Documen; of

The World Bank

FOR OFFICIAL USE ONLY

/'- J ' / s

Report No. 4938a-PO

STAFF APPRAISAL REPORT

PORTUGAL

TEXTILE INDUSTRY RESTRUCTURING PROJECT

April 24, 1984

Industry Department

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

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PORTUGAL

TEXTILE INDUSTRY RESTRUCTURING PROJECT

CURRENCY EQUIVALENTS

Calendar Year 1983 March 1984Currency Unit = Escudo (Esc.) US$1 = Esc.135

US$1 = 110.78 Esc. Esc.1 = US$0.0074

WEIGHTS AND MEASURES

1 kilogram (kg) = 2.2046 pounds1 metric ton (MT) = 1,000 kilograms = 2,204 pounds

1 meter (m) = 1.0936 yards1 square meter (m2 ) = 1.2 square yards

ABBREVIATIONS AND ACRONYMS

BESCL Banco Espirito Santo e Commercial de LisboaBFN Banco de Fomento NacionalBPA Banco Portugues Atl.anticoBPSM Banco Pinto Sotto hayorBdP Banco de PortugalCGI) Caixa Geral de DepositosEEC European Economic CommunityEFTA European Free Trade AssociationIAPIEI Institute for Assistance to Small and Medium EnterpriseITC Internal Trade CenterMFA Multi-Fiber AgreementMIE Ministry of Industry and EnergyPFI Participating Financial InstitutionsSFP Sociedade Financiera PortuguesaSill System of Industrial Investment IncentivesSMI Small and Medium IndustrySPI Sociedade Portuguesa de InvestimentosTA Technical AssistanceTC Textile CommitteeTI Textile InstituteTRU Textile Review Unit

FISCAL YEAR

Government: January 1 - December 31PFIs: January 1 - December 31

FOR OFFICILL USE ONLYPORTUGAL

TEXTILE INDUSTRY RESTRUCTURING PROJECT

TABLE OF CONTENTS

Page

I. INTRODUCTION ................................................. . . 1

II. THE INDUSTRIAL SECTOR ..................................... .... . 2

A. Characteristics and Structure .......................... . ... 2B. Past Trends and Recent Performance ...................... ... 2C. Prospects and Priorities ................................. . . 3D. Development Issues ................................. . ....... 3E. Industrial Policies .................................. . ..... 4F. Industrial Strategy ............................... . ........ 6

III. THE TEXTILE INDUSTRY .......... 8

A. Introduction ............................................... 8B. Structure .................................................. 8C. Machine and Labor Productivity ............................. 9D. Financial Performance .................. 10E. The Textile Market ......................................... 10F. Problems and Issues in Restructuring ...................... 13G. Investment Requirements ................ . 14H. Priorities for Investment .. 14

IV. POLICY AND STRATEGY FOR THE TEXTILE INDUSTRY .................. . 15

Az. Policies ..................................................... 15B. Textile Development Plan ...................... ............ 17

V. THE PROJECT .................................. ................. . 19

A. Project Origin .... ........ .. 9. 1B. Project Objectives and Scope ... .............. .. 20C. Coordination with Other Bank Operations ................. 21D. Project Costs ... ......................................... . 22E. Project Components and Their Financing ..................... 22

VI. PROJECT IMPLEMENTING AGENCIES ............ ...................... 24

A. Background ............................................... .. 24B. The PFIs .............................. .................. . 25C. The MIE/Textile Review Unit .. . ...... .......... *. 28D. The Bank of Portugal .................................... o. 28E. The MIE/Textile Institute .................................. 29

This report was prepared by L Nguyen, A. Sandig, L Zamani of the IndustryDepartment, and R. Ihonsary (Consultant).

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

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Page

VII. PROJECT MANAGEAENT ............................................. 29

A. Textile Restructuring Credit Line .......................... 29B. Technical Assistance Component ........................... .. 36C. Training Component ............................ . .. ......... 37

VIII. BENEFITS AND RISKS ........................ .................... 39

IX. AGREEMENTS ............................................ 40

ANNEXE:S

3-1 Textile Industry Production Balance ........ .................... 423-2 Production Imports, Exports, and Apparent Consumption of

Textiles, 1973-82 ................................... 433-3 Exports and Imports by Textile Products, 1982 .................. 443-4 Portugal's Utilization of EEC Textile Quotas ................... 453-5 Projections of Import, Export and Domestic Consumption of

Textiles, 1982-93 ............ ............................... . 466-1 Banking System: Some Characteristics (as of end 1982) .... ..... 476-2 Banking System: Sectoral Credit Outstanding by Term at year

end, 1978-82 ................. ................................. 486-3 Caixa Geral de Depositos-Non performing Loans and Bad Debts at

year end, 1979-82 ... ..... ... ................ 506-4 The Textile Institute and Textile Training Facilities .......... 517-1 The Projected Commitment and Disbursement Schedule for the

Credit Line Component .......... .............................. 537-2 Draft Terms of Reference for Technical Consulting Services to

the Textile Review Unit ... ................................... 547-3 Draft Terms of Reference for the Textile Training Study ........ 567-4 List of Equipment for Textile Training .... ..................... 58

MAP

Map of Portugal (IBRD No. 18048)

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DOC'JNENTS CONTAINED IN PROJECT FILE

1. Portugal - Policies for Industrial Restructuring, Report No. 3804-PO,August 4, 1983.

2. Analysis of the Portuguese Textile Industries, statistical tables byIND staff.

3. Study of Textile Industry in Portugal, Werner International, 1980.4. Draft Textile Development Plan (1984-87), MIE, November 1983.5. Review of Proposed Textile Incentives, Consultant, December 1983.6. Sample of Textile Investment Projects in Portugal, Report by IND staff.7. A Review of the PFIs Organization, Lending Portfolio and Loan

Performance, December 1983, Report of IND staff and consultant.8. Checklist for Subproject Appraisal, WB staff.9. Guidelines for Calculating Financial and Economic Rates of Return for

DFC Subprojects, Gary Hyde.10. B-Subproject Summary Note.11. Questionnaire for Financial and Technical Data of PFIs.

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PORTUGAL

TEXTILE INDUSTRY RESTRUCTURING PROJECT

LOAN AND PROJECT SUMMARY

Borrower: Republic of Portugal

Beneficiaries: Textile enterprises

Amount: US$34.7 million

Terms: Repayable in 15 years, including three years of grace,at the standard variable interest rate. TheGovernment would bear the foreign exchange andinterest rate risks.

Relending Terms: Beneficiaries would receive credit with maturities notto exceed 12 years, including a maximum of three yearsgrace, at floating interest rates equal to thefloating interest rate payable on local currency loanswith similar terms.

Project Description: The proposed project would assist the Government ininitiating its textile subsector development planthrough a program of policy improvements, andtechnical and financial assistance. The credit linewould be channeled through participating financialintermediaries to support investment andrehabilitation programs of textile enterprises forstrengthening their productivity and competitiveness.It also seeks to enhance the ongoing efforts atstrengthening appraisal and support capacities offinancial intermediaries and technical assistanceinstitutions by upgrading their textile expertise.The project faces moderate risks associated withpossible slow utilization of the credit line and lowerthan expected returns from the enterprise-specificrestructuring programs. Appropriate incentives havebeen introduced to maint_in the interest of theparticipating financial institutions and as well asmeasures to strengthen the appraisal and supportcapacities of the financial and technical institutionsserving the textile sector. A special incentive hasbeen provided under the project to facilitate the useof expert services in preparation of economically andfinancially viable investment programs for thebeneficiary textile enterprises.

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USS million (equivalent)Project Cost Foreign Local Total

Investments 33.0 33.0 66.0Technical Assistance 1.1 1.2 2.3Training 0.6 - 0.6

Total 34.7 34.2 68.9

US$ million (equivalent)Project Finance Foreign Local Total

Bank Loan 34.7 - 34.7Investor self-finance - 21.0 21.0Domestic Banks - 13.2 13.2

Total 34.7 34.2 68.9

Estimated Disbursements:

US$ Million EquivalentFY1985 FY1986 FY1987 FY1988 FY1989

Annual 1.6 8.1 12.6 9.4 3.0Cumulative 1.6 9.7 22.3 31.7 34.7

Appraisal Report: No. 4938a-PO, dated April 24, 1984

I. INTRODUCTION

1.01 The Government of the Republic of Portugal has requested a Bankloan of US$34.7 million to help finance the restructuring investment needsof the textile industry 1/ in Portugal. US$33.0 million of the proposedloan would be channeled through the participating financial institutions tohelp finance the eligible restructuring investments to be implemented bytextile enterprises. Of the remainder, US$1.1 million (includingcontingencies) would be used to fituance part of the specialized technicalassistance services to the eligible enterprises to improve theirefficiency, and to the Ministry of Industry and Energy to strengthen itscapacity to monitor the impact of the textile restructuring process;US$0.6 million would be used to finance a comprehensive training study andspecific textile training equipment. The proposed project with a totalcost of US$68.9 million would finance about 30% of the textilerestructuring investments expected over the 1984-87 period. The balancewould be financed with the industry's own funds and by domestic financialinstitutions and bilateral sources (e.g., suppliers' credits).

1.02 The proposed project is expected to assist about 40 textilerestructuring investment projects. About 75% of these would be in the morelabor-intensive textile activities of finishing and garment makingaccounting for 50% of the US$33.0 million credit line. The restructuringinvestments to be financed are expected to create/maintain about 1,700jobs, at an average cost per job ranging from US$10,000 to US$85,000.

1.03 During implementation, the proposed project would also assist theGovernment to further the gains already made in the policy environment(e.g., revision of the investment incentive system and amendment of laborregulation), particularly in designing new and effective textile incentivemeasures. The Government's adoption of the textile restructuring strategyand restructuring eligibility criteria as defined for the proposed project,as well as the Government's agreement to the principle of a streamlined,fiscal-based and less costly textile incentive scheme mark important stepsin the appropriate direction.

1.04 The proposed project is the direct result of the Government'sdesire to promote subsectoral restructuring. The Bank's first review ofthe textile industry was conducted in August 1977. Subsequently, areconnaissance mission visited Portugal in June 1980 at the Government'srequest to review the restructuring needs and prospects of the industry asproposed in a report by Werner International prepared for the Government.After extensive discussions with the Government of the different technicaland institutional approaches possible for the Bank's involvement in textilerestructuring in Portugal, a satisfactory framework was evolved, and theproject was appraised in September/October 1983, by a Bank missionconsisting of Ms. K. Nguyen, Messrs. A. Sandig and K. Zamani of theIndustry Department and R. Khonsary (consultant). This would be the firstloan made by the Bank to Portugal to support specifically a subsectoral

1/ The textile industry is defined to include spinning, weaving,finishing, knitting and making-up (garments and household goods).

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adjustment program. As restructuring is a long-term evolving undertaking,the proposed project is a first step and an important vehicle for theBank's involvement in the policy issues related to the industrial sector ingeneral and the textile industry in particular. Together with otherongoing industrial operations, this and future subsectoral loans currentlybeing planned would help ensure that structural change takes place at theindustry level in a consistent manner and with minimum disruption.

II. THE INDUSTRIAL SECTOR

2.01 The existing role of the industrial sector in Portugal, and themajor issues affecting industrial development, have been discussed in the1982 industrial sector report 2/ which analyzes the restructuring problemsof the sector and discusses the policies needed.

A. Characteristics and Structure

2.02 The industrial sector is a leading sector in the Portugueseeconomy accounting for about 30% of GDP, 35% of employment, 40% of capitalformation and about 90% of merchandise exports in 1982. The public sectorcontrols the large capital-intensive industries (i.e., steel, oil refining,chemicals, fertilizer, pulp and paper, cement and shipbuilding) accountingfor about 35% of the manufacturing capital stock. These industries areprimarily oriented towards domestic markets. The private sectorpredominates in the other industries, such as textiles, food processing,transport equipment (other than ship-building), electrical-mechanicalproducts, wood, and cork. As the Government increasingly encourages alarger role for the private sector, and as exports represent a key elementin the country's economic development, the textile industry is a prioritysubsector in Portugal's industrial development strategy. Itscharacteristics and performance are discussed in Chapter III.

B. Past Trends and Recent Performance

2.03 During the 1968-73 period, industry (growing at 10% p.a.) was thedriving force of the remarkable growth of the Portuguese economy (6.9%p.a.). The Revolution of April 1974 and its aftermath have resulted inserious disruptions in industrial growth (3% in 1974, -9.7% in 1975, and4.5% in 1976). Sibstantial recovery took place, however, by 1977 with a9.4% growth during the year, essentially based on general improvement inthe productivity of the labor force. In the 1977-79 period, performance ofindustry continued to be good (about 3% p.a. or the same as for the economyas a whole), in spite of the deflationary effects of the stabilizationprogram started in 1977. During 1980-82, the performance of the industrialsector has been mixed and not as dynamic as in the last years of the1970s. Whereas, in 1980, the 6% overall industrial growth rate continuedto be based on strong export performance as in the late 1970s, in 1982(when industrial production rose by about 2%) production in many of the

2/ Portugal: Policies for Industrial Restructuring, Report No. 3804-PO,August 4, 1982.

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main exporting subsectors such as textiles and electrical mechanicalindustries actually declined, and the increase in overall output was onlysustained by the stronger performance in subsectors more reliant ondomestic demand. As the country's policies were progressively adjusted tothe long-term needs of an export-based industrial sector, industrialexports resumed their pre-1974 role as the driving force of industrialprogress, growing at some 26% p.a. in real terms over 1977-79 (compared toa decline of 30% p.a. during the period 1974-77). Growth of industrialexports during the last several years has slowed down to an average ofabout 10% p.a. in real terms.

C. Prospects and Priorities

2.04 The couparative advantage of Portugal lies in the relativecheapness and abundance of skilled labor (although limited by laborproductivity below international standards) (para 2.05) and itsgeographical preximity to the EEC markets. Although its timing is atpresent uncertain, Portugal's planned membership of the EEC will radicallychange the environment in which Portuguese industries operate. On the onehand, there is a potential for export expansion in industrial activitieswith the above-mentioned comparative advantage, once the demand levelrecovers. These activities include shoes/leather, pulp and paper,ceramics, garment-making and various branches in the engineeringsubsector. On the other hand, Portugal will face increased inportcompetition from the EEC partners, and most importantly from non-EECcountries because of expected lower protection vis-a-vis these countries(para 2.08). The textile industry is a prime target to experience thesechanges. Because of its role in the industrial sector in terms ofemployment and exports, it has been designated by the Government as apriority subsector for restructuring and is the focus of the proposedproject.

D. Development Issues

2.05 Portuguese enterprises (large and small, public and privatealike) have long been suffering from structural weaknesses. These includefactors such as uneconomic size of the enterprises, unbalanced productioncapacity, less than optimum product mix and market development, inadequateproduct design and quality control, outdated technologies and shortage ofcompetent management. The above deficiencies are reflected in the lowproductivity of many Portuguese industries. Rough estimates of totalfactor productivity suggest a serious fall in the period 1973-77 averaging2.5% p.a., and only very modest gains thereafter, compared to increases ofbetween 2-4% p.a. in other countries for which broadly comparable estimatesare available. Currently available data suggest that, even though smallimprovements in productivity were achieved in 1980, the situation wasreversed in 1982 and the overall productivity position remains weak.

2.06 At the subsectoral level, the above trends suggest a disturbingsituation: productivity growth in many of Portugal:s traditional exportactivities such as textiles (notably garment-making), engineering, pulp andpaper, and footwear, has not been sufficiently strong to allow fullexploitation of their labor cost advantage and, more importantly, to

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withstand the intensified competition from outside the EEC. One reason forthis is the post-1974 labor legislation which severely restricts theability of enterprises to reduce employment, which now stands at some20-40% above international standards for many subsectors (e.g., as much as50,000 superfluous jobs in textiles).

E. Industrial Policies

2.07 In addition to the important role of overall Government policieslike regulation and monetary policies, the key elements of the Government'spolicy toward industries are the system of fiscal and financial incentives,and trade protection (notably import regulations).

2.08 Protection. External nominal tariffs in Portugal are now quitelow, averaging about 8% overall, 5% vis-a-vis the EEC and 3% vis-a-vis theEuropean Free Trade Association (EFTA).3/ Footwear and clothing are theonly major exporting industries for which the overall protective tariffexceeds 10%. The tariff adjustments of the last 4 years are thusconsistent with Portugal's planned EEC membership, and further reductionsto accommodate free entry from future EEC partners should pose fewproblems. More serious problems will result from the acceptance of EEC'scommon external tariffs against third countries (which would lowerPortugal's independent tariffs from an average of 15% to 9%, and much moresharply for many traditional Portuguese industries such as textile,footwear, furniture, engineering products), and particularly from thedismantling of the currently very cumbersome import regulations which haveoperated as fairly strict tariff barriers on certain goods (e.g.,garments).

