Philippines - Third Rural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 2784 PROJECT PERFORMANCE AUDIT REPORT PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) December 27, 1979 Operations Evaluation Department 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. WEIGHTS AND MEASURES Metric system, except: 1 cavan (paddy) = 44 kg 1 cavan (corn) = 57 kg 1 picul (sugar) = 63.5 kg ABBREVIATIONS AGF - Agricultural Guarantee Fund CB - Central Bank of the Philippines CBCC - Working Unit at CB for NCCC DA - Department of Agriculture DBP - Development Bank of the Philippines DRBSLA - Department of Rural Banks and Savings and Loan Associations, CB IRRI - International Rice Research Institute NCCC - National Commission on Countryside Credit and Collection PCAC - Presidential Committee on Agricultural Credit PNB - Philippines National Bank RBAP - Rural Bankers Association of the Philippines SSLA - Stock Savings and Loan Associations TBAC - Technical Board for Agricultural Credit (working group for PCAC) TSEU - Technical Support and Evaluation Unit, CB UPLB - University of the Philippines at Los Banos FOR OFFICIAL USE ONLY Project Performance Audit Report PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) TABLE OF CONTENTS Page No. Preface i Basic Data Sheet ii Disbursement Table iii Highlights iv PROJECT COMPLETION REPORT 1. Introduction 1 2. Background 1 3. Project Formulation 3 4. Project Implementation 6 5. Project Impact 13 6. Rates of Return 16 7. Institutional Development 18 8. Special Issues 20 9. Bank Performance 25 10. Conclusions 25 Tables 28 ANNEX - Comments received from the Central Bank and 35 the Technical Board for Agricultural Credit 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.  Project Performance Audit Report PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) PREFACE This is a performance audit of the Third Rural Credit in Philip- pines for which Loan 1010-PH was approved in June 1974 in the sum of US$22 million and closed, fully disbursed, in May 1977. The audit report consists of expanded highlights prepared by the Operations Evaluation Department (OED) and the project completion report (PCR) dated January 23, 1978. The PCR was prepared by the East Asia and Pacific Regional Office based on a country visit in August/September 1977. The audit is based on a review of the appraisal report (No. 428a-PH, of May 28, 1974), the President's Report (No. P-1456-PH, of May 30, 1974), the Loan Agreement dated June 17, 1974, the audit reports on two previous agricultural credit projects in the Philippinesl/, the PCR, and correspondence with the Borrower and internal Bank memoranda on project issues contained in relevant Bank files. Bank staff associated with the project was not interviewed. A copy of the draft report was sent to the Borrower. Comments received from the Central Bank and TBAC are in the Annex. An OED mission visited the Philippines in November 1979, in connection with a proposed impact evaluation study, and used the opportunity to discuss this project with the Government. The comments received by the mission mostly support the PPAR and further elaborate on some issues. The suggested corrections and changes in the Highlights and the PCR have been incorporated. Under OED's abbreviated procedures, the audit finds no reason to question the PCR's analyses and major conclusions. 1/ PPAR - Philippines Second Rural Credit Project (Loan 607-PH) [the pre- decessor to the Third Project under audit], Report No. 1277 of August 18, 1976, and PPAR - Philippines First Livestock Project (Loan 823-PH) [an- other credit project], Report No. 2128 of June 30, 1978.  PROJECT PERFORMANCE AUDIT REPORT BASIC DATA SHEET PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) KEY PROJECT DATA Appraisal Actual or Item Expectation Current Estimate Total Project Cost (US$ million) 43.9 47.2 Overrun (Z) 7.51/ Loan Amount (US$ million) 22.0 22.0 Disbursed ) 22.0 Cancelled ) as of 0.0 Repaid ) 7/31/79 2.35 Outstanding ) 19.65 Exchange Adjustment ) 2.85 Borrower's Obligation ) 22.5a-/ Date Physical Components Completed 6/77 3/76 Proportion Completed by Above Date (M) 100 Proportion of Time Underrun (%) 50 Economic Rate of Return (M) Over 80 44 Financial Performance Subloans - lower than expected due to increased costs. Intermediaries - lover than expected due to high arrears level. Satisfactory with the exception of collections. OTHER PROJECT DATA Original Actual or Item Plan Revisions Est. Actual First Mention in Files or Timetable 08/72 Government's Application 01/73 Negotiations 05/74 Board Approval 6/11/74 Loan Agreement Date 6/17/74 Effective Date 8/15/77 8/29/74 8/27/74 Closing Date 12/31/77 5/14/77 Borrower Central Bank of the Philippines Executing Agency Central Bank of the Philippines Fiscal Year of Borrover January 1 - December 31 Follow-on Project Name Fourth Rural Credit Project Loan Number Loan 1399-PH Amount (USS million) 36.5 Loan Agreement Date 4/11/77 MISSION DATA Month, No. of No. of Date of Item Year Weeks Persons Manweeks Report Preparation 1/73 n.a. n.a. n.a. n.a. Preappraisal 6/73 n.a. n.a. n.a. - Appraisal 11-12/73 5.5 5 27.5 5/24/78 Total 27.5 Supervision I 2-3/75 3 1 3 4/ /75 Supervision IL3/ 10/75 3 2 6 12/ /75 Sub-Total 3 9 Completion 4/ 8-9/77 5 3 15 1/17/78 Total 24 COUNTRY EXCHANGE RATES Name of Currency (Abbreviation) Pesos () Year: Appraisal Year Average 1974 Exchange Rate: US$1 - P 7.1 Intervening Years Average 1975/76 US$1 - P 7.4-7.5 Completion Year Average 1977 US$1 * P 7.3 / Overrun due primarily to higher unit cost and increased size of some categories which were partially offset by reduction in some others, see PCR para. 4.08. 2/ US$1.88 million has been sold to a third party. 3/ Also involved in preparation of completion report for the second loan. 4/ Also involved in supervision of the fourth loan.  Project Performance Audit Report PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) DISBURSEMENT TABLE (US$'000 cummulative) Period Appraisal Actual as % Ending Estimate Actual of estimated 12/31/74 2,068 2,240 108 6/30/75 4,906 8,825 180 12/31/75 8,437 16,423 194 6/30/76 12,800 21,784 170 12/31/76 17,400 21,979 126 6/30/77 22,000 22,000 100 l Project Performance Audit Report PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) HIGHLIGHTS The loan provided funds through the Central Bank of the Philippines for on-lending to farmers, fishermen and rural entrepreneurs through qualified rural banks and, starting from this third loan, also qualified savings and loan associations. The project was a continuation and expansion of the second pro ect (supported by Loan 607-PH, closed in June 1974 and already audited by OED- ) and was followed by a fourth project (supported by Loan 1399-PH, currently under implementation). The project aimed at financing farm mechani- zation, transport and other equipment; fisheries and livestock development, as well as cottage and agro-industries. It was to finance approximately 8,000 beneficiaries (mainly small and medium-size farmers cultivating between 2 and 10 ha) over a three-year period. Only 4,500 farmers-/ were reached under the project, 57% of the appraisal estimate of around 8,000. Project funds were fully committed by March 1976, over a year ahead of appraisal projections, as a result of strong demand for tractors, tillers and new trucks influenced by intensive promotional efforts made by dealers. These three categories used 86% of project funds, a 22 percentage points increase over appraisal estimates. Hence, lending diversification sought at appraisal was not realized. The financial rate of return for tractors used in rice areas was reestimated at over 40%. But tractors used in sugarcane cultivation seem to be less profitable or even losing money as a consequence of decreased demands for custom work under the presently prevailing low sugar prices. Returns on locally manufactured power tillers are less than 1%. In spite of this low return, smaller farmers continue to purchase tillers to ensure timely land preparation and to obtain relief from the arduous work of land preparation when using draft animals. Returns on tractors are very sensitive to the amount of custom work done. Since the number of tractors and tillers in certain areas are increasing very fast, competition among contractors is becoming strong and returns on tractors are likely to decrease. The re- estimated economic rate of return for this project is 44%, a very high rate although reaching only half of the appraisal estimate. Institutional development shows varying degrees of success. The Technical Support and Evaluation Unit performed successfully as the planning unit for project implementation, but delegation of lending authority to participating banks under simplified lending procedures was not undertaken. During project implementation it became apparent that the training program for rural banks had to be expanded and conducted more intensively to improve their lending capability. 1/ PPAR - Philippines Second Rural... op. cit. 2/ Most beneficiaries are assumed to be medium-sized farmers, but no survey has been made.  - V - Large arrears have plagued several credit projects in the Philip- pines-Y. The attempt under this project to reduce arrears of participating banks by enforcing a stringent arrears criterion for their participation was ineffective because a large portion of project funds was already committed when the new arrears criterion came into effect. The Government and the Central Bank have already taken a number of remedial actions to improve collections. Also, a study of the factors leading to high arrears at the farm level (sugar price, beef imports, typhoons, etc.) is being conducted by the Central Bank. It is expected that arrears will be reduced to a reasonable level in the future. The following points may be of special interest: - Reflecting the lessons learned under the first and second loans, the project aimed at decreasing the share of farm mechanization, gradually shifting lending to other identified needs in the rural areas. This objective, however, was not accomplished; actually 86% of the project funds went to farm mechanization, instead of 64% as anticipated. Demand for tractors was particularly high, as a result of strong promotional efforts by dealers, bullish markets for sugar exports and peaking sugar prices, and hedging against further increases in price of tractors. Lending under other sub-loan categories evolved slowly, on a relatively small scale or did not materialize at all - like lending for dairy farming (paras. 2.04; 3.02 to 3.04; 4.04 and 4.05; 4.07. See also Annex, A.2 and B.5). - Heavy demand for tractors despite increased prices, and delay in enforcing the 25% arrears criterion (which would have prevented, restricted or stopped the participation of several banks) until most project funds had been commited were the two main reasons for the fast project fund commitment rate (paras. 3.08; 4.02; 4.04 and 4.05; 4.07, and 8.02). - The 25% arrears criterion is considered stringent by CB and TBAC, who also mentioned that it is not an effective measure of the efficiency of the system, and that it limits the number of outlets for rural credit projects - currently for the fourth such project (Annex, A.5, and B.3). - Rapid fund commitment under the project resulted in a funding gap of over a year between full commitment of the third project funds (March 1976) and effectiveness of the fourth loan (June 1977) (para. 4.04). - Unit costs of subprojects increased over appraisal estimates due to either higher unit prices (tractors and imported tillers) or larger operations (larger tonnage fishing boats ; larger fish ponds and fishpens, etc.) No particular effort was made in general to reach the small farmers - actually, the credit agreement includes no specific provision in that respect. Loan terms, risk and cost of servicing may have been a factor in this development. As a result, project beneficiaries were mainly medium-size farmers (paras. 4.08; 5.02; 5.07 and 5.08). 1/ Ibidem. See also PPAR - Philippines First Livestock... op. cit.  - vi - - No monitoring system was established for either lending or to control its impact. A project impact study was carried out and its findings were used in the preparation of the fourth loan. Although the study was overly ambitious and some of the analyses were inade- quate, the results proved useful for the preparation of the follow- ing project (paras. 4.11 and 4.12; 5.01 and 5.02). - All loan covenants were fulfilled (paras. 4.13 to 4.17). - It is reasonable to assume that project funds were additional and did not substitute - to a significant extent - other long-term public funds or sub-borrowers' own funds (para. 5.03). - The participating banks must contribute 10% of the cost of each sub-project. This is objected to by the participating banks, but continues being required by CB and IDA. It remains a controversial issue (paras. 4.03,a; 5.05 and 5.06). - Farm mechanization concentrates on land preparation. Unit labor requirements for land preparation have been reduced drastically, but in general overall labor requirements have increased (although adverse social effects have occurred under particular circum- stances) (paras. 4.12, a to d; and 5.11). A study of farm mechani- zation benefits and detrimental effects will be carried out under the fourth project. - Training courses provided by the Central Bank's Department of Rural Banks and Savings and Loan Associations for staff and management of rural banks contributed significantly to their operations, but the courses were still considered to be inadequate to fully meet their needs (paras. 7.07 and 7.08). - By and large, lessons learned from the first three projects were taken into consideration while preparing the fourth project (para. 10.02). In brief, the project continued to be instrumental in mobilizing domestic funds for agricultural development and in improving the term lending capability of participating banks. Many weaknesses were recognized during its implementation. As a result, appropriate adjustments were introduced into the fourth project: (a) not less than 30% of the loan funds directed to small farmers, (b) limitation on tractor financing, (c) more stringent guidelines on pricing of tractors and imported power tilllers to reduce retail prices, (d) reduced horsepower for tractors used in rice areas and more stringent service requirements, (e) establishment of a Management Advisory Unit for consultation on managerial problems with rural banks, (f) expansion and strengthening of the planning unit, and (g) introduction of a new arrears criterion. However, lending under the fourth project is moving at a much slower pace as a result of the sugar price slump, the oil and machinery price increases, and, accord- ing to CB, the arrears criterion.  PHILIPPINES THIRD RURAL CREDIT PROJECT (Loan 1010-PH) Project Completion Report 1. INTRODUCTION 1.01 The Bank has made four loans to the Philippines totalling US$76.0 mil- lion to assist the government's medium- and long-term rural credit program through the Central Bank of the Philippines (CB) for onlending to farmers, fishermen and rural entreprenuers through qualified rural banks and, starting from the third loan also qualified stock savings and loan associations (SSLAs). The third loan (Loan 1010-PH, US$22.0 million) is the subject of this report, and the fourth loan (Loan 1399-PH, US$36.5 million) is presently under implementation. 1.02 The third credit was almost fully committed by December 1975 and CB started the preparation of a fourth project early in 1976, and gave due consideration to issues and lessons arising from this project. 