RESTRICTED FILE COpy Report No. P 86 Public Disclosure Authorized

This document was prepared for internal use in the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Public Disclosure Authorized

REPORT AND RECOMMENDATIONS OF THE PRESIDENT

TO THE

EXECUTIVE DIRECTORS

Public Disclosure Authorized ON A LOAN TO THE VORARLBERGER ILLWERKE AKTIENGESELLSCHAFT

June 6, 1955 Public Disclosure Authorized REPORT AND RECO!TENDATIONS O' THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A LOAN TO THE VORRLBERGER ILT.RIT ATIESETLLSCHAFT

1. I submit the following report and recommendations on the application of the Vorarlberger Illwerke A.G. for a loan of $10 million equivalent in various currencies.

PART I - HISTORICAL

2. On September 9, 1954 the Austrian Government submitted an application to the Bank for a loan for the Lnersee hydro-electric power project in the Vorarlberg, a province of Western Austria. A Bank mission visited Austria in October and November 1954 to study the position of the applicant company, the Vorarlberger Illwerke A.G. (the VIW) and the LUnersee project.

3. After consideration of this mission's report the Bank agreed to enter negotiations for a loan. A delegation consisting of representa- tives of the borrower and of the Austrian Government arrived in Washing- ton on iarch 9, 1955 and agreement has been reached in the form in which I now present the draft Loan and Guarantee Agreements. The Austrian Ambassador in ashington would sign both the Loan and the Guarantee Agreements. P.ART II - DESCRI?TIO OF THE LOAN

The Borrower

4. The borrower would be the Vorarlberger 111werke A.G., an Austrian power company. The present status of this company is described in Part V.

The Guarantor

5. The loan would be guaranteed by the Republic of Austria.

Purpose of the Loan

6. The purpose of the loan would be to assist in the financing of the Lnersee hydro-electric power project.

Amount

7, The loan would be for the equivalent of $10 million in various currencies. Approximately .7,2 million would be used to pay for imported equipment while the remaining $2.8 mi2lion would be used to purchase equipment produced in Austria. The justification for this is given in Part IV,

Terms

8. The loan would be for 25 years and be amortized by semi-annual instalments beginning May 1, 1960, which are calculated to retire the - 2 -

entire loan by maturity by May 1, 1980, as set out in Schedule 1 of the proposed Loan Agreement.

9. The loan would bear interest, including l commission, at the rate of h 3/ 4 % per annum. The dates for the payment of interest and other charges would be May 1 and November 1 of each year.

10. There would be a commitment charge of 3/4% per annua. Security

11. The loan would be secured by a first mortgage on the Lunersee properties and by an assignment of part of the borrower's rights to and. claims for payments under a contract (known as the Illwerke Agree- ment, 1952) for the export of power to two power companies in Germany. Sufficient of these rights and claims would be assigned as would be required to meet the semi-annual payments of interest and principal on the loan. The German power companies are the Rheinisch-estf9lisches Elektrizit*tswerk A.G. (RWE) and the Energie-Versorgung A.G. (EVS).

PART III - DESCRIPTIUN OF TH1E PROJECT

12. The project is located in Vorarlberg, which is the westernmost province of Austria (French zone). The present power installations of the VIW on the Ill river in Vorarlberg, which now total 356,000 kw, have as their principal function to provide peak power to Germany. The Ll-nersee project will be particularly valuable for this purpose for, by means of pumped storage, it will be able to convert off-peak thermal power into peak winter power,

13. The project, which will have an effective capacity of 190,000 kT when completed, will utilize an alpine lake, LU.nersee, as a reservoir. The storage capacity of the lake will be increased by the construction of a small dam across the lower end. As the natural run off from the catchment area of the lake will not be sufficient to fill its increased capacity, run off from a glacier will be diverted to the lake and water will be pumped to the lake through the same tunnels, syphons and penstocks used to convey water to the new Lilnersee power plant to generate energy, The pumps will be driven by the generators in the LUnersee power plant acting as motors, Off-peak thermal power imported from Germany will be used to operate the pumps. As the cost of off-peak energy is one-third of the price at which winter energy can be sold, the pumping operation is profitable.

