Uruguay - Agricultural Development Project

Document of The World Bank FILE C01 I FOR OFFICIAL USE ONLY Report No. 2779a-UR STAFF APPRAISAL REPORT URUGUAY AGRICULTURAL DEVELOPMENT PROJECT March 27, 1980 Regional Projects Department Latin America and the Caribbean Regional Office 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.  CURRENCY EQUIVALENTS (December 10, 1979) US$1.00 = NUr$ 8.35 NUr$ 1.00 = US$0.120 NUr$ 1 million = US$120,000 WEIGHTS AND MEASURES 1 hectares (ha) 10,000 m2 = 2.47 acres 1 kilometer (km) = 0.62 miles 1 square kilometer (km2) = 0.39 sq. miles = 100 ha 1 kilogram (kg) = 2.20 pounds 1 litter (1) = 0.26 gallons 1,000 kg = 1 metric ton = 0.98 long ton GOVERNMENT OF URUGUAY FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY URUGUAY AGRICULTURAL DEVELOPMENT PROJECT Glossary of Abbreviations ARU Rural Association of Uruguay BCU Central Bank of Uruguay BROU Bank of the Republic East of the Uruguay River CIAAB Agricultural Research Center "Alberto Berger" (La Estanzuela) CIDE Inter-Ministerial Commission for Economic Development CIVET Veterinary Research Center CHPA Honorary Commission for the Agricultural Plan CKO Comission for Ovine Improvement CONAPROLE National Dairy Products Cooperative CONEAT National Commission for Land Agro-economic Studies CREA Regional Centers for Agricultural Trials DIEA Directorate of Agricultural Economics Studies DINACOSE National Directorate for the Comptroller of Livestock Numbers EEC European Economic Community FAO United Nations Food and Agriculture Organization FG Livestock Fund FRU Uruguayan Rural Federation FUCREA Uruguayan Federation of Regional Centers for Agricultural Trials IAIAS Inter-American Institute of Agricultural Sciences INAC National Beef Institute INC National Settlement Institute LAFTA Latin-American Free Trade Association MAP Ministry of Agriculture and Fisheries MEF Ministry of Economy and Finance OPYPA Office for Agricultural Planning and Policy PLAN Agricultural Plan SEPLACODI Secretariat for Planning, Coordination and Information SERPA Economics and Registration Office of the Agricultural Plan SIL International Wool Secretariat SUL Uruguayan Wool Secretariat [ 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.   URUGUAY AGRICULTURAL DEVELOPMENT PROJECT Table of Contents Page No. I. THE AGRICULTURAL SECTOR .................... ...1.......... A. Major Characteristics .............................. 1 Background ................ ..1.................. Sector Composition and Production Trends ...... 1 Productivity .................................. 2 Resource Endowment and Farm Size .............. 3 Economic Policies ..... .............. 4 Marketing and Prices ..... ..................... 5 Exports ........... .................. 6 Taxation ...................................... 6 B. Agricultural Services .............................. 6 Extension ...... ................ 6 Education and Research ..... ............. 7 Rural Settlement .... .................. 8 C. Agricultural Credit ................................ 8 D. Performance Under Previous Projects ................9 Gcneral ...................................... 9 Institution Building ........... .. ............. 10 OED's Project Performance Audit Report ........ 10 II. THE PROJECT ............................................. 11 A. Introduction ....................................... 11 B. Brief Description .................................. 11 C. Detailed Features .................................. 12 Project Area ...... ............................ 12 On-farm Development ..... ...................... 13 Technical Services and Training ............ ... 16 Feeder Road Construction .................. .... 16 D. Project Cost ...... ................................. 17 E. Financing .......................................... 18 F. Procurement ....... .................. . . ......... 19 G. Disbursement ....................................... 19 This report is based on the findings of an appraisal mission (Messrs. M. Ballesteros, G. Soto, J. Glenn and F. Miyanaga (Bank) and M. Rossi (Consultant)), which visited Uruguay in June/July 1979, and a post-appraisal mission (Messrs. Ballesteros and Miyanaga) in September 1979.  Table of Contents (Continued) Page No. III. PROJECT IMPLEMENTATION .......... ................ . . . . . . 21 A. Organization and Management ......... * .............. 21 B. Policies and Procedures Under the Lending Program .. 22 C. Accounts and Audit ............. . .. ...................... 24 D. Monitoring and Evaluation .......................... 24 PLAN Farm/Ranch Development ................... 24 Rehabilitation of INC Colonies ................ 25 E. Progress Reporting ....... ..........*...........**.... 25 IV. TECHNICAL COFFICIENTS ........... . ..................... . 25 V. PRODUCTION, MARKETS AND PRICES .......... ......... 27 A. Production ........................................ 27 B. Markets and Prices ..# . ......... ... 27 Beef ........... . ............................... 27 M,ilk ............................................ s .o...... ... 28 Wool and Mutton ............ ................... 28 VI. FINANCIAL ANALYSIS ...................................... 29 A. Sub-borrowers' Benefits and Financial Rates of Return 29 B. Project Cash Flow ... ................................. 32 VII. ECONOMICANALYSISANDJUSTIFICATION .................. 32 A. Economic Analysis. . .................. 32 Rate of Return . .32 Sensitivity Analysis .. . .............. 33 B. Project Justification .............................. 34 Economic Policy, Production and Exports ....... 34 Income Distribution ........ 34 Fiscal Revenues ... 35 C. Project Risks ................................ 36 D. Environmental Impact ............. ............. 36 VIII. SUMMARY OF AGREENENTS REACHED AND RECOMMENDATION ... ..... 37  Table of Contents (Continued) Page No. ANNEXES 1 Rehabilitation of INC Settlements .................... .... 39 Table - Farm Size Distribution in the INC Colonies Included in the Project ..... 48 Chart - INC Organizational Chart ................. .. 49 2 The Banking System and Agricultural Credit ... .. ..... 50 T.1 - Income and Expenditure Statement of BROU (year ended December 31) ... ............... 54 T.2 - Balance Sheet of BROU (as of December 31) 55 Chart - Organization Chart for Bank of the Republic East of the Uruguay .... ....... 56 3 Indexing of Project Subloans ............ .. .............. 57 4 Supporting Tables and Chart T.1 - Gross Output of the Livestock Sector, 1965-76 .62 T.2 - Area, Yield and Production of Selected Crops, 1970-77 .63 T.3 - General Information on the Rural Sector, 1970 .64 T.4 - Beef Exports by Destination, 1970-77 .65 T.5 - Performance Under Previous Projects: Number and Volume of Loans by Size of Farm. 66 T.6 - Project Cost . .67 T.7 - Technical Services Project Costs .. 68 T.8 - Feeder Road Construction - Cost Estimates 69 T.9 - Estimated Project Cost and Phasing 70 T.10 - Technical Coefficients . .71 T.11 - Farmgate Prices for Agricultural Products 72 Farm Model I: 500-ha Beef Cattle/Sheep Ranch T.12 - Projected Land Use . .73 T.13 - Herd Projection. 74 T.14 - Flock Projection . .75 T.15 - Investment Cost Projection. 76 T.16 - Sales and Operating Costs Projection .77 Farm Model II: 320-ha Crop/Beef Cattle/Sheep Farm T.17 - Projected Land Use . .78 T.18 - Herd Projection . .79 T.19 - Flock Projection . .80 T.20 - Investment Cost Projection. 81 T.21 - Sales and Operating Costs Projection .. 82  Table of Contents (Continued) Page No. Farm Model III: 150-ha Dairy Farm T.22 - Projected Land Use ......................... 83 T.23 - Herd Projection .... .. ..... . . . ....................... . 84 T.24 - Investment Cost Projection ................. 85 T.25 - Sales and Operating Costs Projection ....... 86 Farm Model IV: 200-ha INC Settlement Crop/ Dairy/Sheep Farm T.26 - Projected Land Use ............. ............. 87 T.27 - Herd Projection .............. ............... 88 T.28 - Flock Projection ......... . .................... . 89 T.29 - Investment Cost Projection .................. 90 T.30 - Sales and Operating Costs Projection ........ 91 Farm Cash Flow T.31 - Model I: 500-ha Livestock Farm ............. 92 T.32 - Model II: 320-ha Mixed Farming . .93 T.33 - Model III: 150-ha Dairy Farm ............. .. 94 T.34 - Model IV: 200-ha INC Settlement Farm .. 95 T.35 -BROU Project Cash Flow ................ * ..... 96 T.36 - Economic Rate of Return Calculation .... ..... 97 MAP - IBRD 14493 - Major Project Areas and INC Colonies Included in the Project  URUGUAY AGRICULTURAL DEVELOPMENT PROJECT I. THE AGRICULTURAL SECTOR A. Major Characteristics Background 1.01 Uruguay has a population of about 2.8 million, growing at about 0.8% per year; per capita income in 1978 was US$1,610. About 90% of the population is urban, with greater Montevideo (the Departments of Montevideo and Canelones) accounting for almost three-fifths of the total. About two-fifths of the total population is economically active, one of the highest rates for any country in South America. Some 51% of this active population is employed in the services sector, about one-half of it in the public sector. Industry absorbs 29%, and agriculture 20%. 1.02 Agriculture plays a fundamental role in Uruguay. Although this sector accounts for only about 15% of GDP, agricultural products in various stages of processing represent nearly 90% of total merchandise exports. The importance of agriculture in Uruguay's external trade reflects basic under- lying characteristics of the country such as relative abundance of land suit- able for agriculture and grazing, a small population, and a lack of known mineral resources. Sector Composition and Production Trends 1.03 The agricultural sector of Uruguay consists of two well-defined and geographically separate subsectors: livestock and crops. Livestock accounts for 60% to 70% of agricultural output and consists primarily of extensive cattle and sheep raising; dairy, swine and poultry farming are still relatively minor enterprises. The crop subsector is dominated by cereals, mainly wheat; in recent years, however, the dynamism to the subsector has been provided by two new types of activities; rice growing in the central-eastern part of the country, and fruit, mainly citrus and grapes, in the central-western area. 1.04 Physical, climatic, economic and social factors have combined to give Uruguay a comparative advantage in livestock production which has historically dominated, and is expected to continue to dominate, agricultural activity. Extensive areas of shallow or very shallow soils best suited for pasture; a predominant prairie-type vegetation; and a relatively homogenous temperate climate which facilitates improved pasture grass and legume develop- ment and adaptation of most of the recognized livestock breeds for production of beef, milk, and wool have resulted in the predominance of the livestock subsector over crops.  - 2 - 1.05 The fact that 90% of the country's area is well suited to native or improved pasture production, while only a much smaller proportion of the soil is suitable for cropping, is the principal factor behind the comparative advantage of livestock over farming. This advantage is accentuated by the high irregularity of precipitation, with wide variations around the yearly average of 1,000 mm, which poses a more serious risk to agricultural crop development than to livestock. This risk, however, can be lessened by a livestock-crops rotation as recommended in the technological package of the proposed project. This rotation incorporates the use of a minimum cost fertilization package, basically phosphorous, which stimulates plant growth. This mineral is particularly important to allow for legume production, which, in turn, increases the nitrogen reserves of the soil. The nitrogen build-up after a four- to five-year period in legume-grass pastures provides the basis for crop production with minimum levels of nitrogen fertilization. 1.06 Livestock production in Uruguay has shown sharp fluctuations over the past 15 years. Thus, the late 1960s saw a significant growth (an annual rate of about 6.3%) but some of this ground was lost in subsequent years, primarily as result of cyclical changes in international prices and, in part, because of unfavorable price-cost relationships resulting from adverse economic policies (para 1.12). For the period as a whole, livestock production has remained basically unchanged (Annex 4, Table 1). Beef is the principal livestock sector product. Annual production is about 350,000 to 400,000 tons, of which 50% to 60% is consumed domestically and the rest is exported. Wool production is about 60,000 tons per year, and 90% is exported. About 100,000 tons of mutton are produced annually and the bulk is locally consumed. Milk production stands at about 700,000 tons; exports of dairy products such as cheese and powdered milk have been increasing recently and represent about 4% of total milk production. 1.07 During the past 15 years there has been an increase of about 25% in crop production basically due to increases in fruit and sugar-bearing crops (cane and beets) (Annex 4, Table 2). There has been little change in the aggregate production of grains, by far the largest component of traditional crop production. A significant change has occurred, however, in the composi- tion of grain production, with a decrease in wheat production at a rate of about 2% per year, and an annual increase in rice at about 8%. Wheat produc- tion currently hovers around the self-sufficiency level of about 400,000 tons per year; during the past three years, however, annual imports of 110,000 tons to 220,000 tons have been necessary to make up for production shortfalls due largely to adverse weather. Rice, on the other hand, has expanded rapidly in the center-east of the country, outside the traditional cropping areas; rice exports have more than doubled in the past six years to about 130,000 tons. Rice has become the third largest export commodity, after beef and wool. Productivity 1.08 Uruguayan agriculture is predominantly extensive, with yields that are substantially below those obtained in countries with a similar natural resource endowment. The adoption of relatively intensive production techniques  - 3 - based on pasture improvement has been limited by the unfavorable economic position of the sector. Improved pastures, introduced in the early 1960s, reached a peak level of 12% of total grazing land in 1973, but the low price of cattle in subsequent years resulted in a reduction of this proportion to 8.5% in 1977, as previously improved pastures were overgrazed in an attempt by producers to wait out the low prices, and little refertilization was practiced due to poor benefit/cost relationships. The resulting limited carrying capacity of unimproved land in the livestock sector (less than one animal unit per ha), is reflected in low production of beef per hectare at 45 kg/ha which is only 56% of the level reached in Argentina and 32% of that reached in New Zealand. A similar situation is found in the wool subsector. The cattle slaughter/stock ratio provides further evidence of the low productivity of beef production in Uruguay. During the period 1971-76, this indicator averaged 16% in Uruguay compared to 33% in New Zealand. 1.09 Low yields are also a common feature of the crop subsector. On the average, yields in Uruguay for such traditional crops as wheat and sunflower are about one-half of those obtained in comparable countries. Wheat, the country's main crop, has experienced a noticeable stagnation in yields despite the well-known technological improvements in production available since the early 1960s. The same is true of other crops with the exception of rice and sorghum, both relatively new crops in the country. The poor yield perform- ances are largely explained by the low levels of technology employed and the effect of erosion on soil quality; erosion, in turn, is the combined result of thin topsoil conditions and inadequate soil management practices. The extent to which crop production can be increased through expansion in the area cultivated might vary considerably depending on how much of the land classified as potentially arable is free from erosion problems. On the other hand, ample room exists for increasing crop yields. Resource Endowment and Farm Size 1.10 Uruguay's ample endowment of land resources and limited rural population makes inevitable the predominance of large farms (by international standards), albeit with low average income per hectare. Furthermore, land distribution and agricultural production closely follow the soil conditions which have widely varying suitability for agriculture and productivity levels. Agricultural crops are concentrated largely on the deep productive soils of the Western Littoral (along the Uruguay River) and rice and other irrigated crops in the Northeast. As a consequence of suitable soil conditions and the market opportunities provided by Montevideo (about 65% of the population), truck crop and dairy activities are concentrated near the capital. Beef and sheep are raised in the remaining parts of the country on medium- or large- sized farms (500 ha or above) due to unsuitability of physiographic conditions for most agricultural crops although, in some areas, deeper and more productive soils allow cultivation of grains or other annual crops. Thus, a farm of 500 ha in Uruguay represents a reasonable average between the deep productive soils of the Western Littoral and the shallow, pasture-adapted conditions of other regions; this is also the average of the size of various types of farms (livestock, mixed livestock/crops and mixed dairy/crops).  - 4 - 1.11 While within each type of farming, income is roughly proportional to size, overall agricultural income is far more evenly distributed than land, because of different types of farming e.g. livestock vs. the more intensive dairying. The number of farms below 500 ha--which has come to be adopted in Uruguay as the rough dividing line between the smaller farms and the others--is about 88% of the total number of farms in the country, covering about 28% of the total agricultural area--mostly around Montevideo and in the Littoral areas (Annex 4, Table 3). This proportion, however, is somewhat exaggerated since it includes a number of small holdings which have either mixed rural/ urban characteristics or are being used as part- or full-time homes by people employed in towns. Economic Policies 1.12 Until recently, economic policy in Uruguay focused primarily on inward-oriented industrialization. Many of the policies that were instituted and pursued over the years, with some modifications from time to time, acted to depress agriculture by transferring resources from rural to urban activities. Thus, policies such as: (a) price controls on agricultural products; (b) export taxes on traditional commodities such as beef and wool; (c) high tariff duties on industrial imports, including agricultural machinery; (d) an overvalued exchange rate; and (e) subsidies to inefficient state enterprises through direct government control of industries such as meat packing, reduced the profitability of agriculture and fostered an inefficient system of land use. 1.13 Government policies began gradually to acknowledge the country's dependence on agricultural growth in the mid-1970s. Finally, in August 1978 a set of policy measures was announced that reflected the high priority accorded to the development of the agricultural sector, particularly the livestock subsector where the country's greatest comparative advantage lies. The measures included: (a) elimination of fixed livestock and crop prices; (b) elimination of export duties and geographical barriers for beef and wool marketing; (c) establishment of a uniform import duty of 30% for crops; (d) removal of import restrictions on agricultural machinery (including tractors), establishment of a maximum 10% tariff on assembled tractors and farm machinery and elimination of tariffs on all other agricultural inputs; (e) sale of state-owned meat plants to the private sector; and (f) modifica- tion of the tax on the average potential yield of farms from a gross to a net income basis. Except for the sale of meat plants, which is in process, and the tax reform, which is before the Council of State, all these measures have been implemented. 1.14 The adoption oi these free-market policies for agricultural produc- tion coincided with a general upward swing in world prices, particularly for beef. In the span of one year, beef prices tripled in Uruguay. Producers responded by greatly increasing their plantings of feed crops and their investments in improved pastures. Fertilizer use in 1979 was proceeding at a rate 200% above the average in the previous three years. 1.15 Production in 1979 will not show gains comparable to input use. This is to be expected, however, given the normal retention of animals during the rising price phase of the cattle cycle and the likely substitution of feed crop for food crop plantings during the past year. In addition, the  first six months of 1979 were exceptionally dry. In the medium-term, however, adherence to the free-market policies in the context of generally favorable world prices, should bring about a prompt recovery followed by substantial growth of the agricultural sector of Uruguay. Marketing and Prices 1.16 Marketing of crops is handled by the private sector without Govern- ment interference and no major problems are evident. The Government did, however, have a significant intervention in beef marketing via regulation of the meat-packing industry and direct operation of five state-owned meat packing plants that supplied most of the domestic market (the Montevideo- Canelones area). In August 1978 these intervention measures were abrogated and the meat packing plants are now being sold to private entrepreneurs. 