Shanghai Investment and Trust Corporation (Loan 933-PRC, LOE 7031, And TA 1086-PRC)

7/31/2019 Shanghai Investment and Trust Corporation (Loan 933-PRC, LOE 7031, And TA 1086-PRC)

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ASIAN DEVELOPMENT BANK PPA: PRC 21197

PROJECT PERFORMANCE AUDIT REPORT

ON THE

SHANGHAI INVESTMENT AND TRUST CORPORATION PROJECT(Loan 933-PRC, LOE 7031, and TA 1086-PRC)

IN THE

PEOPLES REPUBLIC OF CHINA

December 2000


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CURRENCY EQUIVALENTS

Currency Unit Yuan (Y)

At Appraisal At Project Completion At Operations Evaluation(October 1988) (October 1995) (September 2000)

Y1.00 = $0.2687 $0.1183 $0.1208$1.00 = Y3.7221 Y8.4518 Y8.2773

ABBREVIATIONS

ADB Asian Development Bank

EA Executing AgencyERPS exchange risk pooling system IDC interest during constructionITIC international trust and investment companyLOC line of creditLOE line of equityMIS management information systemMOF Ministry of FinanceNBFI nonbank financial institutionOEM Operations Evaluation MissionPCR project completion report

PPAR

project performance audit reportPRC Peoples Republic of ChinaSITEN Shanghai SITICO Enterprise Company LimitedSITICO Shanghai International Trust and Investment CorporationSMG Shanghai Municipal GovernmentSMZ Shanghai Municipal ZoneSOE state-owned enterpriseTA technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December.(ii) In this report, $ refers to US dollars.

Operations Evaluation Office, PE-561


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CONTENTSPage

BASIC DATA ii

EXECUTIVE SUMMARY iii

I. BACKGROUND 1

A. Rationale 1B. Formulation 1C. Purpose and Outputs 2D. Cost, Financing, and Executing Arrangements 2E. Completion and Self-Evaluation 3F. Operations Evaluation 4

II. PLANNING AND IMPLEMENTATION PERFORMANCE 4

A. Formulation and Design 4B. Achievement of Outputs 6C. Cost and Scheduling 7D. Procurement and Construction 7E. Organization and Management 7

III. ACHIEVEMENT OF PROJECT PURPOSE 8

A. Performance of Subprojects 8B. Performance of the Operating Entity 9C. Technical Assistance 12D. Sustainability 13

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS 13

A. Socioeconomic Impact 13B. Environmental Impact 13C. Impact on Institutions and Policy 14

V. OVERALL ASSESSMENT 15

A. Relevance 15B. Efficacy 15C. Efficiency 15D. Sustainability 15E. Institutional Development and Other Impacts 16

F. Overall Project Rating 16G. Assessment of ADB and Client Performance 16

VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS 17

A. Key Issues for the Future 17B. Lessons Identified 17C. Follow-Up Actions 18

APPENDIXES 20


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BASIC DATAShanghai Investment and Trust Corporation Project 1 (Loan 933-PRC)

Project Preparation/Institution Building

TA No.TA Name Type Person-

MonthsAmount

($) Approval

Date1086-PRC Institutional Support to SITCO A&O 36 450,000 13 Dec 1988

Key Project Data ($ million) As per ADB

Loan Documents ActualTotal Project Cost 100.00 87.20

ADB Loan Amount/Utilization 100.00 87.20 ADB Loan Amount/Cancellation 12.80 ADB Loan Prepayment 55.10Line of Equity 3.00 0.00

Key Dates Expected Actual Appraisal 18 Aug-3 Sep 1988Loan Negotiations 16-17 Nov 1988Board Approval 13 Dec 1988 13 Dec 1988Loan Agreement 28 Aug 1989Loan Effectiveness 27 Nov 1989 27 Nov 1989Loan Closing 27 Nov 1993 27 May 1994Loan Repayment 15 Sep 2003 24 Oct 1997Months (effectiveness to completion) 48 54

LoanBorrower Government of the Peoples Republic of ChinaExecuting Agency Shanghai Investment and Trust Corporation

Line of EquityAdministering Institution Shanghai SITICO Enterprises Company, Limited

Mission Data

Type of Mission No. of Missions No. of Person-Days Fact-Finding 1 42

Appraisal 1 85Project Administration

Review 1 14Project Completion 1 24

Operations Evaluation 1 24

A&O = advisory and operational, ADB = Asian Development Bank, SITICO = Shanghai International Trust andInvestment Corporation, TA = technical assistance.1 At the time of establishment, its name was Shanghai Investment and Trust Corporation. However, in 1993, its

name was changed to Shanghai International Trust and Investment Corporation (SITICO). The name SITICO isused in this report.


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EXECUTIVE SUMMARY

In December 1988, in line with its interim operational strategy on the Peoples Republicof China (PRC), the Asian Development Bank (ADB) approved a $100 million line of credit(LOC) to the PRC. It was relent to Shanghai International Trust and Investment Corporation(SITICO), the Executing Agency, for onlending to industrial enterprises in Shanghai MunicipalZone for technology upgrading and rehabilitation of obsolete and inefficient plant andmachinery. A line of equity (LOE) of $3 million was also approved for Shanghai SITICOEnterprise Company Limited (SITEN), a subsidiary of SITICO, to make investments in majorityprivately owned enterprises in industry or service sectors to support the Governments efforts inencouraging foreign direct investment and technology transfer. A technical assistance (TA)grant of $450,000 was provided under the Japan Special Fund to help build institutionalcapacity. The objectives of the Project were to (i) help finance technology upgrading of viableenterprises, (ii) strengthen the role of the SITICO group as a major source of equity financingthrough SITEN, and (iii) guide and contribute to further development of SITICO and SITEN.

The loan, to be drawn in various currencies equivalent to $100 million based on ADBsforeign exchange risk pooling system, was funded from ordinary capital resources and attracteda variable interest rate. The loan had a term of 15 years including a grace period of three years.SITICO was expected to add a minimum spread of 1 percent and pass on interest rate andexchange rate risks to the subborrowers. The loan utilization period was four years, and themaximum size of the subloans was $10 million. The subproject sponsors were required tocontribute 15 percent of the total subproject cost for existing projects and 20 percent for newprojects. Expenditure incurred by subborrowers up to 90 days prior to receipt of subloandocuments by ADB was eligible for financing under the LOC.

The project completion report (PCR), although fairly candid and objective, did not specifyan overall performance rating for the Project, but stated that loan utilization and subprojectperformance were generally satisfactory. With the benefit of hindsight, it indicated that thecovenants should have been designed to cater to the specific needs of nonbank financialinstitutions in the PRC. In particular, the PCR illustrated that covenants should have insisted oninstitutional independence of SITICO, clearly defined reserves for doubtful debts, and specifiedmore realistic financial ratios for SITICO given its rapid expansion. The Operations EvaluationMission generally agrees with the PCR, but believes that it could have better analyzed theinformation available at the time to draw more meaningful lessons for future projects. Thisevaluation focuses on (i) effectiveness of project design, (ii) achievement of objectives,(iii) capacity building, (iv) monitoring and supervision, (v) performance of SITICO,(vi) performance of subprojects, and (vii) development impacts and sustainability.

The project design incorporated flexibility on retroactive financing and subloan size limitsthat were responsive to potential demand. However, the design had some weaknesses as well.It followed the traditional LOC approach without adaptation suited to an economy in transition.

Also, it was inappropriate to pass on the foreign exchange risk of a long-term loan tosubborrowers without access to any risk mitigation mechanism. Market conditions at the timemade utilization of the LOE under ADBs guidelines impractical. Finally, the Projectconcentrated only on the credit needs of the enterprises and did not ensure that they wouldoperate in an appropriate enabling environment to sustain their transition to a market economy.

All 23 subprojects financed under the LOC were sponsored by state-owned enterprisesin various industry sectors. To a large extent, the subprojects were successful in upgrading their equipment and surviving the transition to a market economy. The timing of the financing for theProject was opportune, as the LOC became effective when some other sources of foreign


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currency loans had virtually dried up. In the absence of the loan, these state-owned enterpriseswould have faced difficulty in maintaining efficient production given the obsolete state of their machinery and technology. During implementation, however, several subloans had to berestructured due to severe financial problems caused by exchange rate adjustments.

The TA provided consultancy services for a total of 12 months to SITICO and SITEN for project appraisal, monitoring, and supervision, as well as financial planning and liabilitiesmanagement. It also provided overseas training for 13 middle managers in project appraisal andsupervision, which appears to have been successful. Some of the staff members who receivedthe overseas training are now in key management positions. The first computer hardware andsoftware system for financial management was also set up as a result of the TA.

