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RESTRICTEDFILE COPY Report No. P-57This report was prepared for use within the Bank and its affiliated organizations.They do not accept responsibility for its accuracy or completeness. The report maynot be published nor may it be quoted as representing their views.INTERNATIONAL DEVELOPMENT ASSOCIATIONREPORT AND RECOMMENDATIONOF THEPRESIDENTTO THEEXECUTIVE DIRECTORSON APROPOSED CREDIT TO THEREPUBLIC OF KOREAFOR ASECOND RAILROAD PROJECTNovember 29, 1967Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedINTERNATIONAL DEVELOPMENT ASSOCIATIONREPORT AND RECAMMENDATION OF THE PRESIDENT TOTHE EXECUTIVE DIRECTORS ON A PROPOSED CREDITTO THE REPUBLIC OF KOREA FOR A SECOND RAILROAD PROJECT1. I submit the following report and recommendation on a proposedcredit in an amount in various currencies equivalent to U.S. $11 millionto the Republic of Korea.PART I - HISTORICAL2. In 1962, the Bank Group undertook its first lending operationin Korea extending a $14 million IDA credit for a railway project tohelp finance the purchase of rolling stock included in the 1962-1966investment program of the Korean National Railroad (KNR). The creditis fully disbursed and the project was satisfactorily canpleted.3. In the following years Korea's economic policies, which hadled to serious monetary instability and a decline in foreign exchangereserves, precluded any further lending by the Bank or IDA. Beginningin 1964, the Korean Government made determined efforts to improve theeconomic situation which brought about substantial increases in publicand private savings, a slow-down in the rise of the price level, andan increase in foreign exchange reserves. In view of the Government'sefforts the Bank/IDA in 1965 agreed to consider further operations andto sponsor, at the request of the Government, the establishment of aConsultative Group for Korea. A Consultative Group was formed at ameeting in Paris in December 1966.4. In August 1966, the Government asked IDA for an $11 milliondevelopment credit to finance part of the 1967-1971 development programof KNR. This development program is based on the recommendations madeby a transportation survey for the entire country and all modes oftransport which was carried out in 1965/1966. The foreign exchangecost of this survey ($388,000) was financed by the Bank under atechnical assistance grant.5. Negotiations took place in Washington between September 8 andSeptember 25. The Government was represented by Mr. Moon Doh Chung,Assistant Minister, Economic Planning Board, and Mr. Tai Suk Oh fromthe Ministry of Transportation. The KNR was represented by Messrs. Hongand Park.6. The above mentioned IDA credit of $14 million has been theonly Bank/IDA lending operation in Korea.7. The World Bank Group has been instrumental in setting up therecently founded Korea Development Finance Corporation (KDFC). IFChas substantially negotiated an investment of about $0.7 millionequivalent in KDFC which, if approved, would be the first IFC investmentin Korea. At the same time, the Bank negotiated a $5 million loan to-2-KDFC and I expect to bring forward this loan together with the proposalfor an IFC investment in KDFC within the next fewy weeks.8. I also expect to present to the Executive Directors withinthe next few months a proposal to make a small development credit tofinance the foreign exchange cost of h-ighway feasibility studies andof studies related to the organization of highway planning andconstruction, and transport coordination in general.PART II - DESCRIPTION OF THE PROPOSED CREDIT9. Borrower: Republic of KoreaBeneficiary: Korean National RailroadAmount: The equivalent in various currenciesof $11 million.Purpose: To finance the foreign exchange costof special type freight cars and ofconsultants' services.Amortization: 50 years, including a 10 year graceperiod. One-half of 1% of theprincipal amount will be repayablesemi-annually for 10 years commencingDecember 1, 1977 and ending June 1,1987; one and one-half of 1% of theprincipal amount repayable semi-annually thereafter until June 1, 2017.Service Charge: Three-quarters of 1% per annum on theprincipal amount of the credit withdrawnand outstanding.Relending Terms: 25 years, including a 3 year graceperiod at an interest rate of 6% perannum.PART III - THE PROJECT10. An appraisal report entitled "Appraisal of a Second RailroadProject Korea" (TO-598a) dated November 21, 1967 is attached.11. Transportation requirements in Korea are predominantly met bythe railway. Road transport has grown rapidly over the last ten yearsbut remains confined to short distance traffic due to the lack of goodroads. For this reason and because of the overall shortage of transport- 3 -capacity, problems of transport coordination have been minimal. However,the Government is beginning to take steps to cope with coordinationproblems which will become more pronounced in the future.12. Both freight and passenger traffic have been growing at anaverage rate of 8% per annum between 1955 and 1966. KNQR expects thatfreight traffic will grow about 11% per annum during 1967-1971 