Philippines - Jalaur Irrigation Project

Document of The Wofl B~ank IFOR OIFIFHCIAL USE ONLY Report NOY-1973-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE JALAUR IRRIGATION PROJECT January 5, 1977 his decnDeimst ys n restirhcea nuimd mny be ussed by recipheies only in the pedomnnce of tlelir ofkiaI thnftles. Ha$s conqenes may noa oRlerwise be dtiseloseid whihount Word fl n an BUIorwiblon.  CURRENCY EQUIVALENTS US$1000 = Pesos 7.50 Pesos 1,000 = US$133000 Pesos 1 million = US$133,000 ABBREVIATIONS ADB - Asian Development Bank ADCC - Agricultural Development Coordinating Council DAR - Department of Agrarian Reform NIA - National Irrigation Administration NISIS - National Irrigation Systems Improvement Study UPRP - Upper Pampanga River Irrigation Project REPUBLIC OF THE PHILIPPINES FISCAL YEAR Through 1976: July 1 - June 30 Beginning 1977: January 1 - December 31  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE JALAUR IRRIGATION PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for the equivalent of $15 million to help finance the Jalaur Irrigation Project. The loan would have a term of 20 years including four and a half years of grace with interest at 8.5 percent per annum. PART I - THE ECONOMY 2. An economic mission visited the Philippines in April/May 1975 and its report, "The Philippines: Priorities and Prospects for Development, Basic Economic Report" (Report No. 1095a-PH of May 5, 1976) was distributed to the Executive Directors on May 18, 1976 (SecM/76/366). Paragraphs 3-16 below are an updated summary of that report. Annex 1 contains country economic data. L 3. During the 1960s, the economy grew in real terms at an annual rate of about 5-6 percent. 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 benefits of growth were distributed relatively unevenly. As the population and labor force continued to grow rapidly, unemployment rose. Low levels of taxation accentuated these problems and resulted in inadequate public investment in necessary infrastructure and social services. A relatively weak export per- formance combined with a failure to reduce the import dependence of domestic industry resulted in a steady deterioration in the balance of payments posi- tion. 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 for the Philippines, they succeeded in improving substantially the maturity structure of the external public debt. Real GNP during that period increased at about 5 percent a year. In 1972, the Government initiated a series of social and economic reforms including an agrarian reform program, tax reforms, and an administrative reorganiza- tion. 5. In 1973, there was a sharp increase in the level of economic activity in the Philippines and the growth in real GNP doubled to 10 percent. This upsurge was led by the international commodity boom, which resulted in higher export incomes, a strong recovery in agricultural and industrial production for the domestic market, and an expansion in public and private investment. /1 This is the same discussion of the economy as that in the President's Report for the Third Highway Project (Report No. P-19604-PH1of December 13, 1976). This document hs a rastricted distribution and may be used by recipients only in the Perfonnmneo of their official dutis. Its centents mAy not otherwise be disclosed without World Dank authoriatIon.  - 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 was quite vulnerable to the impact of world inflation, the increase in oil prices, and the pro- longed recession in the industrialized countries. While adverse effects of the recession were cushioned somewhat in 1974 by a modest improvement in the external terms of trade, the Philippines was more seriously affected in 1975 by the continued rise in import prices and reduced demand for Philippine exports. While the international economic situation has made it difficult for the Government to realize its objective of accelerating the rate of development, GNP in 1974 and 1975 has, nevertheless, grown in real terms at an annual rate of about 6 percent and the same rate is expected in 1976. 7. Agricultural production has grown at an average rate of 3.2 per- cent per year during the 1970s, a period which has been characterized by unusually adverse weather conditions. Rice production increased by 25 per- cent in 1973/74, but because of damage by typhoons, grew by only 1 percent in 1974/75; the Government had to import 200,000 tons in the first half of 1975 to ensure adequate stocks. However, the rice harvest in 1975/76 was very good due to unusually favorable weather conditions and during this period the Philippines was virtually self-sufficient in rice. The Government continues to give the highest priority to further 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 the social services needed in rural areas, including rural electrification, health and family planning services, and village road and small-scale irrigation projects. 