Colombia - Third Agricultural Credit Project

Document of The World Bank FOR OFmFCIAL USE ONLY FILE COPY Report No. P-2585-CO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE COLOMBIAN INSTITUTE FOR AGRARIAN REFORM WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A THIRD AGRICULTURAL CREDIT PROJECT June 6, 1979 This document has a redtlted dIstibution and my be ued by recipients only in the perfennmce of their offcial duties. Its contets may not oeiwse be dbl_d witout Wrlid Bank autheulxatlon.  CURRENCY EQUIVALENTS Average Calendar 1978 (estimate) Mid-1979 estimate Currency Unit = Peso - Col$ Col$ US$1 = Col$ 39.32 43.62 Col$1 = US$0.0254 0.0229 WEIGHTS AND MEASURES Metric System GLOSSARY OF ABBREVIATIONS AID - Agency for International Development BG - Banco Ganadero BOR - Banco de la Republica CAJA - Caja de Credito Agrario, Industrial y Minero DRI - Programa de Desarrollo Rural Intregrado (Integrated Rural Development Program) FFAP - Fondo Financiero Agropecuario IDB - Inter-American Development Bank INCORA - Instituto Colombiano de la Reforma Agraria (The Colombian Institute for Agrarian Reform) GOVERNMENT OF COLOMBIA FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY COLOMBIA THIRD AGRI]CULTURAL CREDIT PROJECT LOAN AND PROJECT SUMMARY Borrower: The Colombian Institute for Agrarian Reform (INCORA) Guarantor: The Republic of Colombia, which would bear the foreign exchange risk Amount: US$20 million equivalent Terms: Repayment in 17 years, including four years of grace at 7.9% interest per annum. Project DescriptLon: The project would provide supervised credit for on-farm development, including incremental working capital, to about 7,600 land reform/colonization beneficiaries who have had limited access to credit. It would also assist in the development of small agro-industries, provide technical assistance and training programs for INCORA's field staff and beneficiaries, as well as project moni- toring and evaluation. The project faces no unusual risks. The revolving fund to be set up under the project should ensure the timely availability of resources and thus provide for speedy project implementation. Relending Terms and Conditions: Interest rates to subborrowers would be not less than 16% per annum plus 1% for life insurance. For agricultural credit, maximum lending per individual farm family would be Col$ 500,000 (US$12,700). This document hu a restricted disitribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Project Costs: Local Foreign Total (US$ Million Equivalent) On-Farm Development Medium- and long-term investments 15.0 8.8 23.8 Incremental working capital 10.0 3.2 13.2 Subtotal 25.0 12.0 37.0 Small Agro-industries 1.2 1.0 2.2 Subtotal Lending 26.2 13.0 39.2 Technical Assistance Technical assistance and training 0.7 1.3 2.0 Project administration 0.1 - 0.1 Monitoring and evaluation 0.1 0.1 0.2 Subtotal 0.9 1.4 2.3 Total Baseline Cost 27.1 14.4 41.5 Price Contingencies 5.4 3.1 8.5 Total project costs 32.5 17.5 50.0 Financing Plan: Local Foreign Total (US$ Million Equivalent) Subborrowers 5.4 - 5.4 INCORA 24.6 - 24.6 Proposed Bank loan _2.5 17.5 20.0 Total 32.5 17.5 50.0 Estimated Disbursements: Amount by IBRD Fiscal Year ------------ (US$ million) ------------ 1980 1981 1982 1983 1984 1985 Annual 2.8 4.4 6.0 5.8 0.7 0.3 Cumulative 2.8 7.2 13.2 19.0 19.7 20.0 Economic Rate of Return: 38% Appraisal Report: Report No. 2491-CO, dated June 6, 1979  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TC THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE COLOMBIAN INSTITUTE FOR AGRARIAN REFORM WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A THIRD AGRICULTURAL CREDIT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Colonbian Institute fcor Agrarian Reform with the guarantee of the Republic of Colombia for the equivalent of US$20 million to help finance a Third Agricultural Credit Project. The loan would have a term of 17 years, including four years of grace, with interest at 7.9% per annum. The foreign exchange risk for the loan would be assumed by the Government. PART I: THE ECONOMY 1/ 2. Aa economic report on Colombia (2235-CO) was distributed to the Executive DLrectors in January 1979. An updating mission visited Colombia during February 1979 and its report is expected to be distributed by June 8. Its findings are summarized below. Country data sheets are provided in Annex I. Background 3. During the past two decades, Colombia has made substantial progress in the transition from a predominantly rural and agricultural economy made up of largely self-contained regions to a more integrated urban-industrial economy. The productive base of the economy has been widened appreciably, and there has been substantial diversification of production in both the agricultural and industrial sectors. These improvements have been accompanied by rapid growth of non-traditional exports and by the development of a modern sector relying to a considerable extent on imported inputs. As a result, the country has become less dependent on coffee as a source of foreign exchange earnings, and fluctuations in domestic economic conditions resulting from unpredictable shifts in world coffee prices, while still considerable, have become more manageable. Although substantial progress has been made during the past two decades, Colombia is still only partially developed with a limited modern sector superimposed on a large, traditional and economically poor base. Per capita income is low by developed world standards, the maintenance of high employment is a persistent problem, and in 1975 an estimated 55.0% of the rural and 24.0% of the urban population had incomes under the relative poverty level as defined by the Bank. 4. Colombia's population growth rate declined sharply in the past two decades; from well over 3% in the 1950s, to about 2.8% in the early 1970s 1/ Unchanged from Presidernt's Report, Proposed Third Bogota Water Supply, Sewerage and Drainage Project (Report No. P-2525-CO dated May 2, 1979).  and to an estimated 2.1% at present. 1/ This was in large part the result of a rapid decline in the crude birth rate; one of the most pronounced declines ever recorded in a Latin American country. Rising per capita income, rapid rural/urban migration, expanded economic opportunities for women and increased effectiveness of family planning programs are included among the factors responsible for the lower birth rate. Although rural/urban migration slowed from the early 1960s on,as progress was made in eliminating the widespread violence in the countryside, approximately 64% of the current population lives in urban centers and there are now 22 cities with populations exceeding 100,000 persons. Colombia's population is not considered excessive relative to the country's resource base. Economic growth will have to average around 7%, however, especially in the directly productive and service sectors, in order to increase employment at a pace sufficient to keep up with growth of the labor force. 5. Available information--while scanty--suggests that some improvement has occurred in income distribution and welfare of the lowest income groups in Colombia since the 1950s. These gains were probably the consequence of several factors, including migration of surplus labor from rural to urban areas, rapid growth of employment in high productivity jobs in industry and the services and reduced population growth. Policy efforts, particularly since 1967, have been directed increasingly toward improving the welfare of the poorest 50% of the population. These efforts have emphasized both employment generation and greater public investment in health, education, nutrition and urban development. The Bank has strongly supported these efforts. Continued emphasis on growth of the productive sectors of the economy, on industrial decentralization and on programs to encourage small- scale industry and agriculture should provide increased employment oppor- tunities and higher real wages for unskilled and semi-skilled labor in both rural and urban areas. Further improvement in the public services provided to the poor should reinforce these trends and raise the level of welfare of this segment of the population. 6. The Colombian authorities introduced a dramatic change in develop- ment strategy in 1967, shifting emphasis from the then existing protectionist policy of import substitution to measures designed to expand and diversify exports. These policies were highly successful in expanding exports, thereby alleviating the foreign exchange constraint and making possible a substantially higher level of investment. As a consequence, real GDP rose by an average 6.5% annually between 1967-1969 and 1974, well above the historical average. Merchandise exports in current prices expanded nearly threefold during this period, and most significantly, non-traditional exports became an increasingly important source of foreign exchange earnings, in part compensating for slow growth of receipts from coffee exports. By 1974, non-coffee exports comprised 56% of total merchandise exports, up from about 30% in 1967. 