Colombia - Upper Magdalena Pilot Watershed Management Project

Document of The World Bank FILE C W FOR OFFICIAL USE ONLY Report No. P-3106-CO REPORT AND RECONMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INSTITUTO NACIONAL DE LOS RECURSOS NATURALES RENOVABLES Y DEL MEDIO AMBIENTE WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR THE UPPER MAGDALENA PILOT WATERSHED MANAGEMENT PROJECT November 24, 1981 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 Average Calendar 1979 Average Calendar 1980 Currency Unit = Peso - Col$ US$1 = Col$42.550 US$1 = Col$47.280 Col$1 = US$0.02350 Col$1 = US$0.02115 Exchange Rate Effective November 3, 1981 US$1 = Col$57.27 Col$1 = US$0.01746 WEIGHTS AND MEASURES Metric System GLOSSARY OF ABBREVIATIONS CIDA = Canadian International Development Agency CONIF Forestry Research Corporation DNP = National Planning Department DRI = Integrated Rural Development Program EEEB = Empresa de Energia Electrica de Bogota EPM = Empresas Publicas de Medellin FEDECAFE = Federation of Coffee Growers HIMAT = Instituto Colombiano de Hidrologia, Meteorologia y Adecuacion de Tierras ICA = Colombian Agricultural Institute IDB Inter-American Development Bank INDERENA = Instituto Nacional de Recursos Naturales Renovables y del Medio Ambiente ISA = Interconexion Electrica, S.A. PAN National Nutrition Program PIN Plan de Integracion Nacional SCF = Soil Conservation Fund SENA = National Apprentice Service USAID = United States Agency for International Development FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY COLOMBIA UPPER MAGDALENA PILOT WATERSHED MANAGEMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Instituto Nacional de los Recursos Naturales Renovables y del Medio Ambiente (INDERENA) Guarantor: Republic of Colombia Amount: US$9.0 million equivalent. Terms: Repayment in 17 years, including four years of grace at 11.6% interest per annum. Project Description: The project is a first phase pilot scheme to form a basis for major watershed protection efforts in the future. It aims at developing viable technical and organizational programs for: (a) slowing the erosion of agricultural land and water catchment areas and siltation of hydropower reservoirs; (b) maintaining a regular water supply for irrigation and domestic use; and (c) control- ling runoff to alleviate flooding. To achieve these goals, the project consists of pilot investments in three subwatersheds of the Magdalena River designed to intro- duce soil conserving cropping patterns, improvement of livestock management, reforestation of marginal or extremely vulnerable areas and construction of minor structures to reduce erosion. The project also includes research and evaluation components to provide the basis for preparing a follow-up project covering the entire Upper Magdalena Watershed. The project's major risk involves the Borrower's capability to mobilize and lead the activities of the various institutions participating in the project. To minimize this risk, the appointment of qualified managers to lead the project and the execution of subsidiary agreements defining responsibi- lities of key participating agencies would be conditions of effectiveness. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization,  - ii - Estimated Cost: Local Foreign Total ---(US$ million equivalent)-- On-farm Investment 5.3 1.8 7.1 Extension and Training 1.2 0.4 1.6 Public Works (including reforestation) 1.1 0.3 1.4 Environmental Protection and Control 1.3 0.5 1.8 Research and Studies 2.4 2.3 4.7 Preparation of Phase II Project 1.7 1.7 3.4 Project Management 1.2 0.5 1.7 Total Base Costs 14.2 7.5 21.7 Physical Contingencies 0.4 0.5 0.9 Price Contingencies 2.8 1.9 4.7 Total Project Cost 1/ 17.4 9.9 27.3 Project Financing Plan: Government 9.5 - 9.5 Participating Banks 4.8 2.2 7.0 IBRD 1.3 7.7 9.0 Beneficiaries 1.8 - 1.8 Total 17.4 9.9 27.3 Estimated Disbursements: FY82 FY83 FY84 FY85 FY86 FY87 -------(US$ million equivalent) ------ Annual 0.9 2.0 1.9 1.7 1.5 1.0 Cumulative 0.9 2.9 4.8 6.5 8.0 9.0 Rate of Return: Not applicable. Project File: A project file containing working papers has been prepared as a basic guide for the project. It contains detailed descriptions of all components. In view of pilot nature of project an appraisal report has not been prepared. 1/ INDERENA is exempt from custom duties.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INSTITUTO NACIONAL DE LOS RECURSOS NATURALES RENOVABLES Y DEL MEDIO AMBIENTE WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR THE UPPER MAGDALENA PILOT WATERSHED MANAGEMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to Instituto Nacional de los Recursos Naturales Renovables y del Medio Ambiente (INDERENA), with the guarantee of the Republic of Colombia, for the equivalent of US$9.0 million to help finance the Upper Magdalena Pilot Water- shed Management Project. The loan would have a term of 17 years, including four years of grace, with interest at 11.6% interest per annum. PART I. THE ECONOMY 2. An Economic Report on Colombia (3556-CO) was distributed to the Executive Directors in September 1981. This section on the economy reflects the major findings of this report. Country data sheets are presented in Annex 1. Background 3. The Colombian economy has become more resilient to external shocks as a result of the structural changes that have occurred over the past 30 years. Rapid economic growth has resulted in