8. Although progress has been slower than initially planned, the Government has made some progress with its agrarian reform for the nation's one million tenant farmers who grow rice and corn. By May 31, 1976, the Government had issued Certificates of Land Transfer to 216,000 of the 424,000 tenants on holdings of over 7 hectares; thus, title to 378,000 hectares of the total 825,000 hectares of farms occupied by such tenants has been transferred. The Government has raised the cash portion of the com- pensation package to landlords to reduce their resistance to land reform, but strong administrative efforts will be necessary to ensure continued progress in the implementation 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 and 1975 by the worldwide economic slowdown and the depressed demand for Philippine exports. As a result, industrial production increased by only 4 percent in 1974 and 5 percent in 1975. Stepped-up public sector spending for infrastructure development and other priority projects and for the alleviation of recent flood and earthquake damages has contributed significantly to sustaining the higher level of domestic activity in 1976, especially in the construction industry. The longer term prospects for industrial growth are favorable because of the natural and human resource endowment of the Philippines 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 over 3 percent, having risen from 1.8 percent in FY72./1 The Government has also implemented a series of long needed tax reforms and improvements in tax administration. 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. The ratio of national government tax revenues to GNP has increased from an average of 9 percent in the early 1970s to about 12 percent in FY74 and FY75. 11. Significant financial reforms have also been enacted. At the begin- ning of 1976, the Central Bank issued circulars designed to help rationalize the level and structure of deposit and lending rates; deposit rates were raised for the second time in 18 months; long-standing statutory ceilings on the long- term lending rates of banking institutions were increased from 12-14 percent to 19 percent per annum; and the ceilings on short-term lending rates were raised. Efforts were also made to control short-term money market operations and to strengthen the organized banking institutions. These actions should help to improve the mobilization and allocation of domestic resources in the Philippines. 12. In the latter part of 1973, inflation emerged as a major problem in the Philippines. The increase in prices 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. The annual inflation rate fell from 35 percent in 1974 to 8 percent in 1975, and the authorities aim at keeping inflation below 7 percent in 1976. While monthly inflation rates have generally been lower in 1976 than in 1975, there have been moderate inflationary pressures in the last few months resulting from the damages of recent typhoons to food crops, a 25 percent increase in land transport fares, a significant though long overdue raise in the minimum wages, and an increase in the controlled prices for rice and corn. 13. On the external side, the Philippine balance of payments benefitted considerably from the international commodity price boom during 1973. High prices for the country's chief exports, including coconut products, sugar, copper and wood products, resulted in a 70 percent increase in export earnings and a current account surplus of about $550 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 downturn in the econo- mies of the Philippines' main trading partners. As a result, current account deficits of $240 million in 1974 and about $900 million in 1975 were incurred. The current account deficits have been offset by direct foreign investment, inflows of medium- and long-term loan capital, the use of IMF facilities and /1 Fiscal year July 1 to June 30.  - 4 - some short-term borrowing by the Central Bank. During 1976, export receipts are expected to be about 10 percent greater than in 1975, with growth in nonsugar primary exports and nontraditional manufactured exports more than offsetting shortfalls in sugar receipts. Imports are expected to be only about 4 percent greater than in 1975 because of relatively low rates of industrial investment and the excellent rice crop which made rice imports unnecessary. Taking into account trends in services and transfers, the outlook is for a current account deficit of about the same magnitude as in 1975, which will be largely offset by capital inflows; the overall deficit is expected to be about $200 million. In mid-1976, reserves stood at about $1.2 billion, equivalent to four months' imports. Assuming continued sound debt management and the maintenance of a reasonable maturity structure of foreign borrowings, the overall level of external debt of the Philippines is expected to remain within reasonable limits, as the ratio of debt service payments to exports and nonfactor 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 17 percent and its share in debt-service is about 4 per- cent. These shares are expected to increase somewhat in the years ahead. 14. Foreign assistance on concessional terms will be essential to help finance the large 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 development expendi- tures which will be required during the latter part of the decade and that debt service obligations remain within reasonable limits, total commitments of official assistance will need to be maintained in real terms at least at the annual level of about $500 million which was achieved in 1974. The Consultative Group for the Philippines at its meeting in Paris on June 15 and 16, 1976, agreed that it would be reasonable for the Philippine Govern- ment to seek official aid commitments of about $600 million in 1976 and $700 million in 1977. Total new commitments of public and private medium- and long-term capital would reach $2 billion in 1976 and need to be maintained at approximately this level through 1980. 