SITICOs operations witnessed significant growth in the 1990s in its various lines of business. Since 1997, SITICO has been proactive in its asset management, focusing on qualityby tightening risk management, reclassifying assets, adjusting its credit structure, and improvingits portfolio quality and return on capital. It streamlined its operations, diversified investments,strengthened institutional capacity, and improved operational strategies and practices in severalareas, including project appraisal and management information systems. Given normalcircumstances, it is likely that SITICO will be able to survive competition and invest prudently inthe PRCs changing environment.

The overall Project is rated successful. However, the overall assessment is at the lower end of what constitutes successful due to the weaknesses in design that affected the efficacy of the Project. With ADBs interim operational strategy, its objectives were appropriate at the time itwas formulated. A majority of the subprojects that benefited from the financing are operatingnormally. Some subprojects faced difficulties and SITICO has helped them survive. SITICO, asan institution, has fared relatively well and has gained prominence in certain areas such asinvestment banking, aided by project inputs. In addition, the TA was helpful in buildinginstitutional capacity of SITICO through the management information system and financialmanagement upgrades and human resource development through training. The LOE waspremature and was not utilized.

ADB projects of a similar nature in transition economies should move away from thetraditional LOC design, carefully consider the constraints and needs of enterprises in a transitioneconomy including their ability to cope with reforms, and provide for associated risk factors.They should also ensure, through policy dialogue, project design, or donor coordination that notonly are enterprises credit needs met but also that they have an enabling environment tosustain their transition to operating in a market economy.

Several enterprises operating in the Shanghai Municipal Zone lack operationalautonomy and commercial viability. The Government needs to undertake restructuring of these,encourage more autonomy in management, and ensure that they have appropriate links withinand outside the PRC to respond to technological changes and market conditions. Currentprocedures followed by international trust and investment companies promote unhealthy anddistorted delays in portfolio cleanup. The Government, in addition to reviewing its BankruptcyLaw, should require international trust and investment companies to reclassify their assetsaccording to standard international accounting practices and allow them the freedom to allocatesufficient provisions before profit to depict an accurate picture of their financial position.

SITICO has taken significant steps to reorganize its structure so as to achieve its marketpotential and is further automating its business processes using the latest technology to becomecompetitive in its business niche. To continue its focus on prudent and efficient operations, itshould (i) strive to use staff with specialization in handling problem accounts and managingnonperforming loans, (ii) increase the level of loan-loss provisions, and (iii) effectively carry out


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loan and investment monitoring through the use of a risk-rating system capable of providingearly warning signals and of segregating problem assets at an early stage.


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I. BACKGROUND

A. Rationale

1. The early years of the operations of the Asian Development Bank (ADB) in the Peo plesRepublic of China (PRC) were guided by an interim operational strategy developed in 1987. 1 Tomaximize the level of ADBs effectiveness, the strategy required operations to focus on theheavily populated eastern region and three high-priority sectorsindustry, energy, andinfrastructure. As such, Shanghai Municipal Zone (SM Z) was among the first recipients of ADBloans. The Shanghai Investment and Trust Corporation 2 Project was intended to modernize andrehabilitate obsolete and inefficient plant and machinery of the enterprises located in SMZ.Despite its long history as PRCs economic center, the growth and performance of SMZ hadlagged behind other provinces during 1982-1986. The loan was to help redress SMZs industrialdecline by providing foreign exchange resources to finance the cost of imported equipmentneeded by small and medium-sized industrial enterprises.

2. The Shanghai International Trust and Investment Corporation (SITICO) was establishedin 1979 under the ownership and supervision of the Shanghai Municipal Government (SMG).SITICO is a leading international trust and investment company (ITIC) in Shanghai, and hasplayed an important role in fostering the economic development of SMZ by providing long-termloans mainly to state-owned enterprises (SOEs) and PRC-foreign joint ventures. Its mainoperational activities includedbesides providing long-term (foreign or local currency) loansmaking equity investments in domestic and foreign joint ventures, providing consultancyservices, assisting in the procurement of machinery and technology from abroad, and helping to set up joint ventures in SMZ. To undertake these activities, SITICOs articles of association 3 allowed a variety of activities, including lending and investment, consulting and advisoryservices, accepting savings and trust deposits, issuing bonds, international settlement of lettersof credit, and dealing in spot and forward currencies.

B. Formulation

3. Subsequent to preliminary discussions with ADB staff in 1987, the Governmentrequested a credit line from ADB during the Country Programming Mission in March 1988 tomeet a part of SITICOs foreign exchange requirements for providing assistance to state-owned,collectively owned, and privately owned industrial enterprises, including joint venture enterpriseslocated in SMZ. A project preparatory technical assistance (TA) was not considered necessary,and a Fact-Finding Mission was mounted in June 1988. The Appraisal Mission of August 1988confirmed that the Project had been given high priority by the Government, and that SITICOwas a suitable channel for ADB financing (described below).

1 The PRC became a member of ADB in March 1986. The first country operational strategy study for the PRC wasprepared in 1991.

2 At the time of establishment, its name was Shanghai Investment and Trust Corporation, which was changed toShanghai International Trust and Investment Corporation (SITICO) in 1993. The name SITICO is used in thisreport.

3 See Appendix 1 of the project completion report.


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4. In December 1988, ADB approved a $100 million line of credit (LOC) to the PRC for relending to SITICO, and a line of equity (LOE) of $3 million to Shanghai SITICO Enterprise Co.Limited (SITEN), a subsidiary of SITICO, to support the Governments efforts to encourageforeign direct investment and technology transfer. In addition, a TA grant of $450,000 wasprovided under the Japan Special Fund for institutional capacity building of SITICO and SITEN.

At the time of project approval, ADB w as the only multilateral agency assisting SITICO improve

the performance of the industry sector.4

The objectives of the Project were to (i) help the PRCfoster technology upgrading and modernization of the industry sector by financing equipmentinvestments of viable enterprises in SMZ, (ii) strengthen the role of the SITICO group as a major source of equity financing through SITEN, and (iii) guide and contribute to institutionaldevelopment of SITICO and SITEN.

5. At the time of project appraisal, the PRCs foreign exchange reserves were not asabundant as it is today and nonstate sector was still developing. Therefore, ADB played anactive role in arranging a cofin ancing loan of $50 million from the Export-Import Bank of Japan.But this was never finalized. 5 Instead, SITICO has secured a number of long-term foreignexchange loans from other sources since the launch of the ADB Project. 6 The Project wasexpected to mobilize $200 million in incremental capital, generate annual foreign exchangeearnings of $100 million, and create 5,000 jobs. Although the loan was geared to enhanceproductivity and improve product quality in established production facilities, it was also availablefor establishing new projects that would facilitate technology transfer.

C. Purpose and Outputs

6. The basic purpose of the Project was to redress the industrial decline in SMZ byenhancing industrial productivity and strengthening SITICO and SITEN in aspects such asproject evaluation and debt or equity financing. The expected outputs were sustainablesubprojects financed by the LOC and SITENs equity investments, and the enhanced capacityof these institutions to evaluate and supervise such subprojects. The TA was expected toprovide (i) services of three consultants for a total of 12 months to SITICO and SITEN in projectappraisal, monitoring, and supervision, as well as financial planning and liabilities managementcapabilities; (ii) overseas training for about 15 middle managers in project appraisal andsupervision; (iii) equipment and training facilities to implement the above training; and(iv) two-month consultancy services to study accounting and management information system(MIS) computerization. The savings from the TA components were utilized t o purchaseSITICOs first mini-computer and set up an information division in the corporation. 7 Since thiswas the first ADB loan to SITICO and considering its project appraisal capabilities, the free limitfor SITICOs approval was set at $1 million. This was raised during implementation to$2.5 million, demonstrating ADBs confidence in SITICOs project appraisal capability.

4 Although SITICO was an eligible participating financial institution under the $150 million industrial developmentproject loan to SMG approved by the World Bank in January 1991, it did not utilize this facility.

5 The terms of the cofinancing were not acceptable to SITICO.6 Since 1990, SITICO has raised two overseas bonds in the amounts of Y35 billion and $70 million. It has also

borrowed Y9.15 billion and $145 million on the international markets since 1990.7 Project documents indicate that the computerization study was carried out with SITICO funds by local consultants.

ADB found SITICOs request to use savings of TA components amounting to $150,000 to set up the informationdivision justified.


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D. Cost, Financing, and Executing Arrangements

7. The loan amount was equivalent in various currencies to $100 million funded fro m theordinary capital resources under ADBs foreign exchange risk pooling system (ERPS), 8 andattracted a variable interest rate and a commitment charge of 0.75 percent per annum. The loanwas to be effective after SITICOs Policy Statement and Development Strategy Statement hadbeen submitted to ADB. The Government was to relend the loan at the same rate to SITICO,the Executing Agency (EA). The loan had a term of 15 years (up to 2003) including a graceperiod of three years. SITICO was expected to add a minimum spread of 1 percent for onlending to subborrowers and pass on exchange and interest rate risks to them. SITICO wouldalso make arrangements to protect itself from foreign exchange risk from the time of recovery of subloans and repayment to ADB by maintaining and relending these funds in foreign currency.The loan utilization period was four years and the subloan applications were to be submittedwithin two years of loan effectiveness. The maximum size of the subloan was $10 million. Thesubproject sponsors were required to contribute at least 15 percent of subproject costs for existing enterprises and 20 percent for new subprojects. Advance purchases made up to90 days prior to receipt of subloan documents by ADB were reimbursable under the subloan.

