

FEC lost access to the Central Bank's projecs contribution to the secondlow interest rediscount facility. On Instance, namely the value mortgagethe other hand, the maturities of financing. This Ignores constructionFEC's liabilities were considerably loans financed under the project that

lengthened through the provision of were provided for all units built.

substantial long-term loans in 1987. Dy comparing the projects mortgage

Despite this improvement, FEC finne only with Cass total

remained undercapitalized for most of construction-plus-mortgage financ,the period. CO's two contributions the PCR estimated the projecs

of DR 20 million to PEC's equity, contribution to CIE's overall housing

when four were expected, did not keep finance operations to be only half

FEC from becoming a highly leveraged what it approximately was (pare.

operation. On the other hand, FEC 3.25).became more solvent, with a currentratio far surpassing that forecast at 15. Actual physical implementation

appraisal. Provisions for losses, of the housing financed presented few

which did not exist at all prior to problems, except for land titlingthe project,1 were made in accordance uncertainties hich made some schemes

x

infeasible, as had occurred in the housing. The PCR Implied thatsfirst two urban projects. without Ban funds, the low-ostSurprisingly in view of the trend housing program risked becomingtowards increasing coiling prices, extinct for lack of CON support. ThePCR data reveals a fall in the value increases in the project'. ceilingof subloans per unit during prices, with the Bank'. agreement,implementation compared with that followed the trend of CIS operation.estimated at appraisal. The a. a whole. This acceleratedappraisal estimate of the total cost disbursements, but the Audit believesof the houeing component (i.e. the this occurred at the cost oftotal value of sub-loans to be weakening the project's low-incomefinanced under the project) was DR focus (per". 3.29-3.33).1,257 million (US$209.5 million).The actual value of sub-loans by 17. CIIIs appraisal and controlcompletion had fallen to DR 891.5 capabilities Impressed the Audit, butmillion (US$105.3 million), it is difficult to deteroine whatincreasing the Bank'. share in theae capabilitiea od to theproject financing from 29.1% to projectl At appraisal, the Bank had54.7Z. With 15,449 units built and praiaed the high quality of CIE'sfunded, the average sub-loan per evaluations. The low-coat housingunit, according to the PCR, fell from apect of these skills aeemed to havean appraisal estimate of D 83,000 been lost, however, and the Audit(US$13,333) to DR 57,706 (US$6,816). miasion was left with the impressionThe achievement of these dramatic that the CIE/private developersavings Ia not analyzed in the PCR. dialogu on low-coat housing waa notNor does the PCR explain why, if unit a very active one (para. 3.34-3.36).sub-loan. fell so sharply, was itnecessary to successively Increase 18. On the order of 100 localthe celling prices of the units? Infrastructure and equipment(pars 3.26-3.28). subprojects were financed wder the

FEC Projeact. By subborrower and16. For CIE operations as a sector, the portfolio included awhole, housing costs in fact rose diverse range of inveatmenta. Ruralsharply between 1983 and 1990: 125.4% commuMes, autonomous centers,in the case of public developers, and 'municipaltds', and Or6giesO423.4Z for private developer., seven (sectoral utilities) took similartimes faster than inflation. While shares of the amount lent.the Bank financed units are Commercial infrastructure (mostlyaffordable by the lower median-income markets) end urban transport were thepopulation, the average C1-financed most popular subprojects. nC keptprivate sector unit is affordable good control of local investmentsonly by those in the top docile. CII during their construction, but failedmortgage lending also followed a to follow up with adequatetrend toward more costly housing. monitoring. Withut adequate staffDuring 1983-90, the number of resources and equipment for"special regimem (i.e. low-cost) supervision and monitoring, nC isloans awarded per annum halved, while unable to confirm how well thethe number of higher cost 'general investments are performing andregime' loans doubled. CIS employed whether they are being properlyBank funds to finance a much reduced maintaine. A cross-sectionallow-cost housing program, while using analysia by type of local authority,other resources for higher cost

st

city etse, region, and poverty Ipact operations In Morocco'e tightof FBC's rich lending experience to financial market. The suetaiusbilitydate would help policy formulation of the benefits derived from theand clarify sector priorities In housing units financed under theMorocco. project Is likely to be assured by

resident-ovners9 care and19. The Audit mission was Iapressed maintenance In one large schemeby subproject appraisal skills visited in "b.GnCAS however, poordeveloped in-house through on-the-job maintenance "ublic areas couldtraining by FEC staff. Since PEC threaten su - -sinability of themanagement felt that the projact's neighborhood as a viable urbanrules and procedures were well community (par". 3.42-3.44).understood by all parties, a formalmanual was considered unnecessary. 22. As an Integral part of CDC9This might not have mattered when FC sustainability of the FEC operationoperations were small, but an depends on the sustainability of CDCenlarged program requires a clear itself. FC did not become anstatement of policy, rules, and Independent financial institution.operational procedures. CDC can, however, come to FEC's aid

if the need should arise, as it did20, Two other key findings should in 1987. The Audit found no reasonalso be highlighted. First, CIE and to doubt that CDG would be able toCDG/FEC considered the loan amounts fulfil this role, if necessary.of their respective projects Sustainability of the localinsignificant in relation to Investments financed under thesubsectoral needs, Bank projectwill'depend on the ability ofconditionalities, and Bank reporting local communes ad iregies toand information requirements. As a maintain them. Actual performance isresult, CIE and FC's growth-minded unknown, because FEC has yet to carrymanagers were disappointed at the out the necessary monitoring of theseBank's limited financial contribution investments (pars. 3.45-3.46).to their expansion. Second, sincethe proceeds of a Bank loan to DICs ConclusIoS and Lessonssuch as CIN and FnC/CDG are fungiblewithin the institution, this kind of 23. The CIR project Is ratedoperation effectively supports the satisfactory although relative to thework program of the financial optimistic expectations, some resultsintermediary as a whole, not just the were disappointing. Disbursementtargeted components. proved difficult, and concrete

impacts on c1H and Mrocco's housingD~.enahA.1Szsector are not easy to see. most

inportanta the operation failed to21. The C18*'s project benefits stimulate the delivery of lw-costare likely to be sustainable. housing by public and privateAlthough declining profitability and developers, as intended. Theshort-term solvency are cause for Project's sustainability Is vated aconcern, its capital structure likely and Its institutionalremains solid. Resource mobilization development as partial (vs. uncertainat levels sufficient to finance and substantial respectively n theincreasingly costly lending products basis of the PCR). The main lessonsis likely to be CII9a biggest from this exprience include thechallenge in sustainig Its following (pars 6.02):

Mil

(I) Previous Bank-finaned CIN Was relatively smail and(physical) urban development cams to be regarded asprojects in Norocco Insignificant by a growth-demonstrated that bidonvilles minded borrower.and low-cost housing were notcentral to COs housing 24* As a pilot operations the FECpolicy, as they were to Dank Project raised modest expectationssector strategy. The lessons with respect to its likely results.of such earlier experiences Its achievements were mixed butshould be taken into account, subsequent progress was evidentlyeven if design of the new adequate to Justify the recentproject is intended a. a approval of a follow-on operation.substitute for the older The Audit rates the project's overallapproaches$ outcome a satisfactory and its

Institutional development as partial.(ii) As a corollary, the Bank Becaue of the FEC9s continuingshould focus its support on weaknesses In sub-project monitoring,those operations in the DIC the oustainsbility of the project'swhich are a priority for the benefits is rated as uncertain. TheGovernment and the DPC Itself. PCR-based ratings we overallIf not, Bank funding risks performance as satisfactory;merely filling a resource gap Institutional development asleft by the local withdrawal substantial; and sustainability afrom low priority operations, likely. The principal lessonsas appears to have been the Include the following (par&. 6.03):case with CIA's low-costhousing program; (i) To achieve the desired

Institutional and policy(1th) Resources provided via a Impact, It is Important for theline of credit to a DYC are Bank to engage the appropriatefugible within the authority in its policyInstitution, and in practice dialogue. In this case, CDCsupport the intermediary as a was a key policy Interlocutorwhole and all of its and Its active engagement inoperations. Institutional the process should have beenappraisal, therefore, should enlisted;cover all aspects of the DIC,and project design may require (U) For a first operation Inlegally covenanted performance a particular sector, it iscriteria for areas of its Important to spell out Inoperation other than those detail the agreed criteria fordirectly targeted under the eligible beneficiaries andproject (e.g., hotel loans In subprojects. In this case,the case of CIB); aand these details enabled PEC staff

to develop a sound appraisal(iv) Bank influence in a DC methodology for evaluating themust be realistically assessed proposals received. In ain terms of the Importance of c=Wlex subsector such as localthe Bank loan amount in developmant, it is likewiserelation to all new funding important to engage other keylikely to be mobilised by the policy ants, such as HOI andintermediary. The Bank loan to the provincial governors, so as

to eUSUTe their support for theprinciples and procedures ofthe operation. Without euchsupport, there is a risk thatother Investment evaluationcriteria may be introducedwhich conflict with the alas ofthe Bank-financed projecti and

(itt) As in the CIN case, Bankinfluence in a DC aet berealistically assessed in termsof the importance of the Bankloan in relation to all newfunding ltkely to be mobilizedby the Intenaediary Inquestion. After the expectedfollow-on loan did notmaterialize, Bank influencediminished and CDG/jBC regardedthe loan as insignificant inrelation to the sector*s needs.

MOROCCO

FIRST HOUSING LOAN TO CREDIT INNOBILIER IT HOTELIER - CIR (LOAN 2245-HOR)AND

PILOT PROJECT FOR THE COIA=NAL INFRASTRUCTURE FAUD - FEC (LOAN 2272-MORl

A. Introduction

1.01 Bank involvement in the urban sector of Morocco has been a rich andvaried one, spanning nearly two decades. It has Included five lending operationsand five sector studies. The two operations assessed here are referred to inthis report as the OCII Project" and the "FEC Project" respectively. Together,they reflect an important shift In Bank urban sector strategy, not only forMorocco, but for urban lending as a whole. Thus, in 1983, and for the first timein the region (and probably worldwide also), two Bank loans provided lines ofcredit to financial intermediaries in subsectors related to urban development.The proceeds were to be on-lent to real estate developers and local commuesto finance urban housing and Infrastructure respectively. Two earlier urbanprojects in Morocco' had used Bank loans to finance specific urban Improvementprograms in the cities of Rabat, Renitra, and Wekne. The line of creditapproach, by contrast, aimed at using lank loan proceeds to finance Improvementsin any city in the country, provided that the proposed subprojects met certaineligibility criteria.

1.02 Technical feasibility and economic and financial performance criteriawere agreed to detersine which parts (i.e. subprojects) of CIR's ("Cr6ditIamobilier at Hotelier" Real Estate and otel Finance Bank) and FEC's ("Fondsd'Equipement Communal" - Communal Infrastructure Fund) overall investmentprograms would be eligible for Bank financing. This project design was modelledon the development finance company (DIC) approach supported by the Bank toprovide credit for industrial development (pars. 2.01-2.04). Its application

1 Following the convention established in the Bank's recent sector paper ondecentralisation in Morocco, the French words "communes" and "communal"will be used In place of municipality and anIcipal in this report. Thisis to avoid confusion, since the word "aunicipalit6" is used in Morocco torefer to a particular kind of "comimne" i larger urban areas. Thus, asused in this report, the term "local communal development" is synonymouswith the expression municipal development" widely used in other Bankdocuments.

a Rabat Urban Development Project (Loan 1528-MOR, approved in June 1977 andSecond Urban Development Project (Loan 1944-MOR, approved In January1981).

2

to the urban sector, however, was a novelty. The advantages of this approach,

according to the method9s protagonists, included more widespread benefit., more

rapid disbursement and permanent institutional gains. The completion of two such

operations in Morocco for housing and local development provides a good

opportunity to assess whether the results thus far have met expectations in these

sectors.

B. Macroeconomic Context in Nmcco

1.03 Preparation and appraisal of both projects took place at a time of

uncertainty about the prospects of the Moroccan economy. Successive balance of

payments deficits and vanishing external funding cuainated in Morocco's

international payments' crisis in 1983, coincidentally the year in which both

loans were approved.s Thus, the CIN and FEC loans provided welcome relief to

the Moroccan Government (CON) in helping to deal with its external payments

problems, albeit on a very small scale in macroeconomic terms.

1.04 Notwithstanding macroeconomic stabilization and adjustment programs

supported by the IMW (International Monetary aund) and the Bank, pessimism about

the future of the national economy persisted at least until 1986. By that year,

Morocco's external debt exceeded US$20 billion for the first times, and debt

service consumed roughly 40 percent of the country's export earnings, one of the

highest ratios in the world at the time. GDP fell continuously and sharply in

US dollar terms between 1981 and 1985. In 1981, GDP per capita was US$860. By

1985, it had fallen to US$560, the lowest level since 1978. Thus,

identification, preparation, appraisal, and start-up of the CIE and FEC Projects

took place at a tine of gloom about Morocco's macroeconomic prospects, and when

00M urgently needed to mobilise resources to balance its external account.

1.05 By contrast, the second half of project implementation (1986-1990)

coincided with a significant Improvement in macroeconomic performance. GDP

growth resumed, with GDP per capita reaching US$950 in 1990. Unlike the large

trade deficits of earlier year., Morocco earned small current account surpluses

in 1987 and 1988. This turnaround reduced the need for external financial

assistance, and meant that the country's external debt grew anc more slowly than

in the early 1980s. Inflation also showed an Inprovementa during 1987-89, the

annual rate fell to the 2-3 percent range, in contrast to the 6-12 percent of the

1981-85 period.

1.06 Thus, during the second half of project Implementation, optimism

about economic recovery prevailed as Morocco's macro performance Improved. This

had two consequences for the projects under review. First, the need for the kind

of external funding they provided seemed less urgent from a balance of payments

A study of the Moroccan economy during the 1970-1987 period noted thats

"In the analysis of stabilization and adjustment in Morocco from 1975 to

1987, 1983 is a natural dividing point. That year the external payments

crisis began, and the government was compelled to request emergency

financial assistance from external creditors-* Norton, Brenden, Morocoe

Analyeis and Reform of acOl Pli=q Econom Development Institute,Washington D.C., 1990.

3

standpoint than it had at the time of appraisal in 1983. econd, more buoyant0C finances enabled local funding for VIN and FEC to grow, reducing the relativeimportance of Bank lending in their respective balance sheets.

C. The Urban Sector

1. Ravid Urban Growth

1.07 With 4.3 percent average annual growth of the urban population since

1965, fuelled by migration from rural areas, increasingly heavy demands have beenbeing made on infrastructure, services, and shelter in Moroccan citiis.Currently, some 12 million people, or 48 percent of the total population, livein urban areas. According to UNCES (HABITAT) projections, the country's urban

population could more than double over the next twenty years, to account for some71 percent of the total by the year 2010. Fortunately, Morocco's diversifiedurban system has important settlements located throughout the country, so that

many cities can help absorb the pressures generated by expansion of the urban

population. The largest urban agglomerations with their estimated 1990populations ares Casablanca (3.2 million), Rabat-Sal6 (1.2 million), Fe (0.8

million), Marrakech (0.8 million), and Nekn&s (0.7 million).'

1.08 This rapid urban growth has contributed to the proliferation of whatare referred to in Morocco as "bidonvillea, or unauthorized low-income squattersettlements of precariously built shacks without basic services. A Ministry ofHousing (NO) survey identified 1,064 bidonvilles in Moroccan cities in 1989,housing 890,920 people, or 7.9 percent of the urban population.' Similarlyillegal occupation has occurred through the expansion of "habitat clandestine"

or informal housing, which now shelters scme 12 percent of the urban

population.' Informal housing is also illegal, but is home to higher incomeresidents who build better quality units than those found In bidonvilles. In

total, 20 percent of Morocco's urban population lives in housing unrecognized byofficialdom.

1.09 0 and local authorities (especially in Casablanca) made clear thatthese kinds of settlements were unacceptable. Where funds were available,bidonvilles were eradicated and their inhabitants resettled in public housing

schemes. The Bank, on the other hand, had encouraged GOM to consider the

upgrading of these settlements as a more cost-effective and less disruptivesolution. The upgrading approach was tried out on an experimental basis under

the first two urban projects supported by the Bank (pars. 1.16-1.17). Much of

Estimated data on 1990 urban population and projections taken froms UnitedNations Center for Human Settlements (HABITAT), Global Renort on HumanSettlements 1986, Oxford University Press, New York.

Royaume du Maroc, Ministbre de l'Rabitat, Recensement -gnral des

Bidonilles, Rabat, June 1989.

World Bank, Mrocco: Informal nougnJa Unradin and Prevention Policiesand.ognramq EMBS& Urban Projects Division, December 20, 1983.

4

the GCWIBank urban sector dialogue concerned the issue of how to deal with

illegal settlements In Moroccan cities.

2. SuLI and Demand for Urban Shelte

1.10 CON's desire to rid Moroccan cities of bidonvilles and informalsettlements in the context of rapidly growing urb" population presents animmense challenge. Just to replace bidonvilles and Informal housing and rehousetheir 2.4 million inhabitants would require the production of 480,000 new units,assuming one unit per household and five persons per household. A modest ten-

year program to replace all these illegal settlements would thus require annual

production of 48,000 new units. At least an additional 103,000 units per annum

would be needed to meet the demand of new households as city populations continue

to grow at 4.3 percent per year. In short, without considering the replacementneeds of an aing stock, some 151,000 new units would be required each year.

1.11 Against this, Morocco's formal housing supply in its best year (1987)was only able to supply 54,000 units.' By Implication, informal solutions have

to take care of the rest. This means expanding bidonvilles and informal housingas well as overcrowding of the existing stock. OM has made considerable efforts

to increase public sector housing supply, both directly through the Ministry of

Housing (MO), or indirectly through the seven regional planning and construction

agencies (ERACs) and the General Real Estate Company (CGI). Although significantincreases in output were achieved, altogether, the public sector accounted for

only 8,300 units per annum.* Thus, the call for the CI Project to focus

attention on the private sector, responsible for 85 percent of the formal housingsupply, was appropriate.

