Philippines - Chico River Irrigation Project

FILE COPY Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-1783-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO IHE REPUBLIC OF THE PHILIPPINES FOR THE CHICO RIVER IRRIGATION PROJECT - STAGE I March 11, 1976 Thbs document bas a restricted distrIbufton and may be used by recipients only in the performance of their official duties. Its contenits may not otherwise be disclosed without World Bank authorzation.  CURRENCY EQUIVALENTS US$1.00 = Pesos 7.50 Pesos 1,000 = US$133.00 Pesos 1 million = US$133,000 FISCAL YEAR In the Philippines the Fiscal Year covers the period July 1. to June 30.  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE CHICCI RIVER IRRIGATION PROJECT - STAGE I I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for an equivalent of US$50 million. The loan would have a term of 25 years, including 6 years of grace, with interest at 8.5 percent per annum. PART I - THE ECONOMY 1/ 2. The most recent Economic Report - "Current Economic Position and Prospects of the Philippines" (No. 568-PH of November 7, 1974) was circu- lated to the Executive Directors on November 11, 1974. A basic economic mission visited the Philippines in April/May 1975 and is now finalizing its report: the discussion below includes the findings of the mission. Annex I of this report contains country economic data. 3. During the 1960s, the economy grew in real terms at the rate of 5-6 percent per annun. However, the rate of growth was less than the level that might have been achieved if the considerable natural and human resources of the Philippines had been exploited more effectively. Moreover, the bene- fits of growth were not distributed widely and unemployment rose. Low levels of taxation resulted Ln inadequate -public investment in necessary infrastruc- ture and social services. Relatively weak export performance, combined with a failure to reduce the import dependence of domestic industry, resulted in a steady deterioration in the balance of payments position. 4. During 1970-*72, the authorities adopted policies of monetary and fiscal restraint in order to lay a firm basis for future growth. With assistance from the Consultative Group, they succeeded in improving substan- tially the maturity structure of the external public debt. Real GNP during that period increased at about 5 percent a year. In 1972, following severe floods, the President began a series of social and economic reforms in the country including an agrarian reform program, tax reforms, and an adminis- trative reorganizatiorn. These programs are beginning to show results. 5. In 1973 there was a sharp increase in the level of economic acti- vity in the Philippines. This upsurge was led by the international commodity boom, which resulted in higher export incomes in the Philippines, a strong recovery in agricultural and industrial production for the domestic market and an expansion in public and private investment. The growth in real GNP doubled to 10 percent. 1/ This part, except for paragraph 8, which has been updated, are the same as in the President's Reports on the Second Livestock Project (Report No. P-1776-PH) and the Third Education Project (Report No P-1777-PH) both dated March 4, 1976. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - 2 - 6. Like most countries, the Philippines was profoundly affected by the tumultuous events in the world economy that began with the jump in the prices for food and petroleum in late 1973. With international trade the equivalent of almost half of its GNP, the Philippines proved quite vulner- able to the impact of world inflation, the increase in oil prices and the prolonged recession in the industrialized countries. This sequence of events has temporarily frustrated the Government's attempt to accelerate the rate of development, and in 1974 GNP increased by only about 6 percent in real terms. While adverse effects of the recession were cushioned some- what in 1974 by a modest improvement in the external terms of trade, the Philippines has been even more seriously affected in 1975 by the continued rise in import prices and reduced demand for Philippine exports. The real growth of GNP in 1975 is estimated to have been at about the 6 percent rate of the previous year. Improvement in the growth performance in 1976 can be expected only if recovery takes place in the economies of the Philippines' main trading partners. 7. Agricultural production has grown at an average rate of 3.2 percent per year during the 1970s, a period which has been affected by un- usually adverse weather conditions. Rice production increased by 25 percent in 1973-74, but due to serious damage by typhoons, it grew by only 1 percent in 1974-75, and the Government had to import 200,000 tons in the first half of 1975 to ensure adequate stocks. However, initial indications are that the outlook for rice production in 1975-76 is bright. The Government is giving the highest priority to increasing agricultural production and has initiated a number of programs designed to expand the use of fertilizer, irrigation and supervised credit. It has also intensified efforts to expand social services needed in rural areas, including rural electrification, health and family planning services as well as small-scale road and irri- gation projects. 