Document or

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-4042-CH

REPORI AND

OF THE

PRESIDEIT OF THE

TRTION BNK FOR AECOISUCION MiD DEVELOPMENT

TO TM.

EXECUrIVE DIRECORS

ON A

PROPOSED WAN

IN AN MOUNT EQUIVALENT TO US$100.0 NIELION

TO THE

REPUBLIC OF CHIL

FOR AN

INDUSTRIAL FINANCE REs cURl PROJECT

June 27, 1985

.

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

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CUREIC EQUIALR!

(Currency Unit: Chilean P0so (Ch$))

Calendar 1984Currency Unit Average Dec. 31, 1984 May 31, 1985

US$1 Ch$98.478 Ch$128.5 Ch$153.76Ch$1 US$ 0.010 US$ 0.008 US$ 0.0065Ch$1,000 US$10.127 US$ 7.782 US$ 6.504

FISCA.L TMAR

January 1 to December 31

AB RTATIONS

BHC - Banco Hipotecario de Chile(Mortgage Bank of Chile)

BHIF - Banco Hipotecario de Fomento Nacional(National Mortgage Development Bank)

CB - Banco Central de Chile(Central Bank of Chile)

Colocadora - Colocadora Nacional de ValoresNacional (National Securities Underwriter, a private bank)

CPI - Consumer Price Index

IDB - Inter-American Development Bank

IFC - International Finance Corporation

LIBOR - London Interbank Offered Rate

Superintendencia - Superintendencia de Bancos(Superintendency of Banks and Financial Institutions)

UF - Unidad de Fomento(Financial Unit of Account which reflects themovements in the Country's Consumer Price Index)

FOR OMCIAL USE ONLY- i.-

REPUBLIC OF CHILE

I3DS YRIAL INACE RE UCTURIG PROJEC

LOAN AND PROJBCT SUNNAY

Borrower: Republic of Chilea~a

ExecutingAgency: Central Bank of Chile (CB)

Anonut: US$100.0 million equivalent

Terms: Repayment in 15 years, including three years of grace, at thestandard variable interest rate.

RelendingTerms: The Central Bank as fiscal agent for the Government would on-

lend loan funds to commercial banks in US dollars or inChilean pesos. US dollar-denominated loans to commercialbanks would have rates equal to the Bank's interest rate plusa spread to compensate the Central Bank for the Bank's com-mitment fees and for the cost of operating the Technical Unit(TU). Commercial banks would onlend these funds charging athree percent spread. Interest rates on peso-denominatedloans to commercial banks and subloans to beneficiary enter-prises would be equivalent to those of dollar-denominatedsubloans and would be expressed in real terms calculated upona principal expressed in UF, by deflating the respective dol-lar rates by the United States Consumer Price Index (CPI).This would ensure that real interest rates would be the sametor both dollar- and peso-denominated loans and subloans.The repayment terms for subloans would be up to 15 years, in-cluding a grace period of up to three years.

ProjectObjectives: The proposed project would help the Government to undertake a

financial restructuring program of industrial corporations ona selective basis. The project is conceived as a pilot ef-fort that would be replicative in restructuring efforts car-ried on outside of the project.

ProjectDescription: The project would include assistance for: (a) establishing

and financing the institutional framework through which cor-porate restructurings would be devised, negotiated, and im-plemented; and (b) financing the purchase of capital goodsand working capital necessary to maintain and increase pro-duction.

This document has a restricted distribution and may be 11sca! by recipients only in the performance oftheir official duties. Its oDntents may not othewse be dislosed without World Bank authorization.

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ProjectBenefits: The proposed project would help to remove the finmncial dead-

lock that is hindering the recovery of industrial productionin Chile through the establishment of an institutional frame-work geared to promote the financial restructuring of selec-ted industrial companies and the provision of foreign ex-change financing needed by the restructured companies tocarry out required investments.

Projeet Risks: Credit demand could be curtailed if: (a) the economicsituation deteriorates further; (b) the Technical Unit failsto promote restructurings or proves incapable of analyzingthem properly; (c) individual restructurings prove too dif-ficult to be completed within the proposed loan's commitmentperiod; or (d) after being restructured, the firms obtaincredit from other sources. To mitigate these risks, theTechnical Unit would: (i) have detailed Operating Policiesand Administrative Procedures in line with the project's ob-jectives; ard (ii) be staffed by high-level professionalswith experience in corporate restructurings. The benefits toChile would be substantial, and the experience gained in thisoperation would be useful in the design of programs to sup-port firms in financial distress. Therefore, the overallbenefits of the project are expected to outweigh the riskssignificantly.

Estimated Costs: Local Foreign TotalTUS$M4illion Equivalent)

Investment Sub-Projects 147.6 147.4 295.0

Technical Assistance toTechnical Unit 2.4 2.6 5.0

Total Financing Required 150.0 150.0 300.0

Financing Plan:

Government 100.0 0.0 100.0

Other Sources 50.0 50.0 100.0

Bank 0.0 100.0 100.0

Total 150.0 150.0 300.0

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UstimatedDisbUzints: Bank PY: ., 198 t9B 199 l99 199 1992

Annual 1.7 10.2 19.4 30.4 18.0 15.7 4.6Cumulative 1.7 11.9 31.3 61.7 79.7 95.4 100.0

Rate of Return: Not Applicable

Staff ADpraimal Report: Report No. 5433-CH, dated May 20, 1985

REPORT AND RECONNEEDATION OF TEE PRESIDENT OF THE IBIDTO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO

THE REPUBLIC OF CHILE FORAN INDUSTRIAL FINANCE RESTRUCTURING PROJECT

1. I submit the following report and recommendation on a proposed loanto the Republic of Chile for the equivalent of US$100.0 million to help fi-nance an Industrial Finance Restructuring Project. The proposed loan wouldhave a term of 15 years, including three years of grace, at the standard var-iable interest rate. The Central Bank of Chile, as Bxecuting Agency, wouldonlend the loan proceeds to participating commercial banks in US dollar-de-nominated or Chilean peso loans. US dollar-denominated loans to commercialbanks would have rates equal to the Bank's interest rate plus a spread tocompensate the Central Bank for the Bank's commitment fees and for the costof operating the Technical Unit (TU). Commercial banks would onlend thesefunds charging a three percent spread. Interest rates on peso-denominatedloans to commercial banks and subloans to beneficiary enterprises would beequivalent to those of dollar-denominated subloans; they would be expressedin real terms calculated upon a principal expressed in UF, by deflating therespective dollar rates by the United States Consumer Price Index (CPI).This would ensure that real interest rates would be the same for both dollar-and peso-denominated loans and subloans. The repayment terms for subloanswould be up to 15 years, including a grace period of up to three years.

PART I - TE CONONI

2. An economic memorandum on Chile (Report No. 5099-CH) was circulatedto the Board on September 24, 1984. The following paragraphs are based onthe conclusions contained in that memorandum and on information gathered bysubsequent missions that visited Chile in November 1984 and January 1985.Country data sheets are attached as Annex I.

Evolution of the Economy to the end of 1983 11

3. In the four decades following the Great Depression, successiveGovernments sought to reduce Chile's vulnerability to world market fluctua-tions, accelerate economic development and achieve a more equitable distribu-tion of income. With the aim of reducing the country's dependence on im-ports, these Governments intervened in the determination of prices, erectedhigh protective barriers against foreign competition, offered special tax andother incentives to investment and entered directly into production and dis-tribution activities while controlling the allocation of credit and foreignexchange. During 1971-73, the Government undertook a major agrarian reform,expropriated a large part of the private industrial and mining sectors, andfollowed highly expansionary fiscal, monetary, and wage policies. In 1973,the public sector deficit exceeded one-fifth of GDP and stagnation, rapid in-flation and balance of payments problems became acute. Inflation exceeded500 percent and net international reserves were negative by more than US$300million.

1/ Substantially the same as Part I of the President's Report of the RoadSector Project presented to the Executive Directors on June 20, 1985.

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4. After 1973 the structure of the Chilean economy underwent pro-nounced change. The new Government, which came to power in late 1973,promoted private initiative and significantly reduced the role of the Statein the economic sphere. The public sector deficit was eliminated. Allprices, including interest rates, were progressively freed and most distor-tionse to relative prices were removed. Foreign investment was encouraged andtrade barriers were virtually eliminated. Major reforms were introduced inthe tax structure, in the budgetary process and in banking legislation.Finally, most of the enterprises taken over by the previous Government werereturned to the private sector. To reduce the hyperinflation anbd in responseto a major drop in copper prices, the Government initially undertook a severeausterity program; strong fiscal revenue and expenditure actions were imple-mented, the currency was massively devalued and, after 1975, a crawling pegregime was adopted which stimulated export-led growth. A depression, whichdeveloped in 1975, bottomed out during the first quarter of 1976 and, withits first current account surplus in twenty years, Chile was able to serviceits debt and increase substantially its net official reserves.

5. The economy responded well to the reforms. Between 1976-1980 realeconomic growth averaged 8.5 percent per year; by 1977, real GDP had returnedto 1971-1972 levels; by 1980 annual inflation was reduced to 30 percent. Thebalance-of-payments position improved markedly; the value of agricultural andmanufactured exports grew more than sevenfold between 1973 and 197B. Copperrevenues -- traditionally over 80 percent of export receipts -- had been re-duced to half of total export earnings. Net foreign reserves during the1973-78 period averaged over US$1.5 billion. By 1978, real wages and sala-ries had recovered to their 1970 levels and rose further as worker productiv-ity increased. The efficiency of the State enterprises improved significant-ly, and the public sector had an overall surplus by the late 1970s. But sincethese positive developments were accompanied by more efficient labor use, theunemployment rate fell slowly despite a major emergency employment program.

