Uruguay - Fifth Livestock Development Project

CRCULTING COPY py T BE RURN E 0 to REPRTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1691-UR REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC ORIENTAL DEL URUGUAY FOR THE FIFTH LIVESTOCK DEVELOPMENT PROJECT September 25, 1975 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 It may not be published, quoted or cited without Bank Group authorization.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$1.00 = Ur$ 1,940 Ur$ 1.00 = US$0.000515 Ur$ 1,000,000 = US$515.46 WEIGHTS AND EASURES 1 hectare (ha) = 10,000 m2 = 2.47 acres 1 kilometer (kIn) = 0.62 miles 1 square kilometer (km2)= 0.39 sq. miles 100 ha 1 kilogram (kg) = 2.20 pounds 1 liter (1) = 0.26 gallons 1,000 kg = 1 metric ton = 0.95 long ton GLOSSARY OF ABBREVIATIONS BROU Banco de la Republica Oriental del Uruguay CB Central Bank CHPA Comision Honoraria del Plan Agropecuario CIAAB Centro de Investigaciones Agricolas Alberto Boerger (La Estanzuela) (NCAR) CONAPROLE Cooperativa Nacional de Productores de Leche COPRIN Comision de Precios e Ingresos IDB Interamerican Development Bank IMPROME Impuesto Minimo a la Productividad Media INAC Instituto Nacional de la Carne INC Instituto Nacional de Colonizacion IF Livestock Fund MAF Ministry of Agriculture and Fisheries OPYPA Oficina de Planeacion y Politica Agropecuaria PLAN Plan Agropecuario UIDP United Nations Development Programme GOVERNMENT OF URUGUAY FISCAL YEAR January 1 - December 31  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLICA ORIENTAL DEL URUGUAY FOR A FIFTH LIVESTOCK DEVELOPMENT PROJECT 1. I submit the following report and recommendations on a proposed loan to the Republica Oriental del Uruguay for the equivalent of US$17 mil- lion to help finance the Fifth Livestock Development Project. The loan would have a term of 15 years, including 5 years of grace, with interest at 8.5% per annum. The proceeds of the proposed loan would be made available to the Central Bank's Livestock Fund on the same terms and conditions; the Live- stock Fund would on-lend the proceeds to the state-owned Bank of the Republic which would make subloans for periods ranging from 5 to 10 years, including one to five years of grace, depending upon the repayment capacity of the sub-borrower. The principal of each subloan would be subject to monetary adjustment and the interest rate would range from 3% to 8%, depending upon farm size. PART I - THE ECONOMY 2. An economic mission visited Uruguay in December 1974 and again in March 1975. The resulting economic report (498-UR) was distributed on September 17, 1975. A summary of Country Basic Data is attached as Annex I. 3. The dramatic changes in the world economy which began in late 1973 had a staggering impact on the Uruguayan economy. The threefold increase in the price of imported oil (upon which the country is totally dependent), followed by substantial increases in other import prices and culminating in the closure of the EEC to meat imports, brought the country to the brink of economic disaster. The terms of trade loss produced by these developments was equivalent to 2.2% of Gross Domestic Income and resulted in a sharp turn- about in the balance of payments--from a current account surplus of US$37 mil- lion and net reserve gain of US$66 million in 1973 when beef and wool prices were at historic highs, to a current account deficit of US$105 million (equivalent to about 23% of exports) and net reserve loss of US$58 million in 1974 (despite substantial external borrowing). 4. Faced with this extremely difficult situation, the Government ap- pointed a new economic team in July 1974. In addition to the weak balance- of-payments position, the new economic leadership was confronted with a severe fiscal problem. In an effort to sustain real income levels, budgetary subsidies for basic imports had been increased while import levies had been reduced, producing a deficit equivalent to 30% of expenditures. It also  faced skyrocketing inflation, exceeding 100% in 1974, resulting from the fis- cal deficit and inadequate monetary management, and a wage and price policy which generated a wage-price spiral by attempting to maintain incomes of pro- ducers and consumers in the face of declining Gross Domestic Income. 5. The new economic team has moved ahead to introduce a stabilization and economic reform program, the cornerstone of which is liberalization of domestic prices and the foreign trade and payments systems designed to im- prove resource allocation and productive efficiency, and to promote the ex- pansion and diversification of exports in order to stimulate output, income and employment. In line with this, it has already taken action to decontrol domestic prices, eliminate import quotas and relax other import restrictions, and continue frequent exchange rate adjustments (minidevaluations). It has also moved to reduce the disincentives inherent in the tax structure by shifting its revenue base from export and import taxes to taxes on imputed agricultural income (IMPROME) and on value-added. In addition, except for milk, it has eliminated all budgetary subsidies. 