Line of Credit to the National Bank of Egypt (NBE) Project

AFRICAN DEVELOPMENT BANK

ARAB REPUBLIC OF EGYPT

LINE OF CREDIT TO THE NATIONAL BANK OF EGYPT (NBE)

PROJECT COMPLETION REPORT

INFRASTRUCTURE DEPARTMENT JUNE 2006 NORTH, EAST AND SOUTH

TABLE OF CONTENTS

CURRENCY EQUIVALENTS, ABBREVIATIONS, ANNEXES PROJECT MATRIX

BASIC PROJECT DATA i - ii

EXECUTIVE SUMMARY iii - v

1. INTRODUCTION 1

2. PROJECT OBJECTIVE AND FORMULATION 2

2.1 Sector Goal 2 2.2 Project Objective 2 2.3 Project Description 2 2.4 Project Formulation 2

3. PROJECT EXECUTION (ACTIVITIES/COMPONENTS) 3

3.1 Effectiveness and Start-Up 3 3.2 Modifications 3 3.3 Implementation Schedule 4 3.4 Reporting 4 3.5 Procurement 4 3.6 Financial Sources and Disbursements 4

4. PROJECT PERFORMANCE AND RESULTS 5

4.1 Overall Assessment 5 4.2 LOC’s Operating Results 6 4.3 Institutional Performance: The NBE 7 4.4 Loan Conditions and Covenants and their Fulfillment 12

5. SOCIAL ECONOMIC AND ENVIRONMENTAL IMPACT OF THE PROJECT 13

5.1 Social and Economic Impact 13 5.2 Environmental Impact 14

6. PROJECT SUSTAINABILITY 16

7. PERFORMANCE OF THE BANK AND THE BORROWER 16

7.1 Performance of the Bank 16 7.2 Performance of the Borrower and Executing Agency 16

8. OVERALL PERFORMANCE AND RATING 16

9. CONCLUSIONS, LESSONS LEARNED AND RECOMMENDATIONS 17

9.1 Conclusion 17 9.2 Lessons Learned 17 9.3 Recommendation 18

This Project Completion Report (PCR) has been prepared by Mr. Taiwo Adeniji, Chief Financial Analyst, ONIN.1 (Ext. 2351) and Mr. Rachid Ghozali, Consultant Financial Economist on the basis of a PCR preparation mission undertaken in January/February 2006. Any enquiries related to the report should be addressed to the author or to Mr. I. Lobe Ndoumbe, Manager, ONIN.1 (Ext.2163).

CURRENCY EQUIVALENTS, ABBREVIATIONS AND ANNEXES

Currency = Egyptian Pound (LE)

Appraisal PCR (July 2002) (February 2006) 1 UA = LE 5.80797 LE 8.2749 1 US$ = LE 4.36538 LE 5.725 1UA = USD 1.33046 USD 1.43

TABLES

Table No. Title Page No.

4.1 LOC Operations Results by Sector 6 4.2 NBE’s Loans by Customer Category (%) 8 4.3 Distribution of NBE Portfolio by Economic Sector 8 4.4 Structure of the Assets and Liabilities of NBE (2001-2005) 9 4.5 Funding and Liquidity Ratios of NBE (2002-2005) 10 4.6 NBE’s Profitability/Earnings Quality Ratios (2001-2005) 11 4.7 NBE’s Loan Quality Indicators (2000-2005) 11

BOXES

No. Title Page No.

Box 1 El Morshedy Company for Weaving and Spinning 6 Box 2 Egyptian Salts and Minerals Company (EMISAL) 15

ANNEXES

Annex No. Title No. of Pages

1. Map of Egypt 1 2. NBE’s Current Organization Structure 1 3. NBE’s Historical Financial Statements 2 4. Performance Evaluation and Rating 2 5. List of Documents Consulted 1

ABBREVIATIONS

ADB African Development Bank AIG American International Group, Inc. ALCO Asset and Liability Management Committee ATM Automatic Teller Machine BOOT Build Own Operate and Transfer BOT Build Operate and Transfer Bp Basis point (one hundredth of a percent) CBE Central Bank of Egypt CGC Credit Guarantee Company CIB Commercial International Bank CIDA Canadian International Development Agency CIIC Commercial International Investment Company CMA Capital Markets Authority EDBE Export Development Bank of Egypt EIB European Investment Bank ERSAP Economic Reform and Structural Adjustment Program EU European Union GDP Gross Domestic Product GNP Gross National Product IDBE Industrial Development Bank of Egypt IFC International Finance Corporation IMF International Monetary Fund IMP Industry Modernization Program LOC Line of Credit NBE National Bank of Egypt NGO Non-Governmental Organization NIB National Investment Bank NPLs Non-Performing Loans. ROA Returns on Assets ROE Return on Equity SMEs Small and Medium Enterprises TBs Treasury Bills USAID United States Agency for International Development USD United States Dollar

PROJECT MATRIX

COUNTRY : EGYPT PROJECT TITLE : LINE OF CREDIT TO NATIONAL BANK OF EGYPT PROJECT COMPLETION REPORT DATE OF SUMMARY : March 2006

NARATIVE VERIFIABLE MEANS OF ACTUAL ASSUMPTIONS DESCRIPTION INDICATOR VERIFICATION PERFORMANCE

A. SECTOR GOAL 1.1 Contribution of the (Goal to Supergoal)

A.1 Develop and expand industrial sector to 1.1 National Statistics 1.1 The industrial sector the industrial sector to GDP increases from yearbook achieved good 1.1 Enabling enable the sector to lead the present level of growth over the last environment for the economic growth, 19% over the next 1.2 Central Bank of four years, at an conduct of business by employment creation and five years Egypt’s Quarterly annual rate of 9.5%. the private sector is thus contribute to the and Monthly The sector’s provided through reform Government’s poverty 1.2 Contribution of the Economic Reviews. contribution to GDP programs. reduction objectives. sector to exports also remains at about increases over the 1.3 ADB/World Bank 19% 1.2 Government’s

next five years Country Profiles 1.2 The estimate of job continuance of fiscal and monetary policies A.2 Enhance private creation by the 1.3 Significant new sector development by private sector over favorable to industrial and employment created tourism development. supporting small and the last four years is in the industrial medium enterprises. 225,000 p.a. less sector over the next than the GRE’s job five years creation target of 1.4 Increased access of 600,000 p.a. SMEs to investment 1.3 By providing long- capital. term foreign loans to SMEs, the LOC made a good contribution to increasing the access of SMEs to investment capital.

B. PROJECT 1.1 The LOC financed OBJECTIVE 1.1 The number and 1.1 NBE’s project 76 SME subprojects 1.1 NBE would continue The project aims at types of subprojects implementation in tourism, to strengthen its assisting the financed under the progress reports industrial, services project evaluation development of the line of credit. and social sectors. capacities in order to industrial and tourism 1.2 ADB’s Supervision Both new and effectively industries in Egypt by Reports. expansion projects implement the line providing financial were financed. of credit. 1.3 NBE’s annual resources to NBE for on 1.2 The subprojects are audited accounts and lending as medium- and economically viable, reports. long-term loans to viable and all are operating investment projects, with satisfactorily with special focus on SMEs. good loan repayment performances.

C. PROJECT OUTPUTS 1.1 Up to 100 industrial 1.1 NBE’s project 1.1 Only 76 subprojects 1.1 Sustained demand 1. Financial resources and tourism projects implementation were financed, less for NBE’s financial provided to viable financed under the progress reports. than the 100 products. investment proposals line of credit. 1.2 ADB’s Monitoring projected at leading to the setting and supervision appraisal. 1.2 Subprojects well up or expansion of 1.2 More than 1000 new reports. 1.2 The subprojects prepared, industrial and sustainable jobs 1.3 NBE’s annual achieved higher implemented and tourism businesses. created by the sub- report. development impact managed. projects. 1.4 Borrower’s and 2. Viable sub-projects, than estimated at ADB’s project in industrial and appraisal. The completion reports. tourism sectors subprojects together which comply with created/sustained environmental 10,015 jobs, against standards. 1,000 estimated at appraisal, due to their labor-intensive nature.

D. ACTIVITIES Drawdowns on the Line Sub-projects’ preparation, 1.1 Loan & Guarantee 1.1 Subprojects were 1.2 Bank conditions of of credit of US$ 140 Agreements signed well prepared by loan effectiveness appraisal and million. approval by NBE. with the Bank. NBE, and approved fulfilled in time by NBE 1.2 Loan Disbursement by ADB. 1.2 Borrower adheres to Sub-projects review and records. 1.2 NBE fulfilled agreed conditions for the approval by ADB. 1.3 External audit ADB’s loan implementation of the reports. Disbursement approved conditions promptly, LOC. 1.4 ADB monitoring and effected by and the LOC was and supervision ADB. fully disbursed. reports Monitoring of sub- 1.3 LOC was well projects monitored through regular supervision missions by ADB.