1/ Estimated 1978 growth rate. This rate differs from that given as the most recent estimate in the Social Indicators Data Sheet (Annex I) which is an average for the early 1970s.  -3 - 7. Despite the growth of output and the diversification of exports, the country faced some potentially serious problems at the time the new administration took office in 1974. Weakening balance of payments in part related tco the slowdown of growth in the industrial countries, loss of self-sufficiency in petroleum production, deterioration of the public finances, accelerating inflation, and declining investment threatened to reduce growth of output and employment. As a consequence of these develop- ments, ,the Government introduced an economic stabilization program which combined basic reforms of the fiscal, monetary, and trade systems with measures aimed at accelerating long-term economic growth. 8. In an effort to strengthen the public finances, the Government undertook a comprehensive tax reform designed to improve the progressivity and elastiLcity of the tax system. Some of the distortions which had deve- loped in lhe financial system caused by forced investment requirements placed on financial institutions and by differential tax treatment of financial instruments were eliminated. Interest rates were raised in an effort to increase private savings and improve resource allocation. In order to increase the efficiency of the economy through greater reliance on market forces, price controls on a number of industrial and agricultural products were removed, thereby providing greater stimulus for increasing production. Modifications in petroleum pricing policy aimed at regaining self-sufficiency in the production of crude petroleum by improving incen- tives for exploration and exploitation were introduced. Concurrently, the Government initiated policies designed to reduce the subsidy on local consumption of petroleum products, which eventually led to a 220% increase in gasoline prices by 1978. Tariff levels and non-tariff barriers to trade were reduced significantly in order to increase competition and the effi- ciency of domestic firms. While these reforms were successful in improving the public finances and reducing inflation in 1975, they also served to reduce economic growth and the slowdown of domestic economic activity which began in 1974 continued through most of 1975. Recent Economic Developments 9. During the past three years, the Colombian economy has been dominated by developments in the external sector. As the result of a serious frost in late 1975 affecting Brazil's major coffee producing area, coffee exports from that country declined sharply triggering a fourfold increase in the world price of coffee by mid-1977. This caused Colombia's export earnings from coffee to increase to nearly US$1.8 billion in 1977 from US$764 million in 1975, and produced an unprecedented rise in incomes and demand in the country's rural areas. Lagging supply of consumer goods, particularly basic foodstuffs--the production of which was adversely affected by drought conditions in most of the country's interior--failed to keep pace with rising demand and inflation accelerated from 24% in 1975 to 44% in the twelve months ending June 1977. Inflation in Colombia has been moderate relative to that experienced by other countries in the region, seldom exceeding an annual rate of 20%. The acceleration of inflation which took place during the period, therefore, was unprecedented in recent history, and efforts to lower the rate of inflation have dictated economic policy since that time.  - 4 - 10. The authorities responded rapidly by introducing a broad range of fiscal, monetary and trade policies designed to gain control over the explosive increase in prices. Beginning in late 1976 reserve requirements were raised and rediscounting and public sector borrowing from the Central Bank were discouraged. The authorities temporarily suspended their policy of periodically adjusting the exchange rate and prices of petroleum products. In January 1977, a 100% marginal reserve requirement was placed on increases in commercial bank deposits exceeding the December 31, 1976 level. To delay the impact of rising foreign exchange receipts on the monetary base, exporters were required to accept 90-day US dollar denominated certificates of exchange in lieu of cash payment for their exports. In order to sterilize a portion of the increase in foreign exchange earnings from coffee exports, the Coffee Federation agreed to invest a large portion of its receipts in Central Bank bonds, the proceeds of which were frozen in a special account. To increase supplies in the domestic market, a number of measures were taken to liberalize imports. Food imports by the state marketing agency, IDEMA, were increased sharply. In addition, restrictive fiscal measures were introduced to curb growth of aggregate demand and in 1977 the Treasury registered an overall budgetary surplus for the first time in recent years. 11. As a consequence of these measures and a favorable second semester harvest, inflation declined sharply beginning in July 1977. By the end of the year, the annual rate of inflation had fallen to 29%. With inflation subsiding, periodic exchange rate adjustments and gasoline price increases were reintroduced. With few other exceptions, however, the stabilization policies were continued in effect throughout 1978 and by year end inflation had subsided to an annual rate of 17.8%. 12. Because of the lack of dynamism in world markets, slow growth in agricultural production, capacity constraints in the industrial sector and a decline in real investment, the Colombian economy expanded only moderately in 1976 and 1977. Growth of real GDP increased from 3.8% in 1975, to 4.6% and 4.8% respectively in the subsequent two years. The higher growth was a direct result of the expansion of domestic demand brought about by the rise in incomes of coffee producers. Output in the trade and personal services sectors of the economy (including transport and communications) responded strongly to the rising demand, while agricultural output, because of the drought, rose by only 2.2% p.a. on average for the 1976-77 period. Industrial sector output rose by only 5.4% p.a. during this period, despite the strong growth in domestic demand. Because growth occurred in the rela- tively labor intensive sectors of the economy -- personal services, trade, transport and communications and manufacturing -- the urban unemployment rate had declined to an estimated 8% by the end of 1977, from an average 12% during the early 1970s. In addition, there is evidence of labor shortages and rising real wage rates in rural areas during this period, and it is believed that rural unemployment also declined. 13. Preliminary estimates for 1978 show a strong increase in real GDP resulting primarily from continued stimulus to aggregate demand from high coffee receipts and from an expansion of investment. In addition, favorable weather conditions permitted a sharp recovery in agricultural  output. Real GDP growth is estimated at 8% for the year, with agricultural production estimated to have grown by as much as 9% over the low level of 1977. While coffee prices fell considerably in 1978 from their 1977 levels, this decline was more than offset by expanding export volume as Colombia undertook a more aggressive coffee export policy. Consequently, receipts from coffee exports rose to nearly US$2.1 billion for the year. The accompanying rise in domestic demand and a modest recovery in export markets caused manu- facturing and transport anid communications to grow by 8.5% each and trade (including commerce) by 9.0%. Construction activity, which had continued at a low level during the past several years, recovered strongly in 1978, partially as a result of an increase in speculative demand arising from an inflow of funds frem contraband activities. Only the mining sector, in which output fell by 2.3% as a result of declining oil production, failed to show signifi- cant growth in 1978. Open unemployment in urban areas is estimated to have fallen to 7.6% by June 1978. 14. Colombia's balance of payments was also highly favorable in 1978, continuirLg the trend of the previous three years. Largely as a result of the increase in coffee exports, although non-coffee exports rose modestly (7.0%) in real terms also, Colombia's net official international reserves rose by US$664 million, reaching US$2,493 million by the end of the year, equivalerLt to about nine months imports of goods and non-factor services. This increase in reserves occurred despite a nominal 25% increase in import payments,, reflecting the rise in domestic demand, continued overvaluation of the exchange rate and liberal import policies. There were few significant modifications in trade and exchange rate policies in 1978. The slow rate of peso devaluation was continued during the first three quarters of the year, bul: accelerated in the fourth quarter when the pace of reserve accumu- lation began to slow. In general, trade and exchange rate policies were directed towards reducing the impact on the monetary base of reserve accumula- tion by delaying the monetization of export receipts and advancing import payments. These measures complemented monetary policies which were aimed at restraining growth of the money supply. 