Lgt\>(vP RESTRICTED Copy No. 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.