RESTRICTED Report No. P - 5 4 3 This report wa; prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF T HE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDUSTRIAL DEVELOPMENT BANK OF ISRAEL Nfay 8, 1967 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECO11HENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED 1. I submit the following report and recommendation on a proposed loan to the Industrial Development Bank of Israel Limited (IDBI) in an amount in various currencies equivalent to $15 million to be guaranteed by the State of Israel. PART I - HISTORICAL 2. The proposed loan would be the second to IDBI. The first loan, equivalent to $20 million, was signed in September 1965 and has been almost wholly committed. On the basis of the findings of missions in June 1966 - and December 1966, it appeared that IDBI's performance and prospects justi- fied further Bank assistance. Negotiations with representatives of the Government of Israel and the IDBI were held in March 1967. The Israeli negotiators were Dr. A. Neaman, Managing Director of IDBI, and Mr. M. Rottenberg, Legal Adviser, for the Borrower, and Mr. N. Shamnir and Mr. S. Sitton of the Embassy of Israel, Washington, D. C., for the Guarantor. 3. The proposed loan would increase total Bank lending to Israel to $109.5 million. The status of previous loans on March 31, 1967 was as follows: Year U6 N' Edon of Loan Borrower Purpose Amount Loan No. of Loan Undisbursed 1960 265IS State of Israel Ashdod Port 27.5 0.1 1961 289IS Dead Sea Works Ltd. Potash 25.o 0 1962 323IS State of Israel Roads 22.0 0.7 1965 424IS IDBI Industrial 20.0 4c7 Credit Total 94.5 5.5 of which has been repaid 2.9 Total now outstanding 91.6 Amount sold 5.1 of which has been repaid 2.8 2.3 Net amount held by Bank 89.3 -2- The Closing Date for Loan No. 323IS (Road Project) has been postponed from December 31, 1966 to May 31, 1967, at which time the loan is expected to be fully disbursed. IFC has not made any investment in Israel. 4. The Dead Sea Works Limited received a loan of the equivalent of $25 million in 1961 (Loan No. 289 IS) to help finance the construction of a plant for the production of potash and other salts. The potash plant is now in full operation. The Company was planning to expand operations and in 1965 asked the Bank for a loan for this purpose. Meanwhile, how- ever, difficulties arose in coring the system of dykes, and consideration of the loan was postponed. The Bank was recently informed that the Company is making arrangements with the Government and the Bank of Israel for financing of the expansion. PART II - DESCRIPTION OF TIC PROPOSED LOAN 5e BORROIWER: Industrial Development Bank of Israel Limited (IDBI). GUARANTOR: State of Israel. A1MOUNT: The equivalent in various currencies of $15 million. PURPOSE: To assist IDBI in financing private industrial enterprises in Israel. TERM AND AMORTIZATION: 152 years, with semiannual payments beginning on September 1, 1970 and ending on September 1, 1982. The Bank and IDBI will from time to time change the amortization schedule to conform substantially to the aggregate of the agreed repayment schedules applicable to IDBI's loans and investments using proceeds of the Loan. INTEREST RATE: Variable: When a part of the Loan is credited to the Loan Account, the rate of interest charged on that part will be the Bank's current rate for similar loans at the time the credit is made. COMM1ITMENT CHARGE: 3/8 of 1% per annum, accruing from the time the Loan Account is credited with parts of the Loan for individual invest- ment projects. -2- The Closing Date for Loan No. 323IS (Road Project) has been postponed from December 31, 1966 to May 31, 1967, at which time the loan is expected to be fully disbursed. IFC has not made any investment in Israel. 4. The Dead Sea Works Limited received a loan of the equivalent of $25 million in 1961 (Loan No. 289 IS) to help finance the construction of a plant for the production of potash and other salts. The potash plant is now in full operation. The Company was planning to expand operations and in 1965 asked the Bank for a loan for this purpose. Meanwhile, how- ever, difficulties arose in coring the system of dykes, and consideration of the loan was postponed. The Bank was recently informed that the Company is making arrangements with the Government and the Bank of Israel for financing of the expansion. PART II - DESCRIPTION OF THE PROPOSED LOAN 5. BORROWER: Industrial Development Bank of Israel Limited (IDBI). GUARANTOR: State of Israel. AMOUNT: The equivalent in various currencies of $15 million. PURPOSE: To assist IDBI in financing private industrial enterprises in Israel. TERM AND AMORTIZATION: 151 years, with semiannual payments beginning on September 1, 1970 and ending cn September 1, 1982. The Bank and IDBI will from time to time change the amortization schedule to conform substantially to the aggregate of the agreed repayment schedules applicable to IDBI's loans and investments using proceeds of the Loan. INTEREST RATE: Variable: When a part of the Loan is credited to the Loan Account, the rate of interest charged on that part will be the Bank's current rate for similar loans at the time the credit is made. COMMITMENT CHARGE: 3/8 of 1% per annum, accruing from the time the Loan Account is credited with parts of the Loan for individual invest- ment projects. PART III - THE PROJECT 6. A detailed appraisal of the project (Report No. DB--33a, dated April 6, 1967) is attached. 