2. BACKGROUND First Rural Credit Project (Loan 432-PH) 2.01 This initial loan of US$5.0 million (November 1965) assisted in establishing for the first time a nationwide system to channel medium - and long-term credit by using the rural banking system. It was successful as a pilot project. Between 1965 and 1969, 2,594 farmers were financed through 148 participating rural banks for purchase of farm machinery (tractors and power tillers) and irrigation pumps, and for the development of fisheries and livestock as noted in the table below. No. of Amount of Subloans Category Subloans Million Pesos % of Total Farm Machinery 2,118 19.1 89.3 Irrigation Facilities 279 1.0 4.6 Fisheries and Livestock Development 197 1.3 6.1 Total 2,594 21.4 100.0 Second Rural Credit Project (Loan 607--PH) 2.02 This second loan of US$12.5 million (June 1969) financed the same categories as the first loan, but added storage and processing facilities - 2 - and on-farm transportation equipment. Because of the low demand for term credit during the initial stage of project implementation, caused primarily by the effect of the peso devaluation as well as serious natural disasters, final disbursement was completed only in June 1974, a delay of 18 months. From 1969 to 1974, 250 rural banks participated and financed 4,065 farmers. The major share of project funds was again spent for farm machinery (72% for tractors and power tillers) while some gain was seen for development of fisheries and livestock (14%). The two new subloan categories also made moderate progress (9% for new trucks and 3% for storage and processing facilities), but the share of irrigation pumps continued to decrease (i.e. 2% from 4.6% under the first loan). The breakdown by major components is noted in the table below. No. of Amount of Subloans Category Subloans Million Pesos % of Total Farm Machinery 2,636 105.4 71.8 Irrigation Facilities 318 2.9 2.0 Farm Equipment 43 0.8 0.5 Storage and Processing Facilties 161 4.7 3.2 Transportation Equipment 229 12.8 8.7 Fisheries Development 265 9.1 6.2 Livestock Development 413 11.1 7.6 Total 4,065 146.8 100.0 Issues Arising from First and Second Projects 2.03 The two loans were instrumental in encouraging rural banks to handle term credit and in improving their operational capability for term lending. However, the sharp increase of the rural bank loan portfolio in recent years, particularly for short-term loans, was not accompanied by strengthening of rural banks (e.g. managerial capacity and staff capability of rural banks and technical services provided to borrowers) or by a carefully planned collection system, and hence resulted in poor collection performance. To maintain the viability of the rural banking system, concerning which some doubts have been expressed, the focal point of government and CB policies has gradually shifted from promotion of massive lending for increase of food production to upgrading of loan quality and reduction of arrears. 2.04 Issues arising from the two loans were reviewed during the prepar- ation of the third loan and had some influence on project design. It was noted that demand for farm mechanization continued to be strong, and excessive arrears became a major concern. Among the issues reviewed by the Department of Rural Banks and Savings and Loan Associations (DRBSLA) were: new conduits for participation; expansion of subloan categories; establishment of a - 3 - Planning unit; reduction of arrears; contribution from participating banks; decentralization of loan processing; and strengthening of field operations. 3. PROJECT FORMULATION Central Bank Proposal 3.01 Following the satisfactory performance of the second loan, CB prepared in January 1973 a proposal for a third loan which recommended ten new subloan categories in addition to those already included under the second loan. The proposed new categories were (a) reconditioned trucks, (b) farm machinery repair shops, (c) woodcraft plants, (d) dairy farming, (e) fish pens, (f) fishmeal mills, (g) farm-home ownership, (h) banana farming, (i) fruit and vegetable canneries, and (j) meat processing plants. A super- vision mission in June 1973 made an initial review of the proposal, during which particular attention was paid to the justification of new subloan categories. The proposal became the basis for the appraisal conducted in November/December 1974. Major Issues on Project Formulation 3.02 Reflecting the lessons learned under the first and second loans, both CB and Bank agreed to make a number of changes to improve the quality of the term lending program conducted by rural banks and their services to farmers. The major issues raised by the Bank with CB, and resolved prior to Board approval in June 1974, are explained in paragraphs 3.03 to 3.10 below. 3.03 Subloan Categories. CB considered that in the long run the large share of farm mechanization component would decrease and that it would be prudent to gradually shift lending to other existing needs in the rural areas. Of the ten subloan categories in CB's proposal, six were agreed (i.e., recon- ditioned trucks, farm machinery repair shops, woodcraft plants, dairy farming, fishpens, and fishmeal mills), and the remaining four were excluded on grounds of being too complex or nonviable (i.e. farm-home ownership, banana farming, fruit and vegetable canneries, and meat processing plants). Laying emphasis on diversification of term lending, however, CB requested later at negotiations the inclusion of small-scale rice and feed mills for farmers located in remote areas where such services were not available. It was agreed that small rice mills would be financed under a separate Bank loan (i.e. the Grain Processing and Storage Project administered by the Development Bank of the Philippines-DBP) and that, in justifiable cases, fishmeal plants would be equipped with feed mixing equipment rather than financing small feed mills as a separate subloan category. 3.04 Another subject discussed was whether or not to limit the size of tractors to be financed. The Bank proposed a limitation of 80 hp, but CB argued that tractors in excess of 80 hp would be required for farming in the Philippines. The 80 hp limitation was agreed upon, however, because larger tractors were generally used by sugarcane farmers who were be better off and hence able to find other sources of financing. 3.05 Lending Channels. CB initially proposed to include DBP and the Philippines National Bank (PNB) as lending channels in addition to rural banks. This proposal was withdrawn because lending to smaller farmers was not a major function of both institutions, and it was considered most appro- priate to strengthen the rural banking system to serve smaller farmers. It was agreed however to include stock savings and loan associations (SSLAs) which in the past had lent primarily for commercial and housing purposes but had increasingly been financing agricultural investments in recent years. Moreover, SSLAs were regulated and supervised together with rural banks by DRBSLA, and therefore it was felt that participation of SSLAs would not create additional administrative problems. 3.06 Planning and Monitoring. Since the need of a small unit for planning and coordination had already been recognized in implementing the second loan, it was agreed to establish a planning unit in DRBSLA which would assist the management to analyze project data, monitor the project impact at the field level and prepare technical information for field offices. 3.07 Relending Rate to Participating Banks. The Bank suggested that CB's blended interest rate to participating banks should be increased from 7% to 8%. Since secured loans to farmers were fixed at 12%, this increase would have resulted in reducing the spread for rural banks from 5% to 4%. CB strongly favored a 5% margin as the minimuim to offset the high costs in making small subloans and argued a smaller margin would be a disincentive for future participation. Considering the large incentive which was provided for short- term production loans, the Bank agreed with CB to maintain the relending rate at 7%. 3.08 Arrears Criterion. Because of the rapid expansion of short-term production loans, the 25% arrears criterion of the total loan portfolio was no longer considered as a satisfactory limit to check the participation of rural banks with high arrears. It was agreed that the arrears criterion would be changed to arrears not exceeding a certain percentage of demand of subloans made under Bank financed rural credit projects (arrears being defined as "amounts overdue at the end of a twelve month period as a percentage of demand," and demand defined as "principal and interest falling due during the period plus overdue at the beginning of the period") and lowered progress- ively in several stages so that adequate time would be allowed for rural banks to improve their collection rates. 3.09 Retroactive Financing. Retroactive financing of subloans was requested to continue lending and minimize the disruption by the lack of project funds which could discourage future participation. A small amount of retroactive financing (i.e. US$500,000 for subloans made not earlier than April 1, 1974) was approved to meet the credit demand necessary for the coming planting season. 3.10 Guarantee for Fishing Boats. The Bank recommended that borrowers for fishing boats, who normally could not offer the collateral requested by rural banks, should be guaranteed under the Agricultural Guarantee Fund (AGF) to become creditworthy. The government agreed to guarantee only those who borrowed for small boats (up to 3 gross tons) in line with the objective of AGF to protect small farmers. - 5- Project Description and Major Targets 3.11 This project was basically a continuation and expansion of the second loan, but several new subloan categories were added and SSLAs were included as new lending channels. The beneficiaries were expected to be approximately 8,000 small- and medium-size farmers and local entrepreneurs who would invest in farm mechanization, transportation facilities and farm equipment, and the development of fisheries, livestock or cottage and agro- industries to increase food production and farm income and to generate employment opportunities. The estimated total project costs of about US$44 million was allocated for subloan financing with an exception of $100,000 to finance a project impact study. 3.12 This project had a three-year operational period, during which CB would on-lend to qualified rural banks and SSLAs the loan proceeds (50% of total subproject costs) and an additional 30% from government funds at a blended rate of 7% to be repaid to CB in terms similar to those granted to farmers. Participating banks were expected to contribute another 10% from their own funds and lend to farmers at 12%. Terms of subloan repayment differed by cate6ories ranging from three to ten years, with up to three years of grace period for certain categories. All of the detailed terms, conditions and major procedures for this project were incorporated in the Rules and Regulations agreed between CB and the Bank. 3.13 This project consisted of term investments as noted in the table below. Million Million % of Total Pesos US$ Investments Farm Mechanization 158.9 23.4 53.5 Transportation Facilities 43.8 6.5 14.8 Other Farm Development 17.8 2.6 5.9 Fisheries Development 29.1 4.3 8.9 Livestock Development 26.5 3.9 9.8 Agro-Industries Development /a 21.1 3.2 7.1 Total of Subloans 297.2 43.8 100.0 Project Impact Study 0.6 0.1 0.0 Total Project Cost 297.8 43.9 100.0 /aE Includes farm machinery repair shops. - 6 - 4. PROJECT IMPLEMENTATION Effective Date 4.01 The Bank agreed to extend the final date of effectiveness for two weeks because the submission of legal opinions from the government was delayed. This project became effective on August 27, 1974. On the basis of the approved retroactive financing, CB loan teams and participating banks started processing new applications from April 1974. Revisions 4.02 One major adjustment made after effectiveness was to postpone the the date of enforcing the new 25% arrears criterion, based on demand, to qualify for participation (see paragraph 3.08 for definition of arrears and demand). Enforcement was delayed for six months from April 1, 1975 to October 1, 1975, which allowed additional time for rural banks to reduce arrears and remain qualified for participation. Another minor change made was to realloca,e funds (about $44,000) for lending which was the unused portion of project funds originally earmarked for the project impact study. 4.03 The Rural Bankers Association of the Philippines (RBAP), an organi- zation formed by rural banks, submitted to the Bank in September 1974 a proposal which requested a number of changes in project design. The proposal was fully endorsed by DRBSLA and the Department of Agriculture (DA) as well, The issues raised were as follows: (a) Contribution by Rural Banks. RBAP requested the Bank to reduce the 10% contribution requirement to 5% for all rural banks, a level allowed only to new banks with a small networth. The Bank reiterated its belief that the minimum stake to be held by a participating bank in a subproject should be 10% and that 5% was too small a share to be allowed to all rural banks irrespective of their viability.Il (b) New Subloan Categories. Although it had been agreed at negotiations that small rice mills would be financed by a Bank project adminis- tered by DBP and a separate subloan category for feed mills was /1 The 10% contribution has been a controversial issue for some time. The Project Performance Audit Report for the Second Rural Credit Project (August 1976, pp 23-25), for example, questioned the insistence on a 10% contribution. Although the report did not recommend any appropriate rate to be implemented by the Bank, it considered no contribution was needed as long as rural banks were required to carry the total risks of all subloans. Under the fourth loan, however, the contribution rate was fixed at 10% again. The Bank took the position that the 10% was the minimum to ensure rural bank involvement and that it also would be a starting point for rural banks to provide term credit from their own resources. - 7 - considered unnecessary, RBAP requested the Bank to reconsider its position and agree to finance small rice and feed mills under this project. No conclusion was reached because detailed information was not presented for further discussion. (The two categories have now been included under the fourth loan.) (c) Increased Tonnage for Fishing Boats. RBAP requested the tonnage of fishing boats be increased to 20 gross tons because boats up to 5 gross ton were too small to be profitable. As in the case of small rice and feed mills, no conclusion was reached because detailed information was not presented for further review. (The tonnage of fishing boats has now been increased up to 20 gross tons under the fourth loan.) (d) Large Scale Threshers. RBAP requested that the limitation on threshers be removed and threshers with a capacity exceeding the limit of 13 tons a day be financed. Because these large threshers are considered to result in the loss of opportunity for a large number of farm workers who were traditionally engaged in threshing operations and received a portion of the harvest as wages, no change was made and this project continued to finance only small portable threshers usable by smaller farmers. (e) Extension of Repayment Period. RBAP requested that the extension period allowed for arrears due to events of force majeure under this project be applied to similar type of arrears under the first and second loans as well. With the agreement of DRBSLA, the extension period applicable to this project was also agreed for the first and second loans. Lending Performance 4.04 Overall Progress. This project progressed much faster than the lending schedule prepared at the time of appraisal. The first supervision mission in March 1975 reported that