1.17 There are three distinct markets for meat, each absorbing roughly one-third of the total supply: the export market, the capital city area (Montevideo-Canelones), and the interior or rest of the country. Processing facilities are correspondingly differentiated. The export market is supplied basically by ten modern and efficient packinghouses that meet the hygienic and sanitary standards required. The Montevideo-Canelones market has been largely supplied by the five state-owned meat packing facilities which are now being transferred to private ownership. This transfer is expected to improve operating efficiency and reduce processing costs, which were running as much as one-third higher than in export market packinghouses. The interior is supplied from smaller local slaughterhouses which are typically simple, low-cost operations. Although some of the existing processing plants are currently antiquated, aggregate capacity is considered sufficient to handle the increased production expected under the proposed project. 1.18 Milk processing and marketing has been historically dominated by the National Dairy Products Cooperative (CONAPROLE). The system works effi- ciently and ensures ready availability of dairy products throughout the country. Additional processing and distribution facilities are being currently installed outside CONAPROLE's system (Annex 1, para 19), which should ensure continued efficiency in processing and domestic marketing as well as expansion into export markets in other Latin American countries. 1.19 Prices of agricultural products and inputs were subject to numerous direct and indirect controls, the net effect of which was a massive transfer of resources from agriculture to the rest of the economy. It has been esti- mated, for example, that in 1976/77, when beef export prices increased sharply from the depressed levels of the previous two years, input and output price manipulations were equivalent to a tax of 63% of the total value of beef production, in addition to the 23% collected as taxes. 1.20 Crop and meat prices were decontrolled in August 1978. Given the extremely depressed state of crop agriculture as a result of past policies and unfavorable weather, a protective duty of 30% is currently in effect. The only price that continues to be established by the Government is that of high grade fluid milk, which currently covers about 60% of total production; this price is revised quarterly to allow for changes in the cost of inputs. The price of milk for industrial processing is market-determined.  -6- Exports 1.21 The aggregate value of merchandise exports during 1976-78 was about US$600 million per year, of which 16% were beef, 20% wool, 5% rice and 4% hides and skins. Exports of manufactured goods accounted for 42% of the total, compared to about 10% a decade earlier. Since the bulk of these non- traditional exports, predominantly textiles and leather goods, continue to be produced from agricultural raw materials, agriculture remains the principal source of Uruguay's merchandise exports. 1.22 There has been a significant shift in the destination of Uruguayan exports since the mid-1970s, following the closing of EEC's markets to beef (Annex 4, Table 4). Latin American Free Trade Association countries have emerged as major markets for meat, rice and the newly developing exports of dairy products. Exports to the US and the Middle East have also increased considerably. The market outlook for Uruguayan exports, traditional as well as non-traditional, is favorable. Taxation 1.23 The principal direct tax on agricultural incomes is IMPROME (Impuesto a la Produccion Minima Exigible - established in 1968), which is a tax on the average gross potential income of each farm. IMPROME accounted for 40% of all agricultural taxes and 31% of all taxes on income and profits in 1977. The level of taxation is linked to a potential and predetermined level of production, irrespective of whether or not it is actually reached. This poten- tial level of production on a particular farm is arrived at by applying an index of the productive potential of the corresponding land compared to the average for the country. These indexes are calculated by an agency under the Ministry of Agriculture (Comision Nacional de Estudio Agroeconomico de la Tierra - CONEAT) on the basis of countrywide soil surveys. One hectare of average productive potential is commonly referred to as 1 ha with CONEAT index 100. 1.24 IMPROME thus constitutes a fiscal instrument which incorporates incentives to achieve at least average productivity. This administratively complex tax is workable because of: (a) accurate studies about soil utiliza- tion; (b) relatively uniform soil types; and (c) a generally efficient civil service to supervise the program and ensure its equitable application. Tax reform legislation is currently under consideration that would substitute net income for gross income as the tax base of IMPROME, and would consolidate into a single tax a variety of other levies that account for about 20% of agricultural tax collections. The reform does not seek to increase the tax burden on agriculture, but rather to simplify the present system and render it more equitable. B. Agriculture Services Extension 1.25 The Ministry of Agriculture and Fisheries (MAP) is assigned exten- sion functions, but its activities in this field are limited. A reorganiza- tion of MAP is being considered that would systematize and increase the  scope of the extension services. At present, the bulk of public technical assistance is provided by the Agricultural Plan (Plan Agropecuario, PLAN), an autonomous agency under the supervision of MAP. PLAN has been the executing agency of previous Bank-financed livestock projects (para 1.37). It provides support and assistance to farmers in improving livestock and pasture management practices. The PLAN has made efforts in recent years to give special attention to the needs of groups of smaller farmers such as milk producers and mixed farmers in different parts of the country. The National Settlement Institute (INC), an autonomous agency under the MAP, provides limited technical assis- tance to farm settlers. 1.26 Private technical assistance services have developed considerably in recent years. Two major forms exist. One is crop-specific and production- oriented assistance provided by agroindustrial concerns to producers of their respective crops, such as rice, soybeans, sugarcane and beets, barley, and milk. The other is assistance, mainly on farm management, sought by producers that form groups for that purpose. Some of these groups follow the patterns of the Regional Centers for Agricultural Trials (CREA) that have emerged in Argentina following models developed in France. The 40 CREA groups spread throughout Uruguay and covering more than 400,000 ha are associated into a national institution, FUCREA, 1/ which provides support to individual groups by disseminating the CREA approach to agricultural development, coordinating technical assistance, assisting in the formation of new groups and improving the technical level of CREA members and technicians through training courses, study groups, seminars, and such and the publication of a specialized magazine and technical reports. FUCREA also provides a list of approved agricultural advisors to farmers wishing to contract technical assistance directly. 1.27 A separate type of technical assistance is that provided by the Uruguayan Wool Secretariat (SUL) to sheep ranchers and farmers through its Commission for Ovine Improvement (CMO). SUL's affiliation to the Inter- national Wool Secretariat (SIL) provides an opportunity to improve local technologies through experience gained in other countries, supported by local research. Education and Research 1.28 Agricultural education at the university level is a responsibility of the National Faculty of Agronomy which works in close coordination with MAP's system of six agricultural research centers organized around the central experiment station, the "Alberto Berger" Agricultural Research Center (CIAAB), better known as "La Estanzuela." This center, which in the past enjoyed a high prestige in Latin America, has suffered serious and continuous financial and staffing deterioration in recent years. Research, and the transfer of results to farmers, is the responsibility of the Agricultural Research and Technical Assistance Program, a specialized division in the Ministry of Agriculture, largely concentrated on improving methods for the transfer of technology. In addition, the MAP operates a Center for Veterinary Research 1/ Uruguayan Federation of Centers for Agricultural Trials.  - 8 - and, in recent years, has been emphasizing agro-economic research through its Directorate for Agricultural Economics Research (DIEA), which produces most of the published agroeconomic data in the country. A National Commission for Land Agro-economic Studies (CONEAT) is actively engaged in collecting and analyzing information related to land tenure, management and other geo-agro- nomic aspects to be used in the improvement of agricultural policies. Rural Settlement 1.29 Responsibility for rural settlement and land redistribution in Uruguay lies with INC (Annex 1). INC has a priority option in the purchase of land from private owners and, in some special cases, is legally authorized to expropriate land which is required for special settlement projects or which is consistently not used or underutilized. Land acquired by INC is subdivided into smaller but economically viable lots and distributed for purchase in installments or rental among selected settlers. The agency also provides limited technical and financial assistance to its settlers and, through agreements with other national and local agencies, provides support in marketing agricultural products and in developing basic settlement infra- structure. C. Agricultural Credit 1.30 Institutional agricultural production credit is provided almost exclusively by the Bank of the Republic East of the Uruguay River (BROU), a multipurpose state-owned bank (Annex 2). BROU provides several short-term lines of credit for the agricultural sector through its 82 branch office network covering the entire country. Except for loans made under the Bank- financed PLAN program for livestock development and some machinery loans with a two-year repayment period (only 5% of its portfolio), BROU's lending until now has been all short-term. During the past five years, BROU made about 50,000 loans per year amounting to about US$180 million for agricultural production. BROU establishes a ceiling on the credit amount per ha for each crop and finances a higher proportion of the total production cost for small- scale and medium-scale farmers following a policy of assisting smaller producers (Annex 2, para 15). Interest rates have been generally below the high inflation rates that have prevailed in Uruguay over the past 10 years. 