3. Local Government in Cities

1.12 Rapid urban growth also increased the pressure for administrative

decentralization in Morocco. Until the Local Commune Organization Law of 1976,the central government in Rabat had been responsible for most investment

decisions at the local level. Under this law, however, local comunes were given

greater assurance of financial transfers from C0W, although central and

provincial goverrment control over decision-making by local communes remainsconsiderable. According to a recent Bank report, moreover, the specific

responsibilities of local comunes are not always clear.'

MO data for 1984-1989 reproduced In the SAR for the Second HousingFinance Project (Loan 3122-MOR), para. 2.08.

Ibid.

* In the words of this reports *The decree of September 30, 1976 is

ambiguous in its provisions regarding the tasks that the comunes are to

carry out and lends itself to various Interpretations." Degentamtionin Noroccal Local Government EZnendites and Manatement, August 31, 1990,World Bank, par&. 9ile

5

1.13 Although only recently reformed, local goverment has formallyexisted in Morocco since Independence. Administratively, it consists of twotiers. At the first level, the country Is divided Into 40 provinces and 9*prefectures,# headed by governors and prefects, all of whom are directlyappointed by the King and report to the Ministry of the Interior (M01). Today,provincial governors and prefects are responsible fort (1) executing decisionsmade by elected provincial aseemblies (ii) coordinating GCW sectoral Investmentswithin their jurisdictiona and (iII) submitting local commnesO budgets andspending plans to MO and HO (Ministry of Finance) for approval. Governors andprefects function, therefore, as 00's regional representatives.

1.14 The second tier of local goverment, to which the V80 Project wasmainly directed, is made, up of local comunes, Rapid urbanisation has led to anIncrease in their numbers, which now total some 859. Of these units, however,only 99 have significant urban development responsibilities. They are the 59wounicipalitas* and the 40 *autonomous centers* with jurisdiction over the largercities and smaller urban centers respectively. The remaining 760 are ruralcommunes on the order of what might be called village councils in othercountries. Each cowme has an elected local council, which chooses one of itsmembers as president to represent it, fulfilling the role of what Is often adirectly elected mayor In many other countries.

1.15 Morocco Is not a federal system of goverment. The autonomy of thelocal communes is only Incipient and central government still retainsconsiderable control, either directly or through the provincial governors. nownin Morocco as the fministAre de tutelleO of local commnes, NOX is literallyentrusted with responsibility for local government affairs.

D. Govement Poli and Bank Strate,

1.16 The Issue of how to deal with unauthorized urban settlements InMorocco was first discussed by 00W and the Bank in 1972 during preparation of theRabat Urban Development Project and the ensuing debate over the merits ofbidonville upgrading versus eradication were discussed in the Audit of thatproject.' Despite considerable efforts Bank missions to persuade the housingministry to support upgrading, bidonville eradication prevailed as it does today,

Re Moraccos Ubat ad BigSAnd Urban =1Develoent _ProesO Loans 1528119§4-Mt Report No. 9729, June 28, 1991, paras. 1.08-1.11 and 4.05-4.13.

6

although NOR did admit upgrading on a trial basis in the Rabat project. Bankrecommendations for low-cost solutions affordable by the urban poor to reduceunsustainable subsidies for resettlement progress failed to diinish 0M'shostility to bidonvilles in particular."

1.17 Nonetheless, as if to give the Bank the benefit of the doubt, Oagreed to a second urban operation which included bidonville upgrading in thecities of Meknba and Renitra. This became the Second Urban Development Project,approved in January 1981. As the audit of that project pointed out, however, theso-called upgrading operation in Makne was really an urban renewal andresettlement scheme. Lot boundaries on the original site were completelyredrawn, forcing the relocation of a large number of families, effectivelyeradicating the settlement that existed prior to the works."

1.18 No further projects incorporating bidonville upgrading were agreedbetween OW and the Bank. The last attempt by the Bank came in its 1983 sectorpaper on policies and programs for informal housing, which did not lead to thehoped for Bank operation.

1.19 The year 1983, when bidonville upgrading was removed from the sectorpolicy agenda, was also when the CIA Project was appraised. This was a keyturning point in Bank activity in support of urban development in Morocco.

Bank reports and documentation have been reticent in recognizing 0OM'slack of support for bidonville upgrading. The Bank's urban sector review,for example, claimed that O supported upgrading and yet, at the sametime, admitted that without external aid, the programs would cease:"Government commitment to the Iplementation of the [slum upgrading)program clearly indicates that the Bank's efforts to promote theestablishment (of slum upgrading) through the first (Rabat) and SecondUrban Projects have been successful. Continuation of Bank support forslum upgrading is needed to maintain the momentum of these programs whichdepend heavily on foreign financing by the Bank and USAID." (Morocco:Urban Sector Review and Prolect Identification. 1982, para 6.19.) GCO andlocal authority actions, especially in Casablanca, made clear theircommitment towards bidonville eradication, which even became incorporatedin Morocco's national development planning. (Royaume du Maroc, PremierMinistre, Plan d'Orientation your le Dveloosement Sconomigue at Sociale1988-92, Rabat, Section III.) The Bank'a failure to dissuade CON frompursuing this policy, which is still in effect at the time of writitg, isamply discussed in the audit of the first two urban projects (Report No.9729, op. cit*, pars* 3.26 and 4.05-4.13).

Ibid., pars. 4.14-4.17.

1Moreccos InfoRMal NoMaS: 11nradinaan Preention Policies and Proaram.Report No. 4787-MOR, December 1983.

7

Missions began to focus upon sites and services schemes. These had been Includedin the first two urban operations as core house projects and had proved moreacceptable to =0M. Thus, the Bank9a 1982 urban sector paper recommendeds

Funding for the sites and services projects should becontinued, but directed through the housing finance program,which would Include construction of core housingo.. .Because ofits central role in housing finance, the CIA constitutes aunique Instrument with which to pursue a coherent andcomprehensive housing development policy in Morocco. Byfunding through this institution, the Bank could achieve farreaching results in promoting the construction of low-costhousing (including core-housntg) for low-income groups.1"

1.20 In pointing a new direction for its urban sector strategy in Morocco,the Bank vanted to encourage the use of an existing Institution (i.e., CIR) todeliver the more successful product (i.e. sites and services) of the earlierprojects more efficiently. By concentrating upon core houses, the bank hopedthat the beneficiaries would continue to be low-income urban households. Inaddition to charting the entry of CIs into Bank-financed urban operations, the1982 sector paper also supported an expanded role for FEC, arguing that *whereverpossible, FEC be used as a channel for funds, since this will strengthen heinstitution and engender more effective and coordinated Bank operations.UEfforts to develop infrastructure and urban services locally through 00m (withthe support of local communes) had only been partly successful under the firsttwo urban projects. An alternative approach through a line of credit to FZC withmore direct participation by local communes was an attractive alternative for theBank's urban strategy in the early 1980s.

1.21 These were important years for Bank sector strategy and 00M sectorpolicy in Morocco. A Bank sector paper pointed the way towards urban lendingthrough CIN and FEC, leading to the appraisal of two projects in 1983, preciselywhen Morocco's international payments crisis broke. The attractiveness of thenew approach from the Bank's standpoint was its ability to "wholesale$ lendingvia financial intermediaries, to which much project management could presumablybe delegated. Such delegation held out the hope, which vas in practice to befrustrated, of alleviating what was considered to be the heavy supervision burdenassociated with Bank urban projects. It was also attractive to GO, CI, andCDC/FEC, all of whom saw the opportunity of ready access to funds when otherresources coming from abroad were in short supply. The stage was set. As thisreport will illustrates however, many of these hopes were not to be fulfilled,especially in relation to the Bank's strategy of targeting project benefits onlow-income urban households.

1 Horocco: Urban Sector Review and Prolect Identification, World Bank NAUrban Projects Division, March 19, 1982, paras. xxxift. and 6.22.

Ibid., para. 6.17.

8

a. RBank Inolvmn

1.22 Morocco we an experienced Bank borrower, not only for urbandevelopment, but for many other sectors as well. CII, although a newcomer toBank urban operations, had long been responsible for Bank-financed tourismoperations. It was borrower and/or executing agency for four projects between1976 and 1981, specifically* (1) Second Loan to Credit Imobiller at Hotelier(Loan 848, 1972, US$15 million)# (i) Bay of Agadir Tourism Project (Loan 1202,1976, US$21 million); (ill) Loan to Credit Immobilier et Hotelier (Loan 1279,1976, US$25 million); and (iv) Fourth Hotel Development Project (Loan 1943, 1981,US$100 million). Among the findings of the audit of these projects were: (1)inadequate marketing forecasts by CII and (i) the poor financial performanceof the hotel loan portfolio." An important lesson learned, in the words of thePAR, was:

Relying on a DFI alone to pursue a policy dialogue withgovernment, by virtue of the sector knowledge it gains throughappraieal and supervision of individual projects, does notappear to be an effective means of developing clear policyrecommendations or bringing about needed policy changes."

1.23 The Bank had already had important experience in providing lines ofcredit for industrial development in Morocco. These were to support small-scaleindustries, through GON's National Economic Development Bank (BIDE). Theyincluded the Ninth BUDE Project (Loan 2037, 1981, US$70 million), and the Small-Scale Industry II Project (Loan 2038, 1981, US$70 milion). To complete thisbrief reference to projects related to the two operations reviewed in thisreport, mention should also be made of the follow-on Second Housing FinanceProject (Loan 3122, 1990, US$80 million), whose loan io fully committed at thetime of writing. This report makes several references to this operation wherethey help to understand the performance of the first CIR Project. The desiredfollow-on operation to the FEC Project, however, did not materialise, a.explained later in this report (paras. 2.12 and 2.16).

1.24 Although inovative in their own subsectoro, the CIE and FEC Projectswere only a small part of the Bank's portfolio of related operations. Thisportfolio represented a rich pool of experience from which ideas and approachescould be drawn. Previous Bank experience in the country was very relevant sinceit covered either the same sector, the same borrower, or the same line of creditproject concept as the two operations reviewed here.

Report No. 6388, August 1986, pg. aiv.

17 Ibid., para. 42.

9

A. The Line of Credit Anuroach

2.01 In the case of both projects examined io this report, Bank loans wereused to finance lines of credit to CIS and FEC as development finance companies(DFCs) or intermediariese. In turn, these DFCs would on-lend the proceeds of theBank loans to the final sub-borrowers. CII's sub-borrowers (in the firstinstance) were real estate developers, while FEC's were local communes andsectoral utilities (known as "r4giee" in Morocco). Both projects were innovativein their respective sectors. The CIR Project was the Bank's first housingfinance operation in the region, while the FEC Project was only the Bank's secondattempt to finance local development through a line of credit, following thepioneering Cities and Villages Development Bank Project in Jordan (Loan 1826-JO),appraised three years earlier in 1980.

2.02 The benefits of DYC lending, especially for industrial developmentof the kind financed through BIDE, were extolled in a Bank sector policy paperof 1976.' At the time of the appraisal of the CIZ and FEC Projects, Bankenthusiasm for the line of credit approach was high. The satisfactory resultsobtained from DEC operations became material for technical discussions instandard texts." The Bank saw the potential for larger and faster disbursingloans. The US$60 million loan to CI was more than the combined value of loansfor the first two urban projects in Morocco. Even the small loan to FEC (US$16milion) was seen by both CON and the Bank as merely the first step towards amuch larger operation.

2.03 The "wholesale" approach, whereby the Bank could delegate supervisionto the DIC was, according to some in the Bank, an attractive feature. In thewords of the CIA Project PCR: "the full value of Bank assistance to a sector orsubsector is greatly enhanced when Bank loan proceeds are made through financialintermediaries capable of subproject appraisal and supervision. Such capabilityfrees Bank staff from having to scrutinise minute details, allowing them,instead, to focus on broader institutional and sectorial issues" (CIN PCREvaluation Summary, para. 9). As it turned out, neither the CII nor the FECProjects led to a reduction in the level of supervision effort required by the

is World Bank, DeveloMent_ Finances Comanies - Sector.. Policy Paer,Washington D.C., 1976.

See, for example: Baum, Warren C. and Tolbert, Stokes M., Investin inDeveloments: Lessons of World Bank Exoerience, Oxford University Press,New York, 1985, pp. 205-206.

10

Bank." From a borrower's point of view nonetheless, a line of credit operationcan be attractive, since it holds out the prospect of larger, faster disbursingloans. This aspect appealed to 00 as it headed for an international paymentscrisis in the early 1980s.

2.04 The design of these operations generally requires that only eligiblesubprojects meeting criteria satisfactory to the Bank be financed. In practice,however, the fungibility of Bank loan proceeds within the DIC ean. that a lineof credit effectively supports the operations of the DIC as a whole, Includingthose which may not meet the eligibility criteria. For this reason, a thoroughinstitutional appraisal of the agency as a whole has to be a key feature of DICoperations.

B. The Project Intitutions

1. MI

2.05 As one of ON's most Important specialized financial agencies, CISis also Morocco's principal housing bank, with total reported assets of DR 15,1billion (US$1.7 billion) in 1990. As the name implies, it operates in both thehousing and tourism sectors. In the housing sector, CIA lands to public andprivate developers and makes long-term mortgage loans to house purchasers. Fortourism, lending is also made to developers, but for hotels and touristcomplexes. Approximately, two-thirds of CII's leading supports housingactivities, while the remaining third is destined for tourism. CIS mobilizesresources through long-term borrowing on the local and International markets andthrough the issue of short-term discount notes. Since 1989, CII has also beenable to collect deposits directly from the general public.

2.06 Since its creation In 1920, CIS has been constituted as a privatecompany, although, In practices it Is 0M's most Important instrument forexecuting national housing policy. CIH's link to 00M Is not direct, since themajority ownership (55 percent) is in the hands of CDG and of the remainingshares in CIN, insurance companies own 20 percent, commercial banks 15 percent,and Norocco's Central Bank 10 percent (CII PCR, para. 20). CIS's administrationis centralized in its headquarters in Casablanca. By 1991, however, CIN hadacquired some 41 small branch offices throughout the country, most of which wereestablished after 1982. Management operates through six departments (calleddirectorates), each of which deals with both housing and tourism. The financialdirectorate was responsible for the Bank-supported CIN Project.

2.07 The 1983-90 period, during which the CIS Project was implemented, wasone of significant growth for CII. Its staff expanded from some 400 to today's

2o Bank supervision efforts measured by the naber of staff weeks per milliondollars of Bank loan for the two operations reviewed here wasapproximately half that of the first (Rabat) urban project, but twice thatof the Second Urban Project. Staff weeks per million dollars of Bank loanfor the four projects were: 3.8 - Rabat Urban Developments 0.7 - SecondUrban Development; 1.3 - CIE Projects and 1.9 - FEC Project. (Data fromrespective PCRe.)

11

700, and its total assets nearly quadrupled. CIN9s total Incomoe from interestIn 1983 was DR 435.1 million (US$54.0 million), reporting a not profit of DR 72.0million (US$8.9 million). The corresponding figures for 1990 were DR 1,542.9million (US$191.8 million), and a net profit of DR 183.8 million (US$22.9million). This growth was accompanied, however, by a progressive weakening ofthe Institution's financial structure (detales pares. 3.05-3.15). In terms ofday-to-day management, however, CIN remains an efficiently run institution.

2.08 Being well known to the Bank as the result of four tourism projects(para. 1.22), was a key factor recommending CII as borrower and executing agencyfor the housing finance operation. According to the PCR, however, CIS was chosenbecause it was the only financial Institution that could grant long-term loansto the housing sector in Morocco (CIN PCR pares. 2.04 and 8.03). At appraisal,nevertheless, the Bank considered the possibility of incorporating the "BanqueCentrals Populaire" (BCP) into the project. BCP is a commercial bank withexperience in financag low-cost housing programs (I) since 1974. BCP1seventual participation was ruled out, according to the SAR, due to its traditionof risk aversion (CIE SAR par&. 2.15). The audit was informed that BCP itselfdid not want to participate in what it considered to be a highly risky operation,although its possible involvement had been sounded out by Bank missions.

2. CDGlPHe

2.09 An analysis of the institutional context of the FEC Projectinevitably takes CDG as Its point of departure. From policy, financial, andmanagerial points of view, CDC to the institution that controls the ECoperation. For the Bank, CDC held final responsibility for the execution of theFEC Project. Although FEC was given distinct judicial status through a 1959 lawand presents its own financial statements, it is under the direct control ofCDG's senior management. At apprasal, FEC was treated as a Odivision# of CDGthat had been upgraded to a 'department."2 Another way of understanding FECis simply as a special fund, whose management is entrusted by CON to CDG andwhose policy and administration follow CDC norms. As such, FEC is one of threesuch funds whose work programs are administered by CDO."

2.10 CDG Is one of CR's most Important financial Intermediaries, withreported assets of DR 12.6 billion (US$1.6 billion) in 1990. Itsresponsibilities are wide ranging, but are basically to channel savings mobilized

34 The SAR makes a fleeting reference to FEC's 'financial autonomy, sinceFEC is entitled to borrow in financial markets with CON guarantee (FEC SARpara. 3.01). Decisions to borrow and to seek CONs guarantee are CDG'showever.

n The other two are RCAR - "R4gIme collectif d'allocation de retraite* (withtwice FEC's resources), and CNRA - 'Caisse nationale de retraites etd'essurance" (which Is seven times smaller than FEC). (Data frome Catasedo Dep6t et do Gestion, Ramnort Annuel 1990, Rabat).

12

through state Insurance and pension schmes and postal savings accounts intopriority investments for 00W. As already mentioned, CDG Is majority shareholderof CIR (para. 2.06). The Investment portfolio financed through CDG Is similarlywide raniing, and Includes housing and real estate, urban land development,touriesm, industry, transportations Insurance, and local communal development.CDG's headquarters are in the capital Rabat, where the majority of ito 522 staffare located.