initial progress was remarkable, but that it would not continue because of the sharp increase in prices of tractors and power tillers, and also the possibility of a large number of rural banks being disqualified from participation due to high arrears. But the second supervision mission in November 1975 concluded that, quite contrary to the slow down projected earlier, full commitment might be accomplished in early 1976. Heavy demand for tractors despite increased prices and delay in enforcing the 25% arrears criterion based on demand were considered to be the two major reasons for the continued fast progress. Although the details were not available at the time of mission, total costs of subprojects approved by DRBSLA had reached P 274.6 million, 92% of appraisal estimates (P 297.2 million) or 80% of actual lending (P 343.2 million) by the end of September 1975. (Actual lending which became larger than appraisal estimates implied a smaller Bank contribution of 46.6%, down from the estimated 50%.) DRBSLA immediately took two measures to cope with commitments so substantially ahead of appraisal estimates. One was to retain funds for subloan categories other than tractors by suspending financing of tractors for sugarcane growing areas - 8 - (financing of trucks had already been stopped after reaching the agreed limitation in mid-1975), so that commitment would slow down and extend the project period, and minimize the period when project funds were no longer available. The other was to start preparation of a project proposal for a fourth loan. However, this suspension came late and project funds were virtually committed by the end of March 1976 as shown in the table below. New project funds did not become available until the fourth loan became effective in June 1977, thereby resulting in a gap of over a year when funds for term credit were not available. Accumulative Progress Rate (%) Total Costs of Appraisal Actual Subprojects Estimates Lending (Pesos Million) December 31, 1974 60.6 20.4 17.7 March 31, 1975 132.5 44.6 38.6 June 30, 1975 192.9 64.9 56.3 September 30, 1975 274.6 92.4 80.0 December 31, 1975 328.5 110.5 95.7 March 31, 1976 343.0 115.4 99.9 March 31, 1977 343.2 115.5 100.0 4.05 The rapid pace of commitment under this project resulted from a combination of several reasons. First, an average price increase of 30% above the appraisal estimates did not the reduce demand for tractors in contrast to the projection made by the supervision mission (see paragraph 4.04), and in fact exceeded appraisal estimates at the end by 10% in number of units financed and 30% in use of project funds. Second, the expected complete replacement of imported power tillers by locally made ones proved too optimistic. Only about one-third of the total 1,191 units were locally made tillers, although they improved in quality and sold at much cheaper prices (about one-fourth to one-third the price of imported ones). However, their share in the market increased at a fast pace as projected at appraisal./1 It appears that many farmers were able to purchase locally made tillers on their own without borrowing from rural banks. Third, demand for trucks was Ai 1974 1975 1976 No. of No. of No. of Units % Units % Units % Locally made Tillers 2,338 35 5,225 47 5,670 61 Imported Tillers 4,383 65 5,852 53 3,682 39 Total 6,721 100 11,077 100 9,352 100 -9- very strong and the limitation established at 140% of appraisal estimates was reached in mid-1975. Finally, participating banks with arrears in excess of 25% of demand (which accounted for nearly one-half of participating banks) were not disqualified from participation for an additional six months (i.e. until October 1, 1975), and it is presumed that subloans made by them during this period contributed heavily to the accelerated rate of commitment./l 4.06 Progress by Subloan Categories. Progress of lending made by major subloan categories in comparison with appraisal estimates is given in the table below. No. of Subprojects Amount of Subloans (P'000) Appraisal Actual Appraisal Actual No. % No. % Amount % Amount % Tractors 1,771 22.1 1,952 43.1 137,132 51.3 180,226 63.1 Power Tillers 1,000 12.5 1,191 26.3 5,921 2.2 24,647 8.6 New Trucks 250 3.1 562 12.4 27,755 10.4 40,753 14.3 Fishing Boats 300 3.8 40 0.9 17,259 6.5 3,277 1.1 Fishponds and Fishpens 272 3.4 176 3.9 8,962 3.3 11,180 3.9 Poultry Farms 750 9.4 98 2.2 7,930 3.0 8,769 3.1 Swine Farms 1,500 18.7 166 3.6 13,799 5.1 9,656 3.4 Others 2,160 27.0 347 7.6 48,757 18.2 7,088 2.5 Total 8,003 100.0 4,532 100.0 267,515 100.0 285,596 100.0 4.07 Progress of lending among subloan categories was uneven. Tractors, power tillers and new trucks, as in the case of the second loan, again proved to be the fast moving categories supported by intensive promotional efforts of farm machinery and truck dealers, besides the strong demand for mechan- ization in paddy and sugarcane growing areas. The amount of subloans for the three categories increased from P 171 million to P 246 million, an increase of 44% from appraisal estimates, or 22% in percentage from 63.9% to 85.9%. On the other hand, other subloan categories were not so successful. In particular, no subloans were made for dairy farming due to operational difficulties under tropical conditions and limited marketing facilities, and very few were made for reconditioned trucks which could be purchased only for cash due to the limited number of second-hand trucks imported for reconditioning. /1 During the six month period, commitment was P 142 million or 48% of appraisal estimates. However, no survey has been made to determine the portion committed by participating banks with arrears in excess of 25% which would have been disqualified from participation. - 10 - Cottage and agroindustries made a small progress (20 subprojects) because of the difficulties encountered in identification and appraisal of viable enter- prises, and the lack of promotional efforts by CB field staff and rural banks. In conclusion, large financing of tractors, power tillers and new trucks resulted in a shift of project emphasis away from other categories and the degree of diversification sought at the time of appraisal was not realized. 4.08 Subproject Unit Costs. Unit costs of subprojects increased by comparison with appraisal estimates for various reasons; price increases for imported tractors and power tillers, financing of imported power tillers which was not initially provided for, larger tonnage (fishing boats), and larger scale operations (fishponds, fishpens and livestock development). Reduction was seen for new trucks due to financing of smaller sized units. Increases in unit costs by major subloan categories are noted in the table below. No. of Subprolects Unit Costs (P '000) % of Total Subproject % of Appraisal Actual Appraisal Actual Increase Costs (-P '0000) Increase (Decrease) Appraisal Actual (Decrease) Tractors 1,771 1,952 86.0 111.9 30 152,369 218,444 43 Power Tillers 1,000 1,191 6.6 24.0 264 6,579 28,606 335 New Trucks 250 562 123.4 85.8 (30) 30,839 48,205 56 Fishing Boats 300 40 63.9 104.1 63 19,176 4,163 (78) Fishponds and Fishpens 272 176 36.6 75.5 124 9,958 13,281 33 Poultry Farms 750 98 11.7 105.8 804 8,811 10,370 18 Swine Farms 1,500 166 10.2 68.6 573 15,332 11,392 (26) Others 2,160 347 25.1 25.1 - 54,175 8,717 (84) Total 8,003 4,532 37.1 75.7 104 291,239 343,178 15 4.09 Regional Distribution. Use of project funds by regions continued to favor Luzon where rural banks are well organized and farmers are progressive and willing to take advantage of mechanization and other investment oppor- tunities to increase their production and income. The sharp drop in Mindanao seemed to reflect the security problem encountered in the region. However, regional distribution varied widely by subloan categories. In terms of subloan categories 62% of tractors went to Luzon primarily for rice productioni/and 29% to Visayas for sugarcane production; 51% of imported power tillers went to Mindanao and 39% to Luzon; 92% of locally made power tillers went to Luzon where most of the manufacturers were located; and 59% of new trucks went to Luzon and 39% to Visayas. All other categories heavily favored Luzon. Breakdown by regions is noted in the table below: 1/ According to TBAC, tractors financed in the Central Luzon region were also largely for sugar farms (Annex, B.5.a). - 11 - Second Loan Third Loan No. Amount No. Amount Luzon 61% 66% 64% 62% Visayas 20% 22% 22% 31% Mindanao 19% 21% 14% 7% Disbursements 4.10 The fast rate of commitment for subloans by CB resulted in dis- bursements ahead of the appraisal schedule and 99% of loan proceeds were withdrawn by March 31, 1976. Withdrawal of the remaining 1% took some time because reallocating the unused funds for the project impact study was delayed. The actual Closing Date was May 14, 1977, about seven months earlier than the original Closing Date. The rate of disbursements is shown in the table below. Rate of Disbursements (%) Appraisal Actual Semester Cumulative Semester Cumulative December 31, 1974 9.4 9.4 10.2 10.2 June 30, 1975 12.9 22.3 29.8 40.0 December 31, 1975 16.1 38.4 43.2 83.2 June 30, 1976 18.9 58.2 16.6 99.8 December 30, 1976 20.9 79.1 0.1 99.9 May 14, 1977 - - 0.1 100.0 December 31, 1977 20.9 100.0 - - Project Impact Study 4.11 Phase one of the project impact study which covered the first and second loans was completed in October 1975. Phase two of the study planned to cover this project was cancelled because its findings would not have been available in time for preparation of the fourth loan. The study focussed primarily on tractors and power tillers (the two largest categories financed) and the administrative problems in processing loan applications. It also provided an opportunity for DRBSLA to assess term lending conducted by rural banks. 4.12 Trying to cover a wide range of issues, the study was overly ambitious and some of the analyses were inadequate. But the findings were useful in preparing the fourth loan. Some of the major findings were as follows: - 12 - (a) mechanization of land preparation contributed to increased food production through cultivation of land which would otherwise be idle, and through timely multiple cropping; (b) there was no difference in unit yield between land prepared by mechanization and draft animals for paddy, but a substantial increase of 20% to 30% was observed for sugarcane as a result of deep tillage by mechanization; (c) mechanization was used mostly for land preparation due to seasonal labor shortage, and the trend for increased intensity of land use would create new demand for mechanization; (d) despite the reduction of labor requirement for land preparation by mechanization, the total labor requirement increased because of better care of crops during the growing period and larger harvest; (e) financfal returns on tractors and power tillers were heavily dependent on the extent of custom work conducted by borrowers and the availability of custom work within their locality was becoming a major concern in some areas; (f) implements and accessories were not well packaged to meet the need of individual borrowers; and (g) use of heavy tractors in rice farming did not present any distinct advantage over smaller tractors. Covenants 4.13 Retroactive Financing. Subloans made between April 1 and July 16, 1974 were eligible for retroactive financing. Actual withdrawals of expend- itures from the Bank under these subloans reached an aggregate amount of $500,000, the amount approved under this project. 4.14 Subloans for Trucks. Subloans for trucks were not to exceed $3,250,000 in withdrawals from the Bank. The amount withdrawn reached an aggregate amount of about $3 million, and therefore did not exceed the agreed amount. 4.15 Establishment of TSEU. TSEU was established on March 31, 1975, two months later than the agreed date of establishment. This delay occurred because CB first attempted to recruit a Technical Assistant, one level higher than a Division Chief which was agreed with the Bank, to become the head of TSEU. Failing to find a proper person, CB then appointed a Division Chief from its staff without further delay. 4.16 Project Impact Study. CB carried out phase one of the project impact study which covered the first and second loans with the assistance of experts employed from the University of the Philippines at Los Banos (UPLB). However it was agreed to cancel phase two which would have covered this project and the unused funds were reallocated for subproject lending. - 13 - 4.17 Rules and Regulations. The Rules and Regulations which specified terms and conditions of subloans and other procedures were followed strictly by CB and participating banks. The only change made, with Bank agreement, was to postpone by six months the enforcement date of the new 25% arrears criterion from the original date of April 1, 1975 to October 1, 1975. 5. PROJECT IMPACT Overall Assessment 5.01 This project continued to contribute to expanding the rural term credit program atid in mobilizing domestic funds for term investments in agriculture. Crqpping intensity and crop production increased through mechanization which facilitated the adoption of improved technology and timely and efficient use of irrigation water. Development of fisheries, livestock and cottage and agro-industries was also promoted, although on a very small scale. As a result, farm income and rural employment opportunities increased. However, it was not possible to determine the precise impact because DRBSLA could not as part of its planning functions establish a monitoring system to assess the project impact at the farm level. This is now being undertaken under the fourth loan. 5.02 This project did not particularly emphasize lending to small farmers although beneficiaries were defined to be mainly farmers cultivating between 2 and 10 ha. In fact, distribution of project funds among subloan categories was still weighted heavily in favor of tractors and imported power tillers purchased by larger and medium-size farmers. This same trend was observed in fisheries and livestock subprojects: their scale were much larger than the models prepared at appraisal for small farmers. Rural banks in general did not give due consideration to identifing smaller farmers who were viable but were traditionally rejected as lacking in creditworthiness4. No information was available on lending made under this project by the size of farmers due to the lack of a monitoring system. However, a quota system has been adopted under the fourth loan to induce rural banks to serve the financial needs of smaller farmers. 