8. The LOE of $3 million was to be administered by SITEN, established in 1987 to promoteventure capital investments. To be eligible for ADB equity investment under the LOE,enterprises had to be (i) incorporated in the PRC in the industry or service sectors, (ii) bemajority privately owned, and (iii) enjoy considerable management autonomy and freedom todetermine pricing for their products. The main beneficiaries were expected to be PRC-foreign

joint ventures. The minimum and maximum investment limits were $100,000 and $1 million,respectively, and ADBs participation was generally limited to 25 percent of the share capital of the investee enterprise. SITEN was required to make at least a matching investment. Inaddition, a minimum of 20 percent of the investment cost had to be provided by the sponsors.

All appraisals of investment proposals had to be submitted for ADB review within the loanutilization period of two years.

9. The $450,000 TA grant was divided into four components to be implemented accordingto the terms of reference indicated in the project documents. First was $180,000 to finance theservices of three consultants to strengthen project evaluation, project supervision, and financialplanning and liabilities management. Second, $170,000 was allocated for overseas training of about 15 middle managers for a duration of 3-6 months. The third and fourth components wereprovided respectively for a two-month study on computerization of SITICO ($30,000) andprovision of office equipment and training facilities ($70,000). The reports of the consultantswere to be reviewed by SITICO and ADB, a nd consultants recommendations were to beimplemented with the agreement of both parties. 9

10. As part of its restructuring efforts (para. 38), SITICO prepaid the ADB loan in October 1997, six years ahead of schedule. ADB waived the prepayment premium. The prepaymentoccurred three years after completion, and about two years after the preparation of the projectcompletion report (PCR). SITICOs reason for requesting prepayment was the high cost of servicing the loan, since SITICO had by then gained access to cheaper sources of externalfunds.

8 At the time of appraisal, the ordinary capital resources rate was 6.53 percent. ERPS was a means ADB hadadopted to allocate the foreign exchange risk on loans among its borrowers.

9 Unfortunately, full recommendations of the consultants were not available for the Operations Evaluation Missionreview as final reports of three TA components could not be found at either ADB or SITICO, except for one of theparts (financial planning and liabilities management) of the first TA component.


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E. Completion and Self-Evaluation

11. The loan was closed in May 1994 after one extension, six months later than the originalschedule with 87 percent utilization. ADB prepared the PCR in January 1996, following theProject Completion Review Mission of June 1995. The PCR attributed the underutilization of theloan to the noncompetitive variable interest rate charges of ADB. However, it did not analyze therepercussion of the foreign exchange risk borne by the subborrowers. Though fairly candid andobjective, the PCR did not specify an overall performance rating for the Project. However, itconcluded that loan utilization and subproject performance were generally satisfactory. With thebenefit of hindsight, it indicated that the covenants should have been designed to cater to thespecific needs of nonbank financial institutions (NBFIs) of the PRC. In particular, it noted that(i) special covenants should have been included for SITICO to become more institutionallyindependent of SMG, (ii) reserves for doubtful debts should have been defined more clearly,and (iii) financial ratios to be maintained by SITICO should have been more realistic given itsphase of rapid expansion at the time. It recommended SITICO to (i) establish accounting andMIS procedures to monitor loan and equity portfolio performance; (ii) develop operational rulesand regulations to manage problematic loans; and (iii) institute appropriate career developmentprograms for its staff, particularly on securities and derivatives instruments. The OperationsEvaluation Mission (OEM) generally agrees with the PCR, but believes that it could have better analyzed the information available at the time to draw useful lessons for future projects. ThePCR did not evaluate the consultants performance or present any lessons learned from thedesign and implementation of the Project and the actual performance of subprojects.

F. Operations Evaluation

12. This project performance audit report (PPAR) is based on a review of the appraisalreport, the PCR, other documents in ADB files, and records, as well as discussions with staff members of ADB and those met during the OEM. The OEM visited Shanghai in September 2000 and its members met with staff from SITICO, SMG, and the Peoples Bank of China(Shanghai Branch) and visited the sites of five of the 23 subprojects financed by the loan(Appendix 1). SITICO staff were cooperative in discussing many aspects of the Project andprovided mainly its publicly available financial data to the OEM. It also helped the OEM obtainresponses from six subprojects to the basic questionnaire (in Mandarin) that was forwardedprior to the OEM. 10 In Beijing, the OEM visited the ADB office, and met with staff at the WorldBank resident mission, as well as the Ministry of Finance (MOF). The major points examined bythe OEM included (i) effectiveness of design, (ii) achievement of objectives, (iii) capacitybuilding, (iv) monitoring and supervision, (v) performance of SITICO, (vi) performance of subprojects, and (vii) development impacts and sustainability.

13. Subproject analysis is based partly on the results of a survey completed by sixsubborrowers. The OEM found it difficult to obtain survey data from some of the subprojects,particularly those that had repaid their loans. The OEM aimed to visit at least one third of thetotal subprojects, representing several industry categories, and asset and loan sizes. The actualsite visits depended on the availability and willingness of subproject owners to meet with the

10 General information on the subprojects was provided in aggregate form by SITICO, but specific details of restructuring, amounts written off, and outstanding balances for each subproject, were not made available to theOEM.


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OEM and the arrangements made by SITICO. The views of ADBs concerned departments andoffices and those of the Government and EA have been considered in preparing the PPAR.

II. PLANNING AND IMPLEMENTATION PERFORMANCE

A. Formulation and Design

14. In general, the LOC served the purpose it was intended for. It provided enough flexibilityto cover new and existing demand for upgrading and modernizing industrial enterprises in SMZ(Appendix 2). It also allowed for advance purchase of equipment, 90 days prior to effectiveness.Subloan limits were specified to cater to the potential demand that existed. However, the projectdesign had some fundamental weaknesses. First, it adopted a traditional approach todevelopment finance investments and was not geared toward an economy in transition. As thefocus of the Project was on SMZ with many existing SOEs undergoing reforms andrestructuring, employment generation as a major development impact was unrealistic. The loanwas for the introduction of new technology which, generally in the subprojects financed, helpedautomate manual and archaic processes thereby leading to reduced employment in SOEs thatalready had excess employment.

15. Second, it was inappropriate to pass on the forei gn exchange risk of a long-term loanto subprojects without their ability to mitigate the risk. 11 The subborrowers were all SOEsthat were accustomed to operating in a command economy with relatively limited experienceof, and exposure to, foreign exchange risks. Foreign currency earned by the subprojects couldnot be retained and was converted immediately as required under the prevailing foreignexchange regulations. SITICO, as the loan conditions stipulated, took the necessary steps toprotect itself against foreign exchange risks between recovering the loan proceeds from thesubborrowers and repayments to ADB, by undertak ing short-term foreign currency transactions.But it was unable to hedge the risk of its customers. 12

16. Third, the LOE was never utilized; it was subsequently cancelled. Market conditionsexisting at the time made utilization of the LOE under ADBs guidelines impractical. Although theLOE was intended for strengthening SITENs role in equity financing, the eligibility criteriacatered more to the establishment of private enterprises. ADB had specified that theinvestments were to be made in majority privately ow ne d companies, preferably joint ventures,with considerable autonomy in managing their affairs. 13 Given the nature of SITICOs mandateand business, the majority of SITICOs existing and potential clients were SOEs or collectiveenterprises operating under the direction of local governments. In addition, privately owned

11

During project preparation, SITICO expressed concern over ERPS, but was informed by ADB that all publicdevelopment finance investments were subject to ERPS at the time.12 Under ERPS, loans were disbursed to clients in various currencies available in the ADB currency pool at the time

and were debited to their accounts in equivalent dollar terms. The repayment of the dollar equivalent was carriedout in the original currencies borrowed at the prevailing exchange rate, which resulted in the borrowers sharing theforeign exchange risk of the ADB currency pool. Since borrowers had no means to manage the pool of currenciesthey borrowed, they could not hedge the exchange rate risk. ADB stopped lending under ERPS in 1994, andadopted a single currency ($) lending facility. A proposal for adopting the London interbank offered rate plus marginto determine the interest rate is currently under consideration.

13 Although SITICO requested permission to include ADB financing to meet the minimum private shareholdingrequirement, ADB did not agree as ADB was a multinational financial institution owned by governments of member countries.