2.09 Industrial Incentives. As discussed in the 1982 industrialreport, the Bank's review of the Portuguese system of industrial investmentincentives (SII) concluded that, since its inception in 1980, the systemhas not been very effective. During discussions with the Government, thefollowing modifications have been recommended: (i) simplify the complexadministration of the scheme; (ii) introduce more selectivity in the manyforms of incentives to strengthen the signals intended for would-beinvestors; (iii) reduce the magnitude of the investment subsidies granted;(iv) introduce separate incentives for restructuring of existingindustries; (v) remove the bias against investments for equipmentreplacement and rehabilitation; and (vi) replace the incentives forregional development with more effective instruments such as provision ofbetter infrastructure. In March 1983, the Government modified the SIIIto extend the eligibility definition of investments to include replacementof equipment, eliminate the regime of special incentives which formerlyoffered very generous benefits, simplify some aspects of the eligibilityformula, streamline some of the application review and processingprocedures, and incorporate a 30% minimum equity requirement for eligibleinvestments. The revisions have responded in varying degrees to the issuesraised in recommendations (i), (ii), (iii) and (v) listed above. Morerecently, in the context of the first consultation on the incentive policy

3/ This does not include the temporary surcharge of 30% set up in 1983,and reduced to 10% for 1984.

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with the Gov'ernment as agreed under the Bank's second project for Small andMedium Industry (SMI),4/ the Government indicated that it is considering adrastic revision of the investment incentive policy, and may 3bandon thebroad SIII framework altogether to replace it with separate incentivemeasures tailored more specificall.y to individual subsectors, and adopt theEEC's incentive approach for regional development. The Covernment hasasked for the Bank's continued collaboration to elaborate furthler the newincentives. Such follow-up would be carried out during our ecnnomic nndsector work, project work, and for the textile subsector, during theimplementation of the proposed project (para 4.03). The Government'sagreement to the eligibility criteria for textile restrtuctrinig investments(para 7.01) marks an important step in this regard.

2.10 Labor Policies. The labor legislation set tip in 1975 to ensurethe security of labor has made worker releases extremely difficult, andresulted in chronic overmanning in many industries, including textile,engineering and shipbuilding. Contributing to these difficulties is thecollective labor conventions agreed between the enterprises and laborunions after 1975. which among other constraints have limited theenterprises' ability to transfer employees from one function to another.The rigidities in the labor market have gradually eased in recent years, asa result of several factors. Notablv, the Government has been increasinglyauthorizing the use of temporary, renewable labor contracts of one year orsix months' duration. The available legal instrtments have also been usedin more imaginative ways by enterprises (e.g., early retirement offered toan employee in exchange for a temporary contract for a vounger relative).Recognizing that the competitivenMss of Portuguese industries cannot beachieved without accepting job losses in kev subsectors, the Covernment hasin November 1983 approved an important amendment to the existing laborregulation, which defines the procedures and compensation arrangementswhereby industrial enterprises can apply for official authorization toreduce or suspend temporarily the work force and/or work hours when thefinancial and economic viability of the enterprises is jeopardized as theresult of one or several of the following factors: poor market conditions,poor competitiveness due to excessive labor, technological deficiencies, inaddition to the currently allowed condition of bankruptcy. The provisionsproposed seem to be reasonable partial measures, but the general qiuestionof labor mobility will need carefully designed long-term solutions as well,such as retraining, expansion of the production units, etc.

2.11 Monetary Policy. The large public deficits have, since 1980,caused the growth of credit to the public sector to increase more rapidlythan the growth of other forms of credit. This has been the majorconstraint on monetary policy, which has continued to rely mainly on creditceilings to hold down total credit. There have also been stuccessiveadjustments in interest rates. The recent increases in interest rates ondeposits have rapidly expanded the value of savings in the form of bankdeposits. In order to control the expansion of credit, the Bank ofPortugal (BdP) since 1978 has established monthly credit ceilings forindividual banks, determined within an overall limit for aggregate creditexpansion. Initially, purely quantitative ceilings were applied, but in

4/ SAR No. 4185-PO dated March 11, 1983, Loan No. 2263-PO.

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1981 a qualitative approach was adopted in determining the base monthlycredit ceiling for each bank, with the various forms of credits and loanscarrying a different weight (depending on their degree of priority). Thebase ceiling is adjusted in consideration of the degree to which therespective bank extends priority credits relative to the proportion of suchcredit being extended by the system as a whole. In addition, genuinelypunitive penalties on banks for exceeding the ceiling were established.

2.12 Interest Rates. As the Portuguese interest rates were quite lowbefore the Revolution, the gradual increases after the Revolution were notsufficient to compensate for the then accelerating inflation. During thelast five years, however, six interest rate increases were implemented,raising the maximum lending rate from 14.75% to 32.5% and the maximumdeposit rate from 13% to 30%. All loans in Portugal are subject to afloating interest rate which is adjusted when BdP changes interest ratelevels. In the last four years, interest rates on long-term loans havebeen positive in real terms as follows:

Portugal - Interest Rate Trends

Long-term Annual RateLending Rate of Inflation Difference

1980 22.25 17.00 5.251981 July 24.00 20.00 4.001982 April 26.00 22.00 4.001983 March 30.00 25.00 5.00

August 32.50 25.00a/ 7.50

a/ estimated.

The above pattern of positive real long-term interest rate is expected tocontinue as the Government under the October 1983 IMF stand-by arrangementis committed to maintain a flexible stance with respect to interest ratepolicy in order to ensure the relative attractiveness of holding domesticfinancial assets and to control the demand for credit. Confirmation thatthe Government intends to maintain real interest rates at positive reallevels was already obtained in the context of Bank's recent SMI II loan.Currently, some changes are under consideration, including the possibilityof a decline in the final lending rates to reflect the expected reductionin inflation during 1984.F. Industrial Strategy

2.13 - Against this background, two of the main objectives forPortugal's industrial development strategy should be (i) to restructure andmodernize key industrial subsectors and existing enterprises (private andpublic) which have potential for efficient growth, and (ii) to increaseinvestment in and output from new production units and/or new privateenterprises, which can export and, among other things, may help absorb thelabor released from the industries to be restructured. Industrialrescructuring would involve: (i) industrial reorganization (e.g.,through

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phasing out non-viable units or merging them into larger, more efficientplants); (ii) rationalization in output structure (e.g., through betterdesign and quality for existing products, phasing out of some products andintroduction of new ones in the higher value-added categories); and(iii) improvements in plants' efficiency (e.g., through measures to reduceproduction costs, improve management practices, train workers and modernizeequipment). Other priority areas for industrial strategy are optimizationof use of national resources and development of new and existing industrieswith advanced technologies.

2.14 Although the restructuring approach to be adopted for eachsubsector will need to be tailored to its specific problems and needs, itwill basically involve one or more of the three elements defined above.The basic action package for a coherent restructuring program shouldinclude the following components: (i) appropriate policies (e.g.,industrial incentives, labor laws) to guide and support the followingelements of the restructuring action program; (ii) technical assistance andtraining services; and (iii) financing for the corresponding investmentrequirements. In the formulation of these policies, emphasis should begiven to allow market signals, rather than direct Government intervention,to set the direction and pace of restructuring.

2.15 In a recent draft law for industrial development (which is beingreviewed within the Bank at the request of the Government), the aboverestructuring objectives are given high priority for traditional industriessuch as textile and mechanical industries. With Bank assistance theGovernment is already implementing specific restructuring programs for anumber of specific public enterprises (e.g., in fertilizers,hydromechanical equipment, steel casting and valves).5 / The Government hasalso commissioned a number of subsectoral studies for key industries suchas textile, engineering and pulp/paper.6/ The textile subsector study isalready available, and together with the Bank's 1983 report on IndustrialRestructuring, has served as a basis for technical and policy discussionsbetween the Government and Bank during the past three years. Thesecontinuing discussions have led to the Government's new draft plan fortextile restructuring (reviewed in Chapter IV), and form the basis for theproposed project (Chapter V). Discussions about other subsectoraladjustment programs are expected to take place between the Government andBank within the coming two years, as the remaining subsector studies arecompleted, and in the course of the Government's efforts to developprograms/measures to increase the dynamism of the Portuguese industrialsector.

5/ The Bank is currently also assisting the Government in reviewing theproblems of public sector enterprises to formulate a morecomprehensive restructuring action program.

6/ These last two studies are funded under ongoing Bank-financedprojects.

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III. THE TEXTILE INDUSTRY

A. Introduction

3.01 The textile industry in Portugal is wholly owned by the privatesector. It was largely a creation of the import substitution policiesimplemented in the 1930s and its growth since 1946 can be ascribed toexport opportunities created by the disruption of European economiesfollowing the second World War as well as significantly lower labor costsin Portugal as compared with Western Europe. The industry reached its peakoutput in 1973. Following a severe drop due to the 1974 Revolution, it hasbeen gradually increasing its production; in 1982, output reached only 76%of the 1973 level.

3.02 The industry makes an important contribution to manufacturingoutput and in 1980 it accounted for 9.6% of the GDP, 17.5% of theemployment in manufacturing and 26.6% of the total exports. Out of thetotal 175,000 people employed in the textile industry, 105,000 are engagedin primary textiles and 70,000 in downstream activities like garment andmaking-up activities.

3.03 The industry produces a comprehensive range of products, andincludes all stages of manufacturing from spinning to ready-made garmentsand household goods. Portugal imports all its cotton and about half of itsman-made fibers; imported fibers account for about 86% of total fiberconsumption in the primary textile mills. The relative proportion betweenthe natural and man-made fibers (46% in 1980) has remained practicallyconstant since the 1970s. Most of the textile mills use conventionaltechnology, i.e., ring spinning and shuttle looms. In 1980, out of 1.6million spindles installed, only 0.6% were of the high-speed open-end typeand out of 28,000 looms, only 6.4% were modern shuttleless weavingmachines.

B. Structure

3.04 Most Portuguese firms are too small to benefit from economies ofscale. In the primary sector, 81.5% of the companies employ less than 200workers and only 4% of the companies employ more than 500 people.Inadequate scale is less of a factor in knitting and making-up industries,but even here there are many companies which do not achieve a viable scaleof operations as 83.2% of the enterprises employ less than 100 workers.

3.05 The industry is well developed at all stages of production, i.e.,spinning, weaving, finishing, knitting and making-up industries. This,combined with a higher level of protection on finished goods (para 4.02)explains the high share of consumption met by domestic production. Thematerial balance of the textile industry production is shown in Annex 3-1.In marked contrast to such successful textile exporter as Hongkong, whichimports yarn and most of the fabrics and concentrates on morelabor-intensive and profitable downstream operations, the Portugueseproduction structure indicates an excess of yarn and fabrics as comparedwith the downstream operations. The structure of the industry is shown inthe following table.

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Portugal - Structure of the Textile Industry

Active % of % ofOperations Companies Workers Production a/Primary Textiles:Cotton & Blends 431 39.9 43.5Wool & Blends 230 13.6 9.5

Knitting b/ 507 17.5 16.7Garments & Making-up 415 19.8 17.5Other Products c/ 66 4.2 6.2Paper, Cordage, etc. 18 2.1 2.4Man-made Fiber Manufacturing 11 2.9 4.2

Total 1,678 100.0 100.0

a/ By value.h/ Including making-up of knitted articles.c/ Trimmings, laces, canvas, etc.

Source: Study of the Textile Industry in Portugal, by WernerInternational, 1980 (hereafter referred to as the WernerReport).

3.06 Most of the companies are relatively small and family owned, thedegree of vertical integration within any given company is notsignificant. It is estimated that not more than 25% of the mills in theprimary sector are fully integrated, i.e., simultaneously opetate spinning,weaving and finishing facilities. In cotton and man-made fibers, 540weaving mills are serviced by 110 spinning companies indicating a largenumber of independent weavers. This structure allows a fair degree ofspecialization but as the units are small, the problem of economies ofscale still exists.

C. Machine and Labor Productivity

3.07 Further problems arise from the large proportion of agingequipment. The figures in the following table indicate that over 40% ofthe industry's spindles and looms were installed before 1965.

Portugal - Age of Installed Plant (1979)(X.)

Spindles Looms

Pre-1954 13.0 16.11955-59 12.3 5.61960-64 17.9 19.31965-69 12.2 26.41970-74 38.6 16.2After 1974 6.0 16.4

Total % 100.0 100.0

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3.08 Both machine and labor productivity in the Portuguese mills arewell below European and North American standards. The relatively smallsize of the enterprises, obsolescence of the equipment, and less thanoptimal method of operation contribute to low machine productivity. Forexample, the average efficiency in cotton spinning in Portugal is 81.5%compared with the international standard of 93%. The efficiency level inweaving is about 76% vs. 91%, respectively. The labor productivity is alsoaffected by the high degree of absenteeism and overstaffing in theenterprises, as shown in the following table:

Portugal - Labor Productivity Expressedas % of International Levels

Spinning ...... ....... 52.4Weaving .... ... . 57.1Finishing .. ............. 71.0Making-up .. .. ...... 71.5

The productivity problems are exacerbated in many cases by poor managementpractices, high waste, low product quality and poor maintenance resultingin excessive downtime required for mechanical repairs. These factorscontribute to high cost and low profitability for the majority of thetextile enterprises.

D. Financial Performance

3.09 The financial structure of the textile companies is very weak.Traditionally, the enterprises in Portugal have been highly leveraged withborrowed funds. Also after 1974, the unit labor costs increaseddrastically while labor discipline collapsed and production volumedecreased 7/ resulting in lower profits and deterioration of the financialposition. According to the Werner Report, almost half of the companies inthe sector had equity below 20% of total assets. About 27% of thePortuguese textile companies reviewed in the study were making losses andonly one third showed reasonable profits, while the others were marginallyprofitable. This is the position of the industry taken as a whole and itshould be qualified as there are a limited number of larger, modern,integrated and well-managed companies which have been operating efficientlyand profitably, and successfully exporting a large proportion of theiroutput. Nevertheless, discussions with the banks and enterprises indicatethat the deteriorating financial performance of textile enterprises hasbrought into much sharper focus the urgent need for efficient restructuringof the industries.

E. The Textile Market

3.10 The recent development of the textile market in Portugal is shownin Annex 3-2. As noted earlier, textile production in Portugal reached itspeak in 1973 when production was 294 thousand metric tons (TMT) withexports amounting to 60% of the production. Domestic consumption percapita was 17 kg. Imported textile articles (apart from raw materials)

7/ In 1975 production dropped by 46.3% as compared with 1973.

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accounted in 1982 for only about 40% of the domestic consumption, ascompared with 60-70% for EEC countries. After 1974, production droppedprecipitously and in 1978, yarn production of all types amounted to 209THT, fabric production to 187 TMT and the volume of garments and making-upgoods produced was 74 TMT. Domestic consumption per capita was 8 kg in1978, aad reached 8.7 kg in 1982.

3.11 Since 1976, the first year the industry started recovering afterthe Revolution, the production of textiles increased at an annual rate of4.5% until 1980. After 1980, however, production decreased sharply, and in1982, the industry was operating at 80% capacity utilization and still 24Zbelow the 1973 level. In the same period the consumption per capitadecreased by about 30% (Annex 3-2), despite a small increase in GDP percapita. Traditionally, the industry has been export oriented and exportshave been increasing steadily from 121.2 TMT in 1976 to 183.8 TMT in 1982,or at the rate of 6.4% per annum. In 1982, exports amounted to 77.3% ofproduction, the first year that the volume of exports exceeded the 1973level. At the same time, the value of exports has grown from Esc. 14.5billion (US$477 million) to Esc. 94.9 billion (US$1,234 million). In 1973,yarns and woven fabrics accounted for 45% of the volume, while garments andother make-up articles accounted for only 25%. In 1982, the respectivefigures were 27% and 42% (Annex 3-3), indicating a trend towardsexportation of higher value added articles (value added per kg increased inreal terms by 144% between 1973 and 1982). As far as the destination ofexports is concerned, there has been a steady increase in the proportion ofexports to EEC and EFTA countries which in 1982 amounted to 88.8% of thetotal, as compared to 66.4% in 1973, while exports to other countriesdeclined (e.g., share of exports to the US and Canada decreased from about18% in 1973 to about 6% in 1982).

3.12 The growth of textile exports to Western European countries,particularly to the EEC, can be explained in several ways. Thegeographical location of Portugal allows for faster deliveries and lowercost of freight as compared with South American and Far Eastern sources ofsupply. On average, the cost of labor in Portugal is about 70% lower thanin EEC countries; even allowing for 4C% lower productivity, the unit laborcosts in the Portuguese textile sector are about half of those in the EEC.Furthermore, the growth of Portuguese exports to EEC can be traced to theprovisions of the Multi-Fiber Agreement (MFA) regarding international tradein textiles. The MFA regulations apply to imports of nearly 130 categoriesof textile products from 40 countries. Several types of products (mostlycotton yarn, fabrics and garments) in the so-called sensitivecategories V are subject to strict quotas negotiated with the individualexporting countries. In the last five years, the EEC quotas for imports ofPortuguese textile products in the sensitive categories have beenincreasing at the rate of 4-5X p.a. On the whole, MFA appears to have hada beneficial effect on Portuguese textile exports as it allows them, within

8/ Sensitive import categories are defined as those which, due to therelatively low level of investment needed, the easily transportablenature of textile products, the relatively unskilled nature of the workand unsophisticated level of technology, are likely to causedisruptions of the domestic (EEC) markets.