5.03 In view of the shortage of term credit in rural areas and the fact that rural banks were almost entirely dependent on this project for term lending, it would be reasonable to assume that funds were additional and sub- stitution with other long-term public funds did not take place. Substitution may have occurred in the case of some sugarcane farmers who had better access to other sources of funds, but only in rare occasions as the lending program under this project expanded its coverage to borrowers who would have been unable to purchase a tractor without a subloan. To avoid substitution in the future, financing of tractors to sugarcane farmers is being phased out and a small number of such units has been allowed under the fourth loan. 1/ TBAC has mentioned that the appropriateness of the loan terms and conditions to the end users may have also been a factor in reaching its target clientele, particularly the small farmers (Annex, B.2). - 14 - 5.04 The impact of this project on participating rural banks was positive.1/ More rural banks became aware of the need of term credit in a package with short-term production loans to fully increase production. As a result, an integrated approach began to be established to strengthen the rural banking system. For example, inclusion of SSLAs as new lending channels, expansion of eligible subloan categories, enforcement of new arrears criterion based on demand, and establishment of TSEU as well as other institutional and operational changes were all aimed at improving the quality of participating bank lending operations. Monitoring of the total impact of all credit programs became necessary for improvement of the financial well-being of rural banks and their borrowers. Reduction of arrears or training could no longer be approached separately for short-term and long-term lending programs and the reorganization of DRBSLA was timely to facilitate this new approach. Contribution 5.05 Participating banks contributed only 9.0%, of total subproject costs, 1% smaller than the required 10%. Under this project, rural banks in operation for less than three years and with a net worth not exceeding P 500,000 were allowed to make a smaller (5%) contribution while those with a net worth exceeding P 2 million or with savings deposits liabilities of over P 3.5 mil- lion and all SSLAs were required to make a larger (15%) contribution so that an average of 10% on the aggregate could be maintained. Although no survey was made, it appeared that the smaller contribution from the former type of rural banks was not offset by the larger contribution from the latter type of rural banks and SSLAs. In contrast to rural banks, beneficiaries' contri- butions was 16.8% as shown below and exceeded the 10% requirement primarily to reduce the amount of collateral offered to rural banks. IBRD 46.6% CB/Government 27.6% Participating Banks 9.0% Beneficiaries 16.8% 5.06 The 10% contribution continued to be a controversial issue. In its request to the Bank, the Rural Bankers Association of the Philippines (RBAP) maintained that project implementation would be delayed unless contribution was reduced to 5%, especially with the sharp price increases of farm machinery (see para 4.03). Nevertheless commitment progressed at a fast pace (i.e. exceeded 90% of appraisal estimates by September 30, 1975 when the new 25% arrears criterion was made effective), and hence the adverse impact of the 10% contribution requirement was not observable under this project. The major reason RBAP sought a lower rate of contribution does not appear to have been a liquidity problem as claimed, but the reluctance to tie up resources in investments and the higher profitability of short-term lending.2/ Based 1/ TBAC has mentioned that the PCR fails to consider and properly determine whether lending under the project was really profitable for the participating rural banks (Annex, B.1). 2/ Both the CB and the Bank feel, however, that it is wrong in principle and detrimental to the potential developmental role of rural banks to do away with the 10% contribution towards sub-project costs. Moreover, the CB regards the 10% contribution as only a starting point and considers that rural banks should provide large contributions as they acquire experience with rural lending. - 15 - on a capital risk asset ratio of 10%, the guideline enforced by CB, analysis of 248 participating banks and 114 nonparticipating banks (as of March 31, 1976) showed that, on the average, liquidity was not a decisive factor in discouraging participation. It is true however that some rural banks with a relatively large term loan portfolio were in trouble. The findings of the survey is given in the following table. No. of Banks Uncommited Funds per Bank Networth Surveyed (-P '000) Participating Banks Less than P 1 M 194 74 P I to 2 M 52 317 More than P 2 M 2 229 Total 248 - Nonparticipating Banks Less than P 1 M 82 105 P 1 to 2 M 31 1,391 More than P 2 M 1 377 Total 114 - Project Beneficiaries 5.07 The number of beneficiaries was about 4,532, 57% of the 8,003 small and average size farmers (i.e. mainly those cultivating between 2 to 10 ha) estimated at appraisal. Tractors and power tillers accounted for the largest group of 3,143 (69% of the total), followed by a group of 579 for trucks (13% of the total) and much smaller groups for other subloan categories for the remaining 18%. 5.08 The number of indirect beneficiaries was not established precisely but was estimated to be in the order of 80,000 farmers according to various studies for tractors and power tillers (used primarily for land preparation in paddy and sugarcane growing areas). The wide-spread use of custom work has allowed smaller farmers unable to purchase tractors and power tillers to benefit from timely land preparation, solve the delay due to seasonal shortage of labor and draft animals, and save labor and fodder land. Mechanical Land Preparation 5.09 Since over 70% of project funds were spent for purchase of tractors and power tillers, mechanized land preparation is discussed here in detail as the major impact of this project. Tractors and power tillers in the - 16 - Philippines are almost exclusively used for land preparation with some additional use for transport .of farm inputs and produce and providing power to operate threshers and irrigation pumps. Timeliness of land preparation by mechanization enables farmers to take advantage of local conditions for farming, particularly in making the full use of available irrigation water. Intensive land use becomes feasible through cultivation of idle lands and increased cropping intensity. Other reasons given for replacing draft animals were: the drudgery and slowness of land preparation; rest time required by animals for recovery of strength and stamina; inefficiency in hard stony or parched soil; land and labor needed to forage animals; animal rustling; and unreliability due to disease and death. 5.10 The population of carabaos (water buffaloes) has decreased rapidly in recent years from 4.9 million head in 1973 to 2.7 million heads in 1976 and if this declining trends does not change, the need for mechanized land preparation will be accelerated. However, it should be noted that draft animals are still needed to plow the small untilled portion close to the field borders where tractors and power tillers cannot operate and to complete leveling. In particular, it is common for tractors to work across the borders of several plots, if possible, to save time and wear of the machine from continuous change of directions and later rebuild these borders using draft animals. An IRRI study made in 1977 reported that 93% of the surveyed power tiller owners also used draft animals for land preparation and 24% of them still owned draft animals. Effects of Mechanization on Employment 5.11 Mechanized land preparation has become increasingly important with the introduction of improved technology and increased cropping intensity. In the Philippines, the thrust of farm mechanization still remains to be the timeliness of land preparation and replacement of the arduous task of land preparation by draft animals. Although labor requirements for land prepar- ation have been reduced substantially, increase of labor for harvest and other operations due to a higher land use have more than offset the labor reduced by mechanized land preparation, which is generally accompanied by better use of irrigation water and introduction of better technology such as use of fertilizers and high-yielding varieties. This basic pattern of increased labor requirements over the total cropping operation has not changed but some evidence has emerged from recent surveys to confirm that under particular circumstances adverse social effects do occur, which of course preclude broad generalizations. As a result, a study is to be conducted under the fourth loan to examine the long-run impact of mechanization on employment, the most appropriate type of mechanization from an employment standpoint, and also financial and economic impacts of mechanization. 6. RATES OF RETURN Financial Rates of Return 6.01 The estimated financial rates of return for various subprojects ranged at appraisal between 20% and 100%. The key assumptions and unit - 17 - prices were reviewed by the completion mission but its field observation was concentrated primarily on tractors, power tillers and new trucks which accounted for 86% of project funds. The rates of return were recalculated particularly for tractors and tillers used in rice farming and tractors used in sugarcane farming. 6.02 Medium Tractors for Rice Farming. Three major key assumptions were reviewed, namely, cropping intensity, unit yield and the amount of custom work performed. Depending on data sources, cropping intensity of tractor owners has been reported to range between 140% to 250%, greatly influenced by the availability and dependability of water supply for irrigation. Many owners were observed to achieve a high intensity of 190% and the assumption (172.5% with development) used in the farm model was unchanged. Unit yield of 80 cavan per ha seemed to be on the higher side because of a lower productivity observed in large holdings and as a result it was reduced to 70 cavan per ha. Custom work was checked on the basis of annual usage which differed widely from 900 hours to 2,200 hours. Field observation supported an annual usage of 1500 hours as reasonable and, with a 70% productiveness for land preparation, custom work was reduced from 285 ha to 150 ha. With these changes and new unit prices, the rate dropped only slightly from 47% to 43% due to the sharp increase in fee for land preparation which rose from P 140 to P 300 per ha (see Table 2). However, it should be noted that this return would be lower if tractor prices continue to increase rapidly and in certain areas where the density of tractor and tiller population increases, the competition for custom work becomes strong. 6.03 Heavy Tractors for Sugarcane Farming. Since tractor owners had already been preparing land through custom service, acquisition of tractors did not contribute to an increase of sugarcane yield from deeper cultivation, and hence the rate of return of the model was changed to be based on custom work. Therefore, the average yield of sugarcane per ha increase from 60 to 80 tons had no impact on the return. Custom work was increased from 146 ha to 166 ha but the rate of return happened to remain the same 34% (see Table 3). However, the recent drop in farm gate sugar price from P 100 to P 60 per picul appears to have greatly reduced the desire of farmers for replanting or opening of sugarcane land. Although the exact impact of the low sugar price is not available, scarcity of custom work seems to be the major cause of the recent poor repayment performance for tractors in sugarcane growing areas. A reduction of 60 ha in custom work would make the rate of return negative. The extent of price recovery expected from the new international sugar price agreement is not yet known. 6.04 Locally Made Power Tillers for Rice Farming. Two major changes were made to the model used at appraisal. One was to change the time required for land preparation for a tiller from 32 hours to 48 hours per ha. This reduced custom work from 13.6 to 8.8 ha. The other change was to shorten the economic life and amortization period from 8 and 7 years, respectively, to 5 and 4 years respectively. The rate of return dropped from 21% to less than 1% (see Table 4)V In case of imported tillers, prices were at least triple of local made ones and the return became negative in spite of the additional efficiency for land preparation (i.e. 32 hours per ha). However, the large volume of tillers 1/ DRBSLA arrived at a much higher figure (11.8%) assuming a larger farm size (4 ha, the minimum area CB allowed for tiller lending, instead of 3 ha.), a larger area for custom service (20 ha. instead of 8.8 ha.), and a higher cropping intensity (200%, instead of 172.5%). (Annex A.3). - 18 - being purchased by farmers cannot be explained by this low financial return alone and other real benefits should be considered such as timeliness of planting, release from work drudgery using draft animals, and the uncertainty of draft animal power due to endemic diseases. 6.05 Other Categories. Reflecting the large demand for new trucks, the return was over 100%. The return on other items mostly ranged between 20% and 40%. Economic Rate of Return 6.06 The estimated rate of overall return to the Philippine economy was over 80% at appraisal but the recalculated rate was 44%. Market prices of fertilizer and petroleum products approximate their economic costs and no shadow pricing of these commodities were undertaken. Similarly, unskilled labor has been costed at its market rate since the majority of the projects' employment creation would occur in accordance with the crop cycle, the primary determinant of employment in rural areas. 7. INSTITUTIONAL DEVELOPMENT DRBSLA 7.01 Reorganization of DRBSLA. In 1976, DRBSLA established three Supervised Credit Groups (sections within DRBSLA) responsible for all lending on a geographical basis which replaced the previous two Groups responsible for short-term lending and long-term lending respectively. The initial two Groups separated on a functional basis were well suited to establish rules and regulations and other operational procedures for term lending. With a larger flow of credit to rural banks, the interdependence of various credit programs providing production and term loans increased and an integrated approach became necessary to improve all credit programs conducted by rural banks. This reorganization of DRBSLA placed loan teams and credit supervisors engaged in term lending under the control of one Assistant Director who was also in charge of short term lending programs. As a result of these measures, coordination between different credit programs is not expected to improve in the near future. 7.02 Establishment of Planning Unit. TSEU was established in 1975 to function as the planning center for term lending and to assist the management and operational staff for implementation of this project. DRBSLA first suggested that TSEU should be made responsible for short-term lending programs to function effectively as a planning center but agreed that TSEU should initially concentrate on various issues related to this project. In practice, TSEU became involved in short-term lending programs from time to time, but did not formally become responsible for the planning and support of short-term lending until the fourth loan. TSEU's performance was satisfactory and it became responsible for preparation of a proposal for the fourth loan. One problem still unresolved was the establishment of a system to monitor and evaluate the impact of this project at the field level. - 19 - 7.03 Field Staff. Loan teams in charge of subloan approval were increased from five to nine in 1974. This increase of four teams was adequate to process applications without unreasonable delays. However, some delay occurred due to shortage of credit supervisors in charge of preparing farm plans and feasibility studies for individual applications. DRESLA recruited 88 technicians in 1975 but they were not deployed in time to become involved under this project. 