6. While the Government was eager to reduce the economic role of theState, it was equally determined to improve the quality of, and access to,social services to the poor. Previous income distribution policies and pro-grams -- such as price controls, public housing, cheap credit, factor sub-sidies, tax exemptions and broadly-based social expenditure programs -- notonly had had perverse growth effects, but often had been of equal or, in somecases, greater benefit to the urban middle class than to the poor. From themid-seventies on, although the Government spent less on the social sectorsthan predecessor governments (public social outlays only reached 1972 levelsin real per capita terms in 1980), it carefully targeted its spending on theextreme poor through a series of reforms in health and education that loweredsubstantially Chile's rates of infant mortality and child malnutrition.

7. After 1980, economic conditions changed with a major shift inmacroeconomic policy and the later world recession. On July 1, 1979 theGovernment ended its pre-announced crawling peg policy and fixed the Chileanpeso at Ch$39:US$1. This, combined with greatly lessened restrictions on ex-ternal capital flows and public sector surpluses, was expected to adjustdomestic inflation quickly to international levels. Uafortulnately, the timelag in the adjustment of inflation, combined with the subsequent appreciationof the U.S. dollar and 1981-83 world recession, produced an unsustainableboom, financed by massive inflows of foreign borrowings. Between end-1979and end-1981, Chile's private external debt tripled.

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8. The appreciation of the peso -- combined with the growing world re-cession -- finally had an overwhelming effect, as Chile's export earnings andinflows of foreign savings both dropped. By the end of 1981, the economy en-tered a recession. The lag in foreign exchange policy response led theeconomy from recession into depression. In 1982 GDP fell 14 percent. Realvalue-added dropped in construction, which had boomed in 1980/81, by almost22 percent; in commerce by 15 percent; in transport by 10 percent; and inmanufacturing by 22 percent. Real fixed investment fell almost 37 percent, adrop which was all the more discouraging because the country had only begunto improve its infrastructure, which had deteriorated greatly during the1970s.

9. Unemployment soared to 19 percent by 1982 as the economy enteredthe depression. The financial situation of many firms and banks deterior-ated. As early as November 1981, the Government assumed responsibility forday-to-day management of a few insolvent banks, but the situation worsenedconsiderably in 1982, with a series of bankruptcies. The crisis finallyforced the Government to devalue in June 1982, and subsequently follow acrawling peg exchange rate policy. In January 1983, after the IMF agreed toan SDR 795 million Stand-by, a financial crisis was triggered by massivebanking insolvencies and a huge capital outflow. The Government liquidatedsome banks and intervened 2/ in others, providing immediate liquidity toavoid collapse of the financial system. A "shadow program" -- by which theoriginal targets could be met by September -- was then drawn up. By end-July, agreement was reached with foreign banks, providing Chile with much-needed financial support.

10. By following severe deflationary policies, Chile complied with itsoriginal September 1983 IMF targets; a feat that reflects favorably on thecountry's determination to meet its external obligations. A reduction in therate of inflation to 23 percent and a current account deficit of only US$1.5billion were achieved. External balance, however, was achieved at the costof a one percent drop in real GDP. Private consumption fell seven percent.The unemployment rate dropped to 16 percent, but only because the emergencyemployment programs were employing ten percent of the work force.

Recent Economic Developments

11. The depression bottomed out in late 1983. A growing public invest-ment program and Central Bank financing of domestic debt reschedulings sup-ported strong increases in demand and production in the first semester of1984. Furthermore, a March agreement with its international creditors pro-vided Chile with $780 million in fresh medium-term capital and a major in-crease in short-term debt followed. As a result, GDP grew 6.3 percent. In-dustrial, agricultural and fishing output all grew faster than GDP. Employ-ment increased sharply; 250,000 more productive jobs were created -- a 9.2percent increase -- allowing the Government to reduce its emergency-work pro-grams by 137,000 jobs, while unemployment dropped to a 13.3 percent rate --its lowest since 1981.

12. Despite an almost ten percent volume increase in noncopper exports,Chile's export earnings -- denominated in US dollars -- dropped five per-cent. Copper prices dropped 12 percent to the lowest real level since the1930s, so that Chile's record volume of copper exports did not lead to in-

2/ "Intervention," in the Chilean context, means the taking over, by theSuperintendencia, of the day-to-day management of financial institutions,without affecting the institutions' ownership structure.

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creased copper receipts. Noncopper exports also suffered price drops -- 4.5percent -- reducing the earnings from the volume expansion of agriculturaland industrial export products which increased by 31 and 7.7 percent, respec-tively. After two years of heavy import compression, the 1984 recovery ledto imports of $3.3 billion, an 18 percent increase over 1983. Capital im-ports grew fastest -- 44 percent. To cope with the growing foreign trade im-balance and to ameliorate the reduction in copper tax revenues, the Govern-ment increased import tariffs to a 35 percent uniform rate, while devaluingby 23 percent in September 1984.

13. A new three-year Extended Fund Facility (EFF) program has beenagreed with the IMF. To sustain the recovery, a three-year public investmentprogram places emphasis on export promotion and job generation. The conclu-sions of a Bank public investment review mission, which visited the countryin November/December of 1964, are that the program's goals are effectivelysupported by the projects included in the program. Corporate and individualtaxes are now being reformed to stimulate investment and savings and a gener-al financial program was defined by the Superintendency of Banks and theCentral Bank to capitalize intervened banks. Major reforms in the structureof large business groups continue, and ownership conflicts -- which havecaused investment delays -- are being resolved, so that currently-restrictedexport-oriented firms may soon increase production.

Prospects

14. In spite of these actions, the Chilean recovery remains precar-ious. A severe earthquake, which struck the country on March 3, 1985, caus-ing in excess of US$500 million in damage, has made economic recovery evenmore arduous. Growth is severely constrained by foreign exchange limita-tions. The external debt -- including short-term debt -- nearly equalled1984 GDP; interest payments on it were over 45 percent of the country's ex-ports. Increased export earnings depend, in part, on a rapid expansion ofnoncopper exports. The Government, recognizing this, has taken action andhas established an attractive exchange rate policy. It is also taking otheractions to stimulate exports, including import tariff reductions. Even withstrong gains in export volumes, Chile's prospects are linked to its terms oftrade and -- given its high debt burden -- world interest rates. Chile'sterms of trade are expected to improve by about five percent in 1985, basedon current Bank commodity price projections. Near-term interest payments arecurrently being decided during ongoing meetings with international creditorbanks.

15. For moderate GDP growth of about 2.5 to 3 percent to continue overthe medium term, Chile would not only need to increase domestic savings andaccelerate exports, it would also need further substantial net inflows ofcapital. So far, the country has made determined efforts to comply with itsforeign obligations. A realistic exchange rate policy should stimulate astrong volume expansion of noncopper exports, and most of these exports havebetter market prospects than copper. The public investment program is noworiented to support more strongly a productive recovery. Private incentivesare also being oriented to export expansion or efficient import-substitutionas well as to employment and savings generation. Despite these efforts,Chile's continuing recovery and creditworthiness will depend on how much sup-port can be obtained from creditors for its three-year progra1 . Thus far,the country has addressed its medium-term constraints with sound policies,which strengthen prospects for obtaining the necessary external financing.

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Even so, to improve its creditworthiness, Chile will not only need to complywith its EFF and reach agreement with its commercial creditors, but it willalso need to define and implement a recovery program which the Bank can sup-port. The proposed project would be part of such a program; it would make amajor contribution to stimulating corporate financial restructurings, in-creasing investment and production in the private sector. Thus, it wouldrepresent an important element in the country's economic and financial re-covery. Therefore, because the country has so far complied with its externalobligations, and provided it successfully completes its negotiations with itsexternal creditors, it is considered creditworthy for this loan.

PART II - BANK GROUP OPERATIONS 3/

16. By March 31, 1985 the Bank had made 32 loans to Chile, amounting toUS$711.6 million (net of cancellations) of which six were not yet fully dis-bursed. IDA had also extended a US$22.9 million credit to the country for aroad project in FY81. IFC gross commitments in Chile an of the same datestood at US$56.4 million. Annex II has further details on IBRD and IFC oper-ations as at March 31, 1985.

17. Of total Bank and IDA lending to Chile, 27 percent has been forroads, 23 percent for power, 22 percent for agriculture (including irriga-tion), 11 percent for housing, seven percent for mining, five percent forwater supply, and the balance (five percent) for industry, education andtechnical assistance.

18. Historically, the volume of Bank lending to Chile has fluctuatedsubstantially in accordance, inter alia, with the country's economic per-formance and the availability of suitable projects. In the FY75-77 period,the Bank made four loans totalling US$107.8 million to help finance projectsin the agriculture, copper mining and power sectors. The Bank did not lendto Chile in FY78-79, but in FY60 it approved a US$38 million loan for a watersupply project and, in FY81, two loans in the amounts of US$36 million andUS$42 million for a Second Agricultural Credit Project and a Highway Recon-struction Project, respectively. During FY82-84, only one Bank loan, aUS$128 million Second Highway Reconstruction Loan, was made to the country.In FY85 four loans were approved -- a US$56 million loan for AgriculturalServices and Credit, a US$80 million loan for Public Sector Housing, a US$11million loan for a Public Sector Management Technical As3istance Project, anda US$140 million Road Sector loan. The Bank has also modified existing oper-ations to permit almost US$25 million in proceeds to be used for earthquake-related emergency repairs and reconstruction, principally in the transportsector, but also in housing.

