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X4T INATIONAL BA^NK FOR RECONSTRUCTIOIN AldD DEVELOPIMENT Public Disclosure Authorized

REPORT AND RECOM.IENDATTONS

OF THE

PRESIDENT Public Disclosure Authorized TO THE

BOARPD OF EXECUTIVE DIRECTORS

ON THE

LOAN APPLICATION

OF THE

BANK OF FINLAND Public Disclosure Authorized GUMRANTE IM

BY THE

REPUBLIC OF FIVIAND

July 22, 1949 Public Disclosure Authorized INTERNATIONAL BANK FOR

RECONSTRUCTION AND DEVELOPMENT

REPORT AND RECQ\MEND&TIONS OF THE PRESIDENT TO THE XECUTIVE DIRECTORS CONCERNING THE PROPOSED LOAN TO THE BANK OF FINLAN

Page

PART I History of Negotiations 1

II Description of the Proposed Loan 2 III Appraisal of the Proposed Loan

A. Finland's EconOm7nC Position 3

B. The Projects 5 C. Appraipal of the Proposed Loan 7 IV Compliance with the Articles of' Agreement 8

V Recommendation 10

Appendix I Loan and rGuarantee Agreements

IT Finland's Economic Position III The Projects

IV Report of the Statutory Loan Committee CONFIDmITIT.IA

INTERNATIONAT BAT.1 FOR RECONISTRUCTIOT AND DEVELOPItITT

REPORT MSD RSCOOHIfINDATIONS OF TIM PRESIDMNT TO TIE BXECUTIVE DIRECTORS CONCERNING THE PROPOSED LOAN TO THE BANK OF FINLi0ND

1. I submit herewiith the following report and recommendations wYith

regard to an application by the Bank of Finland for a loan of $12,500,000.

PART I -HISTORY OF NEGOTIATIONS 2. In February 1948 the MIinister of Finland in Ltashin.gton announced Pinland.s intention of a.Oplying to the Bank for a loan of $100 million for reconstruction p?urposes, and in the followring summier the Finnish Government

suibmitted, at the recluest of the Bank, information relTting to Finlandis economic position.

3. In September 1948 the Fixnnish Government made an informal applica- tion for a reconstruction loan of $100 million to be spent in the four years 1949-1952, -for agriculture, the wood.working *nd-ustries, electric nowrer develop- ment, the cement and lime industry and transportation. 4. Followving receipt of thio application, the Bank sent a mission to Finland, wrhich spent from October 28 to November 17 assessing the eccno;mic situation, visiting indu$trial establishments, hydroelectric installations, ports and railways, and discussing the loan application with Government officials and leaders of the industries concerned. In the light of the in- formation so obtained, the Bank concluded tiat a loan of $12,500,000 would be appropriate. It was considered that the corrower shoudlcl be the Bank of Finland, that the loan should carry the guarantee of the Finnish Governlment, and that it shou.ld be for a term of not more than 15 years, amortization commencing in 1953. -2-

5.. Negotiation of a loan on this basis was started. on February 1, 1949.

PART I-DESCRIPTION OF TBE PR0POS:E) L0ON Borrower

6. The borrower will be the Banlk of Finland., rhich wtas foundced as a state bannk in 1811 and which has operated, since 1867, wUider the supervision and guarantee of the Finnish Diet. The Bank of Finlanid has the nowers and re- sponsibilities of a central bank. Guarant or

7. The Finnish Government will guarantee fully the payment of iprincipal, interest (includ.ing commission) and other charges on the loan, eand all other obligations of the Bank of Finland in respect thiereof. The B:ank has been assured that enabling legislation has been passed. Amount

8. It is proposed to lend a total of $1z,500,OQO, to be allocated as follows:

Electric Power $ 2,000,000

Wood.working Industries 10,000,000

Limestone Grinding 500,000

$12,500,000 Pur'jose

9. loan The is to provide the foreign exchange necessary to enable Finland to import equipment and materials for the coqmpletion of the first stage of an electric o-.ower program. for the reconstruction and mod.ernization of the woodworking industries, and for the expansion of limestone grinding capacity. The bull of such equipment axid material xill be -ourchased in the U.S.A. -3- Amortization

10. Tlhe loan will be repayable over a period of 15 years, Amortization will commence on February 1, 1953, and wlill continue thereafter by increasing half-yearly instalments sufficient to retire the entire loan by August 1, 1964. Interest Rate

11. The loan wrill bear interest (including commission) at the rate of LF- per annum. The half-yearly instalments of prir.cipal and interest, includ- ing commission, will amount to alpporoximately $"GPTa on and after February 1, 1953. It is proposed that the commission be established by the Bxecutive Di-rectors at 1% per ann,um.

Commitment Charge

12. A commitment charge will be *rovidced, for in accordance with the #bA present policy of the Bank.

Legal Instruments

13, Confidential drafts of the Loan and Guarantee Agreements are attached at Appendix I.

