Mexico - Fourth Livestock and Agricultural Development Project

FILE Copy DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1240a-ME REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A FOURTH LIVESTOCK AND AGRICULTURAL DEVELOPMENT PROJECT May 30, 1973 This report was prepared for. official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1 = Mex$12.5 Mex$1 = US$0.08 Mex$1 million = US$80,000 GLOSSARY OF ABBREVIATIONS NAFIN = Nacional Financiera, S.A. FONDO = Fondo de Garantla y Fomento para la Agricultura, Ganaderlia y Avicultura GSP = General Sub-project, under the Project LIPSP = Low-income Producers' Sub-Project, under the Project FEGA = Fondo Especial de Garantia y Asistencia para Creditos Agropecuarios  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A FOURTH LIVESTOCK AND AGRICULTURAL DEVEIOPMENT PROJECT 1. I submit the following report and recommendation on a proposed loan in various currencies equivalent to US$110 million to Nacional Financiera, S.A. (NAFIN) to assist in financing a program of credits for livestock and agri- cultural development in Mexico to be administered by Banco de Mexico, S.A. as trustee of Fondo de Garantia y Fomento para la Agricultura, Ganaderia y Avicultura (FONDO). As in the Third Livestock and Agricultural Development Project (Loan 747-ME) the loan would be guaranteed by the United Mexican States and would have a term of 20 years including four years of grace, with interest at 7-1/4 percent per annum. The loan would be used mainly to rediscount medium and long-term credits extended to ejidatarios, farmers and agro-industrial enterprises by state-owned and private credit institutions. PART I - THE ECONOMY 2. The economy of Mexico is dealt with in paragraphs 2 - 13 of the President's Report of the same date on a proposed loan to Nacional Financiera, S.A. for a Mexico City Water Supply Project (Report No. P-1207a-ME). A Country Data sheet is attached in Annex I. PART II - BANK GROUP OPERATIONS IN MEXICO 3. For a review of Bank group lending in Mexico, reference is invited to paragraphs 14 -18 of the President's Report of the same date on the proposed Mexico City Water Supply Project. Annex II contains a summary statement of Bank loans and IFC investments in Mexico as of April 30, 1973, and notes on the execution of ongoing projects. PART III - THE AGRICULTURE SECTOR 4. While the main thrust of economic growth came from industrial expansion, the sustained growth of agricultural output was in many ways the outstanding feature of the Mexican economy during the post-1910 revolution period. During three decades (1940-1970) the sector grew, on average at about 5.5 percent per annum in real terms, a record matched by only few countries. It has satisfied  the demand of a rapidly growing population whose incomes were rising throughout the period, transformed the country from a net importer to a net exporter of agricultural products, and transferred savings to the urban sector. Since the mid-1960s, however, production growth has lost impetus, averaging less than 3 percent per annum. While accounting for only 10.1 percent of GDP in 1972, agriculture is still the largest employer of labor, with nearly 40 percent of the labor force. It is also the most important foreign exchange earner; agri- cultural exports amounted to US$933 million in 1972, more than half of total commodity exports. 5. In recent years, agricultural production has failed to keep up with domestic demand. Thile area expansion has traditionally been the propulsive factor, production growth is now becoming dependent on land productivity increases, which accounted fornearly two-thirds of output growth of the last decade. The composition of agricultural output is also changing. From the mid-1960's, livestock has been developing more rapidly than crop production, increasing its share to some 30 percent of total output in 1972. Maize and beans continue to be the basic components of the Mexican diet and are the subsistence crops for most of the peasants; together these account for nearly 70 percent of the rainfed and 10 percent of the irrigated crop land. 6. While until iicently the Government's agricultural policies have been successful in their production objectives, they have not been capable of resolv- ing Mexico's social problems in the rural areas, where inequality in land owner- ship, underemployment and poverty still are prevalent. A vast majority of Mexico's approximately 4 million rural families seem to have been bypassed by the rapid economic growth of the post-revolution period and today barely participate in the market economy. 