19. Execution of Bank-financed projects has been satisfactory. Dis-bursement of Bank loans reached US$32.6 million in FY82. Then in FY83, withthe current depression at its nadir, disbursements declined to US$22.3 mil-lion. This was in large measure because of the two-year lending hiatus aswell as the fact that the farmers' debt burden, and investment uncertainty inthe agricultural sector, created disbursement problems for the FY51 agricul-tural credit project; however, modifications to this project have helped ex-pedite disbursements, and it is now expected that this loan will be fullydisbursed by the closing date. Disbursements on Bank loans in FY64 reachedtheir highest historical level of US$34.5 million.

3/ Substantially the same as Part II of the President's Report of the Road SectorProject presented to the Executive Directors on June 20, 1985.

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20. The Bank's present lending strategy is to support the Government'smedium-term economic adjustment program by focussing on improvements in:(i) external trade policies that would ensure an acceleration of exportgrowth and efficient import-substitution and further diversify production andexports; (ii) public sector management and fiscal policies to reactivate theeconomy and strengthen public savings in a timely way with emphasis on makingbetter use of existing infrastructure and productive capacity; (iii) finan-cial policies to stimulate domestic savings and to allocate credit more ef-ficiently; and (iv) policy incentives to expand productive employment. Theproposed Structural Adjustment Loan is the keystone of this strategy. TheIndustrial Finance Restructuring Loan complements this strategy. These oper-ations would contribute to improved efficiency and enhanced savings, as wellas stimulate much needed employment and output in the private producing sec-tors.

21. Over the next few years, it is expected that the Bank will continuesupporting the Government's medium-term economic adjustment program throughfurther SALs. Sectoral operations will also be prepared in small enterpriseindustrial credit, water and sewerage and in productive sectors such as agri-culture and forestry. As part of the Bank's program of emergency assistance,following the recent earthquake, a Port Reconstruction Project might also beprepared during 1985 and 1986. A proposed multimodal transport operationwould emphasize rationalizing competing modes of transport and prepare thecountry better for the container age. The operation for small industrycredit would help strengthen and diversify the structure of production amongsmaller producers which can be expected to increase efficient import-substi-tution. Lending for water and sewerage facilities would meet importantresidential health needs and would also improve the export marketability offresh agricultural produce. Lending for energy, agriculture and forestrywould not only contribute to expanding output and employment, but would alsoincrease net foreign exchange earnings and savings.

22. Although Chile's debt situation is currently limiting cofinancingopportunities, the responsible way in which the Authorities are handling thecountry's external obligations augurs well for future operations in which theBank could co-lend with commercial banks. International commercial banks areconsidering providing Chile with new funds to tide the country through thenext year but have yet to resume lending on a voluntary basis. Opportunitiesfor cofinancing with the Inter-American Development Bank (IDB) are also beingexplored. IDB has a sizeable program in Chile; it is focusing primarily onagriculture, industry, power, and transportation -- sectors in which the Bankis also preparing operations. IBRD exposure in Chile currently stands at 1.6percent of public debt and about 1.4 percent of total debt.

PART III - THE FINANCIAL AND INDUSTRIAL SECTORS

A. The Financial Sector

23. As of November 1984, the Chilean financial system comprised theCentral Bank of Chile (CB), 38 commercial banks (the largest of which, Bancodel Estado, is Government-owned) and seven financial companies("financieras"). Commercial banks are multi-banking institutions and operateat both the short- and long-term ends of the market, financing all kinds of

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activities and trading in mortgages and commercial paper. Manyfinancieras, much smaller institutions, are associated with commercialbanks. They do not receive demand deposits and account for less than twopercent of the total system's outstanding credit. The banking market ishighly concentrated: of the 38 commercial banks, the five largest accountfor 60 percent of the system's credit. Other financial institutions in-clude sever mutual funds, 12 private pension funds, 51 insurance companiesand the Santiago Stock Exchange. The Central Bank is the highest monetaryauthority in the country, sharing with the Superintendency of Banks(Superintendencia) the supervision of the financial system. It is managedby an Executive Committee of three members, appointed by the President ofthe Republic. The Chairman of the Committee is also the bank's presidentand has a rank equivalent to that of a cabinet member. The Central Bankundertakes all of its credit activities through commercial banks andfinancieras. The Superintendencia is an autonomous body, and its author-ities are appointed by the President of the Republic. Both institutionsare well run and their staffs are highly qualified.

24. Several factors led to the creation of large industrial/financialconglomerates in Chile. At the end of the Allende regime, under the threatof widespread confiscations, the prices of all assets fell sharply, andmany of them changed hands at extremely low prices. When the political re-gime was changed, the assets' prices increased again, creating a specula-tive mood in the business community. Speculation was further encouraged bythe sale of most Government-owned firms that the new Government undertookshortly after its accession to power. Given the depressed state of theeconomy at the time, assets had not yet recovered their equilibrium prices,and those firms were sold in public auctions at very low prices, mostly toconglomerates formed to purchase them. As the economic situation improvedin subsequent years, asset prices increased, and the conglomerates obtainedlarge capital gains. Later in the 1970s, the Government denationalized thebanks, and most of them were bought by the newly formed groups, which thenused the banks' credit to finance further acquisitions and, in some cases,to pay for the shares of the banks themselves. Eventually, these conglom-erates established networks of financial institutions (banks, mutual funds,insurance companies) that channeled the cash they needed to keep on growingthrough acquisitions. Two big groups predominated: the BHC group, con-trolling Banco de Chile and its subsidiaries (accounting for close to 30percent of the financial system's credit) and the Progresa group, con-trolling Banco de Santiago, BHIF and Colocadora Nacional (accounting forabout 20 percent of the system's credit).

25. The trend toward incestuousness in the relationship betweenfinancial and nonfinancial companies worsened at the end of the decade,when a substantial overvaluation of the Chilean peso created incentives forcross currency speculation. From June 1979 to June 1982, the Governmentfixed the foreign exchange rate in dollar terms in order to reduce domesticinflation to international levels. During that period, prices of domesticnontradeable assets continued rising at the diminishing but still highlocal rate of inflation, while the price of the US dollar remained fixed inpeso terms. This made it profitable to borrow in apparently low-interestdollar-denominated funds to speculate in real estate and in peso-denominated financial assets. Moreover, cheap imports discouraged trade-able activities, and nontraditional exports, one of the main sources ofgrowth in the previous five years, lost international competitiveness

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and tended to stagnate. As a result, investment in industrial activitiesremained low, while the private sector's exterial debt was increasingrapidly, from US$2.7 billion at the end of 1978 to US$10.5 billion at theend of 1982. Eventually, close to 60 percent of the private sector debtwas denominated in US dollars, and about 60 percent of it was invested inactivities that do not generate foreign exchange. This credit was highlyconcentrated; at the end of 1982, 19 percent of the financial system'scredit was allocated to firms related to the creditor banks. One of them,the second largest bant in the country, had 4? percent of its total creditallocated to its related companies. When the devaluation finally tookplace in June 1982, the price of domestic assets fell drastically in dollarterms, large capital losses occurred and, in many cases, the value of theclaims on those assets exceeded the value of the assets themselves.

26. In markct economies, losses incurred by defaulting firms arenormally absorbed by their owners, the shareholders of creditor banks, or,if necessary, by the depositors and holders of other liabilities of failedbanks. The Government intended to take this approach when it became clearthat several banks would fail as a result of the mounting financialcrisis. In January 1983, however, as public confidence in the bankingsystem eroded because of the mounting debt crisis, the Government providedCh$100 billion in liquidity assistance to support domestic banks financial-ly, intervened five of them, and guaranteed 100 percent of the value of de-posits. Although, at the time of heavy external borrowing, the Chilean au-thorities had made it clear to all parties involved that no public guaran-tee would be provided for the private debt, in early 1983, it explicitlyguaranteed the external debt of the private financial sector maturing in1983-1984 when it was rescheduled, and provided assurances to internationalcreditors that this debt would be serviced adequately during that period.These guarantees, however justified in the Government's view by the need topreserve the integrity of the financial system and to ensure theavailability of external credit for Chile, effectively blocked the mainmechanism that the market has to allocate losses. As a result, only asmall portion of the losses has been written off by both local and foreignbanks, and there is a discrepancy between the book value and the real valueof the assets.

27. Banks are trying to avoid writeoffs by clinging to unrealisticrepayment agreements they have reached with debtor firms and amongthemselves. This attempt to forestall losses that have already beenincurred has paralyzed the financial markets, at a very high cost to theChilean economy. As a result, the losses that the banking system willeventually hav,e to absorb in its loans to these firms have increasedconsiderably. Furthermore, productive activities are being hindered by thefinancial deadlock since resources are being kept away from efficientcompanies in order to sustain firms that, de facto, went bankrupt yearsago.

28. Since 1982, the Chilean banking system has suffered losses equiv-alent to more than three times its equity capital and has been able to sur-vive only because of the strong support it has received from the CentralBank. The losses, however, were concentrated in banks that had been con-trolled by large conglomerates, and, especially, in the five banks now "in-tervened" by the Superintendencia, which account for 41 percent of thecredit and 66 percent of the non-performing assets of the banking system.Some of the non-intervened banks, however, seem to be in conditions similar

to those of the intervened ones, and only one Chilean bank (BICE) has non-performing assets below ten percent of its portfolio.

29. The Government implemented, in early 1984, a scheme to regular-ize the financial help provided to the non-intervened financial system.Under this scheme, participating banks and financieras sold their worstportfolio to the Central Bank, receiving, in payment, the funds that theCentral Bank had already provided to them as liquidity assistance. Sixteenprivate banks chose not to participate in the program since, under thescheme, participating financial institutions would have to devote all theirfuture profits to repurchasing this portfolio from the Central Bank, payinga five percent real interest rate on the outstanding amounts. In essence,this arrangement is a loan from the Central Bank to the banks' share-holders, precluding them from receiving any dividends or capital gains un-til the whole loan is repaid. The banks can, however, issue new sharesthat would be exempt from this obligation and could receive dividends pro-portional to their participation in the institutions' equity. Implementa-tion of this solution has failed, so far, to solve all cf the portfolioproblems of participating banks. Risk assets (i.e., loans in arrears formore than 90 days, accrued but uncollected interests, and goods r-ceived inpayment as a result of foreclosures, and considered insufficient to covertheir related debts) still represent 34 percent of the non-intervenedbanks' equity capital. Nevertheless, the financial situation of the non-intervened banks is improving since they are operating profitably and arebuilding up reserves to cover potential losses that could arise from theirrisk assets.