6. A new foreign investment law has been passed which accords foreign investment approximately the same treatment as domestic investment. Profit remittance provisions are quite liberal and, in any case, the financial foreign exchange market has been completely freed from all forms of restric- tion and intervention, including those on the remittance of profits. Index- ing of financial instruments is being broadened and maximum loan and deposit rates of financial institutions have been raised to levels which should sti- mulate financial savings, contain the demand for credit and allocate real resources more efficiently. Favorable trade agreements have been negotiated with Argentina and Brazil that should encourage the export of Uruguayan manufactures to these countries. 7. With respect to the stabilization phase of the economic reform program, the Government concluded a Stand-by Agreement with the IMF, the actions of which should result in considerably improved price, fiscal and balance-of-payments performance in 1975. Substantial progress has already been made in stabilizing the economy as evidenced by reduction in the rate of inflation. Thus, in the first seven months of 1975 the cost of living index rose 28.6% compared with 45.1% and 57.3% in the corresponding periods of 1974 and 1973, respectively. 8. While, in view of the disappointing performance over the past two decades, much more in terms of sustained accomplishments will be necessary to reactivate the economy, the response of the private sector so far has been quite encouraging. As a result of the Government's export oriented policies, in the first half of 1975 non-traditional exports rose by about one-fourth to US$127 million over the corresponding period of 1974. The increased export activity has led to a revival of crop and industrial pro- duction, the latter showing the most significant increase in fifteen years. This and the country's resource base augur well for Uruguay's medium- and long-term prospects. For an export-led growth strategy Uruguay has certain advantages -- a highly skilled and well-educated labor force, a strateaic location between the large and expanding markets of Southern Brazil and  3- Buenos Aires, an adequate transport infrastructure to both markets, ease of long distance ocean transport for both imports and exports through the port city of Montevideo and a distinct natural resource advantage in the inten- sive and extensive exploitation of export-oriented agricultural production, especially beef and wool. In addition, there is largely untapped export potential in crop agriculture, food and fruit processing, fisheries and manufactures. The Government is aware of this potential and is determined to exploit it. 9. The successful implementation of the Government's stabilization and economic reform program will, however, not be easy. The program will have to be carried out within the context of a generally depressed world economy, exacerbated in Uruguay's case, by adverse near-term price and mar- keting prospects for its principal exports (beef and wool). Nevertheless, with substantial external financial assistance, it should be possible to implement the program successfully. 10. With a recovery of Uruguay's*principal exports and an expansion of nontraditional exports, GDP growth could be gradually accelerated to 4% per year by 1980. This would be a marked improvement over the 1.4% growth rate of the preceding five years, and would contribute to substantially in- creased employment. This growth pattern would require domestic savings to increase from their depressed level of about 8% of GDP in 1974 to about 12% in 1980. The implied marginal savings effort would partly result from an improvement in Uruguay's terms of trade expected later in the decade. 11. Assuming the reopening of the EEC market and an upswing in the prices of beef and wool, exports may increase more rapidly than imports in the latter part of the period 1975-80. By 1980, exports and imports would be approximately in balance and, as a result, the current account deficit would be relatively small. Thus, despite heavy near-term borrowing require- ments, Uruguay should be able to maintain its international creditworthiness. 