a substantial structural trans- formation of the country from a predominantly rural and self-contained economy to a more diversified urban, industrial, services and open economy. Colombia has reached a point where population pressure on land no longer increases much, if at all. Public sector investment and output now play a greater role, primarily as a result of increased activity on the part of decentralized agencies and public enterprises. Also, greater emphasis on foreign trade has allowed the external sector to grow with non-coffee exports, particularly exports of manufactured goods, expanding rapidly and the range of products sold abroad widening considerably. The growing urban- industrial-services oriented economic activity and a rapid expansion of sur- plus labor in rural areas attracted by higher wages and better services in the cities has given rise to rapid rural-urban migration. This phenomenon, together with the increased participation of women in the labor force, has been instrumental in reducing poverty and improving income and distribution over time. Financial and capital markets have evolved pari-passu with the growing needs of the economy, and Colombia has become an active participant in international capital markets. 4. Real GDP per capita rose by 2.4% p.a. on average during the 1950-80 period, with each succeeding decade registering greater gains in per capita income. This was the result of lower population growth, combined with more rapid GDP growth. Population growth, which had remained in the 3.0% to 3.5% range during the 1950s and early 1960s, declined dramatically after 1965 as a  -2- consequence of a sharp fall in the fertility rate. Greater economic and edu- cational opportunities for women, rapid rural-urban migration, rising per capita income and increased effectiveness of family planning programs contri- buted to the decline in fertility. Colombia's population is currently grow- ing at an annual rate of 2.1%. As a result of the high proportion of women now entering childbearing years, this rate of population growth is likely to continue until the early 1990s. 5. The combination of rising per capita income and expanded public services has brought about a significant improvement in the welfare of the poorest, in both absolute and relative terms. As a result of increased sani- tation control, improved diets and better health care, the crude death rate fell by about 50% and life expectancy rose from 48 years in the early 1950s to 63 years currently. The child mortality rate declined from 20 per thousand in the early 1960s to 8 per thousand in the late 1970s. Infant mor- tality, one of the best indicators of welfare, fell to 65 per thousand in the later 1970s, from about 124 per thousand in the early 1950s. School enroll- ment ratios have increased substantially at all grade levels since 1960s, and by the late 1970s, 91% of urban children aged 7 to 14 were enrolled in school. The poorest income groups have experienced the greatest increases in electricity and water services in recent years and have benefitted more than the average of the population from services of the national health system. In spite of this progress, Colombia remains largely under-developed, with a relatively small modern sector superimposed on a broad, traditional and ^-7- nomically poor base. Development has been concentrated in relatively few areas of the country, public services are still not available to many of the rural and urban populations and unemployment and underemployment are rela- tively high. The coverage of health care and water supply requires conti- nuous improvement and adequate housing is not available to a substantial pro- portion of the population. Rapid migration to the large and medium-sized cities has created urban development problems, with attendant social diffi- culties. Moreover, in spite of the steady increase in per capita income over the past 30 years, substantial efforts are still required to improve and ext- end the benefits of development to the poorest income groups. 6. In large part, the achievements of the past thirty years were the results of government efforts to stimulate the productive sectors, provide the required economic and social infrastructure and establish an effective institutional base in the economy. In the 1950s and early 1960s, development policy favored import substitution supported by high tariff protection and the provision of economic infrastructure by the public sector. It was during this period that the country's major communication and transportation net- works were developed and the transformation to semi-industrial economic structure began in earnest. By the mid-1960s, the prospects for further import substitution were substantially diminished and the country was con- fronted with great economic uncertainty, arising from the fact that economic activity and the balance of payments were heavily influenced by developments in the world coffee market. In order to ease this constraint, during 1967 the authorities adopted an outward-looking development strategy, expanding and diversifying exports and, among the export markets, increasingly tapping the Andean Group countries. Export promotion policies, including frequent exchange rate devaluations, export tax rebates and other export incentives were introduced and the authorities began lowering tariffs somewhat and freeing capital markets from controls