7.04 Resident Examiner System. In 1976, DRBSLA established a resident examiner system which stationed an examiner (in charge of four rural banks) and a credit supervisor (in charge of eight rural banks) in local areas to provide constant and intensive guidance to ensure that they were adequately supervised. The examiner is required to examine every month the four banks assigned to him and the supervisor is required to review every two months the lending operations of the eight banks assigned to him. Introduction of this system was also aimed to assist rural banks in reducing their high level of arrears. Board for Review of Agricultural Credit Policies 7.05 The government established in 1975 the Presidential Committee on Agricultural Credit (PCAC) and its working group, the Technical Board on Agricultural Credit (TBAC), to address basic issues surrounding the future of the agricultural credit sector. TBAC conducts various studies of the sector with its own staff consisting of about 30 specialists and also reviews studies conducted by CB, government agencies and special committees. At the moment, TBAC is conducting a number of studies on the impact of various government sponsored lending programs, and at the Bank's suggestion, also reviewed issues which were considered by the Bank in appraising the fourth project and which would determine the nature of future Bank support for the sector. Special Commission for Collection 7.06 Separate from PCAC/TBAC, the government established in 1976 the National Commission on Countryside Credit and Collection (NCCC) and its working unit in CB (CBCCC) to formulate policies to increase collection rates for government sponsored credit programs and to improve repayment in rural areas. Presently, the two commissions are expected to intensify collection on a national scale and reduce the present high level of arrears of rural banks and other credit institutions engaged in financing agriculture. They will also carry out various educational programs to educate adults and their children living in rural areas on financial disciplines required to maintain a viable banking system to provide credit for agricultural investments. Training 7.07 DRBSLA continued to organize and provide training courses mainly for the staff and management of rural banks. The two major courses given were a three-week orientation course on banking for officers and staff of new rural banks and one-week course on management for directors and managers of rural banks. In particular, attendance of the former course was mandatory for new banks and about 3,000 officers and staff attended the course between - 20 - 1973 and 1976. The Rural Bankers Association of the Philippines also contri- buted to the training effort of DRBSLA. Separate seminars were conducted on various subjects directly related to rural bank operations but not covered in the general training courses sponsored by DRBSLA. 7.08 DRBSLA's training courses contributed significantly to the improve- ment of rural bank operations but were still considered to be inadequate to meet the needs of rural banks. An example is reduction of the present high level of arrears which would require intensive training to upgrade the managerial and operational competence of rural banks so that they become capable of handling a large volume of credit efficiently. To meet new needs of the rural banking system, changes are under consideration now. Further review is expected to be made by the new Training Department which is expected to formulate basic policies for training and to coordinate training programs conducted by various departments in CB. The new department is also expected to establish a career development training program which would provide opportunity to DRESLA's staff. 8. SPECIAL ISSUES Arrears 8.01 New Criterion. High arrears of rural banks continued to be a serious problem for rural banks and CB. A stringent arrears criterion was enforced progressively in several stages so that rural banks would gradually reduce their term loan arrears to qualify for participation. However, rural banks failed to reduce their high arrears during the project period and reduction of arrears remained as a major problem under the fourth loan. 8.02 The new arrears criterion of 25% (lowered to 20% a year later) was ineffective to put pressure on rural banks to reduce arrears. First, enforcement of the 25% arrears criterion was postponed for six months until October 1, 1975 because the time allowed (i.e. up to March 31, 1975) was too short to reduce arrears, and hence a large number of participating banks would have been disqualified from participation. As of March 31, 1975, the average percentage of arrears was 48% of demand and only 73 out of about 260 participating banks would have qualified for continued participation if the 25% criterion had been enforced. Second, reduction of arrears of term loans became a secondary issue to recovery of short-term loan arrears when the criterion was enforced from October 1, 1975 after a six month delay. Close to one-half of participation banks were disqualified, but increased partici- pation was no longer a bottleneck for project implementation. Commitment had exceeded 90% of appraisal estimates and DRBSLA had to deliberately slow down loan processing. Third, the 20% arrears criterion enforced from April 1, 1976, had no impact at all because project funds were already fully committed (i.e. 99.9% of total subproject costs) by that time. - 21 - Poor Collection by Rural Banks 8.03 Many reasons were given for the poor performance of rural banks to improve their collection rates. The major ones were as follows: (a) absence of information on project status due to lack of timely reporting and inadequacy of supervision; (b) unwillingness of rural banks to undertake subloan supervision due to staff shortage and additional costs of carrying out supervision; (c) reluctance of rural banks to take proper actions for collection (such as timely repossession and litigation against willful defaulters), based on the belief that full repayment would be made by the time the final installment became due; (d) hesitation of rural bank to reschedule arrears caused by events of force majeure and other uncontrollable causes, for fear of estab- lishing precedents for lenient repayment; (e) poorly qualified and/or trained rural bank staff; (f) inadequate supporting services for institutional strengthening of rural banks; (g) inadequate technical services available to individual end-borrowers resulting in poor planning, poor appraisal and implementation problems which could not be solved by them; (h) priority given to collection of short-term loan arrears for rural banks to remain eligible for CB's rediscounting facilities; and (i) lack of detailed information on arrears to prepare action plans based on individual subloans due to the inadequate reporting system; 8.04 A brief field survey was made by the completion mission to seek the causes and problems of poor repayment at the beneficiary level. The major findings were as follows: (a) Natural Calamities. Crop failures and other damages resulting from natural calamities were considered a major cause of poor repayment but the extent of arrears due to such damages was not known. There was no system to assess damages and, even if damages were assessed, rural banks normally did not allow rescheduling. As a result, rural banks were not able to separate willful defaulters from those who suffered from natural calamities. The efficiency of loan portfolio management suffered somewhat from failure to reschedule loans. A proper damage assessment system is expected to be developed. The Philippine Crop Insurance Corporation was legally established in June 1978, but has not yet become operational. In the meanwhile, a technical and advisory committee has been formed to work on the details of the scheme. - 22 - (b) Low Product Prices. A sharp drop in product prices from appraisal estimates was another cause for poor payment. Low pork prices made pig farming unprofitable for some time until prices recovered after the government limited import of low-price meat products. During this period, many farmers stopped raising pigs and some went out of business. Even after the recovery of prices, repayment continued to be a problem. The low sugar price is causing some problems at the present. The low prices have reduced profitability of sugarcane farmers, so that the demand for custom work has decreased, especially to open new land for sugarcane cultivation. With less income from custom work, some borrowers have rejected rescheduling and requested repossession of tractors and disposal of other collateral offered to rural banks. Reflecting this adverse situation, there will be no demand for tractors in the sugarcane growing areas under the fourth loan until the sugar price recovers and demand for custom work increases to make tractor acquisition profitable. (c) Diversion of Cash Income. Cash income from custom work was found to be spent for house improvement, purchase of land and farm implements or children's schooling. Repayment of subloans was not forgotten by borrowers, but rural banks generally failed to inform them that an installment would become due in the near future. Lack of information on usage of tractors by defaulting borrowers seemed to be another cause to make this kind of diversion. The inflexible annual or semi-annual installment plan prepared by rural banks usually ignored the seasonal flow of cash income, and collection efforts were intensified belatedly after arrears became a major problem. (d) Repossession. Rural banks did not take timely actions to repossess tractors against borrowers who defaulted for one year or even two years. In some cases, borrowers were found to use their tractors for custom work while defaulting on repayment. As a result, the resale value at the time of repossession was substantially reduced. Another problem was the lack of a market for second hand tractors which discouraged timely repossession. One rural bank had to pool tractors belonging to defaulters, make arrangements for custom work, and collect fees directly from customers because of the difficulty in selling the repossessed tractors. Since repossession of tractors may increase in the near future, it would be advisable to review the possibility of organizing a market for second hand tractors and power tillers. - 23 - Government Effort on Collection. 8.05 For the rural banking system to remain viable and serve the rural areas effectively, the government and CB have taken a number of actions to reduce arrears in the short run and to avoid their occurrence in the long run. PCAC/TB.K were established to review the issues of the agricultural credit sector while NCCC/CBCC were established to formulate basic collection policies. TBAC conducted a special study on ar17ars on all credit institutions involved in financing agriculture, 7 and CBCC is involved in promoting collection campaigns. Both DRBSLA and the Department of Loans and Credits are making every effort to reduce arrears through etablishment of the resident examiner system, denial of access to rediscounting facilities, intensified prosecution of willful defaulters and higher collateral requirement from rural bank management. DRBSLA is presently preparing a plan of action to reduce arrears of rural banks and SSLAs. Participation 8.06 The number of participating banks under this project increased slightly with the participation of SSLAs. There were 248 rural banks and 14 SSLAs by comparison with 250 rural banks which participated under the second project. The lack of participation did not hinder project implemen- tation because a major portion of project funds had alredy been committed when disqualification from participation was carried out under the new arrears criteria. 8.07 Participation of SSLAs was a success. The 14 participating SSLAs (5% of participating banks) handled 332 subprojects (7.3% of the total) amounting to P 38.8 million (11.3% of the total). On a per bank basis, SSLAs exceeded the performance of rural banks. 8.08 A DRBSLA survey of participating banks as of June 30, 1977 showed that only 70 (19%) continued participating under all three loans and 112 (30%) discontinued participation after the first or second loan. It indicated that only 68 (18%) participating under this project would be eligible to participate under the fourth loan; the results of the survey are given in the table below. 1/ Sumbitted to CB-DRBSLA in January 1979 and subsequently transmitted to the Bank. - 24 - Participation Under Number of Participating Banks Third Loan Total Eligible Ineligible /a Undetermined /b Participating Banks First, Second and Third 70 22 35 13 Second and Third 111 25 64 22 First and Third 10 2 5 3 Third 71 13 19 39 Subtotal 262 62 123 77 Nonparticipating Banks First 43 4 25 14 Second 26 - 16 10 First and Second 43 2 27 14 Subtotal 112 6 68 38 Total 374 68 191 115 /J Arrears to be less than (a) 25% of total portfolio, and (b) 30% of demand for Bank-financed subloans. flb Banks not reporting or banks reporting but lacking information on arrears. 8.09 DRBSLA conducted a separate survey to find out the attitude of rural banks towards participation. Most of the 146 responding rural banks were located in Luzon and their opinions were as follows: 1/ (a) eligible rural banks did not participate because they (i) had no knowledge of the project, (ii) lacked the liquidity required for the 10% contribution (iii) were satisfied with short-term lending, or (iv) did not want to tie up their own resources in term lending. (b) rural banks discontinued participation because of (i) increase of arrears (voluntarily discontinued participation or disqualified from participation), (ii) lack of demand for term credit, (iii) rigid regulations on term lending, or (iv) the large amount of paper work involved; and (c) rural banks considered delegation of full authority to process subloans would be a strong incentive for participation. Reporting System 8.10 The monthly progress reports on lending and collection compiled by DRBSLA was found to be incomplete and therefore inaccurate because (a) old data from the previous monthly reports were used for banks not reporting or 1/ TBAC has mentioned the profitability of project lending for the participating banks as another factor to consider in explaining their rate of participation. (Annex, B.1). - 25 -- reporting too late for compilation, which was the major factor for distortion (for example almost 50% of participating banks were in this category for June 1976), and (b) data presented by rural banks were not checked for accuracy. As a result, the monthly and quarterly reports compiled were not reliable as a management tool for review of project issues such as arrears and participation. A separate survey had to be conducted on an ad hoc basis whenever a need arose for review of a special issue or for detailed information. 8.11 As noted in paragraph 8.10, one of the difficulties in improving the rural banking system had been the deficiency of information on rural bank operations. With the increasing number of rural banks and the increased complexity and interdependence of their various functions, the need for timely and detailed information has become crucial to make accurate assess- ments and initiate timely corrective actions. DRBSLA acknowledged the need for additional information and agreed to review the entire reporting system and make appropriate changes under the fourth loan. 9. BANK PERFORMANCE 9.01 Because of the early commitment of project funds, this project was supervised two times only. One or two members spent about three weeks in the field with one staff being involved in both missions. Particular attention was given to reduction of arrears, wider participation, strengthening of the planning function and coordination between short-term and long-term lending program. 9.02 The Bank continued to assist GB in establishing a viable term lending program in the Philippines, but its assistance was gradually broadened to cover the entire rural banking system. As the need for an integrated approach became stronger, the Bank established a close dialogue with TBAC which was responsible for policy review of the agricultural credit sector. Many issues related to the entire sector were discussed in addition to issues directly related to the formulation of the fourth loan. 10. CONCLUSIONS 10.01 This project continued to make a substantial impact in expanding the rural term credit program in the Philippines in a number of ways. Some of the achievements are listed here. (a) continued to be instrumental in mobilizing domestic funds for agricultural development investments; (b) succeeded in establishing SSLA's as new channels to finance farmers not served by rural banks; (c) created TSEU to function as the planning unit for term lending; - 26 - (d) improved rules and regulations and other operational procedures for term lending; and (e) facilitated increased production through mechanization, particularly in using irrigation water efficiently. 