12. As of December 31, 1974, Uruguay's outstanding and disbursed ex- ternal public debt repayable in foreign currency was estimated to be US$559 million. The Bank share in the debt was 13%. External debt is expected to increase substantially (by about 12%) in 1975 due to continued poor prospects for beef exports and increased import requirements associated with industrial re-equipment and the Government's foreign trade liberation program. There- after, in line with the expected improvements in export performance and the ongoing efforts of the Government to improve the country's external debt structure, external public debt should grow at a more moderate rate (about 9% annually). The debt service ratio was 30% in 1973, 29% in 1974, and is expected to climb to 41% in 1975. The IBRD share in debt service was 7.7% in 1973, 7.8% in 1974 and it Is expected to decline to 4.7% in 1975. The high debt service ratio in 1975 is largely a reflection of a poor term structure rather than an absolute size of the debt; Uruguay has sufficient foreign exchange reserves (equivalent to about twelve-months imports) and should have no difficulties in meeting its external debt obligations during 1975. Debt service should decline to about 23% and 16% of exports of goods  - 4 - and nonfactor services by 1976 and 1980, respectively, if required medium- and long-term external credits can be mobilized to improve the country's debt structure. Tn this context, Uruguay has already contracted new external long-term loans with IDB, AID), the Government of South Africa, and a IJS$130 million seven-year Eurodollar loan was recently obtained from a group of US, Canadian and European private banks. PART II - THE BANK GROUP OPERATIONS IN URUG7UAY 13. Uruguay has received US$155.2 million (net of cancellations) in Bank loans. As of August 31, 1975, the Bank held US$73.9 million, including US$4.0 million undisbursed. On a sectoral basis, Bank assistance to Uruguay (11 loans in total) has been 53% for power, 35% for livestock and 12% for trans- port. Execution of Bank financed projects has, on the whole, been satisfac- tory. So far, IFC has not made any investments in Uruguay. Annex II con- tains a summary of Bank loans as of AuWust 31, 1975, and notes on the execu- tion of ongoing projects. 14. The last loan to Uruguay, for the Fourth Livestock Development Proj- ect (Loan 940-UR), was approved in FY-74. The FY-76 program includes the proposed livestock project under consideration today, and a proposed loan to rehabilitate and expand the capacity of non-traditional industrial export- ing enterprises. In addition, work is underway on power and agricultural diversification projects for possible consideration bv the Fxecutive Directors during the next two years. 15. In lending to Uruguay, the Bank tries to assist the Government in achieving four major objectives which are interdependent and complementary. One objective is to bring about a recoverv of the economy by supporting pro- grams leading to increased output, income and employment. A second objec- tive is to help Uruguay increase and diversifv its export earnings. A third objective is to encourage institutional improvements in the management of the economy, particularly in the formulation and implementation of sectoral policies. A fourth objective is to transfer sufficient external resources to complement Uruguay's domestic savings and provide the necessary funds for maintaining an adequate level of investment in a framework of sound domestic finances and a viable balance of payments. 16. While the last objective primarily influences the size of the Bank program in lUruguay, the other three jointly determine its structure. The Fifth Livestock D)evelopment Project is designed to help expand livestock production and exports, and to assist the Government in its efforts to increase crop pro- duction by releasing fertile land now under pastures by more intensive exploi- tion of them. Bank lending for industry and agriculture is aimed at increasing and diversifying exports to assist Uruguay in reducing its dependence on beef and wool for foreign exchange earnings. Lastly, Bank assistance for power is designed to help the country meet its growing power demand, while helping to increase the reliance on local energy sources.  -5- PART III - THE AGRICULTURAL SECTOR 17. The contribution of agriculture to national output and employment is relatively modest but its importance in the country's foreign exchange earnings and in the supply of raw materials for the domestic industry is very signi- ficant. In 1974, the sector contributed 15.7% of GDP and employed 18% of the labor force; however, it provided 86% of the value of all exports (72% live- stock products and 14% crops) and a considerable portion of the raw materials required by the domestic industry, in this way contributing indirectly an additional 15% of GDP. Also, agriculture provided about one-fifth of Central Government revenue. 18. Although practically all of Uruguay's land is classified as suitable for farming and ranching, most of it is under pasture. The proportion of land under crops was only 10% in 1956 and dropped to 8% in 1961, where it has remained since. lJruguay, however, has potential for more than doubling its crop land (from 1.3 million ha to 3.4 million ha), provided fertile land now under pasture is freed to crops (this would require improving pastures to accommodate the large livestock herd), and investments are undertaken to help prevent erosion, conserve soil moisture, and maintain and improve soil fer- tility. 