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FILE COPY Report No. P-406

Public Disclosure Authorized This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Public Disclosure Authorized

REPORT AND RECOMMENDATIONS

OF THE

PRESIDENT

TO THE

EXECUTIVE DIRECTORS Public Disclosure Authorized ON A

PROPOSED LOAN

TO THE

YUGOSLAV INVESTMENT BANK

November 30, 1964 Public Disclosure Authorized REPORT ATD RECOIf!NDATIONS OF THE PRESIDENT TO THE EXi)CUTIVE DIRECTORS ON A PROPOSED LOAN TO THE YUGOSLAV INVESTi=T BANK

1. I submit the following report and the recommendations on a proposed loan in an amount in various currencies equivalent to US$ 70 million to the Yugoslav Investment Bank.

PART I - INTRODUCTION

2. In June of 1962 the Yugoslav Government requested the Bank to consider lending for road construction and railway improvement. The Bank agreed to examine projects in these sectors and made a loan of $ 35 million for a highway project in June 1963 and a loan of $ 35 million for Sarajevo-Ploce railway project in October 1963. In September of 1963 the Yugoslav authorities requested the Bank to consider a further loan for the railtrays and a mission visited in June this year to appraise the pronosed project. Loan negotiations were completed in Washington in October.

3. The proposed loan would increase Bank lending to Yugoslavia to $ 250 million. The status of previous loans as at October 1964 was as follows:

Amount Year No. Borrower Purpose (equivalent in $ million)

1949 20 YU Federal People's Republic Equipment for 2.7 of Yugoslavia timber production

1951 51 YU Federal People's Republic (Electric power, 28.0 of Yugoslavia (mining, transport, (industry, agricul- 1953 73 YU Federal People's Republic (ture and forestry 30.0 of Yugoslavia

1961 277 YU Yugoslav Investment Bank Electric power 30.0

1962 318 YU Yugoslav Investment Bank Electric power 30.0

1963 344 YU Yugoslav Investment Bank Highways 35.0

1964 361 YU Yugoslav Investment Bank Railways 35.o Total (including $ 62 million not yet disbursed): 190.7 of which has been repaid: 20.2 Total now outstanding: 170.5 Amount sold: 1.7 Net amount now held by Bank: 168.8 -2-

PART II - DESCRIPTION OF PROPOSED LOAN

4. The main characteristics of the proposed loan would be as follows:

Borrower: Yugoslav Investment Bank

Guarantor: Socialist Federal Republic of Yugoslavia

Amount: The equivalent in various currencies of $ 70 million.

Purpose: To assist in financing the improvement and modernization of main lines.

Amortization: In 41 semi-annual installments, beginning March 1, 1970 and ending March 1, 1990. Each payment of principal and interest taken together would be approximately equal.

Interest Rate: 5 %

Commitment Charge: 3/8 of 1%.

PART III - THE PROJECT

The Yugoslav Railway System

5. An appraisal report on the project is attached (No.1).

6. The provide the backbone of the country's trans- portation system. The main lines of communication run northwest to south- east along the Save-Danube valley serving the principal agricultural and industrial areas of the country. In the west and north the railway system has been developed almost to western European standards, but in the south development did not really begin until the establishment of the Yugoslav state in 1919. The mountains across the center of the country block access to the coast except at a few points and are a serious handicap to transport.

7. Since 1946 railway construction has been accelerated mainly to serve the growring industrial and mining areas. By the end of 1963, the Yugoslav railways operated some 9,000 route-km of standard gauge line and 2,600 Im of narrow gauge line. In 1963, more than 7WG of all freight traffic was carried by rail. New investment in the railways is required not only to meet growing traffic needs on existing routes but also to open up the less developed areas in the east and south. -3-

8. The organization of the railways is based on the Yugoslav concept of "worker's self-management", and is extremely decentralized. There are 22 railway transport enterprises responsible for the operation of the system. There are also 39 auxiliary enterprises which are respon- sible for such matters as the maintenance and repair of track, the repair of rolling stock and the design and supervision of new construc- tion. The "Community of Yugoslav Railways", in which all the enter- prises are represented, is responsible for the supervision and co- ordination of railway matters for the whole country as well as for general questions such as rates and tariffs, technical standards and overall planning. The formulation of transport policy and the coordina- tion of transport matters is the responsibility of the Federal Secretariat for Transport and Communica-tions. Although these arrangements appear complex the numerous enterprises cooperate well with one another and the railways are efficiently operated.