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companies had just started emerging, and those that had been established could access fundsfrom other investors. Finally, the stock market was in its infancy and other secondary marketswere not well developed. Nevertheless, SITICO continued to make dire ct equity investmentsfrom its own sources, which currently stand at approximately $508 million. 14

17. Fourth, the Project concentrated only on the credit needs of the enterprises and did not

ensure that other factors like appropriate marketing channels, entrepreneurship training,management techniques, and enterprise autonomy were available to the enterprises to competein a fast reforming environment. In the absence of a project preparatory TA, there was neither an analysis of the basic requirements for the loan to achieve its objectives nor a policy dialogueto ensure an enabling environment for the subprojects to prosper. To maximize theeffectiveness of ADB lending, the project design should have incorporated mechanisms toensure that subprojects had access, besides long-term finance, to the above factors, which arerequired for efficient industrial development.

18. Fifth, the OEM agrees with the PCR that the covenants were more designed for a typicaldevelopment financial institution, and paid little attention to the unique mandate and diversity of SITICOs businesses. Special covenants should have been included for SITICO to becomemore institutionally independent of SMG. Clearer and well-defined provisioning requirements for bad and doubtful debts should also have been specified.

19. The design of the TA, including the terms of reference, was appropriate and providedlong-lasting benefits to SITICO. The OEM was advised that SITICOs project appraisal greatlybenefited from the consultancy and overseas training. SITICO continued to make further investments in computer acquisitions and enhancements to office automation and MIS.

B. Achievement of Outputs

20. The selection of subprojects for financing under the LOC was consistent with the mainproject objectives to modernize and expand the industry sector in SMZ. The subborrowers wereall SOEs or collectively owned enterprises. In all, 25 projects were submitted for approval and$98 million (98 percent of the loan funds) had been committed by May 1992. The loan request,review, and approval process flowed smoothly and effectively with an average turnaround timeof two months. Minor delays that occurred were attributed to incomplete financial informationsubmitted by the subprojects to SITICO at the time of application. Two subloans were cancelledprior to disbursement because the borrowing entities were restructured and merged with others.

21. Although most of the LOC was committed two years prior to loan closing in May 1994,actual disbursements inc luding the commitment fees and capitalization of subloan interestduring construction (IDC) 15 amounted to $87.2 million. The underutilization of the committedamount was due to (i) liberal provision by subborrowers for cost overruns, 16 (ii) lower thananticipated equipment costs after commercial negotiations with suppliers, and (iii) thecancellation of two projects. Thirteen subprojects were completed on schedule and 10 haddelays in completion ranging from two to 27 months.

14 Market conditions have developed since then and a second board stock market is being considered.15 At loan negotiations, the Government had requested financing of IDC out of loan proceeds. As the ADB policy on

financing IDC under LOCs was under consideration at the time, the decision to allow such financing was postponeduntil after the approval of the policy change in January 1992.

16 The total cost of the subprojects was 38.5 percent less than the original total estimate of Y1,148 million.


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22. All 23 subprojects (Appendix 3) were located within SMZ and represented a balanceddistribution of the loan across industry sectors with the textile industry representing 22 percent;light industry (17 percent); machinery manufacturing (12 percent); metallurgy (9 percent); andthe balance representing telecommunications, harbor operations, electronics, and chemicals. Allsubloans were used for technology upgrades through modernization (10) and expansion (13).No new enterprise was financed under the LOC. The subloans varied in size from about

$1 million to $10 million, with about half between $2 million and $5 million, and five loans over $5 million. All subprojects were submitted for ADB review and approval as none fell withinSITICOs delegated authority despite an increase in the free limit in April 1991 to $2.5 million.

Approved subloan maturities ranged from less than 3 years to 10 years with six subloans havingmedium-term maturities of 2-5 years, and 17 subprojects with long-term maturities of 5-10years, all well within the loan tenor of 15 years.

23. An indirect goal of the Project was to promote exports and generate foreign exchange.The Project was expected to generate annual foreign exchange earnings in excess of $100 million. 17 Neither ADB nor SITICO monitored the export performance of subborrowersduring the life of the loan, nor did the PCR analyze it. Given the passage of time and lack of enthusiasm of most of the subborrowers to meet with the OEM, the PPAR is unable to presentthe necessary data and evaluate the achievement of this target. The PCR noted that initially,nine subborrowers were geared for export. Of the five subprojects visited by the OEM (Appendix4), four were still exporting a share of 25 to 75 percent of their production. Similarly, it was notpossible to analyze the employment generation objective given the lack of monitoring data andsubstantial layoffs that had been carried out in SOEs during the project implementation period.Some SOEs found peripheral employment (in cafeterias, shops, etc.) for their employees whowere made redundant as a result of technology upgrading implemented to achieve productivitygains.

C. Cost and Scheduling

24. The Project was approved on 13 December 1988, within nine months of its inclusion inthe proposed projects list of the country programming mission, and within six months of the fact-finding mission. However, it did not becom e effective for almost another year pendingcompliance with loan effectiveness conditions. 18 ADB staff evaluated the subloan applicationsduring the period between loan approval and effectiveness, thus minimizing the impact of thedelay on project implementation. SITICO utilized 87.2 percent of the LOC amount(para. 19). Cumulative utilization at the original closing date of 27 November 1993 stood at$85.6 million. The closing date was extended by six months to commit the remaining$1.6 million. On 27 May 1994, SITICO requested that the balance of $12.8 million inundisbursed funds be cancelled. The LOE of $3 million also had to be cancelled becauseSITEN could not find any qualified subprojects (i.e., majority privately owned). About 99 percentof the TA grant was utilized with the savings in the cost of consultancy services being divertedto purchase a mini-computer and to establish an information division in SITICO.

D. Procurement and Construction

17 Exporters at the time could not retain the foreign exchange and had to convert it to local currency at the officialexchange rate.

18 The project agreement and the loan agreements were signed respectively on 12 and 18 November 1989.


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25. As anticipated, the subloans were used to import state-of-the-art technology andequipment from about 16 countries with over 50 percent in value coming from Hong Kong,China; Italy; and Japan. The PCR reports that the procurement was made according to ADBsGuidelines for Procurement , mostly using the international shopping method. SITICO or thesubprojects that OEM visited did not highlight any procurement-related problems. Since the loanwas used to upgrade technology within the existing facilities of subborrowers, construction was

not among the activities financed under the LOC.

E. Organization and Management

26. Monitoring. During project implementation, monitoring and supervision was to be doneat two levels: SITICO operations were to be monitored by ADB and the subprojects were to bemonitored by SITICO. ADBs monitoring of SITICO was done through submission of appraisalreports of subprojects and periodic financial reports of SITICO. Only one review mission wasfielded during the entire implementation period, from 25 to 31 January 1991, over two yearsafter project approval. The Project Completion Review Mission and the OEM were carried outafter loan closing. The OEM agrees with the PCR that more frequent review missions werecalled for, and would have improved the performance of the Project, helped address some of the difficulties the subprojects were undergoing during implementation, and facilitated benefitmonitoring and evaluation.

27. SITICO staff monitored subprojects by evaluating their repayment patterns, analyzingperiodic reports on their financial performance, and making periodic site visits. The focus of SITICOs monitoring was the repayment capabilities of the subprojects. Therefore, SITICO didnot gather information on development impacts of the Project, presumably because ADB did notemphasize this at the time. It restructured several subloans based on the expected operationaland financial performance of the subprojects. After fully repaying the ADB loan, SITICOconverted subloans into local currency loans to help its clients avoid exchange risk.

28. Consultant Performance. According to OEM discussions with SITICO, the performanceof consultants was good once they had an understanding of the characteristics of PRCstransition economy. According to SITICO, consultant evaluation of SITICO operations and thetraining activities that they conducted enabled substantial technology transfer. The OEM isunable to independently evaluate consultant performance due to the lack of documentation andthe unavailability of four out of the five TA final reports that were to be prepared. SITICO staff were trained to better evaluate projects and undertake prudent lending. Subsequent to theconsultant recommendations, changes were made to project approval procedures with theestablishment of a project appraisal committee to assess and manage risks. Monitoring systemswere adopted for loans, returns-on-equity, interest rates, etc., and SITICO staff were trained instandard funds-flow forecasting techniques.

29. Covenants. SITICO generally complied with the covenants (Appendix 5) stipulated inthe Loan Agreement, with exceptions in some cases in meeting the minimum contributions tothe total project cost by subproject sponsors and delays in the timely submission of quarterlyreports and audited financial statements to ADB. The covenants were designed to assist ADB inmonitoring the financial and organizational performance of SITICO. The long-term debt-equityratio and total debt-equity ratio of 5:1 and 10:1, respectively, were maintained throughout the lifeof the loan and even after repayment. Debt service coverage of not less than 1.25:1 was alsomaintained.