2.11 At appraisalg FEC was a very small operation, with a staff (on CDG'spayroll) of only nine. FZC's function was to channel resources by making loanswith maturities of up to eight years to local communes and sectoral utilities("r6gies") for investment in urban infrastructure and services. FEC's principalsource of funds was short-te:m CDG discount notes. Final decisions to approveloans were not FEC's, but were taken by a special Technical Committee, whichincluded representatives of NO and 07, and where FEC was represented by theExecutive-Director of CDC. FEC still does not have its own offices, althoughplans exist to build them. It presently occupies an annex of CDG's headquartersbuilding in Rabat. FEC grew rapidly over the 1983-90 period, while the Bankproject was being implemented. Currently, its staff numbers some 44. In 1983,FEC reported total assets of DR 561 million (US$69.6 million) and total interestincome of DR 36.7 million (US$4.6 million). The equivalent figures for 1990 werefor assets of DR 2,113 million (US$262.7 million) and interest income of DR 207.5million (US$25.8 million). This growth took place against a background of unevenfinancial performances profitability declined and the capital structure remainedweak, although FEC became more solvent and its risk management improved (details:paras. 3.16-3.24).

2.12 The Banks appraisal report Included a long list of FEC's weaknesses.These included: (i) no proven track recordl (i) lack of formalized policies andoperating procedures (iii) lack of rigorous operating principles for projectfinancing; (iv) cursory appraisals of technical and financial feasibility;(v) insufficient personnel in number and experience; (vi) Imbalance in financialstructure with a long-term loan portfolio mainly funded by Short-term discountnotes; and (vii) undercapitalized for an institution with no proven track record- debtsequity ratio of about 7:1 (FEC SAR, parss. 3.01, 3.06, 3.11, 3.25, 3.30).

2.13 An Important question to ask is whether these problems reflected theweakness of an institution, or the absence of an institution. The Audit isinclined to conclude the latter. The SAR itself hints that it did not considerFEC to be a real institutions "If successful, this pilot operation could lead toan expanded role for FEC, including eventually full legal autonomy and financialindependence, so that it can become a aenuine financial institution for thedevelopment of the LCs, able to mobilize on their behalf new resources to meet

CDG operates in the housing sector through its subsidiary the General RealEstate Company (CGI OCompagnie 06nrale ImmobillareO), which plans todeliver 5,654 middle Income housing units over the next five years. CGIis an important borrower of CIN. The CIA Project financed three CGIhousing schemes in the value of DR 120.0 million (US$ 14.2 million) (CIIPCR Part III Annex 2).

13

their large investment requirements, and provide another source of finance inaddition to the central Government budget."(PEC SAR pars. 1.02 - emphasis added).

2.14 The issue of whether FEC was or was not an institution Is not merelysemantic, since policy changes and managerial Improvements as part of aninstitution building effort under a Bank-financed project must evidently beaddressed to a real institution. In the case of the FEC Projects institutionalappraisal and institution building were focussed on NEC itself, without dueattention to CDG as the agency de facto responsible for the operation. In theview of the Audit, a key factor in limiting the nC Project's progress towardestablishing an autonomous institution for local commune financing was thatproject design did not contemplate the active engagement of CDG in the process.The need for a thorough institutional appraisal (which would include CDC) in thiskind of operation is treated as one of the points of special interest below(paras. 4.13-4.14).

2.15 What was missing from FEC that prevented it from being considered a"genuine financial institution" by the Bank's appraisal team? Part of the answercan be found in a memorandum from the Bank's Legal Department at the time ofproject preparation. Referring to FEC as "a simple account operated by CDG, thememorandum noted that: (1) FEC's autonomy is limited by the CDG's GeneralDirector$s authority to grant loans; (ii) FEC's right to borrow, and whether CDGor FEC is responsible for repayment, are unclearl (iii) EC's address is notindicated in its statutes; and (iv) FEC's statutes do not indicate how its staffand directors are appointed. In short, the opinion was that FEC did not have thelegal and institutional status to take charge of a Bank- financed project. Itraised the basic question "who would be responsiblo for the Bank loan, CDG orFEC?" The SAR itself recognizes FEC as being a part of CDGt

FEC was initially managed as a division of CDG and, since1980, as a department. As such, FEC has no proven trackrecord of its own, and its image and credit-worthiness arestrongly linked to CDG's....FEC is managed by CDG, and inpractice FEC's chief executive is the General Director of theCDG. He holds substantial control over the policy andoperations of the FEC and is involved, through loan approvals,in FEC's daily management. Furthermore, as head of CDG - themain supplier of resources to FEC - he practically retainsoverall control on EC's financial policy. In addition, theadministrative tasks for FEC (recruitment, payroll, staffregulations, benefits, steg) fall within the responsibility ofCDG." (FEC SAR paras. 3.01, 3.04)

2.16 At the time of the Audit, FC lacked some of the basic trappings thatwould normally be found in a financial institution, such as a financial director,a legal advisor and departments responsible for marketing and information, forexample. In spite of these misgivings, however, the FEC Project conceived of FECas an institution in its own right. This may have given rise to expectations ofinstitutional progress, particularly with regard to policy and finance, that FEC

a' Legal Department Memorandum of August 17, 1981.

14

as a fund operated by CDG, could not realistically fulfi1. EC could not make

itself autonomous from CDG for example. Focussing on 1EC as an institution meantthat the project lacked instruments, such as legal covenants agreed to by CDG,

which could have encouraged a move towards establishing the genuine financial

institution hoped for at appraisal

2.17 During 1985-87, however, 00K did consider creating a local commune

development (BDCL - "Banque de DWveloppement des Collectivit6a Locales") out of

FEC, along the lines of the Cities and Villages Development Bank of Jordan. The

Bank even fielded a pro-appraisal mission in 1987 to consider lending to the

institution-to-be. Although draft legislation was prepared, it was not

sanctioned and the BDCL vs still-born. It appears that the idea of creating a

fully-fledged BDCL aroused much opposition, not the least from commercial banks,

who feared it would tighten Morocco's financial markets even further. At the

same time, the controversial question of controls whether it be with CDG, MOI,

or full autonomy, would have to be answered. With the limited institutional

progress, the Bank postponed its further support for local development through

FZC. The Region has now informed the Operations Rvaluation Department that a new

law has been promulgated under which FEC Io undergoing a full restructuring. A

follow-on operation, First Municipal Finance Project, which has recently been

approved, includes a specific action plan toward FEC's institutional development.

C. Issues In Protet Prenaration

1. g[

2.18 Spurred by CTI's familiarity with Bank procedures from its earlier

experiences under the tourism loans, preparation of the CIN Project was very

rapid. Barely twelve monthe elapsed between the identification mission and

appraisal. Initially, the Bank had hoped to include a bidonville upgrading

component in the CIN Project. Only by March 1982 did the Bank accept GM' as, and

hence CI*, strong opposition to such a program (details: paras. 1.16-1.18).

From that date, project preparation concentrated on the housing finance component

only. This focus was fostered by Bank staff skills in financial analysis which

became available at that time.

2.19 With the increasing popularity of the line of credit project concept

in the Bank in early 1980., there was strong support by Bank management for

taking this approach in Morocco's housing sector through CIN. Not surprisingly,

the main issues identified by Bank preparation missions were financialt namely

the financial risk of CIE operations involving excessive subsidies and

inadequate resource mobilisation by the institution. The income level of

potential beneficiaries was not cited as a Issue at this stage. Despite the

Banks acceptance of 00's unwillingness to upgrade bidonvilles, the bidonville

issue would not go away. The project Issues Paper highlighted concern that Bank

funds might eventually be used to finance CIR*o bidonville eradication and

resettlement program.

U CDG's own views on the autonomy of FEC are contained in Annex 1.

15

2. fg

2.20 Preparation of the nEC Project was much more protracted. Althoughit wee identified sixteen month. earlier than the CIN Project, the appraisalmissione for both operations were fielded at approximately the same time. Thedegree of Bank discomfort with nC as an Institution matched the degree of itsconfidence in the familiar CIS. A memorandum early in project preparation setthe tone of the Bank management'e miegivinge with FECs

To assign to such a weak organization with no track record,the task of on-lending Bank funds In a wide variety of etors(a sort of mini-World Bank) for projects which typically willnot have any financial or commercial discipline (e.g. will notInvolve the self-interest of an investor) involves realdangers that the Bank funds could be used for quite uneconomicprojects."

2.21 Although it was later included in the Bank' e urban portfolio, the NCproject was prepared by the region9s industrial development and finance (IDF)division. Perhaps an underlying paradigm of credit worthiness of industrialenterprises Induced an initially critical view of the seemingly high risksinvolved in lending to local communes that were not driven by commercialpriorities.

2.22 To placate misgivings about the operation, its preparation proceededas a pilot project. Also, Bank missions harnessed Important arguments in itsfavor, seizing upon support to FEC as an opportunity for a major institutionbuilding effort. The project was also seen as a chance to use NC as aninstrument for reducing regional disparities in the country. The discussion ofthese and other issues and internal arguments within the Bank was a fruitful onesbut it meant that the nEC Project took approximately twice as long to prepare asthe CIS operation. Preparation also required four missions compared with justtwo for the CIH Project, as well as twice the level of staff effort.

D. Project A iratsal

1. 2Z

2.23 Like preparation, appraisal of the CIE Project was rapid, focussingon an analysis and projection of CI's consolidated financial statements and somefinancial aspects of the agency's housing operations. One-third of the appraisalreport is devoted to an analysis of CIR, and more than half of the SAR' s annexesconsist of financial tables. Some of the appraisal projections are compared withCIIR's actual financial performance later in this report (paras. 3.05-3.15).Appropriately for a line of credit operation, financial analysis was the focusof project appraisal. Projectione, done for the first time with the use of acomputer spreadsheet, contained errors (for Instance, total liabilities for 1982-86 do not include a portion of equity due to a spreadsheet error), but they did

' Memorandum from IDFDR of July 17, 1980.

16

not affect the computationg monitoring and iplementation of the covenantedfinancial ratios.

2.24 Scant treatment vas given to CIS policy and priorities. The SARstated thats *CIZ9s Policy Statement approved by the Board of Directors of CIA

in 1974 has been reviewed by the Bank and found satisfactory.* (CIS SAR para.4.02) * The SAR itself does not review the policy statement, nor is the statementlisted among documents available in the project files. In the view of the Audit,the value of a line of credit operation supporting a DIC is considerably enhancedby including the basic policy statement of the agency supported in the staff

appraisal report, as was done In the case of the FEC Project (FRC SAR Annez III).In the circumstancess it to surprising that the Bank did not propose improvementsto what was a nine-year-old policy statement. This might have been appropriatewith regard to policy on arrears, for example, in a financial institution exposedto serious delinquencies on hotel loans which accounted for about one-third of

its portfolio.

2.25 On the other hand, the appraisal of the C1 Project gave moreattention to the eligibility criteria of housing subprojects and sub-borrowers,which were detailed in Schedule S of the Loan Agreement. Maxiaum ceiling prices

of eligible housing were Initially set at DR 32,000 (US$5,333) for the leastexpensive (core unit) and DR 80,000 (US$13,333) for the osat expensive (valk-up

apartment) (CII LA Schedule 5 and SAR para. 3.07).* An appraisal analysisdemonstrated that such units would be affordable by the lower half of householdson Morocco's income distribution curve. In addition, technical criteria

specified maximum standards for physical specifications, such as plot sise and

built area, for example. Further eligibility criteria required that all projects

had a mininum economic rate of return of 12 percent end, for those costing morethan US$500,000, a minimum financial return of 14 percent (CIR SAR pare. 3.07).According to the SAR, the price criteria were derived from CIS market studies

reviewed by the Bank (CIS SAR pare. 3.07). In actual practice, the ceilingprices were raised substantially later on during Implementations as discussedextensively later in this report.

s' The 80,000 ceiling price corresponded to the bottom end of the range of

house values (DR 80,000 - 130,000) under 0099a existing low-cost housing

program (RBM -*Habitation a Bon March6m), funded since 1974 by ICP, andlater administered jointly with CII. See, World Bank, Morocas-rbnaSector,.ftew and Prolect 9Identification March 19, 1982, para. 4.2.Interestingly, the sector paper highlights affordability problems for low-Income families of the BM houngs * ... given the cost of these (RBM)units, households with monthly income below DR 1,500 (in 1982 prices), or

35 percent of the prospective housing demand, cannot afford them.*

1.7

2.26 The Audit noted Inconsistencies between the ceiling prices set andproject cost estimates.a* The appraisal Inconsistency could have been theresult of an exaggerated coat estimate or an understatement of the number ofunits to be financed. In either case, however, the appraisal calculation mayhave sent a signal to the borrower that higher unit coat parameters had in factbeen budgeted than those formally agreed in the projects@ legal documents. Ifperceived in this way, such a signal would have stimulated CIN to aim for highercost uniteS9 thereby helping to undemine the project's low-cost housingobjectives.

2.27 The reasons for the choice of US$60 million as the loan amount remaina mystery to the Audit. According to the SAR, the value had been "scaled down"from the US$81 million called for (CIN SAR pars. 3.03), although the PCR reportsthat it had been increased from US$45 million (CIR PCR par&. 4.02). The Auditcan only add that, if the average unit cost was equivalent to the median of theceiling prices, namely US$9,333, a Bank loan of only US$39 million would havebeen sufficient to finance the 28 percent share of the cost of the 15,000 unitsforeseen in the SAR.

2. IN

2.28 The appraisal mission focuseed on detailed Institutional andmanagerial aspects of the nBC operation. However, as already aentioned, this didnot include an Institutional appraisal of CDG. A Statement of Policy was agreedwhich defined nBC's objectives and explicit lending criteria. One of the mostimportant agreements reached was that FBC loans should only be used to financerevenue generating projects (FnC SAR 2.08).

Total project costs, excluding technical asistance to C18, were estimatedat appraisal to be DR 1,257 million (US$209.5 million), of which the Bankloan would fluance US$59 million, some 28 percent of the total.Construction loans to the value of DR 1,213 million (US$202.1 million)would be provided to build 15,000 new units according to appraisalestimates (CIN SAR par&. 5.02). These estimates Indicate an average costper unit of DR 80,860 (US$13,473), strangely higher than the maximuagreed ceiling price of DR 80,000 (US$13,333). With four ceiling pricesranging from D 32,000 (US$ 5,333) to DN 80,000 (US$13,333) agreed underthe CIS Project, the average imnit cost Ahal have been somewhat below themedian value of the ceiling prices, namely DI 56,000 (US$9,333), assumingan equal number of units financed In each of the four price ranges.

The Audit noted conflicting technical data between the appraisal reportand the Presidents Report concerning the number of housing units to befinanced under the CII Project. Contrary to the 15,000 figure given inthe SAR, the President's Report (para. 63) and the Bank's Press Release,stated that 13,000 new housing units would be financed. If this figurewas correct, the Inconsistency noted in this paragraph would be even moreacute, saince average unit costs would be even higher, namely DR 93,300(US$ 15,546).

18

2.29 The appraisal undertook a le detailed review of F8C's finances thanhad been the case with C18. The maturity Ibalance of IC's balance sheet, withlong-term loans financed by short-term discount notes, was a matter of concern.So too wee FEC's debtsequity ratio of 7s1, a very high rate for an agency withouta track record. Recognizing CDG's ability to come to FEC's aid if necessary, theSAR argueds "such an tabalanced financial structure Ishowever, acceptable aslong as 1IC's financial liability and credit-worthinese are an integral part ofCDG. The financial structure of TIC at this stage to therefore not as isoerelevant to the successful Implementation of the pilot project." (TEC SAR para.3.30) The SAR wee pointing out, correctly, that PEC was not an autonomousfinancial institution but did not shift its focus to CDG itself. Such ananalysis might have helped Bank missions to develop a deeper understanding of CDGas one of orocco's most important financial intermediaries. With COG's directinvolvement, the dialogue about establishing a mechanism for financing localcommune development in Morocco might have reached a successful conclusion.

2.30 The longer preparation time of the IC Project permitted a thoroughappraisal of the eligibility conditions for TIC lending. A detailed 28-pageannex to the SAR spelled out the necessary Information and criteria for 12Csubproject appraisals. As a result of a commendable collaborative effort withinthe Bank, Information was supplied by the relevant operating division, aboutappraisal criteria for projects in seven sectors, namely: water distribution,electricity distribution, urban transportation, productive facilities, urbandevelopment, sewerage, and municipal road projects. The agreed criteria werethen set out explicitly in a Side Letter to the Loan Agreement and were veryhelpful to IC staff in designing in-house appraisal methods.

2.31 In the case of the TIC Project, the Loan Agreement we signed by CONas the borrower and a Project Agreement was signed by both CDG and FTC. Inaddition, four Side Letters specified specific conditions of the project. Inaddition to the one just mentioned, which dealt with appraisal criteria, aparticularly important one was Side Letter 2, in which the project's financialcovenants were detailed (detailst pare. 3.19). This Side Letter was signed onlyby O, making only the Government formally responsible for the fulfillment ofFEC financial performance covenants.

a. Prolect Obiectives and DescrJ2tion

1. 0W Projeal

2.32 According to the SAR, the objectives of the CIR Project weres

- to encourage private and public developers to producelow-cost housing schemes affordable to Income groups on,;he lower half of the urban Income distribution curve

(i.e. with a monthly household Income below US$330 Inmid-1982 prices)l and

- to develop C189s ability to appraise low-cost housingschemes and to advise private and public developers onall aspects of low-cost housing design. (CI SAR para.3.01).