15. Despite the slowdown in the growth of the economy, which is pri- marily a result of worldwide economic conditions, the Government remains committed to regaining the growth momentum which began in 1973 to provide for a continued increase in incomes and employment. Both the Philippine Government and the Bank's Basic Economic Report estimate that it should be possible in the longer term for the Philippine economy to grow in real terms at a rate of about 7 percent per annum provided that good economic management continues and international economic conditions improve. High priority must be accorded to expanding employment opportunities because unemployment and underemployment are still high, and the labor force continues to grow at 3 percent a year. Continued attention must also be given to expanding the Government's effective family planning program to reduce the rate of growth of the population and the labor force. 16. The Government is pursuing a development strategy which focuses on rural development with emphasis on food production; accelerated industriali- zation, both in capital-intensive resource based industries and labor-intensive export industries and a substantial expansion in public sector investment in infrastructure to support the growth of the productive sectors. In support of these objectives, the Government plans to continue its efforts to increase  - 5 - public revenues, to strengthen the capacity of public sector agencies and to foster the growth of exports. The Government recognizes that the increased cost of petroleum and other imports cannot be financed indefinitely by borrow- ing abroad, and it is actively encouraging both local and foreign investors to expand productive investments. It will, however, take time for Government programs to have an impact on the balance of payments, and the Government is, therefore, seeking increased support from the international financial community to assist in the financing of its development effort. PART II - BANK GROUP OPERATIONS 17. By November 30, 1976, the Philippines had received 38 Bank loans /1 (of which two were on Third Window terms) and three IDA credits for a total of $941.5 million, net of cancellations. About one third of Bank lending, $306 mil- lion, has been for infrastructure projects in power, transportation, and water supply and another third, $303 million, has been for agriculture. Of the remainder, about $250 million has been for industry and about $83 million has been for social sector projects in education, population and urban develop- ment. There has been a marked improvement in the execution of Bank-financed projects in the last four years compared with experience in the 1960s, when there were serious problems caused by a shortage of peso counterpart funds and poor administration. All ongoing projects are now being implemented reasonably well. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of November 30, 1976, and notes on the execution of ongoing projects. 18. The Bank's lending program has been designed to continue to support the Philippine development effort with its emphasis on agriculture and infra- structure and its growing attention to the needs of lower income groups. About one third of Bank lending planned for the future would continue to be for agri- culture and rural development projects and another third would be for needed basic infrastructure projects, mainly in the fields of transportation and power. The amount of lending for social sector projects, including education, popula- tion and urban development, is expected to continue to grow rapidly and account for nearly 20 percent of future lending. The balance of future lending would be for industrial development, where growing attention is being given to the needs of small and medium industries with high employment potential. The rapid growth in public revenues during the past five years has allowed for a signi- ficant expansion in public investment and both the ambitious Philippine develop- ment program and the Bank's growing lending program have been designed to make good past neglect and to meet future needs. Bank lending totalled $165.1 mil- lion in FY74, $208 million in FY75 and $268 million in FY76 compared to about $30 million a year in the preceding five years. 19. This is the second loan to be presented to the Executive Directors in FY77. Other loans which may be ready for presentation later in FY77 are for /1 On December 23, 1976, the Executive Directors approved a loan of $95 million for a Third Highway Project.  - 6 - agricultural credit, land settlement, education, power, irrigation and water supply projects; a smallholder tree farming and forestry development project and an inter-island shipping project may be ready in early FY78. A number of these projects are designed to help the Government meet its objective of increasing the productivity and incomes of the poorer segments of the population. 