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the agreed quotas, to compete with higher priced EEC domestic products,while at the same time they do not have to compete directly with low pricedimports from South American and Far Eastern countries. While textilesaccount for about 26% of Portugal's total exports, the role of Portugal asa supplier of textiles to the world markets is rather small. In 1982,Portuguese textile exports (except fibers) accounted for about 4.6% of EECimports from outside EEC sources, and less than 0.5% of US imports. Mostof the EEC quotas assigned to Portugal (except for knitwear and householdgoods) were only partially filled (Annex 3-4).

3.13 The date of Portugal's accession to the EEC was originallyplanned for 1983, but in view of many unresolved problems, 1986 isconsidered more realistic. Regarding textiles, an agreement was reached inSeptember 1982 that after 1983 and prior to the accession, the overallgrowth of Portuguese exports of textiles to the EEC will be limited to anaverage 8-15% p.a. (depending on the product). The same level of growthwould continue during the first three years following accession-afterthat, export limitations would be eliminated. Imports of finished textileproducts into Portugal currently are subject to tariffs (para 4.02) as wellas licensing through import permits administered by the Textile Instituteon behalf of the Ministry of Commerce. This limited the growth of imports(other than raw materials) in the last decade to about 3.5% p.a.; however,this situation will change under the rules of accession. Portugal willhave to share the EEC import program governed by MFAL. This share forPortugal is estimated at about 1.5% of the EEC's external imports, or 25TMT as compared with about 11 TMT of finished textile products (other thanfibers) which are currently imported by Portugal from non-EEC sources.This estimated loss of the domestic share would be certainly a stronginducement for textile enterprises to restructure to improve theircoupetitiveness. No substantial increase of textile imports is expectedfrom Spain, even though Spain may be joining the EEC at the same time asPortugal as the labor costs in Spain are considerably higher than inPortugal and current Spanish exports to EEC countries are negligible.

3.14 Projections for the textile market are shown in Annex 3-5.As GDP is projected to increase by 2% in 1985 and 3% p.a. thereafter, theprospects are for about a 30% increase in production of textiles by 1993.As by that time Portugal would be a full member of EEC, it is projectedthat imports would eventually reach the level of domestic consumptionprevailing in EEC member countries (73%), while consumption would followthe growth of GNP, subject to the observed elasticity of demand fortextiles. On this basis the volume of textile exports in 1993 would amountto 256.6 TMT, growing at about 4% p.a. between 1982 and 1993, about thesame rate as actually observed for 1976-80. The actual growth could behigher but would depend on the timing of the accession as well as thesuccess of the restructuring program, especially in controlling costs byincreasing productivity to compensate for the inevitable increase in thecost of labor after accession. In view of the relatively lower unit costof labor in Portugal (para 3.12) and the smaller share of labor in theproduction cost structure (12% of the cost of spinning, 25% for weaving andabout 40% for making-up industries, 9/) Portugal is cuLrently enjoying a

9/ International Production Cost Comparison (ITMF) (1983).

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considerable comparative advantage. Thus, in terms of Portugal'spenetration into the EEC markets (assuming 3% p.a. growth of EEC textileimports 10/ by 1993) the Portuguese textile goods are projected toincrease to about 2.5% of the EEC's total textile imports as compared with1.6% of the imports in 1982.

F. Problems and Issues in Restructuring

3.15 Restructuring of the industry through rationalization andmodernization of the upstream facilities and expansion of the garment andmaking-up sector should bernefit the industry by: (i) lowering theproduction costs and improving the competitive position vs. foreignmanufacturers; (ii) maximizing the comparative advantage; (iii) increasingthe value added of output and return on in-estment; and (iv) minimizing thenumber of employees facing redundancy through redeployment of manpower fromupstream to downstream activities. Moves towards restructuring theindustry along the lines described above are likely, however, to faceseveral constraints. One of the main problems is the inverted pyramidstructure of the sector wherein the upstream facilities (spinninrg) producemore than can be absorbed by weaving which, in turn, has an output inexcess of the capacity of the downstream garment and making-up industries.Spinning and weaving are considerably more capital-intensive than garmentand make-up manufacture (the cost per new job ranges from $8,000 formaking-up to $150,000 for integrated primary textile operations).Therefore the present structure of the industry is not compatible withPortugal's comparative advantage of low-cost labor. The major objective ofrestructuring should be therefore to balance the production structure whichwould reduce capital costs of investment required, change the composition,and increase the value added of exports. A first step would be to freezethe total yarn spinning capacity and limit the growth of the weavingcapacity 11/ which may involve closing down of some obsolete andfinancially non-viable enterprises. Such a move would take some time tocarry out due to the typically lengthy negotiations between mill owners andlabor unions. Another problem is that in the capital-intensive upstreamoperations, most Portuguese companies are too small to achieve economies ofscale and even in the knitting and making-up sectors, where size is less ofa problem, there are many enterprises below economically viable minimumproduction volume (para 3.04). Because these small enterprises areprivately owned, and managed by family members, structural changes likemergers, take-overs or joint ownership of upstream or downstream operationswould take time to materialize.

3.16 The problem of overmanning of the textile factories in terms ofoperating and non-operating personnel (estimated to amount to 40% in excessof international standards or as many as 50,000 jobs) presents yet anotherconstraint for successful restructuring. The labor legislation has madeshedding of excess labor extremely difficult both in terms of the legalprocedure as well as the cost of severance pay which in many instances mayexceed the net worth and force bankruptcy of the company. Apart from thelong awaited action by the Government to amend the labor legislation

10/ As implied by MFA.11/ Essentially limiting investment to replacement and rehabilitation.

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(para 4.04), the proposed restructuring of the industry in the direction ofexpanding the more labor-intensive knitting, garment and making-upmanufacturing is expected to help redeployment of jobs and alleviate atleast part of this problem. Rough calculations indicate that, if theexcess of workers in the primary textile industry is reduced by about25,000 and productivity in the downstream industries increased from 70% to80% (reducing employment by 9,000), the opportunities created by projectedgrowth of exports of knitwear, garments and making-up articles could absorbmost of the labor to be shifted in the sector.

G. Investment Requirements

3.17 In addition to the overmanning and low labor productivitydiscussed above, the other structural problem is the high average age andobsolescence of the equipment resulting in low machine productivity.The market forecast (Annex 3-5) indicates 1993 production of 289 TMT, anincrease in exports by 80 TMT, and in imports by about 50 TMT (to includeyarn and grey cloth/fabrics when these products may be available morecheaply from the high-volume low-cost producers in other countries afterPortugal's accession to EEC) (para 3.14). Based on the applicationssubmitted for SIII incentives, investments in the textile industry during1980-82 actually averaged about US$100 million p.a. consistent with importdata for textile machinery into Portugal which has averaged aboutUS$90 million p.a. over the 1976-81 period. Consequently, the investmentprojected to take place over the commitment period of the proposed loan(1984-87) would be of the order of US$75-80 million p.a., while the totalinvestment requirements for restructuring the industry may be of the orderof US$1.3 billion over the next decade. This investment rate may not befully realized, however, as availability of investment capital forrestructuring may be limited in this period of expected relatively slowdomestic and EEC growth and restrictive domestic monetary and fiscalpolicies (paras 2.11-2.12). This would have consequences for fundsinternally generated by the textile companies, availability of credit fromthe commercial banks (because they are subject to credit ceilingrestrictions) as well as the availability of foreign currency (in view ofthe Government's policy to control the expansion of foreign debt).

H. Priorities for Investment

3.18 As it appears that funds available for investment may fall shortof the total financial requirements of the textile subsector, it isnecessary to establish certain priorities in terms of access to credit forthe various subsectors within the industry. Consequently, the firstpriority should be given to projects in knitting, garment manufacturing andmaking up industries in view of the low investment costs per job created,higher value added and comparative advantage of the outputs in the exportmarkets. Next in priority would be investments for dyeing, printing andfinishing facilities because of the paramount importance of that stage ofmanufacturing for the quality of the export items, both fabrics as well asgarments and making-up articles; availability of extra capacity would alsoallow the industry to convert low-cost imported grey cloth, a practicecurrently successfully used in the EEC countries.

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3.19 As far as weaving is concerned, returns on investments inrehabilitation are usually higher than those from new projects.Consequently, selective rehabilitation should be given priority overexpansion and new installations (particularly in view of the present stateof technology allowing only a limited increase of width for the existinglooms) as well as boosting production capacity through conversion fromshuttle to shuttleless operation. A detailed recent Bank study 12/indicates that replacement vs. rehabilitation decisions need to be made ona mill-by-mill basis but generally rehabilitation appears worthwhile onlyfor post-1960 installations. In case of older equipment, shortage of spareparts for looms originally supplied by manufacturers which may no longer bein business, as well as limitations in the width and speed increase whichcan be achieved, make the rehabilitation option economically nonviable. Inthe case of spinning, the new high performance spindles operate at speedsabout 40% higher than anything that can be achieved through rehabilitationof the old equipment and also the labor requirements in new installationscan be reduced by 30-50%. Consequently, while the capital cost of newspinning equipment may be up to three times higher, when the difference involume and operating costs is taken into consideration, rehabilitation islikely to be less profitable than replacement with new modern machinery,particularly when the existing spinning machinery is more than 20 yearsold.

3.20 A ranking of priorities for investment following from thediscussion above would thus be:

(i) Knitting, garment manufacturing and making-up;

(ii) Dyeing, printing and finishing;

(iii) Rehabilitation and/or replacement of weaving facilities;

(iv) Expansion of weaving facilities;

(v) Rehabilitation and/or replacement of spinning facilities.

IV. POLICY AND STRATEGY FOR THE TEXTILE INDUSTRY

4.01 Along with the rest of the industrial sector, the textileindustry is both assisted and controlled by the system of investmentincentives, tariffs/import restrictions, and the labor policies discussedin Chapter II. These policies and future directions for the restructuringof the textile industry are discussed below.

A. Policies

4.02 Protection. The tariff adjustments made by the Government overthe last few years in anticipation of the upcoming EEC membership have

12/ Philippines - Textile Sector Restructuring Project, Report No.3700-PH.

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considerably lowered tile protection received by the textile industry.In particular, the tariffs applicable to textile imports from EEC countriesnow range between 3-11%, and those for imports from non-EEC countries arebetween 10X and 70% (these levels not incorporating the temporary surchargeof 30% set up for 1983, and to be reduced soon to 10% for 1984). Furthertariff reductions to accommodate free entry from future EEC partners shouldnot immediately create serious problems for the Portuguese textileindustries. The competition, however, will be more severe from non-EECcountries after Portugal's accession to the EEC, when these tariffs wouldhave to be lowered to a range of 2-16%, and the current import restrictionsfor textile goods would be replaced by the MFA provisions. After EECentry, the effective protection for textile activities would becomenegligible, except for garments (13%). Under the rules of accession agreedduring 1982, within seven years following the accession date (currentlyexpected for 1986), Portugal will have to eliminate all tariff andnon-tariff barriers towards EEC countries, and adjust its external tariffsand import restrictions towards non-EEC countries to the EEC level. Theanticipated loss of some market share to result from these last adjustmentswill certainly exert strong pressures on enterprises for efficientrestructuring.

4.03 Investment Incentives. Under the existing SIII scheme discussedin Chapter II, the textile subsector is eligible for the same incentives asavailable for other subsectors. In a recent draft textile development plan(para 4.05), the Government proposed to supplement the modified SIII withadditional incentives to address more specifically the restructuringobjectives for the textile industry. Our preliminary review of theseproposals 13/ indicates that the additional measures being envisaged fortextiles merely extend the existing SIII, and this linkage would add to theexisting problems of complex administration and excessive budgetary costs.Also, the proposed subsectoral precision (e.g., 4 broad activities dividedinto 58 sub-categories) to be introduced into the textile incentiveeligibility formula seems excessive and counterproductive when consideredagainst the magnitude and probable effects of the differential benefitsthus made available. Against this background, the current thinking withinthe Government for abolishing the SIII scheme, and in particular theintention to set up separate restructuring incentive measures tailored tospecific subsectoral needs, is a desirable policy development, and shouldhave beneficial effects on the restructuring of the textile industry. Astextiles is the first subsector for which this new incentive policy will beapplied, further analyses are needed to design specific and coherentincentive measures for the subsector. The Government has appointed aworking committee (consisting of representatives from the Ministries ofFinance and Planning, Industry and Agriculture) to formulate proposals fora new overall incentive policy. Bank staff will be working closely withthe committee in this process with regards to both the broader incentives(e.g., for regional development) and the more specifically focussedincentives (e.g., for subsectors), in the context of regular sector,project and economic missions to Portugal. The dialogue with regard to thetextile subsector has already begun (para 5.03).

13/ Available in the Project File.

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4.04 Labor Regulations. The labor market conditions appear recentlyto have become more flexible in the textile subsector than in some othersubsectors. One reason is the current high unemployment in the textileindustry (4,918 workers were laid off during the first 6 months of 1983, ordouble the total number for 1982) which has been caused by the seriousfinancial position of many enterprises and has softened the demands oflabor unions. In 1981, the Government issued a decree to generalize forall future labor conventions in the textile subsector new provisionswhereby workers' rights are modified from those agreed to in the 1975 laborconvention. The most recent legislation approved by the Government to setout provisions for suspension of work contracts and temporary workreduction and/or layoffs (para 2.10) should benefit the textile industryand its labor force in the long run, in spite of inevitable losses of jobsin the short term. This economic case seems to have been accepted--albeitwith difficulty--by the parties concerned in the textile industry.

B. Textile Development Plan

4.05 After several changes of Government and versions of the textileplan since 1980, a new draft Development Plan for the Textile Industry 14/to cover the period 1984-87 has recently been prepared by the Ministry ofIndustry and Energy (MIE). At present, its finalization is expected by theend of 1984. The draft Plan provides a diagnostic of the present andexpected problems of the subsector and offers a broad policy framework aswell as two possible alternative approaches for its efficient developmentover the next several years. The objectives and basic approach forrestructuring the subsector as postulated in the draft plan are in linewith those described in paras 2.13 and 2.14.. Namely, restructuringinitiatives should be left to the private sector and market forces, thesize and output structure of the industry need to be reorganized and itsefficiency improved. Within the subsector, indicated priorities are inline with comparative advantage considerations and are given first formodernization and expansion of the downstream activities (finishing,knitting and garment making), and then, efficient rehabilitation/modernization of the upstream activities (spinning and weaving) asdiscussed in paras 3.18-3.20. Consistent with para 2.14, there are threebasic elements as follows:

(a) Policy Changes. These include the tariff reductions and importliberalization, restructuring incentives and labor regulation asdiscussed in paras 4.02-4.04 above. The new textilerestructuring incentives are to be set up in connection with theproposed project with eligibility criteria to be consistent withthe ones defined for the proposed project (para 5.03).

(b) Technical and Structural Improvements. Increased productivitylevels for the different types of activities within the subsector(e.g., spinning, weaving, finishing, garment making) and betteroutput structure would be promoted through technical assistancemeasures to: (i) improve the firm's utilization of productioncapacities, management practices, product development and quality

14/ Available in the Project File.

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control, and marketing approaches; (ii) phase out uneconomicplants and/or reorganize them into more efficient productionunits; and (iii) rehabilitate and/or replace aging equipment.The Government would encourage firms to acquire technicalassistance with a two-pronged approach: namely, through offeringspecial incentives to help eligible firms pay for the technicalassistance services needed to prepare and implement theirrestructuring investments as well as to train their staff andthrough providing incentives to the local consulting firms tostrengthen their capabilities to respond to the industry'stechnical assistance needs. The proposed private initiativeapproach to technical assistance is consistent with the oneadopted for the proposed project (paras 5.09-5.10). Training isan element of the proposed project (para 5.11).

(c) Financing. The last element elaborated in the Government'sTextile Plan is the estimated financing requirements for eachrestructuring scenario. The resources to meet these investmentrequirements (para 4.06) would come in part from the proposedBank loan (paras 5.06-5.08) as well as investors' own resources,external credit (e.g., suppliers' credits) and credits from thePortuguese financial system.

4.06 Restructuring Investment Estimates. The draft Plan offers a setof detailed targets which could be achieved by 1987 for each of the maintextile activities (spinning, weaving, finishing and garment making) in theareas of production output, exports, consumption, employment, capacityutilization and produc-ivity improvements. They are based on theexpectations of, on average, a 5% growth p.a. between 1984-87 in outputquantity; a higher 7% p.a. growth in output value to reflect the highervalue added of the future product mix; almost no growth for spinning; areduction of about 13,400 workers from all textile activities; and anincrease in labor and equipment productivities for each of the main textileactivities to internationally competitive levels (particularly for weavingand garment making).15/ The corresponding investment requirements aLeestimated as shown in the following table:

15/ Available in the Project File.

