Philippines - Rice Processing and Storage Project

RESTRICTED FILE COPY Report No. P-890 This report was prepared for use within the Bank and its affiliated organizations. They. do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A RICE PROCESSING AND STORAGE PROJECT January 13, 1971   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRBCTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A RICE PROCESSING AND STORAGE PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines in an amount in various currencies equivalent to $14.3 million. PART I - HISTORICAL 2. In October 1968, the Government of the Philippines forwarded to the Bank a project proposal prepared by the Development Bank of the Philippines (DBP) for the financing of grain processing and storage facilities. The project proposal drew heavily on the findings of a grain marketing and storage study financed by the United States Agency for International Development. The Bank's economic report of May 24, 1968 had recognized the need for additional rice processing and storage facilities in the Philippines. 3. The project was appraised in April 1969, but further processing of the loan was suspended until the introduction of legislation which would have, inter alia, enabled the Government to relend the proceeds of foreign loans to the private sector and would have authorized the President to waive existing laws in the Philippines which did not conform to the Bank's international competitive bidding procedures for the pro- curement of goods to be financed with the proceeds of the proposed loan. A Bank mission visited the Philippines in February-March 1970 to discuss the effects of the pending legislation on the project. )I. Negotiations for the proposed loan were held in Washington in July 1970. The Government was represented by Dr. Placido Mapa, then Director General of the Presidential Economic Staff; DBP by Mr. Joaquin Gochoco, Manager, Economic Research Department and Mr. Jesus Avancena, Chief Legal Counsel. Following negotiations, a Bank mission visited the Philippines in August 1970 to update project cost estimates and financial projections with particular reference to the effects of the de facto devaluation which resulted from the exchange reform adopted on February 21, 1970. The legislation mentioned above was signed in November 1970 becoming Republic Act No. 6142 after various amendments had been intro- duced during its passage through Congress. Following further discussions in Manila in December and in Washington in January this year final agree- ment on the loan documents which take into account the effects of these amendments was reached earlier this month. 5. If approved, the proposed loan would be the fourteenth in the 'hilippines and would increase the total amount lent to $231.0 million, net of cancellations. The proposed loan would be the fifth loan for agriculture and the first for grain processing. The following is a  - 2 - summary of Bank loans to the Philippines as of December 31, 1970: Loan No. Year Borrower Purpose Amount (IJS$ million) Bank Undisbursed 7 Loans Fully Disbursed 102.2 - 393-PH 1964 Republic of the Education (College 6.o 0.9 Philippines of Agriculture) 467-PH 1965 Philippine Relending to Private 25.0 0.8 National Bank Development Corp. of the Phil. (PDCP) 491-PH 1967 National Power Power (Bataan) 12.0 3.7 Corporation 607-PH 1969 Central Bank of Agriculture 12.5 12.0 the Philippines Credit 630-PH 1969 Philippine Relending to PDCP 25.0 21.9 National Bank 637-PH 1969 Republic of the Irrigation 34.0 33.3 Philippines (Upper Pampanga) Total (net of cancellations) 216.7 of which has been repaid to Bank and others 25.5 Total Now Outstanding 191.2 Amount Sold 12.1 of which has been repaid 10.4 1.7 Total Now Held by Bank 189.5 Total llndisbursed 72.6 6. Although project implementation in the public sector has been gradually improving there remain problems of execution in several Bank projects. Disbursement under two Bank loans has been adversely affected by the February exchange reform. Sub-loan commitments under the Second Rural Credit Project (Loan 607-PH) have been made at only about 20 per- cent of the estimated rate due mainly to the uncertainties created for farmers by the floating rate of exchange and the increase in the cost of imported equipment. The Government is currently making a thorough review of the project and a Bank mission is to go to the Philippines this spring to examine further the effects of the exchange reform on the financial position of farmers and to consider possible adjustments in the project. The demand for industrial loans has also been affected by fluctuations of the exchange rate in 1970 resulting in the slow disburse- ment of the Bank's third loan (Loan No. 630-PH) to the Private Development Corporation of the Philippines (PDCP). With regard to the Bataan Power Project (Loan No. 491-PH), initial disbursements were slower than expected  due to delays in the award of equipment contracts but project construc- tion is now proceeding satisfactorily. The financial position of the borrower, the National Power Corporation, has been affected by increased costs of debt service following the de facto devaluation and by delays in raising tariffs. A rate increase has now been approved by the Govern- ment and the effects of this on NPC's finances are currently the subject of a Bank review. Although only $600,000 had been disbursed on the Upper Pampanga Irrigation Project (Loan No. 637-PH) as of December 31, good progress has been made in implementing the project and disbursements are expected to accelerate with the recent award of the contract for dam- construction. 