1.31 The Bank-financed PLAN livestock development program has been the major source of long-term development credit in the agricultural sector. 1/ The proceeds of the Bank loans and Government counterpart funds were made available to the Livestock Fund (FG) in the Central Bank which, in turn, rediscounted the subloans made by BROU under the technical supervision of 1/ BROU recently established a long-term credit facility for forestry projects.  PLAN. Indexing of subloans was introduced in 1969 in view of the prevailing and expected high inflation. However, the indexing procedure suffered from a few major shortcomings that detracted from effective repayment correction (para 3.12). 1.32 There are 21 private banks in Uruguay. Their agricultural sector operations, while representing 30% of their total loan portfolio, are heavily concentrated on marketing financing rather than production activities. D. Performance Under Previous Projects General 1.33 The Bank has made seven loans to Uruguay, amounting to US$71.7 million, to help finance five livestock development projects in support of the National Development Plan launched in 1957. Project objectives have been to increase beef production and exports through the introduction of technological improvements in livestock production and through institution-building. 1.34 The First Livestock Development Project, initiated in 1961 and completed in 1965, demonstrated methods of pasture improvement on a large sample of commercial farms and this was continued under the Second Project, which was completed in 1970. The Third Project supported continuation of the livestock program for 1971 while the Government resolved remaining sector policy issues, especially in the meat packing industry, and thereby restored the confidence of ranchers so that they would once more invest in ranch development. The Fourth Project, started in 1972, was financed in two stages: Loan 816-UR (US$11.2 million), which was intended to finance operations in 1972 but actually covered operations for both 1972 and 1973, and Loan 940-UR (US$13.5 million), which was intended to finance 1974 operations but in fact financed 1974 and 1975 activities. The main reasons why the Fourth Project covered a longer period than anticipated were, firstly, repeated devaluations of the peso following appraisal which reduced the amount of dollars needed to cover the Bank share of the expenditures made in pesos, and, secondly, delays by the Central Bank in claiming reimbursements from the Bank which had the effect of reducing the dollar disbursement by the Bank because of changes in the exchange rate between the time subloans were financed and the time disbursements were made actually by the Bank. These same factors partly influenced disbursement of the Fifth Livestock Project (Bank Loan 1166-UR for US$17.0 million) which is about two years behind the schedule estimated at appraisal. In addition, the project life has coincided with the trough of the international beef price cycle. However, policy changes made in August 1978 to encourage increased long-term investment and increased world beef prices have significantly increased loan disbursements during 1979. About US$1.5 million remained undisbursed as of January 11, 1980. 1.35 Each of the five projects has financed ranch improvements to in- crease the livestock carrying capacity of the pastures and the production of beef and has also covered technical and consultant services. In addition, the Third and Fourth Projects financed the purchase of equipment and machinery  - 10 - to produce, harvest and process high quality legume and grass seed and hay and improvements in the meat inspection, hygiene, and processing services designed to raise the quality of meat exports. Approximately 59% of the project subloans has been made for pasture improvement; 20% for machinery and equipment; 6% for fencinR: 5% for water points, and 10% for miscellaneous investments. Participating farmers have financed about 35% of their on-farm investments, considerably in excess of the minimum 20% required. Approxi- mately 70% of the number of loans and 40% of the volume of credit have gone to farmers with less than 500 ha (Annex 4, Table 5). 1.36 All five projects have been executed by PLAN, which also assists ranchers and farmers in the preparation and evaluation of their investment proposals. Under the First and Second Projects, funds for the lendinR proRram were channeled through a Livestock Fund established in BROU. Commencing with the Third Project, however, on-lending funds have been channeled through the FG established in the Central Bank. FG partially reimburses BROU for subloans made to ranchers. Institution Building 1.37 The period of implementation of the five livestock projects has witnessed the parallel growth of the PLAN which has won recognition by the livestock production sector as the prime source of technical assistance. The location of its technicians throughout the country allows frequent contact with all strata of producers. This reputation has caused the agency to attract a number of responsibilities in addition to serving project clients, such as providing technical assistance to producers who wish to invest private funds, supervising complementary lines of credit of BROU, and acting as a fiscal agent for the Government in the evaluation of ranch investments, which qualify as deductions from the IMPROME tax base. OED's Project Performance Audit Report 1.38 The OED's PPAR of the Fourth Livestock Development Project (Second Stage, Loan 940-UR) dated June 29, 1979 highlighted four issues: (a) the fact that the diffusion of improved pastures appeared to be reaching a plateau under the price, technological, and management conditions prevailing through 1977; (b) the effect of sectorial economic policy during 1976-78 on project investments, and the announcement of major policy changes in August 1978; (c) the development of the project monitoring and evaluation component; and (d) the continued use of imperfect monetary correction on project subloans (PPAR, para 7). 1.39 Regarding the diffusion of improved pastures and sectorial economic policy, the PPAR concluded that "further improved pasture diffusion is possi- ble, but were (it) to become significant, a set of sectoral conditions must be altered. The policy changes initiated in August 1978, which the Bank has encouraged, move clearly in this direction" (PPAR, para 7). The August 1978 agricultural sector policies would be maintained under the project (para 7.11). The PPAR rated as "of high standard" the monitoring and evaluation system established by the Plan (PPAR, para 43). Finally, the imperfections in carrying out the monetary correction on project subloans would be remedied in the proposed project (paras 3.12 to 3.14).  - 11 - II. THE PROJECT A. Introduction 2.01 The Government of Uruguay has requested a Bank loan to help finance an agricultural development project that would provide further assistance to Uruguay's national livestock and crop development program by making available medium- and long-term credit to beef cattle, sheep and dairy producers for pasture and associated crop improvement and other on-farm investments (tradi- tional component) and by assisting selected colonies of the INC to convert from traditional crops to dairy or mixed dairy-crop farming in areas where continuous cropping and erosion processes have resulted in continuously decreasing agricultural yields (INC component). The proposed project was prepared by the Government with Bank assistance and appraised in July, 1979. 2.02 The proposed project constitutes the entire program of official medium- and long-term credit for agriculture during the next three years. It aims at accommodating an expanded demand for investment credit by producers, in response to the favorable outlook of domestic and world market prices and the new economic policies of the Government. Since individual on-farm investments would be carried out over three years, the proposed Bank loan would have a three-year commitment period with disbursements over five years. B. Brief Description 2.03 The project's objectives would be to consolidate and to expand countrywide the transfer of technologies developed through the programs of research and the experience of earlier livestock development programs and to emphasize the improvement of agricultural crops in traditional agricultural areas where low fertility and soil erosion constitute a limiting production factor. Through this program, the Government proposes to (a) increase produc- tivity in beef cattle and sheep ranches already under production, thus in- creasing production and exports of these products for which the country has a comparative advantage; (b) promote improved cropping practices in areas to which the crops are ecologically suited, ensuring a rational use of land through adequate rotation systems; (c) increase milk production and make use of the favorable market for export of dairy products; and (d) increase the income of smaller farmers by reorienting their production patterns in such a way as to control erosion and improve soil fertility and provide use of farm family labor throughout the year. 2.04 To meet project objectives, funds would be made available for (a) on-farm investment, including seeds, fertilizers, fencing, water points and small irrigation works and equipment, corrals, farm machinery, dairy farm equipment and facilities, and breeding stock; (b) construction of rural roads in the selected INC colonies to facilitate marketing of their products; and  - 12 - (c) improvement of technical assistance facilities (vehicles, office equip- ment, and such) and services as well as training abroad and in-country of PLAN and INC technical staff and short time consultants for both institutions to assist in resolving specific technical issues. 2.05 Three agencies would be involved in project implementation: PLAN with overall responsibility for project implementation, INC and BROU. PLAN and BROU are agencies well known to the Bank, having been associated with the implementation of five Livestock Development projects. INC would be involved for the first time in a Bank-financed project, bringing thereto a considerable element of institution-building. 