19. Farm size distribution, although skewed, does not constitute a major constraint on growth in farm output nor does it have a major effect on welfare since almost 90% of the population lives in urban areas. Furthermore, the long established social welfare system has ensured that rural poverty has not developed to a serious extent. Uruguay, therefore, differs from nearly all other developing nations, including manv of the South American countries, which are basically rural societies. The great majority of the population is employed in the secondary and tertiary sectors; thus, the typical problems of maldistribution of income, unemployment and underemploy- ment have, to a large extent, been transferred to the cities. This does not mean that these problems do not exist in the rural areas but rather that rural poverty occurs on a much smaller scale in Uruguay than is common in developing countries. 20. Three fundamental problems have limited the development and intensi- fication of agricultural production. Firstly, for many years the national development strategy focused on industrial import substitution; secondly, there was a high degree of urbanization and sometimes shortage of labor in the rural areas; and thirdly, the Government had an overwhelming concern with holding down food prices in the urban areas by controlling agricultural prices at an uneconomically low level. The heavy emphasis on industrial development led to policies which turned the terms of trade against agriculture and, as a result, during the 1966-70 period GDP in agriculture decreased at an annual rate of 1.6%. Since 1970, however, as a result of gradually improving sector policies, agricultture has been recovering. During 1970-74, agricultural GDP grew at an annual rate of 3.7%. With the Government's economic reform program, further increases in agricultural production are anticipated. In the near  -6- term, however, growth in the sector will be curtailed by the currently depressed international beef market. The EEC restriction on beef import has been particularly damaging; this has occurred at a time when the size and productivity of the beef herd is at a record level and Uruguay has the potential to more than double the export volume of recent years. Of signifi- cant importance is also the fact that the country's grazing capacity is not sufficient for the large beef herd and, consequently, substantial cattle losses may result. Livestock producers are already encountering serious financial difficulties. To alleviate this problem, the Government has pro- vided a moratorium on repayments of loans made to livestock producers and additional credit to finance the retention of heifers. Also, it is encourag- ing the improvement of additional pastures, including forage, to help main- tain herds at the largest possible number and benefit fully from the favor- able export conditions expected later in the decade. The Bank's Approach 21. Although the Bank's approach to agriculture in the past has been primarily designed to support increased production in the livestock subsector, it will in the future also p:lace heavy emphasis on expanding crop production. The main objectives will be: (a) to increase livestock and crop production, particularly for export, through intensive land use; (b) to encourage the Government to follow price, credit and foreign exchange policies that closely reflect market prices; and (c) to assist in strengthening public sector insti- tutions that play a vital role in the development of agriculture. Within this framework, the Bank would continue to assist. in financing a program to in- crease the carrying capacity of Uruguay's grazing lands to help counteract the negative effects arising from the currently depressed international beef market and promote the diversification of agricultural production. Consist- ent with this, the Bank is executing agency for an agricultural diversification study being financed by UNDP. PART IV - THE PROJECT 22. The proposed project would be the seventh Bank operation for live- stock development in Uruguay, bringing the total assistance for this purpose to approximately US$72 million since 1959 when the first loan for US$7 mil- lion was made. By and large, the execution of projects have been satisfactory. The last operation, Fourth Livestock Project (Loan 940-UR) for US$13.5 million was originally desioned to finance part of Uruguay's livestock development program in 1974. In view of the depressed international beef market, how- ever, only UJS$8.3 million had been disbtursed by end 1974. The remaining portion is expected to be fully committe,i by end 1975. 