8. Although progress has been slower than initially planned, the Government has moved ahead with its agrarian reform for the nation's one million tenant farmers who grow rice and corn. By December 1, 1975, the Government had issued Certificates of Land Transfer in respect of 208,000 of the 424,000 tenants on holdings of over 7 ha; thus, title to 366,000 ha of the total of 825,000 ha farms occupied by such tenants has been trans- ferred. The Government has raised the cash portion of the compensation package to landlords to reduce their resistance to land reform, but strong administra- tive efforts will be necessary to ensure continued progress in the implement- ation of the program. 9. Industry accounts for almost 30 percent of net domestic product, one-third of total fixed investment and 15 percent of total employment. Industrial production, which grew by 12 percent in 1973, was adversely affected in 1974 by the world-wide economic slowdown and grew by only 3.6 percent in 1975. This decline is primarily a result of depressed demand for Philippine exports on the part of the country's main trading partners and the concomitant slowdown in the rate of economic growth in the Philip- pines. Nonetheless, the long-term prospects for industrial growth are favorable because of the natural and human resource endowment of the Philip- pines and a very active private sector.  -3- 10. The Government has made significant progress in increasing public investment. The ratio of public investment to GNP is currently about 3 per- cent compared with 1.8 percent in FY72. The Government has also imple- mented a series of long needed tax reforms and improvements in tax adminis- tration. These reforms, aided by the increased economic activity, the boom in export incomes, and domestic inflation, resulted in a 36 percent increase in national government: tax revenues in FY73, and an estimated 47 percent in FY74. As a result, the ratio of national government tax revenues to GNP has increased from an average of 9 percent in recent years to an estimated 12.3 percent in FY74. 11. In the latter part of 1973, inflation emerged as a major problem in the Philippines and in 1974 consumer prices rose by almost 40 percent. The rise was caused by the large increase in liquidity that came with the export boom in 1973-74, and by a number of cost-push factors, including the higher rate of world inflation. 'To deal with this problem, the Government adopted contractionary monetary and fiscal policies, and attempted to reduce the impact of inflation on consumers by subsidizing such essential goods as wheat, imported rice, and cooking oil. As a consequence of the Government's measures, the annual rate of inflation decreased to less than 20 percent at the end of 1974 and less than 10 percent in 1975. 12. The rapid inflation in 1974 exacerbated the decline in real wages which had begun in 1970. Overall, there was a decline of about 20 percent in real wages during 1974. In order to offset the deterioration of real wages in urban areas, the Government increased the salaries of Government employees and directed private firms to grant emergency cost of living ad- justments to employees earning less than P 600 per month. Nevertheless real urban wage incomes declined and reduced the demand for manufactured products, which contributed to the poor performance of the manufacturing sector in 1974. The depression in the urban areas was partly offset by the improvement in rural incomes that stemmed from continued high prices for agricultural commodities. 13. On the external side, the Philippine balance of payments bene- fitted considerably from the international commodity price boom during 1973. High prices for the cOtntry's chief exports, including coconut products, sugar, copper and wood products resulted in a 70 percent boost 'in export earnings and a balance of payments 'surplus of about $670 million. Since mid-1974 the external trade position has deteriorated, due to the sharp increases in the prices of oil and other imports, less favorable prices for Philippine exports, and reduced'volume of some exports'resulting from the recession in the economies of the Philipines' main trading partners. As a result, the overall balance of payments surplus fell to about $100 million in 1974, and a deficit of about '$400' million was recorded in 1975. Inter- national reserves stood at about $1.1 billion at the end of 1975, the equiv- alent of three months imports. 14. The outlook for 1976 is for exports to increase by about 12 per- cent in real terms on the assumption that there will be some international economic recovery. Imports will need to grow by about 7 percent in real  - 4 - terms in order to maintain the growth of the economy. Due to a modest de- terioration of the terms of trade, the current account deficit may reach about $1.0 billion compared to $860'million in 1974. Medium and long term capital inflows are expected to finance most of this deficit, producing an overall balance of payments deficit of about $200 million. Such a deficit can be managed without serious pressure on reserves through utilization of IMF oil facility and by short-term foreign borrowing by the Central Bank. 15. The overall level of debt of the Philippines is expected to remain within reasonable limits, as the ratio of debt service payments to exports and non-factor services would average about 16-17 percent during the rest of this decade. At present, the Bank/IDA share in total debt outstanding is about 10 percent and its share in debt-service is about 4 percent. These shares are expected to increase somewhat in the years ahead. 