The University of the West Indies

Faculty of Engineering
Notes for: ENGR1000/MENG1006 - INTRODUCTION TO ENGINEERING
Prepared by Dr T.M.Lewis

FUNDAMENTALS OF ENGINEERING PROJECT ECONOMICS

LECTURE 8

1 The World Bank

1.1 The World Bank (The International Bank for Reconstruction and Development) is a 'specialised agency'
within the meaning of Article 57 of the Charter of the United Nations, and is required to function as an
'independent international organisation'.

The Bank maintains working, relations with other specialised international organisations including the
International Monetary Fund (IMF), the Food and Agriculture Organisation Or the United Nations
(FAO), the World Health Organisation (WHO), the United Nations Educational, Scientific and Cultural
Organisation (UNESCO), and the United Nations Development Programme (UNDP).

The Bank was founded, along with its sister organisation, the IMF, at the International Financial and
Monetary Conference at Bretton Woods, New Hampshire, USA, in July, 1944.

The two institutions have complementary functions. That of the IMF is to promote international currency
stability, while that of the Bank is to help create a more prosperous and better-balanced world economy.

The first loans made by the Bank were to European countries to assist them with post-war reconstruction,
but in 1948 the Bank turned its attention to its other major responsibility - the promotion of economic
development in its poorer member countries. This has remained its chief preoccupation.

The capital of the Bank is subscribed by member governments, which now number 109, in accordance
with their economic strength. Only about one tenth of the subscribed capital ($22,900 million in June
1968) has been paid-up, the remainder being at call if required by the Bank to meet its obligations on
borrowings or on loans guaranteed by it. Borrowings in world capital markets are the main source of the
Bank's resources, the guarantee afforded by the Bank's capital structure making it possible to mobilise
private capital through bond issues.

The Bank's Charter contains a number of protective provisions governing loans or guarantees made by the
Bank. Among these provisions are that:
(a) the loans must be for productive progress
(b) except in special circumstances, the loans must be used to finance the foreign exchange
requirements of specific projects
(c) the merits of all projects must be carefully examined and priority given to the most urgent.
(d) the borrower may be a member government or a non-governmental enterprise, but if the
latter, the loan must be backed by a government guarantee.

Under the articles of Agreement, the Bank is also required to exercise 'prudence' in making loans and to
consider carefully the ability of the borrower to meet its repayment obligations. In addition, the Bank is
required to ensure that the loan is used solely for the specific purpose for which it was granted.
No conditions are attached to the Bank's loans requiring their proceeds to be spent in the territory of any
particular member or members.

The Bank requires its borrowers to obtain goods and services purchased with Bank finance through
international competitive bidding unless this procedure is clearly inappropriate. In some cases borrowers
are requested to employ the services of consultants to assist in determining the qualifications of bidders
and in analysing bids.

The granting of a loan is contingent upon the Bank being satisfied that the borrower is unable to obtain a
loan on acceptable terms from other sources.

A part of the Bank's activities which has assumed increasing importance in recent years is the provision of
technical assistance, either by the Bank's own staff or by independent consultants.

Most developing countries need assistance in identifying and preparing projects for financing. They may
also need help with formulating appropriate development policies, establishing effective development
institutions, determining priorities for investment, and other tasks essential to their development. The
Bank has been requested, or found it necessary, to advise on all these and other matters at some time or
another over the years.

Another sphere in which the Bank has played a part has been in helping to settle disputes between its
member countries. Two notable examples are the settlement, in 1960, of the dispute over the sharing of
the Indus Waters between India and Pakistan, and the settlement of compensation claims arising out of
the nationalisation of the Suez Canal in 1956.

It has been stated that, under its Articles, the Bank is required to examine carefully the ability of the
borrower to meet its repayment obligations. Service payments on Bank loans are in foreign currency.
Before a loan is provided, an appraisal is made of whether the amount contemplated is within the limits
which the prospective borrowing country can reasonably be expected to service, taking account not only of
its existing and prospective debts to the Bank, but of all sources of external finance.

In the case of a country whose credit is impaired by the existence of a dispute over a default on its foreign
debt or over compensation for expropriated property formerly owned by foreigners, the Bank's normal
practice is to inform the government involved that the Bank will not assist it unless and until it makes
appropriate efforts to reach a fair and equitable settlement.