PART III - APPRAISATi OF TIHE ?ROPOS)ED LOAN

A. Finland t s Economic Position 14. A report on the economy of Finland dated JanuarY 31, 1949 has already been circulated to the Board. its conclusions, modified as necessary in the light of more recent developments, are given in Appendix II. Thlley may be summarized as followis:

15. Internal Political Situiation - Although the present minority government of Social Democrats (Socialists) is threatened by the "iDemocratic League" (a combination of Communists and left-wing Socialists) and, to a lesser degree, by the Agrarian Party, it has surwvived by narrow margiLns two votes of confidence in 1949 and may conceivably live through its remaining twvo years of office i-internal economic conflicts- are niot intensified andc if the international situation does not deteriorate. iInternational Relations - Internally, Finland continues to enjoy virtually complete independence in political and economic affairs. The neutrality of Sweden, and Finlandts deliberate propriety in her relations with the Soviet Union, have thus far enabled her to remain unaffected by the strained relations existing bet7ween the Great Powers. It must be acknowledged, however, that there are exceptional political riskcs in lending to Finland. 17. Reparations and Other Indemnities - Nearly 80% of the %650 million (in 1948 dollars) payable to the Soviet Union in the form of reparations and other indemnities had been paid off by the iniddle of 19h9, and, although some 414O million remain to be paid in the next three years, the burden oL such indemnities on the Finnish economy will disappear by the end of 1952. 18. Economic Effects of the *ar - Though Finland has gained slightly from wartime expansion of metals and engineering capacity, the war inflicted heavy losses in territory, population, agriculture, industry and shipping. 19. Post-war Recovery - Despite great handicaps, Finland has made a remarkable economic recovery. Both industrial production and the national income now exceed prewTar levels.

20. Internal Financial Situation - State finances are not now an infla- tionary element, and the restrictive credit policy adopted in 1947, but re- laxed slightly this year, has checked inflationary expansion of bank credit. in consequence, prices have until recently been Lalling steadily. Owing, how,,rever, to a reduction in the discount rate, derationing ad the recent devaluatiorn of 15%, the threat of inflation is still present and the situation wi32, continue to require careful handling. -5-

21. Postar Balan o - There have been balance of payments

deficits of {13 million in 1947 and million in 948..4.45 If, however, reparations

and other indemnities had been supplied on a commercial basis there would have

been balance of payments surpluses of ,`g6 r.Aillion and ',49 million, respectively, in these years.

22. Future Balance ofPay,ments - ProspeQts for Finnish exports appzear

favourable, despite the recent fall in world prices, and European couintries should

be able to absorb increasiz^ quantities of timtiber aind wood products over the next

few years, particularly since th3 Finnish Government has showm a readiness to make * whatever adjustments seem necessary, including devaluation, in order to maintain

exports. The Finnish Governme-nt estimates that the end of reparations deliveries

and conmletion of post-war reconstruction should, by 1953, result in a sur,)lus in the commercial balance of payments on current account suff'icient to cover debt amortization.

23. Finlandts dollar balance of payments is less favourable. To date she has had a series of deficits iinvolvin, dollar borrowing of ',18. million. There

are, however, good possibilities that a surx lus can be achieved by 1953.

24. External Debt - Finland's debt record is excellent; she paid off a debt

' of ',206 million (about ',500 million at present prices) betwieen 1930 and 1939. She

has built up a foreign debt of 0`362 mrillion since the war. However, even if this increased by as much as lOO million, as was at one tirmie contemplated, its service seems feasible, providing the marked neak of debt service in the middle 750s can be suceessfully negotiated by exteidixg existing credits or br new borrowing6

B. The Projects

25. The main consideration on which tlhe recommendations on, individual

projects are based, given in more detail in Appendix II, may be summarized as follows: -6-

Electric Powier

26. Shortage of electric power has been one of the main factors limiting production in the export industries and is still a handicap, although the position is improving. Total demand has risen in the last decade by 25% to

4.,000 million kwh a year. Owing partly to the loss of 30% of capacity in the ceded territories and partly to deficient water supply, output in 1948 was only 2,750 million kwh.

27. The development program now being carried out, mainly hydroelectric, should ensure adequate supplies if it can be completed on schedule. This program can be divided into tvwo stages. The first, involvirng 11 hydro- electric plants and 2 stean plants, is already far advanced and should be con- pleted by 1951. Its ccripletion will raise arnnual output to 5,l00 million kwh,

It requires foreign exchange of 16 million, of wrhich $h million can be pro- vided from Finland's own resuro-ices, The Bank proposes to finance the balance of 82 million. The second stage, which is not yet under Wry, is a long range program, which the Bank does not consider suitable for financing at the present time. Woodworking Industries

28. The present shortage of timber and wiood products in Europe, now being relieved by imports from the Wlestern Hemisphere, is likely to last for some years: and providing costs are in line with those of other European exporters, there would seem to be a ready malrket for all that Finland can supplyj 29. New equipment is needed in Finnish mills both to lower costs and increase output. W'Vithout it, the export industries would find it difficult in the face of declining world prices to avoid losses. The recent devalua- tion of the mark was necessitated by precisely such a situation but had to be smali in order to avoid a revival of inflation. IWith new equipment, -7.-

existing capacity can be made much more effective; it is estimated that it

could produce additional exports of about $100 million a year (at 1948 prices) by 1953.