14. The project includes the construction of a 220 kw double circuit transmission line 10.2 km long from the Lhersee power house to a sub- station at Bilrs from which the energy produced by the VIW is distributed to its principal consumers, and a double circuit line 61.6 km long from B'qrs to the German border. The latter will be designed as a 380 kv line, but will be operated initially at 220 kv.. - 3-

Justification of the Project

15. The project will benefit both Austria and Gerrmiany. The Austrian benefits will include additional power output with which to satisfy the demands in Vorarlberg and Tirol, and additional foreign exchange pay- ments from Germany equivalent to about $1,5 million annually on the average. This will be about twice the annual service on the proposed 10 million Bank loan.

16. The benefits to the German power companies -:ill include: the availability of at least 127,000 kw of additional powr for use at periods of peak demand at a cost of about 017 per kilowatt-year (a very cheap cost) and the sale of some of their off peak energy to the project for pumping. Since the alternative for the German comDanies would be a large capital investment in a thermal power plant plus annual costs con- siderably in excess of the cost for Lnersee power, the availability of the peak power from the LMnersee project is very advantageous,

PART IV - APPRAISAL OF TI LOAN

17. A technical report entitled "Appraisal of the Lnersee Project in Austria" (T.0, 756) is attached (No. 1).

Austria's Political Situation

18. Austria's situation in the international field has fundamentally changed since my last report to the Executive Directors of July 6, 1954 concerning the first loan to-Austria. At that time the country was still without a State Treaty and thus still without its long-promised independence and full sovereignty. This is no longer so, A State Treaty was signed between Austria and the occupation powers on May 15 last which still requires ratification. Once ratified, the treaty will put an end to Austria's occupation and restore Austria's full political and economic freedom, although the Trear carries with it some very burdensome reparation payments by Austria to the Soviet Union over the next six years. But the element of uncertainty which accompanied previous operations with Austria on account of the unpredictable attitude of the Soviet occupation forces is now brought to an end by a situation where Austria can firmly and finally speak in its own right.,

19. This happy development in Austria's international relations will, of course, also entail certain internal political changes as normally happen in the wake of regained freedom. With the abolition of Austria's foreign occupation, the main factor which so far prompted the political parties to form a coalition government is likely to be obscured and to make way for more pronounced party struggles. Once the Soviet troops have left the country, the breaking up of the coalition is bound to lead to a resumption of a two-party (or more) system, which is, after all, the essence of a free system. 20, The economic effects of the State Treaty are discussed in the attached memorandum "The Present Economic Position of Austria" (No. 2).

