DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSOCIATIONDOCUMENT OF INTERNATIONAL FINANCE CORPORATION

Not For Public lUse

gL E Report No. P-1178a-AF

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

EXECUTIVE DIRECTORS OF THE ASSOCIATION

AND TO THE

BOARD OF DIRECTORS OF THE CORPORATION

ON A

PROPOSED CREDIT BY THE ASSOCIATION

TO THE

KINGDOM OF AFGHANISTAN

AND ON AN

INVESTMENT BY THE CORPORATION

IN THE

INDUSTRIAL DEVELOPMENT BANK OF AFGHANISTAN.

A DEVELOPMENT FINANCE COMPANY

April 10, 1973

This report was prepared for official use only by the Bank Group. It may not be published,quoted or cited without Bank Group authorization. The Bank Group does not acceptresponsibility for the accuracy or completeness of the report.

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INTERNATIONAL DE7L7h.( 'MENT ASSOCIhTArnTTINTERNIATIONTAL FJANI 'TlE CORPORA TTCGJ

REPORT A:D REC JENDA'I'OiJ o' 'TOT ?OESTE1 TTIC TTlE EXECUTFE DIRECTORS CF T1E1 ASSOC,ATIGON

AND TO THE BOP2Ll OF DIRECTORS OF THE CORPCATIONON A PROPOSE CR3ED TY Ti-ME ASSOCIATION TCi T7*.

kTNGDCE 0OP AFGITANISTAhN

ON AN TNTESTJIr2ENT DY THJE CORPOrtA-jIul,- WINDUSTRIAL DEVELOFIEm-'T BANK OF A.FGHfJISTAN

A DEVEL. 'T ' FINANCE C t7KPA7Ny

1. ] submit the following report and recr)rri,;endat on , cvj a prooco&I

development credit by the Associati of to the Kingdom of Afghan.istan fort,he eoiixralcns of LTS2.C' mi l.lion on standard !DA term,s and on a ,rrnposedequitv investrment by the Corporation of about, US$250,oo1/ equiva.len 1' j lthe Industrial Development Bank of Afghani-stan (IDEA), a new develcpnrmoi,tfinciance companiv. The proceeds of the IDA credit would be onlent to IDBMAat 7¼ percent for about 18 years including three year's grace.

PART I - TE ECONOMY

2. An ec,,nomic report enti tled ''Current Economic P'osition: alQ

Dspects ci0 Afghanistan" (SA-2ca) dated February 1, 1972 was distr but er to tIle E5.ecut,ive Directors in Februarv- 1972 (R72-39' and R72-42). Theparatg,rapns which follow are based. upcn more recent i,nformation obt.aincld

b,- an u,pdating mission which visited Afghanistan in September 1972.Country iata is provided in Annex ,.

3. Afghanistan has been a constitutional monarch:y since 1,9,`l andadopted a new constitution which expanded the role of par ijament in 1J9(L.The country is now in t;he process of developing an effective work nrigrelationship between its legislative and executive branches of government.In December 1972, after an uncertain two and one half month periodfollcwing the resignation of the former Government, a new Government tookoffice w,ith H.T. Mohammed Moussa Shafiq as Prime 1i'_nister. 3eforeappointment of the new Governmenit and while the previous Ciovernmentremained in office at the request of the King, the parliament acted on anumber of long pending items. These included approval of the nationalbudget and ratification of a number of external loans, one of which wasthe IDA credit for the Khanabad Irrigation Project.

Af i' 1G,O0,000, the exact dollar equivalent of which would dependupon exchange rates prevailing at, the time of IFC's investment..The above figure and conversi.ons made elsewzhere in this report arebased upon the current free market rate of Afs 71 .55 to the US$.

.X. With some 15 million ihrLabitants, Aflgharistall is the most

populous landlocked developing country in the woild, and its estimated

cer capita income of about $80 makes it one of the poorest. The countrv

is also one of the most populous of tihe 25 counrtries designated as "leastdeveloped" by the United Nations. Agricu lture predominates in the national

er 2ncny (contributing over 50 percent to Gi'?) but is highly dependent upon

thbe vaoaries of the country's continental cl`-mate. Although efforts are

being made to develop gas prroduction, manufacturing and tourism, future

economi.c growth will depend largely upon progress i.n the agricultule sector.

The economy's problems were aggravated recently by severe drought in 1'.75;

and 1S71, causing agricultural output to decline by 15 percent in 1570 and

by a 'urther 8 percent in 157'71. The two successive drought years were

foll-owed by a severe winter in 1971//72. Because of limited data, it i.s

difficult to measure the effects of these develooments on nati.onail .ncomefigures. Preliminary estirmates, however, indicate a decline in per capita

,ncome during these two years and a ratner slow recovery, despite improved

weather conditions in 1972.