BASIC PROJECT DATA

1. Loan Number : 2000120000104 2. Borrower : National Bank of Egypt (NBE) 3. Guarantor : Central Bank of Egypt (CBE) 4. Executing Agency : National Bank of Egypt (NBE)

A. LOAN

1. Amount: USD 140 million

2. Interest Rate Type: 6 months US $ LIBOR plus a lending spread of 55 basis points 3. Commitment Charge 0.50% per annum 4. Repayment Period 14 years 5. Grace Period 4 years 6. Loan Negotiation Date 3 to 4 September 2002 7. Loan Approval Date 23 October 2002 8. Loan Signature Date 27 March 2003 9. Date of Entry into Force 22 May 2003

B. PROJECT DATA

Appraisal Estimate Actual 1. Total Cost: USD 140 million USD 140 million 2. Date of First Disbursement March 2003 27 May 2003 3. Date of Last Disbursement December 2005 30 December 2004 4. Commencement of Project March 2003 May 2003 Implementation Activities 5. Completion of Project Implementation December 31 December Activities 2005 2004

C. PERFORMANCE INDICATORS

1. Cost Overrun/Underrun N/A 2. Time Overrun/Underrun Nil - Slippage on Effectiveness 2 months - Slippage on Completion Date (12 months) - Slippage on Last Disbursement (12 months) - No of Extensions of Last Disbursement Date Nil 3. Project Implementation Status Completed 4. Institutional Performance Satisfactory 5. Contractor Performance N/A 6. Project Economic Performance Satisfactory 7. Number of Subprojects 76

D. MISSIONS

Type No of Composition Man-days Persons Identification 2 Financial Analyst, Country Economist 20 Preparation 2 Financial Analysts 20

Appraisal 4 Financial Analysts (2), Treasury Officer, 40 Legal Counsel Launching 2 Financial Analyst, Legal Counsel 10 Supervision (Oct 1 Financial Analyst, 7 2003) Supervision 1 Internal Auditor 7 (December 2003) Supervision 3 Division Manager, Financial Analyst, 30 (May/June 2004) and Disbursement officer PCR (Jan. /Feb 2 Financial Analyst, Financial Economist 20 2006) Consultant

E. DISBURSEMENTS

Percent Total Disbursed: USD 140,000,000 100 Unused Balance Nil 0 Amount Cancelled Nil 0

iii

EXECUTIVE SUMMARY

1. PROJECT BACKGROUND

A key strategy of the Government of the Arab Republic of Egypt (GRE) for achieving its development objectives of high and sustainable GDP growth, poverty alleviation, and reduction of income disparities, is the promotion and development of the private sector as the engine for economic growth. Egypt has pursued sustained economic reform programs since the 1990s, with the objective of creating a conducive environment for private sector development. The reform programs have led to reduced inflation, improved public finances, a stable currency, a more robust banking system, and an improved balance of payments position. Reforms in the banking sector also led to increased competition, with credit controls lifted, interest rates liberalised and restrictions on new banking services eased.

Despite these good performances, weaknesses in the economy persist in the area of poverty and employment. To generate employment and reduce poverty require considerable enlargement of the industrial, tourism and export sectors as well as far-reaching support for Small and Medium Scale Enterprises (SMEs). The LOC was designed to address one of the main constraints to the expansion of these sectors: the lack of medium to long-term foreign currency investment funds. Discussions between the Bank and NBE on the LOC started in 1998, but the preparation of the project was delayed due to the GRE’s reluctance to guarantee the facility, which was then a Bank requirement. The facility was eventually guaranteed by the Central Bank of Egypt (CBE), and was approved by the Bank in October 2002.

2. PROJECT OBJECTIVE

The objective of the LOC was to assist the development of the industrial and tourism sectors in Egypt by providing financial resources to NBE for on lending as medium- and long-term loans to viable investment projects in these sectors, targeting especially SMEs.

3. PROJECT DESCRIPTION

The US$140 million LOC provided long-term funding to NBE for on-lending to viable enterprises. The project allowed the bridging of the maturity gap between the demand for long-term loans and the available deposits in the Egyptian financial system to provide such loans. The loan was extended to NBE in foreign currency (US$), and repayment to the Bank would be in the same currency. The NBE had the discretion, however, to on-lend part of the LOC resources to eligible enterprises in local currency when it was satisfied that the resulting foreign exchange risk was adequately covered. The LOC was priced at 6-month Libor plus a lending spread of 55 basis points.

4. PROJECT EXECUTION

The project was approved in October 2002, signed in March 2003 and became effective in May 2003. The first disbursement was effected on 27 May 2003, and the loan was fully disbursed in December 2004. Thus, the LOC was fully implemented within 2 years as against the four-year implementation period envisaged at appraisal. The quick rate of implementation of the LOC is

iv attributable to NBE’s institutional capacity, as well as its extensive and well established customer base, which provided ready clients for the resources of the LOC.

5. PROJECT OPERATING RESULTS

The LOC achieved very satisfactory operating results. The project financed a total of 76 subprojects, with the largest number in the tourism sector (35 or 46%). Large numbers of subprojects were also financed in the manufacturing sector (30 or 39%), with relatively fewer numbers of subprojects in the services (11 or 14.5%) . All the subprojects together have a combined investment cost of US$ 626 million, indicating additional investment flow of US$ 486 million as a result of the LOC. The financed subprojects created and/or sustained a total of 10,015 jobs, significantly higher that the appraisal estimate of 1,000 jobs. The subprojects also contributed to foreign exchange earnings for the country.

6. OVERALL PERFORMANCE AND RATING

The overall project implementation performance is rated satisfactory. The LOC was implemented ahead of schedule, with 100% disbursement. The NBE complied generally with the conditions attached with the loan. After overcoming initial difficulties, NBE submitted reports on the project in the required formats and at expected intervals. The subprojects financed are all operating satisfactorily, with good loan repayment performances. The Bank’s performance was also satisfactory. The Bank showed good flexibility in its acceptance of the guarantee of the CBE in place of that of the GRE, which decision allowed the transaction to go forward. The Bank’s supervision missions were regular and effective, which greatly assisted the implementation of the LOC. The project outcome is also satisfactory. The LOC contributed to improvement in the institutional development of NBE. The LOC is rated satisfactory for sustainability, as most of its achievements and benefits are highly likely to be sustained.

7. LESSONS LEARNED

The following lessons were learnt from the implementation of the LOC:

(i) The project demonstrated the importance of the Bank’s willingness to consider alternatives to its standard requirement for Government guarantee for public sector operations, in the overall interest of addressing client needs and achieving the Bank’s overriding goal of poverty reduction in its RMCs. The acceptance by the Bank of the guarantee of the Central Bank of Egypt for the LOC in place of the sovereign guarantee of the Government of Egypt enabled the operation to proceed, and its development objectives to be achieved. It is therefore recommended that the Bank consider, on a case by case basis, alternative guarantee arrangements for public sector operations apart from Government guarantees.

(ii) The implementation of the project provided a lesson with respect to the definition of “project size” under the Bank’s LOC operations. A clear distinction should always be made between “project size” and “enterprise size” in preparing the Bank’s LOC Agreements.

(iii) The LOC demonstrated the importance of including technical assistance components as integral parts of the Bank’s LOC operations. The inclusion of TA with the LOC would have lessened some of the difficulties encountered during the implementation of the LOC, particularly as regards the approval of subprojects, disbursement arrangements and reporting requirements.

1. INTRODUCTION

1.1 The key development objectives of the Government of Egypt (GRE) are to achieve high and sustainable GDP growth and to alleviate poverty and reduce income disparities. A key strategy to achieve these objectives is the promotion and development of the private sector as an engine for economic growth. The potential of the private sector is to be harnessed through improving the business climate across a broad range of policies (covering trade, finance, and taxation, among others) while the complementary role of the public sector is to be strengthened through enhancing the provision of public services such as infrastructure, education, and macroeconomic stability. This two-pronged growth strategy is expected to help Egypt cope with the challenge of reducing unemployment in the context of a growing labor force. The GRE also intends to pursue equity through redesigning social policies to meet national welfare objectives in a more effective and efficient manner.

1.2 Egypt has pursued sustained economic reform programs since the 1990s. The reform programs have led to reduced inflation, improved public finances, a stable currency, a more robust banking system, and an improved balance of payments position. Concurrently, the Egyptian banking sector has been undergoing deregulation and liberalisation, leading to increased competition. Credit controls were lifted, interest rates liberalised and restrictions on new banking services eased.

1.3 Despite these impressive performances, weaknesses in the economy persist in the area of poverty and employment. To generate employment and reduce poverty requires considerable enlargement of the industrial, tourism and export sectors as well as far-reaching support for Small and Medium Scale Enterprises (SMEs). One of the major constraints to the expansion of these sectors is the lack of medium to long term financing, as well as foreign exchange resources needed to finance inputs in the productive sectors.