7. No IDA credits have been made to the Philippines. IFC has made 5 commitments in the Philippines totalling $24.2 million, of which IFC now holds, net of participations, sales and cancellations, $14.6 million. In addition, IFC's Board of Directors approved on January 5, 1971 a loan of $6.2 million and an equity investment of $1.8 million for the Philippine Petroleum Corporation. 8. A highway project requiring a loan of approximately $8 million has been appraised and should be ready for the consideration of the Executive Directors in the spring of 1971. Further Bank loans for power, agriculture and education are under consideration for FT 1972. PART II - DESCRIPTION OF THE PROPOSED LOAN 9. Borrower: Republic of the Philippines Beneficiaries: Corporations, cooperatives and associations in the private sector. Amount: US$ 14.3 million Purpose: To finance the foreign exchange cost of the equipment and operation of modern rice processing and storage facilities by beneficiaries. Amortization: In 19 years including a four-year grace period through semi-annual installments beginning July 15, 1975 and ending January 15, 1990. Interest Rate: 7-1/4% per annum  Commitment charge: 3/4 of 1% per annum. Relending terms to 11% interest:principal repayable beneficiaries: in 14 years including a grace period of about one year: payment to be made in Philippine pesos. Estimated Economic Rate of Return :25% PART III - THE PROJECT 10. An appraisal report entitled "Rice Processing Project - Philippines" (PA-47a) on the proposed project is attached. 11. Agriculture is the largest sector in the Philippine economy generating about one-third of gross national product, accounting for 80 percent of export earnings and providing employment to over half of the labor force. Rice is the staple diet of the Philippines and rice production takes up almost 40 percent of the total area under cultivation. In the six years prior to 1967, rice production increased at an annual rate of about 1.5 percent, and the Philippines relied on substantial rice imports. In 1967/68, rice production increased by about 11 percent following a concerted government effort towards successful development and cultivation of high yielding varieties. Drought affected rice production in 1968/69; but the momentum has been regained and the Philippines is very near self- sufficiency for the first time in the post war period. 12. The breakthrough in rice production has created serious bottle- necks in the marketing system. Lack of mechanical drying equipment is hindering efficient processing of paddy varieties maturing in the wet season, and traditional milling and handling techniques are proving inadequate for handling commercial flows in major producing areas. Finally, inadequate storage facilities contribute to relatively high spoilage losses and to instability in producer prices. 13. The proposed project would provide long-term credit to the private sector for setting up modern integrated rice processing units in major producing areas. Processing capacity created by the project is expected to be distributed among 6 large units and 60 small units. In total, the proposed project is expected to provide mechanical drying capacity of about 225 tons/hour, modern milling capacity of about 60 tons/hour, bulk storage capacity of about 150,000 tons, warehouse capa- city of about 24,000 tons and other required ancillary equipment and facilities. Project capacity is expected to be located mainly in the highly productive paddy growing regions of Central Luzon.  14. The Bank loan of $14.3 million would cover the foreign exchange component of the project, estimated at 68% of total project cost ($20.9 million equivalent). The legislation referred to in paragraph 4 does not authorize the Government to channel the proceeds of foreign borrowings to the private sector except through a government-controlled institution. The pro- posed loan would therefore be made to the Government which would relend the proceeds to DBP under a Subsidiary Loan Agreement. The interest rate and repayment terms of the subsidiary loan would be the same as the Bank loan except that the Government would bear the foreign exchange risk. Agreement has been reached with the Government and DBP on the text of the Subsidiary Loan Agreement. 15. DBP would make sub-loans from the proceeds of the Bank loan to the private sector covering the foreign exchange cost of sub-projects. DBP would, at the same time, provide finance from its own resources for part of the local currency costs of sub-projects and meet the local cur- rency costs of project administration. The percentage of DBP's contribu- tion to each sub-project would vary depending on the foreign exchange component of the sub-project and the contribution made by the beneficiary, but DBP's share of project financing is expected to amount to about 11 percent of total project costs. In addition, DBP would be obligated to finance, where necessary, the working capital requirements of beneficiaries on terms not less favorable than those which it extends to its other clients for such purposes. The remainder of project costs would come from beneficiaries' contributions expected to amount to 21 percent of project costs. The size of the contribution is reasonable given the financial capabilities of sub-borrowers expected to participate in the project. 16. DBP, a Government owned institution, has total resources of F2,740 million (US $457 million), making it the largest development bank in the Philippines and an important channel of finance for agriculture and industry. While its financial position, as described in paragraph 4.02 and in Annex 8 of the Appraisal Report, is such that the Bank would not consider making a direct loan to the institution, it has the technical competence to administer the project. It has a professional staff of over 1,200 including more than 350 agriculturalists and engineers. It also has prior experience in financing rice processing facilities and, with the assistance of consultants, its staff would be able to handle the appraisal and loan administration of the proposed sub-projects. DBP would be required to establish and maintain a special project account through which all project funds would flow and would be restricted to investing solely in Government securities any repayments on Bank-financed sub-loans which are not currently required for servicing the debt on the subsidiary loan or for meeting the costs of project administration. 