23. The achievements brought about by the Bank's assistance for live- stock development in Uruguay have been considerable. Over 1.2 million ha of pasture land has been improved. Participating ranchers have increased wean- ing rates by 7%, reduced the age of first calving by nearly a year, lowered  -7- the age of marketable steers by at least six months, and raised extraction rates by 3%. Bank assistance also helped to strengthen PLAN, which success- fully channeled US$123 million equivalent (US$54.7 million from the Bank and US$68.3 million from domestic resources) into credits to livestock producers. Lastly, Bank support for livestock development contributed to improving over- all sector policies. The most important are the adoption of: (a) flexible foreign exchange rate policy; (b) lower export taxes on beef and wool facil- itated by increasing reliance on taxes on imputed agricultural income and (c) more realistic interest rates for long-term credit.. 24. The proposed project was appraised in May 1974 and subsequently updated in April 1975. A project appraisal report entitled "Uruguay--Fifth Livestock Development Project" (No. 769-UR), dated September 19, 1975, is being circulated separately to the Executive Directors. Negotiations were held in Washington from August 19 to August 21, 1975. The main features of the project and loan are summarized in Annex III. Project Description 25. The proposed project would support the Government's Livestock De- velopment Program during 1976 and 1977 and would consist of: (a) investments totalling US$23.8 million for pasture and other on-ranch improvements (50.7% and 22.1% of project cost, respectively); (b) investments of about US$0.8 mil- lion to help develop contractor machinery services (2.4% of project cost); (c) US$1.2 million for technical assistance to help improve pasture technology and management and train local personnel (3.7% of project cost); and (d) a contingency allowance of US$6.9 million (about 21.1% of project cost). The proposed project would be implemented nationwide. Ranch Development 26. Beef/Sheep Ranches. The proposed project would finance annually the development of about 1,700 beef ranches averaging about 700 ha each. The typical ranch development plan would consist of: (a) investments in pasture improvements to increase the area under improved pasture from 105 ha to 145 ha (from 15% to 21% of the total area); (b) investments in fencing, water points and machinery to improve pasture management; and (c) investments in breeding stock, especially for areas where intensive crop production has caused a de- pletion of soil fertility and for settlers sponsored by the National Coloni- zation Institute. Average investment cost per unit, including physical contingencies, would be US$6,348 equivalent. 27. Dairy Farming. The proposed project would also help finance annually about 900 dairy ranches, each consisting of an area of about 75 ha. The ob- jective would be to increase the area under improved pasture for each unit from an average of about 20 ha to 30 ha (from 27% to 40% of the area). About 58% of the investment would be for pasture improvement. Each ranch development plan would also include a component for machinery to increase the level of fodder conservation, a practice that is essential for increasing productivity in Uruguay's dairy ranches. Some investments would also be made in fencing,  water points, and, to a lesser extent, breeding stock. Average investment cost per unit, including physical contingencies, would be US$2,563 equivalent. Contractor Machinery 28. The proposed project would help finance loans to individual producers, cooperatives or machinery contractors to purchase agricultural machinery and equipment for the carrying out of ranch development plans. The machinery pur- chased would mainly consist of balers, rakes, seed harvesters and tractors. Technical Services 29. The proposed project would support existing technical services. It would help finance a training program for technicians of PLAN and other agencies, particularly the training of 20 additional staff that would be recruited for the project. It would also help finance additional investments in (a) vehicles; (b) office equipment; and (c) machinery, equipment and mate- rials for demonstration work and extension. Project Costs and Financing 30. Total project cost is estimated at US$32.7 million equivalent, of which US$17.0 million, or 52%', represents foreign exchange requirements. The cost estimate has been based on prices prevailing in Uruguay during the period February-March 1975, and includes a price contingency of 15% and a physical contingency of 10%. The price contingency was estimated under the assumption of a 10.8% inflation rate in 1975, dropping to 8% in 1977. The project would be financed as follows: (a) the Bank loan of US$17.0 million, or 52% of proj- ect cost; (b) the contributions of Banco de la Republica Oriental del Uruguay (BROU) and the Central Bank's Livestock Fund (LF) of US$6.7 million, or 20% of project cost; and (c) the contributions of subborrowers of US$9.0 million, or 28% of project cost. Organization and Execution 31. Plan Agropecuario (PLAN) would continue to be responsible for assessing the technical soundness of ranch development plans, and for coordi- nating and supervising the on-lending. PLAN's technical staff, comprising about 100 university graduates, is well qualified. To improve further its capabilities, assurances were obtained from the Government that it will cause PLAN to employ, for a period of at least five years, a technical director and a senior agricultural economist, both of whom would be accept- able to the Bank (Section 3.01 (b) of the Loan Agreement). 