as means of raising  - 3 - efficiency and increasing the competitiveness of Colombian goods in external markets. These measures were highly successful in relieving the foreign exchange constraint and stimulating growth and employment. However, by mid-1970s the economy was once again experiencing difficulties caused primarily by the world recession and by excessive Central Bank financing of domestic budget deficits. Recent Economic Development 7. In late 1974, the Government introduced a wide range of fiscal and monetary policies designed to correct the structural and policy weaknesses prevailing in the economy at that time. Before these reforms were fully effective, the economy was subjected to strong inflationary pressures arising from a sharp increase in world coffee prices. The increased receipts from coffee exports, together with some official surrender of foreign exchange from illegal exports, caused a turnabout in the balance of payments. Incomes rose rapidly and stimulated aggregate demand; inflation accelerated. Economic growth also accelerated and unemployment fell substantially, both in rural and urban areas. Largely as a consequence of increased coffee tax revenues, the public finances generated surpluses averaging about 7% of GDP during the 1976-79 period, and by the end of 1979, net official international reserves had risen to about US$4.1 billion, equivalent to nearly 12 months imports of goods and non-factor services. 8. While beneficial in many respects, the foreign exchange boom has had a somewhat negative impact on the evolution of the Colombian economy, largely as a consequence of the need for measures to stabilize the economy. Public investment was curbed, thereby delaying some badly needed additions to economic and social infrastructure. The rate of currency devaluation was slowed and the conversion of export receipts into pesos was delayed to moderate the growth of domestic demand, with adverse effects on export expan- sion and diversification. Also, the Government was compelled to maintain high reserve requirements and expand controls over credit thereby reducing, in real terms, the financing available to the private sector via the official capital market. 9. The stabilization measures were virtually unchanged from early 1977 through 1979 but were partially successful in restraining aggregate demand growth; thus relatively high inflation persisted. In response to the increasing stabilizing effects on aggregate demand and the troublesome finan- cial market distortions caused by inflation and the extended period of mone- tary restraint, the authorities began in late 1979 to adjust the stabiliza- tion program. The rate of peso devaluation was advanced to increase export incentives and reduce borrowing abroad, and in early 1980, credit restraints were relaxed by lowering reserve requirements. At the same time, interest rates on time deposits captured by commercial banks and development finance companies -- and on the lending therefrom -- were freed from controls. To offset the inflationary effects of these measures the authorities further liberalized import payments and adopted the policy, supported by the emission of new short-term certificates, of not expanding the subsidized selective credit operations of the Central Bank in excess of the resources captured from private savings for this purpose. The authorities also increased the surveillance and control of the illegal export trade. The effects of the  - 4 - above measures were not immediately noticeable. Real GDP growth declined to 4% in 1980, unemployment started to creep up, and inflationary pressures continued. 10. In 1981, manufacturing activity has remained sluggish,hemmed in by the slow growth in aggregate consumer demand, and limited by power shortages during most of the year. Coffee exports have fallen as a result of reduced world demand and declining prices while non-coffee export growth has weakened. On a more positive note, construction activity, which had fallen sharply in 1979-80, began to recuperate toward the end of the year. In response to favorable price incentives, petroleum production is estimated to have increased by over 5% in 1981. Agricultural output has registered some gains despite decreases in the area planted resulting from a prolonged drought. Both public and private investment have expanded rapidly. Real GDP growth is estimated to have reached 4% in 1981. with the unemployment rate falling slightly. Inflation continued to be a problem in 1981, however, with consumer prices increasing by about 27% for the year. With world coffee prices at relatively low levels for most of the year, Colombia's balance of payments is likely to experience an overall deficit in the US$200 million range. This would still maintain net official reserves at about 10 months imports of goods and non-factor services while reducing inflationary pressures arising from the monetization of foreign exchange earnings. Development Strategy 11. Achievement in this decade of the Government's objectives of increased productivity and maximum economic growth, increased employment, improved distribution of income and greater welfare for all Colombians will require a major effort to remove from the economy the constraints of inadequate economic and social infrastructure and insufficient demand. Infrastructure needs are most pressing in the energy, transportation, and agriculture sector. 