15. Colombia's public finances generated a large surplus in 1978 thereby permitting the Government to relax somewhat the policy of fiscal restraint which formed part of its anti-inflationary program during the previous two years. Current savings of the public sector rose to an estimated 6.0% of GDP, corapared with 5.5% of GDP in 1977, and covered about 90% of public sector investment. Both the Central Government 1/ and the consolidated decentralized agencies increased their savings in 1978, the former by 29% and the latter by 153%. The strong increase in savings of the decentralized agencies, which rose to 1.4% of GDP from 0.7% in 1977, was the result of increased charges for the services they provide and of restraint on current expenditures. Large increases in customs duties and in sales taxes brought about by the growth in domestic demand were the main factors responsible for t'ne increase in savings of the Central Government. As a consequence of this improved financial situation, public sector fixed 1/ Comprised of the National Government, the National Highway Fund and the Social Security Agencies.  - 6 - investment rose during the year, reaching 6.9% of GDP compared with 6.3% of GDP on average for the 1975-77 period. Some of the heaviest investment took place in the development of hydropower and in the petroleum sector, for both explora- tion and development. 16. Despite continuation of the stabilization programs, the rate of of inflation accelerated sharply in January 1979, followed by a more moderate increase in February. At the same time, the international price of coffee fell sharply, prompting the Government to take measures to avoid a large financial deficit for the Coffee Federation. In the past, such deficits were financed in part through recourse to the Central Bank. The Federation, an autonomous entity which meanages the domestic and external marketing of Colombia's coffee, purchases coffee from producers at a fixed price in pesos and then sells it on the world market. Since the Federation stands ready to purchase all coffee offered at the fixed price, it also bears the financial burden of stock accumulation in periods of declining world prices. After paying taxes and marketing costs equivalent to nearly 25% of the inter- national price, the Federation could not sustain the high domestic purchase price given the lower world coffee price without incurring huge losses. To avoid this, the domestic purchase price of coffee was lowered by 12% and the exchange certificate system was abolished for coffee exports. This latter measure will result in the conversion to cash over the next several months of around Col$10 billion in outstanding exchange certificates. To offset the monetary impact of this measure, reserve requirements on term deposits of commercial banks and financial corporations are to be increased gradually over the next few months, to 25% from 20% at present, and prior import deposit requirements have been raised substantially, to 95% from 40% and 60% previously. In addition, the interest rate on dollar denominated certificates issued by the Central Bank was raised to 14% from 7% in an attempt to absorb some of the funds flowing from the exchange certificates. In a separate measure, retail gasoline prices were increase!d in mid-March and Sunday sales of gasoline were outlawed. Gasoline prices have been raised by 67% since September 1978. Development Strategy and Prospects 17. The development strategy embodied in the 1975-78 Development Plan aimed at accelerating the rate of growth of GDP and at distributing the benefits of such growth more equitably. This was to be achieved by increasing the allocative efficiency of the economy through greater reliance on market forces, by providing incentives for increasing private sector investment, by expanding economic and social infrastructure, and by improving public services provided to the poorest half of the population. Substantial progress has been made in carrying out this strategy during the past four years. Public sector investments have focused increasingly on projects designed to alleviate rural and urban poverty and on expanding and improving infrastructure. Compre- hensive integrated rural development and nutrition projects aimed at increasing incomes and welfare of the lowest income groups have been introduced. Urban development projects designed to provide improved services and employment opportunities to residents of slum areas in Colombia's major cities have been initiated. These programs have been complemented by policies to encourage the development of small- and medium-scale enterprises and to decentralize industry away from the three largest cities. This latter policy, together with credit programs aimed at increasing output and employment in agriculture, have been designed to alleviate rural poverty and reduce rural/urban migration. Public  - 7 - sector infrastructure investments have been concentrated on improvement and extension of highway and communications systems. Special priority has been given to the development of domestic energy sources to reduce the country's growing dependence on imported oil. 18. Increased emphasis on provision of improved social services is re- flected in the increased proportion of total National Government expenditure on education, health, and water and sewerage systems, which rose from 33% in 1974 to 38% in 1977. The economic dislocations caused by the coffee boom and the need to concentrate economic policy on short-term management problems have limited expansion of public and private investment and required temporary suspension of some of the measures designed to free the price system and stimulate growth of non-traditional exports. 19. The Government, wbLich took office in August 1978, intends to continue with essenlially the same detvelopment strategy as the previous administration. Under this strategy, economic growth is to be promoted through expansion of non-coffee exports and through measures to stimulate investment and increase the efficiency of resource allocation. This Government proposes to give greater emphasis to expansion of economic and social infrastructure, however, with particular stress on improving transport and communications networks. Improvement in transport and communications infrastructure is expected to encourage increased inter-regional trade which, together with alleviation of the foreign exchange constraint, should further stimulate investment and economic growth. Measures to encourage industrial decentralization have been introduced to complement the actions taken to unify regional markets. 20. Rapid expansion oE domestic energy resources is to be given high priority with the view to riegaining self-sufficiency in energy as early as possible. Even under the most optimistic assumptions regarding development of such resources, however, Colombia will continue to rely heavily on energy imports until the mid-1980s when exports of coal and natural gas are expected to reduce the country's net energy deficit. Small scale agriculture and industry will continue to receive strong support through credit, and low income rural areas are to be helped through rural electrification, health and education programs and through expansion of feeder road projects. Innovative programs such as the integrated rural development (DRI) and nutrition projects financed by the Bank are expected to receive continued high priority. Public investment programs in education, health, water and sewerage and urban development (especially those directed at alleviating urban poverty) are to be continued as well. 21. Given the country's strong resource base and its high level of international reserves, Colombia should be able to achieve annual real GDP growth averaging about 7% during the 1979-83 period. Maintenance of this level of growth will require rapid expansion of non-coffee exports and high savings and investment rates. Public sector investment is expected to expand faster than GDP during this period because of the large proposed programs for infrastructure, social services and energy development. Financial require- ments for this higher level of investment will be substantial and public sector savings will have tco be sustained at the current high levels. Given the expected decline in coffee revenue, improvements will be required in the administration and collection of non-coffee taxes, and additional tax measures  - 8 - may be required. Of equal importance is the continued upward adjustment in prices charged for the goods and services provided by the public decentralized agencies. Growth of non-coffee exports, especially of manufactured goods, will no doubt be strongly influenced by the rates of economic growth of Colombia's major trading partners, but appropriate domestic incentives will also play an important role. In this regard, it is expected that Colombia will follow an exchange rate policy designed to maintain the competitiveness of Colombian exports and that additional export promotion measures will be adopted to encourage both product and market diversification. 