7. Traditionally Mexican society has suffered from sharp income disparities - between regions, between the urban and rural areas and within the rural society. A historically polarized society - comprising a small very rich and large very poor classes - has, since the Revolution of 1910, witnessed a substantial strengthening of the middle classes, but income remains quite unevenly distributed. Thus, the 1972 rural per capita income is estimated to be only about one-fourth of the national average of about US$744; the rural poverty problem is a compound of overall land shortage; inequality in land ownership and inadequate public services and, even in the best of circumstances, will require decades of intensive effort if it is to be overcome. A recent Bank of Mexico study classifies 53 percent of the almost 3 million farms in Mexico as subsistence units, producing only negligible marketable surpluses, 40 percent as traditional, producing cash crops with traditional techniques, and only 7 percent as modern. Growing underemploy- ment is another major problem: there are almost one million landless families in rural Mexico and the rural population is continuing to grow at 1.5 - 2.0 percent per annum. Given the limited opportunities for absorbing new workers in the cities, increasing attention is being focused on employment creation in the rural areas.  -3- 8. The Government has a difficult problem is reconciling growth and social objectives in the agriculture sector. The Government has realized that on2y with adoption of improved technology by a large section of the farming comunity will it be possible to movE! towards an egalitarian rural society while maintaining the needed growth of output. The Project before you assumes special significance against this background; it will improve credit services throughout the country, with a reservation of funds to be relent to small pro- duicers at concessional rates, improve extension services and ensure availability of fertilizers, improved seeds and other production inputs to about 34,000 beneficiary families, two-thirds of whom would be low-income producers. 9. The Bank has made seven agricultural loans to Mexico, four loans (aggregating $71 million) for improvement of irrigation facilities and three loans (aggregating $165 million) for agriculture and livestock credit. Besides the Project under your consideration, two irrigation projects - Sinaloa and Pgnuco - are currently being appraised. The Bank is also working with the Government on two rural development projects - an integrated one covering a series of local- ities, and one in the Upper Papaloapan comprising one region of some 750,000 families - which we hope would to some extent, also benefit landless families in addition to very small farmers. The Bank has offered technical assistance to the Government in preparing the integrated rural development project and the extension agency to be organized *mder the Project you are considering will be an important input for the proposed rural development program. PART IV - THE PROJECT 10. The proposed livestock and agricultural development project (details in Annex III; Appraisal Report No. 133a-ME of May 25, 1973 is being circulated separately to the Executive Directors) consists of (i) a general sub-project which will be a continuation of the projects previously financed under Loans 430-ME (for US$25 million in 1965), 610-ME (for US$65 million in 1969) and 747-ME (for US$75 million in 1971); (ii) a low-income producers' sub-project to assist ejidatarios and small farmers with long-term credit and cmplementary technical services; and (iii) technical services and studies. The first two loans were fully disbursed ahead of schedule. The third project, whose closing date is September 1975, is proceeding about 20 percent behind disbursement projections but funds are expected to be fully committed by December 1973. The total cost of the fourth project would be about US$272 million equivalent, including US$216 million for the general sub-project, US$52 million for low-inceme producers and US$4 million for studies, training and demonstration. The proposed loan of US$110 million, or 40 percent of the total project cost, would provide US$82.8 million for the general sub-project, US$25 million for the low-income producers' camponent and US$2.2 million for technical assistance. The Bank would finance all the foreign exchange costs (US$84 million) and US$26 million of local currency costs; paragraph 13 of the President's Report on the Mexico City Water Supply Project (P-1207a-ME of same date) discusses the need for financing of local expenditure of projects by external lenders.  