19

2.33 Both objectives emphasized stimulating the delivery of low-coathousing by private and public developers. With respect to the criterion fordefining low-cost housing in the present discussion, this report uses the sameone as the CIR Project itself at appraisal, namely units costing less than themax1mum ceiling price of DB 80,000 (pars. 2.35). The focue on low-cost housingwas appropriate given the enormous shortfall in the supply of this kind ofhousing in Morocco, as noted earlier in this report (para. 1.10-1.11). Theobjectives were not stated in the Loan Agreement, which nevertheless containedcovenants related to low-cost housing. This could have contributed to a betterunderstanding by all parties of the spirit, as well as the letter, of anoperation. Fortunately, the Loan Agreement of th follow-on Second HousingFinance Project (Loan 3122-MOR) with CUS does include such a statement.

2.34 According to the Loan Agreement, the project consisted oft

Pa=As A program of subloans for the construction oflow-cost housing units and land development for purposesof such construction later on, and of mortgage loans tobeneficiaries utilising the proceeds of subloans repaidto the Borrower.

PaU.Bs The strengthening of the capabilities of theBorrower9s staff to appraise low-cost housingdevelopment and advise the housing construction industryon low-cost designs through:

(i) the development and application of a land usemodel to evaluate the cost-effectiveness ofalternate land use patterns suitable for low-costhousing developments

(ii) the development and application of a computeriseddata Information system (including the provisionof a computer) to compare and analyse the cost-effectiveness of low-cost housing development,including the housing schemes, financed or to befinanced by the Borrower, and the provision ofappropriate training for the Borrower's staff Inthe application of said information systems and

(tit) a study to evaluate the status of the housingconstruction industry within areas served by theBorrower and to recommend suitable measures forexpanding said industry's iavolvement in low-costhousing development.

2.35 Schedule 5 of the Loan Agreement detailed the criteria for housingschemes eligible for financing out of the loan proceeds, under Part A above, forwhich 99 percent of the Bank loan was destined. Four types of housing wereconsidered eligibles (i) core units - DR 32,000 (US$5,333); (ii) one floorpartially completed houses - DR 48,000 (US$8,000); (iii) one to two floorcompleted houses - DR 62,000 (US$10,333); and (1v) three to four room units in

20

multi-floors houses - DR 80,000 (US$13,333) (CIS LA Schedule 5). These valueswere significantly higher than the low-cost targete set for the Chiles PublicSector Housing Project (Lu 2482-CH), which was appraised at the eae time as theCIR Project. In the Chile Projects core houses were esttmated to cost US$1,870,while the most expensive "economic housing" had a price ceiling of US$9,860 (02DPAR pars. 8). Aside from possible differences in construction costs between thetwo countries, this suggests thate from the outset, the design standards adoptedin the Chilean case were more appropriate In ters of their affordability to low-Income households than those utilized In Morocco.

2.36 The CIN Project provided loans to public and private developers fora period of three years to finance housaing construction. CIS undertook toconvert developers' repayments at the end of the three years into mortgage loansof up to 25 years for purchasers. to acquire the units built. Given the Bank loanterm of 17 years, such an arrangement can lead to a maturity mismatch, sincedeveloper-plus-mortgage loans could have a total maturity of up to 28 years. Inthe case of Bank disbursements for developer finance made In 1989, finalrepayments of related mortgage loans may not be due to CIN until the year 2017,seventeen years after the due date of the Bank Loan itself in the year 20001Underfunded in this sense, the project will oblige CIE to mobilize additionalresources at some point in the future In order to sustain the mortgage lendingprogram foreseen under the project. Such a consequence raises concerns about thelong-term financial health of CIR, an Institution which, already at appraisal,was recognised as facing a resource gap (CIR SAR para. 4.14).

2. FEC Proleat

2.37 Through Project Agreement covenants, CDG and FEC undertook to executethe project in accordance with the agreed Statement of Policy, in which theobjectives were stated (PA sections 2.01(a) and 3.01). The appraisal reportsummarized them as followes 'In support of the Government's regional and communaldevelopment policy, the objective of the project is to assist local comunes Intheir efforts to meet their basic Infrastructure needs... The project would morespecifically assist EC in formasting operating principles for projectfinancing, on the basis of rigorous preparation, appraisal and supervisionstandards and criteria, and Improving the efficiency of its staff in theperformance of their functions.' (FEC SAR pars. 4.01) Appropriately, the FECProject pursued a twin goal of Improving local infrastructure provision, whileat the same tine strengthening the agency that could channel funding for thispurpose.

2.38 According to the FC Project Loan Agreement (Section 3.01), theproject consisted of the following: (1) the financing by FEC of Investmentprojects through sabloans to 'Investment entities' In accordance with theprovisions of the Statutes, the Statement of Policy, and the Schedule to theProject Agreements and (11) the training of FEC staff in project preparation,appraisal, and supervision through the provision of expert services andfellowships to FEC staff. Through cross references to readily accessibledocumentation, the project description was au ct and provided a clear guideto the output expected from the contractual agreements between C0N, the executingagencies, and the Bank. OInvestment entities' were understood as localauthorities, their associations ("syndicate*), and local utility companies

21

(rftes*). The role of these entities was made clear in the Statement of Policymentioned earlier, which also provided a detailed list of eligible subprojects.

111. PROJ EMLMBUTIOQN AND REULTS

A. Start-up Problems

1. Sl

3.01 Rven though the loan was quickly made effective within four monthsof signing, practically no disbursement occurred during the first year ofeffectiveness. This was a disappointing result for a line of credit operationthat was expected to disburse rapidly. According to the PCR, the disbursementdifficulties were due to the project's technIcal criteria being too rigid and theselling price ceiltg too low (CIS PCR para. 4.04). CIR clearly holds the Bankresponsible for thiss "The difficulty [of disbursement] lay in the Bank'sundereatimstes of the real cost of low-cost housing as compared to the norms laiddown by the Moroccan authorities well before the conclusion of the credit line.*(CII PCR Part 11-1I1.)

3.02 If the ceiling prices agreed at appraisal Inplied the production ofhousing that was unacceptable by G0's and local standards, the project would ofcourse, have been technically infeasible. The appraisal report offers adifferent explanation of how the housing types and hence ceiling prices weredetermineds "Four types of housing units have been identified on the basis ofmarket studies carried out by CIS and reviewed by the mission." (CIE SAR para.3.07). Irrespective of the question of who was responsible for defining theceiling prices, there was a hiatus to project start-up through the Inability ofCIN to elicit a supply response for housing unite at those agreed prices.

3.03 CIR prevailed upon the Bank to raise these liits which it is worthrecallIng, were already considerably higher than those of a siailar housingfinance project in Chile appraised at the same time (details pare 2.38). Onlyafter they had been iacreased some 44 percent (by 1985) did the rhytbm ofdisbursements begin accelerate. By 1988, CI's ceiling price for low-costhousing had been increased by 87.5 percent (against an accumulated Inflation of38.4%" in dirhams) to D1 150,000 (US$18,270 in 1988). The PCR reported a lowerceiling price liit for the CIN Project itself of DR 100,000 (CI1 PCR para.5.01). This does not seem to have been observed in practice, however, sincethirteen of the 43 developer contracts awarded were for housing unit pricesbetween DR 108,955 and DR 163,333 (CIR PCI Part III Annex 2, page 1). From thepoint of view of the project's low-cost housing objectives, the Increases made

This point, in relation to the rising cost of land and building materialsis made once more by CII in Annex 1.

Sources 1991 IMf International Financial Statistics.

22

the solution unaffordable by the intended low-income benefioiaries. This aspectis discussed in some detail later in this report (parse. 3.29-3.33 and 4.02-4.04).

2. U&

3.04 Disbursements against the FEC Project were also low at the outset.This was due to the tardy preparation and processing of subprojects by localcommunes unfamiliar with the new approach adopted. In this respect, performanceof the FEC Project was similar to the experience of municipal developmentprojects in other countries. As more proposals were submitted and PEC staffbecome more adept at appraising them, disbursements began to accelerate.

B. Finangial Pe formMa

1. CIN

3.05 A strengthened CIE was one of the by-products expected from the CINProject, but CI* financial performance weakened during the 1983-90 period whilethe project was being Implemented. This was true even during the second half ofthe period (1987-90), by which time Morocco'a macroeconomic performance had begunto improve.

3.06 Profitability declined, falling below appraisal expectations. CIR'sreturn on investment (measured as net profitastotal assets) fell almost everyyear from 1.78 percent in 1983 to 1.32 percent in 1990. This was against anappraisal forecast of 2.47 percent by 1986.u Return on equity (measured as netprofitesequity) fell from 26.5 percent in 1983 to 19.83 percent in 1990, againstan appraisal forecast of an increase of 33.03 percent by 1986. CIH's currentratio (measured as current assetscurrent liabilities) also worsened during the1983-90 period. From 2.1, in 1983, it had fallen to 0.9, In 1990, affectingCI's ability to meet cash needs to pay short-term debt. With ClI's actualfinancial performance generally weaker than forecast at appraisal, it is diffi-cult to understand the PCR's conclusion that "CIE financial performanceindicators have been in accordance with the projected figures in the StaffAppraisal Report" (CIR PCR para. 6.03)." The appraisal report of the follow-onsecond housing finance project (Ln 3122-MOR), analysing the same period as the

In ite comments on the PAR in Annex 1, CI notes that the decline in theprofits was not important, since that decline resulted from substantialloss provisions that had to be made over the years. CIN, therefore,recommends that the analysis be based upon its gross profits whichrevealed a better performance.

Table 4 of Part III of the PCR compares the actual values of elevenperformance indicators with the values projected at appraisal. In ninecases out of eleven, actual performance was worse than projected.. Actualprofitability Indicators, according to the PCR, were particularly poor,being only one-third the rates projected. The Audit*s analysis of CIT'sincome statements and balance sheets suggests that profitability ratiosreported in the PCR may have been under-reported.

23

PCR, notes thats "the analysis of critical performance Indicators, shows some

signs of deterioration (CI I SAR para. 4.14).

3.07 In terms of risk management, CIR had been reluctant to make

provisions against possible losses, especially with regard to its high risk hotelportfolio. Provisions for losses as a proportion of total loans were 0.28

percent in 1983. They rose as high as 0.63 percent in 1987, but fell back againto 0.24 percent in 1990. At appraisal provisions were forecast to rise to 1.2

percent of total loans, even not taking iato account the worsening of arrears on

the hotel portfolio that actually took place. Action programs for reducing hotelarrears were agreed with the Dank at negotiations. (CIM SAR para. 6.01).

3.08 One modest risk-averting covenant did not seem to have been compliedwith on two occasions during Iaplementation. To spread risks among sub-borrowers

(as well as to avoid the monopoly of the loan proceeds by a few largedevelopers), CIR undertook not to finance any housing project whose valueexceeded 20 percent of CI's "aggregate" capital defined as: equity+surplus+freereserves (CIH LA Section 4.10). Nevertheless, a large contract in 1986 for 2,660units in Kohamadia in the amount of DR 121.8 million (US$14.0 million),corresponded to 34.4 percent of CIR$s reported equity that year. Another, in

1987, for 2,589 units with ANP was valued at DR 174.1 million (US$22.3 million),or 44.6 percent of Cm3's equity. These two contracts by themselves accounted for31.9 percent of Bank loan disbursements under the project. The PCR did notreport non-compliance with this covenant however.

3.09 Other aspects of CIF's finances fared better during the 1983-90

period. For example, debt service coverage (measured as interest income sinterestpayments), at 1.5 in 1983 and 1.3 In 1990, remained quite stable. The Loan

Agreement required that CIZ maintain a debt service coverage ratio (amortization

plus interest payments receivedtamortization plus interest payments made) of at

least 1 (CIS LA Section 4.5 a) . The PCR reported compliance with this covenant.Also positive was the fact that CI's administrative overheads remained constantthroughout this period. In 1983, administrative expenses were the equivalent of

0.94 percent of total assets and 8.75 percent of total Income. The equivalent

values for 1990 were 0.96 percent and 8.69 percent, respectively. These results

are consistent with CIR being a well-run institution on a day-to-day basis.

3.10 Concerning CIR's capital structure, performance was mixed. In 1983,CIR's long-term debt:equity ratio vas 11.5, which the appraisal mission

considered high, projecting a ratio of 9.8 by 1986. However, CIH continuedborrowing heavily and its long-term debt:equity ratio rose to 15.5 by 1988.

Recognizing that it was seriously undercapitalized, a major subscription of DR

400 million (US$98.5 million) was made to build up CIt's equity base in 1989.

After that, the long-term debtsequity ratio fell back, with CIE reporting 9.7 In

1990.," instead of agreeing an arbitrary debtequity imit, as in some other

operations, the CIR Project opted for an Interesting, but complex formula

(covering more than two pages of the Loan Agreement), that determined the limit

on the basis of differentiated multiples of the values of CIR lending for housing

In its comments on the PAR (in Annex 1), CIt adds that the most recent

debt equity ratio figures were: 11.32 In 1991 and 10.13 In 1992.

24

and non-housing operations (CI IA Section 4.04). In addition to assuring

adequate capitalization, the formula was intended to stimulate housing anddiscourage other (notably tourism) operations in CI. Although directed to a

laudable goal, this formulation risked setting very high ceilings (18.4 in 1990,for example) if CIS managed to shift all its lending into housing through debt

rescheduling or reclassification. A better solution for the problem of CIE'soverexposure to a poor quality hotel portfolio, in the view of the Audit and with

the benefit of hindsight, would have been to include loan provision as legalcovenants of the project.

3.11 CIH grew significantly during the 1983-90 period in spite of the

weakening of its financial position. In terms of the value of its assets, CIAwas nearly three-and-a-half times larger In 1990 than at project appraisal."Accounting for some 12.8 percent of CIR's long-term debt In 1990," the Bank

remained an important source of financing for CIN and a stabilizing factor in its

balance sheet, but it frovided only 7.3 percent of the funding that led to the

growth just mentioned. Perceiving that ClI's growth owed little to the Bank

after more than two decades and six Bank loans may have induced "borrower

fatigue" in the institution. Growth-oriented management and staff found the loanamount was Insignificant in relation to CI's resource needs. Even so, legal

obligations under the project and information and reporting requirements of theBank and its missions were felt to be demanding. Because of the attention givento this topic by Moroccan interlocutors during the Audit mission, this to treatedas a point of special interest later in this report (paras. 4.06-4.09).

3.12 Bven with its record of growth, closing a potential resource gapremained a constant challenge for CIN. A financing plan was Included in the CIX

Projectl and efforts to 1aprove resource mobilization through studies of new

savings products were included as a component of the follow-on second housing

SS Concerning this growth, the PCR concludes thats #...by increasing itsincome and assets three to four times during project taplementation, CIRhas become one of the strongest banks in Morocco* (CI-PCR para. 6.02).The trends of some key CIS financial indicators reviewed here wouldsuggest that growth alone is not a guarantee of the institutional strengthof a DFC.

In CIR** audited balance sheet for 1990, Bank loans outstanding totalled

DR 1,154.6 million (US$143.5 million). This value includes amounts

pertaining to the earlier tourism loans and the follow-on second housingloan.

s? Over the 1983-90 period, Bank lending in CIROs balance sheet increased byUS$89.7 million, or 7.3 percent of the overall increase of CIX's total

liabilities of US$1,236.3 million. The main sources of growth during this

period weres (i) CON and other loans - US$ 648.2 million; (ii) short-termdiscount notes - US$248.0 millions (iii) short-term loans - US$145.1million; and (iv) equity - US$71.5 million. The growth of short-term

liabilities was responsible for CI3's solvency problems already mentioned.

25

finance operation. In Morocco's tight local financial marketi" CIR has hadto rely upon CDG and BCP as its principal sources of funding. Partly due to thistightness, most CIE bonds Issued on the local market have been subscribed to byCDG. Thus, in 1990 for example, CDG subscribed to 83 percent of CIH obligatorybonds, in the amount of DR 872 million (US$108 million), and BCP took up 64percent of a CIR uedium-term bond issue to the value of DR 250 million (US$31.1million). CIE is now entitled to take deposits from the general public, butthese cannot be expected to grow at the rates to which CIS has been accustomed.Just to maintain its level of operations, CIR will need to mobilize furtherresources, especially as key privileges such as the VAT (value-added tax)exemption on its loans expire.

3.13 Through the solid guarantees given, mostly In the form of land andproperty, arrears on CI8's housing operations, affected only 1.9 percent of itshousing loans. In contrast, hotel lending accounted for one-third of CIR'soperations, and yet was responsible for two-thirds of the arrears (CIH PCR para.6.03). The table attached to para. 6.03 of the PCR demonstrates how hotelarrears grew twice as fast as those for housing durig the execution of the CIEProject. As a number of these poor quality loans are held by state-ownedenterprises, the chances of a political settlement of outstanding debts, possiblynot in the interest of CIN's own finances, is always present. For this reason,a line of credit operation needs to thoroughly appraise other operations of theDFC which might Impinge upon the performance of the sector directly supported bythe project, and agree covenants about their financial performance. The need forthorough and broad institutional appraisal for an operation like the CIR Projectand agreed Improvements in the performance of poor quality portfolios isdiscussed as a point of special interest later in this report (paras. 4.10-4.14).

3.14 Although the foreign exchange risk was borne by 00 (GuaranteeAgreement Section 3.02), CII as borrower undertook In the Loan Agreement to"...take such steps satisfactory to the Bank as shall be necessary to protectitself against risk of loss resulting from changes in the rates of exchangebetween the currencies (Including Dirhams) used in Its leading and borrowingoperations.* (CIR LA Section 4.08). CII Interlocutors of the audit missionraised the issue of foreign exchange losses arising from Bank loans as CIS didin its PCR (CII PCR Part II III.A.1). By chance though, two trends ininternational currency rates have so for reduced the cost of repaying Loan 2245-NOR to the Banks (i) the Dirhsm revalued (in terms of the US dollar) as loanamortization began In November 1987; and (ii) strong currencies (notably theJapanese Yen and the Deutsebmark, which made up 52.7 percent of the loan) werealready highly valued while disbursements were being made. Although lucky sofar, CIE is correct to be concerned about possible foreign exchange risk. As aresult, the issue is being more directly addressed under the Second HousingFinance Project.