22. Greater efforts to increase efficiency and production in the agricul- tural and industrial sectors will also be needed to complement incentives given to non-traditional exports. Programs to meet these needs in the agricultural sector, including integrated rural development, expansion of farm credit, im- proved research and extension services, and upgraded marketing facilities, are already in place and will need to be strengthened. Further development of the country's capital markets is expected to increase private savings and im- prove the allocation of financial resources, thereby providing the basis for more rapid growth of industry. Ongoing and future infrastructure investments by the public sector should facilitate improvements in economic efficiency and lead to more rapid growth of output and employment in both industry and agriculture. 23. Projections of Colombia's energy balance indicate a rapidly growing deficit that is expected to reach significant proportions in the early 1980s in the absence of an aggressive energy development program. To avoid the con- straint on growth that large scale shortages of energy would entail, high priority is being given to the development of additional energy sources. The strategy which is being pursued is to reduce the nation's dependence on petro- leum as an energy source by developing substitutes such as hydropower, coal and natural gas. Major projects are being executed and others prepared to expand hydroelectric power generation and incentives are being given to pri- vate foreign companies for accelerated exploration and development of the country's petroleum, coal and natural gas potential. Exports of coal and natural gas are expected to offset a large portion of the petroleum imports projected for the mid to late 1980s. Conservation of existing resources resulting from higher energy prices is expected to slow the growth in energy demand. While the total investment cost of future energy development is still being determined, preliminary estimates indicate that the required investment could run as high as US$8.0 billion in current prices over the next decade. Even under the most optimistic assumption regarding foreign private investment, suppliers' credits and domestic resource mobilization, external long-term financing of about US$4.0 billion would be required in this sector alone during this period. Any significant delay in implementing the country's energy development program would most likely have serious adverse repercus- sions on future economic growth. 24. Because of the expected continued decline in world coffee prices, accelerating oil imports and the high import content of future investment projects, the current account of the balance of payments is expected to be in deficit throughout the early to mid-1980s. Increased mineral exports including coal, natural gas, and nickel, and completion of the large invest- ments in energy development are expected to relieve the pressure on the  - 9 - balance of payments by the late 1980s. Colombia is expected, therefore, to continue to be a large net importer of capital for some time to come. Its future external resource requirements reflect the need to supplement domestic savings in order to carry out the public sector investment program and to provide increasing amounts of foreign exchange to finance required imports of capital and intermediate goods. Assuming that the Colombian authorities permit a drawdown of international reserves to the equivalent of three months' imports in the years immediately ahead, gross external capital requirements are projected at US$6.3 billion between 1979 and 1983, or an annual average of about US$1,260 million. About half of Colombia's capital inflow during this period is expected to be provided by official multilateral and bilateral sources, with commercial financial credits becoming increasingly important. 25. Colombia's public external debt repayable in foreign currency amounted to US$4.2 billion at the end of 1978, of which US$2.7 billion was disbursed and outstanding. The Bank/IDA share of this external debt was 29% ancl is expected to rise to 31% by 1983, before declining to 29% again by 1985. Although the public debt service ratio fell during the past two years as export growth accelerated, this ratio is expected to increase from 10.3% in 1978 to about 14.7% in 1983. Balance of payments prospects beyond 1980 will depend heavily on the timely development of domestic energy sources and on progress made in executing several natural resource- based export oriented projects currently under preparation. Given the expected continuation of sound economic and financial management and timely execution of the country's energy program, it should be possible to prevent the external sector from again becoming a constraint on economic growth and to maintain Colombia's creditworthiness for the required external borrowing. PART II: BANK GROUP OPERATIONS IN COLOMBIA -26. The proposed loan, the 82nd to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$2,189.6 million (net of cancella- tions). Of this amount, US$1,593.7 million is now held by the Bank; IDA made one credit of US$19.5 million for highways in Colombia in 1961. Disbursements have been completed on 47 loans and the IDA credit. IFC has made investments and underwriting commitments of US$53.7 million in 24 enterprises and now holds US$17.9 million. Annex II contains a summary statement of Bank loans, the IDA credit and IFC investments as of March 31, 1979. The Annex also contains summaries on the execution of the 29 ongoing projects. 27. Since FY68, Bank lending in Colombia has become more diversified and has been concentrated on production-oriented programs and activities which emphasized social as well as economic benefits. Including the proposed project, nine of the thirteen agricultural loans have been made since then, nine of the twelve loans for industry, all three loans in the education sector, one loan for a nutrition project, two loans for an urban development project and all nine loans for water supply and sewerage. This compares with only thirteen loans since FY68 in the power and transport sectors.  - 10 - 28. Bank lending to Colombia in FY78, consisted of loans for nutrition improvement, water and sewerage, urban development, power generation and interconnection, development finance companies and development of an export processing zone, totalling US$354.6 million equivalent. The proposed project would bring total lending in FY79 to US$311.5 for seven projects: two each for water supply/sewerage and power and one each for urban development, aviation development and agriculture credit. Work is also underway in vocational training, transportation, nickel and coal mining development, power, including distribution expansion and rural electrification, oil exploration, land settlement, further agricultural credit and industry, including small-scale and agro-industries, for possible consideration by the Executive Directors during the next two years. 29. The proposed Bank lending conforms closely with the Government's development strategy. To help Colombia develop domestic sources of energy, a substantial part of the proposed lending would be for hydropower. The Bank intends to assist the development of coal mines and petroleum, which hold potential in helping Colombia meet part of its energy requirements and in diversifying exports. Bank involvement in the energy sector would help mobilize additional external financing as some of the projetCts would require co-financing. Other future loans would finance agriculture and industry to assist the Government in its efforts to raise overall productivity, income and employment, and to strengthen and diversify exports. Closely related to these objectives would be the proposed Bank lending for transport infrastruc- ture. In this context, we are assisting the Government in preparing a rural and feeder roads project to integrate the more backward areas of the country into the modern economy. Other loans under preparation for highways, ports and railroads are aimed at helping Colombia handle larger volumes of non- traditional exports and the imported inputs on which the modern sector of its economy relies for expansion. Finally, a relatively large number of loans are being prepared in support of the Government's efforts to help the lowest 50% of the Colombian population. Along with the proposed project, lending for urban development and slum improvement, rural electrification, land settlement and water supply and sewerage projects are principally designed to improve the standard of living of the poor. 30. The operations of external lenders in Colombia are shown in Annex I. While IBRD, IDB, and AID provided about 75% of total external financing to Colombia in the 1961-72 period, their share has decreased since then to approxi- mately 50% for the 1975-77 period. Like the Bank, IDB has given increased emphasis to social projects and has financed projects in low cost housing, urban and rural development, agrarian reform, university education, water supply, and land erosion control. In the future, it proposes to assist Colombia to develop sources of domestic energy and to expand the activity of the productive sectors to help generate increased employment. AID has supported programs in education, urban development and small farm development. It plans to phase out its aid program in Colombia at the end of this year with the disbursement of a US$6 million nutrition loan. The Governments of the Federal Republic of Germany and the Netherlands have also provided concessional financing for social and regional integration projects.  - 11 - PART III: THE AGRICULTURE SECTOR AND INCORA Agriculture's Contribution to the Economy 31. Between 1950 and the late 1960s, agriculture's contribution to GDP declined steadily from 40% ito about 29% at which level it has since stabilized. The decline was the result of slow growth in agricultural production (3.4% per annum) relative to the rest of the economy (5.7% per annum). In the 1970-76 period, agriculture grew at nearly 5% per annum, compared to 5.8% growth in GDP; at the same time, the agricultural sector's terms of trade improved considerably. 32. During the last two decades, noncoffee agricultural exports have grown continuously helping to diversify export earnings. Noncoffee, agricul- tural exports, principally cotton, sugar, rice, flowers, horticultural products, bananas and beef, have grown in value from US$20 million in 1970 to about US$330 million in 1975 and now account for about 20% of total registered exports. In contrast, imports of food and beverages are relatively small, averaging less than 10% of total registered imports; wheat makes up half of the total, followed by vegetable oils, lentils, fruit, barley and dairy products. The Nature of Agricultural Production 33. The gross value of agriculture production amounted to about Col$ 266 billion (US$6.8 billion) in 1978. Approximately 50% of the value of this production is provided by crops, 37% by livestock, and the remainder by forestry, fishing and huntiLng. Within the crop subsector, seven basic staples-- rice, cassava, plantains, potatoes, maize, sugarcane for panela (non-centrifugal sugar) and beans--account for about 45% of the value of production with coffee's share amounting on average for another 30%. Most of the rice is grown on large commercial farms and about half of the potato crop is produced by them. The remaining five major sitaple crops are produced predominantly by small farmers. 34. Large-scale commercial farming dominates the noncoffee export crops and livestock besides producing about 90% of the rice crop which has replaced corn and wheat as the principal staple in the Colombian diet. For many of the modern sector crops, most notably rice and cotton, Colombian production is as efficient as any in the developed world, and productivity follows closely on research results. Tropical and subtropical weather conditions allow efficient farmers to practice intensive double and triple cropping. Land Use and Distribution 35. Colombia's land resources amount to 114 million hectares of which an estimated 17 million are in pasture and nearly 50 million under forest. Of the remaiLnder, just over a million hectares are under coffee and nearly four million are in other crops. The 860,000 farms which are of 10 ha or less  - 12 - amount to over 70% of Colombian farms but cover only 7% of the farm area. On the other hand, 80% of the land is farmed in the 4% of the units which are larger than 50 hectares. Farms are far more evenly distributed for crops alone--26% of the land in units up to 10 hectares and 44% in units over 50 hectares. Livestock farms are generally large, with nearly 80% of the land in holdings of more than 100 hectares and 50% in units of more than 500 hectares. Seventy percent of the farms and 75% of the land is farmed directly or indirectly by its owner, the remainder being farmed wholly or in part by sharecroppers, renters and squatters. Land Reform and the Colombian Institute for Agrarian Reform - The Borrower 36. The most notable development in agriculture during the 1960s was the institutionalization and advancement of land reform. The Colombian Institute for Agrarian Reform (INCORA) was established in 1961--though some previous land reform had occurred as far back as the 1930s. Up to the early 1970's, the Government viewed land reform as the core of the agriculture development program in the country, providing social as well as economic development benefits. As then defined, land reform was to be applied only when land was underutilized or where Government investments in water manage- ment--irrigation and drainage--resulted in the potential for increased utiliza- tion. By redistributing such lands and providing beneficiaries with the complementary inputs, especially credit and technical assistance, the Govern- ment expected to improve the well-being of landless farm labor families and increase agricultural productivity. INCORA was also given responsibility for titling lands and providing support in the newly settled areas of the country, where the land is publicly owned. In the late 1960s, INCORA was given a great deal of support, and through 1970, had purchased or taken over about 3.5 million hectares and had distributed land to over 100,000 farmers. 37. With the rapid development of modern large-scale agriculture and reduced population pressure in rural areas, the Government began in the early *1970s to shift its agricultural strategy giving less importance to land reform. In the first place, an important premise of Colombian agrarian reform, namely the existence of vast amounts of underutilized farm land, was no longer appli- cable. The best valley lands, which had been in extensive livestock produc- tion in earlier decades, were, by the early 1970s, under crop production. Simultaneously, rapid migration had changed the population balance to urban areas. To a Government, whose urban constituency was rapidly approaching 70% of the population, large quantities of inexpensive food as well as increased net foreign exchange earnings became the paramount objectives for agriculture. The Government, therefore, began to concentrate on increasing the productivity of the nearly one million small-scale farmers who already had land. These previously neglected farmers have been and are crucial to the urban economy since they supply most of the domestically consumed food crops, except rice. Government efforts in this direction culminated in the launching of a national Integrated Rural Development Program (DRI) which aims at developing the areas where small-scale farmers predominate and at increasing their productivity and incomes. Most of the leadership for this program had their apprenticeships in various INCORA rural development projects.  - 13 - 38. Although the land reform effort has slowed down considerably, the program continues and haLs made some significant achievements. About 200,000 farmers have received land under the program, though about 80% have received formnirly public lands in colonization areas. Through 1977, five million hectares of privately held land had been acquired under the program. All told, INCORA's beneficiaries amount to about 18% of Colombia's farmers and own about 16% of the land under crops and pasture. The proposed project also supports the Government's objectives of increasing the productivity of small farmers, specifically those who have already benefitted from land reform and colonization programs. Agricultural Credit 39. Credit to the agriculture sector has, since 1972, remained consis- tently at about 20% of total outstanding credit in the country. Two principal sources, Caja Agraria (CAJA) and the Fondo Financiero Agropecuario (FFAP), account for the vast majority of the agricultural lending in Colombia. FFAP is a fund of the Bank of the Republic (BOR), from which resources are on-lent through nearly all banking institutions to the commercial farm sector. Its resources are obtained principally from low yielding bonds which banking institutions are required to hold in lieu of reserves on a share of their deposits. While it accounts for more than 50% of the resources on-lent for agriculture, it supplies funds to less than 3% of the farms which are principal'Ly medium- and large-scale enterprises. CAJA, with about 850 branches spread throughout the country, is the principal source of credit to the small farm sector. CAJA, a mixed public/private bank (89% Government owned) lends funds raised principally from savings deposits and FFAP rediscounts. In addition, there are other sources of agricultural credit which include the Banco Ganadero (BG) which finances principally livestock; the Banco Cafetero which finances coffee and crop diversification in coffee areas; the Corporacion Financiera de Fomento Agropecuario y Exportaciones which lends principally for export agriculture and agro-processing. 