16. Foreign assistance is expected to continue to be of major import- ance in helping to finance the larger investment expenditures which will be necessary for the country's development. In order to ensure that disbursement of external assistance reaches levels'commensurate with the level of develop- ment expenditures which will be required during the latter part of the decade, total commitments will need to be maintained in real terms at least at the level of about $500 million which was achieved in 1974. The Consultative Group for the Philippines at its meeting in Paris on October 1, 1975, agreed that it would be reasonable for the Philippine Government to seek aid commit- ments of about $600 million during 1976. Growth Prospects 17. Despite the slowdown in the growth of the economy which is primarily a result of worldwide economic conditions, the Government remains committed to regaining the growth momentum which began in 1973 to provide for a con- tinued increase in incomes and employment. High priority must be accorded to expanding employment opportunities - in the short-term as well as the long-term - because unemployment and underemployment are still high, and the labor force continues to grow at 3 percent a year. 18. Priority must also be given to expanding food production for the domestic market, to expanding industrial export production and to accelerating development of local energy resources. The difficulties experienced during the last two years in importing sufficient quantities of food at reasonable prices, especially cereals, have increased the Government's resolve to achieve self-sufficiency in rice and corn as soon as possible. The Govern- ment rightly recognizes that the increased cost of petroleum and other imports cannot'be financed indefinitely by borrowing abroad, and it is active- ly encouraging both local and foreign investors to expand the productive capacity of export industries and to undertake major new import-replacing investments. Because it will take time for these investments to have an impact on the balance of payments, the Government is seeking increased support from the international financial community to help carry out its development program and to ease the adjustment to higher petroleum and other import prices. Because of the 'substantial easing of the external debt burden  - 5 - which has taken place in the last several years, the Philippines now has the capacity to borrow externally larger amounts of capital in support of its development program. 19. Given the likely availability of resources and the expected growth in various sectors, it -s reasonable for the Government to plan for a longer term growth in GNP of about 7 percent a year in real terms. To achieve this objective, increased investments will be needed in a wide range of in- dustries. Public investments also need to be increased. A new public in- frastructure program is being prepared, and the Government is putting emphasis on developing nuclear and indigenous power sources and on irrigation, feeder roads and other projects to support increased food production. The Government has made considerable progress in recent years in building up the capacity of public sector agenzies to prepare and execute projects. However, there will be a need for continued efforts to strengthen this aspect of administration. The ratio of publi, investment to GNP will need to rise from the present level of 3 percent to about 5 percent by 1980. To support the level of investment, the Government wilL need to intensify its tax efforts so that the ratio of national taxes to GNP rises from its present level of 11-12 percent to 14 percent by 1980. 20. The Government's ambitious development program will continue to require foreign resources in addition to the capital which would become available for the I-inancing of the foreign exchange component of develop- ment projects. Some financing of local costs is justified, especially for projects of economijc and social importance which need only limited amounts of foreign exchange. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 21. By February 29, 1976, the Philippines had received 32 Bank loans and three IDA credits totalling $791.2 million, net of cancellations. About 36 percent of the Bank/IDA lending, $293 million, has been for infrastructure projects in power, transportation, and water supply and $38 million has been for population and education. Of the remainder about $216 million has been for agriculture and about $250 million for industry. There has been a marked improvement in the way Bank financed projects in the Philippines have been executed in the last three years, compared with experience in the 1960s, when shortages of peso counterpart funds combined with poor administration to cause serious problems. All these projects are now going reasonably well. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of January 31, 1976 and notes on the execution of on-going projects. 22. The Bank's lending program has been designed to continue to support the Philippine development effort with its particular emphasis on agriculture and infrastructure. Shortages of domestic revenues led to low investment for these purposes in the past. The last three years have seen major changes which have helped to overcome these constraints and both the ambitious  - 6 - Philippine development program and the Bank's lending program have been designed to make good past neglect and to meet future needs. Commitments in FY74 amounted to $165.1 million, and in FY75 $208 million compared to an average of about $30 million a year in the preceding five years. 