3$ The Moroccan economy itself continued to suffer from a resource gap,which, In 1990, was equivalent to 6 percent of GDP, given that grossdomestic Investment In that year was 26 percent of GDP and gross domesticsavings 20 percent (data from the 1992 World Delooment Renort, Table 9).Hence the structural need to seek external funding.

26

3.15 The weakening of CI's financial performance during projectImplementation (1983-90) Io a disappointing outcome for a line of creditoperation designed to strengthen a DFC's finances." Could the Bank have donemore in assisting CI to halt this treadt Given CIB's growth objective and theBank's limited financial contribution to that expansion, its chances ofinfluencing events was probably limited. Nonetheless, in a case such as thissdetailed and regular monitoring of financial performance indicators Is necessaryfor the Bank to be well informed.

2. InQ

3.16 Strengthening nC and Its finances was also the hoped for outcome ofthe line of credit project. Like CI, however, nEC's financial performancedeteriorated over the period while the project was being Implemented. In somerespects, particularly profitability and capital structure, nC' s performance wasweaker than CIPs, while in others (e.g., short-term solvency and riskmanagement), it was stronger. But comparison between nC's and CIROs financesis subject to the proviso that NEC was always an integral part of CDG. Thismeant that, if willing to, CDC could provide injections of capital, loans, orcash to overcome nEC's financial weaknesses, as necessary."

3.17 PEC' s profitability deteriorated over the 1983-90 period, especiallyafter it lost access to the Central Bank's low interest rediscount facility in1986. At appraisal, return on equity (measured as net profitsiequity) wasprojected to grow to 9.20 percent by 1986; the actual rate for that year was only1.44 percent. After reporting losses In 1988 and 1989, nEC earned a smallpositive return on equity of 0.66 percent in 1990. Although CON was covenantedto ensure a mInimum 3 percent interest spread for NC, during 1987-90, the actualspread was negative. The increase of nEC resource costs was so sharp that evenkeeping its lending rates above the 10 percent agreed with the Bank, as it did,was insufficient to ensure a profit.

3.18 As mentioned earlier (para. 2.12), nEC's capital structure wasbasically unsound if it were to have been an autonomous financial institution.The basic problem identified at appraisal was that NEC's long-term lending wasfinanced for the most part by short-term discount notes (NEC SAR para. 3.30), butits credit worthiness was, in practice, guaranteed by CDG.1 In 1983, forexample, 72.0 percent of nC's liabilities were short-term. Limited long-termborrowing meant that the long-term debtsequity ratio in 1983 was only 1.1, whilethe overall debtsequity ratio was 6.6. After the loss of access to low-cost

In its comments on the PAR (Annex 1), CIR states that a more global viewof CII finances would reveal as Improvement of the agency's financialsituation (up to 1992).

In its comments on the PAR in Annex 1, CDG confirmed the "absolutesupport" CDC always gave to maintain nC's financial soundness.

*1 Even so, the weakness of nEC's financial structure was given by theappraisal report as the reason for making the Bank loan to CON and notdirectly to CDGJnEC (nEC BAR para. 3.30).

27

Central Bank rediscountingg FEC's liabilities were substantially restructured in1987, through the provision of substantial long-term loans. Long-termliabilities increased from a more 7.4 percent of the total in 1986 to 66.5percent In 1987. Short-term liabilities, on the other hand, fell from 82 percentof the total in 1986 to 25 percent In 1987."

3.19 Notwithstanding this financial restructurIng the FEC operationremained undercapitalized for most of the 1983-90 period. CON was covenantedunder Side Letter No. 2 to the Loan Agreement to ensure that nBC's debtsequityratio would be less than 7. This target vas met only in 1983 and 1985. By 1990,the ratio had soared to 17.4. 00 made two DR 20 million contributions (in 1985and 1988) to FEC's equity out of the four annual Install1ants of this amount thatwere expected. This small Increase in FRC's equity base was Insufficient tobring PEC's capital structure back into balance. A constraint upon the growthof its borrowing would also have been necessary.

3.20 In some other respects, FEC's finances showed improvement during theperiod when the project was being Implemented. Probably the most important wasthat the FEC operation became more solvent. Its current ratio (measured ascurrent assetscurrent liabilities) was a very precarious 0.3 in 1983. At thattime, sC had Insufficient short-term liquidity to meet its cash needs. Thecapital restructuring of 1987 brought Important relief to FEC by reducing itscurrent liabilitiesl the current ratio of that year rose to 0.8. FurtherImprovement was sustained until 1990, when the ratio became a healthy 1.6, dueto a further reduction in short-term discount notes among FEC's liabilities.Possimistically, the Bank's appraisal forecast had foreseen FEC's risky 0.3 ratiopersisting throughout Implementation of the project.

42 From project documentation, it appears that the Bank did not play asignificant role In this tportant decision. The July 1988 supervisionmission's Back-to-Office report made only a three line mention of thisrestructur.,nS, which it learned about from the recently issued auditedaccounts of 1987. The PCR's reference is almost as brief, but usingsyntax that might be misunderstood, leaving an Impression that short-termborrowing substituted long-term bonds, when the opposite was in fact thecase. The PCR*s sentence should reads *Debt consolidation through thesubstitution of short-term borrowing by CDG by long-term bonds reducedFEC's maturity mismatch." (FEC PCR para. 5.05)

28

3.21 WeC's risk management also Improved during project Iaplementation.

At appraisal, FEC made no provisions for losses, and M05 was covenanted to ensure

that reserves equivalent to 1 percent of EC's unsecured loans be made (FEC Side

Letter 2). By 1990, FEC's provisione for losses amounted to 0.9 jercent of all

long-term loane, probably ensuring compliance with this covenant. VEC lendingto local comnunes proved to be low-risk, since repayments were guaranteed through

central government transfers. On the other hand, arrears among utilities

("r6gies") worsened, casting them in the same role as CIROa hotel borrowers which

spoiled an otherwise good quality portfolio.

3.22 The steady decline In FEC's administrative overhead between 1983 and

1990 indicates an Improvement In the operation's day-to-day management. Thus,

in 1983, administrative expenses were equivalent to 5.3 percent of total incomel

the proportion in 1990 was 3.9 percent. Although an Important Improvement, thisstill exceeded the appraisal forecast of 3.2 percent for 1986.

3.23 FBC grew at an even faster rate than CIR during project execution,albeit from a much smaller base. FEC's total assets in 1983 were DR 561 million

(US$69.6 million), only 13.9 percent of CIO's in the same year. By 1990, FEC's

assets had increased almost fourfold to DR 2,113 million (US$262.7 million), some

15.1 percent of CIN$s. Even though substantial, this growth vas less than the

20 percent per annum projected at appraisal. The Bank's financial contributionto that growth was not significant. During the 1983-90 period, long-term loans

reported as liabilities In FEC's finaocal statements Increased by DR 1,633million (US$203.1 million), while Bank lending on FEC's books increased by onlyDB 98.9 million (US$12.3 million), 6.1 percent of the total. The Dank loan was

intended only to finance a small pilot project, but the audit mission perceived

disappointment on the part of CDC and FEC management with the small amount

involved. Clearly, CDG and FEC management felt that their hopes for a major Bank

contribution to their growth strategy had been frustrated.

3.24 In sumary, FC's financial performance during project Implementationvas mixed. Major growth was accompanied by declining profitability andundercapitalization, but brought some improvements in terms of solvency and risk

management. The Bank's hopes of influencing this performance were diminished by

the insignificance of the loan amount in relation to FEC's total resource

requirements in the eyes of the fund's growth-oriented management. In spite of

the improvements, moreover, FBC's finances are still not those of an Independent

financial institution and, as noted earlier, OW decided not to proceed with the

creation of another autonomous entity to handle FEC type of operations.

Important groundwork has been laid, however, for both of these events to occur

in the future under the recently approved follow-on operation.

43 The PCRIs review of the Status of Covenants (FEC PCR Part III Table 5)

does not refer to those included in the Side Letters to the legal

agreements. The Audit itself was unable to confirm compliance, since an

assessment requires specific date on FEC loans to "r6ges" which are not

published in the financial statements. The Audit recomends that, where

possible, legal covenants draw upon published data to make these

agreements effective and transparent management Instruments.

29

C. Proiect Reeglts

1. CIX - fousin=

3.25 The project accounted for some 252 of all the housing unite financedby CIN during the 1983-90 period, a significant share of CIR's total sectoroperations. The funding of each of the 15,449 units completed under the projectinvolved two successive financial operations from CIE's point of view. The firstwas to provide three year construction loans to developers to build the house,and the second was to provide long-term mortgage loans to purchasers to buy theunit built. This Is normal housing finance practice in many countries. In thePCR, however, CHS only counts the project's contribution to the second instance,namely the value mortgage financing. This ignores construction loans financedunder the project that were provided for all units built. By comparing theproject's mortgage finance only with CI's total construction-plus-mortgagefinance, the PCR estimated the project's contribution to CIN9s overall housingfinance operations to be only half what it approximately was.

3.26 The physical Implementation of the CIE Project was relativelystraightforward, except for some cases of inadequate land titling affecting someschemes. Unclear ownership rights made some otherwise eligible progransimpossible for CIB to finance, since they did not offer an acceptable guaranteefor the loans (CIE PCR para. 5.01). Significantly, land titling uncertaintiesin some Moroccan cities had also been found to be a major problem in the twoearlier urban development projects (PAR Loans 152811944-MOR, para. 6.06).

3.27 As mentioned earlier (para. 2.26), Bank documentation reportedcontradictory physical targets for the projects the SAR indicated 15,000 unitswould be financed (CIN SAR para. 5.02), while the President's Report specifiedonly 13,000 units as the target (CIE PR para. 53). The remainder of thediscussion In the present report, however, refers to the 15,000 figure. Theactual number of units financed exceeded both expectations in any case. Asanticipated at appraisal (CIN SAR para. 3.08), the large majority of these units,some 72.9 percent of the total, were located in the Casablanca/Rabat areas.

3.28 The appraisal estimate of the total cost of the housing component(i.e. the total value of sub-loans to be financed under the project) was DR 1,257million (US$209.5 million). The actual value of sub-loans by completion hadfallen to DR 891.5 million (US$105.3 million), Increasing the Bank's share inproject financing from 29.1% to 54.71. With 15,449 units built and funded, theaverage sub-loan per unit, according to the PCR, fell from an appraisal estimateof DR 83,000 (US$13,333) to DR 57,706 (US$6,816). The achievement of thesedramatic savings to not analyzed in the PCR. Nor does the PCR explain why, ifunit sub-loans fell so sharply, was it necessary to successively increase theceiling prices of the units?

3.29 An analysis of CIE lending per unit over the 1983-90 period indicatesthat, for CIS operations as a whole, average lending per unit actually increasedsignificantly, as can be seen from the data in Table 1. For public developersit rose from DR 54,300 (US$6,700) In 1983 to DR 121,300 (US$15,100) in 1990, anincrease of 125.4 percent, about double the accumulated inflation of 62.3 percentduring the same period. For private developers, lending per unit rose much

30

faster from DR 58,000 (US$7,200) In 1983 to DR 303,600 (US$37,800) in 1990, anincrease of 423.4 percent, or seven times faster than price inflation. These aredisappointing trends for a project aimed at stimulating the production of low-cost housing. This conclusion assumes, of course, that subloans as a share of

31

total unit costs have been fairly constant over the period. The average privateunit financed by CIS is probably affordable only by the top docile on the Incomedistribution curve." CIR Project landing to developers, which averaged D157,706 (US$6,816) per unit, was however, less than half the average of CIB'soverall lending to public developers and less than one-third of CIR's typicallending to private developers.

3.30 CI mortgage lending also followed a trend towards more costlyhousing, as can be seen from the data In Table 2. Between 1983 and 1990, thenumber of "special regime" sortgage loans (i.e., those for low-cost housing)awarded fell by one half, while the number of higher income "general regime"loans doubled. There was also a significant Increase in the average value ofgeneral regime loans. The special regime loans, among which the CIN Projectmortgage loans would be classified, maintained a fairly constant value over theperiod around an average of DR 69,300 (US$8,000), somewhat higher than the likelyvalue of mortgages awarded under the project, namely DR 57,706 (US$6,816).Particularly significant, though, was the sharp decline in the nmer of specialregime loans in 1987 and 1988, when only 3,108 and 1,818 were awarded,respectively, in contrast to the 9,779 awarded in 1986. 1987188 would have beenthe period when Bank funding under the CII Project first became available formortgage financing, following the repayment of the earliest developer loans.Altogether, CIN committed DR 687.5 million for special program mortgage loansbetween 1987 and 1990. This was less than the DR 896.5 million that the PCRreports that the project alone made available (CIR PCR Part III Annex I pg. 5).From the data, it would appear that the large majority of CIO low-income mortgageloans since 1987 have been financed through Loan 2245-HOR. A precise estimate

If the mortgage loan had the same value as the per unit value of the CIIloan to the developer, the buyer'* monthly repayments would be US$ 449 fora US$ 37,800 loan over 15 years at 12 percent Interest per annum. Withhousing expenses not exceeding 30 percent of income, this would require amonthly household income of at least US$ 1,497. Even deflating for 1982prices, such an income as Is only enjoyed by the top decile in Moroccowould be necessary in order to afford the average housing offered. Thedistribution is as followss

Monthly .ousehold Income .in US2 of Households I of Total Income - Unoer Limit of Decile

102 4.02 199202 5.8% 204302 6.22 225402 6.82 289502 -7.4Z 332602 9.02 387702 10.12 434802 11.32 513902 14.02 7991002 25.42 -

Sources: CIR-SAR para. 3.09 and World Develowment Renort 1992 Table 30.Data refers to the 1982-1985 period In 1982 prices.

32

of the proportion financed io not possible due to the lack of data regarding theconversion of developer loans into mortSa8e operations. It appears, howe"vthat CIN relied almost exclustrely upon the Bank loan to fund low-cost mortgageloanag while concentratiag its other resources on expansion of the higher cost

general regime progra.

3.31 Because of the funSibility of resources within a DIC9 indlrectlyp theBank loan allowed CIS to withdraw its regular support from low-cost housiag andconcentrate on more popular higher Income operations. The PCR Uapies thatowithout the Bank loan for the CIN Project* the low-cost progress might have

ceased, altogether. In the words of the PCRs *The Project sustatned the pace at

which low and moderate-cost houstag constructon loans were granted when, the

g=vrnment_nae.OrAmIIt.Xed=n=tgitulanyon.0 (CIB PCR Rvaluation Sumary para.5 - emphasis added). In the view of the auditq a Bank-financed operation Is

bound to be less than fully sucsesetul if the borrower io not committed to Its

objectives. The experience of this operation with respect to its low-iacome

targeting seems to bear this out.

3.32 Asset iaflation io the bouetag subsectors especially the risiag priteof urban landq was oited by Iaterlooutors of the audit mssion in Casablanca as

the reason for the Increasiag cost of heasiag. Unfortunatelyq the available data

only perat comperisone for the 1987-90 period. Ovr those four yearog CINconstruction lending per unit rose by 51.0 percentg against an Iacrease of 41.7

percent for urban land in Casablancaq 20.0 percent for building materials# and

16.1 percent for consumer goods generally (data from CIN Aaaual Reports). While

33

land prices rose significantly, the tapliat value of the houses for which CIEwas lending, rose faster still, suggesting that higher quality units were beingdelivered.

3.33 By Increasing the cetling prices of eligible housing by 87.5 percentover 1983-90, the CIR Project followed the sae trend as CIA lending generally.As Morocco's principal housing bank, CIR has to uphold the priorities of itsshareholders and support 00 housing policy. Financial or politicalconsiderations may dictate an approach that does not favor low-cost housing. Forthe Bank, funding an operation ostensibly aimed at low-Income households and thensupporting a strategy that favor. higher Income groups jeopardising an importantsector goal. The Bank agreed Increases In the ceiling prices, but there was noexplicit revision of thr 5bjectives of the CIR Project, as approved. A Banksupervision mission of harch 1986 objected to the rising trend of housestandards, recommending that US$20 million be canceled from the line ofcredit." Except for that occasion, the Bak was generally supportive of thechanges, finally seeing merit in them as the PCR reporteds "the Bank's mainstrength was its flexibility In adapting the changes in the Loan Agreement whichfacilitated disbursements of the loan proceeds.. (CIS-PCR para. 8.01). TheBank's flexibility did indeed accelerate disbursements, but at the cost of losingthe low-cost beneficiary focus of the project. The project's failure to benefitlow-income urban households in Morocco Is treated as a point of special interestlater in this report (pars. 4.02-4.04).

2. CIN-* Technical Aseistance

3.34 According to the PCR, the project'e technical assistance component,which aimed at strengtheniag CI's appraisal capacity, Was successfullyImplemented. However, CIX interlocutors informed the audit mission that theyfelt the operation had brought little change to the agency, whose appraisalmethods, they said, were well established prior to the project. The Bankappraisal mission's own assessment of CI's capability In this field was quitepositives

In the course of more than half a century's experience indealing with housing projects, CIE has developed asophisticated data set concerning building construction costsand standards and also a good feel for housing marketconditions throughout the country. It is against thisbackground that housing projects are evaluated... .CI'sappraisals of housing projects are of high quality, butsomewhat weak regarding economic aspects. Recently, however,as a result of discussions with Bank assions, CIE appraisershave paid more attention to the economic analysis of projectsand have devoted more tine to discussions with developers andto advising them on project concept and design (CIR SAR para.4.03),

a3 Back-to-Office report of April 8, 1986.

34

3.35 The Audit mission was iapressed by CIB's in-house skills and

procedures of project appraisal and control. It was more difficult to aseese

what CI's present capabilities owe to the project. It was clear, however, that

the project stinulated the computerization of project management and accountingtasks that are now carried out with a high degree of professional competence.

3.36 The project *a technical assistance component was to have specifically

focussed on low-cost housing, but, consistently with the trend towards financIng

higher cost units, CIS does not appear to have treated low-cost housing as a

special aspect of technical assistance. CIN was also to have provided technical

assistance to developers to help them develop low-cost housing solutions.