The Governmrentis abiljiry to mobL'`i.ae domestic resources for

development is severely limited. Total n oTre.'r. N e,-t revenues in 1571/72

(fiscal year ending in March) were only 73, mJll.lon, or about $,5 percapita. Agriculture and livestock, the mi-ain souirces of wealth and i ccome,

are not ta-xed directly. The livestock tax was susoended in 1966, and the

land tax amounts to less than 2 percent of total tax revenues. Moreover.it wi,ll be difficult to raise addit1ional revenues from livestock owners

and farmers until they begin to receive mrore direct benefit from develoD-

ment programs than has been the case in the oast.

6. Despite its limited domestic fiscal resources, Afghan4stan

embarked in the early 1550's upon an ambitious Hinvestment programs

amounting annually to between 10 and 15 percent of the country's national

income, thus ending a long period of isolation from the outside world.

Supp)orte(d by loans and grants from bilateral donors, the program was

directed at establishing the basic economic and soc- 2al infrastructure of

a modern society, including roads, power plants, major rec:Lamation and

irrJgaotion schemes, hospitals, schools and ulbEn housinrg projects. Over

tshe ;-ast 2 vears: the Government has contracted foreign loans amounting- me $8,D mlalijon (of whi.ch 686 mi3]i on has beer: disbLrsed), while an

additional $560 million was received in g-rants. Partl.y because of theor.g gestat ionr peri ods of many of the projects undertaken, this aid has

`-.d liittle irnediite beneficial effect on the balance of paynents and has

n,ot given ri.se to a growth in debt servicing capacity equal to the growth

in obligations incurred. There is now an increasing awareness in Afgha-

nistan of the need to re-orient its development strategy towards quicker

,rielding projects and towardis better utilization of the capacities createdb,7 two decades of infrastructure investment..

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,. As a consequence of large scale foreign borrowing, Afghanistanfaces an increasingly serious debt. service problem. Bilateral assistancewas curtailed and project aid disbursements declined sharply from a peakof $75 million per annum in 1966/67 to less than $30 million in 1971/72.During the same period annual debt service payments have increased from$7 million to $28 million, with a resulting decline in net capitaltransfers (excluding commodity aid, mainly food) from $68 million in1966/67 to $2 million in 1971/72. Over 20 percent of the Government'srevenues were budgeted for debt service in 1971/72, and debt service isestimated to have absorbed about 29 percent of export earnings in 1972/73.Afghanistan has recently concluded an agreement with the USSR to reschedule$30 million of $135 million in debt service obligations due on existingdebt during the next five years, and repayment of the remaining $105 millionis expected to be linked closely with the export of natural. gas. Obligationsdue to Western creditors during the same period are about $64 million; theGovernment has also asked these creditors to consider rescheduling a portionof its debt to them. Without such rescheduling, and including additionalservicing of newly contracted debt, Afghanistan's debt service paymentsduring the next five years are projected at an average of $39 millionannually compared with exports (including invisibles) averaging about$110 million each year during the same period. Because of its poverty andthis debt burden, the country does not have the capacity for servicingadditional debt on conventional. terms. In the light of recent efforts toimprove economic performance, however, Afghanistan is eligible for, and isexpected to make good use of, additional IDA financing.

8. The Government has requested the Bank to act as Executing Agencyfor a UNDP-funded Development Advisory Group project, and this proposal isnow being considered by the Bank and UTNDP. The proposed Advisory Groupwould assist the Government in formulating both national economic strategyand specific sectoral policies, programs and projects. In a relateddevelopment, the Government has also announced its intention of introducingchanges in the development rnachinery of the countr7.r and of strengtheningthe role of the Prime Minister's Office in the entire economic process.These two measures would do much to overcome weaknesses i-n Afghanistan'sdevelopment machinery. In the past, projects have been carried out largelyby teams provided by bilateral donors,. and have, therefore, had Littletraining value or institution-building impact. The proposed advisorygroup would consist of a nucleus of three or four full-time advisorsworking closely with counterparts in the Government; this nucleus would besupplemented by specialists on short-term assignments .to assist Afghanagencies with particular development proposals.

PART TI - BAIIIS C.,ROUP 0,FTEHATIGN S 1f ACG HAM'STAI

The Dank Group has made five development credits totalling

U5,,j24.20 nillion (net of cancellations) to Afghanistan. These credits

were for education in 1964 (only $0.3 million disbursed and recently

refunded iunder the Khanabad Irrigation Credit.), highway mraintenance

($5.0 mJll]iOn) in 1969, agricultural credit ('$5.0 million) in 1970,

Yhanabad irrigation ($5.0 million) in 19'71, and :livestock development

(4;? .C0 million) in 19731/. Afghanistan became a mnember of the Bank i n

1955, but because of its economic structure and poverty, financing on

standard Bank terms was deemed inapp.ropriate. It. joined the Corporation

Jrn 1957 and DA in 1 961. PDA approved a $3 .5 mil' lion credit for

education in 1964. The project, however, exnerienced soine difficulties,

and signif- cant cost overruns were anticipated; bv mutual agreement

between the Goverrmoent and 31A, the major portion of the credit was

cancelled in 1969. Meanwhile, conrsiderabl.e staff time and effort

(inc]lu:ing that of a resident mission establi;.hed in Kabul in 1969) have

been devroted largely to projects to improve agr:icultural and industrial

production as well as highway maintenance, air -ransportation, and tourism.