23. Two loans, one of $42 million for the Magat River Multipurpose Project and one of $75 million for the Industrial Investment Credit Project, have already been approved by the Executive Directors in FY76. Two loans, ($20.5 million for a Second Livestock Project and $25 million for a Third Education Project) are scheduled for consideration by the Executive Directors on March 16. In addition to the proposed project, loans for fisheries, grain storage and urban development may be ready for Board consideration in FY76. 24. IFC has made commitments in the Philippines totalling $76.2 million for investments in 13 companies in the fields of development banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibers. Of these investments, as of January 31, 1976, $18.9 million had been sold, $0.4 million cancelled and $3.4 million repaid, leaving a net portfolio of $53.5 million. On the same date all commitments were fully disbursed. Preliminary proposals have been received for an aluminum smelter and other projects in the pulp and paper, dinnerware, metal alloys and shipbuilding fields. PART III - THE AGRICULTURAL SECTOR 1/ 25. Agriculture is the predominant sector in the Philippine economy accounting for approximately one-fourth of the gross national product, over one-half of total employment and about three quarters of export earnings. Over 70 percent of the total land under cultivation is used for production of cereals, of which rice and corn are the most important. The remaining land is primarily taken up by the major export crops: sugar, coconuts, abaca, pine- apples and tobacco. 26. The performance of the agricultural sector will be crucial in determining whether the Philippines can increase income both rapidly and equitably. At present, the domestic market for industrial products is limited by relatively low rural incomes. Although in recent years there has been a substantial change in the internal terms of trade in favor of agriculture, the problems of poverty and income distribution continue to be particularly acute in the rural areas; of the 15 million people in the bottom 40 percent of the income scale, 12 million live in such areas. The Government is aware of these problems and is dealing with them by undertaking agrarian reform, by increasing investment and institutional support in the agricultural sector to raise the productivity of small farmers, and by encouraging agricultural diversification. 1/ A detailed Report entitled "Agricultural Sector Survey - Philippines" (No. 39a-PH of May 2, 1973) was circulated to the Executive Directors on May 21, 1973 (R73-111).  - 7 - 27. A major Government objective is to increase rice and corn produc- tion as a means of increasing incomes of small farmers and attaining national self-sufficiency in foodgrains, thereby strengthening the balance of payments. The ability to assure self-sufficiency in rice will depend to some extent on the bringing of additional land under cultivation, but largely on improving yields through expansion of the area under irrigation, increased cropping intensity, the increased use of fertilizers and agro-chemicals and the provi- sion of adequate credit and other supporting services. High yielding varieties, which were helpful in increasing production since the late 1960s, require a much higher degree of water control than is possible under rainfed conditions or with the typicaL unimproved irrigation systems in the Philippines. At present, only about 900,000 ha, or less than 30 percent of all land under rice, is irrigated with only about a fourth of this area having an assured water supply during the dry season. A program to upgrade and expand irrigation to cover an additional 50,000 ha of rice land a year for the remainder of the decade would be needed to meet domestic rice demand. Investment in irrigation is therefore of high priority. 28. Over half of expected Bank lending for agriculture in the Philip- pines in the next five years is likely to be for irrigation. The proposed project would be the fifth Bank-assisted project designed to provide improved irrigation to increase rice production on the island of Luzon. The first four projects, three in Central Luzon and one in Cagayan Valley in Northern Luzon, 1/ set the example for the type of irrigation rehabilitation, new construction and operation needed for large-scale rice production in the Philippines. These projects are providing improved irrigation facilities, better road systems needed for efficient operation and maintenance and marketing of farm products, stronger supporting services to assist farmers in adopting the new techniques needed to increase production, and technical assistance to help the National Irrigation Administration (NIA) to expand and improve its irrigation program. These projects, together with the project now proposed, will bring about substantial Lncreases in production on about 210,000 ha and will benefit about 85,000 farmers, most of whom are smallholders. Implementation of the existing projects lhas been satisfactory. 