30. Intervened banks (which account for 41 percent of the crclitmarket) show an asset account called "deferred losses" in their books(losses that have already been recognized but have yet to be written off)equal to 93 percent of their nominal equity. In addition, they have sub-stantial arrears and have to repurchase the non-performing portfolio pre-viously sold to the Central Bank. The Government is devising a plan to"recapitalize" these banks in two stages: (a) it would convert into equitya portion of the credit that the Central Bank has given them, in an amountsufficient to put these banks on financial terms equivalent to those of therest of the banking system; and (b) it would then apply to them the schemethat was used with the non-intervened banks. To implement this plan, a lawauthorizing the Government to buy newly issued equity in these banks hasbeen prepared; this law restricts Government holdings in any bank to a max-imum of 49 percent of the shares outstanding at any given moment, andforces the Government to sell the shares to the public within five yearsafter the purchase. The implementation of this plan started in the firsthalf of 1985. Although it could take a long period for the Government tosell its participation in these institutions, the intervened banks would be"recapitalized" as soon as the Government purchases these shares and thebanks enter into the new portfolio repurchasing agreement with the CentralBank, in effect ending the Government's intervention of the commercialbanks.

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D. Th Industrial Sector

31. Since 1973, economic reforms have reduced the Government's inter-vention in the economy, allowing the market to allocate economic re-sources. Of these reforms, the liberalization of the external sector --tariff reductions from a 97 percent average level in 1973 to a uniform tenpercent in 1979, elimination of quota restrictions -- affected thestructure of the industrial sector substantially. The reduction caused ashift in the allocation of resources, away from the production ofimport-substitution manufactures and into resource-based exports. Asubstantial portion of the import-substituting industry disappeared andresource-based exporters, such as pulp and paper, fishing, lumber and freshfruits, grew at a very fast rate. Since the Chilean manufacturing sectorhad been largely oriented toward the domestic market and had growninefficient behind a multitude of trade barriers, the trade liberalizationresulted in a decline in the share of the sector in the country's GDP from25 percent in 1970-1973 to 20 percent in 1981-1983. The share ofmanufacturing employment in the economy also fell from 17 percent in 1977to 13 percent in 1983.

32. Since 1981, the drastic fall in domestic demand has depresseddomestically oriented manufacturers, especially those producing consumerdurables and intermediate ccnstruction goods. Given the nature of Chile'sbalance of payments problemi, further measures to restrict domestic demandcould be necessary. This is likely to have a negative effect upon thefuture growth of manufacturing. The more competitive exchange rate, how-ever, has increased demand for locally produced goods with high domesticvalue-added (e.g., textiles, clothing, furniture and metal products) andhas also increased the international competitiveness of Chilean industry.Several manufacturers whc have so far produced only for the domestic marketare now able to compete internationally and are currently exploring poten-tial markets for their product3.

33. As a percent of value-added, credit to the manufacturing sectordecreased, during the years of overvaluation, from 45.1 percent to 40.4percent, but, as a result of the 1982 devaluation, it went up to 65.7 per-cent. Although this figure is lower than the average for the private sec-tor as a whole (77 percent of GDP), the burden of this debt is proving ex-cessive for some manufacturing companies. As a result, principal and in-terest on these loans have been repeatedly rolled over by commercial banksduring the last two years. A large number of the country's productive com-panies are involved in these agreements and are caught in a vicious circlesince their repayment capacity depends upon their ability to grow, but theycannot expand because they are too heavily in debt to undertake the neces-sary investments. The failure to restructure these companies financiallywhen it first became clear that they would not be able to fully servicetheir debts has significantly worsened their financial condition becauseaccrued interests have compounded their financial distress to the extentthat many of them, which were viable two years ago, now have lest theirequity capital many times over. Although the most seriously affected com-panies tend to be those producing for the domestic market, several export-ing companies are also weak financially, and some of them are troubled bythe ownership problems resulting from the financial collapse of their hold-ing companies.

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(i) Industrial Investment Requirements

34. The 1982-1985 devaluations have created opportunities for export-ers and efficient import-substituting companies, which are currently plan-ning investments, to both increase their efficiency and expand their pro-duction capacity. In total, fixed investment demand from non-mining indus-trial companies can be estimated on the order of US$500 million for 1985-1987, of which US$300 million would represent foreign exchange expendi-tures. The weak financial situation of Chilean industrial firms, however,is making it difficult for them to proceed with their investment plans.Therefore, the materialization of industrial investment and growth crucial-ly depends upon the realization of a case-by-case financial restructuringof industrial enterprises.

(ii) Industrial Restructuring

35. Although the industrial sector is recovering from the 1982-1983 de-pression, its recovery remains precarious. The two major factors hinderingrecovery are: (a) the sector's debt burden; and (b) the legal uncertain-ties stemming from the financial collapse of holding companies. TheCentral Bank has implemented two successive across-the-board reschedulingsduring the last two years, both aimed at firms owing less than US$3 millionequivalent. Firms with larger debts were supposed to renegotiate theirdebts directly with their creditors on a case-by-case basis. The across-the-board programs for the smaller debtors, while extending loan maturitiesand reducing interest rates, addressed short-term constraints and, in ef-fect, have probably delayed the long-run solution: the allocation oflosses among creditors. The first round of renegotiations of the largerdebtors is by now almost concluded. Many of these renegotiations, however,have resulted in unrealistic agreements that leave debtor firms unable tomeet their new contractual obligations and also severely constrained intheir growth potential.

36. Chilean banks could lower their long-run losses if they reducedthe financial burden now imposed upon borrowers through immediate loanwriteoffs (partial or total), conversions of debt into equity, or other re-lief schemes. Liberated from the excess burden, debtor firms could growfaster and repay a larger portion of their obligations than otherwise.Banks have not done this during the past two years, however, because of thefollowing main reasons: (a) a thorough financial restructuring of the pri-vate sector would have caused the banks' own bankruptcy; and (b) creditorsand debtors have been expecting a Government bailout that would allow banksto reduce the financial burden of their debtors without causing losses tothe banks' shareholders. There is a growing perception, however, that theGovernment lacks the financial power required to bail out the entire pri-vate sector. These developments tend to favor the undertaking of a case-by-case restructuring that could effectively liberate efficient firms fromtheir excessive debt burden and undo the financial deadlock that is hinder-ing the country's economic recovery.

37. To undertake a once-and-for-all restructuring, the banks may haveto: (a) reduce their claims on the firms' cash flows and (b) increase theirexposure to finance normalized operations and, when appropriate, their ex-pansion. For the reduction of their claims on the firms' cash flows, banksmay prefer to substitute equity or quasi-equity for debt instead of writing

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writing off loans. This will allow banks to participate in the future pro-fits or cash generation of the restructured firms. The Superintendencia isallowing banks to take newly issued shares as repayment, but the BankingLaw requires them to dispose of shares within a maximum period of threeyears, even if they are non-voting stock. The Government is reluctant tochange this provision of the law because the current banking problems werecaused, to a large extent, by the interconnection between financial andnonfinancial firms; it therefore prefers the use of quasi-equity instru-ments such as subordinated convertible debentures, i.e., loans at low (orzero) interest rates that can be converted into equity shares by the credi-tor, at a specified price and within a given period, and whose payment iscontingent upon the availability of resources to first service more seniordebt.

38. The use of convertibles would allow the banks to wait for a muchlonger period for the firms to generate profits, and then to participate inthem through capital gains, if they can sell the debentures or shares atprices higher than those at which they acquired them. There are provisionsin the law limiting the amount that banks can invest in bonds as well asthe overall exposure that they can have in any single firm or conglomer-ate. The Superintendencia, however, is considering bonds received in pay-ment and increases in exposure derived from restructurings as exceptions tothese provisions. Furthermore, it has upgraded the classification of theremaining debt of properly restructured firms.

39. Given the significant participation of foreign banks in thefinancing of Chile's private sector, the participation of these banks inthe restructuring process is essential. A case-by-case approach, linkingrepayments to the cash-generating capacity of each individual firm, wouldencourage such participation. Moreover, a precedent was established inSeptember 1984, when several foreign banks wrote off 80 percent (US$44 mil-lion) of their claims on an industrial company declared bankrupt, in ex-change for repayment, in cash, of the remaining 20 percent. After this ac-tion was taken, the bankruptcy was lifted and the company is now operatingnormally. It is likely that international banks will have to go throughsimilar operations in the immediate future because no alternative solutionappears to exist for a substantial portion of the country's industrialfirms.

40. If it is restructured well, lending to a company previously infinancial distress could be an attractive business proposition because thecompany would represent a better risk. While international banks are re-luctant to increase their exposure in Chile, Chilean banks have to increasetheir operations in order to recover from their losses, and there are notmany good credit risks in Chile nowadays. A more serious problem is posedby the availability of resources to pass on to the restructured firms,which, at least initially, will have to be provided in part by equipmentsuppliers and by multilateral lending institutions, such as the Bank andthe Inter-American Development Bank (IDB).