10.02 It should be noted that the quality aspects of both short-term and long-term credit programs became a major concern of the government and CB, and many issues arising from this project were reviewed in formulating the project design for the fourth loan. A brief explanation is given on the major issues. (a) Project Beneficiaries. As the number of subloans increased, the farm size of borrowers gradually became smaller than in the past but the majority of subloans went to larger and middle sized farmers who were able to offer adequate collateral. Small farmers benefitted indirectly from the custom hire services provided by tractors and power tillers financed under this project. Since they are privately owned and therefore commercially oriented, rural banks and SSLAs were ill-suited to serve as vehicles for social programs to assist small farmers, but there was considerable scope for redirecting a significant portion of project funds to smaller farmers in general. Redirection of lending has become an urgent problem because rural banks are considered as the primary insti- tutions in the Philippines to deliver credit to small farmers. (Under the fourth loan, a quota system has been established for lending to smaller farmers defined specifically for the loan). (b) Diversification. Lending inclined heavily toward farm mechanization was not changed despite the general criticism on the nature and proportions for tractors in particular. To overcome the aggressive promotional effort of the industry and other forces favoring lending for farm mechanization, it was concluded that a ceiling should be set up for tractor financing. (The fourth loan has established a ceiling for tractor financing). (c) Repayment Performance. The government and CB's remedial actions to reduce arrears did not show any result during the project period. In addition to short-run collection programs, policies were focused on the long-run need to strengthen the entire rural bank operations to avoid new overdues in the future. Although it took time to prepare the set of actions to be taken, the government and CB are now determined to promote these actions vigorously and it is expected to reduce arrears to an acceptable level. (A study to find out the causes of arrears and a plan of action to reduce arrears are being conducted under the fourth loan.) (d) Decentralization. The simple lending procedures aimed to allow rural banks to process small subloans was not successful. There were two reasons for this failure. One was the small size of subloans for delegation (up to F 10,000) which could only finance locally made power tillers, and hence did not draw the interest of - 27 - rural banks with the necessary processing capability. The other was the reluctance of CB loan teams to authorize delegation because of the intensive assistance needed to oversee the quality of processing, particularly during the initial stage of delegation. 1/ (DRBSLA is required to prepare an annual program to promote dele- gatizn of lending authority to rural banks under the fourth loan.) (e) Institutional Development. Establishment of TSEU, expansion of loan teams and credit supervisors in the field have resulted in enhancement of CB's capacity to supervise and improve the quality of term lending conducted by rural banks and SSLAs. To transfer lending responsibility directly to participating banks as rapidly as possible, the need to provide managerial counsel for bank managers has been recognized in addition to the technical services presently provided for lending. (A management advisory unit will be estab- lished under the fourth loan.) (f) Study of Farm Mechanization. The project impact study made under this project focused primarily on farm mechanization but it was not conducted in a sufficiently large scale to form the basis for long-term government policy on mechanization. In particular, the detrimental economic and social effects found in some countries were not analyzed adequately and it was concluded that another study was needed. (A comprehensive farm mechanization impact study will be conducted under the fourth loan.) 10.03 For the future, institutional strengthening of rural banks should be given a high priority and the Bank should become more involved in reviewing the entire credit programs in partnership with the government and CB. At the same time, it is important to review the agricultural credit sectoral issues and define more clearly the role of the rural banking system in extending credit to small farmers. 1/ CB is worried about the risk of unsound lending. Beside the fact that most RBs are not yet fully qualified for a larger sub-loan delegation, CB finds farmers not yet properly educated on borrowing procedures. Thus, they cannot be vigilant enough to ensure a proper handling of their operations with the RPs. - 28 - Table 1: SUBLOANS BY LENDING CATEGORIES Number of borrowers Amount of subloans (P--000) Appraisal Actual Appraisal Actual Lending categories No. % No. % No. % No. % Farm Development Tractors 1,771 22.1 1,952 43.1 137,132 51.3 180,226 63.1 Tillers (local) 1,000 12.5 369 2.2 5,921 2.2 2,834 1.0 Tillers (imported) - - 822 18.1 - - 21,813 7.6 Irrigation pumps 306 3.8 233 5.1 4,591 1.7 2,719 0.9 Storage facilities 179 2.2 11 0.2 6,499 2.4 770 0.3 New trucks 250 3.1 562 12.4 27,755 10.4 40,753 14.3 Reconditioned trucks 200 2.5 17 0.4 11,631 4.4 1,210 0.4 Other equipment 925 11.6 63 1.4 4,890 1.8 1,371 0.5 Subtotal 4,631 57.8 4,029 88.9 198,419 74.2 251,696 88.1 Livestock Development Poultry farms 750 9.4 98 2.2 7,930 3.0 8,769 3.1 Swine farms 1,500 18.7 166 3.6 13,799 5.1 9,656 3.4 Dairy farms 200 2.5 - - 2,114 0.8 - - Subtotal 2,450 30.6 264 5.8 23,843 8.9 18,425 6.5 Fisheries Development Fishing boats 300 3.8 40 0.9 17,259 6.5 3,277 1.1 Fishponds & fishpens 272 9.4 176 3.9 8,962 3.3 11,180 3.9 Subtotal 572 7.2 216 4.8 26,221 9.8 14,457 5.0 Cottage Agro Industries Fishmeal mills 50 0.6 4 0.1 2,643 1.0 218 0.1 Woodcraft 50 0.6 13 0.3 3,173 1.2 567 0.2 Machinery service shop 250 3.2 6 0.1 13,216 4.9 233 0.1 Subtotal 350 4.4 23 0.5 19,032 7.1 1,018 0.4 Total 8,003 100.0 4,532 100.0 267,515 100.0 285,596 100.0 Source: Central Bank of the Philippines. - 29 - Table 2: CASH FLOW PROJECTIONS FOR A MEDIUM (50-68 HP) 4-WHEEL TRACTOR Illustrative Rice Farm (15-ha area) /a (In pesos) Without With project project Year 1 Year 2-7 Year 8-10 I. Cash Inflow Gross income Rice sales lb 78,750 90,563 90,563 90,563 Custom service /e - 45,000 45,000 45,000 Total gross income 78,750 135,563 135,563 135,563 Cash from previous period /d - 10,000 - - Loan: 90% of investment cost - 94,500 - - Total inflow 78,750 240,563 135,563 135,563 II. Cash Outflow Operating cost Land preparation /e 6,750 - Seedbed preparation f 1,350 1,553 Pulling, hauling and transplanting ]A 4,140 4,761 Weeding /1 1,800 2,070 Harvest and threshing /i 11,813 13,585 Drying and hauling ]j 988 906 Seed /k 1,575 1,811 Fertilizer 1 9,000. 10,350 Insecticides /m 4,500 5,175 Irrigation /n 2,625 3,131 Fuel jo - 12,600 Oil and grease ju - 2,520 Repairs LA - 5,250 operator's wage /r - 3,000 Taxes, insurance and implement shed ]Ls - 2,100 Total operating cost /t 44,341 68,812 68,812 68,812 Investment cost - 105,000 - - Debt service /u - 20,706 20,706 - Service fee /v - 2,835 1,629 - Total outflow 44,341 197,353 91,147 68_812 III. Net Cash Flow (I) - (II) 44,341 43,210 44,416 66,751 IV. Financial Benefit/Cost Incremental gross income 56,813 56,813 56,813 Incremental cost 129,471 24,471 24,471 Net benefit (72,658) 32,342 32,342 V. Financial Rate of Return: 43% - 30 - Table 2 (footnotes) /a The model is for a 15-ha rice farm. Mechanization consists of a light- medium power class (50 to 68 HP) imported 4-wheel tractor equipped with paddy wheels and matched with a 60-inch rotovator and trailing disk. The cost of the tractor and implement set is P 105,000 and both tractor and implement are assumed to have a 10-year life. lb Rice sales are computed for a yield of 70 cavans per ha. Cropping intensity without and with project is 150 and 172.5% respectively. The farm-gate selling price for rice is P 50 per cavan. /c The tractor is assumed to have an annual use of 1,500 hours, of which 70% is productive use. Custom work of 150 ha at P 300 per ha is for complete land preparation. Time required for land preparation is 5.7 hours per ha. /d The beneficiary's 10% contribution to the investment cost. /e Custome hire of one rotovation and one harrowing at P 300 per ha for without project. /f Seedling nursery to seed I ha at P 60. I& Pulling, hauling and transplanting at P 184 per ha. /h Weeding at P 80 per ha. /t Harvest and threshing at 15% of gross harvest. /j Drying and hauling at P 0.50 per cavan of gross harvest. /k Seeding rate is one cavan per ha at P 70 per cavan. /1 Fertilizer cost is P 400 per ha. /m Insecticide cost is P 200 per ha. Jn Irrigation fee is 3 cavans for dry season and 2 cavans for wet season. to Fuel consumption is 6 liters per hour at P 1.4 per liter for 1,500 hours. /p Oil and grease reckoned at 20% of fuel. /q Repairs reckoned at 5% of investment cost. fr Operator's wage is P 2.00 per hour. /s Taxes, insurance and implement shed is computed at 2% of investment cost. /t The Barrio savings fund and the Barrio guarantee fund have not been included in operating cost in the model. /u Debt service is an equal sum amortized over 7 years on the loan principal. /v Services fee is 3% of the outstanding yearly balance; averaged for Years 2 to 7. - 31 - Table 3: CASH FLOW PROJECTIONS FOR A HEAVY (GREATER THAN 68 BHP) 4-WHEEL TRACTOR Illustrative Sugarcane Farm /a (In pesos) Without With project project Year 1 Year 2-7 Year 8-10 1. Cash Inflow Gross income Sugar sales /b 189,000 189,000 189,000 189,000 Hauling allowance Le 9,000 9,000 9,000 9,000 Custom service /d - 59,760 59,760 59,760 Total gross income 198 000 257,760 257,760 257,760 Cash from previous period /e - 12,700 - - Loan: 90% of investment cost - 114,300 - - Total inflow 198,000 384,760 257,760 257,760 II. Cash Outflow Operating cost Land preparation /f 1,800 - Cane points ]A 400 400 Hauling points Jh 175 175 Cutting points /1 250 250 Planting 11 675 675 Crop care /k 3,600 3,600 Harvest /1 9,600 9,600 Hauling 1m 36,000 36,000 Milling /n 66,465 66,465 Fertilizer /o 28,552 28,552 Fuel LR - 14,700 Lubricants L% - 2,940 Repairs /t - 6,350 Operators' wages /s - 3,000 Taxes, insurance and implement shed /t - 2,540 Total operating cost 147,517 175,247 175,247 175,247 Investment cost - 127,000 - - Debt service Lu - 25,045 25,045 Service fee /v - 3,429 1,971 - Total outflow 147,517 330,721 202,263 175,247 III. Net Cash Flow (I) - (II) 50,483 54,039 55,497 82,513 IV. Financial Benefit/Cost Incremental gross income 59,760 59,760 59,760 Incremental cost 154,730 27,730 27,730 Net benefit (94,970) 32,030 32,030 V. Financial Rate of Return: 34% - 32 - Table 3 (footnotes) La The model is for a 15-ha sugarcane farm. Mechanization consists of a medium power class (greater than 68 HP) imported 4-wheel tractor which is matched with a disk plow and trailing disk harrow. The cost of the tractor and implement set is P 130,000. The tractor and implements are assumed to have a 10-year life. Mechanization is used for land prepara- tion only on a 3-year rotation such that 5 ha will be prepared annually. (Additional benefits accruing the project as a result of weeding and other farm operations have not been included in the model.) /b Sugarcane production is at the average rate of 80 tons of cane per ha, recognizing a variation between the planted and ratoon crops. Sugar yield is 1.5 piculs per ton of cane. The average farm-gate price of sugar is P 105.5 per picul. /c Hauling allowance paid by sugar central to the farmer, average B 7.5 per ton of cane. /d Custom service - The tractor is assumed to have an annual use of 1,500 hours per year, of which 80% is productive usage. Th custom charge for land preparation is P 200 per ha for plowing, P 100 per ha for disking and P 60 for furrowing. Time required for land preparation is reckoned at 7 hours per ha. Custom work undertaken is 166 ha. l. The beneficiary's 10% contribution to the investment cost. /f Custom work of one plowing (P 200/ha), one harrowing (P 100/ha) and one furrowing (P 60/ha) on one-third of the farm. L& Cane points requires 45,000 cane points per ha at P 1.78 per thousand, 5 ha seeded per year. /h Hauling cane points at P 35/ha, for 5 ha. /i Cutting cane points at P 50/ha, for 5 ha. LI Planting at P 135/ha, for 5 ha. /k Crop care: Animal cultivation P 100/ha and manual weeding P 140/ha. /l Cutting and loading cane at P 8/ton. /a. Hauling - from the farm to the central at P 30/ton. /n Milling - The central retains 35% of the milled sugar. /o Fertilizer: 2-1/2 bags/ha 21-0-0 at P 75/bag, 12 bags/ha 16-20-0 at P 103/bag, and 8 bags/ha 0-0-60 at P 60/bag. 2. Fuel consumption of 7 liters per hour at P 1.4 for 1,500 hours. /q Lubricants reckoned at 20% of fuel. /r Repairs reckoned at 5% of investment. /s Operator's wages: P 2 per hour for 1,500 hours. /t Taxes, insurance and implement shed at 2% of investment costs. /u Debt service is an equal sum amortized over 7 years on the loan principal. /v Service fee is 3% of the outstanding yearly balance; averaged for Years 2 to 7. - 33 - Table 4: CASH FLOW PROJECTIONS FOR A POWER TILLER (RICE PRODUCTION) /a (In pesos) Without With project project Year 1 Year 2-4 Year 5 I. Cash Inflow Gross income Rice sales /b 18,000 20,700 20,700 20,700 Custom work j: - 2,460 2,460 2,460 Total gross income 18,000 23,160 23,160 23, 160 Cash from previous period Ld - 750 - - Loan: 90% of investment cost - 6,750 - - Total inflow 18,000 30,660 2 23,160 II. Cash Outflow Operating costs Wages Le Land preparation 306 - Planting 650 748 Crop care 268 308 Harvesting/threshing f 3,000 3,450 Tractor operator L& - 295 Fertilizer Lh 1,800 2,070 Insecticides /j 900 1,035 Seed Li 315 362 Fuel /k - 1,200 Oil and lubricants /1 - 240 Tractor repairs and maintenance Lm - 900 Insurance and taxes - 175 Draft animal maintenance /n 100 - Levies and charges 635 736 Miscellaneous /o 360 463 Total operating cost 8,334 11,982 11,982 11,982 Investment /a - 7,500 - - Debt service Amortization - 2,222 2,222 - Service charge Lk - 135 74 - Total outflow 8,334 21,839 14,278 11,982 III. Net Cash Flow (I) - (II) 9,666 8,821 8,882 11,178 IV. Financial Benefit/Cost Incremental gross income 5,160 5,160 5,160 Incremental cost 11,148 3,648 3,648 Net benefit (5,988) 1,51 1,512 V. Financial Rate of Return: 0.4% - 34 - Table 4 (footnotes) /a Model based on 3-ha rice farm and custom hire services. An 8 HP single- axle local tiller with associated implements constitute the investment in mechanization. Estimated cost is P 7,500 and economic life is assumed to be five years. /b Based on 150% cropping intensity before investment; 172.5% thereafter. Yield is assumed to be 80 cavans per ha, and farm-gate price, P 50/cavan. . c Total usage of 800 hours, of which 80% is assumed to be productive for land preparatibn at six days per ha (1 plowing and 2 harrowings). Custom work for 8.8 ha is undertaken at P 300 per ha. /d 10% equity contribution. /e 45% of total labor required assumed to be hired; seed bed preparation, drying and hauling assumed to be entirely family labor. /f Based on one-sixth of crop. JR Operator's wages P 12 per