12. The Government's strategy for accomplishing its development objec- tives are set forth in the recently formulatled Plan de Integracion Nacional (PIN). This strategy continues the previous emphasis on export promotion as a means of supplementing domestic demand and assuring balance of payments stability, and on policy measures, including further import liberalization, designed to increase economic efficiency and raise institutional capacity. It proposes a large increase in public investment, giving high priority to energy projects and to the provision of transport infrastructure. Economic decentralization, regional autonomy and the uniting of regional growth centers through improved transport, communication and financial links are directed towards creating an integrated national market, a strategic goal of the PIN. The Plan also places emphasis on the promotion of both small scale and commercial agriculture as a means of diversifying and increasing exports, assuring adequate domestic food supplies, holding down inflation and contrib- uting to the Government's nutrition and welfare goals. Industrial policy objectives are to provide an environment of certainty, along with adequate credit and infrastructure, so that entrepreneurs are encouraged to invest and expand output. Because of its benefits in opening foreign markets, creating employment and bringing in new technology, private foreign investment is to be encouraged. The Government's approach to helping the poor takes on a new orientation in the PIN. Its efforts are focussed upon improving efficiency  - 5 - in the use of resources and strengthening the social service institutions. Programs in the health and education sectors are to be better focussed and integrated, and selected low income and disadvantaged groups, such as workers in the informal sector, children and unemployed youth, are singled out for special attention. Combined with extensions of the Integrated Rural Development (DRI) and National Nutrition (PAN) projects, the new directions given to social programs are expected to raise significantly the welfare of low income groups in Colombia. 13. While the PIN provides a good analysis of the development issues facing the country and sets forth the general guidelines for policies and programs to resolve these issues, there are two important aspects of bringing off the development strategy that are expected to receive increasing atten- tion from the authorities in coming months. The first involves a required deepening of the sector analyses in order to improve coordination in planning and execution sector strategies, and the second has to do with matters related to financing the PIN. Given the large investment required to carry out the PIN strategy, inadequate planning and coordination among sectors or insufficient domestic resource mobilization would be likely to result in sub- stantial resource misallocation and to delay execution of the strategy. The two most important sectors where additional work is urgently required are energy and transportation. 14. Colombia became a net oil importer in 1976 and by 1985 petroleum imports are projected to absorb about 20% of total merchandise exports. In the absence of rapid energy development, energy shortages will become a major constraint on growth later in this decade. Resolution of the energy problem depends on the country's success in developing its abundant domestic energy resources -- hydroelectricity, coal and natural gas -- and also upon increasing petroleum exploration and development. The strategy for doing this will require energy pricing policies that rationalize consumption with energy resource availabilities, a least cost program of investments, sufficient domestic and external financing for these investments, strengthened sector institutions, improved program execution capability and rapid carrying out of investments. Although planning and policy making have improved substantially in many energy sector institutions in recent years, overall planning and coordination in the sector are still weak. A study about to be completed by the National Planning Department is expected to provide the basis for improvements in sector-wide planning and policy-making, and recent pricing decisions have gone a considerable way towards providing the correct signals for regulating consumption and encouraging production. The prices paid to producers (primarily foreign companies) for "incremental" and "new" crude have been raised to levels which provide adequate production incentives, and the retail prices of petroleum products, while still somewhat below international levels, have been increased substantially in recent years. The Government has committed itself to raise energy prices to equivalent international levels as rapidly as politically and economically possible, and a least cost energy investment program is being prepared. Between October 1978 and October 1980, the price of regular gasoline (80 octane) was raised by 125%, from US$0.40 to US$0.90 per gallon; because of exchange rate adjustments, its price has since fallen to US$0.80. At the present time, the Government is considering an additional increase.  - 6 - 15. Colombia's high transportation costs and inadequate service could become a constraint on economic growth, particularly that resulting from development of the country's vast coal reserves and from agriculture. The State Railway is in poor condition and the road network needs maintenance and rehabilitation. The authorities have begun to take steps to improve the country's infrastructure and PIN assigns an important share of future invest- ments to the sector. Investment and Its Financing 16. A substantial increase and redirection of public sector investment will be required in the next several years to carry out the development strategy outlined in the PIN . Over the 1981-85 period, such investment is expected to increase by about 15% p.a. in real terms. The energy and trans- portation sectors are expected to account for the bulk (59.5%) of this investment; however, sizeable real increases in investment are also expected in the nutrition and health, small scale agriculture and industry (including mining), water and sewerage, and education sectors. Overall, public fixed investment is projected to average 8.4% of GDP during the 1981-85 period, and is expected to total Col$1,603 billion (about US$20.5 billion). Private investment will have to increase also during this period to provide the goods and services required by the expanding economy. 17. This increase in investment will demand a major resource mobiliza- tion effort on the part of Colombia's public sector. The buoyancy of the tax system (excluding coffee tax revenues and receipts from earnings on foreign exchange holdings), which has declined in recent years, will have to be increased through new taxes and better tax administration, resources will have to be used more efficiently, and the charges levied for public services will have to be raised substantially in real terms. Since this effort is expected to coincide with increased private sector demand for investment resources, the importance of measures to expand domestic savings cannot be over-stressed. The recent capital market liberalization should encourage savings. A significant increase in voluntary private savings is not likely, however, as long as inflation remains high. Consequently, stabilization remains a sine qua non for the country's future growth and development. Growth and Balance of Payments Prospects 18. Given the country's strong resource base and sound economic manage- ment, Colombia's growth prospects for this decade are good and significant advances in economic welfare are anticipated. The urgent need to relieve the pressure on aggregate demand arising from the growth of foreign exchange earnings and the necessity to increase rapidly imports to develop the country's resource potential and restore higher economic growth requires a shift in the balance of payments from a small current account deficit of US$195 million registered in 1980 to a current account deficit projected to average US$1,865 million, over the 1981-85 period. By the end of this period, net official international reserves would have fallen to a level slightly over four months of imports of goods and non-factor services (a  - 7 - level which is adequate for Colombia) without prejudice to the country's creditworthiness. This should be sufficient to support an average growth of real GDP of 5.5% during this period. Beyond 1985, the current account deficit should improve as a result of increasing export proceeds (partic- ularly coal) and a levelling-off of imports. The current account deficit would fall to about 2% of GDP in 1987 and turn into a surplus of less than 1% by 1990. To achieve real GDP growth of 5.5% per annum, gross domestic investment will have to expand to about 25% of GDP, up from 18% in the early 1970s and 20% in recent years, and to avoid too large an increase in foreign indebtedness, gross national savings would need to average about 22% of GDP. 19. Gross external capital requirements (net of reserve drawdown) are projected to total US$10.3 billion in current prices for the 1981-85 period, for an annual average requirement of US$2,057 million. About 26% of this amount will be required annually for debt amortization and the rest to cover current account deficits. Multilateral and bilateral agencies are expected to provide 33% of these requirements, 50% is expected to come from foreign suppliers and financial institutions and the balance should come from private foreign investment. At the end of 1980, Colombia's public and publicly guaranteed external debt disbursed and outstanding amounted to US$4.3 billion, equivalent to 13% of GDP. The Bank/IDA share of this external debt was 25%. Reflecting the recently increased lending by the Bank and the decline by bilateral sources, this share is expected to increase to about 29% in 1983, before falling to about 25% in 1986. The debt service ratio at end of 1980 was 10% and is expected to climb to 17% by 1985, peak at about 20% in 1988 and then decline gradually. The World Bank's share in public debt service is expected to rise to about 26% in 1985 from about 25% in 1980. With continued sound economic and financial management, Colombia is expected to maintain its creditworthiness through and beyond the 1981-1990 period. PART II. BANK GROUP OPERATIONS IN COLOMBIA 20. The proposed loan, the 94th to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$3,263.9 million (net of cancellations). Of this amount the Bank held, as of September 30, 1981, US$2,687.5 million: IDA made one credit of US$19.5 million for highways in 1961. Disbursements have been completed on 57 loans and the IDA credit. During 1972-77 disbursements averaged