C. Legal Issues

41. Chilean legislation provides an adequate framework for restructur-ings to take place. The main instruments used in financial restructurings(writeoffs, conversion of debt into equity or quasi-equity, subordinated

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loans, warrants and options, preferred shares of various kinds) can beutilized legally in Chile. The absence, in Chilean law, of provisionssimilar to those in "Chapter 11" of the U.S. Bankruptcy Code (temporaryprotection from bankruptcy) has frequently been mentioned as a hindrance topotential workouts. It has also been suggested that its inclusion would bethe main improvement that can be introduced to facilitate debt renegotia-tions. However, this is not a key issue because, under existing Chileanlegislation, creditors and debtors can reach judicial or extra-judicialagreements that substitute for temporary protection from bankruptcy. More-over, even if companies are declared bankrupt, they can continue their op-erations for up to 18 months ("continuidad de giro") if certain conditionsare met, and bankruptcy can subsequently be lifted if creditors accept theconditions set by the receiver to restructure the company (if not, the com-pany is liquidated immediately). This mechanism can actually prove moreeffective than protection from bankruptcy to force realistic agreements be-cause it presents the choices quite clearly and demands more rapid deci-sions.

D. Bank Strategy in the Industrial Sector

42. The financial crisis of the industrial sector is one of the mainobstacles to Chile's future economic growth. The Government, aware thatprevious measures have been insufficient to remove it, has decided to takea case-by-case approach in assisting industrial firms to design and executefinancial restructurings conducive to investment and growth. Financial re-structuring of the private sector involves two tasks: (a) the reduction ofthe financial burden of productive companies to levels that could allowthem to invest and grow; and (b) the strengthening of the banking system towithstand the losses resulting trom this reduction. The Government is cur-rently implementing a program to "recapitalize" the banking system and hasasked the Bank to concentrate its help in this project upon corporate re-structurings.

43. In designing the proposed project, the Bank agreed with theGovernment on the following strategy: (a) case-by-case restructurings wouldensure that scarce financial resources would be allocated to efficientfirms only; (b) all decisions concerning individual workouts would be takenby the parties directly involved (debtors, creditors, shareholders and,when appropriate, receivers and bankruptcy judges); (c) the Governmentwould be a catalyst, facilitating and promoting individual workouts; and(d) the proposed project would set up a mechanism to facilitate restructur-ings and then provide fresh resources to finance the normal operation andexpansion of restructured firms. No funds of the proposed loan would beused for refinancing of existing obligations.

44. Given the magnitude of the private sector debt, it is proposedto use the proceeds of the proposed loan for financial restructurings ofindustrial corporations (including mining and agroindustry), although theproposed project's institutional framework could also be used to help inworkouts of firms in other sectors of the economy. To make restructuringspossible, the Government would agree to abstain from granting subsidizedcredit lines that could compete with the proceeds of the proposed loan witheasier borrowing conditions (Section 3.05 of the draft Loan Agreement).Since the costs involved in the establishment of this institutional frame-work make it suitable primarily for channeling relatively large subloans,

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the proposed loau is expected to assist mainly medium- and large-scalefirms. Help to small-scale firmn would be channeled through a proposed SmallScale Industry Project, now under preparation.

PA IT - TMEPROaCT

45. The proposed project was prepared by the Central Bank of Chile andBank staff missions that visited Chile between June and November 1984. AStaff Appraisal Report entitled "Chile, Industrial Finance Restructuring Pro-ject" No. 5433-CH dated, May 20, 1985 has bedn distributed to the ExecutiveDirectors separately. Negotiations took place in Washington, D.C. from April15 to 19, 1985. The Chilean Delegation was headed by Mr. Claudio Pardo,Director of Chile's Central Bank. Supplementary project data are contained inAnnex III.

Project Objectives and Description

46. The project's major objective would be to assist the Government toundertake a financial restructuring of industrial firms on a selectivebasis. The project is conceived as a pilot effort that would be replicativein restructuring efforts carried outside the project. The proposed projectwould include the following components:

(i) technical assistance for the establishment of a Technical Unitwithin the Central Bank to manage the corporate restructuringand financing of eligible firms; and

(ii) medium- and long-term credit (subloans) to eligible industrialcompanies to finance the foreign exchange cost of (a) machin-ery, equipment, buildings and related civil works; (b) perman-ent working capital; and (c) technical assistance services re-quired by industries.

Project Execution

47. The Republic of Chile would be the Borrower and the Central Bank ofChile the Executing Agency. The Central Bank would create an autonomousTechnical Unit which would be in charge of approving and supervising thefinancial restructuring of eligible companies, and of appraising and approv-ing subloan requests. Subprojects approved by the Unit would be submitted tothe Central Bank's management for final approval. The Unit would have aBoard of Directors consisting of representatives of the Central Bank, theMinistries of Finance and Economy, and the Superintendencies of Banks and ofCorporations. The representative of the Central Bank would be the Presidentof the Unit to ensure a close coordination between both institutions. TheUnit would be staffed with high-level professionals under the direction of amanager reporting to the President who, in turn, would report to the Board.The Unit's operations would not be tied exclusively to the proposed Bankloan, but would also help arrange other workouts. The Central Bank would payfor the expenditures of the Unit, part of which would be covered with a mar-gin of half a percentage point that for this purpose the Central Bank wouldearmark from its net proceeds from this loan (Section II (5) and (6) ofSchedule 1 of the draft Project Agreement). In addition, some of the loanproceeds, amounting to US$2,600,000, would finance the expenditures of ex-ternal and full-time consultants to review subprojects and workout proposals(Section 2.02 (a) (ii) of the draft Loan Agreement). The Unit would

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initially be staffed with a manager. The rest would be e-anomists or busi-ness management specialists with strong financial and corporate backgrounds.The Unit would be managed in accordance with a Statement of Operating Poli-cies and Procedures reviewed and approved by the Bank. Changes to the State-ment of Policies would have to be approved by the Bank (Section 4.01 (i) ofthe draft Loan Agreement).

Subloan Eligibility and Limits

4B. Subloans would cover estimated foreign exchange costs of: (a)fixed assets (machinery, equipment, factory buildings and related civil worksand services); (b) permanent working capital (initial stocks or increases instocks of imported raw materials, spare parts and components required for in-creases in productive capacity or in the rate of utilization of existingcapacity); and (c) technical assistance services required by industries. Un-less otherwise agreed by the Bank, not more than 50 percent of the loanwould be used to finance subprojects requiring working capital financing inexcess of 70 percent of the subloan (Section 2.02 (c) (iv) of the draft LoanAgreement).

49. Eligible firms in need of restructuring should not have government-al participation (directly or indirectly) in excess of 50 percent of theirequity capital, unless satisfactory plans are submitted to decrease such par-ticipation to less than 50 percent within a five-year period (Section I,para. (b) of Schedule 1 of the draft Project Agreement). Similarly, firmscontrolled by commercial banks would not be eligible unless specific plansare submitted to reduce the bank's controlling ownership through sales toprivate entrepreneurs within a three-year period. A firm would be eligibleas beneficiary of the proposed loan only if the ownership of shares adding upto a controlling interest in its capital is clearly and unquestionably de-fined. Also, firms related to the major Chilean groups described in para. 24would be eligible as beneficiaries of the proposed loan provided that theyare no longer responsible for any of their former holding companies' obliga-tions. Initially only firms in need of restructuring would be eligible asproject beneficiaries.

Lending terms and Conditions

50. Proceeds of the Bank Loan -- other than an amount of up toUS$2,600,000 for the Unit (see paras. 47 and 60) -- would be onlent by theCentral Bank to participating commercial banks under subsidiary loanagreements. A condition of loan effectiveness would be that the Central Bankhas entered into subsidiary loan agreements with at least two commercialbanks (Section 5.01 (b) of the draft Loan Agreement).

51. The Central Bank as fiscal agent for the Government would onlendBank funds to commercial banks in US dollars or in Chilean pesos. Interestrates in both currencies for both new and outstanding subsidiary loans andsubloans would be adjusted semiannually to reflect the changes which occurredin the Bank's interest rates. Interest rates on dollar-denominated subsidi-ary loans would be equal to the Bank's interest rate plus a spread that wouldcompensate the Central Bank for the Bank's commitment fees and for the cost

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of operating the Technical Unit. Interest rates on dollar-denominated sub-loans would be calculated by adding a compounded three percent spread to theinterest rates on subsidiary loans. Under present conditions this would re-sult in interest rates for dollar-denominated subsidiary loans and subloansof 9.95 percent and 13.2 percent, respectively (Section II (5) of Schedule 1of the draft Project Agreement).

52. Interest rates on peso-denominated subsidiary loans and subloanswould be the same as those on dollar-denominated loans. They would be ex-pressed in real terms calculated: (i) upon a principal adjusted for localinflation in accordance with the Unidad de Fomento (UF), which reflects thedaily changes in the country's CPI; and (ii) by deflating the respective dol-lar interest rates by the CPI of the US. Under present conditions interestrates for peso-denominated loans and subloans would be about UF plus 4.7 per-cent and UF plus 7.8 percent, respectively, in line with current market con-ditions (Section II (6) of the Schedule of the draft Project Agreement). Ac-cordingly, the Central Bank would review semiannually the formulae for thedetermination and adjustment of interest rates on subsidiary loans and sub-loans, exchange views with the Bank on the results of such review and, ifnecessary, revise such formulae in a manner satisfactory to the Bank so as toensure that the interest rates on subloans determined thereby are positive inreal terms (Section 2.06 of the draft Project Agreement).

53. Subloans for fixed investment and associated permanent working cap-ital would have maximum maturities of 15 years, including grace periods of upto three years. Subloans granted exclusively for permanent working capitalfinancing would have maturities of 18 months to five years including a graceperiod of up to one year. Subloans financed out of the proceeds of the loanwould rank pari-passu with all other senior obligations of the restructuredfirmn in terms of both debt service and repayment in case of bankruptcy (Sec-tion II (3) of Schedule 1 of the draft Project Agreement).