17. To strengthen further DBP's capacity to administer the project, a special grain processing section is being established in the Office of DBP's Chairman to implement the project; before the loan becomes effective, consultants acceptable to the Bank, would be appointed to assist the Section. The appointment of the Head of the section, who is a qualified senior officer of DBP, has been made after consultation with the Bank.  - 6 - Most of the professional staff are expected to come from DBP' s Invest- ment Banking Department which has developed appropriate appraisal and supervision procedures for industrial lending. Furthermore, all sub- loans under the project exceeding $250,000 would be subject to the prior approval of the Bank. These arrangements would provide DBP with suffi- cient technical assistance and supervision to carry out the project effectively. 18. Training would be required to provide beneficiaries' managerial, technical and operating personnel with the skills that would enable them to operate project facilities efficiently and for this reason it would be a condition of effectiveness of this loan that the Government make adequate arrangements for training beneficiaries' personnel at the Univer- sity of the Philippines College of Agriculture at Los Banos. It is expected that this training would be provided under a UNDP-financed grain industries training program which would begin operation this spring and for which the FAO would be the Executing Agency. 19. Beneficiaries would repay their sub-loans to DBP at 11 percent interest over 14 years after approximately one year of grace to permit construction to be carried out. The interest rate would allow satisfactory incentives for beneficiaries to participate in the project and would leave DBP with a spread of 3-3/4 percent on Bank funds, which would be an ade- quate margin to meet administrative costs and reserves for bad debts. It is expected that the Bank loan would be disbursed in 3 years but an addi- tional year has been allowed for possible setbacks or delays. Given the proposed lending terms to the beneficiaries a term of 19 years including 4 years of grace would be appropriate for both the Bank loan and the subsidiary loan. 20. DBP would be responsible for the procurement of goods required by sub-borrowers and all equipment and civil works contracts in excess of $60,000 equivalent would be awarded on the basis of international competitive bidding. DBP, acting on behalf of beneficiaries, would re- quest bids based on suitable bulking of approved sub-projects, 15 to 30 at a time. Local manufacturers bidding on equipment contracts would be allowed a preference of 15 percent or the level of custom duties which- ever is lower. The Bank loan would finance 100 percent of the cost of imported equipment, materials and supplies financed under sub-loans. In the event of a domestic manufacturer winning equipment contracts, the Bank would finance 60 percent of the costs of such contracts, which would represent the estimated foreign exchange component. In addition the Bank loan would finance 100 percent of the foreign exchange cost of consultants and 50 percent of the cost of civil works contracts. If foreign exchange costs prove to be less than expected, it is proposed to increase the number of facilities to be financed under the project. 21. When all facilities are constructed, project processors would handle about 480,000 tons of paddy per year producing 322,000 tons of milled rice having a value, based on projected world market prices, of between $30 and $40 million. The estimated economic rate of return would  - 7 - be about 25 percent. Financial rates of return to the miller are 19 per- cent for investment in a small facility and 24 percent for investment in a large facility. While it is not clear at this time what par value will eventually be agreed with the IMF (the peso has been trading at between F5.80 and P6.43 to US $1.00), the appraisal report is based on a rate of F6.o to a dollar. Sensitivity analysis shows that possible de- viations in the exchange rate from this assumed par value within the range of likely alternatives (US$1 = F5.5 and US$1 = P6.5), have minor effects on financial and economic rates of return and that returns would remain satisfactory under the alternative assumptions considered. In addition to providing an adequate return to project beneficiaries the project is expected to lead to an increase in farmers' income, amounting to about US$2 million annually. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 22. The draft Loan Agreement between the Republic of the Philippines and the Bank, the Report of the Committee provided for in Article III Section IV(iii) of the Articles of Agreement and the text of a Resolution approving the proposed loan are being distributed to the Executive Directors separately. 