AnilneX !I contains a summary statement of WA credits tb Afghaniistan as

of March 31, 1973, and notes on the execution of the on-going projects,with par-ticular reference to the problems imposed by the recent drought.

-here have beena no IFC inves-tments in Afghanistarn.

G10. The Bank Group's lending strategy recognizes that special

efforts will. be required to help Afghanistan -in view of its landlocked

position, its extreme poverty, its shortage of physi.cal resources and

trained manDower, its Political situation, anzd its difficult economic

problemJis. Considerable assistance will, therefore, be required in

oreparing and implementing. future projects. The IDA staI'f aims to finance

two or three projects each year which, in addition to their developmental

and institution-building impact. would be geared to increasing production

and to alleviating the cri.tical foreign exchange shortage. In order to

ensure sound rroject implementation, institutional developmerit, and

traininE of Afghan counterparts, technical assistance will. continue to be

an integral feature of most projects.

1 . In addition tc the IDBA project proposed in ,his report, I arr

also recommending for your consideration in another report a project for

improving aviation comiunication in Afghanistan. ji second road maintenance

project is expected to be appraised shortly, and to be ready for considera-

tion by the Board around the middle of FY714. A tourism, development project.

for which the detailed design engineering work will be initiated shorl ly

with tCBlE financing and tlhe Bank acting as Executing Ag,ent, is expected to

be ready for Board consideration later in 1Y74. Preparatorv work has also

been initiated on other agriculture and public utilities projects. Duririg

FY74 DA also ite;L;nds to undertake a manpower review, in conjunction with

an education recormaissance mi.ssiohn to explore the possibility of future

assistanace for education.

1 1t-' The i_vestock Development Project was approved by tile Executive

Directors on M'arch 20 and is expected to be signed shortly.

PAIT III - THE SECTOR A1D T-E POTJECT

The Industrial Sector

12. Manufacturing and handicrafts together accounted for 2v160 millionor 11 percent of Afghanistan's GDP in 1°69. Emplo.ment for -these activ,tiesis estimated at 250,000 including about 25,000 people working for enter-prises with 50 or more employees. For a country of niearly 15 million,this sector makes a relatively modest contribution to GDP but has poten1tialfor deVelopment and growth. Both the GoveroLment and private entreprerLeulshave been active in the sector. The Government has undertaken projectsin a number of fields including cotton ginning, oil seed extraction a.ndrefining, fruit canning, cotton textiles, tools and fo-rgin.gs, and vehicrlerepai-r and rebuilding; private businessmen have been ..nvolved in venturesfor processing casings and skins, tanning, leather and embroidery goodsmanufacture, cleaning and packing raisins, rayon weaving, plastics andmetal ,,oods assembly, pharmaceuticals, textiles, soft drinks and soapmanufacture.

13. frl.vate investors were active in 'he sector uintil the 1950ls.especially before World War II. One of them, Bank Millie, received conces-sions ard monopoly rights in foreign trade and was in return obliged toprmi.ote and finance industry. During the early 1950's, however, theGovernment began to play a more active role in the industrial sector andsubstantial government investments dominated this sector for nearly 20years. 3y 1970, public enterprises accounted for 75 percent of the sectorinvestment and about half the sales and employment of all manufacturingenterprises employing 50 or more people. Most of the government enter-prises, however, have had a relatively poor record. In many cases,inadequate planning has led to over-investment, law capacity utilization,and production bottlenecks. Accounting systems are inadequate, andmanagement has been generally unable to control operations effectively7.While it is difficult to be certain of income figures for these enter-prises it is probable that the losses which the Gover-nent must absorbfar outweigh the limited earninlgs that the successful firms generate.

1X. -In tlis context, the late 1060's witnessed a resurgence ofarivate interest in the. sector. The Government sponsored and the Parli a-ment passed the Foreign and Domestic Private Investmnent Law (FDPIL) in1 ,67 in aa effort to revive interest of pri-vate investors. Under theprovislo.s of the FDPIL, investors could be granted a variety of indu.e-mertst including fiire-year exemptions from income taxes. taxes on, dividends.duti.-onn narssarv ecu.nment and matexiAl.- and a ten-year exemotion fromexport duties. Afghanistan has signed and ratified the Convention for theSettlement of Investment Disputes. The FDPIL provides private foreigninvestors with the opportunity to request arbitration under the auspices ofthe Convention. As of September 1972, 176 projects (of ohich 142 were Afghanenterprises, 17 joint ventures with foreigners, and 17 foreign-owned) had beenapproved under the provisions of the FDPIL. One hundred and twenty of thesehad been or were being implemented, of which 80 are already operating in anumber of the fields mentioned above (para. 12). An Investment Committee,chaired by the Minister of Commerce, was created by the FDPIL to evaluate anddecide upon individual investment proposals. The Investment Committee isadvised by a technical secretariat which appraises project proposals with theassistance of an Investment Advisory Center staffed in part with internationalexperts.