day; assumed only 50% of custom work done by hired operator. Lh P 400 per ha per crop. /i P 200 per ha per crop. j1 Seeding rate of one cavan per ha at P 70/cavan. /k One liter per hour at P 1.5/liter for 800 hours. /1 20% of fuel costs. /m 12% of investment per year, consisting of simple average of Year 1, 5%; Year 2, 10%; Year 3, 25%; Year 4, 10% and Year 5, 10%. /n Maintenance of one carabao and shed. /o 2% of gross income. /p 2% of outstanding balance; averaged for Years 2 to 4. ANNEX - Comments Received from Government!! A. Comments received from the Central Bank of the Philippines, Department of Rural Banks and Savings and Loan AssociationsZ2/3/ 1. Actual Accomplishment Against Appraisal Target The 3rd CB:IBRD Rural Credit Program had a time frame of three years commencing on June 17, 1974 up to June, 1977. However, fund disburse- ment was completed within eighteen (18) months ahead of completion date. Varying pattern may be noted in the actual program accomplishment against appraisal, both in terms of targeted number of projects to be financed and project costs (Table I). The actual accomplishment in loans granted exceeded by #45.9M or 15.4% over the targeted level of P297.2M, while in terms of accomplishment in number of projects it was short by 3,471 or 43.7%. In terms of cost, the bulk of loans went to farm mechanization, r253M or 78.8%; followed by Farm Transportation, P49.6M or 15.5%; live- stock and poultry, P21.8M or 6.3%; fisheries, P17.7M or 5.1% and cottage agro-industries, rl.2M or 0.3%. It may be noted that for farm mechani- zation, project cost had been overshot by 061.9M or 32.3%. However, the target number of projects had been short by 717 projects or 16.2%. On the other hand, while more projects were intended for livestock and poultry financing (30%), it only got a share of 021.8M or 6.34% of the total. In general, the accomplishment under the project in terms of the completion of the implementation 18 months ahead of closing date may be considered very satisfactory. The failure to attain the envisioned number of projects was due to an interplay of a number of factors, to wit: 1. The trend of the demand was for 4-wheel tractors which had a very high average project cost, hence it absorbed a lion-share of the fund; 2. The inflation rate during the period was high resulting to an increased total project cost on all categories; and 3. The sizes of the projects during the actual implementation was larger than the models used in the appraisal report. 1/ Retyped into single space for inclusion in the report. 2/ The tables and annexes have not been included here. They are available in OED. 3/ These comments were discussed with Central Bank management and DRBSLA staff on November 14, 1979. Some clarifications and additional informa- tion presented there have been added in brackets. - 36 - 2. Increased lending for machinery and failure to diversify lending Actually, there was diversification of the 3rd project to the extent allowed under the rules and regulations - that is, only to the project categories authorized. The lack of flexibility was due to the restrictions imposed to cater to categories only specified under the rules and regulations. The increased lending for machinery during the period was caused by the following conditions: 1. There was more promotional campaign because it was supported by a strong association of machinery dealers; 2. It was believed to be less risky to grant loans for this purpose; 3. Machinery dealers [apprised farmers of the availability of the project funds and assisted] prospective loan applicants in the preparation of loan document requirements; 4. Farmers were trying to beat inflation which resulted in the rising cost of machinery. (It was accepted that buying machineries that time was a speculation of being able to dispose of it at a much higher price in the coming years); and 5. There was a favorable trend in the price of sugar both in the domestic and world market. [Price of sugar peaked during project implementa- tion]. On the other hand, the slow movement of the other categories was attributed to some unfavorable conditions, to wit: 1. Fisheries - a. Lack of promotional activities on the financing of fisheries project by some banks as shown by their loan portfolio for such category. b. Lack of the required real estate collaterals to back up the loan. Most of the small fishing boat operators and fishpond lease-holders of govern- ment properties does not have real estate properties. In cases where fishpond projects are covered by leasehold agreement from the government, other banking institutions accept assignments of rights as security for the loan applied for. This arrangement is not acceptable to rural banks situated in inland areas suitable for fisheries. c. Other banking institutions [mainly the Development Bank of the Philippines - DBP - using funds from IBRD and other sources] grant loans to small fishing outfits with preferential rates of interest. - 37 - d. Inadequacy of marketing outlets due to poor transportation facilities, especially in the remote areas of the country. 2. Livestock and Poultry - a. Lack of quantity and prohibitive costs of feeds. This is the result of integration being undertaken by most commercial feed millers wherein only feeds not absorbed by their own projects and/or contract growers are sold to the public. Therefore, such amount is definitely inadequate. b. Market prices of meat did not increase proportionately with the rising cost of feeds which could be due to price manipulation done by large producers. This was the result of and attributed to the integration of large feedmillers. c. The dumping of cheap Australian beef which pulled down the price of meat. (It affected pig and broiler production, besides beef]. d. Inadequate and insufficient marketing and processing facilities thus, exposing small livestock and poultry producers to be at the mercy of middlement; and e. The apparent reluctance of some financial institutions to invest in the alleged risky enterprises, more so in the absence of a livestock and poultry insurance coverage. 3. Long-Term Economic Return Prospects For Tractor and Power Tiller Financing Farm mechanization in the Philippines has long been a controver- sial issue. Its long-term economic prospects would of course be a good guide as to whether or not such financing as the CB:IBRD Rural Credit Project is necessary. While studies has been conducted along the area of farm mechaniza- tion, findings did not supply a sufficient data or information to be used for a government policy direction formulation. The World Bank is cognizant about this and this is the reason why an Impact of Farm Mechanization Study is made a covenant under the Fourth Rural Credit Project implementation. Some quarters of our society believe that farm mechanization should be discouraged because it worsens the problem of unemployment. Others believe otherwise and this is supported by hard facts gathered from studies conducted by UPLB and IRRI. For instance, UPLB findings in the Study "The Impact of Farm Mechanization: A Critical Analysis", support that while tractorization reduced the time for land preparation, hence, displaces labor in said farm activity, it is more than offset by the increse in total labor requirement in the farm in terms of the resultant increase in the use of irrigation, fertilizer, insecticides, pesticides, weedicides and finally, larger harvests. - 38 - Apart from the aforementioned benefits of tractorization, there is also a trade-off of increases in area cultivated and cropping intensity because of the timeliness in land preparation, which is an advantage over the use of the carabao. This was observed by both IRRI and UPLB reports. With the introduction of improved technology, mechanized land preparation has increasingly become important. However, during the time of the implementation of the 3rd Rural Credit Project, the tractor industry had taken advantage of the adnormal situation. There weas that increase in the price of oil and the world price of sugar was at its peak. Since sugarcane needs deep tillage, the type of tractor suited are the heavy ones, making its demand so great, that prices were increased unreasonably to a level of 89% over a period of two years (1973-75). Such increase in the price of tractor was not felt by the sugar- cane farmers because the price of sugar at the time was at its peak. But with the slump of the sugar prices in the world market in 1976, sugarcane farmers realized that the phenomenon had renered their investment non-viable. During the same period, invested tractors by the rice farmers were also rendered less profitable. Had it not been for the justification that the tractor was to be used for custom servicing, the investment was not really profitable. The price of the tractor had increased faster than the increase in the price of paddy rice which was not linear because it was pegged at V55 per cavan. So the rice farmer was in a situation when his income from the farm could no longer amortize the cost of the tractor. It has been observed that there is a similar increase in the price of the imported power tiller hence, price has become prohibitive especially that its use is limited to rice with the price of such tillers being con- trolled, the imported power tiller is gradually losing its market in favor of locally-manufactured power tillers. At the present price level of locally manufactured power tiller, it is still profitable to use it in rice farming. However, ther is an indica- tion that its price level would increase due to the continuous increase in the cost of energy and labor. Time will come and it is not far-off when price will increase to a level that it would render rice farming no longer profit- able if the price of rice would still be controlled. If this time comes, farmers would likely increase its dependence on the old reliable draft animal, the water buffalo. [But supply of water buffalos is dwindling]. To illustrate further, we have prepared three project models, one for locally-made power tiller, another for an important power tiller and one for a 4-wheel tractor (Annexes A to A-5). Power tillers, both imported and local were assumed to work on four hectares irrigated riceland with custom servicing on 20 hectares per annum. Cropping intensities were assumed to be 200% before and after develop- ment, hence, the incremental gross income was primarily derived from custom servicing. - 39 - The locally manufactured gasoline-fed power tiller was assumed to be V9,000. On the other hand, the imported tiller with diesel engine was assumed to cost V28,000.00. Current prices of gasoline and diesel fuels per liter are at V2.82 and V1.72, respectively. On such bases, the financial rate of return for the local power tiller was computer at 11.78% and the imported tiller registered 3.98%. This shows that financing of power tiller should be analyzed carefully and that proponents should be advised accordingly. On the other hand, the four wheel tractor was assumed to work on 24 hectares riceland. Area worked on under custom servicing was estimated at 142 hectares per annum. Based on the above assumptions, the project registered a 36.94% financial rate of return. However, there has been a decreasing demand for custom work especially in fully irrigated ricelands (big tractors destroy the hard pan). With the current trend, a favorable financial rate of return may not be attained in the near future due to the increasing price of tractor and oil. The same is equally true with power tillers which leads us to believe on the diminishing economic advantage of tractorization. [Long term prospects would depend on the evolution of oil and commodity prices and supply of water buffalos and oxen.] 4. Reasons for higher than anticipated cost per subproject The increase in the cost per subproject was due to an interplay of a number of factors, to wit: 1. The increase in exchange rate. The increase of the rate of exchange started on February 21, 1970, when Circular 289 was issued allow- ing the peso to float and seek its own level in the free market, resulting in the sudden increase of the rate during the last week of February, 1970, which increase continued up to December of 1975. (See attached Table II). 2. Since the bulk of the fund went to farm mechanization es- pecially 4-wheel tractor, which had a high cost per unit, naturally the cost per subproject was higher than anticipated. This was exacerbated by the fact that there was 32% increase in price of tractor in 1975 over that of 1973 price when the project was appraised as shown in Table II-a attached. It was a period when the demand for 4-wheel tractor was high especially in the sugar area due to the favorable price of sugar. This condition created an atmos- phere where the increasing price of tractors was not felt by the sugar farmers. Thus, the brisk demand for tractors despite the increased price brought in more profits to the machinery dealers. - 40 - 5. Effectivenes of the 25 per cent arrears criterion The 25 per cent arrears criterion was not effective in improving the operation of the rural banks and savings and loan association as indicated by the fact that while there were 374 banks accredited since the 1st project (360 RBs and 13 SSLAs), only 248 participated under the 3rd project. The average number of rural banks and SSLAs qualified at a given time is about 100. This respresents only 40% of participating and 27% of the total RBs/SSLAs accredited to participate under the program. In other words, 60% of those which participated under the 3rd project or 73% of the total accredited banks were disqualified at any given time during the implementation. Our experience revealed that the criterion is very stringent and it is not an effective measure of the efficiency of the system. The rural bank's efficiency must be measured on a long-run basis, not just the per- formance within the 12-month period as what the crtiterion is trying to elicit but during the period when amortizations have started falling due. A good example is the attached Table III. As of February 28, 1975, reports from 199 rural banks were received and compiled by the TSEU. These represent 96% of 207 banks wherein report forms were sent. The report covered only 67% of the 298 rural banks with outstanding arrears from their borrower at that time. As shown in the table, the main bulk of the past due items were in Central Luzon, representing 53% of total arrearages. It would also be noted that repayments during the twelve-month period were less than the amortization which fell due during the same period. Should the trend continue, there will be a continuous build-up of the beginning balance of arrearages. This would result in an upward climb of the arrearages ratio on the succeeding months when calculated based on the provisions of Section 1-b-(3) of the 3rd CB:IBRD R & R (Item F or E/C on the table). Of particular interest is the ratio of the amortizations falling due within the 12-month period with respect to the arrearages as of the beginning of the same period. Should the former be less than three times the latter amount, the arrearages ratio would always be greater than 25%, even if all the amortizations falling due within the 12-month period were collected. Such is the case in five (5) regions and in the aggregate figures shown as of the cut-off date of said report. 