2.06 The project would provide credit to participating ranchers and farmers through the BROU on the basis of farm investment plans approved by PLAN technicians. Technical assistance by PLAN and INC technicians would be provided free to farmers with less than 1,000 ha. Larger producers would have to purchase technical advice from private technicians prequalified by PLAN; PLAN approval would also be required of private technicians' farm investment plans before presentation to BROU to request credit under the project. C. Detailed Features Project Area 2.07 The project would be countrywide in scope. However, the largest development is expected in the following areas: (a) cattle and sheep ranch- ing, in the central and northwestern areas of the country with basaltic and crystalline soils; (b) crop/livestock mixed farming in the western littoral area; and (c) dairy development in the south-central Montevideo basin. The INC colonies included in the project are located in the littoral region (see map). 2.08 Basaltic Region. This extensive area covering about 3.5 million ha (21% of the country's area) comprises mainly dark clay loam to sandy loam soils derived from basaltic rocks. Effective depth is shallow to very shallow and, except for widely scattered and limited areas of deeper soils, generally in the area of contact with the alluvial soils of the littoral, these lands are best suited for pasture only or in rotation with small grain. It is in this area, as well as in the Crystalline, that the majority of the cattle- sheep ranches can be found. 2.09 Crystalline Region. This region comprises some 3.9 million ha and is subdivided into two areas. The first one (2.6 million ha) occupies a large portion of the central part of the country and comprises deep soils of  - 13 - medium texture and generally low inherent fertility, derived from the under- lying crystalline rocks. These soils are highly susceptible to drought and erosion and, except in limited areas on the eastern and southern borders of the region, are mainly suited for pasture and some grain. The second area, located in the eastern part of the country, covers 1.3 million ha and has soils very similar to the first but even more vulnerable to drought and erosion risks. Both the areas together represent 23.5% of the country's surface and account for a large number of the cattle and sheep ranches of the country. 2.10 Littoral Region. Suitability to crop production and geographic location along the Uruguay River have been the two major criteria for iden- tifying this region, which covers about 1.4 million ha. Soils are extremely variable ranging from deep, heavy, productive soils of basaltic origin with somewhat limited internal drainage in the northern Artigas and Salto Depart- ments, to moderately deep light textured soils of low fertility associated with more productive soils in the southern portion of the region. In the central area, mainly in the Paysandu Department where the selected INC colonies are located, the soils are much lighter in texture and lower in inherent fertility, thus being more susceptible to chemical depletion and erosion. In the northern part of the region, where the "Dr. Antonio Rubio" settlement is located, however, there are .areas of deep soils of basaltic origin which do not correspond to the typical shallow Basalt Region nor to the predominant soils of the Littoral and have therefore not been included in either category in the map. These lands show signs of depletion after years of continuous cropping but have a marked response to crop-pasture rotation and to the introduction of improved pastures including legumes. 2.11 Southern Region. This region, extending around the capital city of Montevideo to the north, east and west, covers about 900,000 ha of mainly deep, heavy, productive soils with medium to high fertility. Dairy and truck farming dominate the agricultural activities in this region, close to the nation's largest domestic market and main export point. Except for some isolated milksheds throughout the country, the majority of dairy farming activities included in the proposed project would be located in this region. On-farm Development 2.12 Farm plans have been developed for enterprises that are represen- tative of farms in the various areas of Uruguay. The illustrative models correspond to four types of enterprises; cattle-sheep ranches, crop-livestock farms, dairy farms and INC mixed dairy-crop farms. Greater variability as to farm size and level of development exists in the typical cattle-sheep area which accounts for the majority of the land area of the country, while dairy crop-livestock and INC models would have smaller variations around the models presented. Throughout this report, farm size is expressed in ha with CONEAT index 100 (para 1.23). 2.13 Livestock Development (Farm Model I). The beef-cattle-sheep model represents a 500-ha farm in the basaltic and crystalline geographical areas where extensive production is traditional. There are natural soil fertility differences in these zones, which could give an advantage in levels of production  - 14 - to the crystalline zone, but due to the overriding importance of management of pastures and cattle for productivity and the lack of significant difference in these human-influenced factors among zones, it is considered permissible to group them in the models. The model illustrates a beef-sheep complete cycle production scheme with the production of fat steers and lamb for slaughter. Improved pasture is increased from 1% of total pasture area without project to 20% at full development. Pasture improvement is the major investment item, with smaller investments in fencing, water points, stock handling facilities, and machinery and equipment. About 1,900 beef-sheep ranches would be expected to participate in the project. 2.14 Mixed Farm Development (Farm Model II). This represents a 320-ha crop-livestock farm situated in the littoral or south-central-western part of Uruguay, the traditional grain producing areas. Due to the high cost of nitrogenous fertilizers, there is an ever increasing interest in the use of pasture-crop rotations, utilizing phosphatic fertilizers to stimulate legume growth in pastures and taking advantage of the natural nitrogen build-up during this rotational phase to produce grains in the crop rotation with relatively low levels of chemical nitrogen application. Because of the relatively longer period required for pastures in the rotation, the proportion of total farm area dedicated exclusively to crops decreases from 38% to 34%, but an additional 11% is planted with crops in association with new pastures. Area in improved pasture increases from 7% of total land area to 56%, permitting the farmer to continue a complete cycle for sheep and to shift from breeding to fattening for cattle. The investment to be undertaken is primarily in pastures, with machinery and equipment and livestock management infrastructure having secondary importance. About 600 mixed farms would participate in the project. 2.15 Dairy Farm Development (Farm Model III). The 150-ha dairy model is representative of farms on better soils located near the main population centers, especially Montevideo. These are primarily family-owned and operated units with a relatively large percentage of improved pasture without project (40%) which is increased to 83% at full development. In addition to pasture improvement, investments are to be made in milk handling facilities (milking machines, milk sheds, cooling tanks), fencing and watering facilities. About 300 dairy farms would participate in the project. 2.16 INC Model (Farm Model IV). The INC rehabilitation model utilizes an approximate average farm size of 200 ha. The project would encourage a shift in production from a basically crop to mixed farming system with emphasis on dairy cattle. Farmers would continue to produce crops but would decrease from 37% to 30% the farm area in cultivation and increase area in improved pasture from 25% to 54%. This should result in better utilization of family labor by increased emphasis on dairy cattle and sheep production, and allow for improvement in soil conservation and fertility. On-farm investment would be primarily in pasture improvement, machinery and equipment and livestock management facilities. The INC project component would include about 220 farms.  - 15 - 2.17 The following table shows the type and average cost of the three year investment plans expected for each farm category: Number of Subloans Investment 1/ -------Year ---(US$'000)--- 1 2 3 Total Average Total % Livestock ranches (F.M. I.) 620 640 640 1,900 16.9 32,100 44 Mixed farms (F.M. II) 200 200 200 600 39.5 23,700 32 Dairy farms (F.M. III) 100 100 100 300 33.1 9,900 13 INC farms (F.M. IV) 70 75 75 220 36.5 8,000 11 Total 990 1,015 1,015 3,020 73,700 100 1/ Excluding price contingencies. 2.18 The composition of investments in each farm model would be as follows: Farm Model Investment I II III IV I II III IV (US$ '000) (% of Total Investment) Pasture Establishment 10.2 22.4 12.3 9.3 60 57 37 25 Fencing 1.5 3.4 1.8 2.1 9 9 5 6 Water points/Irrigation .2 2.3 1.0 4.1 1 6 3 11 Buildings & Construction - - 1.9 1.7 - - 6 5 Machinery and Equipment 5.0 11.4 12.1 11.3 30 28 36 31 Cattle - - 4.0 8.0 - - 13 12 Total 16.9 39.5 33.1 36.5 100 100 100 100 2.19 The investment costs per farm are substantially higher than those in previous projects in Uruguay. To a considerable extent, this is explained by (a) the increased cost of fertilizer and petroleum products, which weigh heavily in the cost of establishment of improved pastures, and (b) the longer investment period (three years, instead of one or two) contemplated under the proposed project. In addition, investment costs are high because of increased investment expected in farm machinery. 2.20 Under the proposed project, the investment in machinery is based on purchases of tractors and equipment by one-third or one-half of the participa- ting farmers, depending on the model. This relatively high proportion follows from the low rate of acquisition of machinery and equipment in recent years due to the high import duties prevailing. Since 1978 those duties have been reduced to 10% and a general replacement of equipment is now practical not- withstanding the considerable increase in prices in the international market.  - 16 - 2.21 The above considerations also apply to the INC settlers and lead to a high investment per farm. The possibility of equipment sharing by these producers was investigated, but was not deemed feasible due to the seasonality of equipment use. This substantial investment in machinery by one out of every two INC settlers and the significant investment in construction and in livestock are called for by the shift which they are seeking to achieve from a purely crop production pattern to a mixed crop-dairy system. Technical Services and Training 2.22 Technical services provided by PLAN and INC would be supported under the project. Training would be provided both locally and abroad to PLAN and INC technicians, particularly to new (replacement) PLAN technical staff and to the INC technicians assigned to work with the selected settlements. Additional funds would be provided for replacement of vehicles, machinery, office equipment and materials for demonstration work and technical assist- ance. Short-term consultant services would be provided to strengthen both the PLAN and the INC programs for a total of about 88 man-months. Training for agents of both institutions would be provided for a total of 120 man- months of fellowships for PLAN and 28 man-months for INC. 2.23 Work on a future project, for possible Bank financing, with emphasis on support to small farmers is expected to be undertaken in Uruguay during the life of the proposed project. Adequate expertise for project preparation is available in the country as is relevant statistical data for the tradi- tional components, from the PLAN's monitoring and evaluation system and other sources. Some field surveys and other prefeasibility studies may, however, be needed to investigate the position of small farmers in different regions and to spell out specific steps for dealing with their problems. In partic- ular, as the pilot program included in the present project for rehabilitatiiig a few INC settlements is to be extended to the whole western littoral regio) in a second stage operation, studies are likely to be required for identifyit-g suitable settlements and determining appropriate agricultural, agroindustriaL and infrastructural investments necessary for their rehabilitation. A sum of up to US$200,000 would, therefore, be available under the technical assistance component of the proposed project for financing consultant services and o_her expenditures for such studies and surveys for the preparation of a future project, as and when needed, on the basis of specific proposals received from the Government and acceptable to the Bank. Feeder Road Construction 2.24 About 60 km of farm-to-market roads would be built under ti- project to serve INC project colonies at a cost of US$600,000. About 35 km would be in the Quebracho area of the Department of Paysandu and 25 km in Colonia Rubio in the Department of Salto. These roads would permit efficient collec- tion and transport of milk from project farms to local processing plants. Construction and maintenance of these roads would be included in the existing agreements between INC and the corresponding municipalities, which execute the works on force account. INC finances 70% of the costs and the municipality absorbs the remaining 30%. This arrangement has been in operation satisfac- torily for several years.  - 17 - D. Project Cost 2.25 Total project cost, including price contingencies, is estimated at US$111.0 mill _n (including taxes and duties amounting to US$3.4 million), of which US$58.5 million, or 53%, represents foreign exchange costs. Project costs have been estimated on the basis of January 1979 prices, and a price contingency amounting to 37% of baseline costs, has been added. Price contin- gencies are based on a phasing of investment over a five-year period. The expected price increases are 11% in 1979, 9% in 1980, 8% in 1981 and 7% thereafter. A physical contingency of 15% has been applied to civil works for feeder road construction. The average cost of consultancy services is estimated at US$5,000 per man-month. The project's total consultant require- ments are estimated at 88 man-months. Project costs by component are summarized in the table below. Project Cost Foreign Project Cost Baseline Exchange Local Foreign Total Costs Costs ---(US$ million) ---- --------(%)-------- On-Farm Development Livestock Development 14.4 17.7 32.1 40 55 Mixed Farm Development 9.7 14.0 23.7 29 59 Dairy Farm Development 4.4 5.5 9.9 12 56 INC Settlement Development 4.5 3.5 8.0 10 44 Subtotal 33.0 40.7 73.7 91 55 Technical Services 4.9 1.6 6.5 8 23 Feeder Roads 0.4 0.2 0.6 1 30 Total Baseline Costs 38.3 42.5 80.8 100 53 Contingencies Physical 0.2 - 0.2 - 30 Price 14.0 16.0 30.0 37 53 Sub-Total 14.2 16.0 30.2 37 53 Total Project Cost 52.5 58.5 111.0 137 53 Note: A list of investment items which would be financed under on-farm development appears in Annex 4, Table 6. See also Tables 7 and 8, Annex 4, for details on Technical Assistance and Feeder Road Project Costs, and Table 9 for estimated project phasing.  - 18 - E. Financing 2.26 Financing of the project would be shared in the following amounts and proportions: Sub-borrowers BROU Bank Amount % Amount % Amount % Amount Project Components -------------------- US$ million------------------- Livestock development 6.4 20 19.3 60 6.4 20 32.1 Mixed farm development 4.8 20 14.1 60 4.8 20 23.7 Dairy farm development 2.0 20 5.9 60 2.0 20 9.9 INC settlement development 1.0 13 4.8 I 60 2.2 27 8.0 Technical services - - 4. 9 72 1.6 23 6.5 Feeder roads - - 0.2-' 40 0.4 60 0.6 Total Baseline Cost 14.2 18 49.2 60 17.4 22 80.8 Contingencies 5.2 18 18.4 60 6.6 22 30.2 Total Project Cost 19.4 18 67.6 60 24.0 22 111.0 1/ Government's contribution. 2/ INC would contribute 10% and municipalities 30%. 2.27 The proposed Bank loan of US$24.0 million would finance 41% of the foreign exchange cost or 22% of the total project cost. Project beneficiaries would finance US$19.4 million, representing about 18% of the total. US$60.0 million, or 54%, would be financed by BROU and US$7.6 million, or 6%, by the central government through PLAN and INC and by municipalities. The Bank loan would be made to the government at the Bank lending rate prevailing at the time of loan approval, for a term of 15 years, including three years of grace. The Government would assume the foreign exchange risk and would on-lend the proceeds of the on-farm investment component of the loan to BROU through the FG in the Central Bank; BROU, in turn, would make subloans to project benefi- ciaries. Lending terms and conditions between Government and BROU and between BROU and project beneficiaries would be set in a subsidiary loan agreement to be entered into by the Central Bank and BROU (para 3.16).  - 19 - 2.28 The project's credit program would be financed as follows: BROU Bank Total Lending Amount % Amount % Amount % ------------(US$ million)---------------- Beef-sheep ranches 19.3 75 6.4 25 25.7 100 Crop-livestock farms 14.1 75 4.8 25 18.9 100 Dairy farms 5.9 75 2.0 25 7.9 100 INC farms 4.8 69 2.2 31 7.0 100 Price contingency 15.9 74 5.4 26 21.3 100 Total 60.0 74 20.8 26 80.8 100 F. Procurement 2.29 Under the project, international competitive bidding following Bank Guidelines for Procurement, would be required in the procurement of vehicles, machinery and equipment directly imported by PLAN and/or INC, amounting to about US$800,000, whenever the size of individual contracts exceeds US$100,000. Both PLAN and INC would be encouraged to bulk such items into large contracts, either individually by each agency or jointly, whenever possible. Similar type contracts of less than US$100,000 would be awarded in accordance with the borrower's internal procurement procedures, which include local competitive bidding, acceptable to the Bank. The investment items such as fertilizer, seeds, machinery and equipment to be procured by approximately 3,000 project sub-borrowers throughout Uruguay over a three-year commitment and five-year investment period are varied and not suitable for bulk procurement through international competitive bidding. These goods, and services such as technical assistance (together amounting to about US$73.7 million), required under the sub-borrowers' investment programs would therefore be obtained through local, well-established, competitive commercial suppliers. Adequate servicing facilities are available for the machinery and equipment. Civil works for the feeder road construction, amounting to about US$600,000, would be done on force account by the municipalities. Assurances were obtained during negotiations that the procurement procedures outlined would be followed. G. Disbursement 2.30 The Bank would disburse over a period of five years: (a) 25% of the total amounts previously disbursed by BROU for subloans to project beneficiaries of the traditional component, amounting to US$16.8 million;  - 20 - (b) 31% of the total amounts previously disbursed by BROU for subloans to project beneficiaries of the INC component, amounting to US$2.8 million; (c) 100% of total expenditure for technical advisory services, training, and studies, amounting to US$1.1 million; (d) 100% of the foreign exchange expenditures for vehicles and equipment under the technical service component, amounting to US$0.8 million; and (e) 60% of total expenditures for feeder road construction, amounting to US$0.5 million. A sum of US$2 million would remain unallocated. 2.31 The Bank would reimburse for the project subloans made by BROU to project beneficiaries against a certificate of expenditure, the documentation for which would not be submitted for review, but would be retained by the BROU for inspection during the course of Bank supervision missions. Certifi- cation by BROU and the PLAN Technical Director would be required. All other disbursements would be made against normal documentation. 2.32 As in recent projects, the Bank, in converting local currency to foreign currencies, would use the exchange rate prevailing at the mid-point of the month in which subloans were made and not the exchange rate existing on the day the Bank disbursement is actually made. This disbursement pro- cedure would enable the Bank to achieve its objective of contributing its full share under the high inflation in Uruguay and the Government's policy of frequent mini-devaluations. 2.33 The estimated schedule of Bank disbursements, assuming that the date of effectiveness of the proposed loan would be no later than June 30, 1980, would be as follows: Bank FY 1981 1982 1983 1984 1985 FY Semester 1 2 1 2 1 2 1 2 1 2 Disbursement During semester 0.9 1.7 2.6 3.6 3.8 4.0 3.0 2.2 1.2 1.0 Cumulative 0.9 2.6 5.2 8.8 12.6 16.6 19.6 21.8 23.0 24.0  - 21 - III. PROJECT IMPLEMENTATION A. Organization and Management 3.01 The agencies involved in executing the project would be PLAN, INC and BROU. PLAN would have overall responsibility for project implementation, INC would be responsible for settlement rehabilitation, and BROU would be responsible for the provision of credit to farmers for carrying out investment plans designed or approved by PLAN and INC technicians. PLAN and BROU are agencies well known to the Bank, having been associated with the implementa- tion of five Livestock Development projects (paras 1.34 to 1.37), while this would be INC's first experience in a Bank-financed project. INC would estab- lish a Project Implementation Unit in the project area, which would provide technical assistance to settlers under the supervision and guidance of the Technical Directorate of PLAN. Since, under the proposed project, producers with more than 1,000 ha would have to secure their own technical assistance from private professionals, either individually or through groups such as CREA, PLAN would also be responsible for prequalification of private consultants and for approval and supervision of investment plans prepared by them. 3.02 PLAN has responsibility for preparing farm and credit plans as well as for provision of technical assistance to producers who wish to invest in their establishments with either borrowed funds or with their own. PLAN technicians are also responsible for verifying farm and ranch investments that are claimed as deductions on IMPROME taxes. These activities are carried out under the direction of a Technical Director and an Assistance Technical Director through a field staff consisting of five area supervisors, 15 zone supervisors and 80 field technicians, most of them agronomists. The Central Office in Montevideo also contains an Economics Section (SERPA) which collects field data to monitor the economic effects of investments and management practices and to disseminate the results to participating farmers. There are also sections of extension, water resources, seeds and agricultural machinery and a laboratory for soil microbiology and inoculant control. 