11. The Project has two objectives: first to help expand Mexico's live- stock and agricultural production by increasing the flow of institutional credit along with technical services, and thereby provide the rapidly growing population with its food and fiber needs and contributing to the country's export earnings; and second to draw some of the hitherto neglected ejidatarios and small farmers into the market economy and to enable them to benefit from modern production technology. Evidently, in the context of the staggering problem of rural poverty in Mexico, the Project will make a modest and experimental contribution and will touch only some of the rural poor. However, if successful, the Project will establish an approach which could be developed and expanded relatively quickly in the coming years. 12. As in the previous projects, NAFIN, the Borrower, would transfer the proceeds of the Bank loan to FONDO which would rediscount loans made by participat- ing banks for long-term investment in livestock and crop production and in agro- industries. The past distribution of funds among major users - approximately 60 percent for livestock raising, 31 percent for annual and perennial crop farming and 9 percent for agro-industries - would continue. 13. The FONDO was established in 1955 by the Government of Mexico to provide the combination of funds and technical services necessary to make a significant impact on agriculture and livestock development in the country. Lending was to follow commercial criteria and FONDO was directed to operate through private credit institutions by refinancing their loans. In 1965, regional banks of the government-owned Banco Nacional Agropecuario system were granted access to the rediscounting facilities of the FONDO. Now, Banco Ejidal and Banco Agricola, two public banks with special responsibility for ejidos and small- holders, would be granted access to the rediscounting facilities of the FONDO to help in execution of the low-income producers' sub-project. 14. As in the previous projects, all loans to primary borrowers would be based on FONDO-supervised evaluations as to technical and financial viability; participating banks (official and private), who would generally assume lending risks, would determine borrowers' creditworthiness. Since 1965 when the Bank made the first agriculture credit loan, the FONDO has emerged as a financially sound institution, playing a vital role in channeling long and medium-term investment funds to Mexico's agriculture sector and almost all the important publicly owned and private banks active in the sector use the FONDO's discounting facilities (Mex$2,500 million, equivalent to US$200 million was discounted by FONDO in 1972). Extension and technical services are weak in Mexico and the FONDO has made a significant contribution by expanding its own technical staff to 465 by 1972 and in addition has assisted the participating banks with training of more than 400 technicians for agricultural lending. It maintains an adequate network of 70 offices and agencies supervised by six regional offices. The past institution-building role of FONDO for lending to the comparatively well- off farmers is now to be extended to operations concerning the poorer farmers.  - 5- The General Sub-Project (GSP) 15. The GSP is essentially a continuation of the previous three projects; on the average farmers and livestock owners would contribute about 15 percent of their investment requirements and agro-industry borrowers about 20 percent, while the balances would be financed by loans from participating banks, which would then be refinanced by FONDO (on average) to the extent of 81 percent. A sample survey of the loans already made reveals that on the average, investors contributed 15 percent from their own savings and borrowed US$18,300, and that their net cash operating income increased by 45 percent as compared to their income before such investment. 16. The terms of loans to ultimate borrowers under the general sub-project and the terms on which these loans would be rediscounted by FONDO, would vary with the size of the loans. For loans up to US$12,000 the interest rate would be 10 percent, and for larger loans 10.5 to 12 percent. The rediscount rates would range from 7.5 to '0 percent, providing the participating banks with a spread of 2.5 percent, except on loans in excess of US$80,000 where the spread would be 2.0 percent. The proposed interest rates to be paid by borrowers of US$20,000 or more are one percentage point higher than those under the Third Project and reflect the continuing objective of bringing long-term loan interest rates in agriculture into closer alignment with commercial rates. The proportion of loans eligible for rediscounting would range from 90 percent on loans of less than US$12,000 to 70 percent for loans in excess of Us$hO,000. Repayment terms would reflect the projected cash flow of the borrowing enterprise and range normally from three to fifteen years including grace periods of one to three years; in exceptional cases loans would be made for up to twenty years. The