1.4 In 1998, the Bank received from several Egyptian banks, both public and private, requests for lines of credit (LOC) to assist SMEs. One of the requests was from the National Bank of Egypt (NBE), a commercial bank wholly owned by the GRE. Following the review of the requests, the Bank decided to consider a line of credit to the NBE from the public sector window. Project preparation took a long time as the project team had to deal with a number of difficult issues, including the policy of the GRE not to provide any guarantee for the borrowings of its enterprises. A compromise was reached when the Central Bank of Egypt (CBE) stepped in and offered to guarantee the proposed loan.

1.5 Following the resolution of the policy issue related to the guarantee, a number of Bank missions visited Egypt in respect of the proposed LOC to NBE. The final appraisal mission was carried out in April/May 2002, and the LOC approved by the Board of Directors in October 2002. This Project Completion Report (PCR) has been prepared based on the reports of the several supervision missions undertaken during the implementation of the project, as well as information gathered during a PCR preparation mission undertaken in January 2006. Other documents consulted in the preparation of the report are detailed in Annex 7.

2. PROJECT OBJECTIVE AND FORMULATION

2.1 Sector Goal

The goal of the GRE in the industrial sector is to develop and expand the sector to enable it to lead economic growth and employment creation. As one of its main strategies for achieving this goal, the GRE is actively providing support to, and promoting the development of SMEs due to their capacity to generate the greater number of jobs.

2.2 Project Objective

2.3 Project Description

2.4 Project Formulation

Origin

2.4.1 The Bank supported Egypt’s macroeconomic reforms started in the 1990s1. These reforms paved the way for an environment of high economic growth, with GDP growth rates averaging about 6% during the period 1997 – 2000, and a stabilized macroeconomic framework, including reduced inflation, a turnaround in public finances, a relatively stable currency, and an improvement in the balance of payments position. However, growth and investment levels faltered after 2000. GDP growth rate decelerated between 2000 and 2003, averaging only about 3.2 percent per annum. The loss of growth momentum was accompanied by a decrease in both private and public investment. Private investment declined from around 11 percent of GDP in 1998 to around 8 percent in 2002, a serious cause for concern since it was widely expected that private investment must serve as the main engine of future growth and employment. During the same period, public investment fell from around 15 percent of GDP to around 8 percent. The economy needed to create about 550,000 new jobs each year just to accommodate new entrants in the labor force. Of these job requirements, about 350,000 are expected to be generated by SMEs.

2.4.2 The LOC was conceived to provide Bank support to the GRE’s resource mobilization efforts, and thereby assist in sustaining the reform programs and the economic growth that they engendered. The LOC targeted the high growth sectors of industry and tourism. Given that SMEs are the main generators of employment in Egypt, the LOC’s focus on these enterprises was particularly important for the GRE’s economic growth and poverty reduction efforts.

1 The Bank approved an Economic Structural Adjustment Loan of US$ 100 million to Egypt in 1991 in support of the reform programs.

Preparation, Appraisal, Negotiation and Approval

2.4.3 The GRE’s original request to the Bank for the LOC was submitted in 1998. Thus, it took about five years to complete the preparation, appraisal and negotiation of the LOC before it was approved in October 2002. There were two main issues responsible for this long delay: one related to policy, while the other related to project-specific operational issues. These issues are discussed below.

2.4.4 The policy issue related to the GRE’s insistence that it would not provide its sovereign guarantee for the borrowings of its commercial enterprises. Given that the NBE is wholly owned by the GRE, the Bank’s policy required that any loan to it should be guaranteed by the Government. In order to resolve this problem, the GRE proposed that the Central Bank of Egypt (CBE) issue a guarantee for the loan in place of the Government. The Bank carried out an extensive assessment of the Egyptian proposal, in order to ensure that it was consistent with Bank regulations, and also that it would not pose any major legal or financial implications for the Bank’s operations. After the assessment, which took over two years to complete, the Bank accepted the proposal for a guarantee of CBE in place of a full GRE guarantee for the loan.

2.4.5 After the policy issue was resolved, there were further delays in the processing of the LOC due to operational project-specific issues. These issues relate to the use of the resources of the LOC (the Bank insisted that the resources should be used to finance investment expenditures of SMEs, while NBE wanted to use the resources for its general commercial banking operations), the amount of information requested by the Bank, and the financial terms of the loan. Dealing with these issues took a long time, but they were eventually resolved to the satisfaction of both parties, which allowed the loan to be approved in October 2002.

3. PROJECT EXECUTION (ACTIVITIES/COMPONENTS)

3.1 Effectiveness and Start-Up

3.1.1 The LOC was approved in October 2002, under the condition that its signature would be subject to the Bank receiving a satisfactory “Letter of No Objection” to the transaction from the GRE. Differences arose between the Bank and the GRE as to the wording of the required Letter. The differences were due to the need for the GRE to confirm, through the Letter, that the LOC would enjoy the Bank’s Preferred Creditor Status, as do all other projects with full Government guarantee. There was a delay in the signature of the LOC Agreement as the differences were being resolved. This was eventually done, and an acceptable Letter of No Objection was submitted by the GRE to the Bank for the operation. The LOC Agreement was then signed on 27 March 2003, about six months after its approval.

3.1.2 After the LOC’s signature, NBE moved quickly to fulfill the conditions precedent to its effectiveness. The LOC was declared effective on 22 May 2003, less than two months after its signature. Upon submission by the NBE of a disbursement application together with the necessary supporting documents, the first tranche of the LOC, in an amount of US$ 56 million, was disbursed, on 27 May 2003.

3.2 Modifications

There were no major modifications to the LOC scope or design during its implementation.

3.3 Implementation Schedule

3.3.1 At appraisal, the LOC was expected to be implemented over a three-year period (2003 – 2005). However, actual implementation took less time than was envisaged. The LOC was fully implemented by 30 December 2004, or within two years of its approval, as against the three years originally envisaged. The original three-year implementation schedule was proposed at project appraisal due to the fact that NBE was a first time Borrower from the Bank, and there was the likelihood of encountering difficulties during implementation due to its unfamiliarity with the Bank’s policies and procedures. Some difficulties did arise due to this reason, but they were resolved within reasonable times, which allowed the quick implementation of the LOC.

3.3.2 The faster than expected implementation of the LOC could also be attributed to NBE’s institutional capacity, as well as its extensive branch network and well established customer base, which provided ready clients for the resources of the LOC. The NBE is the largest bank in Egypt, with a large number of branches and strong customer base. The fact that the preparation and appraisal of the LOC took a long time, during which period the NBE had identified and pre- assessed the pipeline of viable sub-projects eligible for the LOC also contributed to the quick implementation rate.

3.4 Reporting

Difficulty was experienced in project reporting during the early stages of LOC implementation. Language was one major source of difficulty. Most project documents, including subproject financial statements, were in Arabic and it was practically impossible to translate all of them. The fact that NBE was a new borrower and therefore not familiar with the Bank’s procedures and reporting requirements also added to the difficulties. With the assistance of Bank staff during supervision missions, the NBE addressed these reporting problems by making organizational changes aimed at improving data collection, information processing and reporting according to the Bank’s requirements. The NBE eventually submitted the required reports to the Bank, including (i) detailed progress report on the implementation of the LOC; (ii) full reports on the subprojects financed with the resources of the LOC; (iii) the financial statements of a selected number of the financed subprojects (translated into English); and (iv) Audit report on the LOC by an External Auditor.

3.5 Procurement

The procurement of goods and services under the LOC were to be carried out by the subproject promoters in accordance with established commercial practices. The Bank reviewed the procurement methods utilized by the project promoters in the course of approving subprojects for financing under the LOC, and confirmed that appropriate commercial practices were employed for procurement activities. Most of the goods purchased with LOC funds were procured mainly from suppliers in Egypt, while some were procured from other member countries of the Bank.

3.6 Financial Sources and Disbursements

3.6.1 The special account method of disbursement was utilized for the LOC as recommended at appraisal. The first tranche disbursement, for US$ 56 million, was effected in May 2003, while the second tranche, for the same amount, was disbursed in August 2003. Thus, US$ 112 million or 80% of the LOC was disbursed with six months of loan signature. Following the second tranche disbursement, a mission from the Bank’s Internal Audit Department (AUDT)

5 visited NBE in October 2003 for an audit review of the utilization of the amounts disbursed. The AUDT report raised a number of issues regarding the utilization by NBE of the disbursed amounts. The issues raised related mainly to the adequacy of the documents provided by NBE to justify the utilization of the disbursed amounts. The AUDT report then made a number of recommendations on how to improve the financial management of the LOC.

3.6.2 The main recommendations contained in the AUDT report were that:

(i) Given that most of the subprojects financed from the LOC originated from NBE branches scattered throughout the country, NBE should make arrangements for the centralization of information on the subprojects at its headquarters for easy access by ADB missions; (ii) NBE should reflect the conditions of the LOC, such as on procurement, in the sub-loan agreements with its sub-borrowers; and (iii) NBE should compile the documentary evidence of the utilization of the proceeds of the LOC.