-c tl dci.?estic anco exoort ,arkcts '.iXr cconsc`e--.nble score .;or-.e r- cne deve]opment of tne sector. ILigh transnort c osts inpcsced b, r*frl stan'5 landlocked 'aosition afford some prc`tec-ic- for producers

so:Te .neavy, or bulky products. .it the samle time, tlese costs i_ncre..se-:--.,estment costs for imported eouipment to highler levels thnn would. bethe ^ase in countries whllich are better situatcd gerd g hica lr. Theicuestic market, however, offers gc(-' ;--:ect. .- . ? oductiou ofLe-rt`lizers, oeuecL. agrcculitural implements. ;?rOcsse,Cd a' -`.cuitu-.-;.1.coir.:._dities, 'o.u_: iiinO mater:ials. :iardu:re ard ''L) jT docs uoe;nt alexport iTarl:ets exi st for processcd a(,ria fItura oroducts. anriie Y -ru-tsaod ver-etab 1-. e^ .-"or export to neighbor±ing ^.out..:;.es are one uossib:]1 ,0 ;dried ants, -rrpe -,raded anid paclcaCgtl. for- ,orld-iTide exlort ::s or.Lther-ossibi. i1ty; thle ex-port of chilled and frozen lllea+l to Ira _ci-he CU uL

stat_;-- i s 'et an,ther. Mea`: exnort i.s Likelker -t,o u ai-de-ta,xe½ a., a.e tu e be-'L,-een. the Governmen.-t and private Ivi ? ' ' -the s'^. ulltero_house compa.:,c being- established .''or ' ' . ve

o 'ec... The co rnstr-uct ioni OL exoart- orierited -. 'ii W,uerhoue- s ,'t 'eat;xz'urthe-- aportunities for processing pelts, hid.es, and u 1 oduc as we1.'as for more ex-tensive leather processing based iaoroi harides r-aJ.'v- .ts.

m.lbrr-idered leather products and carpet weaving, while :Lcse'1 r t e -ocottage industlr n,roduct'ion methods, offer scone for further dev_1 ma)ea..t

'hese and other activities, there is considerable poential fafo, well.-orga-zeda, s' 1 -sa'e enterprises.

1 c>. i:ioot p`-iv-ta ventares undertaken in the i dutia se r siCcep.ECassage .}_' the EDlL have lacked the support sfAifghaaist -'camimareral banks which have snoiwrn little inte:rest in prov:I'.i lh r,d -luirr or

~g -.- er'.~ ''uc-nds for the r ren1t rescrgenne of pri-vatc tctercs. i n the -se ctcr -Fhe A'o Iint-w1 l a r I t,! an cii> '- ii aoS ets

Th i - . (Olilt .5(!m .lb oi iS the 1 arees-t of the thiree b-ncks aLi.'cer aror s .J, utiols of a central cank. T In recent rears cred- te_-t.erfled ao private 'ims bVs the Da Afgr'a: istan Ban'- hias been of 'c aer

' o,- -i.' Af 01 )i D''14 mni1L.ion), mostlvy in short ter.m] '.rade+ this illsttutiun is generally not respon,sive to the - :dlastr-.

seo-I --c §s '-l .-̂ or' longer *.erm capita' . The other .;- wo bak-s are the-as

1- . I y Te `Iarat,- San'K and thre Bank Millie, eacl w- i L-b a sset - ' a, ;3 -,1.f-i ion (^bout JS2 ` m- l.ion). The for;-e: is 6., percent gov_ rmnent-owri.ed and s c-emianI- es la short t,erm fnaIncing of ex tori- and i o-- S."he pr`vatelj oivcnied Banlc Millie was once activ_ in ar anot'nc new p _

;'eni'v T.ni b-u Lasge inve s --1ents i a small -ro)up o-' -,.e:l asLalinaCU•2,!L, U-.airprises- -ren , ears mowever, :Snn lie b jn _ ii

-t fl ' coonicn new buosrness and has coi e d -tseLf largely tomeeting of the financial need's of its own holdings. None of these threebanks has shown interest in handling development finance activities. Facedwith limitations in the banking system, most entrepreneurs have had to relyupon their own resources and only a few of the larger undertakings have beenfinanced with suppliers' credits. As a last resort, Afghan entrepreneurs canturn to the bazaar where annual rates of interest range from 18 to 36 percent.

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In the circumstances, the bazaar has hardly been a significant source of'medium and long-term capital for industrial investment. The effort w-LiT7hwoul d have been required to re-orient the three existing banlks to nUder-take efficient term financing functions would have been great; and: onbalance, establishment of IDBA represents the most satisfactory solution.The proposed project would help IDBA to begin these operations on a soundbasis.