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Portugal - Textile Industry Restructuring ProjectMIE's Draft Textile Development Plan (1984-87)

Estimated Investment Requirements(Esc. 10Y)

Optimum IntermediateApproach a/ Approach b/

Equipment:Replacement/Rehabilitation 86.6 57.3 22.4 31.2Additional New Equipment 11.7 7.7 14.4 20.0

Buildings and Installation 22.5 15.0 13.4 18.7Working Capital 16.0 10.6 14.9 20.7

(Subtotal) (136.8) (90.6) (65.1) (90.6)

Technical Assistance 13.4 9.0 5.1 7.2Fund for Acquisition of Coupanies 0.9 0.4 1.6 2.2

Total 151.1 100.0 71.8 100.0

(in US$ million) (1,119.3) (532.0)

a/ The optimum approach is based on the hypothesis that equipmentwould be rehabilitated/replaced such as to have equipment not morethan 15 years old by 1987.

b/ The intermediate approach is based on the hypothesis ofequipment not more than 25 years old by 1987.

4.07 Even though the intermediate approach with the investmentenvelope of US$532 million equivalent seems to reflect correctly the realmedium term investment needs of the subsector, it still appears toooptimistic. As indicated in para 3.17, a more reasonable target isconsidered to be about US$200-250 million during the 1984-87 period. Theproposed project would be a pilot program to initiate the intermediatedevelopment approach, with follow-up programs to be prepared based on therestructuring progress to be made during the coming years and additionalresource requirements.

V. THE PROJECT

A. Project Origin

5.01 As indicated in Chapter III, the Bank has been involved since1977 in reviewing the restructuring problems and prospects for the textilesubsector in Portugal. Different technical and institutional scenarios fortextile restructuring have been extensively discussed with the Government.The Bank's involvement in this process has thus evolved to reflect abroader subsectoral approach, and is proposed to be implemented via atextile restructuring credit line channeled through Portuguese financial

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institutions.16/ This approach is adopted to allow a timely and concreteopportunity for assisting the Government in the formulation of soundpolicies for its textile development plan, as well as to support theGovernment's desire to give all textile enterprises equal possibility ofaccess to the restructuring process.

B. Project Objectives and Scope

5.02 The proposed project would assist the Government and enterprisesin implementing the objectives of the Textile Development Plan(paras 4.05-4.07). The main project objectives are to help the Portuguesetextile industries strengthen their competitiveness through improvements inlabor and machine productivity, product design and quality, manpower skillsand the policy environment. These objectives require actions on thefollowing: (a) provision of specialized textile consulting services toassist eligible enterprises and participating financial institutions (PFIs)in the design/preparation, appraisal and implementatica of viablerestructuring projects, and to assist MIE's Textile Review Unit (TRU,para 6.08)) in monitoring the implementation of the textile restructuringprocess, developing a textile information system, and carrying out thenecessary studies for improving subsector performance, e.g., markestudies; (b) financing, through a number of PFIs, of the physicalrehabilitation, modernization and expansion of existing enterprises andcreation of new production units in the textile activities which meet theguidelines of the Government's Textile Development Plan, as furtherspecified in the eligibility criteria (para 7.01); (c) financing of atraining component to include a study to develop a comprehensive trainingprogram and the purchase of equipment for the quality control and trainingfacilities being operated by existing textile technical and educationalcenters in Portugal; and (d) assistance to the Government to further thegains already made in the policy environment, and in particular to assistit in designing a textile incentive structure and finalizing the draftTextile Development Plan (paras 5.03 and 7.11).

5.03 The Bank's assistance to the Government on the textile policyfront (para 5.02 (d)) represents the most important contribution of theproposed project to the restructuring of the Portuguese textile subsector.One such contribution is already in the project's institutional designwhich emphasizes reliance on private initiatives, in particular the need tokeep separate the policy and financial functions. Another is theestablishment of specific and consistent restructuring criteria (para 7.01)to guide the financial institutions and the textile enterprises. Ineffect, in the face of growing problems in their textile portfolios, thebanks have already tried financial rescheduling, but with marginal successbecause these actions most of the time do not address the roots of the-problems. About'two-thirds of the textile enterprises at present are facedwith an increasingly precarious financial position (para 3.09), and do nothave a clear concept of the future potential of the industry nor the

16/ Preparation of the proposed project has yielded several restructuringinvestment projects which subsequently had to be financed with otherresources, such as the Bank's second credit line to BFN (FY81).Profiles of these projects are in the Project File.

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specialized technical expertise to guide them in the restructuringprocess. The above profitability problems, to be aggravated with theanticipated loss of some market share after the EEC accession (paras 3.13and 4.02), are already putting heavy pressures on both the textileenterprises and their bankers for efficient restructuring. Finally, thereis the formulation of textile restructuring incentives which the Governmentintends to set up within the (draft) Textile Development Plan (para 4.03).These incentive measures, if well formulated, would be helpful to encouragefurther the enterprises toward improving efficiency and competitive-zss.The Government has agreed to the principle of a new textile incentivescheme which is characterized by fiscal-based benefits, concentratec in afew simple instruments, with simple administration procedures and smallerbudgetary requirements than the existing SIII. In adeition, the Governmenthas agreed that the new textile restructuring incentives will be governedby eligibility criteria which are consistent with the criteria developedfor the proposed project (para 7.01). The Bank will be working closelywith the Portuguese authorities in the formulation of these textileincentive measures, providing the services of expert consultants asneeded. As discussed above, because there are already strong naturalpressures on both the enterprises and the banks for restructuring in thetextile subsector, and the proposed project provides the resources,technical assistance, and the technical/financial guidelines (as part ofthe agreed eligibility criteria) to launch such restructuring at theenterprise level, the immediate availability of the Textile DevelopmentPlan and incentives would not be crucial to the proposed pilot project.Rather than waiting for the formal promulgation of the Plan to participate,our active involvement will facilitate the launching of the neededrestructuring exercises at the enterprise level which are justified on thebasis of the enterprises' economic and financial conditions. It has beenagreej that satisfactory textile incentive proposals would be formulated incollaboration with the Bank and incorporated in the final draft legislationto implement the Textile Development Plan for the Government'sconsideration by December 31,1984.

C. Coordination With Other Bank Operations

5.04 Within the Bank's program of support to the industrial sector inPortugal, the proposed loan would be complementary to the US$30 millionSKI II loan (Loan No. 2263-PO) to finance eligible SMI investment projectsin all activities of the industrial sector. Since the Government hasrequested that SMI II continue to finance textile SMIs, specialarrangements have been agreed with the implementation agencies of SMI II toensure a consistent approach towards restructuring of the textile industry(para 7.15). Coordination with the US$100 million Bank loan to BFN (LoanNo. 1942-PO) is ensured via the proposals in para 7.16.

D.- Project Costs

5.05 The total cost of the proposed project is estimated to beUS$68.9 million of which the proposed Bank loan is US$34.7 million. Abreakdown of project costs by major components is shown in the followingtable:

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Portugal - Textile Industry Restructuring Project(US$ million)

Foreign a/ Local TotalProject Costs

1. Eligible restructuring investmentsto be financeda) in high-priority activities b/ 16.5 16.5 33.0b) in other activities b/ 16.5 16.5 33.0

33.0c/ 33.0c/ 66.02. Technical assistance

a) to eligible enterprises 0.8 1.2 2.0b) to MIE/T%U 0.2 - 0.2

1.0 1.2 2.23. Training

a) training study & training abroad 0.2 - 0.2b) training equipment 0.4 - 0.4

0.6 - 0.6

4. Contingencies 0.1 - 0.1Total 34.7 34.2 68.9

Project FinancingBank loan 34.7 - 34.7Investor self-financing - 21.0 21.0Domestic Banks - 13.2 13.2

Total 34.7 34.2 68.9

a! This includes direct and indirect costs in foreign exchange.b/ For definition, see para 7.01.c/ For explanation, see para 5.07.

E. Project Components and Their Financing

5.06 Restructuring Investments Component. The proposed allocation ofBank funds of US$33.0 million for financing of eligible restructuringinvestments is based on: (i) the expected investment requirements anddemand for restructuring the Portuguese textile subsector for the period1984-87 (paras 3.17 and 4.07); (ii) the PFIs' projected 3-year pipeline oftextile investment projects and the expected proportion thereof which wouldmeet the eligibility criteria as elaborated in para 7.01; (iii) theprojected pipeline of textile SMI projects to be financed under theon-going SMI II loan over 1983-1986 (para 5.04); and (iv) the expecteddomestic resource availability (para 2.11) and the continued uncertaintiesin the present investment climate in Portugal and in the EEC.

5.07 Of the estimated total project costs (US$68.9 million), theproposed Bank loan of US$34.7 million equivalent would be lent to theGovernment at the applicable variable Bank interest rate (currently 10.08%)and for a term of 15 years including 3 years grace. The proposed textilerestructuring credit line (US$33.0 million equivalent) would be channeledthrough the BdP to the PFIs. The onlending rate from the PFIs to the

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textile enterprises is given in para 7.11. Although Bank funds may be usedto finance up to 65% of the individual investment costs, on average it isexpected that the credit line amount actually would cover 50% of theestimated US$66.0 million total restructuring investment costs. Thebalance would come from the investors' own funds (about 30%, para 7.01),and borrow:ings from the PFIs and/or other external sources (e.g.,suppliers' credit). The total investment costs of the projects to befinanced in part under the proposed credit line would represent 30% of theinvestment requirements for 1984-87 as estimated in the Government'stextile restructuring plan (para 4.07). The proposed credit line would bea pilot program, to be extended in view of the restructuring progress to bemade over the next years and additional resource requirements when theseare justified.

5.08 The proceeds of the restructuring zredit line would be used tofinance textile investment projects which meet the eligibility criteriaelaborated in para 7.01 and involve the rehabilitation and/or modernizationof existing fixed assets and/or acquisition of new fixed assets (excludingland, but including permanent working capital and technical assistanceservices). The proposed credit line is expected to finance about 40textile investment projects. As defined in para 7.01(a), about 75% ofthese would be in the higher priority textile activities of finishing andgarment making with an expected investment cost per job of less thanUS$45,000 and US$10,000 respectively. The average size of investment costis expected to be about US$1.0 million for these higher priority textileactivities, and about US$2.5 million for the other activities - spinningand weaving. Based on average costs per job ranging from US$10,000 toUS$85,000, the restructuring investment projects to be financed under theproposed credit line are expected to create a total of about 1,700 jobs.

5.09 Technical Assistance Component. This component consists of aspecial scheme to finance part of the consulting services to be provided toeligible enterprises and the Textile Review Unit (TRU). Of the proposedloan, US$1.0 million would be allocated to the technical assistancecomponent. This amount would not require Government budgetary support forits initial startup and for its repayment to the Bank (para 7.22). Thisamount would cover on average about 34% of all the services to be providedunder the project. Of the US$1.0 million, US$0.8 million is expected to beexpended for textile technical assistance (TA) to enterprises and US$0.2million for technical assistance to the TRU (paras 7.17-7.18). The balanceof the technical assistance expenditures would come from the beneficiaries(own funds or borrowings, para 5.07).

5.10 The technical assistance services would be provided by consultingfirms as described in paras 7.17-7.18. These services consist of advisingon investment project preparation and designing of action programs toimprove operating practices, management and accounting procedures, designnew products, adopt new marketing approaches for the enterprises;assessment of the technical design of investment projects, their choice oftechnology, provision of market, EEC productivity, price and costinformation for the enterprises, PFIs and TRU. Based on the totaltechnical assistance cost estimated in para 5.05, it is expected that notless than 285 consultant-months would be available during 1984-87 for

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technical assistance at the enterprise level, or on average 7 man-monthsper subproject. The consulting services for the TRU would consist of atotal 24 man-months to be spread over the same period.

5.11 Training Component. This conponent would consist of: (a) astudy to develop a comprehensive training program for the textile industry;(b) equipment for training/quality control for facilities of the TextileInstitute (TI) in Oporto and Covilha, and training/testing equipment forthe University of Minho in Guimaraes; and (c) some advanced training abroadfor staff of related Government agencies (MIE, Institute for Assistance toSmall and Medium Enterprises (IAFMEI), TI). The cost of this component isestimated to be US$0.6 million. The Bank loan would cover 100% of theestimated cost of this component, and would be disbursed to the Governmentwho would channel it to the MIE/TI for implementing the training componentthrough its normal investment budget allocation process (paras 7.20-7.22).The estimated cost of the proposed component is broken down as follows:

Portugal - Estimated Cost of Training Component

US$(a) The Study based on 20 man-weeks of consulting

time plus travel and contingencies 50,000(b) Equipment for University of Minho 250,000

Equipment for the Textile Institute 150,000(c) Advanced textile training

Three persons - two year courses leading toMaster Degree 60,000

Ten persons - six months textile technologycourses 50,000

Contingencies 40,000Grand Total 600,000

VI. PROJECT IMPLEMENTING AGENCIES

A. Background

6.01 The proposed project would strengthen the Government's efforts tofoster private initiatives by relying on a broad-based institutional set-upfor the implementation of the textile restructuring program. In additionto the beneficiaries which would be responsible for implementing therestructuring subprojects, the project relies substantially on the PFIs,with the MIE and its specialized agencies also to be involved in someaspects of the project implementation and in the monitoring thereof.

B. The PFIs

6.02 There are at present 17 financial institutions involved inindustrial financing in Portugal: the Bank of Portugal (Central Bank);nine nationalized commercial banks; Caixa Geral de Depositos (CGD) which isthe major public savings institution; Banco de Fomento Nacional (BFN) which

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is the Portuguese industrial development bank; and two investmentconpanies, the public sector Sociedade Financiera Portuguesa (SFP) and thefirst privately owned, recently established Sociedade Portuguesa deInvestimentos (SPI); and three new leasing companies established in thelast two years. At tne time of appraisal, five financial institutionsagreed to participate in the proposed project, based on the objectives andconditions established for the proposed credit line (Chapter VII). Thefirst four are the largest in the banking system in terms of net assets(Annex 6-1), namely CGD, Banco Portugues Atlantico (BPA), Banco Pinto SottoMayor (BPSM) and Banco Espirito Santo E Commercial de Lisboa (BESCL).Together, they account for over 50% of the total outstanding creditportfolio as of the end of 1982. The fifth PFI is the smaller,IFC-assisted SPI which can offer equity financing in addition toconventional medium and long-term investment credit to industries. Sincethe appraisal mission, two other banks namely, Banco National Ultramarino(BNU) and Banco Borges Irmao (BBI) have also expressed interest inparticipating in the proposed project. These two institutions (andeventually, others in the banking system) would be added to the list ofPFIs when a satisfactory Bank assessment is made of their textile appraisalcapabilities.

6.03 Textile Financing. Loans from the banking system have been themajor source of finance for all industries in Portugal. As shown in thefollowing table and detailed in Annex 6-2, as of the end of 1982, the totalcredit portfolio of the banking system was about Esc. 1,661.7 billion(US$21.0 billion equivalent at end of 1982 exchange rate), about evenlydivided between short-term credit (49.7%) and medium- and long-term credit(18.3% and 32.0%, respectively).

Portugal - Banking System Loan Portfolio - December 31, 1982(billion Esc.)

IndustrialTotal Credit Credit Textile CreditValue % Value % Value %_

Up to one year 825.9 49.7 384.7 64.1 83.1 73.1One to five years 303.6 18.3 91.3 15.2 18.0 15.9Over five years 532.2 32.0 124.6 20.7 12.6 11.0Total 1,661.7 100.0 600.6 100.0 113.7 100.0

(% Share) (100.0) (36.1) (6.8)

Of the total credit outstanding, industrial credit accounted for more thanone third (36.1% in 1982, decreasing from 40% in 1978), while the textileindustry has continued to maintain about a 6.8% share of total creditoutstanding. At the same time, the commercial banks held about threefifths of the total banking system credit portfolio (60.2%) while thesavings and investment banks' share was about two fifths (39.8%). As seenin the following table, at the end of 1982, the credit portfolio of thecommercial banks, at about Esc. 1,000.9 billion (or equivalent toUS$12.7 billion at end of 1982 exchange rate), was heavily concentrated onthe short-term (74.4% of the total) although the share of term credit has

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been gradually increasing. This reflects in part the fact that thecommercial banks were allowed to lend medium- and long-term only since1974. As shown in Annex 6-2, while the share of industzial credit in thetotal credit portfolio has been decreasing over the last five years (from50.2Z at the end of 1978 to 43.6% at the end of 1982), the textile industryshare has remained at about 10% over the last five years. Theconcentration of industrial and textile portfolio of the commercial bankson short-term credit was even heavier than in total credit, accountingabout 80%, although the situation has improved over the last five years(from about 91% at the end of 1978).

Portugal - Commercial Banks Loan Portfolio - December 31, 1982(billion Esc.)