3.6.3 The Bank worked closely with NBE to implement the AUDT recommendations. Their implementation led to the setting up of a new Unit in NBE, the Accounting Unit for International and Environmental Agreements (AUIE), with the responsibility for the coordination of the implementation of donor-financed projects, including the collation of information on the development impact of the projects. Thus, due to this process, NBE’s institutional arrangements for implementing developmental projects were strengthened. The process led to some delay in the disbursement of the third and final tranche of the LOC resources, which was eventually effected on 30 December 2004.

4. PROJECT PERFORMANCE AND RESULTS

4.1 Overall Assessment

4.1.1 The LOC was aimed at assisting the development of the industrial and tourism sectors in Egypt, with particular focus on SMEs within the sectors, by providing them access to investment funds for viable projects. The resources were to be used to finance the foreign exchange requirements for the procurement of capital equipment, and to finance permanent working capital requirements. The resources were expected to finance up to 100 industrial and tourism subprojects, and assist in creating more than 1,000 sustainable jobs.

4.1.2 An analysis of the actual performance of the LOC shows that it has satisfactorily met the objectives set at appraisal. The LOC amount of US$ 140 million was fully disbursed ahead of schedule. The proceeds financed 76 investment projects, which were less than the number envisaged at project appraisal. However, the number of jobs created as a result of the LOC was much higher than the appraisal target. As at the PCR mission, a total of 10,015 jobs were estimated to have been created or sustained by the enterprises financed by the LOC. The enterprises also contributed to foreign exchange earnings for Egypt. A typical subproject is the El Moushedy Company for Weaving and Spinning, a family owned, but professionally run business that underwent modernization and expansion using the resources of the LOC. Some details about the company is provided in the box below.

Box 1 El Morshedy Company for Weaving and Spinning

Background: The El Morshedy Company for Weaving and Spinning is a family owned business that was established in 1972. The company was previously engaged only in yarn spinning, but decided in 2003 on the modernization and an upward integration of its activities into weaving. The company requested the NBE to finance its new weaving operations, as well as the expansion of its original spinning plant.

Activities Financed by the Bank’s LOC: The Bank’s LOC, through the NBE, part financed the company’s expansion project. The project involved the construction of new factory buildings, procurement and installation of additional spinning equipment as well as new weaving equipment, and the procurement of synthetic fiber yarns. The total project cost was US$ 10.5 million, with US$ 2 million coming from the LOC.

Status of Implementation and Operation of the Project: As at the time of PCR preparation, the project was over 95% completed and was already operational. The factory building was completed; the machinery and equipment purchased have been delivered and almost fully installed, with only a few yet to be installed.

Project Development Impact: The completion of the project significantly increased the company’s spinning and weaving capacity from about 3.5 million meters of fabrics per annum to 10 million meters. The company has total staff of 450, 350 of whom were new employees for the modernization and expansion project. While the project did not directly earn foreign exchange, as its products are sold locally, it has saved foreign currency resources for the country.

4.2 LOC’s Operating Results

As mentioned earlier, the LOC financed a total of 76 investment projects. The tourism sector has the largest number of subprojects, with 35 or 46% of the total, followed by the manufacturing sector, with 30 subprojects or 39.5 of the total. There were 7 subprojects in the services sector representing 9.2% of the total, with the balance of 4 subprojects or 5.3% of total in the social sector (education and health). The average sub-project investment cost was US$ 8.2 million with the minimum at US$ 1.3 million and the maximum investment cost at US$ 10.5 million. The average sub-project loan size was at US$ 1.83 million, with a range from US$ 0.75 million to US$ 2.0 million. All the subprojects together had total investment cost of US$ 626 million, indicating an additional investment inflow of US$ 486 million as a result of the LOC. In terms of jobs, the tourism subprojects achieved the highest rate of job creation per unit of investment, with a total of 8,063 jobs created or an average of 230 jobs per subproject and 30 jobs per US$ 1 million of investment. Manufacturing subprojects came next with an average of 54 jobs per subproject and 7 jobs per US$ 1 million of investment, while the lowest rate of job creation was with the enterprises in the services and social sector, with an average of 31 jobs per subproject and only 1 job for every US$ 3 million of investment (Table 4.1 below). In addition to boosting NBE’s capacity for lending to SMEs, the Bank played a positive catalytic role as the US$ 140 million LOC facilitated investments of US$ 626 million, highlighting the positive leverage of the Bank’s involvement. 7

Table 4.1 LOC Operating Results by Sector

Invest. no of sub % number of % jobs/ Avge Loan Avge Invest. costs projects jobs created subproject size($ mil) Cost($mil) ($ mil) Tourism 288 35 46.1 8,063 80.5 230 1.79 8.22 Mfg. & 241 30 39.5 1,611 16.1 54 1.82 8.04 Industry Services and 98 11 14.5 341 3.4 31 1.99 8.9 Social ------Total 626 76 100 10,015 100 132 1.83 8.24

4.3 Institutional Performance: NBE

The Legal Framework

4.3.1 The National Bank of Egypt (NBE) was the Borrower and Executing Agency of the LOC. The NBE is Egypt’s first and largest public sector bank, fully owned by the GRE. The bank was established in June 1898 as a private joint stock commercial bank with central banking responsibilities until the Central Bank of Egypt (CBE) was set up in 1960. NBE was nationalized in 1960, as were all banks then operating in Egypt, and its assets were merged with five other nationalized foreign banks. NBE, reincorporated as a Joint Stock company in 1965, is licensed as a bank and is subject to the regulation and supervision of the CBE. The NBE has a paid up capital of LE 2.25 billion and its equity was LE 6.3 billion as of June 30 2005.

Management and Organization

4.3.2 The GRE appoints NBE’s Board of Directors. With the exception of the issuance of new shares, the GRE delegates authority for the strategic decision making and day-to-day management of the bank to the Board of Directors and the Executive Management (EM) respectively. The Board .comprises the Chairman, two Deputy Chairmen, a General Manager/Board member, and four non-executive Directors. In the context of the ongoing banking reforms aimed notably at strengthening governance, the Board and EM of NBE were recently strengthened with the appointment of leading private sector professionals. The EM is made up of the Chairman, two Deputy Chairmen, the Executive Board Member, and six Executive General Managers. Mr. Hussein Abdel Aziz Hussein, who was appointed Chairman about two years ago, has been in service with NBE since 1965, and has held several executive management positions, including that of General Manager of the Credit Division for 3 years, and that of the Investment Division for 2 years. NBE organization chart is presented in Annex 2.

4.3.3 NBE’s activities are organized in two major groups: the Business Group, comprising Investment Banking, Corporate Banking, Branch Management, Treasury & International Banking, Retail Banking, and Special Cases; and the Control and Support Group, comprising Risk Management, Finance & Control, Research & Development, Human Resources, MIS & IT, and Logistics & General Affairs (see Annex 2 for NBE Organizational Chart). The bank has been the most successful among the public sector banks in redirecting its operations towards a commercial approach, and weaning itself off the legacies of a public sector orientation, such as non-performing loans.

Staffing and Training

4.3.4 NBE had total staff strength of 9,900 as of end 2005, an increase of 413 compared to the total staff of 9,487 at project appraisal. About 55% of the staff is clerical, secretarial and other services. Professional and middle management staff make up close to 40%, while 5% are executive/general management staff. About 20% of the staff are women, represented at all levels and account for 21% of top management positions. Staff turnover at NBE is very low, mainly because the staff employment conditions are competitive, and the bank enjoys a good corporate image in the country. NBE provides its employees with extensive training to enhance their skills and to ensure that they keep abreast of developments in their fields. NBE owns a well equipped training center in Cairo.

Accounting and Auditing

4.3.5 NBE’s financial statements are prepared in accordance with international accounting standards and are audited by two firms of external auditors2 approved by the CBE. Provision is made for specific loans and contingent liabilities in addition to a percentage for general risk, computed on the total of other loans and contingent liabilities excluding cash deposits and bank guarantees issued by reputable banks based upon management assessment and detailed periodical studies of loans and contingent liabilities. Bad loans are written off (out of the related provision) in case of failure of measures taken for their collection. As part of their annual audit, the external auditors are required, by CBE regulations, to assess the adequacy of NBE’s loan provisions and issue a special report to the CBE.

Operational Performance

4.3.6 Loan Portfolio. NBE achieved net loan assets growth during the period 2001 -2004, with loans increasing 21% from LE 48.44 billion at end FY 2001 to LE 58.8 billion at end FY 2004. FY 2005, however, saw a sharp increase in loan assets from 58.6 to 65.6 LE billion or 11.5 % for the year and half the increase for the period 2001-2004 due to the improvement in the economic environment. NBE continued to pursue its strategy, started in 1990, of shifting its lending focus from public to private sector customers, and its loan portfolio is relatively well diversified across business and economic sectors. Loans to the public sector have declined from as high as 56% of total loans in 1995 to 23% by 2004 but jumped again to 31% in 2005, while the share of the private sector in total loans increased from 44% to 77% over the same period but declined to 69% in 2005. The share of households’ loans declined from about 12% to 8% and remained at about 8-9% for the last 3 years (Table 4.2). The resources of the LOC contributed about 9% to the LE 9.2 billion growth in NBE’s loan portfolio between 2003 and 2005.

