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FILE COPY R.to. Public Disclosure Authorized

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INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMEN1 Public Disclosure Authorized

REPORT AND RECOMMENDATIONS

of the

PRESIDENT

Public Disclosure Authorized to the

EXECUTIVE DIRECTORS

on a

LOAN TO THE BANK OF

March 16, 1955 Public Disclosure Authorized REPORT ANM RECMIUNDTTONS OF THE ?RSID&iT TO

THE EXECUTTVE DIPECTORS 9N A LQAN TO THE

BANK OF FINLAND

1. I submit the following report and recommendations with regard to an application by Finland for a loan in various currencies equivalent to $12 million.

PART I - HISTORICAL

2. The Bank has already made four loans to Finland totalling $38.3 mil- lion. One loan was made to the Republic of Finland and three to the , vith the guarantee of the Republic of Finland. The loans have made a significant contribution to Finland's postwar recovery. It has been estimated that without the projects which they helped to finance, Finland's export capacity would have been about 10% less than it actually is.

3. The Finnish obligations now held by the Bank total !32.9 million: of the total amount originally lent, SO.2 million has been cancelled, and $5.2 million repaid (including a prepayment of $0.9 million due in 1956).

4. The proceeds of the loans have been relent to various companies: $25.8 million have been allocated for projects in the woodworking indus- tries; $11.3 million for electric power projects and $1.3 million for agricultural projects,

5. Various proposals for further loans have been made over the last two years, and in the spring of last year the Bank agreed to send a mis- sion to investigate loan possibilities.

6. The mission was in Finland from April 19 to May 19, 1954. After reviewing the Finnish economy and studying the leading industries, the mission concluded that the Bank would be justified in making a loan of between $10 and 015 million for the electric power and wooeworking indus- tries.

7. Finnish representatives were in hashington in September for tech- nical discussions about the projects which might be included in the loan and after further study of the projects final negotiations were opened in Washington in February 1955.

PART II - DESCRIPTION OF THE PROPOSED LOAN

Borrower

8. -The Borrower would be the Bank of Finland. -2-

Guarantor,

9. The Republic of Finland would guarantee fully the payment of principal, interest (including commission) and other charges on the loan, and all other obligations of the Borrower under the Loan Agreement. Purpose

10. The proceeds of the loan would be used to assist in financing im- ported equipment required in specific projects for the extension of the electric power system and for the expansion and modernization of the wood- working industries. Amount

11. The loan would be in the amount of $12 million, mainly in European currencies. According to present estimates, the proceeds of the loan would be disbursed as follows: For Purchases in: Equivalent

Denmark $ 60,000 120,000 5,320,000 1,700,000 1,650,000 50,000 2,650,000 Unallocated 450.000 $12,000,000 The Danish crowns, French francs, Swiss francs, sterling and U. S. dollars are available out of 18% releases and borrowed funds. Germany has re- leased D 20 million ($4.76 million) and the balance required will be pur- chased with borrowed Dutch guilders. A release of Swedish crowns has been requested.

Terms of the Loan

12. The loan would be repaid by twenty-five semi.-annual payments of which the first would be due on April 15, 1958 and the last on April 15, 1970. On and after April 15, 1958 the sum of interest and principal due each half year would be about $640,000 equivalent.

13. The loan would bear interest, including 1% commission, at the rate of 4-5/8% per annum. A commitment charge of 3/4% per annum has been pro- vided for.. - 3,-

PART III - APPRAISAL OF THE LOAN

The Finnish Economy

14. . A report entitled "The Economy of Finland" (E.A. 41-a). was circu- lated to the Executive Directors on October 12, 1954 (R.833). Annex I is a note on recent economic developments.

15. . Finland has largely-recovered from the war. Reparations and other payments to are at an end, the productive assets lost in the terri- tories transferred to Russia have been replaced and the Karelian refugees have been absorbed.

16. - The gross national product in real terms is about 40% above the prewar level, the increase in per capita product being about 25%. The output per worker in industry has risen by 32% and in by 15%. Owing to industrialization, the econor is now more diversified than be- fore the war, but it is still heavily dependent on foreign trade.

17. . The industrial sector is dominated by the woodworking industries and the metal working and engineering industries. The woodworking indus- tries had to replace the mills lost to Russia and have only recently re- gained their prewar level of output. They provide the most important source of foreign exchange earnings, accounting for more than three-fourths of total exports. The capacity of the metal working and engineering indus- tries had to be doubled to produce reparation goods required under the peace.treaty with Russia. Since the completion of reparations in 1952 these industries have been able to develop some commercial export trade with the Soviet bloc, but as a rule they are not able to compete in west- ern rarkets. The overwhelming part of Finland's total trade, however, is still with the West.