Subproject Appraisal and Supervision

54. Workout proposals for compnies seeking Bank financing would be ar-ranged by the companies themselves (or by consultants hired by them). Partic-ipating commercial banks vould assume the commercial risk of subloans fi-nanced out of the proceeds of the proposed loan and, therefore, would have toundertake a thorough appraisal of the proposed subprojects, and any restruc-turing arrangements involved. The Unit would carry out a detailed analysisof each workout proposal to ensure that: (a) the firm would become econom-ically and financially viable as a result of the proposed workout on thebasis of reasonable assumptions regarding its future performance; (b) theproposed restructuring, if carried out, would be legally binding and nofurther claims could be leveled against the firm in connection with itsliabilities at the moment of the restructuring; (c) the ownership of thebeneficiary firm's controlling interest is incontestably defined; (d) theproceeds of the subloan would not be used to repay obligations existing atthe moment of the restructuring; and (e) the proposed operation is in accord-ance with the Unit's Statement of Operating Policies and Procedures. Uponthe Central Bank's approval, the first two subloans requiring Bank financingand, subsequently, all those requiring Bank funds in excess of US$5.0 millionequivalent would be submitted to the Bank for approval (Section 2.02 (b) ofthe draft Loan Agreement). No enterprise, including its subsidiaries, wouldbe eligible to obtain financing from the proposed loan in excess of US$15million equivalent and not more than US$10.0 million equivalent would beallocated for working capital in any given subloan (Section 2.02 (c) (v) of

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the draft Loan Agreement). Any subloan exceeding US$10.0 million equivalentcould be processed only after confirmation that best efforts have been madeto arrange a cofinancing program undertaken with IFC, other multilateralagencies and/or commercial banks.

55. The workout proposals would include: (a) a marketing plan, aimed atincreasing the firm's revenues, through emphasis in the more profitable pro-ducts and customers; (b) a production plan, which could include measuresranging from curtailment of productive capacity to a fuller utilization orexpansion of existing capacity; and (c) a financial work out plan. Thefinancial work out plan would typically include: (i) streamlining of manage-ment and administration; (ii) the sale of unnecessary assets; (iii) a reduc-tion in the firm's financial burden, and other measures to improve the firm'sfinancial situation (extended maturities, for instance); (iv) an issue of newshares to mobilize fresh capital, whenever possible; (v) a request for a sub-loan that could include financing for free-standing permanent working capi-tal, fixed investment, or a combination of both; and (vi) financial projec-tions showing the expected results of all these planned measures (Sections1.02 (n) and 2.03 (a) and (b) of the draft Loan Agreement).

56. The Bank would finance subprojects when their financial and econom-ic rates of return exceed 11 percent in real terms. Evaluation criteria havebeen included in the Unit's Statement of Operating Policies and Procedures.The Unit would also request, as part of a subloan approval process, an inde-pendent legal opinion confirming the legality of the proposed arrangements.Covenants limiting the incurrence of future loans would be included in sub-loan agreements.

57. Commercial banks would regularly supervise the subprojects theywould finance to see that subloans are utilized for the purposes intended andthat the financial and other conditions affecting the subproject'sperformance are progressing satisfactorily. A copy of their periodicsupervision reports would be submitted to the Unit, which would review it andwould have the right to obtain clarifications from either the beneficiaryfirm or the corresponding commercial bank. The Unit would be responsible forsupervising the performance of participating commercial banks and theircompliance with the conditions agreed in the proposed loan.

Participating Intermediaries

58. No intervened banks would be allowed to participate in the proposedproject as long as they remain intervened. All other commercial banks wouldbe eligible to participate, provided that they sign a subsidiary loan agree-ment in terms satisfactory to the Bank (Sections 1.02 (g) and (h) of thedraft Loan Agreement).

Project Costs and Pinacing

59. As mentioned before (para. 34), the investment cost of industrialprojects is estimated at US$500 million for 1985-87, with a foreign exchangeneed of US$300 million. In addition, imports of current inputs for industryare estimated at US$1.2 billion per year. Of these amounts, approximatelyUS$800 million would be demanded by firms eligible for Bank financing underthe proposed project. After taking into account other probable sources(i.e., a proposed US$130 million IDB loan for free-standing working capitaland suppliers' credits), and given the pilot nature of this project, a Bank

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loan of US$100 million equivalent is proposed to help fill the soetor'sestimated foreign exchange gap. The rest of the financing for the programwould be provided by suppliers' credits and internal resources of the firmsinvolved. It has been estimated that this amount is needed to make ameaningful impact in the corporate sector, an well as to justify the creationof a Unit to manage financial restructuring loans, which could later be thekey agent in the replication and expansion of the restructuring process bythe Government.

60. The proposed US$100 million loan would have a maturity of 15 years,including three years of grace. The loan would be committed over a 36 monthperiod and would be allocated as follows:

(i) US$97.4 million for the credit component which wouldcover the foreign exchange costs of subloans made bycommercial banks for working capital or fixed investmentpurposes, including increases in, or rationalization of,productive capacity of enterprises and for technicalassistance required to undertake those projects; and

(ii) $2.6 million to help finance the consultancy costs of thespecial Technical Unit created by the Central Bank toappraise workout proposals.

61. The Government would assume the foreign exchange risk between thecurrency pool obligations incurred under the Bank loan and the currency ofthe Central Bank's onlending to commercial banks (i.e., US dollars or Chileanpesos). The loan would be repaid according to a standard fixed amortizationschedule. The Central Bank as fiscal agent for the Government would utilizethe proceeds accrued from the repayment of principal and interests of sub-loans, which are not required for the repayment of the loan, for paying theadministrative expenses of the Technical Unit and for making loans for thesame purposes, and under similar terms and conditions as the loan (Section2.02 (c) of the draft Project Agreement).

Special Account

62. To ensure timely payment of reimbursement claims, a Special Accountin US dollars will be established in the Central BRnk to cover estimated ex-penditures for four months (Section 2.02 (d) of the draft Loan Agreement).The Bank would make an initial deposit of US$10 million into the Special Ac-count. The Central Bank would claim reimbursement of expenditures from theSpecial Account upon presentation of fully documented withdrawal appliea-tions. The Central Bank would submit to the Bank a monthly certified state-ment on the Special Account reflecting transactions during the previous month(Section 3.02 (a) (iii) of the draft Project Agreement).

Procurement and Disbursement

63. Procurement procedures would conform with standard practice for In-dustrial Development and Finance loans; the Unit would monitor procurement tobe financed out of the proposed loan in order to ensure that the items arereasonably priced and appropriate for their intended purpose. The loan pro-ceeds would be disbursed against 60 percent of the fixed investment and per-manent working capital requirements of approved subprojects. This percentagereflects estimated average foreign exchange costs of the respective expendi-ture categories. Terms of reference for consultants hired to provide techni-

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cal assistance in the implementation of subprojects/workouts, would have tobe acceptable to the Unit and the procedures used for hiring such consultantswould be in accordance with the Bank's standard guidelines. Expendituresmade not more than 180 days prior to the date of the receipt by the Bank ofthe corresponding financing requests, would be eligible for disbursementunder the Proposed loan -- rather than the 90 days customary under the Bank'sindustrial development and finance loans -- in view of the administrativecomplexities and the time lags involved in a two-tier operation with manyparticipating financial intermediaries. The Closing Date of the loan wouldbe December 31, 1991. Retroactive financing of up to US$10 million, or tenpercent of the loan amount, would be provided to cover expenditures eligiblefor financing under the loan realized by participating commercial banks priorto Loan Signing but after February 1, 1985 (Section 2.02 (c) (i) of the draftLoan Agreement).

Accounts and Auditing

64. Beneficiary firms would be requested to appoint external auditorsacceptable to the Unit. Commercial banks participating in the proposed pro-ject would be required to maintain adequate records reflecting their opera-tions financed out of the proposed loan, and to submit annual statements ofaccount, audited by independent auditors following principles satisfactory tothe Unit. The Central Bank would maintain adequate records concerning theprogress of the project and reflecting, separately from its other operations,the operations and financial transactions related to the proposed loan, in-cluding the Special Account. These accounts would be audited by independentauditors following principles satisfactory to the Bank (Section 3.02 (a) (i)of the draft Project Agreement).

Benefits and Risks

65. The proposed project would help remove the financial deadlock thatis hindering the recovery of industrial production in Chile by establishingan institutional framework through which corporate workouts could be devised,negotiated, and implemented. The project would also contribute to set repli-cative examples that could be extended outside the project to other econom-ically viable, but financially troubled, firms in other sectors of the econo-my. Finally, the project would further help in closing the foreign exchangegap which currently curtails the country's economic growth. A total of 20-30industrial firms are expected to benefit directly from the project.

66. On the risk side, commitments could fall short of expectations if:(a) as a result of copper prices remaining low, or international interestrates high, for a long time to come, the country's economic situation deteri-orates substantially, causing a contraction in investment credit demand; (b)the Unit fails in promoting restructurings or proves incapable of analyzingthem properly; (c) individual restructurings prove too difficult to be com-pleted within the proposed loan's commitment period; and (d) once restruc-tured, currently troubled companies obtain credit from other sources. Giventhe precarious condition of the Chilean economy, and the uncertainties as-sociated with restructuring, the risks of the project are considerable. Tomitigate these risks: (i) intervened banks will not be allowed to partici-pate in the project and at least two commercial banks would participate inthe financing of each subloan, jointly and severally assuming the responsi-bility for carrying out the respective subproject to completion; (ii) all

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financial restructuring requests will be appraised by a Technical Unitattached to the Central Bank, staffed by high level professionals withexperience in corporate restructurings; and (iii) detailed Operating Policiesand Administrative Procedures for the Unit have been prepared to ensure thatrestructuring proposals will be in line with the project's objectives. Thebenefits to Chile could be substantial, and the experience gained in thisoperation would be useful in the design of programs to support firma now infinancial distress. Therefore, the overall benefits of the project are ex-pected to outweigh the risks significantly.