2 The auditors are Mostafa Shawki & Associates, and the Central Agency for Auditing.

Table 4.2 NBE’s Loans by Customer Category (%)

Sector 2000 2001 2002 2003 2004 2005 Industry 2004 Public 23 20 20 20 23 31 17 Private 77 80 80 80 77 69 83 Of which, 62 65 67 70 67 58 70 Business Household 10 12 9 8 8 8 12 Others 5 3 4 2 2 2 1 Total 100 100 100 100 100 100 100 Source: NBE and CBE Annual Reports 4.3.7 The distribution of the portfolio by economic sectors (Table 4.3 below) shows that the portfolio is relatively well diversified across sectors with no specific concentration risk. NBE’s operations cover a wide range of economic sectors, with the following distribution as at end June 2005: industry (36%), tourism (15%), services (31%), trade (9%), agriculture (1%) and other sectors (8%). The increasing share of industry in the Bank’s loan portfolio is one of the major drivers for NBE borrowings in hard currency and for longer maturities. Tourism has increased sharply in 2005 to 15% from the 9-11% level where it has been since 2000. It is noted that the bulk of the Bank’s LOC resources (84%) were utilized to finance enterprises in the industry and tourism sectors. Table 4.3 Distribution of NBE’s Portfolio by Economic Sector

Sector 2000 2001 2002 2003 2004 2005 Industry (2004) Industry 36% 39% 40% 42% 42% 36% 35% Tourism 11% 10% 9% 11% 10% 15% 8% Services 24% 25% 26% 25% 25% 31% 29% Trade 13% 10% 10% 11% 12% 9% 15% Agriculture 1% 1% 1% 1% 1% 1% 2% Other Sectors 15% 15% 14% 10% 10% 8% 11% Total 100% 100% 100% 100% 100% 100% 100% Source: NBE and CBE Annual Reports

Financial Review

4.3.8 Balance Sheet. NBE’s historical balance sheet is summarized in Annex 3. Total assets grew at an average annual compounded rate of 16.6% since the LOC’s appraisal, increasing from LE 87.13 billion at end June 2001 to LE 161 billion at end June 2005. The structure of assets has also changed over the period. Loan assets as percent of total assets decreased from 56% at end of FY 2001 to 41% at end of FY 2005, while the share of liquid investments in total assets increased from 25% to 45% over the same period. These changes have largely reflected the economic conditions in the country during the period, with the increases in liquid investments driven by the higher interest rates on T-bills. The LOC resources contributed about 2% to the growth of NBE’s asset base between 2003 and 2005.

Table 4.4 Structure of the Assets and Liabilities of NBE (2001 – 2005)

Industry Average 2001 2002 2003 2004 2005 2004 Assets as percentage of total assets Cash and balances with Banks 17.13 17.34 23.21 24.15 31.66 26.05 TBs and Government Securities 8.3 15.24 16.25 16.93 13.47 5.39 Trading Securities 2.77 4.02 4.18 4.78 6.08 4.20 Loans and Acceptances 55.59 50.23 45.85 44.72 40.72 46.76 Non-Trading Securities 9.85 6.74 5.02 4.86 3.72 n/a Other Assets 5.87 6.04 5.14 4.18 4.04 7.60 Fixed Assets 0.49 0.39 0.36 0.38 0.31 n/a Total 100 100 100 100 100

4.3.9 The structure of NBE’s liabilities over the last five years has remained fairly stable. Customer deposits continue to provide the bulk of the bank’s funding, representing over 80% of total assets over the period, reflecting NBE’s strong domestic franchise. This stable and relatively less expensive funding source has been the bedrock of NBE’s strength and success over the years. However, the short-term nature of most of the customer deposits has created maturity mismatches in NBE’s assets and liabilities, both for local and foreign currencies. Addressing the maturity mismatches was a financial objective of the LOC with respect to NBE balance sheet. The 14-year US$ 140 million LOC resources represented 33% of NBE’s total long-term liabilities US$ 430 million as at end of FY 2005, and helped in elongating the maturity profile of the bank’s liabilities.

4.3.10 Funding and Liquidity Risks: NBE has a solid deposit base with customer deposits constituting the bulk of its funding. Stable deposit funds, including savings, have built up over the years due to its large customer base, an extensive countrywide branch network, and effective deposit gathering abilities. As of 30 June 2005, NBE had LE 134.30 billion in customer deposits representing 83.2% of total assets. Savings deposits totaled LE 39 billion or 29% of total deposits, while term deposits of more than one-month maturity totaled LE 47 billion or 35% of total deposits.

4.3.11 NBE has always maintained good liquidity positions. As at June 30 2005, the bank had a total of LE 72 billion in liquid assets, representing 45% of total assets. Net liquid assets (less inter-bank takings) were LE 64 billion or 40% of total assets. Loans to deposits ratio was at 49% down from 55% the previous year and below the three previous year’s average of 55.3%, while customer deposits to total funds averaged 82% over the same period. As shown in Table 4.2 below, NBE’s figures compare favorably with the banking industry averages. The bank was required, as a condition of the loan, to maintain a minimum liquid asset ratio of 25%. As shown in Table 4.5 below, NBE has maintained consistently a liquid asset ratio above the minimum 25% required. This ration stood at 45.6% at the end of FY2005 the highest it has been during the period of review.

Table 4.5 Funding and Liquidity Ratios for NBE (2002- 2005)

Industry Total/ 2002 2003 2004 2005 Average (2004) Total Customer Deposits (LE million) 81,460 92,573 105,328 134,304 461,697 Of which: Demand deposits 6,448 6,703 7,818 8,380 46,742 Time deposits 45,352 42,904 43,509 46,529 202,713 Savings Deposits 23,950 31,719 38,750 39,064 186,769 CDs & Others 5,710 11,247 15,250 40,331 25473 Customer Deposits /Total Funds (%) 80.29 78.97 84.04 84.0 72.89 LTD to Total Funds (%) 3.21 3.43 3.5 1.6 2.37 Loans/Customer Deposits (%) 65.22 60.96 55.88 48 64.17 Liquid Asset Ratio (%) 32.58 39.46 41.01 45.1 45.64 * Source: NBE and CBE Annual Reports

4.3.12 Capital Adequacy: The CBE increased the minimum capital adequacy ratio for Egyptian banks from 8% to 10% in 2003. The guidelines for the calculation of the ratios are generally in line with the Basel Accord standards. In March 2003, the GRE injected LE 1.25 billion of Tier 1 capital into NBE to enable it comply with the new minimum capital ratio. NBE’s capital adequacy ratio (based on risk weighted assets) currently stands at 11%, which is higher than the regulatory minimum. NBE was required, as a financial covenant of the LOC to maintain a CAR of not less than 10% throughout the currency of the LOC. NBE complied with this covenant.

4.3.13 Income Statement. The historical income statements of NBE for the 5-year period 2001 – 2005 are summarized in Annex 3. NBE remains a profitable bank despite the pressures on net income due to increasing provisions and declining interest margins due to lower loan volumes and higher levels of lower yielding liquid assets. NBE’s profitability remained virtually at its 2004 level during 2005, with net income at LE 358 million. There was a sizeable net gain of LE 840 million from the sale of securities during the year. This was however offset by a significant increase of LE 1 billion in provisions for the year compared to 2004, thereby bringing accumulated provisions on non performing loans to LE 9.2 billion from LE 7.9 billion. Fees and commission income continue to be strong, increasing 6.8% during the year to LE 1.34 billion.

Table 4.6 NBE’s Profitability and Earnings Quality Ratios (2001 – 2005) Industry 2001 2002 2003 2004 2005 Averages (2004) Int. Income/Total Inc.(%) 83.16 85.22 81.71 81.04 77.98 n/a Interest Margin (%) 12.51 10.59 13.67 17.02 17.14 n/a Cost-to-Income (%) 27.36 27.45 25.01 28.62 32.29 n/a Provisions/Op. Profit (%) 48.88 38.51 49.26 52.54 55.75 n/a Net Interest on Assets(%) 1.00 0.73 0.85 1.01 1.17 1.20 Return on Assets (%) 0.58 0.36 0.28 0.27 0.24 0.40 Return on Equity (%) 12.15 8.46 6.38 5.45 5.51 12.60 Source: NBE and CBE Annual Reports

4.3.14 Asset Quality. NBE’s loan classification guidelines are generally in line with international best practice. Any account that is overdue is classified as “watch”, while those that are 90 days past due are classified as “substandard”, with provisions equivalent to 20% of the outstanding balance net of liquid collateral made, and interest recognized only on a cash basis. Accounts that are 180 days past due are classified “doubtful”, with the provision cover raised to 50%. For accounts that are over 360 days past due, full provisioning is made to cover the gap between the amount outstanding and liquid collateral. A 1-3% general risk provision is also made against good loans.