IndustrialTotal Credit Credit Textile CreditValue % Value X Value _

Up to one year 744.5 74.4 348.1 79.8 80.0 79.6One to five years 170.4 17.0 63.5 14.6 15.7 15.6Over five years 86.0 8.6 24.6 5.6 4.8 4.8

Total 1,000.9 100.0 436.2 100.0 100.5 100.0

(Z Share) (100.0) (43.6) (10.0)

6.04 Together, the five PFIs accounted for 50% of the totaloutstanding credit portfolio extended to the textile industry as of the endof 1982. As detailed in the Project File and summarized in the followingtable, the PFIs' textile share has been relatively constant at this levelsince 1978. Their textile portfolio is characterized by a highconcentration in short maturity credit. Most of these short-term creditstend to be rolled over a longer duration as needed by the enterprises. Ofthe five PFIs, CGD has been the most active in term lending to industriesand to textiles with over 90% of its textile lending in long-term creditsduring 1978-1982. Although growing considerably from the 1% share in 1978,CGD's role in textile financing is still very small (only 6% of the totalportfolio of the banking system in 1982). BPSM continues to be the mostimportant financier of the textile subsector, maintaining over 1978-1982 a17% share of the total textile portfolio of the banking system. A largeshare of BPSM's loans for textiles (just as for industries in general) hashowever very short maturity (84% in 1982, although already declining from ashare of over 98% in 1978). BPA and BESCL have been moving steadily intoindustrial and textile financing since 1978. The PFIs' role in textilefinancing is shown in the following table.

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PORTUGAL - PFIs and Textile Financingas of December 31, 1982

(billion Esc.)

TOTAL CREDIT INDUSTRIAL CREDIT TEXTILE CREDIT

ST HT + LT TotaL ST MT + LT Total ST Kr + LT TotalvlLue S Value _ Value Z Value Z Value Z Value _value a Z v a lIuu e

BESCL 98.4 12 38.0 5 136.4 a 50.4 13 22.9 11 73.3 12 9.3 11 5.0 16 14.3 13

SPSF 96.6 12 53.7 6 150.3 9 51.3 13 13.1 6 64.4 11 16.1 19 3.1 10 19.2 17

BPA 149.7 18 31.9 6 181.6 11 70.7 18 10.3 5 81.0 13 12.4 15 3.1 10 15.5 14

CCD 44.4 5 342.6 41 387.0 23 17.4 5 46.1 21 63.5 11 0.5 - 5.8 19 6.3 6

Spi 0.0 - 1.7 0 1.7 - 0.0 - 1.2 - 1.2 - 0.0 - 0.3 - 0.3 -

PFIS 389.1 47 467.9 56 857.0 51 189.8 49 93.6 43 283.4 42 38.3 46 17.3 55 55.6 50

Allbanks a/ 825.9 100 835.8 100 1,661.7 100 384.7 100 215.9 100 600.6 100 83.1 100 30.6 100 113.7 100

a/ This includes all comercial banks and savittgs institutions (e.g., CGD).

6.05 Institutional Set-Up and Capabilities of PFIs. All privatePortuguese owned financial institutions, with the exception of the smallsaving banks, were nationalized in 1975. CGD has always been public. Thenationalized credit institutions are legal entities with administrative andfinancial autonomy, organized in the form of public sector enterprises.Each is managed by a Board of Directors, consisting of a Chairman, a ViceChairman and five Board Members. While the board is jointly responsiblefor the overall management of the institution, board members also havespecific individual responsibilities for staff and line functions. Boardmembers are appointed by the Council of Ministers from among publicadministrators, with experience in the financial sector either in bankingor public sector finance. As nationalized entities, the total equity ofthe banks is held by the Treasury. More details on the organization andoperations of each of the PFIs are found in the Project File.

6.06 Based on the Bank's experience under the SKI projects as well asour recent review of their textile appraisal reports, the overall standardof the PFIs' project appraisal is generally satisfactory. Their appraisalreports are usually of good quality (with the level of details and depthincreasing with the size of projects), although there are variations fromreport to report depending on the staff and regional office involved. Thefinancial standards maintained by the PFIs for their lending are reasonablystringent, and their appraisal reports/loan agreements contain specificrelevant covenants for the financial rehabilitation of existing enterpriseswhen appropriate. A most critical common weakness in the appraisal ishowever the market evaluation. This is now being addressed in part with

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the macro and sectoral supply/demand information which is becomingavailable from the subsectoral surveys/analyses undertaken by MIE andspecialized trade associations. Improvements in this area would also comefrom more consistent verification of the market information presented inthe appraisal reports with relevant marketing sources (e.g., InternationalTrade Center (ITC), specialized consulting firms). For the textileinvestment projects, the PFIs are being encouraged (via incentives providedwithin the proposed project) to seek more specialized advice to improvetheir analyses of market competitiveness and prospects. Another area forimprovement is the technical appraisal. At present, the five PFIs have 13competent mechanical and chemical engineers with some experience in thetextile industry. In addition, 2 PFIs are regularly using qualifiedconsultants for appraisal of textile subprojects. The PFIs have takensteps to improve the textile knowledge of their engineering staff throughattendance at special courses and seminars organized by the Universities ofMinho and Beira. Some PFIs have also recruited additional technicians withtextile experience. The PFIs have agreed in the context of the proposedproject to increase utilization of external textile specialists tocomplement and provide on-the-job training for their own technical staff.Measures for future technical improvements have been discussed and agreedwith the PFIs during appraisal, and will be followed up during projectsupervision (e.g., training and hiring of staff as needed, closercollaboration with trade associations and technical departments ofuniversities).

6.07 Quality of PFIs' Portfolio. As detailed in the Project File,during the last several years, the percentage of the PFIs' non-performingloans (i.e., overdue, arrears and bad debt) tended to decline from a rangeof 12-18% in 1978 to about 8-10% in 1982, except for CGD for whom thepercentage has remained at about 3% over the same time period. The loanperformance data for the industrial sector and the textile subsectoravailable only for CGD (Annex 6-3) show that about 71% of bad debts on theCGD portfolio correspond to loans extended to industry. Bad debts amongloans to the textile subsector represent 9% of CGD's total bad debts at theend of 1982, which is a high percentage if one considers the low (1.6%)share of total CGD portfolio represented by textiles. Textile bad debts asa share of the CGD's textile loan portfolio were 3.7% in 1982 which is suchhigher than the CGD average. It is nevertheless an improvement over the4.5% share of bad debt in textile loans at the end of 1979, although it hasincreased slightly from the end of 1981 (3.4%). The performance of loansextended to textile enterprises should improve as the restructuring programfor the textile subsector would in time yield a significant improvement inthe financial condition of the enterprises.

C. The MIE/Textile Review Unit

6.08 To maintain a global view of and coordinate the futuredevelopment of the textile industry, the MIE will maintain a Textile ReviewUnit (TRU) to be located within the MIE. The main activities of the TRUwill be to: (i) monitor the impact of the overall restructuring program;(ii) carry out studies for improving subsector performance such as in theareas of marketing, energy conservation, environmental control, etc.; andon this basis, (iii) develop a textile information system for use by the

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banks and the enterprises. In particular, the TRU will also collaboratewith the PFIs to review the overall nature and direction of therestructuring investments being financed by the PFIs (as detailed in paras7.03-7.06). In all the activities above, the TRU will coordinate withexisting institutions with relevant expertise. The TRU will have a basiccore of two full-time textile specialists who are the MIE staff currentlyworking on the draft Textile Development Plan. To strengthen its presenttechnical abilities, the TRU would be assisted by textile consultants to befinanced under the project (para 5.10). The TRU will report to aninterministerial Textile Committee (TC) which would meet twice a year toinstruct the TRU in its activities, review its findings andrecommendations, and make policy adjustment as needed. The TC wouldconsist of representatives of the MIE, the Textile Institute, theIndustrial Planning Department of the MIE, the Ministry of Finance andPlanning/Treasury, and the Ministry of Labor. The documentation toformalize the TRU (including designation of its core staff andresponsibilities according to the principles above) has been reviewedduring negotiations and found satisfactory.

D. The Bank of Portugal

6.09 The Bank of Portugal (BdP) has the usual powers of a centralbank, including the setting of mandatory reserve requirements, maximuminterest rates and credit ceilings (paras 2.11 and 2.12). It financescredit institutions through its rediscount facilities. Under the Bank'sSMI I and II projects,17/ BdP acted on behalf of the Government asthe apex organization in channeling the funds to the PFIs. Thisarrangement proved very satisfactory and is used under the proposed loan(para 7.06).

E. The MIE/Textile Institute

6.10 The Textile Institute (TI) is an autonomous public agencysupervised by the MIE. It has been effective in monitoring textileinport/exports, negotiating and administering textile trade agreements,establishing product quality standards and carrying out necessarylaboratory testing. The TI on delegation from the MIE and in collaborationwith other relevant training institutions (e.g. University of Minho), wouldadminister the training elements included in the proposed project (para7.22). More detailed discussion of TI and the training facility is foundin Annex 6-4.

VII. PROJECT MANAGEMENT

A. Textile Restructuring Credit Line

7.01 Design Features. The proceeds of the proposed credit line wouldbe channeled through the BdP to the PFIs for financing textile investment

17/ All nine commercial banks, CGD, BFN, and SPI participate in theseprojects.

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projects. These investment projects will need to meet the followingrestructuring eligibility criteria:

(a) At least 50% of the credit line amount would finance investmentprojects belonging to the following higher priority textileactivities: manufacturing of woven and knitted garments, makingup of household articles, and textile processing activities suchas dyeing, printing and finishing. These higher priorityinvestment subprojects should have an investment cost per jobcreated/maintained not to exceed US$10,000 for garment making,and US$45,000 for textile processing and knitting activities.

(b) The balance of the credit line would finance investment projectsin spinning and weaving subject to the following conditions:

(i) for spinning, no new additional capacity would be financed;no equipment older than 20 years would be rehabilitated andreplacement of existing facilities would be financed only ifthe resulting productivity improvements for labor andequipment would allow productivity levels 18/ higher thanthose prevailing in EEC (para 7.04);

(ii) for weaving, no equipment older than 20 years would berehabilitated, and all new or modernized looms should have aminimum width of 190 cm and be able to operate above 200picks per minute; and

(iii) for both spinning and weaving, the investment cost per jobwould not exceed the current costs of jobs in the EEC forsimilar activities (para 7.04).

(c) All investment projects should be financially and economicallyviable with a financial rate of return to be at least 12% for allsubprojects, and an economic rate of return to be at least 12%for project with investment cost above US$1.0 million. Theex-factory price should be at most equal to the border price EECfor the main products of investment projects. In case ofinvestment projects involving forward integration for an existingenterprise, the transfer price for the main products to be usedin the downstream operations equal to the border price EEC woildbe used in calculating the economic rate of return (para 7.,4).

(d) All investment projects to set up new production units/enterprises should show labor and machine productivitylevels 19/ commensurate to the levels in the EEC for similarproducts (para 7.04), and in the case of existing enterprises,investment projects should show the productivity improvements andcost savings for the enterprise as a whole.

18/ Such as kg output/operator hour for spinning.19/ Such as km or weft yarn inserted/operator hour for weaving, and meters

of fabrics processed/operator hour for dying, printing and finishing.

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(e) The investor (particularly in the case of existinj enterprises)should accept to undertake an appropriate technical assistanceprogram as a condition of the subloan when considered necessaryby the FFI (para 7.04). This program should contain clearlyestablished objectives, scope of actions, targets for theexpected performance improvements and timetable forimplementation and monitoring of the action programs.

(f) The minimum of investor's own funds 20/ in the investmentproject should be 30% of total investment costs in the case of anew company; in the case of expansion or rehabilitation, ownfunds should initially be at least 20% of the total assets(excluding land) of the whole existing enterprise (including theproposed investment project) to increase to 30% within 3 years ofinvestment completion.2i/ Investor's own funds is defined aspaid-in share capital plus retained earnings plus investor'spersonal loans. These investor's personal loans would not exceed30% of the total own funds and would be subordinated to all otherenterprise debts, and could be serviced only: ti) afterprincipal, interest, and other charges on enterprise debts havebeen fully serviced, including arrears, and (ii) after suchpayment, investor's own funds are not less than 30% of totalassets. These investor's personal loans could not be prepaid oraccelerated so long as any amount due on all other debt remainsoutstanding.

7.02 The eligibility criteria (a) and (b) are designed to address theneed to reorient the present production capacity structure towards textileactivities where Portugal has a comparative advantage and export potential(para 3.19), while still catering to the upgrading need of the othertextile activities (paras 3.18-3.20). Criteria (c) through are to helpimprove the productivity and competitiveness of the enterprises.Criterion (f) aims to correct the financial structure of the enterprises(see also para 7.04 below).

7.03 Implementation. In brief, the proposed credit line would beimplemented by the PFIs, MIE/TRU and BdP. The primary responsibility restswith the PFIs who would identify, appraise, approve eligible subprojectsfor financing (subject to the Bank's prior review for certain categories asindicated in para 7.05 below), identify their technical assistance need asappropriate, and supervise their implementation. The TRU would review theFFIs' subproject reports to obtain a global view of and monitor thesubsector restructuring program, as well as keep records of thedisbursement of TTA grants (para 7.22). The BdP would centralize theadministration of the textile credit line and keep accounts on the approvedsubloans.

20/ Special reserves resulting from the revaluation of assets according tofiscal laws (which takes place from time to time) would be included.

21/ This is defined to be the date at which commercial production relatedto the investment project can start.

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7.04 The PFI would be responsible for identifying and appraisingtextile investment projects in accordance with the criteria spelled cii? inpara 7.01 above. The subproject appraisal report will cover all technical,managerial, marketing and economic aspects, as well as the financialposition and performance of the subproject and its sponsors.22/ In thiscontext, the PFI should be guided by the following financial targets:(a) the current ratio for the enterprise (including the investment project)should not be less than 1.2 to be achieved within 3 years of investmentcompletion; and (b) the debt-service ratio for the enterprise (includingthe investment project) should not be less than 1.2 to be achieved within 3years of investment completion. The calculation of financial and economicrates of return required for all subprojects will be carried out accordingto the Bank's guidelines 23/ and will be presented in the subprojectappraisal reports. In addition to the above eligibility criteria andperformance target guidelines, the investment cost estimate for the textilesubprojects should include appropriate physical and price contingencies (onaverage, expected to be up to about 20% of the value of civil works,equipment and other services) to allow for possible changes inconstruction, cost increase due to inflation and/or unexpected delays inproject implementation. The PFI would also be responsible, with assistancefrom specialized consultants when needed (para 5.10), for verifying theoutput prices, productivity levels and cost per job proposed for thesubprojects with corresponding EEC levels (para 7.01(b)(i) and (iii), (d),and (e)); for ensuring that the appropriate procurement procedures arefollowed when relevant (para 7.07); and for assessing the technicalassistance need of the subprojects during :heir subproject appraisal andincorporating it in the subproject appraisal report. The PFI would referthe enterprises to select from the approved list of textile consultants(para 7.17) for implementation when need for such services is indicated.Should the PFI feel that these actions are essential for the success of thesubproject, an appropriate technical assistance program would be made acondition of the subloan agreement by the PFI. In its monitoring of thesubprojects, the PFI would ensure that the agreed action program isproperly implemented by the textile borrowers.

7.05 The PFIs alone would decide whether to finance a textile projectusing the proceeds of the Bank credit line and their own resources asappropriate. The PFIs will bear the credit risk for the totality of creditgranted to the enterprises. For existing enterprises, the financialcovenants, when imposed by the PFIs in their loan agreement, will coverboth the Bank's subloans and the PFIs' portion of the credit granted. Inview of the complex nature of the restructuring exercise and in order toallow meaningful Bank involvement in the subproject review for institutionbuilding purposes, Bank staff would appraise jointly with PFI staff thefirst 3 subprojects of each PFI regardless of investment size. Ifsatisfied with the PFI's textile appraisal quality, for each FFIsubsequently there would be a free limit set at US$1.25 million for reviewand approval as follows:

22/ A comprehensive checklist for subproject appraisal, distributed to thePFIs for reference, is available in the Project File.

23/ The -Guidelines for Calculating Financial and Economic Returns of DFCProjects," by C. Hyde, June 25, 1982 (already given to the PFIs) isavailable in the Project File.

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(a) eligible subprojects with investment cost less thanUS$1.25 million (to be called B-subprojects) would be appraisedand approved by the PFIs in accordance with the eligibilitycriteria and standard guidelines provided in paras 7.01, 7.02 and7.04 above. Promptly after its approval of a B-subproject, thePFI would send: (i) a note (describing briefly the subprojectand listing the eligibility criteria which the subproject hassatisfied) 24/ to BdP who would convey on behalf of the Bankformal authorization to withdraw from the credit line proceedsfor the B-subproject in question; and (ii) a copy of theB-subproject dossier to che TRU for information. Every month,BdP would send a list of these B-subprojects for information tothe Bank, which may request to review in detail with the PFIconcerned any of the listed B-subprojects during its periodicsupervision missions of the credit line; and

(b) eligible subprojects with investment cost greater thanUS$1.25 million (to be called A-subprojects), the PFIs wouldsimultaneously send (i) one copy of the appraisal report (inEnglish or French) of these subprojects to the Bank for itsreview and approval; and (ii) one copy to the TRU for its reviewon the basis of no-objection within 15 days. This means that,for the A-subprojects where the TRU may have questions orreservations, these would be communicated within the 15-dayperiod mentioned above to the Bank, with copy to the concernedFFI. After consultation with TRU when relevant, and uponsatisfactory review of the PFI's subproject appraisal, the Bank'sapproval of these A-subprojects would be telexed to the PFIconcerned, as well as to TRU and BdP for information.