PAR! V - LEGAL USIETS h AND RITT

67. The draft Loan Agreement between the Republic of Chile and theBank, the draft Project Agreement between the Central Bank of Chile and theBank, and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the ExecutiveDirectors separately. The main conditions of the draft Loan Agreement arereferred to in the text of this report and are listed in Section III of AnnexIII.

68. The following events are specified as Special Conditions ofEffectiveness for the proposed loan: (i) the Borrower has designated theCentral Bank as its fiscal agent; (ii) the Central Bank has entered into Sub-sidiary Loan Agreements with at least two Participating Banks; (iii) the Bor-rower shall have secured external financing sufficient to cover the foreignexchange required to close the Borrower's balance of payments account for itsfiscal year 1985; and (iv) the Technical Unit shall have been staffed in amanner satisfactory to the Bank (Section 5.01 of the draft Loan Agreement).

69. I am satisfied that the proposed loan would comply with theArticles of Agreement of the Bank.

PART VI - ONS

70. I recommend that the Executive Directors approve the proposed loan.

A. W. ClausenPresident

AttachmentsJune 27, 1985Washington, D. C.

-21 - AM= IPa8e 1 of 6

T A-5 L I6%

cons S-CXL MIIBU:" DMsCRILI tuiiuu m S (HUcE3om A*usa ms

M (uST t ) UNIN NIU ZIIDUOUe

19 db- 197OLb- RITDUa iL IAT. ALICL A CM

ML C . 5)TOURL 73n.0 737.6 757.0

11.IL 134.4 13.9 174.3

mm aU Con) 66.0 IIC0.0 2210.0 2100.4 2345.3

CKIIACRU W O11. i)AhLU) 370.0 679.0 734.0 993 1122.6

_m m mS.DA13o.wo-wo1 ( _coUISS) 7363.0 9349.0 1147.0

£ _ 1 O ItL) 47.6 73.2 62.1 66.S 46.6

101LT101 TRAR 2000 (MILL) 14.7STIISO T IOPUIAT=O (HILL) 20.7IIULATIOS lIOl 1.7

POIUIATIOU 3351?PM SQ. M. 10.0 12.4 14.9 33.7 82.9PM Sq. M. *51. LAND 56.4 "9.0 4.6 92.4 136.9

POEUAUIOU AGE SUIVCJU2 (I)0-14 uS 39.1 36.1 31.4 39.9 31.6

15-4 US 5b.5 57.2 62.9 56.0 61.165 MD ARM 4.3 4.6 S.6 4.1 7.1

3O3OLATiOU mE!3 3LT1 (I)TOTAL 2.2 2.1 1.7 2.4 1.613Y4 3.7 3.1 2.4 3.6 3.7

CUOZ 6M K12E (MR ITOIS) 34.0 20.l 23.1 31.3 23.4cUm DEATH 34Z (MR 305) 12.6 O .9 6.7 3.1 8.6GS O7UPUOICTI 3ATZ 2.5 1.6 1.3 2.0 1.6

FAIILT IIWFICA 5T023. A_NAL (T0U15) .. 216.7 26.6 /c-s5 CZ or OA D .. .. .. 40.3

113 OF MO 30. rEL CAPtTA(196-71-100) 90.0 104.0 98.0 114.3 114.5

MM3 CAPITA SfPLI OFCILZZS (Z OF orEiQIFrJs) 110.0 110.0 114.0 110.6 126.61 IS015 (GS "a1 DU) 71.0 71.0 76.0 67.3 89.7

OF WRICH AEIKAL AM 3.S 28.0 30.0 27.0 Ic 34.1 34.3

CKILD [ACES 1-4) ORT LATr 20.0 9.0 2.0 3.7 5.2

LIln mEc. AT S161 (WTEARS) 56.9 62.4 69.7 64.7 67.4IWA*Jr N1T. RATE (13 TOM) 119.0 32.0 27.0 60.6 54.2

ACCSS TO SAFE WATER (110P)TOrA. 62.0 5460 62.0 /d 65.413343 76.9 67.D 93.0 Td 76.1Rom 11.4 13.0 36.0 73- 46.2

AS To mrm DIsOSLCZ W 35r11aX1)

AL .. 29.0 32.0/ 3 2.91M 33.0 36-0 T 67r0

3 .AL 10.0 it.o7* 24.5

POIATWO 33 WUTSICIM 1760.0 2150.0 1930.0 Id 1917.7 1065.60F9. PER NURSING P30S 61.40.0 41.0 430.0 7 315.J6 704.4

7OP. PER HOPITAL EDTOTAL 260.0 260.0 280.0 /t 367.2 326.3U134 270.0 260.0 320.o7 411.5 201.5RURAL 161000 770.0 2636.33

ANUSS5 MM HOSPITAL 3re .. .. 26.0 ic 27.3 20.0

AV111*5 SmE Or oUSOLuTOTAL 5.4 5.1URN" 3.2 53.0RUJAL 0.0 5.5

AVE3AGE N0. Of rEmus/aornTOTAL 1.7 1.4URBA 1.0 1.3Room 2.0 1.7

Acms To ELCT. (z Or Um9L%)TOTAL 70.6 .. 76.9 ./11 $6.3 .. To-313L 23.9 .. 35.0 7..

-22- ANN IPae 2 of 6

ADJUSIRS lu u. I&1.piDmEI SOUM 100.0 107.0 111.0 L0s. LOW

mmLE 11L.0 107.0 111.0 L06.3 101.1PNauE 107.0 106.0 114.0 L06.5 96.1

3C31UI 2OZAL 24.0 39.0 17.40 63.2 16.1VWAL 26.0 36.0 13.0 61.3 6.9VULAL 26.0 43.0 62.0 446. 10.6

vocATOIL CS e BiO t) 26.2 33.0 26.2 331.6 11.

IZL-MA0133 ATtO3m .. 10.0 34.0 /i 30.1 25.1

aucouuaw 140 13.0 20.0 1.6l 20.5

ADLT LT3A0T UTZ Cs) 3.6 69.0 .. 79. 713.6

PASSENGER CAISTNOUSAND O 7.6 16.6 40.2 46.0 56.730 /T! UDSO p0o 130.6 149.6 292.7 125.6 164.9TV 3nZCZtZ fWU po0 0.1 13.4 110.1 107.2 1".1NEWSPAPER CDAUT G6UAL

MUTEMT-") CRCalUTAnoMR 21001AND lOPUTIO 13L.6 34.1 66.6 63.5 96.3

02131 OUL ATTINDANCE/CAPITA 7.1 J 4.7 1.46 2.6 2.9

-TOTAL LAR FORCE (TOUS) 2505.0 2885.0 3690.0

muA (ClERClT) 21.? 22.0 26.4 23.2 34.5ACUCULTKUE (PERCIET) 30.2 22.6 19.2 31.1 40.7IOUSTIRT (11C1I) 20.1 21.0 19.4 23.9 23.3

PARTICIPATION UATZ (PELICEUT)TOTAL 33.0 30.6 32.1 32.2 62.9MALE 52.1 6.4 U7.7 U9.3 56.7

FawZ 14.2 13.5 16.8 15.2 31.0

ZOWOIIIC DEPENECr 362o 1.3 1.4 1.2 t.4 0.9

DI6UPRVATE II*OEZVED 11T

11Gzsr 5S O0F 135OLDI0 .. ..310315? 20S 01 UIJOSEILDS . 51.4 '1 .....ILONEST 202 0 HOU S . 4L A .T 6. ..LOES?T *02 0F VOUSZUOLD .. 13.4 71

ESTIM ABSOLUTZ 1091M2 X1100HLEVL CUSS PU CAPITA)

UR .. .. 360.0 /d 288.2ITEAL .. .. .. 166.0

ZE7111AMZ W.ATIVE 2011?! IT OMLIVL CUSS 'A CAPIA)

as .. .. 640.0 /d 522.6RURAL .. .. .. 372.4

ESTIATED POP. BEW ABSOLUnPoVET nECE LEVE (S)

nURB .. ....

u.A~ .. .. . ..

Mr? AVAILABLEMOT APPLICABLE

H O T C S

/a 7he group averas for each indicetor aro populatlonu-weibted arithimetic mu. Covera of countries own theIndicators depends on availability of date and iu not unifom.

lb Unless othervie noted. -eta for 1960' refer to any year betmens 1959 aod 1961, rlta for 1970- betwen 1969 mad1971; and d-ta for 'Nast Recent Atl.te' betmeen 1910 and 1982.

lc 1977; /d 1979; 1o 1975; If 1978; /Peraonnal in overnment or.icte oly; 1962; /1 1966.