29. The proposed project would follow the same approach to improving and expanding national irrigation systems in the Cagayan Valley. The Valley exports rice to other regions of the Philippines and has large land and water resources which can be developed to increase rice production. It is also one of the poorest reglons in the country as per capita income is only about $80 compared to the naltional average of $240. The National Irrigation Systems Improvement Study, recently financed under the Tarlac Irrigation Systems Improvement Projeci: (Loan 1080-PH), will help identify and prepare similar projects in other regions for future Bank lending. 1/ Upper Pampanga River Irrigation Project, Aurora-Penaranda Irrigation Project, Tarlac Irrigation Systems Improvement Project and Magat River Multipurpose Project, financed by Loan 637-PH, Loan 984-PH/Credit 472-PH, Loan 1080 and Loan 1154-PH respectively.  - 8 - PART IV - THE PROJECT Background 30. The proposed Chico River Irrigation Project is a logical develop- ment in the potentially rich, but underdeveloped Cagayan Valley in Northern Luzon. It is adjacent to and an extension of lands to be irrigated under the Magat Project (Loan 1154-PH). The whole project is expected to be implemented in two stages over a nine year period. Stage I, which is now proposed, would irrigate 19,700 ha by gravity diversion from the Chico river, providing an assured water supply during the wet season and a dry season supply adequate to irrigate 17,000 ha. The diversion dam, intake structures and main canal would be built with adequate capacity to serve both first and second stage irrigation development. Stage II would expand the irrigated area to 49,000 ha and would be dependent on flow regulation provided by a multipurpose storage dam planned for construction on the Chico river about 20 km upstream from the diversion dam. 31. The Chico river irrigation project feasibility report was prepared by NIA. The Department of Public Highways (DPH) prepared the feasibility report for the provincial roads program, which is also included in Stage I. A Bank mission appraised the Stage I project in October 1975 and negotiations were held in Washington in February 1976. The leader of the Government negotiating team was Ambassador Eduardo Z. Romualdez. The Appraisal Report (No. 1009a-PH) on the proposed project is being circulated separately to the Executive Directors. Annex III of this report contains a loan and project summary. The Project Area 32. The project is located in Cagayan, Isabela and Kalinga - Apayao provinces in the Cagayan Valley of Northern Luzon. Most of the project area is devoted to rainfed cultivation of rice during the wet season. Con- sequently rice yields are low, and adoption of high-yielding varieties has been slow. On those lands which are now irrigated, the systems are not completely developed; water-distribution is poor and dry season water supply is limited. There are a number of small towns with populations of less than 10,000 people within the area. Several of the larger towns provide banking, storage and processing facilities and supplies of inputs to the agriucltural area. The Cagayan Valley is connected by a national highway to Central Luzon and Manila in the south and to the port of Aparri on the Babuyan Channel to the north, so that there will be adequate means of transporting rice produced under the project to major consumption areas, either by truck or by ship. Agrarian Reform in the Project Area 33. The Department of Agrarian Reform has identified all tenants and farm holdings in the project area. Some 8,000 families, or a total of 44,000 people live in the project area. Of these, there are about  -9- 4,100 tenant farmers on 8,470 ha and 3,950 owner operators cultivating 11,230 ha. The traiisfer of landlord holdings larger than 7 ha will benefit some 2,800 tenants. When the land transfer is complete, some 6,800 owner operators, or 85 percent of the farmers in the project area, will cultivate 17,100 ha or 87 percent of the land. Moreover, the remaining 1,300 tenant farmers on holdings under 7 ha will no longer be sharecroppers but will be protected by written lease agreements providing for equitable payments of fixed rents. Description of the Project 34. The proposed project would: (a) upgrade existing irrigation systems and expand irrigation service to currently rainfed rice lands to serve a total of 19,700 ha; and (b) improve 65 km of provincial roads in the area adjacent to the Magat Multipurpose project. The main components of the project are: (a) Irrigation Development (i) construction of a diversion dam and intake works on the Chico river; (ii) construction of a catch dam and intake works on Talaca creek; (iii) rehabilitation of the existing 1,400 ha NIA distribution system and construction of a drainage system; (iv) construction of an irrigation and drainage system for small local communal systems totalling 3,200 ha and for small pump irrigation systems totalling a further 3,200 ha; (v) extension of an irrigation and drainage system to 11,900 ha of presently rainfed rice lands; and (vi) procurement of vehicles and equipment (b) Provincial Road Program (i) improvement of the Roxas-Gamu road (35.2 km); (ii) improviement of the Cabatuan-Cauayan road (11.0 1cm); and (iii) improvement of the San Mateo-Alicia road (18.9 km). The project would also provide for preparation by NIA of a feasibility study of Stage IT irrigation and technical assistance to help NIA