Plroject history

17. Si-nce 1963 and parttŽularly in the period from 1963 to 1967,the Bank and IFC staff has intermittently discussed with the Goverrnment,Afghan private investors, and prospectuive foreign investors the possibild L,wrof establishing an industrial deve7lpment bank for Afghanistan. The broadoutlines of the proposed project took shape under the leadershi ofO theChase MV!anhattan Bank (Chase), and a Law of' Industrial Banks (IDEA Law)was drafted in 1967. The enabling legislation, however, languished irnthe Parliament and it was only in 1971 that the ID3A Law was approved.At that time, the Afghan Sponsoring Committee for such a bank was revivedurnder the leadership of the former FTnance Uinister, Dr. Mohani.mad Aman,and the Bank Group was again invited to rev-iew the proposed Project.Appraisal cf the project took place in Julyr 17?2. Following IhAs sestablishment in early March, 1973, negotiations were held in Washingtor.between March 12 and March 21, 1973. The Afghan delegati.on was hleaded b,yDr. A.J. Nour Ali, President of IDBA. and included Mr. Nassim Yusuf ofthe Ministry of Finance, and 14r. Vasadachari Srinivasan, General Managerof IDBA.

The Project

18. The proposed project would assist IDBA in beginning its operationsas a source of medium-and long-term capital for the industrial sector inAfghanistan. The proposed IDA credit of $2.0 million would provide for theestimated foreign exchange component of IDBA's business during its first twoyears of operation. The proposed IFC investment of about $250,000 would repre-sent 18-3/h percent of the foreign equity to be invested in IDBA and 7½ percentof TDBA's total equity. Annex III presents the major features of the proposedproject. 'The Appraisal Report (Report No. 66a-AF) is being distributed separatelyto the Executive Directors.

19. The IDBA Law provides for the establishment of IDBA as a legalentity. IDBA will have an initial capital of $3.4 million equivalent, ofwhich 60 percent is now owned by Afghan investors and 40 percent will beowned by a group of foreign shareholders, including (it is proposed) IFC.Under the IDBA Law, no single interest may hold more than 15 percent ofIDBA's share capital and the total of foreign shareholdings is limitedto 49 percent. Afghan shareholders have fully subscribed and paid in60 percent of IDBA's share capital. Five foreign banks led by Chasehave agreed to invest a total of some $1.1 million in IDBA, if IFC agreesto make the proposed investment and IDA provides the proposed credit.The proposed final breakdown of holdings of IDBA's share capital is presentedon page 3 of Annex III.

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20. IDBA will operate in accordance with a Policy Statement, draftedin consultantion with the Bank Grcup, and will provide both debt and equityfinancing to enterprises in Afghanistan. The IDBA will normally limit itstotal financial assistance to a single enterprise to 20 percent of its ownshare capital and free reserves, and will not normally hold more than20 percent of an enterprise's share capital. Pursuant to the provisionsof the draft Project Agreement, IDBA would not incur long term debt inexcess of three times its equity.

21. The domestic resources of IDBA are largely determined by theprovisions of the IDBA Law. The Law provides for a $7.8 million equivalentloan from the Government-owned Da Afghanistan Bank. About $840,000 ofthis loan was paid upon establishment of IDBA; the remainder will bedisbursed by the Da Afghanistan Bank in five equal annual installments.IDEA will pay 2 percent per annum on the loan, and each tranche is to be re-paid over 20 years, including ten years grace.

Onlending Arrangements

22. The proposed credit would be provided to the Government onstardard terms, for onlending to IDBA at 71i percent per annum for aperiod of 18 years, including 3 years grace. IDIE4 would lend to itsborrowers at 10 percent per eanum for up to 15 yea3's, and its borrowerswould assume the foreign exchange risk on the foreign exchange componenrt.The Government feels that these terms might discourage the establishmentof smaller enterprises, and therefore proposes to assist enterprises withfixed assets, other than buildings and land, of less than $100,000 byrebating to them their interest expenses above 8 percent on foreign exchangeborrowings. This would redace the cost of foreign exchange loans to smallenterprises to 8 percent per annum, plus the assumption of foreign exchangerisk. It is proposed that IDEA administer this arrangement for the Govern-ment in respect of IDBA's borrowers. The institution's policies on interestrates and foreign exchange risk coverage, and the impact of the Government'spolicy of assisting small-scale enterprises, will be reviewed by IDBA inlight of experience gained during the first year of its operations. Adjust-ments will be made, if necessary, following discussions between the Govern-ment, IDBA and the Association.

3oard of Directors and Executive Committee

3i. I'ie Board of Directors of TDBA consists of four represeatat vresof Afghan shareholders, three representatives of' the prospective foreignshareholders, the President, and the General Manager. The Board ofDirectors will meet once or twice annually; directors will serve fouryear terms. The Board elects from among its members a five-man ExecutiveCommittee consisting of two A1lCharn directors, one foreign director, the:resident and the General Manager. The Executive Committee wnill be

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responsible for IDBA's operations between Board meetings and has beendelegated the necessary powers, including that for approval of allinvestments, by the Board.

Management and UiNDP Technical Assistance

24. The President and General 1,anager are the principal officers ofDBA. The IDBA Law provides that the President be an Afghan citizen.