40. Although not a bank, INCORA has since 1963 been the principal source of credit for land reform beneficiaries. INCORA's resources are on-lent through CAJA and BG or are used to guarantee funds lent by those institutions to INCORA's farmers. Between 1975 and 1977, INCORA made and guaranteed sub- loans of about US$17 million equivalent per year to about 9,800 beneficiaries or 5% of its beneficiaries. INCORA farmers, who number about 18% of the total and own 16% of the land, receive only about 3% of the institutional credit. Their limited access to credit stems, in part, from their inability to mortgage their land until it has been fully paid for--mortgage is the required form of collateral for long-term lending--and from the banks' general reluctance to deal with INCORA beneficiaries. In addition to providing needed credit to INCORA's beneficiaries, one of the objectives of the proposed loan is to increase the interest of financial institutions, especially CAJA, in lending to INCORA farmers.  - 14 - 41. The interest rate structure in Colombia is complex and varies both within and among institutions. In general, agricultural lending rates are lower than average interest rates in other productive sectors. Interest rates for agricultural credit have generally been negative in real terms during the 1972-77 period. However, present Government policy is to achieve or maintain positive real rates of interest. As a result, in 1978, most interest rates were positive in real terms and have been raised further (end of 1978) to ensure that result. Rates of interest for credit from INCORA have varied depending principally on the origin of the funds, rather than on the achievement of any specific objective. In line with a recent rise in agricul- ture lending rates and in an effort to bring coherence to its interest rate structure, INCORA has recently decided to unify its structure and raise rates. Bank Role in the Sector 42. Bank lending for agriculture has focussed principally on supervised agricultural credit and support for irrigation/drainage and colonization projects which have involved some forms of land distribution. Of the ten Bank agriculture loans to Colombia made since 1966, four have been for agricultural credit, two for colonization, three for irrigation/drainage and one to support DRI. Bank efforts in agricultural credit have aimed at increasing agricul- tural production, expanding the availability of credit for long-term farm investments and at strengthening the institutions (FFAP, CAJA and INCORA) in the sector. The remaining projects have all focused on increasing pro- ductivity, incomes and welfare of small farmers. The first irrigation and colonization projects, which were both area specific integrated rural develop- ment projects have provided valuable experience to the Government for the development of DRI. The Borrower's Performance in Prior Projects 43. INCORA has been the principal executing agency, with responsibility for six of the ten Bank projects, including the First Agricultural Credit Project (Loan 624-CO). With the exception of two drainage projects (Loans 502-CO and 849-CO) which encountered problems of soil salinity and farmer transience, INCORA's performance has been quite good. In general, its project management and technical staff have been adequate and at times superior. The project audit reports for Loans 624-CO and 739-CO (SecM77-828 and SecM78-556) reveal that project objectives were substantially achieved with rates of return in line with those at appraisal. The audit report for Loan 624-CO questioned INCORA's role as a lending institution, rather than as an agricul- tural development institution. In contrast with the proposed project, however, the project beneficiaries in the first loan were mostly medium-sized farmers who owned land independently of INCORA but happened to be living within INCORA project areas; the beneficiaries under this project would be solely farmers and settlers who have benefitted from INCORA's land distribution program. 44. INCORA's overall performance has been satisfactory, but in recent years has been adversely affected by insufficient financial and political support. Reduced budgetary support has resulted in project delays, while the  - 15 - institution's political difficulties caused serious morale problems within the institute. The new administration which took office in August 1978 has provided bet:ter financial support to the institution and together with the management of INCORA has begun to refocus the institution's effor's away from politically contentious land acquisition to the consolidation of past efforts and extension of its colonization program. INCORA has the capacity to carry out such efforts, provided its financial situation and management can be strengthened. The proposed project would assist in this endeavor. Already, in fulfillment of conditions to process this loan, INCORA has appointed finan- cial management consultants and has taken steps to improve its accounting and information flow practices. Furthermore, under the proposed loan, the Bank would join the Government in setting up a revolving fund which would provide additional 'Liquidity to INCORA and thus, ensure rapid project implementation. With the measures already taken and to be taken in conjunction with the proposed project, it is expected that INCORA will be strengthened and will be able to carry out effectively its responsibilities as an agricultural development institution. PART IV: THE PROJECT Background and Objectives 45. The project was prepared by INCORA with assistance of two FAO-CP missions and the Bank's Resident Mission. It was appraised by a Bank mission in December 1978. Negotiations were held in Washington, D.C. in May of 1979, with a Colombian delegation led by Mr. Virgilio Barco, Ambassador to the United States. 46. The project aims at increasing the availability and access of credit to land reform beneficiaries in Colombia, so they can become viable farmers, and be weaned from INCORA eventually to the conventional channels of credit and technical assistance. The project also aims to increase the capacity of INCORA to: (a) provide technical assistance to land reform beneficiaries; (b) organize and develop its overall credit structure; (c) encourage the development of small-scale agro-industries to expand marketing outlets for farmers; and (d) improve its financial and information management. While the project investments would be focussed on only 12 areas, the project would improve the overall institution, so that it can better carry out its various farm development and colonization programs. Project Description 47. The project would support a four-year supervised agricultural lending prcogram and development of a small number of agro-industrial ventures by farmers grouped in cooperatives. Specifically, the project includes: (a) agricultural credit for 7,600 farm families; (b) credit for up to 60 small-scale agro-industries;  - 16 - (c) consultant services, training, vehicles and equipment for technical assistance to farmers; and (d) the establishment and operation of a monitoring and evaluation unit. 48. The subloans are expected to be committed over a four-year period and disbursed over five years. Twenty-four man-months of consultant services for monitoring and evaluation including the training of INCORA technicians would be financed under the project. Vehicles and equipment would be provided in order to increase the efficiency of technical assistance and monitoring and evaluation. Project Areas 49. Project activities would be concentrated in 12 of the 20 INCORA administrative regions. Approximately 150,000 of the 200,000 beneficiaries of INCORA's land reform and colonization program are dispersed in many areas of the country and at present cannot be efficiently served by INCORA. A portion of these beneficiaries are being supported under DRI (see para 37) and more are expected to receive assistance with future expansions of that program and similar rural development/settlement programs carried out by INCORA. The remaining approximately one-quarter of INCORA's farm families are concentrated in twenty regions where INCORA maintains support programs for the farmers. The twelve project areas were selected on the basis of productivity potential, existing infrastructure facilities and technical manpower, and unavailability of alternative sources of finance. It is expected that INCORA will be able to reach effectively most of the 50,000 farmers in INCORA areas as the institutional capacity is strengthened and the country's rural infra- structure is expanded. 