FONDO rediscounts would be secured by, and would have the same maturities as, the promissory notes representing loans disbursed to sub-borrowers. Low-Income Producers' Sub-project (LIPSP) 17. The FONDO facilities have so far been utilized essentially by enterpris- ing farmers willing to apply modern technology, and the previous Bank-financed projects made an important contribution to crop and livestock production in Mexico. Since 1963 the Government has also been making a conscious effort to extend credit, through the FONDO operations, to smaller farmers at concessional rates of interest (initially 5.5 and now 7.6 percent). With the assistance of two USAID loans (US$20 million in 1963 and US$21.5 million in 1966) and two loans from Inter-American Development Bank (US$20 million in 1968 and US$32 million in 1971) a total amount of US$68 million had been rediscounted by FONDO until September 1972 under these programs. Farmers with gross annual income of up to US$8,000 (or net of about us$5,000) are eligible to borrow under the above program. With the enactment of the new Agrarian Law (1971) the possibilities of extending agricultural credit to ejidatarios and small farmers have improved and US$25 million of the proposed loan will be set aside to assist farmers with net annual family incomes up to 1,000 times the legal daily minimum rural  - 6 - wages for the zone (approximately US$2,000). It is estimated that a substantial portion cf the beneficiaries will be those having annual family income around US$600 - 700, and thus belonging to the poorest 25 percent of the Mexican population. 18. Technical support services are regarded as the sine qua non for success of the low-income producers' sub-project and the Government hasiseVip a special fund for technical assistance and guarantee for agricultural credits (FEGA) with an initial contribution of US$2 million. The FONDO will make special efforts to organize and strengthen these technical services in some of the poorest parts of the country, (States of Oaxaca, Guerrero, Queretaro and Aguascalientes - see attachiid map), where the ejidatarios and snall farmers are in greatest need of such assistance. In addition, the low-income producers in other parts of the country also will have access to facilities under the sub-project. 19. For reducing credit risks it is the practice in Mexico to encourage formation of groups or cooperatives of small producers for the purposes of institutional borrowing, and to require crop, livestock and life insurance from the beneficiaries. This practice will be continued under the Project, though eligible individual farmers will also have access to the funds. The sub-project is estimated to benefit 22,600 families through 1,746 loans. 20. The beneficiaries under this sub-project will pay an interest of 7.6 percent, the ceiling prescribed by the Bank of Mexico for such loans. Given continuation of Mexico' F rate of price increase of recent years of about 3.5 percent, this will yield a modest positive interest cost in real terms. The beneficiaries will contribute 5 percent of the investrnent cost and borrow the remaining 95 percent from a participating bank, which in turn will receive dis- counting facilities at 4.6 percent for 90 percent of the loan from the FONDO. The sub-loans will be repaid in three to fifteen years (in exceptional cases up to 20 years), including grace periods ranging from one to three years. 21. In August 1972 the Bank of Mexico changed its reserve deposit require- ments to make it attractive for private banks to chanrel 2 percent of their deposits to small farmers at 7.6 percent interest, while banks in the Federal District may channel 3 percent of their deposits in this way. With the guarantee from the new Trust Fund, FEGA (paragraph 18) for recovery up to 80 percent of such concessional loans to small farmers the private banks will be able to participate in the sub-project and it is one of the objectives of the Project to give them incentives to extend their operations to lower income segments of the farm population. Besides the private banks and Banco Nacional Agropecuario, which have experience with FONDO operations, the Banco Ejidal and Banco Agricola will be two new government-owned participating banks and between them will account for more than half the sub-lending under LIPSP. 