undertake an erosion control study of the Magat and Pampanga river catchments, and to  - 10 - establish a system to monitor production inputs and the flow of project benefits for all Bank-assisted irrigation projects. Project Cost and Financing 35. The project is estimated to cost a total of $84 million, of which $33 million or 40 percent would be in foreign exchange. The cost estimates include provision for physical contingencies of 20 percent for the irrigation and road works and 10 percent for the erosion control study and the monitoring system. These also include price contingencies, amounting to 26 percent of total project cost, which take into account the projected rate of international and domestic inflation. The Bank loan of $50 million would finance 60 percent of the total project cost; that is the foreign exchange cost plus US$17 million of local cost requirements. The need for some exter- nal financing of local costs was discussed in paragraph 20 above. The Govern- ment would finance the balance of $34 million from budgetary resources. To ensure a timely and continuous flow of funds, the Government would, as a condition of effectiveness of the Loan, cause NIA to set up a special fund for implementation of the project (Sections 3.02 and 5.01(a) of the Loan Agreement). The Government would deposit money in the fund and replenish it at monthly intervals to a level equivalent to the estimated total amount of payments for goods and services required for the project during each subse- quent two month period less the estimated payments to be made by the Bank directly to suppliers, contractors and consultants. Project Execution 36. All components of the project, except the provincial road pro- gram, would be implemented by NIA. The road program would be implemented by DPH. NIA was established in 1964 to develop, operate and maintain all national irrigation systems in the Philippines. It is a well managed insti- tution which is successfully executing the other Bank-assisted irrigation projects. However, NIA is being reorganized to meet the requirements of the Government's accelerated irrigation development program. One of the first results of the reorganization has been the creation of a Special Projects Organization Office headed by an Assistant Administrator which would manage major externally assisted projects, This office would be responsible for carrying out the proposed project. The post of Assistant Administrator in the newly created Special Projects Organization is presently being filled on a temporary basis. As a condition of effectiveness of the proposed loan, NIA would designate an Assistant Administrator to serve on a full-time basis. NIA would consult with the Bank before making any appointment to this position (Sections 3.04 and 5.01 (b) of the Loan Agreement). 37. As the proposed project is adjacent to the Bank-financed Magat project, a division of the Magat Project Office (which has a Project Manager who reports directly to the Special Projects Organization) would be respons- ible for its execution. The Assistant Project Manager for the Chico Project would report to the Magat Project Manager and have responsibility for the irrigation facilities to be constructed under the proposed project. NIA would provide additional support staff and facilities to enable him to carry out his responsibilities.  38. For operation and maintenance purposes, the Chico project would comprise one district under the Magat project with support provided by the three Magat divisions dealing with administration, equipment and agricultural development. To coordinate the provision of agricutural services to farmers, the Government is in the process of setting up an Agricultural Development Coordinating Council (ADCC) under the Magat Project, which would also have responsibility for the Chico project. (Section 3.05 of the Loan Agreement). 39. The Specinl Projects Organization of NIA would be responsible for the Erosion Control Study and for Input-Output Monitoring (a study to assess the adequacy of the supply of agricultural inputs and provide for a warning system to identify bottlenecks as well as to determine the magnitude and distribution of benefits in Bank-assisted irrigation projects); NIA would employ consultants, satisfactory to the Bank under terms of reference acceptable to the Bank, to assist in both these activities (Section 3.06 of the Loan Agreement). The Project Development Division of NIA would be responsible for preparing the feasibility study for Stage II irrigation. The Department of Public Highways (Region II) would be responsible for the construction of the three provincial roads. After construction, maintenance of the roads would become the responsibility of the Provincial Engineer, Isabela. Both DPH Region II and Isabela Province have adequate staff and equipment to carry out this work. Cost and Benefit Recovery 40. NIA is autaorized to collect from the users of irrigation systems, fees to finance operation and maintenance of the systems and to recover construction costs. Irrigation fees on the national irrigation systems have recently been raised to the equivalent of two cavans (100 kilograms) of paddy per ha in the wet season and three cavans (150 kilograms) in the dry season to be applied uniformly to all national irrigation systems. As an exception to the uniform rate policy, the Government has agreed to raise the rates on the