50. The project areas encompass large portions of the country in twelve administrative departments (provinces) of which about 775,000 ha are farmed by 35,000 INCORA beneficiaries. At the project preparation phase, INCORA eliminated about 20,000 of the potential 35,000 beneficiaries, principally because they do not have economically justifiable investments or have bad repayment records. The remaining 15,000 eligible families which farm roughly 423,000 ha of land are the potential beneficiaries of the proposed project; 5,500 operate 537 collective farms, 7,000 operate individual farm holdings and 2,500 are settlers. Currently, 63% of the agricultural area is in grassland, 15% in crops and 22% fallow. Mixed farming with extensive live- stock operations, subsistence crops and minor species predominate. Most of the farmers are relatively new to farm management and have few resources in addition to land. They, thereby, require intensive technical assistance and a high percentage of farm financing. At present, only about 6,000 of the potential beneficiaries are being supported from INCORA's on-going lending operations. By completion of the project, most of the fallow land is expected to become productive.  - 17 - Cost and Financing 51. The total cost of the project net of taxes is estimated at US$50 million equivalent of which US$17.5 million equivalent (35%) correspond to the foreign exchange costs. Project costs have been estimated on the basis of December 1978 prices. The costs for consultants are estimated at US$4,800 per man-month. Price contingencies amount to 21% of base costs and are based on forecasts of yearly domestic and international price increases. 52. The proposed Bank loan of US$20 million would cover the estimated US$17.5 million equivalent of direct and indirect formign exchange costs and US$2.5 mi:Llion of local costs. Local currency financing is recommended in order to bring the Bank's share of financing to a level (40%) commensurate with the minimum for other previous projects for low income groups and thereby, maintain a level of particiLpation that would help ensure the achievement of the institutional goals of the project. In addition, such participation would further emphasize the importance which the Bank attaches to the assistance of INCORA beneficiaries and to the role of the institution itself. 53. Project beneficiaries would finance an estimated US$5.4 million equivalent representing about 11% of project costs. The remaining 49% or US$24.6 million equivalent would be financed by INCORA from budgetary transfers from the Government in the form of equity contributions. The Government would assume the foreign exchange risk. A breakdown of project costs and financing is presented in the Project and Loan Summary. Procurement and Disbursement 54. Vehicles required for the project estimated to cost about US$1.6 million equivalent would be procured under international competitive bidding in accordance with Bank guidelines. The project beneficiaries would purchase the items required for the investments through local established commercial channels. Inputs, equipment, machinery and on-farm civil works would be varied and not suitable for competitive bidding. Foreign firms are adequately represented in Colombia and there is a good network of competitive suppliers of agricuiltural inputs. Contracts for consulting services would be awarded on terms and conditions and to firms or individuals acceptable to the Bank. 55. Disbursements would be made for 100% of the cost of consultant services and overseas training and of the foreign cost of directly imported vehicles; 76% of the local expenditures for vehicles procured locally; and 46% of subloans. In order to ensure adequate and prompt resources for on-lending under the project, a revolving fund would be established with US$2.0 million equivalent sufficient to cover three to four months lending operations. The establishment of such a fund and the deposit of INCORA's contribution in an amount acceptable to the 3ank (US$1.08 million equivalent) in the fund would be a condition of effectiveness (Section 8.01(b) of the draft Loan Agreement). Upon effectiveness, the Bank would disburse an initial contribution to the fund of US$0.92 million equivalent. Subsequent Bank disbursements to reple- nish the fund would be carried out according to standard procedures, but provided that the Government's share of the fund has already been approved (Part 4c(iii) of Schedule 1 of the draft Loan Agreement). At the request of  - 18 - any of the three parties concerned, the Government, the Bank and INCORA would review the operation of the revolving fund and by agreement modify, if neces- sary, the operation-and size of it (Section 3.02(a) of the draft Loan Agreement). The above procedure is expected to speed the execution of the project and facilitate the complete disbursement of the loan by June 30, 1985. Lending Policies and Procedures 56. The proposed project would finance technically and financially viable farm and agro-industrial investment plans. With the exception of coffee production and cattle fattening operations, all farm activities would be eligible for financing. It is expected that most of the sub-loans would be for: (a) on-farm irrigation, drainage and land levelling works; (b) cocoa and sugarcane; (c) purchase of tractors and equipment; (d) purchase of beef, dual-purpose and dairy cattle and minor species including pigs and poultry; (e) pasture development; (f) investments for annual crops; and (g) seasonal inputs. The expected agro-industrial investments include grain storage and drying, vegetable freezing and dehydration facilities, rice milling, processing of non-centrifugal sugar, milk collection points and cheese making plants. 57. In order to ensure that the resources are on-lent to the maximum number of beneficiaries, individual farmers would be eligible to borrow up to Col$500,000 (US$12,700) provided, however, that their indebtedness in- cluding previous outstanding and unpaid debt would not exceed Col$500,000. Sub-loans would finance up to 90% of the total medium- and long-term on-farm investments including a declining percentage of incremental working capital. Financing for beef cattle and/or milking would not exceed 75% of the investment plan and would be limited to 25 cows and one bull per beneficiary. Furthermore, the total number of cattle financed per beneficiary would be limited to the number required to bring the herd size to 25 cows. Based on the financial analysis of farms, the above limits are estimated to be sufficient to develop a viable farm. For lending to cooperative farms, the limits are equal to the above multiplied by the number of families in the group. Subloans in excess of US$200,000 equivalent would require the prior approval of the Bank. Assurances have been provided that the above policies would be followed by INCORA (Schedule 5 of the draft Loan Agreement). 58. Interest rates under the project would be at a rate of not less than 16% per annum, plus 1% per annum for life insurance. Domestic inflation (average annual rate) was 20% in 1976, 34% in 1977 and 17% in 1978. Based on current projections of gradually declining inflation rates of 16% in 1979, 14% in 1980 and 12% thereafter, over the four-year commitment period of the proposed loan, the on-lending rate would be positive in real terms. Although recent developments suggest that inflation during 1979 may be somewhat higher than forecast, the interest rate is expected to be on average positive in real terms during the commitment period of the loan. The Government's policy is to achieve or maintain positive real interest rates throughout the economy and to this end it intends to adjust the rates of the two major sources of agricultural credit (FFAP and CAJA). The interest rate under the proposed loan would, therefore, be tied to the rates of these two sources. The interest rate would be set no less than 2% lower than the standard nominal rates for commercial farmers under FFAP, provided, however, that the resulting interest rates would be no higher than CAJA's interest rates for small farms (Part C.2.  - 19 - of Schedule 5 of the draft Loan Agreement). Currently, CAJA's small-scale farmer rate is also 16% and the FFAF' on-lending rate is 18%. Furthermore, in order to bring greater coherence to the interest rate structure within INCORA, assurances have been olbtained that by July 1, 1980, interest rates for all INCORA subloans would be standardized to the rate under the project (Section 4.04(b) of the draft Loan Agreement). 