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30. Covenants requiring SITICO to maintain adequate provisions for bad and doubtful loansand investments were not clearly defined. SITICO had set aside reserves for loan andinvestment losses in excess of what was permitted at the time under MOF regulations (para. 66)by making additional provisions on an after-tax basis. However, such provisions wereinadequate to cover potential losses given the quality of the portfolio. Nine of the23 subprojects 19 did not meet the stipulated minimum contribution by sponsors of subprojects.

III. ACHIEVEMENT OF PROJECT PURPOSE

A. Performance of Subprojects

31. To a large extent, subprojects under the loan facility fared well. Of the 25 projectsoriginally approved by ADB and SITICO, two were cancelled (para. 20). Fourteen borrowersrepresenting 53 percent of the loan amount fully repaid the subloans. Two subborrowers, one inthe textile industry and the other in electronics, went bankrupt. Of the remaining seven,representing 25.2 percent of the total loan amount, four continue to repay SITICO according tolong loan maturities originally granted under the LOE, while the other three are facing seriousdifficulties. Many subloans required restructuring due to the severe problems caused by theforeign exchange adjustment burden (Figure 1). Partial interest has been forgiven by SITICO onthe troubled loans and a reduction of the interest rate granted on a number of subloans(following repayment of the ADB loan). In general, most subprojects were successful inupgrading their equipment and surviving the transition to a market economy. Based on site visitsand information reviewed, and given the ownership structure of the borrowers, overallperformance has been positive in the face of reforms and the challenging environment.

19 However, two had contributions from SITICO to meet the 15 percent contribution by sponsors.


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32. Financing the subprojects under the loan facility came at a very opportune time whenmany other so urces of foreign currency loans were held up as a result of negative politicaldevelopments. 20 A majority of the SOEs that benefited from the loan facility would have haddifficulty in maintaining efficient production given the obsolete state of their machinery. Somesubprojects were able to export their products (para. 23).

33. Only one of the five subprojects that the OEM visited could be categorized as an outrightfailure. The subproject (producing plastic products) was conceived with poor planning andlimited market knowledge. Production was hampered by existing equipment that could notmatch the capacity of the highly sophisticated equipment acquired through ADBs financing. Inaddition, given the lack of market knowledge, the product mix could not be changed to cater toclient preferences. Finally, management decision making was constrained by other influences.The subproject ha s remained relatively idle for the past three years, and SITICO will incur losses as a result. 21 The four other projects visited vary in their degree of success, but overallare doing well. One of them, a rubber and tire company, has grown and is said to have becomea world player ranking 15th (worldwide) in the tire industry. A light manufacturing companyproducing industrial blades attracted a foreign partner due to its strong market position helpedby the ADB loan. Two other textile companies remain in business and are performing relativelywell despite the difficulties encountered in textile manufacturing and fierce external competition.

ADBs financing helped them modernize to remain viable and competitive, while many of their counterparts had to shut down.

20 The loan was approved a few months prior to the 1989 Tiananmen events, which virtually halted all foreigninvestments to the PRC. ADB continued disbursement under the approved loans but stopped new loan approvalsfor about a year.

21 Due to stringent regulations, SITICO has not been allowed to write off this loan as yet.

Figure 1 : Avera ge Excha nge Rate of YuanAgainst US Dollar (19 88 -19 99 )

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B. Performance of the Operating Entity

34. Operational Performance of SITICO. In 1992, the Government reduced its directinvolvement in the management of the SITICO group and established new entities to hold itsshare ownership in different enterprises. The Shanghai International Group holds SITICOsshare on behalf of the Government. The current shareholding of SITICO consists of 14 shareholders, all of which are SOEs, with SMG representing 66 percent. After years of reliance on lending activities as the predominant source of revenue, SITICO has refocused itsoperations in response to the evolution of the finance sector.

35. SITICOs operations witnessed tremendous growth in the 1990s in its different lines of business (Appendix 6). Total revenues grew from Y246.5 million in 1988 to Y2,792.8 million in1997 at an average annual rate of 27.4 percent (Figure 2). With the ADB loan and SITICOsfocus on commercial lending, revenue from financing operations increased steadily from69 percent of total revenues in 1988 to 93 percent in 1990. As SITICOs operationsstrengthened, the company began to diversify into other areas for its revenue stream, andincome from investment and other operations began to gain importance. From 1992 onward,revenue from commercial lending activities dropped to an average of 75 percent of totalrevenues.

Figure 2: SITICO Total Revenue and Profits

36. With its rapid expansion beginning in 1992, SITICO understood the need for a review of its operational strategy. In 1995, it set up new businesses such as the investment bankingdivision responsible for financial advisory services, asset management, merger s andacquisitions, an international division, a legal division, and the Shainvest Company. 22 Thisresulted in a rapid increase in income from investment, fiduciary, and real estate operations.The traditional focus on commercial banking was downplayed for eventual phasing out. To meetits capital needs, SITICO increased its registered capital from Y1.5 billion to Y2 billion at the endof 1995.

22 Incorporated in Hong Kong, China, Shainvest is responsible for developing business in Southeast Asia.

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37. By 1997, the financial market in the PRC began to exhibit strain from the fast growthexperienced earlier in the decade. Borrowers and financial institutions alike suffered as a resultof excessive lending, speculative investments, and real estate construction in excess of demand. In response, from 1997, SITICO focused on enhancing asset quality by tightening itsrisk management, adjusting its credit structure, and improving its portfolio quality and return oncapital. Operations were further streamlined through elimination of redundant layers. With the

investment banking operations strengthened, SIT ICO has remained one of the active membersof the Shanghai Stock Exchange in recent years. 23 Equity investments continued in joint ventureand domestic companies, representing a rough mix of 40 percent and 60 percent, respectively.The securities business became the mainstay of the corporation with total transaction volumeexceeding $2 billion annually.

38. The restructuring of the SOE and industry sector created the impetus for SITICO toestablish a new trust division in 1998. SITICO saw the opportunity to become involved in thisactivity to further enhance its consulting and investment banking activities. The trust divisionwas further expanded in 1999, in preparation for the new trust law. It sought opportunities inunderwriting and managing clients funds including securities, industrial, high technology, andventure funds. SITICOs operations in terms of growth and profitability peaked at the end of 1997 (Figure 2). Since then, SITICO has further cut back on commercial banking activities,which brought gross income down by 46 percent and 58.2 percent for 1998 and 1999,respectively.

39. The need to restructure, rationalize, and further consolidate took on real urgency. Withthe adverse effect created by the collapse of Guangdong International Trust and InvestmentCorporation, raising foreign debt became difficult. International credit ratings of SITICO wereallowed to lapse. In 1998, it achieved a noteworthy milestone by paying back all its foreigndenominated debt, totaling $139 million.

40. Financial Performance of SITICO. Consolidated financial statements for all itssubsidiaries are prepared by SITICO and are audited by Shanghai certified public accountantsin accordance with the Accounting Standard of Enterprises issue d by MOF, which has issuedunqualified reports since the start of the Project (Appendixes 7-10). 24

41. SITICO shows a sharp rise in revenue growth between 1991 and 1994 (Appendix 8) a sa result of new loans approved and other income from investment and real estate activities. 25 However, income growth declined steadily since 1994 as a result of the reining in of activities,consolidation efforts, and restructuring. Despite the steep decline in revenue that began in1997, average annual revenue growth for 1989-1999 remained at 20.8 percent. During thesame period, SITICOs net profit as a percentage of total revenue averaged 15.8 percent,indicating its long-term profitability. Net profit, which stood at Y33.6 million in 1989, reached ahigh of Y605.5 million in 1997, and then declined to Y147.8 million by the end of 1999.Following the shift of its business focus to investment and trust operations, income in theseareas began to play a more significant role as it climbed from 20.8 percent in 1995 to 34 percentin 1999. During this period (1995-1999), SITICO gained importance as a major player in

23 The failure of Guangdong International Trust and Investment Corporation in 1998 created a negative impact on theITICs international ratings. At the request of SITICO, ratings have been allowed to lapse and subsequentlywithdrawn.

24 Audited financial statements (although in line with current practices in the PRC) made available to the OEM do notreveal as much detail as current international practice regarding charge-off and recoveries, or any other details onspecific provisions.

25 Compared to the projections made in the report and recommendation of the President, SITICO attained the targetsfor net profit/average equity and earnings spread with a lag of 3-4 years.