18. To maintain political and social peace, wages and farm incomes were steadily raised after the war at the same time as the country was being re- built. As a consequence there was a heavy . In 1951, when the wood products boom was at its height, wages and farm incomes were stabilized but at the same time linked to the cost-of living, resulting in an inflexible income structure high in relation to those of competing countries. Internal inflationary forces were still latent, however, and it was only with the help of declining import prices and some subsidies that a further major rise in the cost of living and a subsequent rise in Tages could be avoided. In the fall of 1954 labor and farm interests again pressed for an improvement in their real earnings. By introducing new subsidies and abolishing the sales tax on certain goods it was possible to bring the cost of living index back to slightly under the 1951 level. The price paid was a deterioration in the budget situation. ,

19. . While Finland has thus lately reversed the direction of her previous progress towards a freer economy, the authorities recognize that any in- creases in the living standard of the population must be kept within the -4- limits set by the ability of the export industries to compete on the world market. Actually, with the help of a strong demand for Finnish export goods, Finland's foreign trade (including reparations) has yielded a surplus throughout the postwar period, except in 1952. Al- though there may well be temporary setbacks, the long-run outlook for Finnish export trade appears to be good.

The Projects

20. The projects are described in detail in Annex II ("Appraisal of Power and Woodworking Industry Projects in Finland" - T.0. 73-a).

21. Of the total of P12 million, about one-third would be for the electric power projects and about two-thirds for the woodworking proj- ects. The funds to be made available by the loan would represent about one-fifth of the total cost of carrying .out the projects, and the Bank of Finland would obligate itself to make available all the remaining currencies needed, local and foreign, if they should not be otherwise available (Annex III).

22. The separate projects summarized below have been selected because of the substantial contribution they may be expected. to make to the de- velopment of the Finnish economy. They are all technically and finan- cially sound and of high priority. Orders for the main items of equip- ment have been placed on the basis of competitive international bidding.

23. The power projects consist of the Petajaskoski hydro plant with an allocation of $3,350,000 and the Vaasa thermal plant with an alloca- tion of $850,000, a total of 4,200,000. The Petajaskoski hydro plant will have a capacity of-100,000 kw and will- be located on the Kemi River in northern Finland. The Vaasa thermal plant will have a capacity of 30,000 kw and will be located in Vaasa in western Finland.

24. The hydro plant will be directly connected to the national power grid and will help to meet the estimated increase in demand for electric power by industrial and domestic consumers. The thermal plant will ini- tially be connected to a regional network and will provide a supply of power to industrial and domestic consumers in the Vaasa area. At a later stage the plant will be connected to the national power grid and provide an addition to the reserve of thermal generating capacity in Finland required in years of water shortage. -

25. The projects of the five woodworking companies to be included in the proposed loan are the following: Project Aprroximate Allocation Enso-Gutzeit Qy Expansion of sulphate pulp mill $ 1,480,000 Iymin 0y Modernization of pulp and paper mills 2,890,000 W. Rosenlew & Co. Expansion of sulphate pulp and kraft paper mills 2,540,000 A. Ahlstrom 0y Modernization of groundwood mill 170,000 Afnekoski Qy Auxiliary facilities (chemical and power) at .sulphite pulp mill 270,000 Unallocated 450.000

Z 7.800.000 41 //2

-5-

26. Of the five, two should result in significant increases of saleable products, while in the other three, the main effect should be cost re- duction, through more complete utilization of existing capacities, more complete recovery of chemicals hitherto wasted and fuel savings. The Finnish trade balance should benefit through increased exports and some small savings on imported fuel. The increased export capacity will be mainly in sulphate pulp (Enso-Gutzeit) and kraft paper (Rosenlew) and, to a minor extent, in newsprint (Kymin and Ahlstrom). The annual gross value of increased output, when the new capacity is in full operation, should exceed $20 million equivalent, of which the greater.part would represent increased exports. In three of the projects (Enso-Gutzeit, Rosenlew and Afnekoski) chemical recovery equipment will make possible direct fuel savings as well as the recovery of valuable chemicals.

27. The allocation of $7,800,000 for the woodworking industries in- cludes an amount of $450,000 which it is proposed would be used for addi- tional items for the expansion programs of the companies mentioned above, as agreed between the Borrower and the Bank, or for contingencies and the like.