The Dorrower and the Illwerke Agreement of 1952

21. The Vorarlberger Illwerke A.G. was first established in 1924 in order to develop the hydro-electric power resources of the Ill River and Linersee. The ownership of the company has always been largely German and at the end of World War II 90% of the shares were in the hands of the German power consumers. These shares thus became a "German asset" within the meaning of the Potsdam Agreement of 1945 and, as such, the right to dispose of them was vested in the Allied Powers. The United Kingdom, the U.S.A. and France made use of this right in Art. 22 of the Austrian State Treaty -- and the Soviet Union followed the same course in a separate declaration, contained in Annex IIto the Treaty -- by relinquishing to Austria "all property, rights and interests held or claimed by or on behalf of any of them in Austria as former German assets or war booty". The ownership of the German-held shares in the VIW, which since 1945 had been operated under the supervision of the Austrian Ministry for Transport and Nationalized Industries, will therefore in the near future be transferred to the Austrian Government, which will most likely nationalize the company and make it part of the Austrian State power network. The Government had in fact already earmarked the VIW for nationalization in the Nationalization Law of 1947; nationalization has now become even more likely owing to the provisions in para, 13 of Article 22 that "none of the properties, rights and interests transferred to it (Austria) as former German assets shall be returned to ownership of German juridical persons or, where the value of the property, rights and interests exceed 260,000 schillings, to the ownership of German natural persons".. 22. It was because of the uncertainty about the future status and the economic basis of the company prior to the State Treaty that a compre- hensive agreement was concluded between the company and its principal consumers in 1952. The purpose of this agreement -- the Illwerke Agreement -- was to provide a firm basis for the operation and future expansion of the VIN. It contains provisions governing the allocation of the company's output between its various consumers in Germany and in Austria; it covers the basis upon which the company's costs shall be reimbursed by its consumers and it provides that the two German power consumers RE and EVS and the province of Vorarlberg, shall make certain financial contri- butions (in the form of loans) to meet the cost of construction of certain agreed future projects, of which L Inersee is one. The contract is to remain in force for a period of 80 years and is unaffected by the disposition of the former German shares of the VIW by the State Treaty., 23. The VIW raised a £2 million sterling loan in 1929. This loan has been in default since February 1940, owing first to German restric- tions from 1940 to 1945, and from 1945 onwards to Austrian exchange regu- lations. The default is unquestionably the result of circumstances beyond the VIWs control; the company's ability and its willingness to pay in local currency have never been in doubt The VIW now intends to refund the entire outstanding £-loan in the near future and it has already raised the necessary funds last March by a successful internal bond issue of 100 million schillings. The Austrian Government has given its consent to a conversion of these funds into £-sterling.

24. In m opinion the VIW is an acceptable borrower. It has taken steps to settle its defaulted obligations as soon, as it was possible to do so and it is provided, by the Illwerke Agreement, with a firm long-term basis for its operations.

Financing of the Liinersee Project

25. The total cost of the Linersee project is estimated to be 1,003 million schillings ($38.6 million). The company can provide 323 million schillings from its own resources and 223 million schillings will be available in the form of building contributions fro;i the German power consumers and from the Province of Vorarlberg. It is proposed that the remaining requiremEats -- 457 million schillings -- be covered by a loan of up to 200 million schillings from the Austrian L4nderbank, and by a loan of $10 million equivalent (260 million schillings) from the Bank.

26. Of the total cost of the project, equivalent to $38.6 million the equivalent of $7.2 million will be required for imports. After inter-. national bidding orders have been placed in Germany and in Switzerland for the greater part of the imports; however, a number of smaller orders have yet to be placed. The German Government has agreed to the use of up to DM 25 million ($5.9 million) from Germany's 18% subscription in order to meet the cost of equipment to be purchased in Germany.

27. The remainder of the loan, about $2.8 million, will be used to cover local expenditure. To ensure that this portion of the loan is of maximnu benefit to Austria it will be disbursed in a currency or currencies which are in no way tied to goods or services from the countries whose currencies are offered.

28. In Austria, a country where manufacturing industry is comparatively highly developed, the need for external capital considerably exceeds the need for additional imported capital equipment. In these circumstances, the Bank can meet the capital needs of its borrowers only by making part of its loans available to cover expenditures in local currency. Thus, in this as in the earlier Bank loan to Austria some of the proceeds are required to meet expenditure within the country.

Prospects for Repayment of the Loan

29. In view of the short time -- less than a year -- which has elapsed since the report on "The Econor of Austria" (E.A. 37a) was circulated, no complete economic report is being submitted at this time but the memorandum entitled "The Present Economic Position of Austria" (No. 2) discusses the principal developments since the previous report. -6-

This memorandum concludes that, although the economic benefits to Austria of a State Treaty will be great in the long run, there will be a consider- able burden to be carried during the next six years. There is no reason to believe, however, that it will prove unmanageable. It may safely be assumed that Austria's ability to service its external debt, including the loan here proposed, will certainly not be impaired.

30. The only interruption of payments on Austria's external debt, apart from the war period, occurred in 1932 when the transfer of debt payments was suspended for a year. This was brought about by the foreign exchange crisis which followed the failure of the Creditanstalt. But considering the extreme difficulty of this period, Austria's prompt resumption of transfer and the successful negotiation of a debt agreement after World War II, the Austrian debt record can be regarded as satisfactory.