whilepassenger traffic would continue to grow at an annual rate of 8%. Tomeet this growth substantial investments are required.13. The development program of KNR for 1967-1971, providing forexpenditures totalling Won 57.4 billion (U.S. $217 million equivalent),would increase the capacity of the railway sufficiently to meet theexpected traffic growth and is considered sound. The project consistsof the first three years of KNR's development program coveringconstruction of new lines, increased station and line capacity, trackand structure improvements, and the acquisition of motive power androlling stock. The total cost of the project is estimated at aboutWon 36.3 billion (U.S. $137 million equivalent) with a foreign exchangecomponent of about U.S. $h0.3 million equivalent. The proposed IDAcredit and existing or proposed loans from other countries wouldprovide the foreign exchange required for the project. Contracts tobe financed out of the proceeds of the proposed credit would be awardedon the basis of international competitive bidding.14. The proceeds of the proposed credit would be used to financethe import of 600 hopper cars required to meet an expected increase incoal traffic by about 25% and of 450 tank cars to provide for theexpected doubling of the volume of oil traffic over the project period.In view of the urgent need for the equipment, contracts for the carshave already been awarded. In placing these contracts, 1NR observedthe Association's requirements concerning procurement. Expenditureshave not been incurred yet by KNR under these contracts.15. Coal handling facilities, particularly in the Seoul area,do not permit at present the most economical use of coal cars. TheGovernment and the coal industry are making efforts to correct thissituation and the Government has agreed to employ consultants tostudy and advise on this problem. The foreign exchange cost of theconsultants would be financed under the proposed credit. Because ofthe pressing need for a solution to the problems of coal trafficemployment of the consultants satisfactory to the Association, wouldbe a condition of effectiveness of the credit.16. Until 1963, KNR was a bureau in the lqinistry of Transportation.Following a requirement of the 1962 Credit Agreement, KNR wasestablished in 1963 as a separate entity within the Ministry ofTransportation with its own budget and accounting under an independentrailway manager appointed by the Government. The Government has nowdecided that KNR should be organized as an autonomous entity and hasset up a committee to study the problems involved. This will give- 4 -KNR more authority and flexibility in its operations, especially withrespect to the allocation of funds within its budget, staffing and wagepolicies, and tariff policies.17. At present, the KNR management still suffers from a lack ofsenior qualified engineering, economic and accounting staff. Until thisdeficiency can be made up by recruitment from universities, KNR'smanagement must rely extensively on the advice from consultants incarrying out its development program. Consultants to advise on the useand preparation of statistics, traffic costing, the maintenance ofrolling stock, and the planning and design of marshalling yards will beemployed by KNR and the foreign exchange cost of these consultants isprovided for under the proposed credit.18. KNR's financial position is sound. More than two-thirds ofthe funds required for the 1967-1971 development program will begenerated by the operations of the railways. Rates of return have beenlow in the past because tariffs were low and increases in recent yearshave not fully offset increases in costs, due mainly to increased wagesand salaries. The Government proposes to increase passenger fares by50% and freight rates by 30% not later than January 1, 1968. On thisbasis, the forecast of income and expenditure over the period 1967-1971,taking into account substantial rises in wages and salaries, shows ratesof return of about 5% over the years 1968-1971. The Government and KNRhave agreed to take the necessary steps to maintain and improve furtheron this level of return.PART IV - LEGEL INSTRUMENTS AND AUTHORITY19. The draft Credit Agreement between the Republic of Korea andthe Association and the Recommendation of the Committee provided for inArticle V, Section l(d) of the Articles of Agreement are beingdistributed to the Executive Directors separately. The draft CreditAgreement generally follows the pattern of Agreements for projects ofthis type and is similar to the previous Agreement providing for acredit for railways in Korea.PART V - THE ECONOMY20. A report entitled "The Economy of Korea" (FE-55a) datedJune 17, 1966, in eight volumes was distributed to the ExecutiveDirectors; Volumes 1-IV and VI-VIII were distributed on June 27,Volume V was distributed on November 4, 1966. The report noted thatthe implementation of appropriate fiscal and monetary policies hadreduced the monetary instability which marked the years 1962-1964 andhad accelerated the growth of capital formation, production and exports.It concluded that the prospects for