20. As of October 31, L976, IFC has made commitments in the Philippines totalling $78.9 million for investment in 14 companies in the fields of devel- opment banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibres and edible oils. Of these investments, $18.1 million had been sold, $0.4 million cancelled and $7.2 million repaid, leaving a net portfolio of $53.3 million, including $2.8 million undisbursed. Preliminary proposals have been received for projects in the wood and mining industry. PART III - THE AGRICULTURAL SECTOR 21. Agriculture is the predominant sector in the Philippine economy accounting for about one third of net domestic product, over one half of total employment and nearly three quarters of export earnings. Over 70 percent of the 9 million ha of land under cultivation is used for the production of cereals, of which rice and corn are the most important. The remaining land is taken up by the major export crops: sugar, coconuts, abaca, pineapples, and tobacco. 22. The performance of the agricultural sector will be crucial in deter- mining whether the Philippines can increase income both rapidly and equitably. At present, the domestic market for industrial products is limited by rela- tively low rural incomes. Although in recent years there has been a substan- tial change in the terms of trade in favor of agriculture, the problems of poverty and income distribution continue to be particularly acute in rural areas; of the 15 million people in the bottom 40 percent of the income scale, 12 million live in rural areas. The Government is aware of these problems and as noted in paras. 7 and 8, has initiated a number of programs designed to assist the rural poor. 23. The major goals the Government has set for the sector are sustained self-sufficiency in cereals, particularly rice and corn; devel- opment of the livestock and fisheries subsectors; and expansion of agri- cultural exports. Sustained self-sufficiency in cereals would not only strengthen the balance of payments, but would also help raise incomes for much of rural population. The ability to assure self-sufficiency in rice will depend largely on improving yields through increased cropping intensity, the increased use of fertilizer and agro-chemicals and  -7- the provision of adequate credit and other supporting services. High yield- ing varieties, which helped to increase production in the late 1960s, require a much higher degree of water control than is possible ufider rainfed condi- tions or with the typical unimproved irrigation systems in the Philippines. At present, out of 3.2 million ha planted to rice, only 1.3 million ha, or 40 percent, is irrigated. A program to upgrade and expand irrigation to cover an additional 50,000 ha of rice land a year over the next decade would be needed to meet the growing domestic rice demand on a sustained basis. Investment in irrigation is therefore of high priority. 24. Since the late 1960s, the National Irrigation Administration (NIA), with assistance from the Bank and from the Asian Development Bank (ADB), has been engaged in upgrading and extending large irrigation systems, mainly in Luzon and to a lesser extent in Mindanao. In addition to rehabilitation of existing canals and structures, the construction of new ones, the provision of better drainage and access and the introduction of water management and rotational irrigation practices, additional water supply is being provided in some areas through the construction of storage or by transbasin diversion. However, NIA has not neglected the need for rehabilitation and upgrading of the badly deteriorated smaller systems scattered throughout the Philippines. The National Irrigation Systems Improvement Study is expected to lead to pro- jects increasing rice production on a total of about 150,000 ha with the highest priority for improvement in a number of regions of the Philippines. A first project in Leyte in the Eastern Visayas and in Northern Luzon, which are among the poorest areas of the country, has already been appraised by the Bank. 25. About one half of the expected Bank lending for agriculture in the Philippines in the next five years is likely to be for irrigation. The pro- posed project would be the seventh Bank-assisted irrigation project designed to increase rice production in the Philippines. It is the first such project on the Visayan islands. The first six projects, three in Central Luzon, two in the Cagayan Valley of Northern Luzon and one on Mindoro Island,/1 set the pattern for the type of irrigation rehabilitation, new construction and opera- tions needed for increasing rice production in the Philippines. These projects are providing improved irrigation and drainage 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 and training to help the National Irrigation Administration (NIA) to expand and improve its irriga- tion program. These projects, together with the project now proposed, will bring about substantial increases in rice production on about 235,000 ha and will benefit nearly 100,000 farmers, most of whom are smallholders. As noted in Annex II, while there have been some difficulties in attracting interest /I Upper Pampanga River Irrigation Project, Aurora-Penaranda Irrigation Project, Tarlac Irrigation Systems Improvement Project, Mindoro Rural Development Project, Magat River Multipurpose Project Stage I and Chico River Irrigation Project Stage I, financed by Loan 637-PH, Loan 948-PH/ Credit 472-PH, Lvan 1080-PH, Loan 1102-PH, Loan 1154-PH and Loan 1227-PH respectively.  in bidding on the part of local contractors and there have been substantial cost increases under