3.03 PLAN's responsibility for maintaining high standards for farm and credit plans and for technical assistance would continue under the new project and would be extended to include training of INC technicians and approval and supervision of farm and ranch plans of these professionals as well as of private consultants who would be providing paid technical assistance to medium and large producers. At present, all PLAN staff are locally recruited and, with the exception of short-term consultants, would continue to be so in the proposed project. 3.04 All PLAN activities are carried out at the direction of an Honorary Commission and specifically through the President of the Commission and the PLAN technical director. The administration and data analysis activities are directly supervised by the technical director while field direction is chan- neled through the technical subdirector to the area supervisor, thence to the zone supervisors and finally to the field-level technicians.  - 22 - 3.05 There appears to be reasonable contact between technicians and producers. Each technician is provided with a vehicle to carry out his work. Because of low salaries relative to the private sector, basically technicians of all levels have part-time jobs and dedicate about 60% of their time to PLAN activities. There is no proposal for an increase in PLAN technical staff for the proposed project since a large portion of their technical assistance functions would be assumed by private agro-professionals. This lessening of duties should more than offset the increased responsibilities of training of INC technicians, review of INC credit plans, and supervision of private consultants, apart from assistance to other smaller farmers, including dairy and mixed farmers, who will receive greater attention than hitherto. 3.06 INC's responsibilities cover a variety of activities related to settlements of about 2,400 small farmers on land purchased by the Government. These activities include financing of land purchases, capital for farmers' cooperatives, and public services such as installation of small agroindus- tries; construction of infrastructure related to settlements; storage, market- ing and transport of agricultural products and inputs; coordination with educational institutions and public agencies; and a variety of social and cultural activities geared to settled farmers and their families. 3.07 INC is directed by a five-member board and administered by a General Manager and his support staff. The staff of INC, which totals about 260, includes 62 university-level professionals, of which 35 are agronomists; an additional 32 subprofessional level technicians; and 160 administrative officials. These personnel are distributed in seven central divisions and 12 departmental and 14 regional offices located in actual or potential settle- ment areas though 70% are assigned to Montevideo. 3.08 INC's financial resources originate mainly from rentals charged for settled lands (about 62%), with grazing fees, and contributions from Govern- ment making up the remainder. The major part of this income is taken up by the operational budget of the agency, and, because funds for expansion or develop- ment are very scarce, the decision was made to concentrate its limited resources on the execution of a small rehabilitation project in one of the critical settle- ment areas. Even the limited support for the project's settlement rehabilita- tion component would require assignment of specialized staff to assist in the preparation of farm plans and coordinate and supervise their execution. In this task they would receive support and supervision from PLAN to ensure a uniform technological level throughout the country. INC would establish a Project Implementation Unit consisting of one coordinator and seven technicians and required administrative staff. The coordinator should have qualifications and experience acceptable to PLAN and to the Bank. Assurances to that effect were obtained at negotiations. Establishment of the Project Implementation Unit would be a condition of disbursement against the INC component of the loan. Further, the execution of a contract satisfactory to the Bank embodying arrangements between INC and the municipalities for the construction of feeder roads would be a condition of disbursement of the Bank loan for the feeder roads component. B. Policies and Procedures Under the Lending Program 3.09 Credit to sub-borrowers would be channeled through BROU under a subsidiary loan agreement with the Government as represented by the Central Bank. BROU, through its Plan Agropecuario Department, would extend subloans  - 23 - to finance up to 80% of investments under the traditional project component and up to 87% under the INC component. Subloans would be made on the basis of farm plans approved by PLAN and prepared by PLAN or INC technicians or by private consultants previously authorized by PLAN (para 3.01). The cost of fees for technical assistance to prepare farm plans for subloan applications and for advisory services during the implementation of the on-farm investments, up to a maximum of 10% of the amount of the subloan, could be included as an investment item to be financed. Evaluation of the creditworthiness of subloan applicants and analysis of the investment plans would be carried out by BROU. 3.10 Project subloans would have repayment terms ranging to a maximum of 10 years, including grace periods of up to five years. Repayment and grace period terms for each subloan would be established by BROU in consultation with PLAN or INC technicians on the basis of the cash flow projection of the corresponding farm plan. Loans from the Government to BROU would have the same repayment terms as provided by BROU to its subborrowers. 3.11 The Government would on-lend the proceeds of the Bank loan to BROU 'in local currency equivalent, assuming the foreign exchange risk. However, the principal outstanding on Government loans to BROU and on the subloans made by BROU to project sub-borrowers would be adjusted in accordance with variations in one of three indexes of producer prices that would be calculated and published monthly by the Directorate of Agricultural Economics Studies (DIEA) of the MAP and the Directorate General of Statistics and Censuses of the Planning Ministry. 3.12 Indexing practice under previous Bank-financed projects experienced three major shortcomings that detracted from effective repayment correction. They were (a) stipulation that the applicable index would be the lower of a meat/wool index or the consumer price index; (b) addition rather than compound- ing of successive adjustment factors; and (c) a six-month lag between the dates of calculation and of application of the adjustment. These shortcomings would be eliminated under the proposed project. 3.13 Adjustment of principal under the proposed project would be based exclusively on indexes of producer prices. Given the objective of production diversification, the varying patterns of short-term price movement among live- stock, crops, and dairy products, and the extreme awareness and sensitivity of producers to these differences and their impact on the cash flow of their enterprises, three indexes would be employed, incorporating weights for these products derived from the corresponding farm models (meat/wool, crops/meat, and milk/meat). The index to be applied to any subloan would be determined by the technician from PLAN in accordance with the output mix reflected in the sub-borrowers' farm plan. Furthermore, successive adjustments would be compounded, and the lag between calculation and application would be reduced to two months. Further details are in Annex 3. 3.14 The methodology and operational aspects of the proposed indexing have been discussed and agreed upon by officials of all agencies involved in project design and implementation. The principles and procedures of the  - 24 - proposed indexing have been detailed in a circular issued by the BROU on December 27, 1979, which is satisfactory to the Bank. Assurances were obtained at negotiations that these indexing principles and procedures would be maintained in future years. 3.15 Prnducer's minimum contribution would be 20% of the investment cost, except project INC settlers who would contribute 13%. The maximum loan to any participating farmer would be US$150,000 (at 1979 prices). The Govern- ment, making use of reimbursements from Bank loan proceeds, would on-lend to BROU 25% of the value of BROU project subloans to traditional farmers and 31% of subloans to project INC farmers. Annual rates of interest charged by BROU to sub-borrowers on the adjusted principal would be 5% for farmers with 500 ha or more, and 3% for those with less. The BROU would receive a margin of two percentage points on Government loans. This interest rate structure has been selected to encourage investment in farming, benefitting smaller producers and to maintain the financial soundness of the institution. 