JUE* 1984

- 23 - AMUECIop T! Sam ~~Page 3 of 6

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kd- -m -. _~~~~~~~~~WbAkmw No -n n ur w z - am

m~~ -

camm RD c Pmabct 19.436 7.8 5.7 -14.3 -0.8 6.3 2.0 3.0 3.6 3.4 3.4 3.8l bndu 1,749 3.8 5.3 -2.3 0.9 7.3 3.5 3.0 3.5 3.5 3.5 3.5

Tm&stiy 4,275 6.2 2.6 -21.6 3.0 11.5 2.0 3.0 2.5 3.5 3.5 4.5aew 13.410 9.1 6.7 -13.4 -1.9 4.6 1.5 3.0 3.0 3.3 3.4 3.6

cmmw_tl- 16,848 4.2 12.2 -13.5 -5.8 4.5 -1.7 0.0 1.3 1.5 1.1 1.8Co. 7umvm_t 2,718 31.2 5.7 -65.4 15.3 72.1 -0.2 14.2 3.4 9.4 10.3 9.7

am t Gdom wWS 4,66D 14.3 -5.3 10.9 1.4 4.1 6.5 8.0 4.5 5.1 5.5 5.7f Cmb mdWS -4.822 18.7 14.7 -32.9 -9.4 14.2 -12.5 1.6 2.1 3.6 3.5 4.2

Comm Ihdmml s.vh 842 27.7 -41.1 -36.7 -1.7 84.7 36A.9 32.9 14.1 21.2 21.8 16.0

- Ihflabr 549.0 29.2 13.4 11.3 26.9 15.3 25.0 25.0 25.0 25.0 25.0 25.0

of - t -M amm ) conl _ *1. )en_ a(M 0om Mm.) (at 1977 om)

190 1915 1W I33 1990 19-105 IW1SQ 1940 11540

Cko -tic Pmjez 1OO. 10 .0 100.0 100.0 100.0 -0.3 7.5 -0.9 3.0"aLtu1 6.8 6.6 7.2 9.4 9.6 0.0 Z_9 1.7 3.3

25.5 2D.3 21.4 20.8 21.0 -1.7 7.6 -1.6 3.2swIm 67.7 73.1 71.4 69.8 69.4 3.7 8.1 -1.1 2_9

C _jqzdm 82.9 889 832 81.5 74.5 0.0 6.4 -1.3 1.2*e= I_..mz 16.5 13.1 21.0 15.0 19.9 -11.6 19.6 -9.7 9.0

b xof Coads md NFS 15.0 25.5 22. 25.8 28.5 2.5 15.1 0.8 5.0h*uaof od aNS 14.4 27.4 27.0 22.4 23.0 -2.7 19.3 -6.8 3.6

amu. 1bclm.1 s!hv 15.1 7.9 13.9 9.0 19.2 -7.7 18.5 -7.9 17.9

An a 2 fG

V 1n3 18

Gmnuc XWOMMOMB 32.9 26.4n0c _to m 245 29.2sphu (C) mr IbtkIi (-3 8.4 -2.8Cqpl ] t1muz 4.6 4.5F aOElg Fliq -1.0 0.6

19pr 190-a~~~~~ nnE

GNP hcodl YAM (Z) 2.5 3.49GNP Per Cq. th litR (Z) 0.9 1.2

& G.W CRqmt Quath RitX CZ) 1.5 1.9

CRn 7.1 5.6lbxgizml Su*p Roo 0.87 0.76Tqpat ELmtd.ty 1.12 1.14

a/ Ririn of Swath In pwojcatad valms In oitn pti-.R fay _mcu

TEI ftudy.

- 25 -WT5of 6

mum - -n

A- ANOL *mm me

ll,Dim 1us whz_ m'

t 3.41 4.6 Q16 4.6 5.5 6.0 6tcon- ~ ~ ~ ~ 11.35 3.8 3.8 3.8 3.8 3.8 3.8

1AVI1ura1 Wab 366 7.4 7.6 7.3 7.5 7.6 7.83miacbiw GM& 1,259 4.5 4.5 4.6 6.7 8.1 6.4o01 dGaab 424 5.2 4.7 5.1 5.1 5.0 5.0

_ _dim bpJw 3,390 0 2.0 1.9 3.7 3.9 4.6Food 424 -1.7 0.0 0.0 1.1 0.0 1.3Ibd Qm Gam) 411 0.0 2.1 2.4 3.4 3.6 3.8PatrJl alI. 1*jidw 2.7 0.0 1.7 2.4 3.0 3.5 3.7Odor InainJLas& Cqital Can& 528 0.0 2.9 2.4 4.8 5.2 5.9

1 (1977-1W)

ano Pd=m ain 119 126 137 149 161 174ua't Ftm -* 115 122 132 143 152 165VW* of - .i 103 103 103 04 105 105

5/2585

M - 04ma mI.971.5 (1Ion

PEO.IECTED

5At inM* ofi G* a MS -21.3 421. -3197 -OLI -31L8 -1.033. -3,211.3 -219.1 SPA -QuL0 sii U3 1,.= I.=2 Ms ioudwt of amk A5 Ws 035 2.412,9 2.40112 z.us 4.W2LA 3.863 S.ms.s s.O.o a.I.A 4.s1.e W.S 1.133 '.22 ijim '.in

1m8 of Gld A Ws -2O.08. -3.960. -MOI -3.12LO -3.23.1 -7,0.0 -6.33. -231L.1 -4,W82 -4.731. -,31 -4,111 -5,101 4,08 -.1132 -1,33lIt 5-33or Im -191.4 -321. -3RA9.4 U 393.3 *U1. -1.MBJ -I.5.1 -2.I6LI -I.203 -1.32. -MOW -2.72 -2.21 -2.161 -2.13 -2,2334 TA.UfM 3.b W VA 0. 1M. 4.9 01.2 "A1 43 9. 9.7 A10 ME IV? M3 MI LsfInt" kIm bl -40.1 131.6 -mu1. -L. 129 -4214J -2,083. -4.3. -2.436A1 -3.013.2 -[..4 -3.31 -1.210 -l.a. -l.m -1.8 -L.=1

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LMbA

- 27 - ANN XIIPage 1 of 2

THE STATUS OF MM GROUP OPERATIONS IN CWLE

A. STATEMENT OF BANK LOANS AND IDA CREDITS (as at March 31, 1985)

Loan or US$ millionCredit Fiscal Amount (less eancellations)Number Year Borrower Purpose Bank IDA Undisbursed

25 loans and one credit fully disbursed 326.2 22.9 1/ -

1832 1980 Chile Water Supply 32.4 - 7.71902 1981 Chile Agri. Credit 36.0 - 11.01927 1981 Chile Highway Recon. 42.0 - 0.42297 1983 Chile Highway Recon. II 128.0 - 97.22481 1983 Chile Agri. Serv./Credit 56.0 - 56.02482 1983 Chile Housing 80.0 - 60.72504 1985 Chile Public Sector Mgt. 11.0 - 11.0

Total 711.6 22.9of which has been repaid 208.9 4.5

Total now outstanding 502.7 18.4

Amount sold 7.2of which has been repaid 7.2

Total now held by Bank and IDA 502.7 18.4= =

Total undisbursed 244.0

1/ Includes exchange rate adjustments. The original amount of the creditwas US$19.0 million.

- 28 -ANNRM IIPage 2 of 2

B. STATIINT OF INC INYISTHINTS (as at March 31, 1985)

Placal Type of Auount In US$ sillionYoeg ibll"r Dilneas Lon !qq Total

1958, 1959, Empresa Minera de1966, 1984 Mantos Blancos Copper mining 35.10 4.25 39.35

1959, and Fideos y Alimentos1965 Carozzi S.A. Food products 1.50 0.15 1.65

1960, 1961and 1965 Cemento Bio-Bio S.A. Cement 1.20 0.10 1.30

1963 Cia. Manufacturera dePapeles y Cartones Pulp and paper 3.00 - 3.00

1970 Minera Sagasa S.A. Copper mining 10.45 0.45 10.90

Money and Capital1982 Inverchile Markets - 0.20 0.20

Total gross commitments 51.25 5.15 56.40less cancellations, terminations,repayments and sales 34.75 0.70 35.45

Total Commitments now held by IFC 16.50 4.45 20.95

Total Undisbursed 20.00 1.88 21.88

- 29 -

AN3 IIIPage 1 of 2

RNIUBLIC 0 CEIL!

I DUSTRIAL 1IRAICR NTRUCTURING PROJECT

SUPPLfTAI ! PROJECT DATA S1HET

Soetion I: Timetable of Key Events

(a) Time taken by the country to prepare project: 11 months.

(b) Project prepared by: Central Bank with Bank assistance.

(c) First presentation to the Bank: June 1983.

(d) Departure of Appraisal Mission: October 24, 1984.

(e) Completion of Negotiations: April 19, 1985

(f) Planned Date of Loan Effectiveness:

Section II: Special Bank Implementation Action

None.

Section III: Special Conditions

1. The Borrower would provide assurances that:

(a) the Government would not make available subsidized lines of creditfor financial restructuring with terms and conditions that couldundermine the proposed loan (para. 44);

(b) the Technical Unit would be managed in accordance with a Statementof Operating Policies and Procedures satisfactory to the Bank(para. 47).

Cc) not more than $50 million of the loan would be used to finance sub-projects with a working capital requirement exceeding 70 percent oftotal estimated cost (para. 48);

Cd) eligible firms will not have governmental participation in excessof 50 percent (para. 49);

(e) on-lending arrangements between the Central Bank and eachparticipating institution would be covered by subsidiary loanagreements containing terms and conditions satisfactory to the Bank(para. 50); and the Government would assume the cross-currencyrisk (para. 61);

- 30 -

ABDEI IIIPage 2 of 2

(f) interest rates would be reviewed by the Borrower and the Bank everysix months for purposes of maintaining interest rates positive inreal terms; and responding to market conditions (para. 51);

(g) the basis for establishing the interest rate charged on peso/denomn-inated subloans reflects Chile's rate of inflation (para. 52); and

(h) a Special Account of US$10 million would be established to insuretimely payment of reimbursement claims (para. 62).

2. Special conditions for loan effectiveness would be: (i) the Borrowerto designate the Central Bank as its fiscal agent; (ii) the Central Bank toenter into Subsidiary Loan Agreements with at least two Participating Banks;(iii) the Borrower shall have secured external financing sufficient to coverthe foreign exchange required to close the Borrower' s balance of payments ac-count for its fiscal year 1985; and (iv) the Technical Unit shall have beenstaffed in a manner satisfactory to the Bank (para. 68).

r