23. The draft Loan Agreement contains provisions normally used for agricultural credit projects. A Subsidiary Loan Agreement, satisfactory to the Bank, would be entered into between the Borrower and DBP and the execution of the Subsidiary Loan Agreement is a condition of effectiveness of the proposed loan. The Operating Policies and Procedures governing the onlending of the proceeds of the Loan are set forth in Schedule 5 to the draft Loan Agreement. PART V - THE ECONOMY 2h. An economic report, "The Current Economic Position and Pros- pects of the Philippines" (No. EAP-16a, dated August 10, 1970), was distributed to the Executive Directors on August 29, 1970. This report formed the basis of discussions at a meeting convened by the Bank in Paris last October to consider the establishment of a Consultative Group for the Philippines. The consensus of this meeting was that impressive efforts had been made towards restoring financial stability to the Philippine economy and that its long term growth prospects were favorable. 25. An IMF mission is currently visiting the Philippines to discuss progress under the Standby Agreement of February 1970 and to consider the further requirements of monetary and fiscal policy for the year ahead. Financial improvement, following the de facto devaluation of February 1970 and other stabilization measures has been satisfactory. The external situation was markedly better in the first 11 months of 1970; export earnings reached a level of 20 percent above the 1969 mark, imports were reduced and the trade deficit dropped from $263 million in 1969 to only $5 million. The Government has been successful in rescheduling claims by European and US commercial baniks amounting to $227 million,  - 8 - but debt service is nevertheless a heavy burden for the next few years. It amouited to 33 percent of' exports in 1970. I-However, with the imriproved trade position, the Philippines was able to meet this debt service and at the same time raise the level of international reserve:s by K6Y uidLlion (October 1969 to October 1970). 26. The need f'or effective management of the external debt has recently received legislative recognition with the incorporation in Republic Act No. 611h2 of a debt limitation clause. This stipulates that in contracting external debt the Government should ensure that the result- ing debt service on both public and private debt should not exceed 20 percent of the average of the foreign exchange receipts for the three years preceding the year in which the debt is incurred. This legislation should help to keep the Pnilippines debt service ratios within manageable limits in future years. It also emphasizes the need for the Philippines to mobilize a larger share of their resource requirements internally, and to secure more advantageous repayments terms on its f'oreign borrowings. Provided suitable grace periods are negotiated, the Philippines has room to incur additional long-term debt on conventional terms within the ceilings of this new legislation. 27. The Philippines can also be considered creditworthy for substantial additional borrowing . The present debt service difficulties should be out of the way by the mid-1970's with a debt service ratio down to around the 15 percent level by 1976 or 1977. Potentials and prospects for further economic development and export growth justify substantial additional foreign borrowing. Growth of the econorm has been curbed in the past year by the severe pinch of stabilization and debt service requirements. However, the longer term growth record of the Philippines has been reasonably favorable and can be expected to be so in the future, given the substantial resources of the country, its dynamic private sector, and the public development ef'fort to which the Government is now comitted. PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 28. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMIMENDATION 29. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Washington, D.C. January 13, 1971  ANNEX Page 1 of 2 PHILIPPINES BASIC DATA Area 297,000 square kilometers Population Total (1970 mid-year) 38.5 million Rate of Growth 3.5% Density 130 per square kilometer Gross National Product Total 1969(Tcurrent market prices) P31.7 billion Growth Rate 1968/69 6.2% Per Capita GNP 1969 US $211 Gross National Product by Expenditure (percent) 1962 1969 Private consumption expenditure 7Th7 7T77 Government consumption expenditure 8.8 9.7 Gross domestic capital formation 19.6 19.9 Net exports of goods and services -7.2 -3.9 Net factor income from abroad -0.5 -0.9 Errors and omissions 1.2 -1.0 100.0 100.0 Net Domestic Product by Origin (percent) 1962 1969 Agriculture, fishery and forestry 30.8 35. Mining and manufacturing 20.4 18.9 Others 48.8 45.5 100.0 100.0 Balance of Payments (US $ million) 1959 1964 1969 Merchandise export 5757 -77 Merchandise import -524 -780 -1,131 Net services -95 -1 - 132 Net transfer payments 131 109 152 Current account balance 56 85 -238 Net long-term capital 79 32 101 Basic balance 135 117 -137 Major Exports (percent) 1969 Coconut products 19 Sugar products 18 Forest products 33 Mineral products 19 Others 11 100  ANNEX Page 2 of 2 Foreign Exchange Reserves (US $ million) Oct. 1969 Dec. 1969 Oct. 1970 International reserves a/ 148 126 21 Net reserves b/ -147 -71 -39 External Debt (US $ million) c/ April 1970 Long term 624 Medium term 457 Sub-total l,o-l Short term 329 Total 1,1410 1970 1971 Debt service d/ 460 309 Debt service ratio d/ 32.5% 20.5% Central Government Operations FY 1963 FY 1969 (Million Pesos) Revenue 1,778 2,862 Current expenditures 1,493 2,873 Capital e-ipenditures 390 844 Net cash operating deficit e/ 186 637 IMF Position Quota US $110 million Drawing outstanding US $100.5 million Par value - up to February 21, 1970 P3.90 per US $1 After February 21, 1970 P5.80 to P6.43 (floating) Bank/IDA Operations Bank loans outstanding (December 31, 1970) US $191.2 million Undisbursed US $72.6 million a/ Net reserves of commercial banks plus gross reserves of Central Bank Net reserves of commercial banks plus net reserves of Central Bank c/ Public and private debt Assuming debt rescheduling _/ Including government corporations