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consulting and advisory services, and as a lead manager to large projects in SMZ. On the other hand, real estate operations, general administration, and loan loss provisions as a component of total expenses rose dramatically from 14.3 percent in 1995 to 37 percent in 1999, reflectingmainly the deterioration of asset quality. The increase in unearned interest revenue further confirmed the deterioration of the loan portfolio. 26

42. This prompted SITICO to assume an active role in managing the asset portfolio. ThusSITICO continued to reduce its exposure to commercial real estate while focusing on theresidential sector, which had strong demand and promised better returns. In response to assetquality deterioration, the shareholders again increased the paid-in capital to Y2.5 billion in 1998,demonstrating their confidence in SITICOs consolidation efforts. Reflecting prudent practice,SITICO set aside additional reserves after tax for doubtful assets and loan losses for the period1996 to 1999. Furthermore, SITICO Investment Management Company was reorganized in1998 with its registered capital increasing from Y750 million to Y1 billion, and charged withconsolidating and restructuring the nonperforming assets. Reserves for bad and doubtful debtswere increased by Y211 million during 1999 and stood at Y516.3 million at the end of 1999.

43. SITICOs assets grew from Y4,642.5 million in 1989 to Y23,556.2 million in 1999(Appendix 9), yielding an average annual growth rate of 36.2 percent until 1994, which thendecelerated to 2.1 percent during 1995-1999. Gross medium- and long-term loans peaked in1998 when they stood at Y6,982.5 million. The initial rapid growth was coupled with an increasein liabilities as SITICO increased its deposit mobilization and took on additional externalborrowings to fund its activities. Current ratios were maintained at between 1 and 2 times anddid not drop below this range during 1989-1999. Long-term debt to equity was at a reasonablelevel of 4 times in 1995, but improved to 2.2 times in 1999 following the capital increase.

44. CAMEL 27 analysis shows (Appendix 10) a high leverage ratio of 8.3 times; this peaked in1995, as a result of increased borrowings to meet loan and investment demands. It dropped to5.1 in 1999 after SITICO in 1997 embarked on repayment of its external debt. This leveragelevel is acceptable for a development bank. Asset quality, as highlighted earlier in the analysis,shows a steady deterioration resulting from rapid growth and poor credit risk management.Other banks and NBFIs had similar experiences in the PRC during the same period. Loans inarrears (Appendix 11) as a percentage of gross loans began t o increase sharply from1.3 percent in 1994 to 22.8 percent in 1996 and 20.7 percent in 1997. 28 Loan loss provision wasalso increased to 1.9 percent in 1999. It appears insufficient given the asset quality, but better than the guideline of 1 percent stipulated by MOF. A review of management performanceindicates an aggressive growth posture and high earnings at the expense of asset quality.However, management should be commended for taking early action to diversify operations andmake additional loan loss provisions on an after-tax basis, a practice not common in the PRC.

C. Technical Assistance

45. The TA is rated successful. It was useful in providing several capacity-building measuresat SITICO. The first computer hardware (AS 400) and software system for financialmanagement was set up as a result of the TA. Although not initially intended, savings from other components of the TA were utilized with the approval of ADB to purchase an advanced softwareand hardware system to automate SITICO business processes. The integrated financial

26 SITICO did not make available the risk rating classifications of the loan and investment portfolio to the OEM.27 Capital adequacy, Asset quality, Management effectiveness, Earnings, and Liquidity position.28 SITICO did not share data for subsequent years with the OEM as the ADB loan was fully repaid in 1997 (para. 6).


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accounting software program designed and installed in 1992 is still being used in combinationwith a network of 200 computers purchased later by SITICO. The hardware has been upgradedto keep up with technological advances. In August 2000, SITICO purchased new computer equipment to further automate its business processes and conduct paperless onlinetransactions in preparation for its new predominant role as an investment and trust company.

46. Overseas training provided by the TA also appears to have been successful. Twobatches of middle level staff totaling 15 people from SITICO and SITEN were trained in projectappraisal and supervision techniques in Manila and Singapore; and in turn, they trained theremaining account officers to form a team to appraise and supervise projects. Some of the staff members who received overseas training are now in key management positions. Staff havebeen using the training manuals prepared (in English) by the consultants for several years.

D. Sustainability

47. The main development impact of the Project has been the ability of the SOEs to survivethe past decade with the help of the subloans under the Project. The subloans were used toimport modern technology and equipment from industrialized countries. It appears that most of the subprojects would not have survived the reforms had it not been for injection of funds toupgrade technology. The ADB loan was made available at a time when many foreign investorswere reluctant to invest in the PRC. Following the ADB loan, SITICO was able to raise about$600 million from other sources for its operations.

48. When the technological advancement of a subproject was coupled with marketemphasis and skill training, the subprojects generally prospered and the productivity of their employees increased. However, in some cases, despite the revamping of the enterprises, theywere unable to find appropriate markets and did not have the experience, information, or agentsto help them. Almost all subprojects faced fierce competition from both outside and inside thePRC, and several changed their product mix and improved productivity to face marketchallenges. However, given the burden of large pools of employees, some SOEs were unable tobe competitive. Others, which received help by way of joint ventures or opening up saleswindows abroad, were able to cut employment substantially. Enterprises in this category appear to be sustainable and are able to service the subloan or have already repaid it fully. At present,due to the rapid advances in technology in some sectors (e.g., telecommunications), even thoseenterprises that survived at the time now need to further upgrade their equipment. Only a few,reportedly, have their own funds for this purpose. The continued sustainability of suchenterprises, therefore, lies in their ability to finance further upgrading of their equipment andrationalization of their labor costs.

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS

A. Socioeconomic Impact

49. The Project had several positive multiplier effects in generating economic activity. Somesubprojects that were visited provided indirect business opportunities to the employees whowere laid off, in cafeterias and stores adjacent to the factory. Others that survived the onslaught


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of the reforms and competition continued to provide employment not only to their employees,but also helped other enterprises in their group by absorbing the job losses of those enterprisesthat could not operate profitably. In addition, by upgrading technology, they provided backwardand forward linkages to other enterprises in related industries. The Project did not targetwomen, and there were no specific provisions to promote women and their development. But anumber of subprojects, especially textile and light manufacturing enterprises, employ a

substantial number of female workers.

B. Environmental Impact

50. As the Project was approved in the late 1980s, the project approval documentscontained no environmental mitigation measures or related clauses. Because most of thesubprojects financed were light assembly type, the environmental compliance required wasgenerally good housekeeping practice and/or wastewater treatment facilities. However, theProject had no significant impact on the improvement of environmental performance. In somesubprojects visited, wastewater treatment plants constructed in the 1970s are operating and thelaboratories are in working condition. Some housekeeping was needed in most enterprises.Scrap materials from discarded equipment appear to be stored on factory premises for a longtime prior to recycling. Environmental management in subprojects varied depending on the in-built facilities (e.g., bags to collect fibers from cloth) and the extent of management focus onenvironmental concerns. Some enterprises producing mainly for export were careful aboutdisposal of waste material, but some others did not even have proper employee safetystandards. Some enterprises generated high volumes of fiber during production, but did notprovide protection masks for workers (mostly women). However, the workers wore caps toprevent their hair from getting caught in the machinery. Though the noise level in someproduction areas was extremely high, the workers were not provided with earplugs.

51. Even though environmental regulations are in place, it is often very difficult to enforcethem in practice. Therefore, it is useful to consider alternative incentives and penalties toencourage environmental compliance. In other LOCs, compliance with environmentalregulations is often attached as one of the conditions that financial intermediaries have toevaluate prior to approving or restructuring subloans. This requires training of financialintermediary staff to understand the basics of environmental management in the subproject, aswell as an ADB review of how environmental compliance is being handled by the financialintermediaries and the subprojects.

C. Impact on Institutions and Policy

52. SITICOs operations have matured since the loan was granted by ADB, and so have itsstaff. It is evident that the initial training for project appraisal and the overseas training had animpact on SITICOs current practices. SITICO has become more cautious in selecting deals andis pursuing higher quality assets. Its advisory and investment services arm has a high profileand has succeeded in securing prestigious mandates.

53. Following the recommendations of the TA, SITICO has continued to emphasize staff training. SITICOs training functions are managed under the Human Resources Division.Selected staff members are sent by SITICO for external short-term training from time to time,and on their return, they generally impart their knowledge to fellow staff who work on similar


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aspects. Ten staff members are, for example, currently attending Masters in Business Administration courses in universities. SITICO expects that for it to fulfill its future role, its staff will need further training, especially in risk management and structured finance.

54. Following the TA on financial planning, SITICO is pursuing new lines of business in itseffort to consolidate its activities in line with the new trust law currently being drafted. Since

1995, SITICO has modified its organizational structure (Appendix 12) to match the changes inoperations. Due to the indefinite status of the new trust law (Appendix 13), it remains unclear asto how much preparation and staff development need to be carried out to meet the requirementsof the new law, as well as to respond to market developments.

55. Considering that SITICO is an arm of SMG, its commercial orientation and expertise indealing more vigorously with problem assets remain underdeveloped. The same loan officersthat have dealt with the account relationship during favorable times continue to do so as theseassets have become nonperforming. Managing troubled debt requires the time and specialexpertise that the loan officers may not possess.