9. The financial organization of the various enterprises differs considerably from that customary in other countries. The total receipts of the system are assigned to the several enterprises in accordance w¢ith a formula designed to give all the enterprises an equal opportunity to obtain financial rewards from efficient operation. A consolidation of the accounts of all the railway enterprises shows that for the system as a whole operating revenues in 1963 were $ 300 million equivalent and operating expenses $ 264 million.

10. The railways have prepared a Seven-Year Investment Plan, 196h-70, which is part of the General Social Plan of Yugoslavia. The railways' plan provides for capital investments of almost $ 1 billion equivalent over the seven-year period. The main items in the plan are: 1) the electrification and installation of modern signalling equipment on three main lines, 2) the construction of four new marshalling yards and modernization of one existing marshalling yard, 3) renewal of the permanent way, bridges and structures of the entire system, 4) purchase of locomotives and rolling stock, and 5) remodelling of stations and freight yards, and the conversion of narrow gauge to standard gauge lines. The first two items of the Seven-Year Investment Plan form the project which the Bank has been asked to help finance. The railways intend to finance the purchase of locomotives and other rolling stock as far as possible from suppliers' credits, and the improvement of line and station capacities from loans from interested cities and republics. The remain- ing parts of the plan will be financed from the railways' own funds. The Reconstruction and Modernization Program of Main Lines

11. The three lines included in the project are the most important lines for both domestic and international freight traffic in Yugoslavia. They are: (i) Jesenice (the frontier station to Austria) - - Zagreb--Nis-skopje-Titov Veles (towards Greece); (ii) Rijeka- Zagreb; and (iii) Vrpolje-Sarajevo. These three lines connect the six largest cities - Belgrade, Zagreb, Sarajevo, Skopje, Ljubljana and Rijeka. The area which they serve encompasses about two-thirds of the nation's economy and about one-half of its population. One- third of Yugoslavia's industrial enterprises producing about 60% of its industrial output are situated close to them. In 1963, the three lines accounted for one-half of the railway's total freight traffic. It has been estimated that freight traffic will increase at between 5% and 6% annually over the next seven years. The project will approximately double the capacity of the lines and make it possible to carry the traffic faster and with greater safety.

12. The project consists of: 1) the installation of electric traction on the above main lines; 2) the installation of modern signalling and telecommunication systems over the lines and of automatic block systems on those sections with the heaviest traffic loads; 3) the construction of four new marshalling yards at Belgrade, Zagreb, Ljubljana and Skopje, and the extension and modernization of the existing yards at Nis and Doboj. The project is well-conceived and includes only items of the highest priority.

13. The installations are essential if the railways are to carry the increased traffic forecast for 1970 and beyond. Work has started already on the marshalling yards and on the electrification between Jesenice and Ljubljana; the other works are expected to begin soon. Completion of the project is scheduled for the end of 1968. The total estimated cost of the project is $ 185 million equivalent and the economic benefits in the form of savings of time and reductions in cost are expected to provide a return of 14 percent on the investment. The proposed loan of $ 70 million would provide about 38% of the total investment. It is not possible at the present time to determine precisely what the foreign exchange component would be since many orders and contracts have not been placed. However, the total amount of procurement which will be subject to international competition is $ 75 million; this includes a minimum of $ 33 million of equipment and materials which are not produced in Yugoslavia and which must therefore be imported.