4.3.15 NBE has seen some deterioration in its asset quality as represented by the NPLs ratio, which increased from 12% in 2001 to 19.8% as of end 2005. The deterioration largely reflected the overall difficult economic conditions in Egypt during the past few years, but also the tougher loan classification rules applied by NBE. The difficulties in the foreign exchange market since 2001 with the sharp 100% devaluation of the Egyptian pound has been particularly hard on industrial enterprises, which comprise the majority of NBE’s customers. Furthermore, the long drawn negotiations with the GRE to settle the NPLs of public sector enterprises are yet to be finalized, further complicating NBE’s NPLs situation. The NBE is aggressively tackling the NPLs problem. During 2003, the bank created a new Special Cases department to focus on difficult NPLs. It has recently been in discussions with defaulting borrowers to reschedule difficult loans. The department has restructured or settled nearly LE 6 billion of NPLs. While loan provisions have increased, from LE 7.9 billion to LE 9.20 billion during 2005, the loan provisions coverage fell, from 75% to 65.7%, during the year due to a faster rate of growth of NPLs relative to provisions. The proposed restructuring of public sector banks in the context of the FSRP will address the public sector NPLs, including those of NBE.

Table 4.7 NBE’s Loan Quality Indicators (2000 – 2005)

Indicators 2000 2001 2002 2003 2004 2005 Industry (2004) Gross Loans (billion L.E ) 34 54 59 64 68 74 241 NPL/Gross Loans (%) 11 13 14 16 18 19.8 19 Loan Provision/Loans (%) 8 8 9 9 10 12.4 15 Loan Provision/NPL (%) 83 81 78 74 75 65.7 67 Capital/Gross Loans (%) 7 7 7 9 10 12.5 7 Source: NBE and CBE Annual Reports

4.4 Loan Conditions/Covenants and their Fulfillment

4.4.1 There were two conditions precedent to first disbursement of the LOC. The first related to the opening and maintenance of a special foreign exchange account, and the second required an undertaking from the NBE that the proceeds of the LOC would be used to finance only viable subprojects which comply with environmental standards and the laws of Egypt. NBE fulfilled the two conditions within a relatively short time, which enabled the loan to be declared effective within two months of its signature.

4.4.2 The condition relating to the sizes of subprojects created some difficulties during the implementation of the LOC. The LOC Agreement established a limit of US$ 10.5 million for the size of subprojects to be financed from the line. The NBE interpreted this limit as referring to the size of specific investments being financed by the Bank, such that, for example, if a big enterprise decides to undertake a small expansion, the LOC should be able to finance it as long

13 as the cost of the expansion is not more than US$ 10.5 million. The Bank explained to NBE that since the LOC was to finance SMEs, the total size of the enterprise, including any expansions, should not be more than the established limit. Even though the NBE eventually agreed with the Bank’s position on this issue, the misunderstanding affected the NBE’s utilization of the LOC resources.

4.4.3 The approval procedures of subprojects for the LOC established a free limit, in line with the Bank’s LOC guidelines, of US$ 2 million, up to which the NBE is allowed to finance sub- loans without prior Bank approval. The Bank’s experience under the LOC was that NBE ensured that it kept all its sub-loans within the US$ 2 million threshold, such that no subproject was submitted for the Bank’s prior approval. While this was within the regulations, it nevertheless weakened the Bank’s oversight on the implementation of the LOC, and prevented early discovery of potential difficulties. In retrospect, given that the NBE was a first time customer of the Bank., the free limit should have been limited to a percentage of the loan.

4.4.4 NBE fulfilled the “Other Conditions” of the LOC except the one that required it to improve the ratio of its NPLs from the 12% at the time of appraisal to less than 10% within three years from the signing of the LOC Agreement. As of June 30, 2004 this ratio stood at 16% and climbed to 19.8% at the end of 2005. A significant portion of NBE’s NPLs were owned by public enterprises. As at project appraisal, strong efforts were being made at the Government level to address the public sector NPLs. Their resolution would have significantly improved NBE’s NPLs ratio and brought it into compliance with the Bank’s loan condition. Unfortunately, the issues surrounding the public sector NPLs were very complex, and their resolution proved to be more difficult than was envisaged. Thus the non-resolution of the problem within a reasonable timeframe made it impossible for NBE to be able to achieve the required reduction in its NPLs ratio. Furthermore, the issuance and enforcement by the CBE of tighter provisioning guidelines contributed to the deterioration of the NPL ratio at NBE and other public banks. The problem of public sector NPLs within the banking sector is now being addressed in the context of a Bank-supported financial sector reform program being implemented by the GRE.

4.4.5 In retrospect, while the conditions attached to the LOC addressed the operation and management of the LOC, the wider issues of the banking sector at large were not fully addressed, including the necessary measures to resolve the NPLs issue. The adequacy of NBE’s management information system to monitor a multitude of small projects in branches across the country, to collect the information and to prepare the necessary reports, notably those required by the Bank was also over-estimated at appraisal.

5. ECONOMIC, SOCIAL AND ENVIRONMENTAL IMPACT OF THE PROJECT

5.1 Economic and Social Impacts

5.1.1 The high level of utilization of the LOC and the significant employment generated by the sub-projects means that its economic impact was maximized. Economically, subprojects financed have had, and are expected to continue to have positive impacts on employment, the foreign exchange balance, environmental improvements and development of the private sector in Egypt.

5.1.2 By providing competitively priced long-term funding to NBE for on-lending to viable investment projects in Egypt, the LOC assisted in improving the depth of the financial sector in Egypt. It helped fill a funding gap in the Egyptian financial sector given that an overwhelming proportion of the funding available to banks is in the form of short-term customer deposits. In

14 order to minimize their maturity mismatches, banks have tended to lend these funds also on short-term basis, mainly to finance trading activities. By providing long-term funds, the LOC addressed the funding weakness of the financial sector, thereby addressing one of the major constraints faced by banks in being able to provide long-term investment lending.

5.1.3 The LOC resources were used to finance SMEs, thereby supporting the GRE’s strategy of developing SMEs as an important engine for economic expansion and poverty alleviation. Egypt’s long-term National Economic Strategy (1997 to 2017) calls for the creation of 550,000 new jobs every year to 2017 in order to cope with new entrants to the workforce (estimated at 513,000 per annum), as well as reduce the level of unemployment. SMEs are expected to account for up to 350,000 of the new job requirements, and their development is therefore of critical importance to the GRE’s poverty reduction strategy. The relatively high number of jobs created through the implementation of the LOC is a measure of the appropriateness of this strategy. All the SME projects financed by the LOC were private enterprises. The LOC therefore contributed to private sector development in Egypt by providing scarce long-term resources to private investors and businessmen.

5.1.4 Furthermore, the availability of long-term investment funds helped to address some of the structural weaknesses of the Egyptian economy. It helped shift investment activities from trading to productive sectors, thereby providing more impetus to the tourism and manufacturing sectors. The subprojects financed from the LOC created 10,015 jobs, thereby providing disposable income for more than 10,000 households some in the rural areas, thus contributing to poverty alleviation. By financing SMEs, many of which are located in rural areas and utilizing local raw materials, the LOC assisted in efforts to develop rural economies, contributed to the development of local entrepreneurship and technical skills, and enhanced the incomes of local dwellers, thereby improving their standards of living. Several of the subprojects financed were foreign exchange generating projects, either through exports of goods, such as the manufacturing subprojects, or through the provision of services to foreigners, such as the tourism subprojects. Thus, the LOC contributed to the availability of foreign exchange for the country. The subprojects also contributed to Government revenues through tax payments (value-added tax, income tax and corporation tax), as well as revenues for the country's utilities (telecom, power and water).

5.1.5 At the institutional level, the LOC assisted NBE in promoting productive investments, and also in increasing the commercial focus of its activities as the proceeds of the LOC were used to support private sector investments. The LOC significantly increased the financial resources available to the NBE, contributed to its assets growth, which helped enhance its profitability. The financial covenants included in the LOC Agreement served to ensure that the NBE strengthens its institutional and operational capabilities, and applied prudent banking principles in the conduct of its business, thus helping to strengthen its financial governance and position.

5.2 Environmental Impact

5.2.1 The Egyptian Environmental Affairs Authority (EEAA) is responsible for the development and implementation of environmental regulations in Egypt. Environmental protection in the country, comprising the legal framework and its implementation by the EEAA, is considered good and meets international standards. According to the Egyptian Law No. 4 of 1994 on Environmental Conservation, and its implementation ordinances, all new projects in the country are subject to environmental screening, assessment and clearance by EEAA. The EEAA classifies projects into three categories from A to C depending on the magnitude of their impact

on the environment. Projects considered to have high environmental impact require a full EIA, while those with medium impact require only a limited assessment report equivalent to the Bank’s Environmental and Social Management Plan (ESMP). The EEAA’s procedures are in line with the Bank’s environmental guidelines.