The Bank attaches the greatest importance to assuring itself that a particular project for which a loan is
required is not only economically and technically sound, but that its order of priority in relation to other
possible projects has been carefully determined in the light of overall development requirements of the
country concerned. The Bank will not make loans to cover vague or unspecified development
programmes.

Normally a Bank loan is related to the expenditure on imported goods and services required in carrying
out a project. The remainder of the financing must normally be provided or found by the borrower.

The rate of interest charged by the Bank on its loans is based on the cost to the Bank of raising money in
the world's capital markets. It is kept as low as is compatible with the need to maintain the Bank's
financial strength and reputation.
2. Caribbean Development Bank

2.1 Background
The Caribbean Development Bank arose out of a series of meetings and conferences in the 1960's
culminating in the agreement of Heads of Governments, in 1967, in Barbados, to accept a UNDP report of
a team of experts who had examined in detail the establishment of a financial institution for encouraging
economic growth and development in the Caribbean.

The Bank was formally established by the Agreement which was signed on October 18, 1969 in Kingston,
Jamaica and started operations in January 1970. Its headquarters are at Wildey, St Michael, Barbados.
Its main purpose, enshrined in Article 1 of the Agreement, is:
"... contributing to the harmonious economic growth and development of the member countries in the
Caribbean and promoting economic co-operation and integration among them having special and urgent
regard to the needs of the less developed members of the Region."

2.2 Membership
Membership of the Bank is open to:
(a) States and Territories of the Region
(b) Non-regional states which are members of the UN or any of its special agencies

Its regional members include all the territories of the British Commonwealth together with Colombia and
Venezuela. Canada and the United Kingdom are non-regional members while the USA and the Federal
Republic of Germany, although not members, are deemed to be 'eligible source countries' for the
procurement of goods and services.

2.2 Financial Resources

The financial resources of the CDB fall into two categories:
(a) Ordinary Capital Resources - which are subscribed by member countries - about US$200m.
(b) Special Funds supplied by Canada, USA, United Kingdom, Venezuela, Colombia, The Federal
Republic of Germany, New Zealand and Trinidad and Tobago - about US$105m.

2.4 Lending Activities

The two major categories of loans reflect the source of funding. Thus, ordinary operations are financed by
Ordinary Capital Resources while special operations are financed by Special Fund Resources.

In accordance with Article 15 of the Bank's Charter, the CDB provides financing by furnishing the
borrower with currencies to meet principally, the foreign exchange costs of projects, while leaving
Governments to supply financing for local inputs. Interest charges are low and flexible, the Bank's policy
being to charge rates which, in its own judgement, are appropriate.

The first loan was granted in April, 1971 and since that time a wide range of projects - agricultural,
agricultural product processing, small manufacturing, roads and bridges, ports, sea and air transport,
airport buildings, hotels, electricity, water supply, telephones - have received the Bank's financial
support.

Before a loan can be approved, a project must be appraised by the Bank's staff, the appraisal document
must include:
(a) Present capital cost of the project and construction period.
(b) Annual operation and maintenance costs projected for the life of the project.
(c) Resources - projected for the life of the project.
(d) Financial rates of return to the owner of the project.
(e) Rates of return to the community (territory) in which the project is located.
2.5 Technical Assistance
 Among its many activities, the Bank provides technical assistance to regional members in the following
areas:
(a) co-ordinating development programmes
(b) assisting in the identification and preparation of project proposals and generally providing technical
assistance through its advisory services and consultants.

2.6 Regional Activities

The Bank engages in a number of regional activities in its efforts to promote economic co-operation and
integration in the Region. Among such activities are:
(a) Promotion of projects which have a direct integration aspect, mainly in three sectors: agriculture,
transportation and industry.
(b) Promoting and financing regional agricultural projects as part of the Regional Food Plan accepted at the
Heads of Governments Conference of 1975.

2.7 Approval by the Board

Only the Board of Directors is authorised to take decisions concerning loans, equity, investments,
technical assistance and other operations.

2.8 Organisational Structure

The Board of Governors is the highest policy making body which normally meets once per year. Each
member country nominates one Governor and one alternate Governor.