Dr. A..J. Nour Ali was appointed President in iKarch and is well qualifiedfor the post. Because IDA is a new institution and the first developnmentfinance companr in Afghanistan, it has recognized the merit of securingtechnical assistance during the first few years of its operations.Accordingly, IDBA and the Government have arranged for UaBF f nancing(with the Bank acting as Executing Agency) of three internationall-rrecruited experts for four years. Mr. Vasadachari Srinivasan has beenappointed General >anager under this arrangement; he is a former Bankstaff member with experience managing development finance companies.A financial mranager and a manager for IDBA's Technical Department lhavealso been recruited. An important responsibility of these three expertswill be the training of IDBA's Afghan staff to take over the day to dayoperation of the institution.

3usiness Prospects and Rate of Return

25. The DBA will be operating in a largely untested market formedium-and long-term capital in Afghanistan. In the circurnstancesdefinitive business forecasts are difficult to make. It is, however,anticipated that the IDEA could reasonably expect to provide about20 percent of the capital required for new investment during the nextfew years and that initial annual commitments of ID3T will be of theorder of $2.0 million. Over half of these initial commitments areexpected to be in foreign exchange. Based upon relatively conservativeprojections for growth in business at 10 percent per annuml, IDBA's netprofit on share capital is expected to average about 14 perce-t from tilethird through fifth years of o-erations.

PART rr - THE IE, I-ITESITE-IT

2c. It is proposed that IFC subscribe for cash 18.000 shares of TDj3Aat par value of Af 1,000 each (about US$250,00, equivalent), pursuant toa Subscription Agreement to be entered into with mB3A. Both Afghan andforeign investors attach great importance to ThJ 'Is proposed investment.The shareholders of IDBA have expressed the desire that IFO be representedon IDBA's Board. IFC, through a representative on the Board, could contr-bute significantly to TDBA's pursuing sound investaient ,policies andgenerally assure close relations between IDBA and the Bank Group. I intend,therefore, to nominate a suitable person to represent IFC on the Boardof ID3A.

27. The main conditions for paying the subscription will be(a', thai all of the Association's conditions of effectiveness of thero=posed c-redit have been ftlfilled, except for the requirement that the

private foreign investors, including IFC, have subscribed and paid fortheir shares in IDBA, and (b) that the private foreign investors shall1.ave, either prior to or contemporaneously with the IF'< subscription andoarnenfI subscribed and paid for a total of 78,000 shares (32.5 percentof IDPiA's share capital).

FAiT V - LEGALi INS-SlER-ilrrETJTIS AND AUTT-10=7IT

or.. The draft Development Credit Agreeme:-m between the KingdGm of

Af'ghanistan, and the Association, the draft Project Agreement between theAssociation and the IndustriaL Development Bc;•k Df Afghanistan, theneport of the ]omaittee provided for in Article V, Section 1 (d) of the_rticles of Agreement, and tle text of thle resolution approving theproposed credit are being dis-tributed to the Executive Directors separately.The draft agreements conform to the normal pattern of agreements withde-velopment finance companies. In accordance -with Section 3 (ii) ofAlrticle III of the Articles of Agreement of the Corporation, the GovernTnentof the Kingdom of Afghanistan has been notified of the proposed investment.

2-. I am satisfied that the proposed deve'Lopment credit complieswith the Articles of Agreement of the Association and that, the Proposedinvestment by the Corporation complies with the Articles of Agreement ofthe Corporation.

PART VI - RECOMMENDATIONS

30. I recommend that the Executive Directors of the Associationapprove the proposed development credit and that the Board of Directorsof the Corporation approve the proposed investment on substantially theterms outlined above.

Robert S. McNamaraPresident

AttachmentsWashington, D.C.Apri110, 1973

COUNTRY DATA - AFGHANISTAN

AREA POPULATION DENSITY14.6 million (mid-1971) 22 per sq.km.

635,000 sq.km. Rate of Growth: 2% (from 1960 to 1970) 100 per sq.km.arable land

POPULATION CHARACTERISTICS (1971) HEALTH (1969)Crude Birth Rate (per 1,000) 50.5 Population per physician 20,700 (1969)Crude Death Rate (per 1,000) 26.5 Population per hqspital bed 6,900 (1969)Infant Mortality (per 1,000 live births)

NUTRITION (1964-68 EDUCATION (1968)Calorie intake as of requirements 88% (1964-68) Adult literacy rate 204 (196d,Per capita protein intake (grams) 65 (1964-68) Primary school enrollment

GNP PER CAPITA IN 1970 / US $80

GROSS NATIONAL PRODUCT IN 1970/71 ANNUAL RATE OF GROJTH (%. constant prices)

US $ Mln. . i/ 1960-70

GNP at Market Prices 100.0 2-1/,'Gross Domestic InvestmentGross National SavingsCurrent Account Balance -29 -Exports of Goods, NFS 86Imports of Goods,NFS 112 10.5

GOVERNMENT FINANCE General Government(AFS MIn. 1& of GDP (AFS Mln.)19771 1970/71 1971/72

Current Receipts 5719 12 5821Current Expenditure 5156 11 5493Current Surplus 563 1 328Capital Expenditures 1731 4 1868External Assistance (net) 628 1 929

MONEY, CREDIT AND PRICES Sept. Sept.