5.2.2 The environment ranks high in the list of priorities at NBE and this is reflected in its lending operations. There is an Environmental Unit within the Credit Division, and new environmental policy guidelines have been developed. NBE’s credit policy requires that the projects that it finances go through the EEAA environmental screening, and meet all the other requirements to be able to get an environmental clearance from the Authority. The production of the environmental clearance is a requirement for credit approval. After project approval, the NBE’s Environmental Unit monitors closely the implementation of agreed environmental management plans. The PCR mission confirmed that the projects financed by the Bank’s LOC obtained the necessary environmental clearance from the EEAA. Apart from the general environmental compliance, there were also some important success stories with regards to the environment, such as the Egyptian Salts and Minerals Company Limited (EMISAL), a company established to help improve the environmental situation of one of the biggest lakes in Egypt (see box below).

Box 2

Egyptian Salts and Minerals Company Limited (EMISAL)

Background: Egyptian Salts and Minerals Company (EMISAL) was established in 1984 to

“save” Lake Qarun, in Fayoun Province of Egypt. With the introduction of a new irrigation th system in the Province in the early 19 Century, lake Qarun started to suffer from extra salination. The lake was gradually converted from a fresh water lake, with fresh water fish, into a salt water lake, suitable only for fish of the marine environment. It was eventually decided that the only way to save the lake is to get rid, in an economic way, of the excess salts added to it annually. EMISAL was thus established with the primary objective of extracting 300,000 tons of salts from the lake every year.

Company’s Activities: The company currently produces anhydrous sodium sulphate (capacity:

100,000 tons p.a.) for industrial use, and sodium chloride (capacity: 150,000 tons p.a.) for both industrial and domestic uses. The company is now building a new 27,000 tons p.a. magnesium sulphate plant.

Activities Financed by the Bank’s LOC: The Bank’s LOC, through the NBE, is part financing the new magnesium sulphate plant. The project involves construction of the building to house the plant, as well as procurement of equipment. The total project cost was US$ 9.5 million, with

US$ 2 million coming from the LOC.

Status of Implementation and Operation of the Project: The project’s implementation was on going as at the time of the PCR preparation. The plant building was under construction, while the equipment has been ordered.

Project Development Impact: The EMISAL project has fulfilled its objective of saving lake

Qarun. Since its establishment in 1984, the salinity level of the lake has been stabilized, and its deterioration halted. The new magnesium sulphate plant, being financed with the Bank’s LOC, would further assist the fulfillment of the objective. The project also has economic and social benefits, as some of the product would be sold externally to generate foreign exchange, while the plant will employ 200 staff, 130 of whom will be new employees.

6. PROJECT SUSTAINABILITY

The sustainability of the LOC is dependent on the sustainability of the subprojects financed, as well as the institutional sustainability of NBE. Project records and visits to the site by Bank staff show that the subprojects financed by the LOC were well implemented, and the completed ones are operating satisfactorily. All the subprojects are current in their debt service to NBE, which attests to quality of NBE’s selection process, and the satisfactory operations of the projects. With respect to NBE, the institution continues to post strong and improving operational and financial performances as discussed in Section 4.3. The NBE is expected to remain a strong and creditable financial institution in Egypt.

7. PERFORMANCE OF THE BANK AND THE BORROWER

7.1 Performance of the Bank

7.1.1 The Bank’s overall performance is judged satisfactory, even though the assessment of NBE’s capacities in certain areas were over optimistic. The Bank’s decision to deliver its industrial and tourism sectors support operations in Egypt through the NBE turned out to be the correct decision, given the satisfactory performance of the LOC. The Bank’s assessment of the NBE as a strong financial institution capable of effectively implementing the LOC also turned out to be correct. However, the Bank’s assessment of NBEs management information systems might have been optimistic given the difficulties experienced in collating information in respect of financed subprojects. Similarly, the condition requiring NBE to reduce its NPLs ratio from 12% to 10% within a specified period might not have taken adequate consideration of the underlying causes of high NPL ratios in the Egyptian banking system. Rather than improving, NBE’s NPLs ratio actually deteriorated during the implementation of the LOC.

7.1.2 The Bank performed well in addressing constructively emerging problems and correcting them promptly notably during supervision missions. The Bank carried out several supervision missions, sometimes twice in a year, in order to assist NBE in the implementation of the LOC. The supervision missions were effective, and were largely responsible for making it possible for the LOC to be fully utilized.

7.2. Performance of the Borrower and Executing Agency

The NBE’s overall performance, as the Borrower and Executing Agency of the LOC, is satisfactory. The NBE moved quickly to fulfill the conditions precedent to the effectiveness of the LOC Agreement, which greatly assisted the speedy implementation of the project. The NBE ensured that only economically viable subprojects, which were well prepared in accordance with the Bank’s guidelines, were selected for financing under the LOC. Disbursement requests were prepared in line with the Bank’s procedures, and the approved subprojects were effectively implemented. The Borrower performed less than satisfactorily in reporting but improved significantly as the implementation progressed. The NBE was highly committed to the successful implementation of the LOC.

8. OVERALL PERFORMANCE AND RATING

8.1 The overall performance of the LOC is presented in Annex 4. The overall project implementation performance is rated satisfactory. The LOC was signed within six months after approval, and declared effective within two months after signature. The line was implemented

17 faster than was estimated at project appraisal, and was 100% disbursed. NBE complied with the operational conditions and financial covenants attached to the loan, except on the issue of its NPLs. Reports submission presented some difficulties at the early stages of the project, but the NBE, with the Bank’s assistance, reorganized its internal processes and beefed up its institutional mechanisms for collating information regarding the implementation of the LOC. After these, reports submission became satisfactory, with project progress reports and audit reports submitted as required by the Bank. The Bank’s performance in respect of the project was also satisfactory.

8.2 The project outcome is rated satisfactory. The relevance of objectives is, in retrospect, fully confirmed, and the project achieved its major objectives. The inability of the project to address wider financial sector issues in Egypt is considered a weakness, although this is a general problem with LOCs. The NBE has demonstrated its commitment to the subprojects financed by the LOC, and the project achievements are considered highly likely to be sustained.

9. CONCLUSIONS, LESSONS LEARNED AND RECOMMENDATIONS

9.1 Conclusions

The Line of Credit to NBE was conceived on the background of the GRE’s economic reform program. The LOC was designed to support the reform program, particularly the GRE’s resource mobilization efforts as well as its efforts to promote private sector initiatives and investments in the country and to create employment. The LOC achieved its development objectives satisfactorily. Despite initial delays during preparation and some difficulties in the early stages of implementation, the LOC can be considered successful since it had a meaningful and positive impact in support of SMEs and the industrial and tourism sector. Given the successful implementation of this LOC and the positive impact it had both at sectoral, economic and institutional level, within NBE, it should be expanded to consolidate the gains of the first LOC and ensure wider reach of the SME sector.

9.2 Lessons Learned

The following lessons were learnt from the implementation of the LOC:

(i) The project demonstrated the importance of the Bank’s willingness to consider alternatives to its standard requirement for Government guarantee for public sector operations, in the overall interest of addressing client needs and achieving the Bank’s overriding goal of poverty reduction in its RMCs. The acceptance by the Bank of the guarantee of the Central Bank of Egypt for the LOC in place of the sovereign guarantee of the Government of Egypt enabled the operation to proceed, and its development objectives to be achieved. It is therefore recommended that the Bank consider, on a case by case basis, alternative guarantee arrangements for its public sector operations apart from Government guarantees.

9.3 Recommendation

Given the importance of the banking sector and the financial sector in general in spurring economic growth and poverty alleviation, and the limitation of lines of credit to address constraints at the sector level, it is recommended that the Bank provide adequate support to efforts to reform the financial sector in its RMCs. Such support would ultimately result in strong financial intermediaries that would be able to effectively implement the Bank’s lines of credit operations in the countries.

ANNEX 1

LINE OF CREDIT TO THE NATIONALBANK OF EGYPT

This map was provided by the African Development Bank Group exclusively for the use of the readers of the report to which it is attached. The names used and the borders shown do not imply on the part of the Bank and its members any judgment concerning the legal status or a territory nor any approval or acceptance of these borders. 6 Annex 2

REPUBLIC OF EGYPT LINE OF CREDIT TO THE NATIONAL BANK OF EGYPT

NBE’s Organization Chart

Chairman • Chairman Office • Security Department, Inspection Division, Legal Division, Complaints Division, Public Relations

Control and Support Groups Business Groups

Risk management Logistics & General Affairs Investment Banking Corporate Banking • Credit Risk • Premises & constructions • Direct Investments (PE) • Credit Marketing • Securities & asset • Credit Follow-up • Supplies & Logistics • Feasibility Studies & management • Non-Credit Risk Project Appraisal • Credit Investigations • Investment Trustees • Corporate Finance & Advisory • Market Research

MIS & IT Branch Management Special Cases • IT & Data processing Finance & Control • Branches • Credit Settlements • MIS • Financial Control • Branches Management • Workouts • Archives • Financial statements & unit budgeting • Branches Re-engineering • Correspondent Accountg.