Prospects of Repayment

28. Finland has an excellent debt record. Her foreign debt is compara- tively small, less than 10% of the gross national product. On December 31, 1954 it was equivalent to $276 million, a decrease of $60 million since the end of 1949. Of this debt, 55% was.due to the dollar area, 41% to Sweden and the remaining 4% to other countries. 29. Total payments will remain fairly stable at slightly more than $20 million up to 1960 before they start declining. This amount represents only some 3% of exports. The dollar component of the service payments, however, constitutes more than half of the total and will remain above $10 million for the coming decade. As Finnish dollar earnings are fairly limited, the dollar service payments represent as much as one-fifth to one-fourth of total dollar area exports. 30. Finland's natural resources provide a sound basis for further development. On the other hand, Finland's ability to save is limited and she needs foreign capital to help develop her productive capacities, especially those utilizing her hydroelectric power and forest resources. The dependence of her foreign exchange earnings on the export of wood products has in the past created temporary difficulties for her external payments and could do so again. There is still the unsolved problem of internal social and economic strains and stresses. But such factors have not hitherto interfered with the servicing of Finland's foreign debt and there are good reasons to think that they will not prevent Finland from maintaining her good record as a debtor. Companies in the woodworking industries, while faced with the threat of rising costs, are generally -6- efficient and their products are firmly established in export markets.. Their current expansion plans are well within the limits set by Finland's forest resources. The long-term market prospects for pulp and paper products are favorable.,

31., Finland is therefore justified in incurring additional external debt and a loan equivalent to the suggested $12 million should be well within the limits of Finland's creditworthiness. Finland is earning a large surplus in pounds sterling and can currently convert this surplus into other European currencies. Her dollar position is steadily improv- ing, but her current dollar earnings are still small as compared with the service payments on the existing debt, and it is therefore sound to keep any new-dollar borrowing within moderate limits.

32.- In making previous loans to Finland the Bank considered and accepted whatever risks might be inherent in lending to a country in her gebgraphi- cal position. I am satisfied that in accepting similar risks in making the present loan the Bank will be acting prudently in the interests of Finland and of the Bank's members as a whole.

PART IV - LEGAL INSTRUMS and the 33. Drafts of the Loan Agreement between the Bank of Finland Bank, and the Guarantee Agreement between the Republic of Finland and the Bank are attached as Annexes IV and V.. The draft Loan Agreement incor- por4tes Loan Regulations No.. 4 dAted October 15, 1952 and is similar-to the previous agreements with the Bank of Finland. Copies of the draft let- ters concerning the agreements between the companies which are to carry out the projects and the Bank of Finland are attached as Annex VI. PART V .. COMPLIANCE WITH ARTICLES OF AGREEMENT

34. Annex VII attached hereto contains the Report of the Committee provided for in Article* III, Section 4 (III) of the Articles of Agreement of the Bank. Articles 35. I am satisfied that the proposed loan complies with the of Agreement of the Bank.

PART VI - RECOMMENDATIONS of 36. I recommend that the Bank at this time make a loan in the amount $12 million in various currencies, for a total term of 15 years, with in- terest, including commission,at 4-5/8% per annum, and on such other terms as are specified in the form of Loan Agreement and Guarantee Agreement attached hereto.

Eugene R. Black President

Washington, D. C. March 16, 1955 RESTRICTED

ANNEX I

FINIAND - RECENT ECONOVIC DEVELOPMINTS

External Situation

1. The brisk demand for Finland's main export goods, products of the woodworking industry, continued throughout 1954, although the price advances were relatively small. Mainly due to larger volume, the value of total ex- ports increased by almost one-fifth in 1954, compared to 1953, but it was still smaller than in 1951, the postwar peak. The value of total imports increased by one-fourth in 1954 compared to 1953; the increase in volume was slightly larger since the terms of trade moved favorably. Raw material imports were high, replenishing inventories which had been depleted in 1953.

2. Total 1954 current transactions are estimated to yield a surplus of some FMk. 8.5 billion ($35 million). New borrowing was approximately equal to amortization. Accordingly, the net foreign exchange reserve increased by the amount of the current surplus to some FHk. 36 billion ($155 million), sufficient to cover about three months' imports. The composition of the re- serve is now much more favorable than a year ago, since the holdings of gold and dollars, as well as of EPU currencies, are somewhat larger than those of Eastern currencies.

3. The.export outlook for 1955 is good. It is unlikely, however, that Finland will be able to continue enlarging her foreign exchange reserves, as internal conditions are likely to result in a higher demand for imports.

4. The improvement in the export industries in 1954 does not mean that the so-called cost crisis which developed in 1953 has been solved. It is, true that somewhat higher prices and greater volume of sales of wood brod- ucts have been reflected in substantially higher earnings in the woodwork- ing industries and companies which have modernized their mills or which draw a substantial part of their timber needs from their own forests are in a relatively good position, but many other companies are still finding dif- ficulty in operating profitably in face of rising costs.