The Board of Directors has eleven members - 9 regional and 2 non-regional - each of whom holds office
for two years. It exercises all powers delegated to it by the Board of Governors', meeting about six times a
year. The President, who is the chief executive officer of the Bank, is elected by the Board of Governors to
a five year term of office and may be re-elected.

The first President (1970) was Sir Arthur Lewis (St Lucia) Nobel Prize winner and former Vice
Chancellor of the University of the West Indies. He was succeeded in 1974 by Mr William Demas of
Trinidad and Tobago.

3 PUBLIC AND PRIVATE FINANCING

3.1 Central Government Finance

The sources of finance for investment in the public sector fall into two groups: internal and external.

Internal sources of finance are relevant only to those nationalised industries in which the internal cash
flows provide a source of finance for the industry's investment needs. In effect this source forms part of the
annual receipts of the central government, since it reduces the amount of external finance that has to be
provided by the government for the industry's growth.

External sources of finance for public sector projects are simply sources which are not internal to the
industry concerned, but are available to government, such as taxes and borrowing.

3.2 The Nationalised Industries

Whenever their cash receipts exceed their cash payments, the nationalised industries generate their own
internal finance. If this excess is not paid over directly to central government as a kind of dividend, it can
be retained for investment or re-investment inside the industry. This both reduces the central
government's revenue and its need to provide external finance in the form of loans to that industry. The
more profitable the industry the greater will be the amount of internal financing possible. In this respect a
profitable nationalised industry would resemble a company in the private sector which generates the
finance it needs for expansion.
 In the nationalised industries, the whole of the external finance required is normally provided from
government sources in the form of fixed interest loans. A fast-growing or modernising nationalised
industry may regularly be requiring fresh loans from government, each of which may have a different rate
of interest attached to it. The nationalised industries are expected at least to pay the interest on the loans
they receive from government.

On public investments it is not normally appropriate to assess new projects on the basis of commercial
interest rates. These rates would be unlikely to reflect the opportunity cost of finance to the community. As
a result, public sector investments are either assessed on the basis of their internal rates of return or on the
basis of their net present value when discounted at a social discount rate specified by government.

The nationalised industries are usually required to apply discounting tests in assessing new capital
projects. In addition to these tests, these there are also overall financial objectives which need to be met.
The financial objectives vary from industry to industry.

3.3 Private Sector Financing

When a private company wants to invest in a new project it must also find a source for the money
required. There are two principal alternatives, which have different and far reaching implications for the
companies involved. The alternatives for capital investment projects are, long term loans or ownership
finance.

(a) Long Term Loans

Because capital investment projects have extended life spans it is normal that where loans are required,
these are long term in nature. Various different types of loan finance is available for extended periods of
time, such as: debentures, Loan Stocks, Notes. The terms of repayment on each are different, and each
has advantages and disadvantages in specific circumstances.

The terms of issue state the interest and date of repayment. Such loans are usually issued in units, for
example, $100, with each unit being transferable. Depending on relative interest rates, such units may be
sold for a discount or for a premium. The interest on a loan stock is fixed by a legal contract under which
the company is liable whether it makes a profit in a given year or not. Interest on loans taken out for
capital investments usually attracts a tax allowance.

(b) Ownership Finance

If a company does not want to take out a loan and thereby commit itself to the schedule of repayments it
can try to raise the money from amongst its owners (shareholders). This type of financing may be raised
by issuing Preference Shares or Ordinary Shares, each share having a nominal value and can be bought by
the existing shareholders or new ones. Such shares are transferable. Preference Shares have a fixed
interest rate or dividend which can be paid when the company makes sufficient profit or has available
undistributed profits accumulated from previous years.

Since dividends paid on preference shares are not allowable as a deduction for taxation, preference shares,
are not often issued. The holders of ordinary shares bear the greatest uncertainty of all those who provide
finance regarding the return they receive. Ordinary shares can be issued at a premium over the nominal
value but not normally at a discount. Dividend are not paid on ordinary shares until interest on loans and
dividends on preference shares have been paid. Likewise, if the company is wound up, the ordinary
shareholders may be repaid whatever remains after loan liabilities and preference shareholders have been
repaid.