196 ;2i 90 1'1 ;L 21Z(Million AFS outstanding end period)

Money and Quasi Money 6419 7893 8468 9049 8403 9375Bank Credit to Public Sector 5239 9068 9870 10911 10420 11618Bank Credit to Private Sector 560 979 927 1052 582 915

bALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1968-70)

1969 1970 1971 US $ Mln. %(Millions US S)

Exports of Goods, NFS 82.1 85.7 97.2 Dried Fruits + Nuts 18.8 25.6Imports of Goods, NFS -126.0 -112.1 -120.8 Karakul Skins 11.8 16.1Resource Gap (deficit a - ) - 43.9 - 26.4 - 23.6 Cotton 6.5 8.9

Factdr Services and Transfers All other commodities 36. 49.4(net) - 8.9 - 2.2 - 24,7 Total 73.4 100.0Balance on Current Account - 52.8 - 8.3

'EXTERNAL DEBT, DECEMBER 31, 1972Net MLT Borrowing + Grants USS_Mln

Disbursements 62.4 42.2 49.8 Total, Outstanding + Disbursed 607.4Amortization - 22.8 _7i6 -28.1Total 39.6 18.6 21.7

DEBT SERVICE RA;tIO for 1971/72 27%

Other Capital (net) incl.Errors + Omissions 8.1 7.8 6.9

SDR Allocations 4.9 4.0 4 3

Overall Balance - 0.2 - - 15.4

Gross Reserves End of; 1969 1970 Ml Jan.'7341.2 45.5 60.6 54.8

Net Reserves 30.9 30,7 49.1 52.4

IBRD/IDA LENDING, Mlarch 31. 1971) (Million US S ):

RATE OF EXCHANGEOfficial Rate Free Rate. Sept. 1972

IBRD IDAUS $ 1.00 - 45 APS US$ 1.00 a 78.28 AFS

1.00 - US $ 0.0222 1 AF a S0.0128 Outstanding + Disbursed - 5.1Undisbursed _ 9.9Outstanding incl. Undisbursed 7U

g Indicative. Reliable estimates of GNP are not available.

Europe Middle East + N. AfricaApri , 1973

Annex IIPage 1 of 3

THE STATUS OF BANK GROUP OPERATIONS IN AFGHANISTAN

A. STATEMENT OF BANK LOANS AND IDA CREDITS-/(as at March 31, 1973)

Loan or US$ millionCredit Amount (less cancellationjNumber Year Borrower Purpose IDA Undisbursea

158 1969 Afghanistan Highway 5.0 2.1Maintenance

202 1970 Afghanistan Agric4ltqral 5.0 3.1Credit

248?/ 1971 Afghanistan Irrigation 5.0 4.7

Total 15.0 9.9

B. STATEMENT OF IFC INVESTMENTS(as of March 31, 1973)

None

I/ This statement does not include the US$ 9.0 million credit for the LivestockDevelopment Project which was approved by the Executive Directors on March 20,and is expected to be signed shortly.

2/ Credit 68 for an Education Project in 1964 was cancelled at the Government'srequest in 1969. $0.3 million which had been disbursed for the project wasrefunded under Credit 248.

Annex IIPage 2 of 3

C. PROJECTS IN EXECUTION

Cr. No. 158 Highway Maintenance Project: US$ 5.0 million Credit ofJune 26, 1969; Closing Date: December 31, 1973.

The Highway Maintenance Project of June 1969 (Credit No. 158-AF)became effective in mid-1970 afte-r it was ratified by the Parliament whichmust approve all foreign borrowing. During much of the next two and onehalf years, the Government was forced to divert scarce local funds fromthis and other projects for relief operations following the drought of 1970and 1971. Progress on the H'ighway Maintenance Project, therefore, wasconstrained by a shortage of local funds during this period, but the Govern-ment is now providing sufficient financial support. There have also beendifficulties in recruiting key Afghan counterpart personnel because ofunattractively low civil service salaries; but recently, progress has alsobeen made toward solving this problem, and in February a very capablePresident was hired for the project department.

Cr. No. 202 Agricultural Development Bank Project: US$ 5.0 millionCredit of June 2a, 1970; Closing Date: December 31, 1974

The Agricultural Credit Project of ..une 1970 (Credit No. 202-AF)became effective in December 1970, In conjunction with the project, theAgricultural Development Bank of Afghanistan (AgBank) was reorganized withthe assistance of a UNDP-fwaded German management team. AgBank's staff hasbeen strengthened, loan appraisal methods upgraded, and loan collectionprocedures improved. The nrumber of AgBank onlending operations has increasedsignificantly under the guidance of the contracted management group; andalthough disbursements for the project were slowed by the recent drought,commitments are once again increasing. A second three-year contract withthe consultants has just been concluded.