Human Resources • HR Planning Treasury & Int’l Banking Retail Banking Research & Development • Training • Correspondent Banking • Retail Products & Services • Economic research • Personnel • Int’l Financial Services • Private Banking • Operational Development • Payroll • Treasury & Dealing Room • Policies & procedures • Staff Services Division

Annex 3 Page 1 of 2

REPUBLIC OF EGYPT SMALL AND MEDIUM ENTERPRISES SUPPORT PROJECT NBE'S HISTORICAL BALANCE SHEET (LE MILLION) As at 30 June: 2005 2004 2003 2002 2001 Assets Cash and balances with Banks 50,973 31,801 28,569 18,347 14,924 Treasury Bills and Government Securities 21,721 22,296 20,001 16,117 7,229 Trading Securities (net of provisions) 933 6,346 5,149 4,257 2,413 Loans and Acceptances (net of provisions) 64,808 58,856 56,433 53,130 48,436 Non-Trading Securities 13,710 6,462 6,176 7,125 8,586 Other Assets incl. Invt in Subs 7,475 5,454 6,326 6,391 5,118 Fixed Assets (less accumulated depreciation) 495 486 439 412 424

Total Assets 160,115 131,701 123,093 105,779 87,130

Liabilities and Shareholders' Equity Due to Banks 8,249 9,377 13,953 9,845 8,370 Customers' Deposits 134,304 105,328 92,573 81,460 67,182 Of which Demand Deposits 8,380 7,800 6,703 6,448 6,173 Time and Notice Deposits 46,529 43,500 42,904 45,352 37,422 Savings Deposits 39,064 38,728 40,682 27,972 21,218 Other Deposits 40,331 15,300 2,284 1,688 2,369 Credit Balances and Other Provisions 8,510 6,239 6,677 6,897 4,645 Long-Term Loans 2,452 4,389 4,017 3,256 2,979

Total Liabilities 153,516 125,333 117,220 101,458 83,176

Shareholder's Equity Paid Up Capital 2,250 2,250 2,250 1,000 1,000 Reserves 3,992 4,118 3,623 3,321 2,954 Net Profit for the year 358

Total Shareholders' Equity 6,599 6,368 5,873 4,321 3,954

Total Liabilities and Equity 160,115 131,701 123,093 105,779 87,130

Contingent Liabilities and Other Commitment 97,872 87,251 78,447 67,051 61,131

Annex 3 Page 2 of 2

REPUBLIC OF EGYPT LINE OF CREDIT TO THE NATIONAL BANK OF EGPT NBE’S HISTORICAL INCOME STATEMENT

2005 2004 2003 2002 2001

Interest on Loans and Balances with Banks 7799 5500 5272 5279 5195 Interest from Treasury Bills and Bonds 2162 2044 1863 1341 1223 Less Costs of Deposits and Borrowing 8254 6260 6160 5919 5615

Net interest 1707 1284 975 701 803

Commisions and Fees on Banking Services 1339 1254 1174 1156 1053 Shares and Investment Certificates Deposits 323 370 218 219 204 Profit / (Loss) on Selling Trading Securities 840 99 1,054 140 74 Profit on Foreign Exchange Operations 190 -9 -1,020 -476 -44 Other Revenue 139 51 171 109 13 Net Operating Income 4,538 3,049 2,572 1,849 2,103

Total Income 12,792 9,309 8,732 7,768 7,718 Less Provisions 2,530 1,602 1,267 712 1,028 Administrative Overheads and Other Expenses 1,337 1,089 743 677 482 Revaluation Differences on Non-Trading Securities 252 -27 209 76 65

Total Expenses 4,119 2,664 2,219 1,465 1,575

Operating Profit 419 385 353 384 528 Non Operating Profit 1 2 2 0 0

Profit Before Tax 420 387 355 384 528

Less Taxes 6349303463 Net Profit for the Year 357 338 325 350 465

Annex 4 Page 1 of 2

ARAB REPUBLIC OF EGYPT LINE OF CREDIT TO NBE PROJECT COMPLETION REPORT

PROJECT IMPLEMENTATION PERFORMANCE

Component Indicators Score Remarks (1 to 4) 1. Adherence to Time Schedule 3.5 Project completed ahead of schedule 2. Adherence to Cost Schedule N/A 3. Compliance with Covenants 3 Complied with loan conditions and covenants, except that regarding the ratio of NPLs 4. Adequacy of Monitoring & Evaluation 2 Supervision missions adequate. Progress and audit reports and Reporting submitted, after initial difficulties 5. Satisfactory Operations 4 All subprojects are operating satisfactorily and have good loan repayment performances. Overall Assessment of Implementation 3.1 The overall implementation performance of the LOC is Performance rated satisfactory.

BANK PERFORMANCE

Component Indicators Score Remarks (1 to 4) 1. At Identification 4 The Bank identified and initiated discussions with NBE as a strategic partner in the delivery of the Bank’s assistance for financing of SMEs. Bank also made strategic policy decision to accept the guarantee of the CBE for the LOC instead of that of the GRE. Project reflects GRE priorities and the recommendations of the CSP were taken into consideration in the project. 2. At Preparation/Appraisal of Project 3.5 The project was well prepared with complete desk review done. There was close co-operation with Legal, Disbursement, FTRY and Audit in the course of the preparation/appraisal of the project. 3. At Supervision 3 Bank’s supervision performance is satisfactory. Adequate supervision missions were carried out, from Operations, Disbursement and Internal Control Departments. Mission composition generally adequate. Overall Assessment of Bank Performance 3.7 The Bank’s overall assessment is rated satisfactory plus.

ANNEX 4 Page 2 of 2 PROJECT OUTCOME

No. Component Indicators Score Remarks (1 to 4) 1 Relevance and Achievement of 3.1 The project achieved its major objectives, and also achieved a Objectives meaningful development impact. i) Macro-economic Policy 2 Project has little or no impact on macro-economic policies, but assisted in meeting macroeconomic objectives.. ii) Sector Policy 2 Project supported Government strategy in the sector. iii) Physical 3.5 The physical implementation of the subprojects financed by the LOC were successfully completed. iv) Financial 4 Adequate financial resources were made available. v) Poverty alleviation & Social & 3.5 Project had strong impact on poverty alleviation, mainly Gender through job creation vi) Environment 3 The sub projects complied with environmental regulations, while some implemented environmental measures had a significantly positive impact on the environment vii) Private Sector Development 3.5 Project promoted private sector development as most of the LOC resources went to private sector projects.

2 Institutional Development (ID) 2.5 The achievement of institutional development objectives is substantial and sustainable. i) Institutional Framework including 3 Project assisted the institutional development of NBE. restructuring ii) Financial and Management 2 Project’s financial and management information systems were Information Systems, including weak and needed improvements during implementation. Audit Systems Reports on sub projects were not always readily available. 3 3.4 The sustainability of the achievements and benefits of the Sustainability project is likely. i) 3.5 NBE is committed to the sustainability of the subprojects and Continued Borrower the strength of sub-borrowers financial situation, and most Commitment project achievements are highly likely to be sustained. ii) 3 The institutional framework for NBE is improving Institutional Framework satisfactorily. iii) 3.5 The subprojects financed are technically viable, and Technical Viability and Staffing appropriately staffed. iv) 3.5 The financed subprojects demonstrated good financial viability, Financial viability including cost and loan repayment performance of sub borrowers has been recovery systems good iv) 3.5 The subprojects financed demonstrated economic viability, and O & M facilitation (availability of would be able to meet their O & M financing needs from recurrent funding, foreign operations. exchange, etc.) 3.2 The overall assessment of the project’s outcome is satisfactory. Overall Assessment of Outcome

ANNEX 5 ARAB REPUBLIC OF EGYPT LINE OF CREDIT TO NBE PROJECT COMPLETION REPORT

List Of Documents Consulted

1) Appraisal Report – Line of Credit to NBE

2) Loan Agreement between the National Bank of Egypt and the African Development Bank

3) Annual Project Audit Reports

4) Annual Financial Statements of NBE (2001 – 2005)

5) Central Bank of Egypt’s Reports (various issues)

6) Egypt Private Sector Country Profile (September 2005), African Development Bank

7) Archives of Financial data and correspondence available in the Bank (Disbursement data, Back-to-Office Reports, Supervision Reports, Internal memoranda, correspondence exchanged with the Borrower and Executing Agency, etc.).