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V. OVERALL ASSESSMENT

A. Relevance

56. The Project is rated relevant given the Projects goals and purpose. The objectives werein line with ADBs interim operational strategy at the time. Similarly, the TA was relevant giventhe institutional strengthening that was needed. However, the LOE was premature and itsdesign did not correspond to the objectives of strengthening the role of equity financing thatexisted at the time of project formulation.

B. Efficacy

57. The LOC helped modernize and rehabilitate some of SMZs existing obsolete andinefficient plant and machinery. However, due to the absence of an appropriate enablingenvironment, some subprojects had difficulties in achieving this objective. The TA was helpful inproviding the basis for several capacity-building measures to SITICO that resulted in systemsupgrades and human resource development through training. The premature LOE did notachieve its purpose. Given the lack of adequate analysis and preparation for some of itscomponents to achieve the intended output, the Project is rated less efficacious.

C. Efficiency

58. The Project had several components: the LOC, TA, LOE, and cofinancing arrangementsthat were envisaged. The LOC and TA were disbursed without undue delays and complications.Savings from the TA were diverted to strengthen the information division of SITICO. Theconsultancy services provided to strengthen SITICO enabled it to become a more efficient andcapable fina ncial institution. The benefits of the LOE and the cofinancing arrangements werenot realized. 29 The Project is rated efficient considering the use of the inputs that it provided.The lack of preparatory work that should ha ve been done prior to project approval has alreadybeen considered under the efficacy rating. 30

D. Sustainability

59. In the absence of detailed financial and other economic data, it is inappropriate to ratethe sustainability of the subprojects. SITICO has, though, matured as a financial institution withenhanced capacity and improved operational strategies and practices in several areas,including project appraisal, MIS, consulting, and advisory services. Given normal

29 The LOE was never utilized as eligible investments could not be found, while the cofinancing agreement was notsigned as SITICO did not agree to the terms and conditions.

30 The weaknesses in the ADB performance during the implementation of the Project are not considered in the overallproject rating; they are considered separately in para. 62 and the section Lessons Identified.


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circumstances, it is likely that SITICO will be able to survive the competition and operatesuccessfully. Therefore, project sustainability is rated likely. However, with the current state of flux that the ITICs are going through and the anticipated regulatory changes about to take placeunder the new trust law and other pending securities laws, future sustainability of SITICOdepends both on the mandate that it will receive and on the institutional capacity building that itneeds in order to undertake that mandate.

E. Institutional Development and Other Impacts

60. The institutional development of SITICO is rated moderate. SITICO has developed thenecessary skills to carry out its activities and is attempting to respond to anticipated changes.Not knowing what the future entity would look like, it is difficult to determine how SITICO ispositioned as an institution to handle its new role. It has, in the past, shown its ability to adapt toa changing environment and displayed its maturity and prudent practices by reviewing itsoperational strategy, redirecting its investments, and improving asset quality. Given itsexperienced management, and its emphasis on staff training and information management,SITICO has the potential to adapt into a dynamic institution under the pending ITIC regulations.

F. Overall Project Rating

61. The Project is rated successful overall (Table 1). Given the project design and itsobjectives, it is considered to have been appropriate at the time. A majority of the subprojectsthat have benefited from ADB financing are operating normally, while some have faceddifficulties and SITICO has over time helped them survive. As an institution, SITICO has faredrelatively well and has gained prominence in certain areas such as investment banking, aidedby the project inputs. The TA has been productive, but the premature LOE was not utilized.

Table 1: Overall Project Rating

Criterion Assessment Rating (0-3) Weight (%) Weighted Rating

1. Relevance Relevant 2 20 0.402. Efficacy Less Efficacious 1 25 0.253. Efficiency Efficient 2 20 0.404. Sustainability Likely 2 20 0.405. Institutional Development Moderate 2 15 0.30Overall Rating S 100 1.75

Assessment Ratings:Relevance: 3 = highly relevant; 2 = relevant; 1 = partly relevant; 0 = irrelevant.

Efficacy: 3 = highly efficacious; 2 = efficacious; 1 = less efficacious; 0 = inefficacious.Efficiency: 3 = highly efficient; 2 = efficient; 1 = less efficient; 0 = inefficient.Sustainability: 3 = most likely; 2 = likely; 1 = less likely; 0 = unlikely.Institutional Development and Other Impacts: 3 = substantial; 2 = moderate; 1 = little; 0 = negligible.

Overall Rating:HS = highly successful 2.5 < HS 3.0S = successful 1.6 S 2.5LS = less than successful 0.6 LS < 1.6U = unsuccessful < 0.6


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G. Assessment of ADB and Client Performance

62. ADB Performance. The loan was prepared fairly quickly without the benefit of a projectpreparatory TA or previous experience in dealing with the client. The project design had severalweaknesses (paras. 14-19), some of which stemmed from ADB lending policies at the time, aswell as inadequate evaluation of the particular circumstances of the PRCs transition economy.Given the importance and size of the loan, ADB performance was clearly less than satisfactoryin monitoring the Project closely through regular onsite visits and relied mostly on reportingrequirements. More frequent field visits would have enabled ADB to recognize early on some of the drawbacks of the LOC and help correct the situation. Because this was one of the earlyloans to the PRC, and especially to a transition economy, it was imperative that ADB staff supervised the implementation of the Project more closely and encouraged SITICO to adoptbest development finance practices.

63. Client Performance. As expected, SITICOs focus was on the repayment capacity of the subprojects; and in the absence of ADBs impetus, closer monitoring of the subprojects toobtain the necessary data on development impacts was not considered. With the exceptionsnoted in para. 29 regarding a few covenants that SITICO partially complied with, in general itabided by the Loan Agreement. As could be expected of a government-controlled financialinstitution, SITICO was flexible in restructuring the overdue loans and providing working capitalto help some troubled enterprises get back on their feet. It prepaid the ADB loan and convertedthe remaining overdue subloans into local currency long-term loans. In the face of fast evolvingfinancial markets, SITICO managed to respond effectively by streamlining its operations,enhancing its asset quality, and diversifying its portfolio. Therefore, the performance of SITICOis rated satisfactory.

VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

A. Key Issues for the Future

64. The Gove rnment is currently drafting a new trust law, which will provide a legal basis for the trust concept. 31 When designing the specific regulatory details to govern the ITICs, it shouldlook into appropriate operational guidelines for NBFIs to encourage more autonomy, use proper loan classifications and provisions, and ensure that appropriat e supervision measures are inplace to obtain early warning signals of oncoming difficulties. 32 For the ITICs that may bedissolved, social impact assessments and mitigation measures need to be prepared in additionto their restructuring strategies.

65. Several SOEs operating in SMZ still lack operational autonomy and commercial viability.It is evident from the evaluation (para. 17) that credit was only one of the inputs that wereneeded by the SOEs to operate in a market economy. Therefore, SMG needs to undertakerestructuring of these enterprises. In particular, SMG should encourage more autonomy inmanagement of enterprises through the establishment of joint ventures and private companies.

31 It is unlikely that the new trust law will provide the necessary details on governing ITICs.32 ADB financed a study of NBFI (TA 1941-PRC) in 1993. In addition, ADB is currently assisting the Government to

draft the new trust law and review the insolvency law as part of ADBs law and policy reform program in the PRC(TA 3032-PRC).


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It also has to ensure that viable enterprises have appropriate links within and outside the PRCto make sure timely responses to technological changes and market conditions are undertaken.Through the creation of appropriate social safety nets and pension funds, the pressure on theenterprises to carry an excessive employment burden can be eased. 33

66. The current procedures specified by MOF make it very difficult for SOEs to declare

bankruptcy and, as a result, for ITICs to write off bad debts. They promote unhealthy anddistorted delays in portfolio cleanup. This prevents the ITICs from making adequate provisionsfor loan losses and misrepresents the profits before taxes. In addition to reviewing itsBankruptcy Law, the Government should require the ITICs to classify their assets according tostandard international accounting practices and allow them the freedom to allocate sufficientprovisions before profits to depict an accurate picture of their financial position.

B. Lessons Identified

67. ADB projects of a similar nature in transition economies should move away from thetraditional LOC design, carefully consider the constraints and needs of enterprises in a transitioneconomy and their ability to cope with reforms, and provide for associated risk factors.Specifically, ADB should address the following points:

(i) ADB should ensure, through policy dialogue, project design, or donor coordination, that not only are enterprises credit needs met but also that theyoperate in an appropriate enabling environment (e.g., appropriate governmentpolicies and streamlined bureaucratic procedures, technical skill enhancement,marketing information, adequate infrastructure facilities) to sustain the transitionto a market economy. If not, the LOC will not be truly effective.

(ii) When the foreign exchange risk is passed on to subborrowers, ADB should makearrangements to increase subborrower awareness of the risk involved. It shoulddiscuss with the Government and the EA possibilities for minimizing the risk (i.e.,hedging the risks or retaining the subborrowers foreign exchange earnings, if any, to service the loan).