5. For years the demand for imports has been held in check by licensing, which has in effect protected home market industries unable to compete on the basis of world prices. The government is investigating the possibility of liberalizing quantitative restrictions on imports. Even with a substan- tial increase in import duties, however (an increase of 50%o has recently been made) further measures will be required before quantitative restric- tions can be removed to a significant extent.

6. The W10.million credit granted by the USSR last year and originally regarded purely as a stand-by is expected to be drawn on in the near future. Another credit of the same amount has been promised by the Russians. One- half of the credits will be kept as part of the foreign exchange reserve of the Bank of Finland, and the other half will be used for imports of capital - 2 - equipment. These-credits are in addition to Finland's regular trade surplus with the USSR, which is partly settled in gold and Western currencies to enable Finland to import raw materials from the est needed for her Russian exports.

Internal Situation

7. Production, particularly.in the export industries, developed very 'favorably during 1954, and at present there is hardly any unused capacity in the,economy except some minor seasonal . In 1954 the-real gross national product is believed to have risen by some 6% compared.with 1953, in spite of the fact.that the harvest showed a total decline of almost 5%. Con- sumption probably increased by less than investment, which was supported by strong building activity and replenishment of inventories. The prospects for the 1955 national product appear to be good, but the increase will probably not exceed 3%.

8. The main threat to Finland's internal economic stability emanates from the demand for higher real incomes by the .different pressure groups. Since the 1951 stabilization agreement was adopted, wages.and farm income have been linked to the cost-of-living index. In the fall of 1954 this index threatened to exceed, mainly for technical reasons and not because of genuine price rises, the crucial point of 105 (1951 = 100) at which wages and farm income would have to be adjusted. In line with the recomendations of the Economic Council, a body representing the different economic interests set up in September 1954, the Prime Minister, a Swedish Party member, tried to get the coalition parlies in his government, the Social Democrats and the Agrarians, to adopt a program which would lower the cost-of-living index to well under 105. The Prime Minister, however, failed,not least because of the much greater demands mada by the 'Central Labor Organization, which threatened to call a general strike if its demands were not met.

9. A new coalition government between the Social Democrats and the Agrari- ans, with the Agrarian leader, Mr. Kekkonen, as Prime Minister, was formed on October 20, 1954. This government launched a more far-reaching program under which the cost-of-living index was brought down to 98. Agricultural subsidies were increased, foodstuffs prices decreased and,the sales tax was completely abolished on textiles and reduced on building materials used in residential building. Furthermore, the salaries of civil servants were increased. In spite of the decrease in living costs industrial labor is now pressing for higher wages, and forest labor has already obtained substantial increases.

10. The total cost of the government.program for 1955 is estimated at FMk. 36 billion, which will be an additional strain on the government budget. The 1954 budget showed a cash surplus of some FMk. 9 billion on total expendi- tures of some FM1. 200 billion. Most of the surplus, however, was due to the liquidation of excess inventories held by the State Granary and the State Rail- ways. A preliminary estimate for 1955 shows a cash deficit of FNk. 16 billion. Some of the additional expenditure due.to the government program will be covered by increases in .corporation taxes (corporate income tax rates have been -3 -

increased from 32% to 38%) and import duties, reduction in unemployment expendi- ture and abolition of refunds to the woodworking industries of the special ex- port levies made in 1951. 11. The Bank of Finland has tried to pursue a conservative monetary policy to check the demand for credit caused by the export boom. The need for such a policy will clearly increase when the effects of the budget deficit start exerting their influence. With the improved bank liquidity resulting from the influx of foreign exchange, however, the Bank of Finland has lost more and more of its power to influence the lending policy of the commercial banks. The latter in 1954 increased their lending by FMk. 23 billion (20%) compared with FMk. 4 billion in 1953. The Bank of Finland, however, has recently made an agreement with the commercial banks and the savings banks for the introduction of reserve requirements to control the volume of bank credit. Furthermore, the Bank of Finland has contracted its own commercial lending and increased the spread between minimum and maximum interest rates with the result that .the average level of.interest rates applied by the Bank of Finland has risen. On the other hand, the government program includes a recommendation of lower in- terest rates, but this decrease has not yet been brought about. Conclusions

12. The long-term market outlook for wood Droducts is good. The danger is that the new demands for higher incomes by pressure groups might jeopardize internal monetary stability and that rising costs might price Finnish wood products out of the market. In the past the have met and dealt with such situations and they can be relied upon to make whatever adjustments are necessary to enable the export industries to market their products. The report on the Economy of Finland dated October 12, 1954 (E.A. 41-a) indicated that a loan of $12 million would be well within Finland's creditworthiness limits and there seems to be no reason to change that view.

March 16, 1955