59. Most of the funds would be on-lent with INCORA's consent through CAJA's branches located in the project areas. Under an existing arrangement between the two institutions, CAJA acts as a banking agent and INCORA is responsible for approving subloans and for assuming the credit risk. However, to facilitate the eventual "graduation" of project beneficiaries to CAJA's normal lines of credit, CAJA would be provided with adequate spreads to assume the credit risk for a portion of project subloans and to finance a share with its own resources. The procedures and the relationship between CAJA and INCORA would be defined in a subsidiary agreement, acceptable to the Bank and the Government, the signing of which would be a condition of effectiveness (Sections 3.02(b) and 8.01(a) of the draft Loan Agreement). Other banks would be eligible to participate in the project, under terms and conditions acceptable to the Bank (Section 3.02(b) of the draft Loan Agreement); however, only the Banco Ganadero is expected to participate. 60. A consolidated and revised credit manual would be submitted for comment to the Bank by September 1, 1979 (Section 4.04(a) of the draft Loan Agreement). INCORA's procedures which are already in use for agricultural sublending are generally satisfactory and only require minor revisions and consolidation. The manual would also include specific procedures for agro- industrial sublending, whichL are currently not adequate. Assurances have been obtained that for each agro-industrial subloan, a feasibility study would be prepared and submitted to the Bank for approval (Part B 2 of Schedule 5 of the draft Loan Agreement). Since INCORA itself does not have the technical assistance expertise for agro-industries, each subloan application would be accompanied by satisfactory arrangements for related technical assistance. After INCORA has sufficient experience and expertise in this field, Bank approval requirements would be relaxed. Production, Marketing and Financial Analysis 61. The annual value of incremental production generated by the project, about US$20.7 million, is expected to be distributed among a variety of crops (sorghum, sugarcane for panela, cocoa, corn, rice, cassava and potatoes) and livestock products. Consequently, the incremental production of each indivi- dual commodity is expected to be small relative to total production within each region and nationally and would be insufficient in itself to affect the prices of any of them. None of the commodities is expected to face demand constraints and marketing claannels are adequate to absorb the increased production. 62. Financial rates of return for four farm investment models are between 12% and 45% in constant 1978 prices. When applying forecasts of commodity price trends to the analysis, the returns increase for all four models--the rate of return for pure beef cattle ranches improves from 12% to 18%. Intro- duction of small amounts of minor livestock species would also raise the rate  - 20 - of return significantly for pure beef cattle operations. The highest rates of return are associated with rainfed crop farms, where small investments yield considerable benefits. All farmers would benefit substantially with incomes per capita in real terms increasing by 25% to 50%, from US$282 to US$366 per capita without the project to US$360 to US$760 with the project. Farmer adoption of improved techniques is expected to follow the experience with other INCORA projects. Benefits, Justification and Risks 63. The project would increase the productivity, employment and incomes of about 7,600 land reform and colonization beneficiaries, and would expand agricultural production as well as contribute to reduced imports and increased exports. The net annual foreign exchange savings of the project at full development are estimated to be US$13.5 million (in 1979 prices). Incremental production of corn, cocoa and milk would reduce import requirements, while increased rice, panela and beef production would result in higher exports. The project would generate annually about 1.5 million man-days of additional labor, equivalent to 6,450 full-time jobs. It is estimated that 75% of the new employment or about 4,800 jobs would be filled from hired labor with the remainder from currently underutilized family labor. 64. The economic rate of return calculated on 95% of project costs is estimated at 38%. The calculation is based on financial costs which are con- verted to economic costs on the basis of border prices, to correct for import duties and other taxes, and an estimated shadow price of labor. Traded commodities produced are priced at projected import or export prices as applicable and converted to farm prices based on transport costs and differ- ences in quality of output. Non-traded commodities are priced at constant 1978 levels. The high economic rate of return results principally from the favorable price forecasts for most of the project commodities and from the high proportion of project funds that would finance improvements on rainfed *farms, which yield early returns. Sensitivity analysis indicates that a 50% decrease in benefits, a 60% increase in operating costs or a simultaneous increase in costs of 20% and decrease in benefits of 20% would bring the rate of return down to the 11% opportunity cost of capital. A rate of return has not been calculated for the 5% of project cost to be invested in agro- industries, since the specific investments are not yet defined. 65. The most important non-quantifiable benefit of the project is the strengthening of INCORA, so that it can serve effectively an increasing percentage of its land beneficiaries. Another non-quantifiable benefit is the expected "graduation" of some project beneficiaries to conventional sources of credit thus freeing up financial resources for other land reform/colonization beneficiaries. 66. The project faces no unusual risks. INCORA technicians are capable of carrying out the project and agrarian reform beneficiaries have already demonstrated a willingness to adopt improved technologies. The establishment and operation of a revolving fund under the project and the financial commit- ments provided by the Government are expected to ensure adequate project liquidity and minimize the likelihood of project delays.  - 21 - PART V: LEGAL INSTRUMENTS AND AUTHORITY 67. The draft Loan Agreement between the Bank and INCORA, the draft Guarantee Agreement between the Republic of Colombia and the Bank, and the report of the Committee provided for in Article III, Section 4(iii) of the Bank's Articles of Agreement are being distributed to the Executive Directors separately. 68. Special conditions of the loan are listed in Section III of Annex III. Conditions of effectiveness would be that: (a) INCORA has signed a subsidiary agreement, satisfactory to the Bank, with Caja (Section 8.01(a) of the draft Loan Agreement); and (b) a revolving fund has been established and the initial Government contribution acceptable to the Bank (US$1.08 million equivalent) has been deposited :Ln the fund (Section 8.01(b) of the draft Loan Agreement). A condition for each Bank disbursement to replenish the revolving fund would be that the Government has approved its corresponding disbursement to INCORA (Part 4c(iii) of Schedule I of the draft Loan Agreement). 69. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI: RECOMMENDATION 70. ]: recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments June 6, 1979  - 22- ANNEX I Page 1 of 5 COLOMBIA - SOCIAL INDICATORS DATA SHEET REFERENCE GROUPS (ADJUSTED AVERAGES COLOMBIA /a LAND AREA (THOUSAND S0. KM.) - MOST RECENT ESTIMATE) TOTAL 113 .9 SAME SAME NEXT HIGHER AGRICULTURAL 224.8 MOST RECENT GEOGRAPHIC INCOME INCOME 1960 /b 1970 /A ESTIMATE /b REGION Ic GROUP /d GROUP Ie CNP PER CAPITA (US$) 220.0 370.0 710.0 1066.7 867.2 1796.4 ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) 491.0 606.0 671.0 911.1 578.3 1525.0 POPULATION AND VITAL STATISTICS TOTAL POPULATION, MID-YEAR (MILLIONS) 15.4 20.6 25.0 URBAN POPULATION (PERCENT OF TOTAL) 53.0 /0 60.3 64.3 57.9 46.2 52.2 POPULATION DENSITY PER SQ. KM. 14.0 18.0 22.0 25.6 50.8 27.6 PER SQ. KM. AGRICULTURAL LAND 71.0 93.0 111.0 77.6 93.3 116.4 POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS. 46.6 46.6 44.1 42.0 42.9 34.8 15-64 YRS. 50.4 50.4 52.7 52.2 53.5 56.0 65 YRS. AND ABOVE 3.0 3.0 3.2 3.7 3.5 5.7 POPULATION GROWTH RATE (PERCENT) TOTAL 2.9 2.9 2.8 2.7 2.5 1.6 URBAN 6.0 jj 5.5 /h 4.5 4.3 4.7 3.4 CRUDE BIRTH RATE (PER THOUSAND) 46.1 /I 44.3 /I 40.6 /I 35.8 37.8 27.0 CRUDE DEATH RATE (PER THOUSAND) 14.7 11.0 8.8 9.1 10.8 9.9 GROSS REPRODUCTION RATE 3.2 3.2 3.1 2.6 2.5 1.9 FAMILY PLANNING ACCEPTORS, ANNUAL (THOUSANDS) .. 115.4 177.3 USERS (PERCENT OF MARRIED WOMEN) .. .. 31.0 15.1 20.0 19.3 FOOD AND NUTRITION INDEX OF FOOD PRODUCTION PER CAPITA (1970=100) 98.0 100.0 109.1 102.1 107.3 103.8 PER CAPITA SUPPLY OF CALORIES (PERCENT OF REQUIREMENTS) 94.0 92.0 94.0 103.9 105.3 110.4 PROTEINS (GRAMS PER DAY) 50.0 51.0 47.0 60.3 63.0 77.7 OF WHICH ANIMAL AND PULSE 28.0 29.0 24.0 26.7 21.7 22.2 CHILD (AGES 1-4) MORTALITY RATE 16.3 .. 12.1 8.7 8.0 1.9 HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) 54.7 58.5 60.9 62.6 57.2 63.0 INFANT MORTALITY RATE (PER rHOUSAND) 100.0