It is stressed that, as agreed during appraisal, the subproject review bythe TRU would be sector oriented, covering the scope and directions of therestructuring efforts, rather than involving a detailed project-by-projectreview and control. The objective is for the TRU to monitor the progressof the restructuring program in general as well as of the proposed projectin particular (para 6.08). It is estimated that under the above subprojectreview procedures, the Bank would closely review and directly approve atleast 50% of the total number of subprojects. If durii.6 the initialsubproject co-appraisal and/or subsequent subproject review process, thetextile appraisal quality of any PFI is not satisfactory to the Bank, thatPFI would take appr-priate remedial actions as agreed between the Bank andthat PFI. Until saAisfactory quality is shown, the Ban'- would continue torequire all subproject appraisal reports for its review and approval.

7.06 The responsibilities of BdP would be carried out by a small unit(already designated during appraisal for the proposed textile credit line)and will be to: (i) maintain an accounting system for subprojects forwhich commitment of Bank funds is approved; (ii) request withdrawal offunds from the credit line special account (para 7.08) and channel them tothe PFIs; (iii) prepare and send to the Bank a monthly statement ofexpenditures requesting replenishment of the credit line special account;

24/ Format distributed to the PFIs is available in the Project File.

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(iv) collect from the participating banks the payments of interest andprincipal, and transfer these funds to the Treasury for servicing of theBank loan; (v) hold all documentation related to each subloan forcommitment and disbursement amounts as well as update them to take intoaccount possible increases or cancellations when the subprojects arecompleted; and (vi) prepare the quarterly commitment/disbursement statusreport for the credit line (para 7.09). The signing of an Agency Agreementbetween the Government and BdP satisfactory to the Bank would be acondition of effectiveness of the proposed loan.

7.07 Procurement Procedures for Subprojects. When a subprojectinvolves the purchase of a single package of equipment with value equal toor greater than US$1.0 million, the Bank's International CompetitiveBidding (ICB) procedures, with prior review by the Bank, will be followedby the PFIs and enterprises. For equipment purchase valued at less thanUS$1.0 million but more than US$200,000 at least three price quotationswill be obtained from qualified suppliers from more than one country.Within this latter category the Bank's prior review would be required forsingle packages exceeding US$500,000. Procurement of goods costing lessthan US$200,000 equivalent would follow local competitive procedures of thePFIs.

7.08 Disbursement Procedures for Subprojects. A special account forthe credit line would be set up in a financial institution in the form of arevolving account with ap initial deposit of US$3.6 mil'lion, to simplifydisbursements under the proposed credit line. In line with the procedurescurrently used in the Bank's ongoing SKI credit lines, BdP would receivefrom the PFIs documentation justifying expenses actually incurred forapproved subloans, the maximum amount of these subloans being 65% of thecorresponding total investment costs. BdP would verify, in collaborationwith TRU, when technical advice is needed that the documentation for theseexpenses is satisfactory. The Bank would replenish the initial deposit ofUS$3.6 million upon receipt of a certified monthly statement ofexpenditures to be sent by BdP. No Bank reimbursement would be made forexpenditures made more than: (i) 90 days prior to the BdP's formalwithdrawal authorization for the subprojects in the cases under the freelimit; and (ii) 120 days prior to the Bank's date of receipt of thesubproject dossier, if the subprojects are above the free limit. Theestimated disbursement schedule for the proposed credit line is discussedin para 7.14.

7.09 Audit Procedures. The records and accounts maintained by BdPfor the credit line and the approved subprojects (para 7.06) would beaudited each fiscal year by the Audit Council of the BdP, which wouldprepare a report certifying that the amounts received and paid by BdP forthe credit line and individual sub-loans together with the documentaryevidence used by BdP as basis for withdrawal of Bank funds aresatisfactory. This report will be sent to the Bank no later than sixmonths after the end of the fiscal year in question. The Bank has examinedthe legal provisions establishing the Audit Council as well as the InternalAudit Department, and found that this Council together with the staffsupport from the Internal Audit Department do meet the normal standards ofindependence from the entity under audit, suitable qualifications andsatisfactory experience.

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7.10 Periodic Review of the Credit Line and Reporting Procedures. ThePFIs would supervise the Bank-financed subprojects in terms of riskassessment, eligibility and technical assistance, and BdP in terms of thesubloan disbursement. The TRU would collaborate with the PFIs and BdP toprepare for the TC and the Bank a semi-annual restructuring report based onan agreed sample of approved textile subprojects and corresponding dataprovided by the PFIs and BdP. The format of this semi-annual report wouldcontain an analysis by: (i) the FFIs of the progress in projectimplementation (e.g., construction, equipment installation, production,financial covenants if any) for each subproject compared to the originalimplementation schedule as proposed in the appraisal report, the problemsencountered by each subproject together with the status of their resolutionand the actual capacity utilization, sales, production costs, exports,etc., of the enterprise as compared with tne projections made in theappraisal report, and of the sub-borrower's repayment performance; (ii) theBdP of the status of subloan commitment and disbursement; and (iii) the TRUof the status of the incentives granted, the overall results and progressof the restructuring exercise being implemented, and a review of the TRU'sown activities (para 6.08). In addition, every 3 months, BdP would preparefor the Bank a short progress report presenting actual total commitment anddirbursement by the PFIs under the credit line, to include any change inthe committed amount for each subloan.

7.11 Terms and Conditions of Bank Financing. The Bank credit linewould finance up to 65% of the total investment cost of each eligibletextile subproject, this percentage being estimated as corresponding to themaxinum foreign exchange component (direct and indirect) of the types ofinvestment eligible under the project. For all subprojects, the expectedaverage would be 50% of total investment costs. The terms of subloansfinanced out of the proposed credit line would be in line with therepayment ability of the investment enterprise, as determined by the PFIs.Although the average term of subloan is expected to be about 7 years,including a grace period of 1 to 2 years for principal repayment, subloanterms may be up to 12 years including a grace period of up to 3 years. Thetextile investors would pay to the EFIs the floating interest rateapplicable to similar medium-term credits available in Escudos (currently32.5% and positive as discussed in para 2.12). The difference between thisonlending rate and the Bank's lending rate would be allocated as follows:3.0% to the PFI, 0.5% to BdP, and the balance to an account to be set upfor the proposed project by the Treasury for the Government to cover theforeign exchange and interest rate risks on subloans, as well as therepayment of principal and interest related to the US$1.0 million of theproposed loan allocated to technical assistance (para 7.17). In view ofthe changing conditions now expected in the financial community (e.g.,possibility of a decline in final lending rates and reduction in theinflation rate in 1984), the Government has agreed to carry out by December31, 1984 an analysis of the basis for allocating the above interestdifferential, and after review with the Bank of the findings/conclusions ofsuch analysis, take the necessary measures to revise as needed theseallocation amounts (in particula,, the margin for PFIs which would need toreflect their costs of intermediation under the proposed credit line, theirefficient use of resources, and the general economic conditions such asinflation and investment risks). Finally, until the Government's draft

- 36 -

Textile Development Plan is enacted into law (para 5.03), the Governmenthas agreed that the PFIs would follow the principles of the agreed textileeligibility criteria and appraisal standards in all their lendingoperations for investment in the textile subsector. The PFIs have alsoagreed to the principle above.

7.12 In January 1982, BdP has agreed to grant a credic ceilingincentive to the PFIs utilizing Bank's credit lines, whereby a PFI'smonthly credit ceiling is adjusted by the amount of the credit line it usedduring the previous month.25 / This credit ceiling incentive is consideredby the PFIs as a key factor in maintaining their interest in utilizing thefunds available under the Bank's credit lines. To ensure continuedinterest from the PFIs in the proposed textile credit line, BdP has agreedto maintain the credit ceiling incentive for this project. This has beenconfirmed at negotiations.

7.13 Textile Restructuring Protocol. All the above subprojecteligibility criteria, terms and conditions, the respective roles andresponsibilities of BdP, PFIs and TRU for implementation of the proposedloan would be incorporated in a textile restructuring protocol, a draft ofwhich was discussed during negotiations. The signing of this protocol byBdP, PFIs and MIE would be a condition of effectiveness of the proposedloan.

7.14 Completion Dates and Disbursement Schedule. The final date forsubproject submission and the closing date would be September 30, 1987 andJune 30, 1989 respectively, both dates already incorporating a 6-monthcontingency. Based on the commitment experience of other credit lines andthe disbursement profiles for the industrial sector in Por.ugal, commitmentand disbursement estimates for the credit line component are given inAnnex 7-1.

7.15 Coordination Between the Proposed Credit Line and OngoingProjects. To ensure consistency in approach between the SMI II credit lineand the proposed textile restructuring line (para 5.03), the Government,BdP and IARMEI have agreed during appraisal to: (i) apply the same textileeligibility criteria, appraisal standards and procedures (as specified inparas 7.01-7.04 above) in addition to the already agreed SMI II criteria;and (ii) IAPMEI would become party to the textile protocol (para 7.13) onlywhen the funds under the SMI II credit line are fully committed, and wouldthen play an advisory role in the channeling of eligible SMI textilesubprojects originating from the banks which are not yet signatories to thetextile protocol, or who may not wish to become signatories to the protocol(because they may not be prepared to incur the higher overhead costsexpected with such direct participation, paras 7.04-7.05). The Portugueseauthorities have agreed that, under these conditions, the SMI II protocol

25/ This incentive does not work counter to the Government's stabilizationprogram, because, although the Bank's credit line is not included inthe individual bank's credit ceiling, it is included in the overallcountry credit ceiling; thus the sum of the individual bank creditceilings is set at a lower level than the country ceiling decided onby BdP.

- 37 -

would be amended at the latest by date of effectiveness of the proposedtextile project, to reflect the textile restructuring eligibility criteriaguidelines and appraisal aspects (paras 7.01-7.04). Agreement was alsoreached that IAFMEI would provide its SMI textile subprojects withappropriate technical assistance through hiring, when needed, ofspecialized textile consulting services from the same approved consultantlist mentioned in para 7.17 below to be paid out of its own consultantbudget, a principle already agreed in the context of the SMI II creditline.

7.16 With regard to the coordination procedure for the Bank's BFN IIcredit line, the Government and BFN have agreed that the BFN's loanagreement would also be amended appropriately to reflect the sameprinciples and technical assistance arrangements as outlined above forIAPMEI. However, due to the slow utilization of the BFN II loan, it is notlikely BFN would become a PFI under the proposed project.

B. Technical Assistance Component

7.17 Technical Assistance for the Enterprises. As described inpara 5.09, US$0.8 million would be available to all investment projectseligible for Bank financing, when a specific technical assistance actionprogram is assessed by the PFIs as necessary for the successfulimplementation of the proposed investment projects, and/or performanceimprovements to be achieved by the enterprises (para 7.04). These fundswould be disbursed from a technical assistance (TA) special account(para 7.22) and be used to obtain technical services for thepreparation/design of their investment projects, elaboration andimplementation of specific action program aimed at improving theproductivity and/or financial performance of the enterprises. The cost ofthese textile technical assistance services is estimated to be on average3% of the total investment cost of the subproject. The TA special accountwould contribute, as a grant, 50% of this cost subject to a maximum totallimit of US$20,000 per subproject, with the investor paying for the balance(with own or borrowed funds). Budgetary requirement may not be needed tocover these TA grants given to enterprises, because they would be coveredby the 1.25% of the interest payments made by the textile enterprisesfinanced under the proposed credit line fparas 7.11 and 7.18). Because thelocal consulting industry does not yet have adequate textile advisingexperience, foreign consulting firms would be selected jointly by theGovernment and Bank staff 26/ according to Bank's guidelines to establishan approved list from which the beneficiary enterprises can choose or bereferred to by the PFIs to obtain the needed technical assistance. Toinduce further development of the Portuguese textile consulting industry,the selection of consulting firms would give extra weight to foreign firmswith satisfactory arrangements of collaboration and/or joint venture with aPortuguese company. It was agreed at negotiaLions that this list ofapproved consultants would be finalized and available by October 31, 1984.

7.18 Technical Assistance for the TRU. The TA special account wouldalso finance the US$0.2 million technical services to assist the TRU in

26/ Preparation work to invite interested firms is under way.

- 38 -

setting up an information system to monitor the implementation of thetextile restructuring program in general and the proposed project inparticular and carry out necessary studies for improving sector performance(e.g., market studies). The costs of these services would also berecovered through the 1.25% of the interest payments as described in para7.17. Analysis shows that these payments would be sufficient to repay theUS$1.0 million over the life of the Bank loan to the Government. It isenvisaged that there would be one man-year of general textile expertiseavailable on a part-time basis to support the TRU staff over the 1984-87period. This general expert would be strengthened whenever necessary witha total of 12 man-months of services from specialized textile experts forspecific subsectoral issues. The draft terms of reference and timetablefor the assignment for these technical assistance services have beenfinalized during negotiations (Annex 7-2). It was agreed that thetimetable for the consulting assignment would specify that the first worksession with TRU will take place not later than October 31, 1984.

7.19 The PFIs would use the above approved list of consulting firmsand/or would call on the services of other qualified consultantsto help them in their technical appraisal and procurement for thesubprojects (para 7.04).

C. Training Component

7.20 The MIE/TI would coordinate with existing relevant institutions(Ministry of Labor, universities, technical/vocational schools) to carryout the training study. The draft terms of reference for the study wasfinalized during negotiations (Annex 7-3). The study would be initiated byOctober 31, 1984 and its recommendations expected to be available byMay 30, 1985 for review by the Government and Bank. Orders for theequipment for the TI's laboratories and University of Minho would be placedby May 1,1985 (lists in Annex 7-4). The draft proposals for advancedtraining of the Government staff involved in textiles (para 5.10) would befinalized by June 30, 1984. Disbursements for this component would be asdescribed in para 7.22 below.

7.21 Procurement. The above equipment would be purchased according tonormal Government procurement practices, which have been found satisfactoryto the Bank.

7.22 Disbursement Procedures for the TA and Training Components. TheTA special account would be set up in a financial institution in the formof a revolving account to simplify disbursements for the TA and trainingcomponents. Of the total US$1.6 million allocated to these two components,this TA special account would receive an initial deposit of US$160,000.

(a) The US$800,000 allocated to cover the TA services for approvedsubprojects would be disbursed by the Treasury based on thetechnical assistance action program included in the subprojectreports prepared by the PFIs and/or the subloan agreements signedbetween the PFIs and the beneficiary enterprises. Disbursementsfrom the special account would be at 50% of the TA costs or up toa total of US$20,000 per subproject on presentation of actual

- 39 -

invoices submitted by the beneficiary enterprises via MIE/TRU,with copy to the sponsoring FFI for information. The Governmenthas agreed to allow promptly the necessary foreign exchangeconversion for the beneficiary enterprises to pay the balance ofthe technical assistance costs.

(b) The US$200,000 of technical assistance to the TRU, would bedisbursed by the Treasury from the TA special account at 100% ofthe costs on presentation of actual invoices submitted by theconsultants via MIE/TRU.

(c) The total of US$600,000 allocated for the training componentwould be disbursed from the TA special account at 100% of thecosts, on presentation of actual invoices submitted by theMIE/TI.

7.23 The total of US$1.0 million allocated for the TA component(parts (a) and (b) above) is expected to be disbursed over the 3-yearcommitment period of the proposed project (para 7.14). The Bank wouldreplenish the initial US$160,000 deposit in the TA special account uponreceipt of a monthly statement of expenditures to be sent by the Treasuryfor all contracts under US$10,000 equivalent in foreign exchange orUS$20,000 equivalent in local expenditures; full documentation would benecessary for contracts with values in excess of the above limits. TheMIE/TRU would keep all records for review by the Bank's supervisionmissions. This TA special account would be audited every year by anindependent auditor whose report would be sent to the Bank within 4 monthsof the end of the year. The opening of both the special accounts for thecredit line (para 7.08) and TA (para 7.22) will be a condition ofeffectiveness of the proposed loan.

VIII. BENEFITS AND RISKS

8.01 Benefits and Policy Impact. This is the first Bank loandesigned to address subsector restructuring in Portugal. The major benefitexpected from the proposed project is that it would help initiate the muchneeded restructuring program for the textile industry in Portugal. In thissense, the most important benefit of the proposed project would behelp the Government develop a coherent restructuring framework to guide thePortuguese textile enterprises in their performance and profitabilityimprovement. The Ministry of Industry and Energy has prepared a new draftDevelopment Plan for the subsector elaborating alternative restructuringscenarios which are consistent with comparative advantage considerations.The Government and financing institutions have agreed with the set oftextile restructuring criteria formulated for the proposed project whichprovide the technical and financial guidelines for efficient restructuringof the subsector. The Government is currently thinking of abolishing theexisting cumbersome and overgenerous investment incentives system, andagreed to work out in the context of the project new proposals for moreeffective, fiscal based incentives. The specific proposals for textilerestructuring would be incorporated in the final draft legislation

- 40 -

implementing the Textile Development Plan for Government's consideration byDecember 31, 19B4.