6. Rationale for and actual achievements of institutional changes introduced under 4th Project The Rationale for the Establishment of the Technical Support and Evaluation Unit (TSEU) Although decentralization had sped up loan processing, it had, to some extent, isolated CB Agricultural Credit Supervisors and Loan Teams from access to technical know-how and information which is more readily available at headquarters. There was a greater need for project coordinatioin. The Agricultural Credit Supervisors are capable and qualified in their own fields - 41 - but they cannot be expected to be familiar with the full range of the most suitable and up-to-date techniques in agricultural and livestock development to assist all loan applicants and rural bank borrowers. There was insufficient technical guidance and direction since DRBSLA staff was largely engaged in loan processing. Even at headquarters there were no qualified personnel to undertake these functions on a fulltime basis. Hence, the Technical Support and Evaluation Unit was established to perform the following functions: 1. To monitor the CB:IBRD Rural Credit Project operations and evaluate results at farm level; 2. To maintain liaison with government agencies and research institutions engaged in agriculture and fisheries developoment; 3. To collect information applicable to developments financed under the project for dissemination to management, technicians and Loan Teams; and 4. Prepare project proposals for World Bank financing. Achievement of the TSEU The role of TSEU with respect to the 3rd CB:IBRD Program continued to be essentially one of monitoring, evaluation and technical support for field operations. Although the unit was organized in May 1975, the unit has developed a high standard of work, according to the appraisal mission. Dur- ing the project implementation the unit has limited its activities to term lending under the CB:IBRD program. In keeping the objective of integrating all credit operations in the Department, and to meet a growing need for staff support of CB representation in multi-agency credit bodies, the TSEU has expanded its activities on staff support to short-term production activities as well. For the details of the accomplishment of the unit, please see the attached accomplishment report as of December 28, 1976 (Annex B). 7. Reasons/results or corrective action taken regarding poor collection The collection on IBRD is not impressive as the program is af- fected by a number of factors like the poor price of sugar and increasing price of oil. There was a significant increase in the price of crude oil in FY 1974. From a low level of 2.48 (US dollar per barrel) in FY 1973, it went up to 9.28 in FY 1974, registering close to a three-fold increase in a span of one year. In the subsequent years (FY 1974-78), it has maintained its upward trend at the average rate of 8 per cent per annum. - 42 - The consumers' price index rose from a level of 116.3 in FY 1973 to 156.9 in FY 1974, exhibiting a 34 per cent increase during the period. However, over the FY 1974-78 stretch, price indices increased annually at the average rate of 8.3 per cent. A drastic fall in the price of sugar occurred in 1974. From an all time record high of US$597.34 per MT in 1975, it plunged to 292.80 in 1976, registering a more than 100 per cent slump in one year. The price went down further to 209.58 in 1977 and 191.6 in 1978. Over the period of 1974-78, the price of sugar in the world market was decreasing at the rate of 25.6 per cent per annum. j Seriously affected by the price situation were a number of farmer-beneficiaries cultivating less than 50 hectares of sugar farms. The farm mechanization category absorbed above 75% of the fund under the 1st, 2nd and 3rd projects. This farm mechanization component is largely 4-wheel tractors which are mostly used in the sugar areas, hence, severely affected by the unfavorable price of sugar. On a quarterly basis, the collection is shown in Table IV attached. The accumulation of arrears had made the picture bad. On the basis of a 12-month period, the collection recovery is not also good as shown in Table V. CB:IBRD Financing Program - Schedule of Aggregate Repayment and Arrearages. To improve the situation, a number of measures were undertaken by the Central Bank, to wit: 1. Encouraged the rural banks to restructure loans which have been affected by calamities and conditions beyond the control of the farmer, through the issuance of guidelines on the restructuring of delinquent loans under MC No. 75-42, covering loans under the 1st and 2nd projects and under Circular Letter No. 79-61 covering loans under the 3rd and 4th Projects. 2. Advised the field staff of the DRBSLA to intensify follow-up of projects for collection purposes and render technical assistance in project implementation. 3. Continuous improvement in the appraisal and evaluation capabilities and efficiencies of Loan Terms. 8. Ten per cent (10%) contribution by Participating Banks Under the 3rd project, the financing institution shall finance not less than 10% of each subloan out of its own resources, except that RBs which have been in operation sor less than three years and have a net worth not exceeding V500,000 (or such lower amounts as maybe determined by CB from time to time), shall be required to contribute not less than 5% of such amounts out of their own resources and SSLAs shall be required to contribute not less than 15% of such amount out of their own resources; provided that in the aggregate such contribution of all Financing Institutions to the sum of all subloans shall be not less than 10%. - 43 - The attached table (Table VI) shows that the RBs contribution to the total project cost is only 8.52% lower by 1.48% than the 10% required, while SSLAs contribution is 12%, higher by 2% than what is required under the program. On the aggregate, contribution both for RBs and SSLAs is only 9.02% or lower than the required 10%. The reason for the aggregate contribution of the Financial In- stitutions to be lower than the required aggregate is the participation of rural banks with networth of V500,000 or less. These are the RBs which are really in dire need of loanable funds. More of these size of RBs participated compared with larger RBs. Since there were only 14 SSLAs out of 248 banks which particpated under the program, its contribution of 15% was not sufficient to offset the 5% contribution of the small RBs. 9. Project Impact on Employment The project (had a positive] impact on employment, [which] may either be of direct or indirect effect. The project impact in terms of the direct effect on employment, maybe measured by the number of operators needed to operate the 4-wheel tractors, power tillers, trucks, threshers, and irrigation pumps financed under the program; and by the number of workers required for coastal fishing boats, fishponds, poultry, piggery, fishmeal plants and woodcraft projects also financed under the program. The indirect effect of the project on employment would be the derived demand for facilities and labor resulting from its forward and back- ward linkages as exemplified by: 1. Increase in the number of tractors means an increase in the number of repair shops for servicing and an increase in the number of spare part dealers for tractors; 2. Increase in the number of tractors means an increase in the area cultivated, increase in cropping intensity, increase in the use of agricultural inputs, increase in labor requirement which would finally in- crease production and increase production would require an increase in proces- sing facilities and trading; and 3. Increase in livestock projects means an increase in labor requirement, increase in feedmill plant, increase in feed mixing plant, increase in feed dealers and increased trading of livestock products. - 44 - B. Comments received from the Technical Board for Agricultural Creditl/2/ General The Report, as a whole, presents a relatively comprehensive and fair evaluation of the project's implementation. It has taken into account the extent by which objectives were achieved and what factors have directly influenced the rate and manner by which the Project has performed. Specific A few comments on the report are however in order: 1. Profitability to lending institutions (Secs. 8.08, 8.09) In explaining the rate of participation of financial institutions and how well they performed as conduits of credit in the Project, the report fails to consider and properly determine whether lending under the project is really profitable for the participating rural banks. 2. Terms and Conditions to end borrowers (Sec. 5.02) The report is also silent on how effective and appropriate were its loan terms and conditions to end user in reaching its target clientele, particularly the small farmers. 3. Arrears Criterion (Secs. 3.08, 8.01, 8.02) The arrears criterion imposed by the IBRD, which is based on "demand", is considered stringent and serves as a limiting factor to increasing the number of outlets for the Rural Credit Project. In relation to the Fourth Rural Credit Project, it continues to contribute to the conflict between the ob- jective of the implementing agency to move the funds fast according to project timetable by expanding the outlets, on the one hand, and quality portfolio management, on the other hand. Recent agreement by IBRD to include private development banks as lending channels for the Fourth Project may, to a certain extent, address the problems of limited qualified and actually participating banks. 4. The cash flow projection of a power tiller project based on a 3-hectare farm does not properly incorporate the existence of competing claims on the farmer's income as well as his household's expenses for consumption and others. The use of cash flow projections based strictly on a project's cost and return may be fine for a 15-ha. module but unrealistic for a small farm 3-ha. module. Reflecting the above conditions in the cash flow analysis may eventually show that there is really no net cash balance to speak of for the farm household even with a power tiller project (Sec. 6.04). 1/ Annex III, Preliminary Considerations of Policies Relevant to the Issues Raised by the World Bank, dated September 20, 1976, has not been included here. It is available in OED. 2/ These comments were discussed with TBAC management and staff on November 14, 1979. - 45 - 5. Demand for tractors and share of sugar industry With regard the economic factors which affected the high demand for machin- eries and the subsequent conditions that contributed to poor collection performance under the Project, the following may be added (Annex 1): a. Bullish market for sugar export and price increases beginning 1974, which reached an all time record high of US$597.34 per MT in 1975, encouraged heavy borrowing for farm tractors by sugar farmers. Data indicate that tractor financing under the 3rd Rural Credit Project comprised about 87 per cent of total amount of lending for farm machinery along. Demand for tractor financing for sugar farms was strong and rapid during 1974 to end of 1975 that the 3rd RCP funds were exhausted by the end of 1975 or 18 months before project completion date (i.e., June 1977). Contrary to the Performance Audit Report's conclusion that tractors for sugar farms were primarily confined in the Visayas region (Sec. 4.09), tractors financed in the Central Luzon region were also largely for sugar farms (Secs. 4.04, 4.05, 4.07, 6.03). b. Hedging against further increases in price of tractors (77HP), which, on the average, increased by about 80 per cent from 1973 to 1975, was one of the factors that further encouraged the brisk market for tractors along with the aggressive sales drive by the industry and the favorable market for sugar. c. World Sugar prices took a downward trend beginning around the last quarter of 1975 and plunged from US$597.34 per MT in 1975 to US$292.80 per MT in 1976 or a decline of 51 per cent. This deteriorated further to a level of $191.60 per MT in 1978. The depressed sugar price conditions upset tractor project's cash flow projections, reduced custom servicing, etc., thus affecting debt servicing on tractor loans (Sec. 6.03). Since this is the bulk of lending under the 3rd Rural Credit Project, the repayment performance as a whole was pulled down to a low level as reflected in the repay ment rate of 33.4 per cent to Central Bank by rural banks as of September 30, 1979 (Secs. 8.04b). 6. Long-Term Economic Prospects for Tractor and Tiller Financing a. Under the 4th Rural Credit Project, credit for tractors was estimated to constitute 45.7 per cent of total project cost and power tillers, 11.9 per cent. The amount of funds disbursed by subloan category as of December 31, 1978 showed that tractor and power tiller financing consisted 47.8 and 9.6 per cent, respectively, of the total V170.57M disbursed. However, the rate of disbursement of program funds in the first half of the project life was very slow compared to the targets and the rate of move- ment of the 3rd Rural Credit Project. In terms of monthly disbursement of funds, it averaged only V9.5 million. b. The slackened pace in the implementation is materially affected by the following combined factors: the sugar prices slump, the rounds of oil price increases and the rise in machinery prices. - 46 - i) Prospects in sugar price recovery. From a high average of US$0.30 per pound in 1973-74, the price of sugar slid to US$0.20 per pound in 1975 and dropped to as low as US$0.07 to US$0.08 per pound in 1976-78. An antici- pated world supply deficit of 3 to 4 million tons in sugar for 1979-80, however, is expected to check and alter the downward trend in the price of sugar. Although the futures market price for the commodity now stands at US$0.15 per pound, sugar price recovery in the immediate years is still expected to be slow. ii) Impending series of oil prices hike and increase in machinery prices. An average of 10 per cent increase in the price of oil is again expected when the OPEC meets in December. This may yet trigger off another round of price increases. iii) In view of the above a much reduced volume of lending for tractors and power tillers can be anticipated. A shift in the direction of lending under the 4th Rural Credit Project should thus be consciously geared towards other sub-project components, e.g., post harvest equipment (portable threshers and driers), fisheries development, livestock and poultry and cottage and agro-industries. There is evidence in the current nature of business under the 4th IBRD Project of a movement towards more diversification. 7. Comparison of repayment performance: other programs vis a vis IBRD projects. As shown in Annex II, collections for short-term financing have ranged from 67 to 95 per cent, while IBRD loans registered a collection rate running below 50 per cent. The collection rates are now comparable, however. While the short-term lending programs reckon repayment based on loans already fallen due, both the DBP-IBRD and CB-IBRD projects compute repayment on the basis of total loans granted, which include both current and past due outstanding amount. 8. Update information on other items in report (Secs. 7.05, 8.04a and 8.05). a. The basic policy issues on rural credit submitted by the World Bank to Technical Board for Agricultural Credit (TBAC) was already addressed by the Board in 1976 (Annex 3 "Preliminary Considerations of Policies Rele- vant to the Issues Raised by the World Bank"). The Board's views were consequently considered by IBRD mission in the formulation of the 4th IBRD project. b. The crop insurance program has not as yet been pilot tested. The President signed last June 11, 1978, PD 1467 creating the Philippine Crop Insurance Corporation. Pending its operationalization, a technical and advisory committee has been formed to work on the details of the scheme. The program may eventually be implemented mid 1980 (Sec. 8.04a). c. The TBAC has completed the study on the non-repayment of agricultural loans in the Philippines, which was one of the covenants of the 4th Rural Credit Project loan. The final report was submitted to CB-DRBSLA in January 1979 and duly transmitted by CB to IBRD (Sec. 8.05).