7. The Industrial Development Bank of Israel Limited (IDBI) is Israells largest industrial finance company. Since its establishment in 1957, it has financed between 20% and 25% of the countryls gross industrial investment. At December 31, 1966, IDBI's principal sources of funds were as follows: Equivalent in If, U.S.$ (million) Share capital: Voting 15 5 Nonvoting 324 108 Reserves and surplus 23 7 Long term loans 225 75 587 195 The ownership of IDBI's voting shares is representative of all major economic interests in Israel; the Government owns about 26% and private domestic in- vestors, 54%. Foreign investors hold about 20%. The Government has provided about 60% of the non-voting share capital and has partially guaranteed over L0% of the outstanding loan portfolio. It has minority representation on IDBI's Board and principal committees. The Government considers IDBI to be the major vehicle for industrial development throughout the country. However, IDBI is independent in its day-to-day operations and deals with loan applications on their individual merit. 8. IDBI is soundly managed and is conservative with regard to the risks it is willing to assume. Management functions, though guided by a Board of Directors of 56 members, are largely in the hands of three policy committees and the Managing Director. Competence of the professional staff is generally high. The staff's ability to appraise projects has been developed, reducing IDBI's former dependence on assessments made by the Ministry of Commerce and Industry. 9. IDBI has approved a total of almost IŁ770 (about $257) million in loans since its inception. Loans have averaged just over I4Ldt0,000 ($1477,000) for terms varying from four to twenty years, with the average size increasing in recent years. About half of IDBI's total loans have been ex- tended for projects in less developed areas of the country. Many of these loans carry Government guarantees and subsidies in the form of reduced interest rates to the borrower. The textile and leather industries have received a third of IDBI's loans. Although losses have been insignificant, the number of loans in arrears or undergoing legal proceedings increased during 1966, reflecting a general recession in Israel. Nearly all of these, however, carried Government guarantees, which protect IDBI from any significant financial risk. 10. Although before 1962 most of IDBI's loans were linked to the U.S. dollar or to the cost-of-living index and bore interest at a rate of 8%, current loans are unlinked, and the normal interest rate on IDBI's loans is slightly below the 12% maximum permitted by law. A part of the interest received is paid to the Government as consideration for the Government's insuring most of IDBI's foreign exchange liabilities against devaluation. The average yield from loans and investments is presently 8 3%, while the overall cost of resources is about 6.4%. Pretax income amounts to about 10% of average net worth. Since 1958, some 80% of after-tax income has been distributed as dividends. As a result, reserves are less than 8% of portfolio, but risks are diminished by the Government guarantees and other security obtained for loans. 11. Equity investments, including shares in a subsidiary investment company, account for only 6% of IDBI's total portfolio and are not expected to increase very much. About half of these investments are in manufactur- ing companies, with the other half in investment companies engaged in chan- neling funds to small and medium-size enterprises. The subsidiary company has not made much progress since its establishment in 1962 and is expected to remain dormant for the next few years. At present, IDBI does not plan to make equity investments, except in connection with financial reorganiza- tions of companies in which it has an existing interest, and also intends to simplify the subsidiary's portfolio. 