8.02 The project would also have important institution-buildingeffects on the financing institutions (in line with the efforts ongoingunder the Bank's SMI credit lines), particularly in terms of strengtheningtheir capacity for viable long-term textile financing based on betterproject analysis and follow-up. The technical assistance component and,more importantly, the financing arrangements as designed, should helppromote more responsible involvement in the technical assistance programfrom the entrepreneurs themselves. In addition, the broad-based technicalassistance delivery approach proposed should help develop the domestictextile management consulting capabilities, thus further encouragingprivate initiatives to achieve a successful restructuring exercise. Thetechnical assistance for the Textile Review Unit is another key element ofthe institution-building efforts of the project. It should strengthen theexisting Government ability to monitor the restructuring program and helpformulate effective policy adjustments to ensure its successfulimplementation.

8.03 Risks. The major risk involved in the proposed project is thepotential slow utilization of funds by the participating financialinstitutions, in spite of their commitment to the objectives of textilerestructuring in general and of the proposed project in particular. First,the PFIs may be less active because of the current interest rate structureand credit ceiling policy of the Bank of Portugal. To minimize this risk,care has been taken to provide the participating banks with sufficientincentive to use the Bank funds: the subproject review, approval,procurement and disbursement procedures are kept streamlined while stillallowing for the Bank's involvement; also, the Bank of Portugal's creditceiling incentive would be maintained for the PFIs. Second, the PFIs maybe less successful in their investment promotion because the presentinvestment climate may be worse than expected, thus depressing further therate of textile investment. This risk should be reduced somewhat by thevery conservatively estimated amount of the credit line. The TA grants toassist companies in preparing market-oriented, viable restructuringprograms should help ensure that the optimal decisions are taken ininvestments. Another risk relates to the fact that implementation of theneeded restructuring approaches as well as technical assistance/trainingactions are complex and may be more difficult than expected. The intensivesupervision which the Bank intends to give to the subprojects should helpthe participating banks better appraise and coordinate the design featuresof individual restructuring cases, and thus, help limit the above risk.Serious disruptions and/or departures in the implementation of the projectobjectives should also be avoided with the monitoring and coordinationarrangements set up for the Textile Review Unit. The proposed projectwould lay the foundation for a necessarily long-term and complexrestructuring process supported by sound policy actions for an importantindustry. In this context, the above risks are judged to be acceptablewith the safeguards provided.

- 41 -

IX. AGREEMENTS

9.01 The following would be conditions of effectiveness for theloan:

(a) the Agency Agreement satisfactory to the Bank to be executed onbehalf of the Government and the Bank of Portugal (para 7.06);

(b) a protocol (or financing agreement) to be signed by Banco dePortugal, MIE and the participating financial institutionsidentified to date. This agreement would spell out allprinciples and procedures listed in paras 7.01-7.14 in accordancewith the draft discussed during negotiations (para 7.13); and

(c) the special accounts for the credit line and technicalassistance/training be opened in a financial institution (para7.23).

9.02 Agreement was also reached on the following points:

(a) that the final draft legislation to implement the TextileDevelopment Plan, incorporating the restructuring incentiveproposals to be developed in collaboration with the Bank, besubmitted by MIE by December 31, 1984 for consideration by theGovernment (paras 4.03 and 5.03);

Cb) that the Textile Review Unit set up within the MIE have theagreed staffing and responsibilities (para 6.08);

Cc) that appropriate subproject procurement, disbursement, audit ofthe credit line special account, and reporting procedures befollowed (paras 7.07-7.10);

(d) that until the above textile legislation is enacted(para 9.02(a)), the PFIs follow the principles of the textilerestructuring eligibility criteria, guidelines and appraisalstandards as established for the proposed project for all theirtextile restructuring investment financing (para 7.11);

(e) that the Government carry out by December 31, 1984 an analysis ofthe basis for allocating the differential in the interest ratecharged by the Bank and the on-lending rate and, after reviewwith the Bank, revise as needed the allocated amounts, inparticular the PFIs' margin (para 7.11);

(f) that the BdP maintain the credit ceiling incentive for theproposed project (para 7.12);

(g) that the approved list of textile consultants for use by eligibleenterprises be established by MIE and available by October 31,1984 (para 7.17);

- 42 -

(h) that the technical assistance services for the TRU be availableaccording to the discussed terms of reference and schedule(para 7.18);

(i) that the training component be carried out according to thediscussed terms of reference, schedule and procedures (paras 7.20and 7.21); and

(j) that the Treasury would disburse for the textile technicalassistance grants to eligible enterprises, TRU, and the trainingcomponent from the TA special account and keep records of thisaccount which would be appropriately audited (para 7.22).

9.03 Based on the above agreements, the project is suitable for a Bankloan of US$34.7 million.

Industry DepartmentApril 1984

POR1UGALTEXTILE RESTRUCTURING PROJECT

Textile Industly Production Balance

_ _~~~~~~~~~~~~~~~~~~I tXTLE IMAM tRY SOCtjrit" WANCE (i lae) |1974

ULIASECtOR tE N FABC mIcUPRnCLS OESnCM Ii

Am YOMl2wo ~~~~~mcoh AS Lt&4jp Altb6

MVWS ~~~~~Al itirs ContrwmzaA Flin 3500 ODIO1W410 IS M0.650 Yawn 14ran

IZ~~~~~~~~~~~~~~~~~~~~~~A Fabri MIAMI } 3 3_ 4~~~MFb -18450_

WAPMeClh i0MM making-upSpun Ycxn UbE bhv 101 Secio209 10 ava jca7.0

PROOMMN As _0tens _ IkI"Kfh"I 251 __

M130 Rope Atetbrc. 28, I I I 9*_l

Ihw 1T50

Mau 161 11.*, .

hy l * Capl s*iU

ShAi Pkg - C kOAMO ft*jct . Repor No 3809

-om 19M4

URIW.AL - ThFILE INJSiRY REsnJCREDG FiCr

Producticn, Lqports, Exports and Apparent Conumption of Taxiles, 1973-02('OOO m torn)

Rate1976-2

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 (2)Production a/

Inports oTf Fibers 271.1 200.6 151.2 194.6 204.4 160,1 203.3 215.2 194.9 194.5Plus: Producticn of Hanmade Fibers 26.8 14.2 10.6 15.8 22.1 30.2 35.1 34.6 39.3 40.0

Total 297.9 214.8 161.8 210.4 226.5 190.3 238.4 249.8 234.2 234,5Less: Exports of Fibers bl 3.8 2.2 3.8 4.0 1.2 3.5 5.2 4.8 11,2 11.5

Projctim 294.1 212.6 158.0 206.4 225.3 186.8 233.2 245.0 223.0 22, 1.2

iports (Not)Tbtal Tiports 307.2 239.2 174.1 226.4 236.7 187.1 234.9 259.5 233.5 232.9

ness: Imports of Fibers 271.1 200.6 151.2 194.6 204.4 160.1 203.3 215.2 194.9 194.5liports (Nat) 36.1 38.6 22.9 31.8 32.3 27.0 31.6 44.3 -38.6 -M.T 3.2

Exports (Nat) 4Total Exports 176.3 167.3 123.9 121.2 118.5 138.8 162.2 155.5 168.6 183.8les: ports of Fibers b/ 3.8 2.2 3.8 4.0 1.2 3.5 5.2 4.8 11.2 11.5

Exports (Net) 172.5 165.1 120.1 117.2 117.3 135.3 157.0 150.7 157.4 172.3 6.4

4vpRat CopcicnPromLctiln 294.1 212.6 158.0 206.4 225.3 186.8 233.2 245.0 223.0 233.0Plus: Imports (Nat) 36.1 38.6 22.9 31.8 32.3 27.0 31.6 44.3 28.6 38.4

Ibtal 330.2 251.2 180.9 238.2 257.6 213.8 264.8 289.3 261.6 271.4less: Exports (Not) 172.5 165.1 120.1 117.2 117.3 135.3 157.0 150.7 157.2 172.3

Apparent Cm tin 1577 86.1 6 0 .8 1MIT 140.3 7.5 1 07.8 138.6 189.1 (5.2)

Poplatien ('000) 9,271.0 9,348.0 9,426.0 9,501.0 9,577.0 9,798.0 9,877&0 9,967.0 [0,067.7c/ 10,167.30/ 1.1

Apparent Conmption Per Capita (kg) 17.0 9.2 6.5 12.7 14.6 8o 10.9 13.9 10.3 87 (7.0)

(Op_ing iwnwtory Is asuad to be eq ul to clasLng Invtory.,/ Exports ef flbacs in 1978 are eadeted./ Fatited.

bwrns: Tiutitute of Textlles; World Bank Atlas, 1980; World Tibles, 198); Taxtlla Orgam, various lsaes; an staf estites.

JrIstry DapartnutMrdh 1984

-45- ANNEX 3-3

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Exports and Imports by Textile Products (1982)

Exports Imports BalanceTRTaj MCa/ TMT MC T MC

Fibers 11.5 1.1 194.5 23.8 (183.0) (22.7)Yarns 23.7 6.4 22.1 7.7 1.6 (1.3)Woven Fabrics 25.6 13.9 9.0 7.7 16.6 6.2Knitwear 22.1 25.6 1.3 2.1 20.8 23.5Garments 17.0 25.3 0.4 0.8 16.6 24.5Other Productsc/ 83.9 22.6 5.6 2.6 78.3 20.0

Total 183.8 94.9 232.9 44.7 49.1d/ 50.2

a/ Thousand Metric Tonsb/ Million Contos; in 1982 one Conto - US$13.if/ Mainly household articles and cordage.t/ plus domestic man-made fiber production - 40 TMT.

Source: Instituto dos Texteis.

Industry DepartmentMarch 1984

POKI1:AL - TEXrE DIUSWY RESCIUREG PMD=JEC

Portugal's Utilization of EEC Mie¢lle Qxotas

1979 1980 1981 1982 1983Cat. Iten a/ lhits b/ Ac/%d/ A Z A X A % 9 Ae/ X f/

1 (ottci Yarns 'Off/ 12.0 10.4 13 12.4 7.5 40 12.7 7.2 43 13.0 8.3 36 13.3 3.9 502 Cotton Fabrics DIM 7.0 6.6 6 7.2 4.1 40 7.4 3.6 51 7.9 6.3 20 8.1 3.8 303 Hui-made Fabrics ¶iT 6.8 5.4 21 6.9 3.6 48 7.1 3.9 45 7.4 4.6 38 7.6 2.8 454 Knitted Underwar wtlh/ 35.9 38.0 (6) 37.2 38.5 (3) 38.5 39.6 (3) 41.8 43.7 (5) 43.9 23.8 195 Knitted Outerear MP 11.2 9.8 12 11.8 12.5 (6) 17.5 12.5 0 13.9 24.3 (3) 14.6 7.6 226 Man's & Boys' Trousena MP 5.2 4.1 21 5.4 3.2 41 5.6 3.6 36 2.8i/ 2.3 18 3.01i/ 1.4 307 l&mnts 6 Girls' Blouses MP 2.2 2.7 (23) 2.3 2.2 4 2.4 2.1 12 3.4 2.8 18 3.5 1.2 498 1I-n's & Boys' aiirts MP 6.6 7.3 (16) 6.9 6.5 6 7.2 5.6 22 7.7 7.9 (3) 8.1 4.3 20

20 Ibusehold l'xtiles IMfI 6.4 6.8 (6) 6.8 6.1 10 6.9 7.2 (4) 7.5 9.1 (21) 8.0 4.1 2333 Other Huin-mde Textiles I 4.3 4.7 (9) 4.5 2.9 36 4.8 3.3 23 5.1 3.2 37 5.5 1.3 64

a/ Within 10C, itema in categpries 2 and 3; 2 or 3 vs. 20; 4, 5, 7; 6 and 8; and 33 and 90; are interchmnlable; tire are also within each category carry-fonxard and advanced shipwaet provisions.

/ Qjota.c/ Actual shipots.j( 2 Ixlcw or (above) the quota.e/ First eight mxths of 1983.f/ Projected over 12 mxths./ lmhand uetric tons.

h/ Hillion pieces./ Qiota for the lK oaly.

Sourc: Instituto dos TexteLs.

Lmiustry DepartantMardi 1984

-47 - AMNEX 3-5

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Projections of Import, Export and DomesticConsumption of Textiles - 1982-93

(Thousand Metric Tons)

AnnualGrowth

1982 1986 1993 1982-93

Production a/ 223.0 229.7 289.5 2.6%Imports b/ 38.4 43.5 81.1 7.8%Population c/ 10.2 10.6 11.4 1.0ZConsumption per Capita d/ 8.7 9.0 10.7 2.0%Domestic Consumption 89.1 95.4 122.0 3.2%Exports 172.3 178.6 256.6 4.0%

a/ Based on mill consumption and assuming GDP growth per capita of -0.5for 1983; -1.5 for 1984; 2.0 for 1985; and 3% in 1986-93.

b/ Growing at the 1976-82 rate (3.2X p.a.) until 1993 reaching 73Z of thedomestic consumption in 1993, in line with the average for EECcountries; excluding import of fibers.

c/ Growing at the rate of 1.0% p.a. (million).a/ Assuming 0.85 elasticity of demand in the 1976-80 period.

Source: FAO: World Apparel Fiber Consumption Survey, 1983.

Industry DepartmentMarch 1984

PORIJGAL - MUIE IkUSflrY BESUCRJ PRPECr

Banking System: Some Characteristics (as of end 1982)

MllUons of conmtos c/

[epoeitt, Nkt = Dbposits = Credit No. of No. of

Institutions Assets Sigft At notice Total granted branches employewand tem b/

Caixa G'eral de D epaito st..............o 576.7 141.8 286.2 428.0 379.0 283 8,482

Other savings and investment banks

Banro do Fonento Naional.oe............... 171.1 3.8 47.9 51.7 132.1 20 838Credito Predial Pbrtu u ge................... 136.0 20.8 69.1 89.9 88.4 56 2,503Muitepio Coral - CO. Economica de Lisboa 64.2 8.0 43.9 51.9 47.6 28 1,000

Comaercial banks a/

Banco Pbrtugues do AtIanticosee............ 444.2 67.4 269.5 336.9 277.6 133 5,564Banco Pinto & Sotto Mayor .................. 325.5 55.5 200.8 256.3 202.7 119 6,581Banco Espirito Santo e Comercial de LlAsboa.. 312.9 61.6 182.5 244.1 178.9 130 6,592Banco 1acional Ultramarino.................. 301.5 57.9 166.6 224.5 121.9 142 5,621Lanco Borges & I nm a o 278.3 38.8 191.7 230.5 178.9 93 4,369Bunco Tbtta & ADoreSo.opooo*40.............. 273.0 50.9 117.2 168.1 168.9 124 4,774Uhkao de Bancos Pbrtugueses................., 183.2 37.8 120.2 158.0 104.9 118 4,358Banco Fcnsecas & Burnay*oeest.....ae........ 166.5 40.4 96.9 137.3 94.3 98 4,026Banco Comercial dbs Acores r........es....... 11.5 3.3 6.5 9.8 6.3 12 42a

/Only nrtional banks.b/ WithoLut deduction of provisions.

COnto - 1,000 escuidos.

Source: Bank of Portugal,

Industry DepartmetMarch 1984

P .ER1JL - TMa1 INWUSI RESgJCIwR FJwcr

ys-M

Sectoral Credilt Outstanling by Term at Year-end 1978-82

E6c. (000,000) Percentages19788/ 1979 1980 1981 1982 197 8a/ 1979 1980 1981 1982

Ibtal Credit< i year 380,315 457,335 557,127 719,638 825,953 68.1 61.3 58.3 54.1 49.71-5 years 74,982 106,281 133,784 2D9,622 303,581 13.5 14.2 14.0 15.8 18.3> 5 years 102,847 182,751 264,293 400,428 532,202 18.4 24.5 27.7 30.1 32.0

558,144 746,367 955,204 1,329,688 1,661,736 100.0 100.0 100.0 100.0 100.0- - - = - - - - -- % of Total

Credit CutstandivnIndustrial 1978P/ 1979 1980 1981 1982

< I year 189,068 232,470 273,398 341,429 384,732 84.0 74.8 70.8 66.9 64.1 49.7 50.8 49.1 47.4 46.6 £

1-5 yeams 22,681 34,893 45,626 70,479 91,301 10.1 11.2 11.8 13.8 15.2 30.2 32.8 34.1 33.6 30.1> 5 years 13,285 43,409 67,422 98,420 124,568 5.9 14.0 17.4 19.3 20.7 12.9 23.8 25.5 24.6 23.4

225,034 310,772 386,446 510,328 600,601 100.0 100.0 100.0 100.0 100.0 40.3 41.6 40.5 38.4 36.1

TextileKiu try % of Total Credit

< 1 year 33,190 42,933 54,467 75,823 83,095 84.6 83.2 81.6 75.5 73.1 8.7 9.4 9.8 10.5 10.11-5 years 3,564 4,106 6,874 14,460 18,034 9.1 8.0 10.3 14.4 15.9 4.8 3.9 5.1 6.9 5.9> 5 years 2,481 4,535 5,383 10,091 12,609 6.3 8.8 8.1 10.1 11.0 2.4 2.5 2.0 2.5 2.4

39,235 51,624 66,724 100,374 113,738 100.0 100.0 100.0 100.0 100.0 7.0 6.9 7.0 7.5 6.8

X of Industrial Credit<1 year 17.6 18.5 19.9 22.2 21.6 'a'1-5 years 15.7 11.8 15.1 20.5' 19.8>5 years 18.7 10.4 8.0 10.3 10.1 -x

a1 1978 figures exclude Investnint Banks, 17.4 16.6 17.3 19.7 18.9

Source: Banco de Fbrtugal, Boletim 'Mmstral.