30. The Bank proposes to lend an, amount of $10,000,000 for the most

urgent part of the modernization and expansion program. This amount appears

to be adequate in view of the $10,l000,000 credit granted by the Export-Import

Bank in September 1948 and the timber equipment loan of $2,500,000 contem- plated by the Bank.

Cement and Lime Industry

31. The industry is proposing to expand capacity and o-utput by about

70% of the 1948 level by 1952, at a total cost of '13.0 million, of wshich $7.2 million would be in foreign exchange.

32. Most of this expansion would be in the production of cement and lime, used mainly in the building industry. Since constructi.on of dwellings is already at a high level, and since the desirability of increasing the use of cement in building to release timber for export has not been established, the Bavi, does not consider that it should finance the expansion of capacity for cement and lime production as such.

33. Food production would be increased substantially if the application of limestone powder in agriculture, at present only one-third of prewar, could

Drought up to the prewar levels to correct the excessive acidity of the soil intensified by wartime neglect Qf drainage. The Bank accordingly pro- poses to finance in the amount Qf :'5QQ0,000 suoh additional equipment as is re-' quired to increase the output of limestone powder from the current level of 170,000 tons a year to 500,000 tons a year in 1953.

C. Appraisal of the Prooed Loan

34. The Loan will assi-st Finland in maintaining the pace of her econornic recovery. The electric power and woodworking projectp will help to redice costs in the export industries by increasincj the efficiency and capac- ity of existing production facilities and making possible, through elimina- tion of power more continuous operation. The limestone powder project will increase food production. The three projects will thus make possible further expansion of Finnish exports, including those to the dollar area, and a re- duction of imports, thereby improving the orospects of obtaini-ng a balance of nayments surplus, after the completion of reparations, sulfficient to ser- vice the foreign debt.

35. Furthermore, by increasing her exports to European countries, Fin- land will assist these countries to reconstruct their economies, and will in some measure help them to deal with their dollar deficits.

PART IV - COTAIPLIANCE WITH ARTICLES OF AGREEMENT

Compliance w.mith Article I of the Articles of Agreement

36. The proposed loan is within the purposes of the Bank as set forth in Article I of its Articles of Agreement. The Droceeds of the loan will be used to pay for the import into Finland of equipment, materials and services required for repair7 extension and modernization of procluctive facilities in the wroodworking inidustries, for the completion of the first stage of the elect-ric power program novrr in progress, and for the expansion of capacity for producing agricultural limestone. Thus, the proposed loan comes within the purpose specified under paragraph (i) of Article I of assisting in the recon- struction and development of the territory of a member of the Bank, by facili- tating the investment of capital to restore the economy of such member which was disturbed by war.

Compliance writh Article III, Section L, of the Articles of Agreement

37. The proposed loan conforms to the applicable provisions of Section 4 of Article III of the Articles of Agreement of the Bank. -9-

(a) The Republic of Finland, the member in whose territories the

prop,osed projects will be located, ia not itself the borrow.er but it ijill fully

guaraiatee the repayment of -the -principal and paymernt of int-eres L and other 6iarg&s on the loan.

(b) Inquiries lmade by the B,nk and other available informution

furnaished sutisf.fctory evidence that in the prevailing market conditlions the

3anlk of Finland would be unable otherwise to obtain a loan urnder conditions

which, in the opinion of the Bank, are reasonable.

(c) There is annexed hereto aind marked Appendix TV a res?ort of

the comrmittee provided for in paragraph (iii) of article III, Section 4,

recoimmending each of the projects for which the loan is to be made,

(d) It a.:ppears that the rate of interest and other charges are

reasonable and that such rate, char es and the schedule for reparnent of

I)rincipal are appropriate to the projects.

(e) There is satisfactoryr evidence that in makinv the propoosed

loan the Bank will be actin-', prudently in the interests both of the Republic

of Finland arid of the mlrnbers of the Banlc as a whole. Due re,ard has been paid to the prospects that the Bank of Finland and the Republic of Finland will be in a position to meet their obli,gdtions under the pro-)osed loan.

(f) The pro)osed loan is for the purpose of specific projects of reconstruction and development within the meanin, of parav,raph (vii) of oection 4 of Article III.

Co liance with Articl III Section ) of the iirticles of .,reement

38. The form of Loan Agreement contains provisions to ensure that the proceeds of the loan will be used only for the purposes for which the loan is granted. PART V - RECO1AIAENDATION

39, I recommend that the loan to the Bank of Finland in the amount and on the conditions stated above be granted.

Eugene R. Black President

Qttachments

July 22, 1949