further rapid growth were favorableprovided growth of the domestic savings rate and of financial assistancefrom abroad continued.21. An economic mission wlhich recently rtetuxned frcm. Korea wasfavorably impressed by the performuance of the Korean economwy. Theeconomic growth has furtA2s'r accelerated in 1960 anld 1967. The increaseof GiNP in real terms in 1966 amounted to 130 W43 and, in spite of adverseweather conditions affecting part of the grains production, GAJP growthis expected to exceed 1Og in 1967. The leading sector is manufacturingwhere the growrth rate has recently exceeded 20, a year. Most of therapid growth of manufacturing is coinected with the expansion of exports,wlhiclh rose from $175 milJ.ion in 1965 to $250 million in 1.966 and ;iillprobably reach $350 nillion in 1967. This phenomenal increase inexports - of a vide variety of light industr1ial projects sold in alarge number of developed countries is due to the ability of Koreanentrepreneurs, techniciacns and worikers, and tle wholehearted support ofthe Goverrment. Another favorable factor of recent years is the largeforeign exchange earnings (mostly services and remittances) as a resultof the Viet Namn conflict0 The manufacturing boom is exerting a strongpull onl the output of the construction industry and the services sectors0Recently a pow-er shortage has arisen. Despi'te a large investment- oilthe expansion of power facilities, the shortage may impose a restrainton the growth of manufacturing production in at least part of 1968. Inorder to ovorcome similar existing bottlenecksg it is necessary toexpand and improve transportation facilities in Korea022, The upsurge of activity is accompanied by a sharp rise ingross investment w-hich has risen fron 147t` of GNP in 1965, to 21.7%in 1966 and which is expected to rise to 22.4i% in 1967. A major partof the increase in investment is being financed by increased doilesticsavings of the Government and the private sector, Stepped-up taxcollection, increases in public utility rates and restraint in currentexpenditures have led to a sharp increase in public savings. Thereduction of m.onetary instability in recent years and the generallyfavorable development of the economiy hlave greatly favored an increasein private sector savings.23. The recent acceleration of tho growth of the economy has ledthe Governm3nt to believe that economic growth can be maintained at avery high level. The Government's objective for 1968 is a GNP grow-thrate of 10% in real terms, In view of favorable demand conditions athome and abroad, and a large increase in productive capacity frominvestments currently being undertaken, this objective of the Governmentmay be feasible provided power and transportation bottlenecks do not puttoo much restraint on the economy. The Government is determined tostave off the danger of financial instability inherent in very rapideconomic growth by following the stabilization policies outlined inagreements wyith the Fund and the United States.240 Despite more savings at home, the need for foreign capitalrenains large. United States grant assistance and low interest long-term loans, mainly froiii the Uxtited States and Japan, are beingsupplemented by a large amount of foreign suppliers' credits.Indebtednoss, especially to foreign equipment suppliers, is rising-6 -rapidly but with debt service averaging about 9% of prospective foreignexchange earnings, it is still manageable. The country could stand someadditional debt on conventional terms; however, to prevent an undueincrease in debt service obligations in the future and in viewi of thelow per capita income of $113, it appears desirable that a large partof foreign assistance be on concessional terms.PART VI - COMPLIANCE 'WTITH ARTICLES OF AGREEMENT25. I am satisfied that the proposed credit would comply with theArticles of Agreement of the Association.PART VII - RECUIIIENDATION26. I recommend that the Executive Directors adopt the followingresolution:RESOLUTION 1O.Approval of Credit to Republic of Korea in an amountequivalent to U.S. $11 millionRESOLVED:THAT the Association shall grant a Development Creditto the Republic of Korea in an amount in variouscurrencies equivalent to eleveni million United Statesdollars (U.SO $11,000,000), to mature on and prior toJune 1, 2017, to bear a service charge at the rate ofthree-fourths of one percent (3/4 of 1%), and to beupon such other terms and conditions as shall besubstantially in accordance with the terms and conditionsset forth in the form of Development Credit Agreement(Second Railroad Project) betwreen the Republi-c of Koreaand the Association which has been presented to thismeeting.Attachmnent George D. WoodsPresidentHovember 29, 1967

Report and recommendation of the president to the executive directors on a proposed credit to the Republic of Korea for a second railroad project

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Report and recommendation of the president to the executive directors on a proposed credit to the Republic of Korea for a second railroad project

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