(iii) In establishing the covenants for the financial intermediaries, ADB shouldcarefully consider the mandate and the diversity of the institution, and specifyspecial covenants to ensure its prudent lending practices and independence asan institution.

(iv) Project documents for LOCs need to include environmental covenants to requiresubprojects to comply with the environmental regulations governing their enterprises.

68. Financial institutions such as SITICO need to examine the projected cash flows of subprojects to determine realistic maturity periods and monitor subborrowers operationscarefully. They should also use staff with specialization in problem accounts and collection towork together with the account officers when loans remain in arrears beyond a certain period. Inaddition, they should effectively carry out loan and investment monitoring through the use of a

33 ADB is currently assisting the PRC in social security reforms (TA 3148-PRC).


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21

risk-rating system that will help in identifying early warning signs and in segregating problemassets at an early stage.

C. Follow-Up Actions

69. SITICO has taken significant steps in reorganizing its structure to cater to its marketpotential and is further automating its business processes using the latest technology to becomecompetitive in its business niche. To continue its focus on prudent and efficient operations,SITICO needs to make the following adjustments as indicated in Table 2.

Table 2: Recommendations and Follow-Up Actions

Recommendations and Follow-Up ActionsEntity

Responsiblefor Action

EntityResponsible

forMonitoring

Timing

1. Increase level of loan loss provisions based onthe proper loan classification of SITICOsportfolio reflecting either the new Peoples Bankof China classification or the internationalaccounting practice. a

SITICO MOF Within sixmonths

2. Prepare a human resource development planidentifying skills, experiences, andcompetencies required for the various positionsand incorporate a program for staff goal setting,assessment, training, recruitment, and personalcompensation linked to the individual goals andSITICOs own targets.

SITICO SMG Within oneyear

3. Build flexibility in the investments for management information system upgrading toadapt to SITICOs future role.

SITICO SMG Immediate

MOF = Ministry of Finance, SITICO = Shanghai International Trust and Investment Corporation, SMG = ShanghaiMunicipal Government. a Current Peoples Bank of China guidelines for loan classification were not mandatory for SITICO at the time of the

Operations Evaluation Mission. Once the loans are classified to different risk classifications, general loan lossprovisions are calculated for inherent but unidentified losses existing in pools of homogenous loans. These reservepercentages are based on loss experience in the relevant categories. The general provisions may increase from 1percent for unclassified loans to at least 20 percent for substandard loans and at least 50 percent for doubtfulloans.


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APPENDIXES

Number Title Page Cited on(page, para.)

1 Overview of Subproject Financing 21 4, 12

2 Implementation Data 22 4, 14

3 Overview of Subprojects and Current Status 23 6, 22

4 Selection of Sample Subprojects 24 7, 23

5 Compliance with Loan Covenants 25 8, 29

6 SITICO: Key Performance Indicators 26 10, 35

7 SITICO: Consolidated Cash Flow Statements,1995-1999 27 11, 40

8 SITICO: Income Statements, 1988-1999 28 11, 40

9 SITICO: Consolidated Balance Sheets, 1988-1999 29 11, 40

10 SITICO: Camel Analysis 30 11, 4011 SITICO: Loans in Arrear, 1989-1997 31 12, 44

12 SITICO: Organizational Charts 32 14, 54

13 International Trust and Investment Companies 34 14, 54


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OVERVIEW OF SUBPROJECT FINANCING

SubloanNo. Name of Subproject

TotalProject

Cost(Y000)

ADBLoan

Amount($000)

BorrowersContribution

(Y000)

PercentContributo Total

bySubborro

(%

001 Shanghai Cutting Tool Works 14,455 3,515 1,380 9.5002 Shanghai Long Distance Telecom Office 28,000 4,900 9,772 35.0003 Shanghai No. 6 Weaving Mill 32,562 4,675 3,000 9.0

004 Shanghai No. 3 Worsted Mill 12,687 2,180 2,397 18.9005 Shanghai No. 1 Plastic Products Factory 45,495 7,223 11,403 25.0006 Shanghai Tsen Tire Rubber Factory 40,808 6,725 7,000 17.2007 Pengpu Machine Building Plant 69,506 3,468 53,137 76.4008 Shanghai No. 2 Textile Machinery Works 14,879 2,823 1,525 10.2009 Shanghai Long Distance Telecom Office 20,927 2,800 7,683 36.7

010 Shanghai Huang Pu Radio Components Factory 10,957 1,772 1,706 15.6011 Shanghai No. 2 Dyeing and Printing Mill 40,763 5,290 15,794 38.7012 Shanghai No. 1 Silk Weaving Mill 18,590 4,148 2,156 11.6013 Shanghai Machinery Blades Factory 11,990 1,626 3,500 29.2014 Shanghai No. 1 Silk Printing and Dyeing Factory 34,003 5,783 3,930 11.6015 Shanghai Local Telephone Bureau 20,218 1,500 13,123 64.9016 Shanghai Magnetic Wire Factory Cancelled017 Shanghai No. 19 Radio Factory 16,418 3,035 2,093 12.7018 Shanghai Harbor Towing Corporation 22,000 2,400 9,448 42.9019 Shanghai Suburb-County Post Telecom Bureau 18,676 3,128 2,100 11.2020 Shanghai Harbor Bureau 51,400 8,943 4,000 7.8

021 Shanghai Harbor Jungonglu Container Handling Corp. 52,864 9,974 0.0023 Shanghai Household Chemical Product Factory 7,296 980 2,200 30.2

A01 Shanghai Tire and Rubber Corporation 361,305 5,000 190,000 52.6

A02 Shanghai First Refrigeration Machinery Works 44,983 5,367 16,000 35.6

ADB = Asian Development Bank, SITICO = Shanghai International Trust and Investment Corporation.


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22 Appendix 2

1. Number of Subloans Made 24 a

2. Sectoral Distribution of Subloans

a. 3 14.605 17.0b. 5 19.345 22.0c. 1 1.308 2.0d. 4 10.580 12.0e. Metallurgy 3 8.182 9.0f. Electronics 1 1.501 2.0g. 7 29.333 34.0

i. Towing Services 2.335 3.0ii. Harbor Operations 8.322 10.0iii. Containerization 7.065 8.0iv. Communication Services 4.721 5.0v. Telecommunications 6.889 8.0

h. 0 2.348 3.0Total 24 87.202 101.0

3. Size of Subloansa. Less than $100,000 1 0.009 0.0b. Over $100,000 to $500,000 0 0.000 0.0c. Over $500,000 to $1 million 0 0.000 0.0d. Over $1 million to $2 million 5 7.520 9.0e. Over $2 million to $5 million 13 42.833 49.0f. Over $5 million 5 34.492 39.0g. IDC 2.348 3.0

Total 24 87.202 100.0

4. Other Breakdown of Subloans

By Geographical Distributiona. Within Shanghai Municipality 24 84.854 97.0

b. Outside Shanghai Municipality 0 0.000 0.0c. IDC 0 2.348 3.0Total 24 87.202 100.0

By Purposea. New 0 0.000 0.0b. Expansion 14 55.208 63.3c. Balancing, Modernization, and Replacement 10 29.646 34.0d. IDC 0 2.348 2.7

Total 24 87.202 100.0

By Maturity of Loansa Up to 2 years 0 0.000 0.0b. Over 2 to 5 years 6 18.504 21.8c. Over 5 years 18 66.350 78.2

Total 24 84.854 b 100.0

5. Line of Equity

Shanghai SITCO Enterprises Co., Ltd.(SITEN)

a This includes loan approved to Shanghai No. 1 Magnetic Wire Factory which was later cancelled.b While $87.202 includes interest during construction, $84.854 is based on actual disbursements.c Not utilized.

Source: Project completion report.

$3 million c

Interest During Construction (IDC)

Date of Amount Approval Approved

28 Aug 1989

TextilesChemicalsMachinery Manufacturing

Others

Subloans ($'000) %Light Industry

IMPLEMENTATION DATA

Actual Loan UtilizationNo. of Amount


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Appendix 4

SELECTION OF SAMPLE SUBPROJECTS

1. The Operations Evaluation Mission requested the Shanghai International Trust andInvestment Corporation (SITICO) to select the sample of subprojects for site visits based on thefollowing criteria:

(i) eight subprojects which are representative of project financing;

(ii) asset size to include two large, two small, with the others falling in between;

(iii) loan size to include borrowers ranging from small ($2 million) to large (over $5 million);

(iv) industries representing textiles, machinery manufacturing, metallurgy, and other;

(v) at least three subprojects that are exporting; and

(vi) financial and operational performance ranging from good to poor.

2. The final selection depended on SITICO making the arrangements in identifying thesubprojects and subprojects willingness to me