Ifforts by the audit mission to obtain information from CIR about private

developers, however, were unsuccessful. Vrom the CIS staff interviewed, theaudit mission had the ipression that CIS is not actively developing its data

base on private developers. The mission's contacts with such developers

confirmed that their dialogue with CIS on a technical level was not a very active

one.

3. P,

3.37 According to the PCR, some ninety subprojects were financed under the

loan. The Audit mission was given a list of 109 subprojects by PBC, which

included the PCR's ninety, but with some variations on the amounts per

subproject. Both figures are considerably higher than the 30 subprojects

anticipated at appraisal, but are consistent with a project ained at financing

small subprojects, up to a maximm value of US$1.0 million. (ISC-SAR para. 4.09).

The PCR provides a detailed breakdown showing the variety of borrowers and the

different sectors served (nEC PCR Part III Table 4). The portfolio of

investments financed under the loan to very diverse both by type of sub-borrower

and sector, with no one type predominating. FEC lending (in terms of value) wasshared in siailar proportions by the four kinds of sub-borrowers, namely rural

communes (26.6 percent of total), autonomous centers (16.0 percent),

"municipalit6sO (33.1 percent), and Or6gies" (24.4 percent). Among sectors,commercial infrastructure (consisting mainly of markets) accounted for the

largest share (24.6 percent), with urban transport (which included the

acquisition of vehicles) In second place (17.1 percent).

3.38 By including many different types of subprojects in different cities,

the investments were consistent with the objective of assisting local communes

in their attempts to meet basic infrastructure needs. The level of effort,

however, was very small, so that the loan made only an insignificant contribution

to meeting the total local infrastructure needs throughout Morocco. nEC$s

lending program as a whole could generate a wealth of information about the

priorities for local investments in Morocco, from the point of view of local

communes and provinces. The Audit recommends that a cross-sectional analysis of

this experience be carried out in the future by type of local authority, city

size, region, and poverty impact in order to help orient sector policyformulation. Understanding of the priorities of the local communes would be

particularly important.

35

3.39 PEC kept very good control of the local Investments it financedduring execution, but did not follow them through with systematic monitoring.FEC's follow-up and monitoring unat, with only four professionals and onemicrocomputer, is seriously understaffed and underequipped. It to responsiblefor overseeing a portfolio worth some US$300 million spread throughout thecountry in a multiplicity of small investments. With the unit*a present limitedresources, field visits to the subproject sites, for example, are Impossible.In the absence of monitoriag, it Is not possible to be sure about how well theseInvestments are performing and how effectively they are being maintained. Weaksupervision and monitoring was recognised as a problem by CDG and IEC management,who assured the Audit mission that they were addressing this shortcoming.

3.40 Technical assistance and training provided under the project helpedstrengthen FEC procedures and management. It to Important to remember that,according to the appraisal report, recognised operational procedures hardlyexisted at all In FEC prior to the Bank-financed operation. A number of FECstaff improved their project appraisal capabilities by on-the-job training duringimplementation of the project, reaching a high level of technical competence.The Audit mission was Impressed by the in-house skills developed in the use ofelectronic spreadsheets for project appraisal. Today, some six staff (out of atotal of 44) are familiar with the techniques used, a high skill density withinthe organization.

3.41 An informal on-the-job approach did not work as well, however, forthe elaboration and dissemination of the FEC operations manual. A formal manualwas not prepared since FEC management felt that the line of credit approach waswell enough understood by all staff. While FEC was still very small, thisinformal approach may have worked, but an enlarged FEC needs to have a clearstatement of the policy, rules, and procedures of the operation. The fact thatmany local commune dossiers of proposed investments had to be returned by FECbecause they were incomplete is indicative of an incomplete understanding of theoperation's rules. An operations manual would not only clarify such rules, butits use would help highlight where Improvements in procedures could be made. Inthe view of the Audit, this type of operation benefits considerably by having itsrules clearly and formally set out for the information of all projectparticipants.

D. Suetainabiill

3.42 In the case of a line of credit to a DYC, there are two distinctdimensions to sustainability, namelys (i) the long term prospects for the DICitself; and (ii) the physical permanence and continued performance of thespecific investments financed through the operation. Each aspect is brieflyassessed in turn.

1. SU

3.43 The sustainability of CIN as a financial intermediary in Morocco'shousing market is directly itaked to the itstitution's financial performance,analysed in some detail earlier In this section (paras. 3.05-3.15). CIR*sdeclining profitability, increasing risks of short-term insolvency, andIncautious risk management are of concern to those responsible for its future

36

financial health. On the other hand, CIB8* oapital struature remained solid,even through a period of rapid expansion of its leading operations. Perhape themost Important challenge for CIS In sustainiag its operations In the future Ito ensure that it can continue to mobilize adequate resources to avoid afinancing gap. This will not be an easy task in Morocco's tight financialmarket, where interest rates might soar if DICe and banks compete too intensivelyfor scarce funds. Given the Increasing cost of the housing Units it finances,CIS will have to mobilize more and more resources just to maintain the same levelof physical output of the recent past. In order to sustain the level of itsoperations, the audit considers that CIN will inevitably be obliged to developlower cost financial products, such as loans for core house production, of thekind originally foreseen under the project. 00te* own action would be Importanttoo, in increasing the supply of urban land (principally through deregulation).This would help slow down asset inflation and enable the financial resources ofCIE and other banks to reach a greater number of beneficiaries.

3.44 As far as the physical austaluability of the housing financed by CIEis concerned, experience in Morocco and elsewhere has shown that, when they owntheir homes, residents generally provide the proper saintenance of their housingunits. The construction quality of apartment dwellings built by both public andprivate developers that were visited by the Audit mission In Casablanca was good.Nonetheless, a recent Bank report mentioned poor quality of work as one of thekey problems of the Moroccan construction Industry." What did concern theAudit was the poor quality of the public spaces in the very large (30,000 unit)Salmia housing scheme In Casablaca, partly financed under the CIR Project. Ifthese common areas are allowed to continue to deteriorate, falling propertyprices could undermine the value of mortgages pledged and hence the financialviability of the scheme for CIS. Urgent action by the local authority andresidents themselves is necessary to sustain this kind of neighborhood as aviable urban community. Overalls the sustainability of CIS and that of specificinvestments financed through its operations are rated as likely."'

2. CDGIFC

3.45 As mentioned earlier JA this report and in other Bank documents, 8Cwas integrally a part of CDG, so its sustainability depended directly on thesustainability of CDG itself. Not being an independent financal agsancy, nRC didnot bring together the necessary financial conditions for sustained development,as the analysis of IMC's financial performance above showed (paras. 3.16-3.24).nFC's profitability and capitalization were not adequate for what would berequired of an autonomous financial institution. Still, CDG to at the same timenC's guarantor and principal source of funds. As it did through therestructuring of nC's liabilities to 1987, CDG can come to nC's aid when

Ann B. 81wan, The Constrotion. Sector in . MNA Countries, World BankInternal Discussion Paper, Zurope, Middle last and North Africa Region,August 1990, pg. 63.

47 The rating of uncertain sustainability at the time of the PCR review hasbeen upgraded due to more comprehensive Information obtained during theAudit.

37

necessary. Although the Audit did not undertake a detailed review CDG's ownfInances, there was no reason to doubt that CDG, as one of Morocco's largest andmost important financial institutions, would not be able to sustain PEC'soperations through difficult periods, should the need arise.

3.46 The oustainability of the specific Investments made through FEC willdepend upon the effective operation and maintenance of them by the beneficiarycommunes and "r6gies". Since nEC does not effectively monitor these investments(para. 3.39), there is no systematic Information on how well these investmentsare being operated and maintained. In addition, the majority of them are recentconstruction and it is still too early to assess the adequacy of maittenance.,Nevertheless, the well known limits to local communes' maintenance andoperational capabilities is a cause of concern making sustainability of benefitsuncertain.

IV. OTHER POIMTS8O0 SPECIAL INTEREST

A. Poverty sImact

4.01 Both projects assessed in this report aimed to bring benefits to low-Income urban households in Morocco. The CIH Project was the more explicit of thetwo in targeting low-income beneficiaries by aiming to stimulate the supply oflow-cost housing solutions affordable to those on the lower half of the incoZ1distribution curve (CIR SAR par*. 3.09). The iEC Project's low-incomebeneficiary targeting was only indirect and Implicit, mainly through the attemptto deliver infrastructure and services to poorer regions of the country. Theappraisal report did recognise, however, that the FEC Project was part of theBank9s sector strategy of extending services to rural and urban low-income groups(nEC SAR para. 2.15).

1. maI

4.02 The appraisal poverty targeting of the CIR Project on households withmonthly incomes of up to DR 2,000 (in 1982 prices, or US$333) was modest one interse of urban poverty in Morocco. A Bank study in 1989 estimated the urbanpoverty threshold to be a household monthly income of DR 1,030 (in 1985 prices,or US$107) for families in the lowest decile of the income distribution." Themore modest appraisal parameters were nevertheless reasonable to help ensure theoperation's financial feasibility as well. The 87.5 percent increase in theceiling prices over the 1983-1988 period (para. 3.03) meant that housing unitseligible for CIR finance under the project were no longer affordable by the

World Bank, Norocco: Reachina the Disadvantatedt Social ExoenditurePriorities in the 1990s. Vol, 1LIain enort, Oct. 19. 198.. nag. 3 andAnendix 1. ehis study estimat2d tM urban noverty threshold for-Moroccoas DR 2.473 wer gerson per year tin 1985 nrces)., eauivalent to a minimummonthly income of DR 1.030 in 1985 urices (U8107) for a five person urbanhonsehol-

38

original target population. In order to purchase a house at today's top ceilingprice of DR 150,000 (in 1991 prices, or US$18,405), a minimum household monthlyincome of DR 4,456 (in 1991 prices, or US$547) would be necessary. This wouldbe to repay a 15 year mortgage loan at 12 percent interest corresponding to 75percent of the value of a the unit.

4.03 The risk of failing to target low-inom beneficiaries was recognizedat appraisal, but not specifically as a result of the project's delivery of moreexpensive housing unit. In the words of the appraisal reports "there is adanger that the pressures in demand resulting from a shortage of housing couldlead to higher income groups obtaining the shelter facilities targeted for thelower Income population.... As CIR has very limited experience In low-costhousing financing, there is a risk that it will tend to finance subprojects inthe highest price range allowed by the eligibility criteria." (CIA BAR pars.5.04-5.05). In the view of the Audit, the risk that the project would deliverhigher standard housing units than planned was exacerbated by the perhapsinadvertent signal the Bank gave in favor of higher cost housing by budgetingaverage unit costs in excess of the agreed norms (detailss para. 2.26).

4.04 The CIS Project was appraised and presented to the Board as a lineof credit that would assist a DPC well known to the Bank stimulate the deliveryof low-cost housing in Morocco. The project financed units are affordable by thelower median-income population, but the broad sector Impact was the opposite ofthat intendeds (i) instead of increasing the supply of low-cost housing, thestandard and cost of housing units financed by CIN In general rose significantly(pars. 3.28); (ii) with the sharp Increase of ceiling prices, the CIA Projectitself was able to finance more expensive units than foreseen at appraisal (pars.3.03); and (iii) Bank loan proceeds were nevertheless used to finance whatremained of a low priority lower-cost housing program, freeing CIR to use itsother resources for priority mortgage lending for higher standard units (para.3.30). Given that the projectOe objectives were not formally revised, theoperation failed to achieve its basic aim as set out in the appraisal report whenthe loan was approved by the Board.

2. FEQ

4.05 The FEC Project financed local commune subprojects throughoutMorocco, some in the poorer regions of the country. Nowever, the location of aninvestment in a poor region Is not by itself a guarantee that its benefits willbe perceived by the poor of that locality. Nonetheless, many of the investmentsmade, notably covered markets and public transport infrastructure and equipment,brought benefits mainly to lower income Inhabitants of the local communes. Adefinitive conclusion about the poverty impact of the TEC Project as a whole,however, must await the results of an effective project monitoring system thatFEC has yet to Implement (detailes pars. 3.39-3.41).

39

B. For Borowers. Loan Amounts. Wre Instanifteant

4.06 Both CIN and CDGIF2C interlocutors made it clear to the audit missionthat they considered the Bank loan amounts for their respective projects to beinsignificant in relation to the needs of each subsector. In return for thesesmall amounts, they felt that fulfilling conditions agreed in legal documents andmeeting the Bank's reporting and information requirements were a heavy price topay. CIN made the point about the relative unimportance of the Bank loan to itresource mobilization in the PCRt "although Loan 2245-MOR provided the fairlylarge sum of US$60 million, it represented a small proportion, averaging lessthan 2 percent of the total funds mobilized by CIE during the loan disbursementperiod 1983-90" (CIE-PCR Part II II.A)."

4.07 Growth-minded managers of both CIR and FEC were evidently frustratedby the limited contribution Bank funds made to the expansion of their operations.As already noted, CDG vas a much more Important source of funds for bothoperations as a whole (paraes. 3.12, 3.16, and 3.18). Although the Audit missiondid not have access to the details of the conditions of CDG finances, it probablycame with fewer technical and policy conditionalities tbpz the Bank's muchsmaller amounts did. The lesson of these experiences is that, when growth to aDFC's prime objective, the Bank's Influence Is prnportional to its financialcontribution to the agency*s expansion. When alternative sources of fundingexpand rapidly, the Bank's scope for action and influencing events is even morelimited.

4.08 For CIE, an institution that has now been responsible for six Bank-financed projects, the risk of "borrower fatigue" (para. 3.11) can beconsiderable if its management feels that little can be gained for the agency'sSrowth objective from a comparatively small loan amount. If this happens, aBank-funded operation such as the CIA Project and its objectives risk becomingdemoralized and its Importance in the eyes of the borrower diminishes (paras.3.17 and 4.06). In these circumstances, project goals are unlikely to be fullyachieved. Future operations are likely to be more successful when the Bank's ownstrategy for the sector Is in harmony with the objective function of the DFC,namely growth in the case of CII.

4.09 As a new executing agency for a Bank-financed project, the risks ofCDG/FEC developing borrower fatigue were lower. In addition, the prospect of asubstantially larger follow-on loan -- sincerely contemplated by both 00M and theBank if the pilot Project were to prove successful -- served as an Importantstimulus to PEC management and staff at least during the first half of projectimplementation. When a second loan was postponed, the Insignificance of the

49 In its comments on the PAR in Annex 1, CDG, confirmed that Bank financingmade only a very small contribution to ICs balance sheet.

so An analysis of CIR's 1990 balance sheet Indicates a higher, but still verysmall, contribution of Loan 2245-MOR to CIE's capital structure. By theend of 1990, the US$ 60 million loan was fully disbursed and US$ 16.2repaid to the Bank, leaving a balance of US$ 43.8 million, or some 3.9percent of all long-term loans to CIS.

40

pilot project loan for CDG/FEC was brought into perspective. By that time,however, Important improvements to EC's procedures and operations under theproject had already been achieved.

C. Institutional Anyalsal In Lime of Credit fterations

4.10 The experience of both operations reviewed in this report underscoresthe importance of the Bank's having a thorough understanding of the responsibleDIC in a line of credit operation. In providing a line of credit which isfungible within a DPC, the Bank is effectively supporting that agency'* work

program as a whole and not just the eligible components on which the loanproceeds are directly targeted. Medium to long-term development gains will beelusive if a line of credit helps Improve the performance of the target sectoronly, while the credit worthiness of the institution as a whole is undermined bythe deteriorating quality of another portfolio.

4.11 The fungibility of resources within CHI was well demonstrated underthe 1housing finance project. Experience under this project demonstrates that,when a Bank loan accounts for only a small share of a DFC's resources, evenexplicitly targeting the loan proceeds on eligible low-cost housing cannotguarantee that the supply of that type of housing will be stimulated. Analternative project design is thus recommended. Instead of using its funds to

finance specific subprojects, the Bank could explicitly agree overall (butprecise) targets with the DFC (say, at least two-thirds of all housing unitsfinanced each semester to be low-cost). The Bank could then finance a time-sliceof the overall program over a given period, disbursing on the condition that the

targets had been met. Since such targets would have to be DFC-wide, the Bank'sinstitutional appraisal would have to encompass all the main activities of theinstitution, especially its appraisal and lending criteria for all sectors.

4.12 The CIE Project, which was ostensibly concerned only with housing,had to face the difficulties raised by CIR arrears on hotel loans. The Bank's

appraisal recognized the problems posed by the hotel portfolio and even agreedan action program for reducing arrears, but gave no details of how this was to

done, nor how the program was to be followed up (CIN SAR para. 6.01). Despitethis program, delinquencies on hotel loans worsened during the implementation ofthe project. With the benefit of hindsight, it now seems clear that the housingfinance project could have helped CIR deal more effectively with this problem if

the legal documents had included financial performance covenants aimed at

improving the quality of the agency's hotel portfolio.

4.13 The PEC Project experience also demonstrates the Importance of

thorough institutional appraisal, but for different reasons. In the PBC case,the key Issue was one of institutional identity and responsibility. During

project preparation, the Bank mulled over the first issue, when there was muchdoubt about the Institutional status of FEC (paras 2.13-2.16). Although FEC was

treated as the project executing agency at appraisal, 00 was the borrower andCDG also signed the Project Agreement. Experience has shown that CDG was the "a

gag project institution. By focussing its institutional appraisal on FEC,however, the Bank did not develop a fuller understanding of, and relationshipwith CDG itself. A knowledge of CDG' policies, priorities, management,

41

financial products, and criteria for decision making by the Bank would have beena necessary condition for the Bank to engage it In a sector policy dialogue.