Execution of the Project

14. The project will be constructed by the communities of railway enterprises at Belgrade, Zagreb, Rijeka, and Sarajevo and the railway transport enterprise at Skopje. The organization and staff of the -5-

railway enterprises are competent both administratively and technically. All the equipment for electrification, signalling and telecommunications and some specialized equipment for the marshalling yards will be purchas- ed after international competitive bidding. Almost all the installation of the equipment and one contract for earthworks at the Belgrade marshal- ling yard will also be given to international tender. The remainder of the work would not be suitable for a foreign contractor because of the small size of the contracts or, in some cases, because of the need to avoid interfering with the operation of trains. Equipment made in Yugoslavia will be used if its cost does not exceed that of foreign equipment including customs duties. It is likely that the equipment will be provided by a foreign manufacturer and a domestic manufacturer working in cooperation. In this way equipment designed by the foreign firm can be produced with a maximum of domestic components which mini- mizes the customs duty payable. The present duties, which are still provisional in character, range generally from 25 to 40 percent. They were imposed in 1961 when Yugoslavia adopted a unitary exchange rate and were intended to provide partial compensation for the elimination of a system of multiple rates. Realistic comparisons betwieen Yugoslav costs and foreign costs are difficult to make because of the distortions in the price system created by the multiple rates. Yugoslavia has provision- ally acceded to GATT and plans to apply for full membership which will require negotiation with other contracting parties under which substan- tial reductions in the tariff may be made.

15. The proposed loan would be made to the Yugoslav Investment Bank which is the main channel used by the Federal Government for foreign development loans. The proceeds of the loan would be relent by the Yugoslav Investment Bank to the railways on the same terms as those of the Bank loan.

PART IV - LB;xAL INSTRUI4ENTS AND AUTHORITY

16. The draft Loan Agreement between the Bank and the Yugoslav Investment Bank and the draft Guarantee Agreement between the Socialist Federal Republic of Yugoslavia and the Bank are being distributed to the Executive Directors separately. The draft Loan and Guarantee Agreements are substantially similar to those of the previous loan to the Yugoslav Investment Bank for the Sarajevo-Ploce project.

17. Sections 4.01 to 4.03 of the Loan Agreement prescribe the provisions of the agreements to be entered into between the Yugoslav Investment Bank and the beneficiary enterprises responsible for carrying out the Project. The conclusion of these agreements in a form satisfactory to the Bank is an additional condition of effectiveness of the Loan Agreement (Sections 8.01 and 8.02). -6-

PART V - ECONOMIC SITUATION

18. A memorandum on the economic situation of Yugoslavia is attached (No. 2). The memorandum describes how, after a period of readjustment in the two preceding years, the growth of the Yugoslav economy accelerated in 1963 wihen the gross material product increased by l2V. Investment in 1963 exceeded 30% of the gross material product. Although exports continued their rapid rise, increasing by nearly 5% to $ 790 million, and net invisible earnings almost doubled to reach $ 137 million, there was a 19~% rise in imports so that the balance of payments deficit at $ 86 million was substantially greater than in 1962. However, this was more than covered by the inflow of foreign capital.

19. The formulation of a development plan for 1964-70 is now well- advanced. The plan places less emphasis on the growth of investment and more on raising living standards and on achieving a closer integration of the Yugoslav with the world economy. High priority is given to the expansion of exports which are expected to grow by about l%J annually, and to the further growth of invisible earnings, especially from tourism.

20. Although the service on Yugoslavia's external public debt is expected to absorb about 18.5 percent of foreign exchange earnings in 1964 the total external debt of $ 1.1 billion is not excessively high. Service payments are heavy because much of the debt is short-term; over the period 196h-70 some $ 820 million have to be repaid. Yugoslavia will need subs- tantial capital imports if the growth of the economy is to be maintained, but as long as she can continue to borrow, the new credits serve in effect to roll over the existing ones. Difficulties would arise if the volume of external credits Yugoslavia could obtain were to be sharply cut. lWhile this seems unlikely, the Government has in the past shown itself able to take strong measures when necessary to meet its external payment obligations. Moreover, the recent agreement to extend for four years the settlement of pre-war Yugoslav dollar bonds is an indication of the Government's willingness to meet its obligations. In these circumstances and in view of the projected fast growth in foreign exchange earnings, I consider Yugoslavia creditworthy for the proposed loan from the Bank.

PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT

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