31. Austria's present external debt, including the Bank loan of $12 million equivalent for the Reisseek-Kreuzeck project, is unusually low at approximately $103 million equivalent, less than one-third of the pre-war debt. Taking into account the fall in the value of money and the rise in Austria's national income, the reduction in the real burden of external debt has of course been much greater, Debt service payments amount to only 2% to 3% of annual foreign exchange earnings in the peak years, so that the external debt could be greatly increased before it became a significant factor in the total balance of payments.

32. The Ltnersee project will earn foreign exchange directly by the export of power to Germany and the Loan Agreement provides for an assignment of revenues received by the borrower from the German power consumers as security for the loan.

PART V - LEGAL INSTRUI-ENTS AND AUTHORITY

33. A draft Loan Agreement is attached (No. 3). A draft Guarantee Agree- ment is attached (No. 4).

34. The draft Loan Agreement is similar to the Loan Agreement for the previous Austrian loan (Reisseck-Kreuzeck Project, Loan No. 102 AUA), but it differs both from that Loan Agreement and from the standard form in a number of respects. The principal differences are to be found in the pro- visions dealing with the security for the loan and the bonds. The follow- ing provisions deserve to be mentioned:

(a) The Loan Agreement contemplates that in the event of partici- pations or sales out of the Bank's portfolio, bonds, as dis- tinguished from interim certificates, 1l be issued only after the appointment of a trustee who can represent all creditors under the Bank loan with respect to the security. The relevant sections are Sections 4.02, 5.09s 5*10, 5.11 and 5.12.

(b) In Section 5.03(a) the Borrower covenants to perform its ob- ligations under the Illwerke Agreement 1952 and not to agree to any modification or change of that agreement which would impair its ability to service the loan or to finance the project. (c) Section 5.03(b) provides for the assignment of such portion of the Borrower's rights to payment under the Illwerke Agreement of 1952 as are needed for the Borrower's half-yearly service payments under the Loan Agreement. The Bank agreed to this form of assignment because it had been used in the previous public loans of the Borrower.

(d) Section 5.04 provides for a mortgage on the LUnersee properties.

(e) Section 5.06 (a) contains a negative pledge clause precluding the creation of liens on the LUnersee properties ranking in priority to or equality with the Bank's mortgage. It is contemplated that the Bank will agree to the creation of a mortgage ranking equally with its own to secure the loan of up to 200 million schillings from the L9nderbank referred to in paragraph 25 above (No. 5).

(f) Default under the assignment or the mortgage is added to the events permitting the Bank to suspend withdrawals or to premature the loan.

(g) Section 7.01 contains conditions as to the effectiveness of the Loan Agreement. These include an assignment satisfactorily and validly made, the approval of the assignment by the two German electricity companies, RIE and EVS, and the execution of the mortgage.

(h) Paragraph (a) of Schedule 3 amends Section 3.01 of the Loan Regulations so as to permit disbursements on account of local expenditures for the project.

35. The draft Guarantee Agreement is identical with the Guarantee Agree- ment for the Reisseck-Kreuzeck loan. It is contemplated that, as in that loan, the Bank will agree under the negative pledge clause to except assets of those nationalized enterprises which are organized and managed along the lines of private corporations (No. 6).

PART VI - COMPLIANCE nITH ARTICLES OF AGEEMENT

36. The report of the Committee rrovided for in Article III, Section h(iii) of the Articles of Agreement of the Bank is attached (No. 7).

37. I am satisfied that the proposed loan complies with the Articles of Agreement of the Bank.

PART VII - RECOMMENDATIONS

38. I recommend that the Bank make a loan to the Vorarlberger Illwerke AG in the amount of $10 million, or the equivalent in other currencies, to be guaranteed by the Republic of Austria, for a total term of twenty-five years with interest (including commission) at 4 3/4% per annum, and on such other terms -8-

as are specified in the form of the Loan and Guarantee Agreements attached hereto and that the Executive Directors adopt a resolution to that effect in the form attached (No. 8).

Eugene R. Black

Washington D. C,