4.14 The principal intention of the 1EC Project was to create a viableand, in due course, autonomous financial Institution. The Bank's postponing ofa follow-on operation appears to Indicate that the performance of the pilotproject was not considered successful enough to justify Immediate further supportto WC. Between 1985 and 1988, 00 did consider creating an autonomous localcommune development bank (DCL), but these plans were shelved in favor ofcontinuing with the InC arrangement under CDG. Evidently, the question ofcreating an autonomous financial agency had Important political repercussions.CDG would itself have been a major player In any such rearrangement. A lessonof this experience Is that, through familiarity with key project agencies, theBank can review the political pros and cone of such measures to all institutionsinvolved, including CDG. A lot was at stake, since a fully fledged local communedevelopment bank could have become one of the largest financial Institutions inMorocco.

D. Role of Subproject ArAigal in _EC _rnJect easion Makina

4.15 The Audit was Impressed by the quality of subproject appraisalmethods developed in-house by the FEC team. The techni.al, economic, andfinancial aspects of all subprojects In all sectors were thoroughly reviewed byFEC staff through the application of evaluation models that used Lotus 123spreadsheets on microcomputers. The appraisal techniques were developed in-houseby FEC staff. The project evaluation and eligibility criteria detailed in the28 pages of annexes to Side Letter One to the legal agreements proved to be avaluable input for the development of these techniques (para. 3.40). Theexperience demonstrated that detailed legal agreements can contribute to thetechnical progress within a client institution.

4.16 What is not clear, however, wae the extent to which these wellconceived subproject appraisal techniques were actually used to guide decisionsto approve proposals for FEC finance. This was, In part, because the processingof local communesO applications for FEC finance followed a long path, involvingImportant instances of decision-making outside FBC Itself. A brief review of theprocess will help set n8C's subproject appraisal work into the broader context.

4.17 Local communes first present their proposals for Investments to befinanced by FEC to their awn provincial governors (para. 1.13). The governorsthemselves evaluate the proposals to determine which are consistent withprovincial priorities and regional development plans. Those found to beInconsistent are not processed further and are not seen by FEC. Precisely howmany proposals are turned down at this stage Is nou known to the Audit.Proposals approved by the governors are sent to the Minsstry of Interior's LocalAuthorities' Department (DOCL - Direction Oft6rale des Collectivit6s Locales) forevaluation.

4.18 The Audit was informed that some 25 percent of the proposals receivedby DOCLIMDI are turned down at this stage because ofs (i) Incompatibility withlocal development planes (i) Insufficient debt service capacityl or (iII)

42

infringement of legal or regulatory requirements. The remaining 75 percent

finally find their way to M80 via CDC. Only after receiving the proposals from

DGCLIMOI, does FMC begin its evaluation. Despite the previous checks, the audit

mission was informed that MBC still has to request additional Information for

some 60 percent of the proposals, whose dossiers are considered incomplete. FEC

informed the audit mission that it generally finds that 90 percent of the

proposals are economically and financially justifted, yielding Internal rates of

return of at least 12 percent. What the Audit was surprised to learn, though,

was that even proposals for subprojects not justified by the appraisal are still

sent to the CDG/FEC Technical Committee, which generally approves all the

proposals submitted to it. That being the case, the result of the subproject

appraisal does not affect the likelihood of the proposal being approved.

4.19 From the process just described, an excellent subproject appraisal

technique developed by FEC, is perhaps not being fully used as a management tool

to help decision-making. This is for two reasonst (1) the local communes'

original proposals are reviewed twice before being appraised by nC, which means

that FEC does not evaluate all proposals and some well-justified projects may not

even reach the agency if they do not mast other criteria applied by provincial

governors and DGCL/MOI and (it) the result of satisfactory subproject appraisalby FEC was insufficient to guarantee financing.

1. Inadeauate_ Monitori -ni Tes of ZnJect gltiea

4.20 Both operations reviewed here aimed at urban sector Improvements,

specifically by stimulating the provision of low-cost housing and assisting local

authorities to meet their urban infrastructure needs. In the course of

implementing these projects, however, executing agencies and Bank missions made

only sporadic attempts to determine what their quantitative achievements were in

terms of these goals. One of the reasons given for inadequate monitoring was

that both local management and staff and Bank missions had tight supervision

schedules, overloaded with taske concerning day-to-day project administration.

In this respect, successful project monitoring requires that the Bank allocate

adequate resources for project supervision.

4.21 Bad emphasis been given at appraisal to defining performance targets

in terms of low-cost housing supply and arrangements for their monitoring the

CI Project might have met its original low-income beneficiary objectives. With

the support of Bank missions, CIE ight have monitored, among other thingsa (i)the annual delivery of low-cost housing as a proportion of the total (CIRefficiently compiles this kind of Information on its own housing loans in its

annual reports already) in relation to an agreed targets (1i) the number of

private developers engaged in the delivery of low-cost housing and the type of

problems they face, with recommendations about the kind of technical assistance

they need to help them increase outputs and (Lit) the results of CIE's

appraisals, highlighting the kinds of problems identified with low-cost housing

projects and suggesting design and other modifications to help overcome them.

4.22 Insufficient supervision and monitoring of the FEC Project was

discussed earlier in this report (pars. 3.39 and 3.46) and mentioned by the PCR

(FEC PCR para. 9.04). CDG/FEC management are aware of this problem and are

43

planning to strengthen this capability of the TIC operation. The annualmonitoring of the following might have been useefuls () Infrastructure deficit,declared need., and actual delivery for each local comunes (it) the actualperformance of the infrastructure and services financed by FC loans comparedwith the projected performance at appraisals (111) local commune' projectappraisal capacity and technical assistance needs to strengthen its and (v)Investments financed by nC during the year in terse of region, city size, typeof local authority, and beneficiary Income levels. Through its now extensivelending operations, n8C has accumulated a rich body of knowledge about localdevelopment in Morocco. Sector dialogue within the country itself and in theBank, would benefit considerably from a fuller and more widely disseminatedunderstanding of this experience.

4.23 Monitoring Indicators need to be discussed and performance targetsagreed at appraisal end, where they refer to the DFC itself, could beincorporated as covenants to the legal agreements. Converting such indicatorsInto effective management tools can be one way of reducing the risk of such aproject losing sight of important objectives.

P. RritrnU&m l2oct

4.24 The lack of monitoring makes it difficult to draw conclusions aboutthe environmental impact of the operations under review. Nevertheless, the kindof lavestments made through the CIN and FEC Projects are likely to have hadpositive impacts on the urban environments in the cities in which they were made.Residents of housing schemes financed by CIH, independently of their incomelevels, should now be enjoying mtnu environmental health conditions derivedfrom the provision of a safe water supply and through connections to sewerage andstom drainage systems. Although mostly felt b the occupants of the housingschemes as the project's direct beneficiaries, these subprojects should alsocontribute to an overall Improvement in enviroamental health in the cities inwhich they are located. It is also reasonable to expect that the majority of thelocal commune and #regie* investments financed by FEC, such as those for streetpaving and drainage, water supply and sewerage, and solid waste collection anddisposal, will have resulted in environmental Improvements.

44

V. = =QuANDI= nh.M IGWC

A. Experiences of Borrwer and Executin Agencies

1. MIf

5.01 Because of CIR's long experience in the sector and with the

Implementation of Dank operations, procedures for project identification,

appraisal, and administration of subloans were already in place. It was

precisely this tn-house ability that made CII an attractive borrower for the

Bank. CT's day-to-day management of the project vae indeed efficient,

especially with respect to administration of the housing loan portfolio. The

excellent quality of CIB's Annual Reports and the housing sector analyses they

contain confirms the high level of professional skills available to CI8.

CIR/Bank relations were reportedly good, notwithstanding CIN's perception of the

insignificance of the loan amount and "borrower fatigue" discussed earlier

(details: para. 4.08-4.11). A major disappointment was CIE's unwillingness or

inability to pursue the project* low-cost housing objectives. This points to

the critical Importance of borrower "ownership* of project goals for their

eventual attairment.

2. CDIE

5.02 CDG/FC satisfactorily fulfilled their obligations during project

implementation. FEC provided information requested by supervision missions and

submitted periodic progress reports to the Bank. Although, like CIR, management

and staff in CDG and PSC considered the Bank loan amount to be too small, this

did not have as demoralizing an effect on relations with the Bank, since the hope

of a large follow-on loan was an Important positive stimulus. FEC was able to

perfect its subproject appraisal technique. and apply them to all Investments

made, not only those financed through the Bank loan. In spite of occasional

setbacks, cooperation between CDG/FEC and the Bank was good. PEC was supportive

of the audit mission and provided all the information requested by it.

B. Role of the- ank

5.03 The CIZ and the RIC Projects were similar insofar as they each

represented the Bank's first Incursion through line of credit operations in their

respective sectors. The Bank's role, though, was distinct in each case,

especially during preparation. The region's urban projects division responsible

for the CIN Project was breaking ne ground in dealing with the financial aspects

of housing. In contrast, the IDF division that prepared the FEC Project was

familiar with the financial aspects of this type of operation, but had to deal

with a different kind of borrower and sub-borrowers than it was used to in

industrial finance projects. During supervision, when the urban projects

division assumed responsibility for both operations, the Bank's role in both

became similar. Now the Bank broke the new ground in each case can provide an

object lesson for future operations of this type.

45

1. IR Protect

5.04 A housing finance line of credit was seen by those responeible as aradical departure from earlier physical development operations supported by theBank in the sector. For the Bank, it was a potentially creative moment whenstaff with financial analysis skills were deployed for the first time in theurban sector, and staff specialized in physical planning and engineering had toacquire new financial skills.

5.05 Despite its being an innovative operation, and one in which the Bankhad no previous experience, the project was prepared and appraised quickly (para.2.18). Inconsistencies found in appraisal data on project costs (para. 2.26),as well as the start-up problems encountered (para. 3.01), point to lapses inpreparation. A better preparation might have allowed the Bank either to designa feasible low-cost housing finance operation in relation to policy and marketparameters in Morocco or recognize that the low-cost housing approach it espousedwas incompatible with those parameters. Not least of all, the Bank should havetaken better note of its previous experience in the urban sector in Morocco, andin particular the previous setback to its strategy of bidonville upgrading whichOW opposed (paras. 1.16-1.19).

5.06 According to the CIS PCR, one of the advantages of the wholesalingof Bank lending through a line of credit operation was that Bank staff did nothave to "scrutinize minute details," thus permitting them to concentrate on"broad institutional and sectoral Issues* (CIE PCR Evaluation Summary para. 9).This Implied a lighter Bank supervision load, but in actual practice, the CIAProject's supervision effort, measured as Bank staff weeks per million dollarsof loan, was approximately twice that of the Second Urban Development Project (Ln1944-MOR), although considerably less than the Rabat Urban Project (Lu 1528-MOR)(para. 2.02). Bank supervision missions of the CIA Project still had to occupythemselves with many details, although of a different kind from those encounteredin the earlier physical urban development projects.

5.07 Much was learned from this experience and applied to later operationselsewhere. In spite of the disappointing results obtained, the projectrepresented a worthwhile effort to set a new direction for Bank urban lending inMorocco which, at the time of its appraisal, risked becoming paralyzed throughthe divergent approaches of GCM and the Bank to the issue of Morocco'sbidonvilles.

2. FEC Polest.

5.08 During preparation and appraisal, the region's ID division broughtits experience with line of credit financing to the urban sector. IDP's lack offamiliarity with urban sector institutions, however, raised concern about thepossible lack of credit worthiness of local communes and dictated a cautious paceto project preparation. Such caution was justified in view of the uncertaininstitutional status of FEC itself in relation to CDG (paras. 2.13-2.16 and 2.20-2.21). Project preparation was protracted and the Bank deployed twice the staffresources as for preparation of the much larger CI Project, yet the lack ofattention given to CDG In the appraisal process was a major emission by the Bank.More preparation time, however, gave the Bank the opportunity to help introduce

46

some useful management techniques and procedures into EC operations, especiallyin connection with subproject appraisal.

5.09 Bank supervision began well, but clearly became less intensive as theprospects for a larger follow-on loan diminished. The Bank continued discussionswith O about establishing a local comme development Bank, even to the pointof fielding a pre-appraisal mission in 1987. The level of staff effort forsupervision was greater than that of the CIS Projects and supervision missionshad to concern themselves with many details of the operation, such as theconditions of employment of a technical advisor and encouraging nC to makeprompt payments to consultants. The effectiveness of staff contribution to theproject diminished as hopes for a follow-on loan receded.

V1. COWCMUION AND LESSONS LEAR=E

6.01 This section brings together the conclusions and most Importantlessons for future efforts from the rich experience afforded by the preparation,appraisal, and Implementation of the CIE and nEC Projects.

1. CIS Proleat

6.02 The CIN Project accounted for a significant share of all housingunits financed during the 1983-90 period. The Project is rated as satisfactory,although relative to the optimistic expectations, some results weredisappointing. It did not lead to a fast-disburitg loan, nor to theinstitutional and sectoral Impact that the Bank bad hoped for. Perhaps theexpected results of 'wholesalings Bank lending through a DEC In a complex sectorsuch as housing were unduly ambitious. In actual fact, disbursement proveddifficult. Concrete project Impacts on CIE as an institution and the housingsector in Morocco are difficult to see. In torm. of its own declared objectives,the CIR Project did finance units that are affordable by the lower median-incomepopulation, but it failed to stimulate the delivery of low-cost housing by publicand private developers." Cls* long experience in the sector and itsestablished in-house ability to effectively deal with project processing andadministration of subloans made it, however, an attractive borrower for the Bank.The Project9s institutional objectives are rated as partial (vs. substantial onthe basis of the PCR). CH**s capital structure remains solid, although itsprofitability has declined. Experience in Morocco reveals that the maintenanceof housing units is assured by resident-owners. The Project*s sustainability israted as likely (vs. uncertain on the basis of the PCR). The key lessons to bedrawn from the experience Include the followings

51 According to CIE comments on the PAR in Annex Is this was in spite ofCI's disposition to see the project well executed and also its ownefforts in a broad campaign to promote this kind of housing amongdevelopers.

47

(1) It to important to take Into account the lessons ofearlier experience In the sector even if the proposedproject design to intended to substitute earlierapproaches. Particularly relevant in this case to theprotracted 00M/8ank policy housing sector dialogue thatoccurred during Implementation of the first two urbanprojects which clearly showed 00*s preference for highstandard housing solutions. Unlike Bank strategy forurban development, 00 sector policy did not havebidonvilles and low-cost housing as its centerpiece;

(tt) When it focuses its support on those operations in theDEC whtch are not a priority for the Government and theIntermediary itself, Bank funding risks merely fillinga resource gap left by the local withdrawal from lowpriority operations, as clearly appears to have been thecase with low-cost housing in the CIR Projectl

(tit) The resources provided via a line of credit to a DFC arefungible within the Institution. Consequently, a lineof credit project must be understood as one thatsupports the DEC and all its operations. For thisreason, institutional appraisal of a DFC should extendto all its activities. Where the performance ofoperations other than those targeted (i.eq hotel loansin the case of CIR) can affect the results of theproject, agreed performance standards for them should becovenanted In a project's legal documents;

(IV) The Bank policy Influence turned out to depend on theimportance of the loan amount in relation to new fundinglikely to be mobilised by CIB. The Bank loan to CIA wasrelatively small and came to be regarded asinsignificant by the borrowerl and

(v) As lender, the Bank should evaluate all aspects of DFC.financial performance, Including profitability and riskmanagement in the case of CIE. However, satisfactoryfinancial performance is not a sufficient condition toassure project success. For this, the fulfillment ofproject objectives, namely stimulating the delivery oflow-cost housing in the present case, also has to beachieved. A monitoring system should be in place tomeasure progress in these areas as well.

2. IEC Project

6.03 The PBC Project was a pilot operation and raised modest expectationswith respect to its likely results. Its achievements were mixed. Physicalsuccess and partial, but Important institutional development were counterbalancedby poor supervision and manitoring of sub-projects and declining financialperformance. TMC remained part of CDC and made negligible progress toward full

48

autonomy which appeared to discourage Iamediate further support by the Bank.Subsequent progress was evidently adequate to justify the recent approval of theFirst Muicipal Finance project (approved on June 10, 1993). The Audit rates theoverall outcome of the project as marginally satisfactory, and its sustainabilityas uncertain. The PCR-based ratings weres overall performance as satisfactory;institutional development as substantiall and sustainability as likely. The keylessons of the experience of the P8C Project Includes

(i) To achieve the desired Institutional and policy Impact,it is important for the Bank to engage the appropriateauthority in Its policy dialogue. In this case, CDG wasa key policy interlocutor and its active engagement Inthe process should have been enlisteds

(i) for a first operation in a particular sector, it is wellworth spelling out in detail the agreed criteria foreligible beneficiaries and subprojects. In the case ofthe FEC Project, these details enabled RKC staff todevelop a sound appraisal method for evaluating theproposals received. It is likewise Important to engageall Important policy agents in a complex subsector suchas local development, in this case including VO and theprovincial governor., so a. to ensure their support forthe principles and procedures of the operations and

(ti) As to the case of CIN, the Banke Influence turned outto depend on Importance of the Bank loan in relation tonew funding likely to be mobilized by the DIC. Afterthe expected follow-on Bank loan got delayed, Bankinfluence diminished as CDGIFC came to regard the FECProject loan amount as Insignificant In relation to thesector's needs.

49

Annam1L

Commente from the Borroer and Executina Aaenget(Treolatiom from rnch orig8al)

Cateo de Dpot et de GestionP.O. Box 408Rabatmorocco

ApTil 15, 1993

Enersy and Infrastruture DiviDoaOperations avaluation DepartmentWorld ankWasington, D.C.

For the attention of Mr. Yves Albt

Sir

With your letter of March 26, 1993 you kindly sent Us aPerformance Audit Report on the pilot projet for the Communal Infrastru=turelund - lEC (Loan 2272-M).

Raving namied this report, we have the honor to send youenclosed a memorandum containins a muber of cafente and olarificationeprompted by the conluLonm of this report, whic we would like to seereflected in the final version.