32. The Livestock Fund of the Central Bank (LF), established under the Third Livestock Project (Loan 698-UR), would continue to be depositary of all funds under the project. The state-owned Banco de la Republica (BROU), upon receipt of ranch development plans approved by PLAN, would continue to make  -9- subloans and collect repayments. BROU would rediscount with LF (Central Bank) 85% of each subloan made and, for its service, would receive a 2% interest rate spread. Relending Terms 33. Subloans would be granted to ranchers for a period of not less than five years or more than ten years, including up to five years of grace. Within these limits and on the basis of the repayment capacity of subborrowers, PLAN will determine the terms for each subloan. The maximum grace period permitted would be one year longer than in the preceding program. The extension seems justified to help participating ranchers recover from the negative effects of the currently depressed international beef market. In the case of machinery contractors, subloans would be for a period of five to ten years, including one year of grace. Any subloan that, by itself or when added to earlier subloans made to the same subborrower, either under the proposed project or earlier projects, is in excess of US$100,000, would require prior Bank approval (Schedule 5 to the Loan Agreement). 34. As in the two previous projects, all subloans would be subject to monetary adjustment. The principal of the subloans would continue to be adjusted on April 30 of each year by applying an index constructed by adding to the value of the index at the end of the previous year the lower of the percentage increase in (a) the average cost-of-living index for the 12 months ending on October 31 of the immediately preceding year, compared with the average for the previous 12 months, or (b) the average price of 48.0 kg live- weight of beef and 3.9 kg of wool during the 12 months ending on October 31 of the immediately preceding year, compared with the average for the previous 12 months. A three-tier system of interest rates would continue to be applied to the subloans (higher for the large producer and lower for the small produ- cer). For holdings of up to 250 ha the interest rate would be 3%; for hold- ings of between 251 and 400 ha the interest rate would be 6%; and for holditgs above 400 ha and machinery contractors the interest rate would be 8% (Schedule 5 to the Loan Agreement). 35. In view of the inflationarv conditions still present in Uruguay and the currently depressed beef prices, the latter can be expected to limit the extent of monetary adjustment. Thus, in the short run it is unlikely that the indexing system will result in positive real interest rates. Assum- ing an average inflation rate of 25% for 1976-77 and 15% thereafter and a strengthening of beef prices as forcast by the Bank, a zero real rate of interest would be achieved over the 10-year repayment period of a subloan. Given the depressed state of the livestock industry, a hardening of the indexing formula so as to achieve more positive interest rates would appear inappropriate at the present time, and likely to discourage the necessary long-term investment. Nevertheless, if the Government succeeds in its efforts to achieve lower inflation rates than those assumed above, the real interest rates charged under the project would become positive.  Procurement 36. Subborrowers would procure investment inputs through normal commer- cial channels. International competitive bidding following Bank Guidelines for Procurement would be required in the procurement of vehicles, machinery and equipment directly imported by PLAN whenever the size of individual con- tracts exceeds US$100,000. PLAN would be encouraged to bulk together such items into larger contracts whenever possible. Similar type contracts of less than US$100,000 would be awarded in accordance with the Borrower's internal procurement procedures, which include local competitive bidding and are considered satisfactory. Disbursements 37. IWith commitments by Banco de la Republica (BROU) extending over two years, Bank's disbursements are expected to occur over a two-and-one-half year period. The Bank would disburse against 37