22. The Banco EUidal and the Banco Agricola have faced management and operational problems, accumulating sizeable bad debts. The bulk of their past operations consisted of shoru-term credits. Realizing the value of specialized  - 7 - banks to any effort to help low-income producers, the Government has recently taken steps to improve them: top management has been reorganized, loan accounts are being examined and bad debts written off, and the accounting and technical staff is being increased and trained. The FONDO will assist these institutions to expand and improve their long-term lending to the rural poor, especially by training their technicians. The discounting facilities under the Bank-assisted project will be handled through special accounts for such funds, to enable close supervision of the sub-lending and recovery operations. As under the general sub-project the participating banks will repay to FONDO promptly the amounts they recover from the borrowers. Procurement 23. As under the previous loans for agricultural credit in Mexico, and as is common to most agricultural credit operations, purchase of the equipment financed under the proposed loan will be made by the beneficiaries themselves, who will individually buy quite small quantities of widely diversified products, both foreign and domestically made, through local dealers and distributors. In these circumstances, formal international competitive bidding is not practicable. The Government has undertaken to issue promptly the necessary permits for the import of machinery and equipment required for the Project. The sub-borrowers will obtain at least three quotations for imported breeding stock and five quota- tions from not less than three countries for purchase of agro-industrial equip- ment when the cost of such equipment in any sub-project exceeds Us$100,000. Disbursement 24. Disbursements to sub-borrowers would take place over three years. Since the loan is expected to be committed in about two years, disbursements, which are made against 56 percent of FONDO's rediscount payments, are expected to cover about five years. The disbursement projections are presented in Annex III. Economic Evaluation and Benefits 25. The economic rate of return of the Project is estimated at approximately 29 percent; 26 percent on the general sub-project and 41 percent on the low- income producers' sub-project (with shadow pricing for family labor at 25 per- cent of actual wage levels). If labor on the low-income producers' sub-project were charged at the actual wage, the return on this sub-project would be 25 per- cent. 26. Under the general sub-project 10,843 sub-loans are expected to be made and under the low-income producers' sub-project 1,746 sub-loans benefitting 22,600 families are forecast. The estimated current and projected income levels of the beneficiaries under various investment models are summarized below:  Net Family Income Rate of Return Net Current Family on Full Develop- on Incremental Income Level (US$) Economic Activity ment (US$) Investment 700 Beef cattle 1,478 22% 700 Dairy cattle 1,671 27% 600 Annual crops 1,280 39% 600 Perennial crops 1,3h0 27% 7,600 Beef cattle 16,563 26% 4,595 Dairy cattle 10,746 21% 1,840 Piggery 9,896 31% 6,490 Annual crops 10,050 30% 4,590 Perennial crops 12,800 28% 27. On full development the Project will increase Mexican production of livestock and agricultural products by approximately the following percentages: Beef 11 Milk 6 Pork 10 Cotton 13 Corn (-1) Sorghum 26 Beans 6 Alfalfa 10 Grapes i7 Bank Loan Terms 28. The three previous Bank loans for livestock/agriculture credit projects had terms of 20 years, including four to five years of grace. Under the Project, sub-loans (including a grace period up to three years) up to 20-year terms are expected to be made in the first two years and disbursed within five years. The Goverrment, as in the previous loans, will take over the repayment of the Bank loan, leaving the amounts received from the participating banks with the FONTDO to be used for further medium and long-term lending for FONDO-evaluated livestock/agriculture projects. PART V - LEGAL INSTRJMENTS AND AUTHORITY 29. The draft Loan Agreement between the Bank and Nacional Financiera, S.A., the draft Guarantee Agreement between the United Mexican States and the Bank, the draft Project Agreement betwreen the Bank and Banco de Mexico, S.A., the Report of the 'bmmittee provided for in Article III, Section 4(iii), of the Articles of Agreement and a draft Resolution approving the proposed loan, are being distributed to the Fxecutive Directors separately.  - 9 - 30. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 31. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments. May 30, 1973   AiTRIx I Page 1 COUNTRY DATA - MEXICO AREA POPULATION DENSITY 94l.O million (mid-1972) 27.4 per km2 1,473,000 h12 Rate of Growth: 3.,44. (from lc9oto 1972) 1843 per km2 of 'arable" area-" POPULATION CHARACTERISTICS (1972) HEALTH (150R) Crude Birth Rate (per 1,000): 43.1 Population per physiciafr : 1,852 (1968) Crude Death Rate (per 1,000): 3.2 Population per hospital bed 510 (1966) Infant Mortality (per 1,000 live births) 56.4 INCOME DISTRIBUTION (1969) 2/ DISTRIBUTION OF LAND OWNERSHIP (1960)