12. IDBI is expected to maintain its share of total industrial invest- ment in Israel over the next few years. During the next two years, its lending is estimated at IŁ215-220 ($71-73) million, and funds required, in addition to those to be obtained from existing or expected sources, are estimated to be about IŁ75 million ($25 million). The proposed Bank loan of $15 million would supply about 27% of the net new capital (about $55 million) required to meet projected loan demand during the two-year period. 13. The Bank's loan would be restricted to foreign currency expendi- tures, in contrast to the first IDBI loan, which was available for both foreign and local currency purchases. IDBI will have to submit to the Bank for prior approval any sub-loan (i) for which IDBI intends to use IŁ1e5 million or more of funds from the Bank loan and (ii) where the total sub- loan to be made by IDBI for a project is IŁ2.5 million or more irrespective of the amount of funds contributed from the Bank loan. In addition, until the Bank agrees otherwise, IDBI will submit for Bank approval all projects, regardless of size, for which IDBI expects to receive a Government guarantee. - 5 - PART IV - THE ECONOMY 14. A report entitled "tCurrent Economic Position and Prospects of Israel" dated May 1, 1967 (EA 167c) was distributed to the Executive Directors on May 3, 1967. The report discusses in detail recent develop- ments in the Israeli economy and concludes that Israel is creditworthy for the amount of the proposed Bank loan. 15. A large capital inflow, in the fcrm of transfers, direct invest- ments and foreign loans, has contributed for the past many years to the spectacular growth of the economy. However, inflationary pressures have accompanied this growth and have endangered the competitive position of several Israeli industries vis a vis foreign producers. Due to the limited size of the domestic market, futuiregrowth of the Israeli economy will have to rely to a considerable extent on the expansion of exports. Therefore, to enhance Israel's competitiveness in foreign markets, it is expected that future economic policies will pursue development targets which are more selective than in the past and encourage greater efforts in, and the flow of larger resources to, export oriented sectors. 16. While it is to be expected that the Israeli authorities will do whatever is practicable to encourage savings and keep the deficit on external account within limits, it is clear that the continued expansion of the economy, in export industries and elsewhere, will requi:e a contin- ued inflow of capital. Prospects for this inflow over the next year or two are good, and at the present time no further Bank lending to Israel is contemplated. The outlook may, however, change and the Bank will wish to review from time to time the economic situation and prospects of the country. PART V - LEGAL INSTRUMENTS AND AUTHORITY 17. The draft Loan Agreement (Second Industrial Finance ProJect) between the Bank and the Industrial Development Bank of Israel Limited and the draft Guarantee Agreement (Second Industrial Finance Project) between the State of Israel and the Bank have been distributed separately. The agreements generally follow the pattern of those for the Bank's recent loans to development finance companies, and the security provisions are similar to those in the Loan Agreement for Loan No. 424 IS. 18. Also being distributed separately is the report of the Committee provided for in Article III, Section 4 (iii), of the Articles of Agreement of the Bank. PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 19. I am satisfied that the proposed loan complies with the require- ments of the Articles of Agreement of the Bank. -6- PART VII - RECOITENDATION 20. I recommend that the Executive Directors adopt the following resolution: RESOLUTION NO. Approval of Loan to Industrial Development Bank of Israel Limited in an amount equivalent to U.S. $15,000,000 to be guaranteed by State of Israel. RESOLVED: THAT the Bank shall grant a loan to Industrial Development Bank of Israel Limited, to be guaranteed by State of Israel, in an amount in various currencies equivalent to fifteen million United States dollars (U.S. $15,000,000), to mature on and prior to the date or dates to be determined as set forth in the form of Loan Agreement (Second Industrial Finance Project) between the Bank and Industrial Development- Bank of Israel Limited which has been presented to this meet- ing, to bear interest at the rate or rates of interest to be determined as set forth therein, and to be upon such other terms and conditions as shall be substantially in accordance trith the terms and conditions set forth in said form of Loan Agreement and in the form of Guarantee Agreement (Second Industrial Finance Project) between State of Israel and the Bank, which have been presented to this meeting. George D. Woods President By S. R. Cope Attachment Washington, D. C. May 8, 1967