Bank-assisted Centtral Luzon projects and the Magat Project to a level equivalent to about 3.5 cavans (175 kilograms) of paddy per ha in the wet season and 4.4 cavans (220 kilograms) in the dry season. These rates would be reached gradually over a period of five years from completion of construc- tion. As the proposed project would be operated as a division of the Magat Project and cropping intensities and farm incomes at full development would be similar, the level of irrigation fees agreed for the Magat Project would apply. These rates would be sufficient to cover operation and maintenance costs and to recover (without interest) the total investment cost over a reasonable period (Section 4.03 (b) (iii) of the Loan Agreement). Using a dis- count rate of 10 percent and a period of 50 years, the proposed level of charges would result in a cost recovery index (ratio of incremental payments by project beneficiaries to the incremental costs of construction, operation and maintenance) of 29 percent and a benefit recovery (ratio of incremental pay- ments by a typical farm family to incremental income) of 11 percent. 41. The collection rate of water charges has risen from 50 percent of the total amount collectible in 1969 to 66 percent in 1974; further  - 12 - improvement is required. NIA is aware of this need and is studying collection rates for all national systems, which vary considerably in different systems. The results of this study are expected early in 1977 and would provide information on the level of service received by farmers and the reasons for differences in collection rates. On the basis of this study and in consultation with the Bank staff, the Government expects to make judgments about the appropriateness of the level of charges, the reasons for the relatively low rate of collections and the best method for designing a cost recovery system more consistent with overall fiscal policies. In the future, the government would consult with the Bank annnually about the adequacy of water charges and collection rates (Section 4.03 (b) (ii) of the Loan Agreement). Procurement 42. The civil works contract for the Chico diversion dam and main diversion canal ($19.1 million, or about 50 percent of the total irri- gation civil works cost) would be awarded on the basis of international competitive bidding in accordance with Bank Group Guidelines. Other civil works in the project service area ($19.8 million) would be scattered over five separate areas and include rehabilitation of a 1,400 ha canal system, construction of new systems for 11,900 ha of rainfed rice lands and a large number of individual communal and pump irrigation systems totalling some 6,400 ha. These have to be planned and executed to avoid as far as possible both the growing season and bad weather. This work would not be suitable for international competitive bidding as it consists of relatively small systems which are spread over a wide geographical area and would be phased over the project implementation period. In the past, NIA has experienced considerable difficulty in attracting local bids for such works. Several steps have been taken under Bank-assisted projects to strengthen local contractors, including financing of reconditioned equipment and providing higher mobilization allow- ances. Even with these steps, it is doubtful that all civil works could be done by local contractors and some of them would therefore have to be carried out by force account. NIA is presently carrying out a number of its other projects by force account, and it has built up considerable construction capability. However in the light of NIA's large work program in the years ahead, it would not be desirable to rely too heavily on force account under the proposed Chico project. Therefore NIA would investigate ways of expanding the execution of civil works by contract, so that the amount of work done by force account would not exceed 40 percent of the total cost of the civil works not subject to international competitive bidding (para B(b) of Schedule 4 to the Loan Agreement). The balance of this work would be carried out on the basis of competitive bidding procedures advertised locally in accordance with local procedures, which are acceptable. 43. Equipment and vehicles for force account construction, operation and maintenance, the erosion control study and the input-output monitoring program (about $3.3 million) would be procured after international bidding in accordance with Bank Group Guidelines. For purposes of bid comparison, a preference of 15 percent of the c.i.f. price of imported goods, or the customs duty, whichever is lower, would be extended to local manufacturers.  - 13 - Off-the-shelf items costing less than $10,000 each would be procured through local shopping because any advantage of international competitive bidding would be clearly outweighed by the administrative costs involved. The total cost of such items would not exceed $300,000. There is adequate local com- petition for such items and foreign firms are well represented in the Philip- pines and would be allowed to participate. The three roads to be improved under the provincial roads component of the project would be advertised by DPH in one package ($4.8 million), under international competitive bidding proce- dures following thE Bank's Guidelines, which would provide for the option to bid on one or all of the three roads. Disbursements 44. The Bank loan would be disbursed for 100 percent of the c.i.f. cost of directly imported equipment vehicles and materials, 100 percent of the ex-factory cost of such items manufactured locally and 65 percent of the cost of such items imported but procured locally. For costs of consultants and technical assistance, the loan would be disbursed for 100 percent of the foreign exchange cost or 60 percent of total cost. Disbursements for both irrigation and provincial roads civil works would be for 60 percent of certified monthly progress payments or expenditures and for 100 percent of the foreign exchange cost of the contractors' mobilization expenditures. Benefits and Justification 45. The proposed Stage I project would contribute to the Philippine Government's objective of attaining self-sufficiency in rice, improving the productivity and incomes of small farmers and promoting regional balance in development. The project would provide better water control, improved drainage and the necessary agricultural supporting services and thus increase rice yields and production on the 19,700 ha. It would increase dry season irrigation from 5,000 ha at present to 17,000 ha at full project development and in so doing wouLd provide the equivalent of an additional 4,700 full time jobs. Total paddy production in the project area would increase from the present level of 50,000 tons to 147,000 tons per annum. The increase would provide enough rice to feed 600,000 persons per year and the net foreign exchange savings would be $20 million a year at projected world market prices. The projecl:'s irrigation component would benefit directly some 8,000 farm families and 2,,000 landless families, or a total of 55,000 people. The great majority of these people currently have very low incomes. At full project development in 1986, per capita farm income in the project area would increase from $55-$260 at present to $290-$535 compared to projected national average per capita GNP in that year of $465. 46. The road component (costing $9.1 million) would improve access links between the irrigation service areas of the Magat and the proposed Chico pro- jects and existing n!ational highways and, thereby, reduce the costs of trans- porting farm inputs and production. The erosion control study would formulate control measures and land use patterns to correct existing damage and prevent further damage to thbe Pampanga and Magat catchments. The monitoring program would assess the adequacy of the supply of agricultural inputs and provide for  - 14 - a warning system to identify bottlenecks to their timely provision to farmers; it would also provide information on the magnitude and distribution of benefits in Bank-assisted irrigation project ateas. This information would be useful in formulating future policies. 47. In the economic analysis, the full costs of the diversion weir and the main canal, intended to serve both Stages I and II, are treated as part of irrigation development in Stage I. Assuming the project would have 50 years life, the full agricultural benefits would be attained in 1986, and applying farm gate prices for rice and fertilizer based on the Bank's commodity forecasts for 1985, a shadow exchange rate of US$1 = P8.30, and a seasonally variable shadow wage rate for unskilled farm labor, the economic rate of return of the irrigation component (costing $74.9 million) of the Stage I project would be 15 percent. Sensitivity analyses indicate that even under a number of adverse assumptions, the rate of return would not faIl below 11 percent. If part of the costs of the diversion weir and main canal are charged to Stage II of the Chico project, the economic rate of return on the Stage I project would be 21 percent. 48. For the road component, assuming a 15-year project life, the econo- mic rate of return would be 20 percent for the Roxas-Gamu road, 18 percent for the Cabatuan - Cauayan road and 15 percent for the San Mateo-Alicia road. The overall economic rate of return for the road component would be 17 percent. PART V - LEGAL INSTRUMENT AND AUTHORITY 49. The draft Loan Agreement between the Republic of the Philippines and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank and the text of the Resolu- tion approving the proposed loan are being distributed separately to the Executive Directors. The setting up of the Special Fund referred to in paragraph 35 and the designation of the Assistant Administrator referred to in paragraph 36 would be conditions of effectiveness of the Loan. The draft Agreement conforms to the normal pattern for loans for irrigation projects. 50. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 15 - PART VI - RECOMMENDATION 51. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President by: J. Burke Knapp Attachments March 11, 1976   Armex I Pag 1 of 3 pages UITDATA - PHlUPPIN3 300,000 hey 39. (d-I ) Ni otl arable lad SO:I^L lUSllll ePhlippineK R PER CAUTA USI (AIIAS BLaS & 160 / 220 L 220 /b 370 l 310 /b DU(CRAPUC CMRtA reto (per housum) * -5 4! 43 j 38 4.d 28 aude dath rate pr hwan) .. 12 , 10 13 7d 8 Infant eastlity rat (per tbcumad lw births) .. 80 80-90 1U5. 7 Life eeeotan at birth (yeas) 51 /f 58 59 55 65 Oros ro&rodauaQ rdohe 3.3 3.2 2.6 dR 2.5 Plpotlon ro*bh rzt f 3.0 3.0 3.1 2.5 Zr 2.2 Z Pepaatiou powtb rate - 3rbe .0 4 h 4.5 6.0 Age structure (percent) 0-14 16 4 45 42 15-61 51 5 52 54 65 nd mre 3 3 3 4 3 Age dependency ratio 1.7