3.16 The Government, through the Central Bank, would enter into a sub- sidiary loan agreement with the BROU, incorporating terms and conditions of the lending operations specified in the preceding paragraphs. The execution of the subsidiary loan agreement, acceptable to the Bank, would be a condi- tion of loan effectiveness. Assurances were obtained during negotiations that subloans would be made under the terms and conditions stated above, and that, in accordance with the recent decision of the Government's Economic Council, BROU would refrain from offering to producers lines of credit for purposes covered by the project on conditions more favorable than those agreed under the project. C. Accounts and Audits 3.17 Separate project accounts would be maintained by the Central Bank, BROU, INC and PLAN. Accounting procedures for these institutions are ade- quate. All project accounts would be audited by independent auditors accept- able to the Bank. Auditing to date, carried out by the Government Court of Accounts (Tribunal de Cuentas), has been satisfactory. Assurances were obtained at negotiations that certified copies of the audited financial statements and signed copies of the auditors' reports in respect of all the project accounts would be sent to the Bank within four months after the end of the fiscal year. D. Monitoring and Evaluation PLAN Farm/Ranch Development 3.18 Project monitoring for the farm/ranch development component would be carried out by PLAN's existing monitoring unit, Economics and Registration Office of the Agricultural Plan (SERPA). The unit would prepare annual  - 25 - monitoring reports for the component and make them available to the Govern- ment, to the PLAN Honorary Commission, and to the Bank. During negotiations, assurances were obtained that PLAN would furnish the annual monitoring reports to the Bank within four months following the end of each project year. Rehabilitation of INC Colonies 3.19 Monitoring facilities for the INC project component do not exist at present. Assurances were obtained at negotiations that a minimal monitoring unit based on the norms designed by PLAN would be established within the Special Projects department of INC. This unit could later be expanded in the event of a follow-up project to cover additional settlements under the rehabil- itation program. As in the case of PLAN, reports would be prepared and made available to Government, to the INC Board, and to the Bank within four months following the end of each project year. Assurances to this effect were obtained during negotiations. E. Progress Reporting 3.20 Semi-annual progress reports would be prepared by PLAN and INC on their respective components. The reports would be sent to the Government and to the Bank not later than two months following the end of each semester. PLAN and INC would also prepare comprehensive draft completion reports for the farm/ranch development and rehabilitation of settlements components, respectively. These completion reports would be submitted to the Government and to the Bank not later than six months after the closing date of the project. Assurances on these points were obtained during negotiations. IV. TECHNICAL COEFFICIENTS 4.01 The project area would encompass the entire range of geographic, climatic, farm size and soil type variations in Uruguay. Four farm/ranch models have been developed for the purpose of project budgeting and financial studies (Annex 4, Tables 10 to 34). Actual and projected technical coeffi- cients were based on experiences of (a) the first five livestock projects; (b) data supplied by DIEA; (c) data from the project preparation staff; and (d) experience gained from field visits and producer interviews during appraisal. The technical coefficients applied in this report are as follows:  - 26 - Livestock Mixed Farm Dairy INC Model I Model II Model III Model IV 500-ha ranch 320-ha farm 150-ha farm 200 ha farm WP 1/ FD 2/ WP FD WP FD WP FD Weaning Rate, % Cattle 59 71 59 - 3/ 60 74 55 75 Sheep 72 82 64 80 - - 70 86 Off-take Rate % Cattle 16 23 20 - 3/ 27 4/ 32 4/ 31 4/ 34 4/ Sheep 20 40 24 38 - - 24 - Stocking Rate (AU/ha) 0.6 0.8 .87 1.1 0.8 1.0 0.69 1.14 Pasture Improvement (% Improved area/ ranch) 1 20 7 56 40 83 25 54 Meat Production (kg liveweight/ha/year) Beef 37 64.5 75.9 135.4 61.7 107.7 36.6 84 Sheep 5.5 8.9 4.5 19 - - 1.2 11.7 Milk Production (liters/ha/year) - - - - 736 1,920 554 1,120 Wool Production (kg grease wool/ ha/year) 5.2 7.0 4.9 15.9 - - 0.8 6.7 Crops: (kg/ha) Sunflower - - - 900 - - 500 900 Wheat - - 900 1,500 - - 800 1,500 Soybeans - - - 1,400 - - - - Area in Crops - - 38 - - - - - (% of total farm) - - 38 34 - - 37 30 1/ Without project. 2/ At full development. 3/ After year 4, the breeding enterprise ceases. 4/ Male calves sold at birth.  - 27 - V. PRODUCTION, MARKETS AND PRICES A. Production 5.01 Annual output of the major commodities of the project farms without and with the project would be approximately as follows: With Project Incremental Production Without at Full as Percentage of 1974-78 Commodity Project Development Average National Production (tons '000) ( Wheat 78.0 109.0 8 Sunflower/Soybean 3.3 31.0 44 Beef 1/ 2/ 51.0 108.0 14 Sheep 1/ 10.0 23.0 12 Milk 50.0 129.0 12 Wool 7.0 10.0 5 1/ Liveweight. 2/ Includes breeding heifers available for sale. 5.02 At full development, it is estimated that annual incremental produc- tion resulting from the project and its proportion to the country's 1974-79 average production would be respectively, about 27,600 tons and 44% for sunflower and soybean; 57,000 tons and 14% for beef; 79,400 tons and 12% for milk; 13,000 tons and 12% for sheep; 3,000 tons and 5% for wool. Using 1978/79 farmgate prices, the total value of annual incremental production due to the project would be about US$55 million and the incremental herd value would amount to US$28 million at full development. B. Markets and Prices Beef 5.03 Incremental project production of beef would be largely for export. Uruguay exported 100,000 tons to 150,000 tons (carcass) of meat each year during 1974-78, or about one-third of production. The long-term market out- look for beef export is favorable. The Bank projections are that beef exports from developing countries should grow at more than 5% per year. Prices are also projected to increase from US 95.6 cents per kg in 1978 to US 119.5 cents per kg in 1985 (Argentine frozen manufacturing beef export to the European Economic Community (EEC)), both expressed in 1978 constant dollars. Uruguayan exports have met some problems in the three major import markets, the USA, Japan and the EEC. The USA and Japan do not accept uncooked beef from coun- tries affected by foot-and-mouth disease and the EEC, the major market for  - 28 - Uruguayan beef until 1973, imposed a virtual ban on imports from non-EEC and associated countries in July 1974. While this ban has been gradually relaxed, EEC remains an uncertain market for large exportable surpluses of beef. Consequently, Uruguayan beef exporters have been actively seeking outlets in other areas where there is a growing demand, e.g. other Latin American countries, non-EEC countries in Europe, the Middle East and some countries in Africa. In 1978, for example, Brazil and Egypt were the largest importers of beef from Uruguay, together accounting for about 70% of the total export volume. Thus, the incremental beef production envisaged under the project should find a good export market. The marketing system and processing facilities for beef (para 1.17) are adequate to meet project needs. Milk 5.04 Milk production in Uruguay has been about 680 million liters per annum in the last five years, most of which is consumed domestically. Domestic demand has been mostly satisfied by local production, but small amounts of powdered milk are imported to fill a supply gap in wintertime. The present internal market for dairy products is about 210 liters per capita, which represents a high level of consumption. An efficient processing and distribution system ensures that dairy products are available throughout the country (para 1.18). Most of the milk produced is marketed by CONAPROLE. 5.05 All incremental production under the project would be for industrial processing. Uruguay's exports of dairy products have been growing rapidly in the past five years, rising from 2,000 tons in 1973 to 5,000 tons in 1977. Latin American Free Trade Association (LAFTA) countries, especially Brazil, Peru and Mexico, have been importing about 80% of the total. Since LAFTA countries are expected to have a deficit of dairy products amounting to 4 million tons annually over the next decade, the incremental milk production under the project should find readily accessible export markets. Best export opportunities at present are in specialized hard cheese and highly refined casein. Wool and Mutton 5.06 Production of wool in Uruguay has been around 60,000 tons per year and 90% of the production is exported mostly in the form of grease wool (about 35%) and tops (about 40%). Wool contributes 20% of Uruguay's export earnings and Uruguay accounts for 3% of the world's wool exports. The principal export market for Uruguay's wool are European countries. EEC countries import 50% of the total and East European countries, 20%. Export market prospects for incremental wool production are good. 5.07 Lamb and mutton are a secondary consideration in sheep raising. About 1.0 million head are slaughtered for sale and 80% of these (about 5,000 tons) are exported. Additionally 2 million head are consumed on the farm. There is room, therefore, to expand both exports and domestic consumption. Accord- ing to a MAP study, per capita annual consumption of sheep meat in Montevideo  - 29 - is about 0.7 kg, whereas the national average is 4.3 kg, reflecting the preference of urban population for beef over sheep. Rising beef prices should eventually change the consumption pattern of urban dwellers and good quality sheep meat, especially lamb, is expected to find an expanding market. In any case, the increasing demand for sheep meat in Europe, the USA, Japan and the Middle East should readily absorb any incremental production under the project which could not be sold in the domestic market. 5.08 The project would be expected to have a sizeable impact on the production of oilseeds in which Uruguay has a considerable deficit. The edible oil deficit is currently about 8,000 tons per year. Soybean is a relatively new crop to Uruguay, but an increasing number of more progressive farmers are growing it successfully. The strong demand on world markets makes soybean an important future crop for Uruguay, not only for import substitution, but also for export of beans and/or by-products at a later stage. Additional sunflower seed production under the project should also find a ready market domestically, and existing plant capacity is adequate for processing it. VI. FINANCIAL ANALYSIS A. Sub-borrowers' Benefits and Financial Rates of Return 6.01 Sub-borrowers' benefits have been analyzed on the basis of the farm models detailed in Annex 4, Tables 31 to 34. The technical assumptions for these models are given in Chapter IV. The financial assumptions underlying the models reflect input (investment and operating expenditure) and output prices of the respective harvesting seasons of the 1978/79 crop year. On these assumptions, sub-borrowers' benefits and financial rates of return have been calculated and are summarized in the following table:  - 30 - Farm Model Model I Model II Model III Model IV ___------- (US$ 000)