We hope you roceive it i order and rmia,

ey tmuly your.,

utidel LahioDireotor General

so

Annex 1Page 2 of 13

Caieae do D6p8t et do GestionP.O. Box 408RabatMorocco

April 15, 1993

PEC Project (2272-MOR

Performance Audit Revort

The use made by 18C of the World Bank loan for US$16 million,signed on March 23, 1983, is the subject of a Performance Audit Reportprepared by the Bank staff.

The report provides an assessment of the overall performance ofthe pilot project for 7EC, its institutional Impact, its economicrepercussions and the financial performance of EC itself.

Examination of this report by the Casse de D6p6t do Gestion (CDC)calls for the following comments and observationsa

1. General context and ietitutional ramework

The Performance Audit Report focuses particularly on the degree ofthe involvement of CDG in project Implementation. On this subject, we need toexplain the legal nature of the linkages between CDG and the PED and itsImplications.

In accordance with its bylaws and those of n1C, prior to itsreorganisation which came into effect from the beginning of 1993, CDG wasplaced in charge of the administrative and financial management of 1EC, as apublic establishment with legal status and financial autonomy.

The negotiations for the IBRD loan were conducted with theMoroccan Government and of course with CDG through FEC itself. ProjectImplementation complied fully with the terms of the pertinent loan agreement.It was naturally also carried out under the responsibility of CDG.

We atill do not agree, however, with the idea raised in the PARthat PEC's autonomy was limited by CDC. On the contrary, as an establishmentwith total autonomy, CDG allowed this agency to commit the contracted funds onthe best termo. The assessment to the effect that EC's performance would notbe that of an autonomous financial agency should also be qualified because,

51

Anne IPa&e 3 of 13

other than this normative aspect, its involvement and its financial structureare, given its institutional structure, as described earlier, indisting-utabable from those of CDG. In a nutshell, any analysis must be directed inthis spirit of organic and operating osmosis between the two organisations.

2. Importance of CDG S =onort

As soon as PEC was created, it was to receive technical andfinancial support from CDC. This aspect should be underlined in the PAR.

Until 1986 PEC vas funded primarily in the form of thediscounting of bills of exchange by CDC. This type of financing accounted forthree-quarters of FEC's total resources in 1986. From November 1, 1986onwards the discounting of FEC bills of exchange vas no longer eligible forrediscounting by the Bank Al-Maghrib. This change, together with the desireto proceed with a reorganisation of 0EC In order to bring it into tune withthe growing financial accountability of local authorities, was to mark thebeginning of a consequent consolidation of this agency's resourcest it hadrefocused the mobilisation of its borrowed funds onto the domestic bondmarket, one of the leading organisers of which was none other than CDC.

Ever since, the bulk of the funds has been contributed by CDC andits services (CNRA and RCAR) via the bond market. In 1989 and 1990 F&C's loanholding status was as followst

1989 1990CDG subscription as percentage of total issued 191 322CDG subscriptions and managed services (CHRA-RCAR) 411 72Z

In this connection, as vas pointed out In the PAR, IBBD*sassistance is limatd. In terms of outstanding amounts, the IBRD loanaccounted for 3.41 of FOC total asets in 1986 and 4.72 In 1990. Most of itsfunds come from the domestic financial market, In particular the CDG group.Disbursements from the IBRD line of credit contributed only 6.1Z of FEC'stotal long-term borrowings.

CDG's involvement has thus always translated into considerablefinancial assistance to F8C and has never been an obstacle to its autonomy.Quite to the contrary, CDG constantly encouraged this establishment to searchfor new sources of financing, while remaining ready to come to its rescue, ifnecessary.

52

Ane 1hae et14

3. E2's..2eLtemMnce

At the technical level

In the early eighttes, RC bad a very small staff. A sustainedrecruitment drive vas made, however, to order to keep up with the expansion ofits activities. Between 1975 and 1960 only 7 people were hired. This =umbervas increased by 19 between 1980 and 1985 and by 14 between 1986 and 1991. Itnow has a staff of 44.

This nmber, which to considered insufficient to the PAR, hasnevertheless enabled 180 to develop a proportionately more extensive activity,in terms of both loan, granted and loans disbursed. Compared to otherfinancial agencies, 180 eanages, with a much lower mpersounel coats/volume ofbusiness" ratio, to achieve a remarkable performance.

The expertise and professional competence of its staff has risen,thanks to this reorganisation. The PAR, in drawntg attention to this aspect,indicates that the audit aission was tipressed by the competence with whichprojects are appraised by 13C.

As for the evaluation and supervision of the project., once theyhave received financing, this remains rather complex but could be handled withadditional necessary technical and human resources. Moreover, though theremight be some weakness at the project supervision level, attention needs to bedrawn to the fact that the projects were maost often carried out In response tothe urgent needs of the c*ome* Interested and that their finsancig, whichwas backed by the supervisory Ministry and its local authorities, originatedmore from State assistance to local development than from the sole interest ofbanks in the profitability of the projects.

At the financial level

The PAR refers to the choages that have taken place In thefinancial structure of 13C aisie 1983. These changes have, in severalrespects, been favorable and beneficial.

There are several Indicators of such an effects

* A steady IMprovement in total assetes D 561 million in 1983,DR 1,280 milon In 1987 and 2,603 allion In 1991.

* A consolidation of resoucess reflected in a reduction In theshort-term liabilitleatotal assets ratio from 722 in 1983 to 252in 1988 and 122 In 1991. In correlation, thanks to the domesticfinancial market, log-term resources have developed rapidlys themedium-and long-term debtitotal ssets ratio, which was only 1O

53

in 1985 quickly climbed to 661 In 1987 and had reached 832 by theend of 1991.

* The project*' return on equity, measured as net profit./equity,did, admittedly, show a significant deterioration, this ratiofalling from 6.6% in 1983 to 0.61 in 1987. Losses even had to bereported in the following two years.

from 1990 onwards however, this ratio began to recover, showing0.3% in 1990 and 2.66Z in 1991, even allowing for large provisionsfor losses. Beyond these developments, this Indicator is stillnot sufficient by itself to provide an Indication of the financialviability of FIC. Furthermore, any setback or even decline in theresults is attributable primarily to an increase In financialcosts generated by the use of more costly foreign resources.

* The only unfavorable element in the financial activity of PECundoubtedly still lies in the large volume of arrears payable bythe Rfgies de Transport (transportation sector utilities), whichtotaled about DR 60 million in 1991, and for which reserves wereestablished in accordance with current legislation. Overall,however, FEC's arrears now represent only 3.21 of total loansoutstanding. Generally speaking, this problem is now beingsettledl the arrears should be paid by the local governments towhich the pertinent Zwies are linked. What was stated In the PARshould be qualified by the fact that PEC contined, throughoutthis period, to receive the absolute support of CDG.

* Some Important measures were taken in order to Improve the statusof FEC, including increases in the rates charged to local

governments and rASius. These increases were introduced, Inparticular following the elimination of FEC's access to the.-entral bank for the rediscounting of its bills of exchange.

Thus, In addition to the 101 rate, which came into effect in 1986,five other rates were decided on on April 7, 1989 and wereadjusted on July 12, 1990. What is more, it would be wrong not totake account of IBC's special role as a local developmentfisancing agency, expected, among other things, to provide itsassistance to rural communes and autonomous centers, and localgovernments, most of which have Insufficient resources at theirdisposal. The rate for rural communes was therefore kept at 102,i.e. less than the cost of external resources, which was 10.601 in1989 and 10.93Z In 1990.

54

AnnezPage 6 of 13

4. Socioeconomic Indast

As highlighted in the Project Completion Report and referred to Inthe PAR, IBRD's US$16 million lne of the credit was used to finance 90projects.

The number of projects submitted to the Bank for approval underthe loan was actually 109, 90 of which were approved for a total amount ofsubloans of DR 134 million, representing 422 of the total cost covered by FOCassistance. The 19 projects not approved by the Bank were eventually financedby 1EC for a total of approsiately DR 226 million.

IBD Loan 2272-MOR has been fully disbursed saceFebruary 8, 1990.

The sectoral breakdown of the projects financed under this loanshould be identified in the report. Two key elements need to be stresseds

* 83 projects correspond to infrastructure for local governments.The IBRD loan proceeds allocated to these projects totaledDR 107 million, i.e. 442 of the loan in question.

* The sectoral breakdown of the assistance Is extremely diversified.In terms of the projects approved, three sectors account for mst,with 67 projects. These sectors are commercial Infrastructure,sanitation and water supply. In terms of financing, there Isgreater dispersion, i.e. 282 for commercial infrastructure, 222for sanitation, 121 for urban transport and 142 for water supply.

In terms of the total financing provided by FEC, these foursectors received 252, 212, 171 and 142, respectively.

It goes without saying that the projects financed will definitelyhave a socioeconomic Impact, since they contribute to the creation andupgrading of infrastructure, the primary benefiaaries of which are ultaimatelythe low-income and middle-Income segments of the population.

55

Annex 1Page 7 ot..13

Service du Credit lamobilier et IndustrielDivision du Cr6dit et des InvestisementsDirection du TrEsor et des Finances BatArieuresMinistry of financeXingdom of Morocco

GAIZL/A167

The World BankWashington, D.C.

For the attention of Mr. Yves Albouva Inrastructure and RnerU Diviston

Gentlement

Further to the Performance Audit Report you kindly sent me, I havethe honor to provide the following coamments a

1* The report notes the slow pace and disbursement difficulties thatcharacterized both the CIN and P8C projects. One of the factors responsiblefor this problem, which should be mentioned in the report, is the mismatchnoted between the criteria established by the Project and the programs adoptedby the two institutions involved and considered by them as well suited to theframework of the Project. This is particularly true in the case of the CIOloan, mobilization of which necessitated the relaation of various aspects ofthe lending conditions to bring them into line with the requirements of CIR'sprograms.

2. The report also indicates that the CIN Project did not totally benefitthe target group. This situation, the causes of which were discussed by CIIin the PCR, calls for two commentsa

- The project's objective, i.e. to Iaprove the supply of low*incomehousing, cannot be achieved simply by easing financialconstraints.

- The report concludes that it is necessary for the Bank's projectsto take an overall approach that encompassee all aspects of theactivities performed by the financial Institution serving asintermediary for project Implementation. One of the lessons to belearned is that it to also necessary for the Project to have

56

Pane 8.of 13

a broad view of all aspects and all dimensione of what Is beingfinanced. The CII project reveals, In this respect, that therewere sm Iportant Issues concerning the supply of low-incomehousing that had not been euamined and for which this projectfailed to provide the necessary solutions. What the housingsector needs from the World Bank is financial assistance as wellas assistance with Institutional and legal reforms, through aproject that to sufficiently broad based to deal with all theconstraints of the sector (financing instruments, land tenureIssue, etc.).

Faithfully yours,

lt Mohamed DAIRMDirecteur du Tr6sor at des Finances Ext6rieures

57

CauDIT UmoIlttr UT UorM1Mn (ea)Directorate of Flnanc Canablanca, May 11, 1993

IBXD1818 a Street, NWWashington, DC 20433

Attentions Infratrutur and 2nergy Divislon,Operationa gvaluation Department

Dear Sira,

i am pleased to send you herevith the Domments of the CIZ on thePerformance Audit Report on the fixst urban development project (oan 2245-

(signed) TA AbderrahimPinancUal Director, cM

56

Annex 1

Raa 10 o 13

Comments on the Performance Audit Reporton 1BRD Loan 2245-MOR

As part of its evaluation of projects financed by ZROD, the OperationsEvaluation Department has prepared an Audit Report on the First UrbanDevelopment Project in Morocco (Loan 2245-MOR made to the CIN in 1983).

The value of this report is evident insofar as it identifies the main

lines of the project and highlights its shortcomings, with the aim ofadjusting the Bank*s operations and maximizing the induced effects of theloan.

We would note, however, that the report sent to the CIR gives rise totwo series of comments, the first pertaining to project execution and thesecond to the financial performance of the CIN.

A - PROJECT EXCUTION

It should be recalled that the purpose of this line of credit was toencourage private and public developers to produce low-cost housing,affordable to low-income groups, and to develop the CIue ability to appraisehousing projects and advise developers on the execution of this kind ofhousing.

To be eligible for financing, the subprojects had to meet the followingcriterias

- The price of land was not to exceed DR 180 per m2l

- The average area of the dwellings was not to exceed 100 a2;

- Core units were priced at DR 32,000#

- One to two floor partially completed houses were priced at DX

48,000;

- One to two floor completed houses were priced at DR 62,000;

- Three to four room units in multi-story buildings were priced atDR 80,000.

These parameters were found to be inoperative, as the core units, even

if they could theoretically be produced in line with the above-mentionedcriteria, had no appeal for Moroccan households, which led to a total lack ofinterest by developers in this kind of housing.

59

AnneRARaa1nita

Purthermore, and contrary to what to stated in the report, the Cia,despite its desire to see the project succeed and the extensive sensitisationcampaign undertaken vis-A-vis private and public developers, came up againstthe problem of the non-availability of housing units satisfying thesecriteria.

This situation was due in particular to the quickly rising cost of landand construction materials the report notes the 41 percent rise in urban landin Casablanoa and the 20 percent increase in construction materials in theperiod 1987-1990 alone.

As a result, the CMa was unable to aske any withdrawals from the loan in1983, and two years later, i.e. at the end of the third year, only D 32million, or 6.25 percent of the total amount of the loan, had been disbursed.

Consequently, CIN had to pay a substantial commitment charge on theundisbursed balance, amounting to DR 10,061,276, equivalent to US $2,016,057,or 3.36 percent of the total amount of the loan.

The negotiations between the Bank and CIR led to a series of changes inthe eligibility criteria in order to align them with market realities and takeaccount of price increases; accordingly the upper limit for refinancablehousing was raised as follows*

Year Amount in DR

1983 80,0001984 95,0001985 115,0001986 130,0001987 140,0001988 150,000

It must not be forgotten that this credit line was phased over arelatively long period. Although it was signed on April 11, 1983, the finaldisbursement did not occur until Jan. 29, 1990, following three successiveextensions of the closing date.

There was no alternative to revising the eligibility criteria, since ifthis had not been done the loan would not have been disbursed. This isconfirmed by the refinancing criteria adopted for the second Urban DevelopmentProject, which includes two kinds of VIT, with ceilings of DR 150,000 and DR300,000 respectively.

60

Annes.Pae 12 of 13

B - FINANCIAL ROA O H CIR

The Performance Audit Report reters to the deteriorating financialperformance of the CIN between 1983 and 1990. This observation is essentiallybased on the behavior of the net profit margin, which, however, cannot be usedas a benchmark.

The analysis of a series of management, profitability and structuralindicators, as set out in the Appraisal Report prepared by the Bank in 1988for the Second Rousing Finance Project (Loan 3122-MOR), and in the ProjectCompletion Report on Loan 2245-MOR, indicates that in fact the financialperformance of the CIS improved over the period 1983-87, an improvement thatwas reinforced in the years following the conversion of the CIR into a depositbank.

In any event, the downturn ir. the net profit margin indicated in theBank's report, from 3.61 percent in 1983 to 2.57 percent in 1987, i of nosignificance, since this indicator is based on the net result. However, thenot result includes a significant amount of provisions set aside each year asa prudent measure to offset arrears, although the risks involved are in factminimal, in light of the guarantees given.

Consequently, it that part of the provisions set aside for bad debts notinvolving any risk is restored, net profitability in fact continues to improvefrom one year to the next. This is confirmed by the perfoaance of the grossprofit margin, which has behaved very favorably, as noted in the above-mentioned reports.

Contrary to the assertion in the report regarding the low level ofprovisions against possible loses, the following table indicates a certainstability, since the ratio of provisions to total lending plus arrears has notworsened over the years.

Year 1983 1985 1987 1990 1992Provisions 116 191 225 327 489Loans + Arrears 3,655 4,554 ,548 9,787 15,201Provisions/Loans 3.17 4.19 3.43 3.34 3.21

As regards the debtsequity ratio, we would point out that thisindicator, which did indeed rise from 10.35 to 13.97 between 1983 and 1987,has never reached its maximum permitted level of 15 percent. It should alsobe noted that two successive capital increases in 1988 and 1989, whichprovided DR 500 million of new money, were made for the purpose of increasingthe CiR's lending capacity. As a result the debtaeguity ratio steadilyimproved to reach the very satisfactory figure of 11.32 in 1991 and then 10.13in 1992.

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Pae13 of 13

Pinally, we would point out that, as regards deposits, the share of thiscategory of resources continues to increase in relation to other sources offunds. indeed, as a result of the importance accorded by CIS management todeposits, their share in total resources has increased over the last fiveyears from 2.5 percent in 1988 to 7.5 percent in 1989, 9 percent in 1990, 12percent in 1991 and 16 percent at the end of PT1992.

A more comprehensive view of the CIa's situation, as measured by anumber of important indicators, reveals a continuing improvement of which thefollowing significant results are evidences

- The constantly expanding level of activity, generating an ever-increasing cash flow over the years (DR 111 million in 1983, D178 million in 1988 and DR 504 million in 1992);

- The good performance of gross profits, particularly from 1988onwards, in which year the CIR initiated its deposit operationsthis margin reached 3.65 percent at the end of 19928

- The maintenance of the debtsequity ratio at very reasonablelevels

- The very low level of administrative expenditure (below theestablished norm);

- Satisfactory liquidity and debt-service coverage ratios;

- The provision of real estate guarantees for all loans made by theCie in addition to the State guarantee for all hotel loans.

As regards the mismatch which indeed exists between the due date forrepayment of Loan 2245-MOR and the maturity of the subloans to which itsproceeds were applied, the CII will rely on the Bank to help it find asolution that matches the reimbursement of the Bank's loan to the repaymentsto be made by beneficiaries of the subloans in question.

It should be noted that this mismatch involves a difference of 11 years,since the total maturity of developer-plu-mortgage loans on the one hand is28 years and the rembursement period of the IBRD loan is 17 years.