Cr. No. 248 Khanabad Irrigation Project: US$ 5.0 million Credit ofJune 11, 1971; Closing Date: June 30, 1976.

The Khanabad irrigation }'ro-ect of June 1971 (Credit No. 248-AF)became effective in mid-December 1972, after considerable delay in obtainingparlianentary action on this and a nwnber of other external loans. Duringthe past two years, the Parliament has been preoccupied with domestic issuesand failed to consider the foreign borrowing proposed by the Goverrnent.When the Khanabad Credit was finally considered in November 1972, however,it was approved unanimously. In eary December -the Government completed theremaining steps for making the credit effective, including the establishmentof a new department to look after the project, appointment of an experiencedAfghan to head it, establishment of an imprest account for the project, andthe appointment of engineering and agricultural consultants; therefore, theGovernment has now begun to implement the project. Moreover, in order toavoid. the sort of delay experienced with the Khanabad Irrigation Project,-the Government is considering legislation which, if enacted, would streamlinethe process of parliamentary approval of external borrowing.

Annex IIPage 3 of 3

Livestock Development Project: US$ 9.0 millionCredit; Closing Date: September 30, 1978

The Livestock Development Project was approved by the Boardon March 20. It is expected to be signed shortly, as soon as theincorporation of the Herat Livestock Development Company (one of thetwo project entities) has been completed.

Europe, Middle East and North Africa RegionApril 10, 1973

Annex IIIPage 1 of 3

AFGHANISTAN - IDBA PROJECT

Credit and Project Summary

Borrower: Kingdom of Afghanistan

Beneficiary: Industrial Development Bank of Afghanistan (IBBA)

Amount: US$ 2.0 million equivalent

Terms: Standard

Relending Terms: Government would onlend the IDA Credit toIDBA at 74 percent per annum for 18 yearswith 3 years grace. IDBA would pay acommitment charge of 3/4 of one percenton amounts authorized for withdrawal withrespect to specific projects but notwithdrawn. IDBA would relend to itsborrowers at 10 percent per annum for upto 15 years. IDBA's borrowers would bearthe exchange risk on their borrowings3 but asystem of Government rebates would reducethe effective interest cost to small scaleborrowers to 8 percent for foreign exchangeloans.

Project: IDBA's requirements for the financing of theimport component of sub-projects.

Estimated Disbursements: Year ending June 30 197h 1975 1976

US$ million 0.3 0.8 0.9

Free Limit: $50,000 for individual sub-loans; $500,000aggregate limit.

Debt Covenant: Maximum debt/equity ratio of 3:1

ANNEX IIIPage 2 of 3

1/Projected Total Commitment

Year ending June 30 1974 1975 1976 1977 1978(in US-mil1ioT

Annual Commitment 2.0 2.2

Financed by

Opening balance of uncom-mitted funds - 4.8

Share capital 3.4 -

Internal cash generation 0.2 0.3DAB loan 2.2 1.4Proposed IDA credit 1.0 1.0

6.8 7.5

Closing balance of uncom-mitted funds 4.8 5.2

Projected Balance Sheet

Assets

Current assets 5.5 6.3 6.9 7.7 8.5

Loans o.6 2.2 4.1 6.o 7.8

Other assets * * * * *

Total Assets 6.1 8.5 11.0 13.7 16.3

Liabilities

Borrowings 2.6 4.8 7.1 9.5 11.8

Eauity 3.5 3.7 3.9 4.2 4.5

Total Liabilities 6.1 8.5 11.0 13.7 16.3

* = less than $100,000

Debt/Equity Ratio 0.7 1.3 1.8 2.3 2.6

Projected Earnings

Total earnings 0.3 0.5 0.7 1.0 1.2

Total expenses 0.1 0.3 0.4 0.5 0.6

Net profit 0.2 0.2 0.3 0.5 o.6

ANNEX IIIPage 3 of 3

1974 1975 1976 1977 1973Net profit as % of:

average net worth - 6.2 9.1 11.9 1l.3share capital - 6.8 10.4 ll.2 18.i

Debt Service Coverage (times) 5.3 3.1 2.4 2.3 2.3

Proposed IDBA Ownership 1/

IDBA Ownership (US$ equivalent)

Foreign Local Total Percent

Afghan Investors -- 2,013 2,013 oO.OChase Manhattan Bank 252 -- 252 7.5IFC 252 __ 252 7.5First National City Bank 252 __ 252 7.5National Westminster Bank 252 -- 252 7.5Industrial Bank of Japan 252 -- 252 7.5Credit Lyonnais 84 - 84 2.5

2/ 2/Total l,342 2,013 3,35h i0o.0

Appraisal Report

Report No. 66a-AF dated April 6, 1973EMENA, DFC Division

1/ Based upon a free market rate of exchange of Af 71.55 = US$12/ Figures do not add to totalsbecause of rounding.

Europe, Middle East and North Africa RegionApril. 10, 1973

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