EFORMAL - lORa E SeX REb1nRDUliRWNr WECT

Carclal Banks

Sectorial Credit Outstandi,ng hY Term at Year-end 1978-82

E- (000,000) Percentages1978 1979 1980 1981 1982 1978 1979 1980 1981 1982

Total Credit< I year 346,045 408,503 493,211 650,262 744,458 88.4 86.0 83.4 79.0 74.41-5 years 40,817 53,843 73,654 122,232 170,457 10.4 11.3 12.5 14.8 17.0> 5 years 4,723 12,849 24,188 51,246 86,014 1.2 2.7 4.1 6.2 8.6

391,585 475,195 591,053 823,740 1,000,929 100.0 100.0 100.0 100.0 100.0- _ -s _* _2_---- % of Total

Credit OutstandingIndustrial 1978 1979 1980 1981 1982Credit< 1 year 179,086 213,526 245,791 311,823 348,066 91.2 88.6 86.2 82.5 79.8 51.8 52.3 49.8 48.0 46.8 in1-5 years 15,595 22,578 30,483 48,339 63,466 7.9 9.4 10.7 12.8 14.6 38.2 41.9 41.4 39.5 37.2 0> 5 years 1,797 4,948 8,923 17,791 24,655 0.9 2.0 3.1 4.7 5.6 38.0 38.5 36.9 34.7 28.7

196,4'78 241,052 285,197 377,953 436,187 100.0 100.0 100.0 100.0 100.0 50.2 50.7 48.3 45.9 43.6

TextileInkutr_y< I year 32,972 42,512 53,138 73,531 79,967 91.8 91.7 88.3 82.1 79.6 9.5 10.4 10.8 11.3 10.71-5 years 2,706 3,021 5,493 12,456 15,672 7.5 6.5 9.1 13.9 15.6 6.6 5.6 7.5 10.2 9.2> 5 years 224 838 1,583 3,556 4,818 0.7 1.8 2.6 4.0 4.8 4.7 6.5 6.5 6.9 5.6

35,902 46,371 60,214 89,543 100,457 100.0 100.0 100.0 100.0 100.0 9.2 9.8 10.2 10.9 10.0

Source: Banco de lbrtugal, Eolatim Trimestral.Ph%N

In&uwtry DepartmentMhrdh 1984

-51 ANNEX 6-3

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Caixa Geral de Depositos - Non-Performing Loans 1979-1982Esc (000,000) and Percentages

1979 1980 1981 1982

Value 4,841 6,724 7,053 13,294Overdue 0 0 0 0Arrears 4,096 5,897 6,036 9,820Bad Debt 745 827 1,017 3,474

x Composltion 100.0 100.0 100.0 100.0Overdue 0 0 0 0Arrears 84.6 87.7 85.6 73.9Bad Debt 15.4 12.3 14.4 26.1

Z of Loan Portfolio 3.0 3.0 2.4 3.4

ProvisionValue 745 827 1,107 2,614Z of Loan Portfolio 0.5 0.4 0.3 0.7

- Arrears & Bad Debt 15.4 12.3 14.4 19.7- Bad Debt 100.0 100.0 100.0 75.2

Bad Debt at Year-end 1979-82Esc (000,000) and Percentages

1979 1980 1981 1982

Total Bad Debt 745 827 1,017 2,614

Sectoral DistributionIndustry 653 746 821 1,867Agriculture 92 77 193 732Housing 0 0 3 6Other 0 4 0 9

Textile IndustryValue of Bad Debt 184 183 191 235% of Industrial Bad Debt 28.1 24.5 23.2 12.6

Bad Debt by Age: 184 183 191 235< I year 184 0 19 1641-5 years - 183 172 71> 5 years _ _

Bad Debt as X of Sectoral Loan PortfolioAgriculture 3.0 1.9 2.2 n.a.Industry 1.1 1.0 0.9 n.a.Textile Industry 4.5 4.3 3.4 3.7

Source: CGD Financial Statements and data to mission.

Note: Non-performing public sector, public enterprise or state-guaranteedloans are maintained in arrears, not transferred to bad debt and notprovided against.

Industry DepartmentMarch 1984

-52- ANNEX 6-4

Page 1 of 2

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

I. The Textile Institute

1. The Textile Institute (TI) is primarily engaged in compilingstatistical data on export and import of textile articles, negotiating nadadministering of textile quotas under MFA and other bilateral agreements,as well as issuing of import permits on behalf of the ministry ofCommerce. TI is also operating two laboratories (one in Oporto for cottonand synthetic fibers and one in Covilha for wool), which are responsiblefor establishing quality standards and testing of raw materials importedand articles exported by the textile and garment industries (para. 20below). TI is financed through special taxes paid by the manufacturers,exporters, and importers of textile articles, based on their annualrevenues. This arrangement gives TI some degree of autonomy but as thelevies do not cover all the expenses and the difference is paid by theMinistry of Industry, TI is subject to the same rules and regulations(including salaries) which apply to Government employees. TI has a staffof 400, including about 50 professionals. Because of the recent budgetrestrictions, TI has difficulties however in recruiting and retraining wellqualified textile engineers, as there is practically no funds available fortraining of personnel or modernization of the existing laboratoryfacilities. TI plays a most important role for the textile industry in thecollection, diffusion of textile knowledge, and more importantly as-spokesman for the subsector. Consequently, it is in the best interest ofthe subsector that TI should be involved in the training and technicalassistance components of the proposed Bank project.

II. Textile Training Facilities

2. Traditionally, high school level textile training was carried outin Portugal in vocational schools and the last three years of thecurriculum in these schools was directed to teaching of trades including upto 50% of practical experience. Following the 1974 revolution thevocational training system has been changed and the students in the lasttwo grades (10 and 11)) have now an option of choosing either a vocationalor a general instruction program and usually eiect either the generalprogram which qualifies them for university entrance or other trades whichare believed to open better prospects for employment than the textileindustry. Currently.only-about 3% of the students take textiles as asubject at any time during vocational training and less than 1% of thestudents 1/ elect textiles as a career, in spite of the fact that theindustry accounts for 25% of the manufacturing jobs in the areas served bythe schools (Porto, Guimaraes and Covilha).

3. Apart from the image of the textile industry which is perceivedto offer lower than average wages and limited career opportunities due tothe cyclical nature of the business, the other reasons for the low interest

1/ In 1981 only 18 students graduated in textiles.

- 53 - ANNEX 6-4Page 2 of 2

in textile t;aining appear to be: (a) poor state of the trainingfacilities; tb) demoralization of the teaching staff as since 1975 theschools have not been teceiving any funds for purchase of new or repair andmaintenance of the existing textile equipment; and (c) student interest inthe subject has been minimal and the textbooks not available.

4. The postrevolutionary reforms established also university leveltraining for textile engineers at the University of Minho (UMG) inGuimaraes and the University of Beira (UBC) in Covilba. Both universitiesoffer five-year courses in textile engineering and textile technology.Both institutions have a competent teaching staff and are endowed withsuitable buildings but very few training facilities (although a recentgrant from USAID should materially improve the situation at UBC). So farthe interest of university students in the textile courses offered by bothinstitutions has been minimal and in 1983 only 11 students will graduate,or, one for each two faculty members. The figures indicate about 80%attrition rate as compared with the initial enrollment, but on the wholeonly 10-15% of the students leave university without degrees, it appearsthat many students enroll in textiles as a way to gain admission andsubsequently switch as soon as more desirable courses become available.The condition of the training facilities, lack of textbooks in Portugueseand poor communications between the academia and industry are generallyheld responsible for this state of affairs.

5. The vocational schools as well as the universities are underjurisdiction of the Ministry of Education but there is very littlecooperation regarding sharing of the limited machinery, buildings,laboratories and library facilities; the same applies to the textiletesting units of the Textile Institute even when training facilities aresituated in the same location.

6. A successful restructuring program would require a continuousinflow of skilled operators, mechanics, supervisors and engineers into thesector. The present structure and practice of teaching textile subjectsresults in grossly inadequate number of graduates at both vocational anduniversity level to meet the demands of the industry, particularly in viewof the imminent accession of Portugal to the EEC which is likely to resultin more demanding competitive environment and in order to increase theoutput of skilled personnel a capital investment in textile traininginfrastructure is indicated. However, before any expenditures are actuallymade, a detailed study to develop a comprehensive training program isrequired.

Industry DepartmentMarch 1984

- 54 -ANNEX 7-1

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Projected Commitment and Disbursement Schedule l/for the Credit Line Component

Calendar Commitment (US$ million) Disbursement (US$ million)Year Quarter Quarterly Cumulative Quarterly Cumulative

1984 TV 1.0 1.0 - -

1985 I 3.0 4.0 0.5 0.5II 3.0 7.0 1.0 1.5III 4.0 11.0 1.5 3.0IV 4.0 15.0 2.0 5.0

1986 I 4.0 19.0 2.0 7.0II 4.0 23.0 2.0 9.0III 4.0 27.0 3.0 12.0IV 3.0 30.0 3.0 15.0

1987 I 2.0 32.0 3.0 18.0II 0.5 32.5 3.0 21.0III 0.5 33.0 3.0 24.0IV - - 3.0 27.0

1988 I - - 2.0 29.0II - - 1.0 30.0III - - 1.0 31.0IV - - 1.0 32.0

1989 I - - 0.5 32.5II _ _ 0.5 33.0

Total 33.0 33.0

NOTE: The above schedule is in accordance with past commitment experienceand disbursement profile for the industry sector in Portugal Actualcommitment and disbursement will depend on the response of the PFIsand textile industry to the restructuring program. Furthermore, theschedule is based on the assumption that the proposed project willbe considered by the Bank's Executive Directors in May 1984.

1/ The estimated disbursement schedule for the US$1.7 million TechnicalAssistance and Training components is as follows: US$0.3 million in1985, 0.8 in 1986; 0.4 in 1987; and 0.2 in 1988.

Industry DepartmentMarch 1984

_55 ANNEX 7-2Page 1 of 2

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Draft Terms of Reference for Technical Consulting Servicesto the Textile Review Unit (TRU)

A. Background

1. The proceeds of the credit line provided by the Bank under theproposed loan would be channeled through the participating financialinstitutions (PFIs) to finance eligible textile subprojects.1 / The Bankof Portugal would serve as the apex institution to monitor theadministration of the credit lines, keep account of the approved textilesubloans and channel disbursement and repayments on these subloans. Tomonitor and coordinate the restructuring of the sector, a Textile ReviewUnit will be established within the Ministry of Industry.

2. The functions of TRU would be to (a) review the appraisal reportsof textile investment projects as already prepared by the PFIs and on thebasis of the information contained therein, develop a textile informationsystem regarding production capacities, costs and productivities,consumption and export performance of each activity within the textilesector; (b) monitor the implementation, progress and impact of theGovernment's restructuring policies in general and of the proposed Banktextile restructuring loan in particular; (c) identify and implement thestudies necessary for improving the sector performance.-

3. TRU will require technical assistance in its work. The cost oftechnical assistance to TRU will be financed from the Textile TechnicalAssistance Account. It is estimated that TRU will require the services ofan ex-2rienced international textile consulting company which would berequiced to supply about two man-years of senior level consultingassistance over the three year period of the commitment of the loan(1984-87).

B. Manpower and Function of Technical Consulting Service

4. It is envisaged that one of the above man-years will be availableon a part-time resident basis (e.g., one consultant to work in Lisbon withTRU staff for a total of 5 months during the 1st year of the projectimplementation, 4 months during the 2nd year and 3 months during the 3rdyear). This resident consultancy (RC) will begin about October 31, 1984.The consultant will have an economic and technical educational background,at least 15 years of -management experience in textile industry as well asmanagement consulting experience on both sector and project level.Knowledge of Portuguese, French, or Spanish will be a definite asset. Hewill be expected to be able to call on hie company, whenever necessary, toobtain statistical data and specific production cost and price information,as well as the services of the company's technical specialists familiar

1/ An attachment would be provided to the consultants, reproducingeligibility criteria presented in paras 7.01 and 7.02.

- 56- ANNEX 7-2Page 2 of 2

with specific segments of industry such as spinning, weaving, processing,knitting and making-up. These specialized services will add up to thesecond man-year of consulting requested.

5. The RC will be responsible for helping the TRU staff in theirreview of the subproject appraisal reports to see how the investmentproposals contained therein are consistent with the restructuringguidelines set out for the textile industry. On the basis of datacontained in these subproject reports, the RC will also be responsible iorassisting TRU in establishing an information system including data on pastand expected textile production capacities, costs and productivities,consumption, exports and imports in Portugal as well as pertinentup-to-date intelligence such as costs, prices, tariffs, quotas, and MFAprocedures in the export markets relevant to the Portuguese textilesector. Theseinformation would be used by the RC to assist TRU in generalmonitoring of the restructuring of the sector including the progress ofimplementation of the Bank project, and preparing quarterly progressreports for the Government and the Bank. The RC will also identify andimplement the necessary studies (productivity, costs, marketing, qualitycontrol, waste management, etc.) for improving and maintaining thecompetitiveness of the sector.

Industry DepartmentMarch 1984

-57 ANNEX 7-3Page 1 of 2

PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

Draft Terms of Reference for the Textile Training Study

1. A successful restructuring program would require a continuousinflow of skilled operators, mechanics, supervisors and engineers into thesector. The present structure and practice of teaching textile subjectsresults in grossly inadequate number of graduates at both vocational anduniversity level to meet the demands of the industry, particularly in viewof the imminent accession of Portugal to the EEC which is likely to resultin more demanding competitive environment and in order to increase theoutput of skilled personnel a capital investment in textile traininginfrastructure is indicated. However, before any expenditures are actuallymade, a detailed study to develop a comprehensive training program isrequired.

2. The study should include a review and make appropriaterecommendations for follow-up on the following points:

(a) the feasibility of discontinuing the teaching of textiles antvocational schools for day students and utilizing the manpowerand infrastructure resources for the more popular eveningcourses;

(b) the possibility of sharing of the resources at the local levelbetween universities, vocational schools and the laboratories ofthe Textile Institute to maximize the use of the existingfacilities;

(c) the institution of a program of soliciting the industry and majorsuppliers of textile machinery to donate the required equipmentneeded so as to reduce the amount of funds required for capitalinvestment;

(d) review of the syllabi of the universities of UMG and UBC;possibility of reducing the existing program from 5 to 3 yearsand combining textile technology and textile production programsat UMG into one comprehensive curriculum and replacing advancedacademic science subjects by more practical busiaess managementcourses;

(e) feasibility of a program of interchange of teaching and industrypersonnel-for teachers to acquire some industrial experience andindustry people to get some exposure to the teaching and researchaspects; and

(f) determination of the cost of capital investment required afterrationalizing the programs and sharing of the trainingfacilities.

-58- ANNEX 7-3Page 2 of 2

It is estimated that the proposed study would require about 20 man-weeks ofconsulting time, would cost about $50,000 equivalent. It is expected thatthe study would be initiated by September 15, 1984 and its findings andrecommendations available by April 15, 1985 for review by the Governmentand Bank.

Industry DepartmentMarch 1984

-59- ANNEX 7-4

PORTUGLL - TEXTILE INDUSTRY RESTRUCTURING PROJECT

List of Equipment for Textile Training

Testing Equipment Urgently Required for Textile Institute's Laboratories

US$ (1984)Description Estimated Cost

Yarn Uniformity Tester 37,000Uster Automatic Dynamometer 20,000Fabric Permeability Tester 8,000Hoffman Steam Press 6,000Laboratory Bleaching/Scouring Machine 6,000Soxlet Extractors and other Glassware 5,000Spectogram and Infrared Equipment 16,000Autoclave and Drying Ovens 3,000Vibrodynamic Testing Equipment 27,000Miscellaneous 16,000

TOTAL 150,000

University of MinhoList of Urgently Required Testing Equipment

US$ (1984)Description Cost Estimates

Uster Yarn Uniformity Tester 60,000Digital Fibrograph 50,000Uster Automatic Dynamometer 20,000Light Fastner Testing 14,000Instron Stress-Strain Tester 40,000Laboratory Thermofixing Unit 26,000Laboratory Bleaching/Scouring Machine 12,000Hoffman Steam Press 6,000

TOTAL 228,000Contingencies 22,000

GRAND TOTAL 250,000

Industry DepartmentMarch 1984

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