US$86 million equivalent per year, then declined slightly to US$82 million in 1978 but increased sharply to US$138 million in 1979 and to US$215 million in 1980. Improving perfor- mance of social sector institutions in the execution of Bank-financed pro- jects, the gradual containment of inflationary pressures, which should allow relaxation of fiscal restraint, and increased Bank lending for infra- structure projects, all point to higher level of disbursements in the future. IFC has made investments and underwriting commitments of US$78.7 million in 26 enterprises and, as of September 30, 1981, it held US$24.0 million. Annex II contains a summary statement of Bank loans, the IDA credit and IFC investments as of September 30, 1981. The Annex also contains summaries on the execution of the 36 ongoing projects.  - 8 - 21. In response to the objectives established by successive Governments (self-sustained economic growth, increased employment and improved income distribution), since 1966, Bank lending to Colombia has become more diver- sified with heavier concentration on production-oriented programs and activi- ties which emphasize social as well as economic benefits. All three loans for education have been made during this period, and so have 12 of the 14 loans for industry, 12 of the 14 agricultural loans, one loan for a nutrition project, two loans for urban development projects and all nine loans for water supply and sewerage. During the same period, 19 loans were made in the power and transport sectors, while before 1966, 22 out of a total of 25 loans were made to these sectors. 22. Bank lending to Colombia in FY81 consisted of two loans for power generation and distribution projects, and one each for rural roads, irrigation rehabilitation and village electrification totalling US$550 million equivalent. In addition to the loan presented in this report, the FY82 program includes proposed loans for secondary oil recovery, rural development, highway rehabi- litation and railways. Work is also under way on projects for petroleum development, mining, oil refining, electric power, agricultural credit, agro-industries, fertilizers, water supply and sewerage, ports and rural education for possible consideration by the Executive Directors during the next two years. 23. The proposed Bank lending conforms closely with the Government's development strategy as outlined in the PIN (paragraphs 12 through 15). To help Colombia develop domestic sources of energy, a sizeable part of the proposed lending would be for hydropower. The Bank intends to assist in the development of coal mines which hold potential in helping Colombia meet part of its energy requirements and in diversifying exports. In support of the Government's objective to increase the supply and the recovery of domestic petroleum, the Bank plans to finance petroleum projects as a complement to investments of private firms and, for the first time, become involved in projects which promote the efficient processing of hydrocarbons. Bank financing in the energy sector would also assist in strengthening major institutions and in mobilizing external finance as some of the projects would require substantial co-financing. Other future loans would finance agriculture and industry to support the Government in its efforts to raise overall productivity, income and employment, and to increase and diversify exports. Closely related to these objectives would be the proposed Bank lending for transport infrastructure. In this context, the Bank is assist- ing the Government in preparing a highway paving and rehabilitation program in support of the increasing interregional flow of goods and services. A loan under preparation for ports is 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, several loans are being prepared in support of the Government's efforts to help the lowest 50% of the Colombian population. Lending for rural electrification, rural development, agricultural credit, water supply and sewerage, irrigation and rural education projects is principally designed to improve the standard of living of the poor.  - 9 - 24. The operations of external lenders in Colombia are shown in Annex I. While IBRD, IDB, and bilateral sources provided about 75% of total external financing to Colombia in the 1961-72 period, their share has decreased since then to approximately 50% for the 1976-79 period and is expected to decline further to about 40% of external capital requirements during the period 1980-85. Like the Bank, IDB has given increased emphasis to projects with a poverty orientation such as low-cost housing, urban and rural development, agrarian reform, university education, water supply, rural electrification and land erosion control, but in recent years it has increased its lending for power and industry. In the future, it proposes to assist Colombia in developing sources of domestic energy and in expanding productive sector activities to help generate increased employment. USAID has supported programs in education, urban development and small farm development, but is phasing out its aid program in Colombia. The Govern- ments of Canada, the Federal Republic of Germany and the Netherlands have also provided concessional financing for basic needs and regional integra- tion projects. PART III. EROSION AND WATERSHED MANAGEMENT Water Resources 25. Colombia is endowed with abundant water resources. Hydropower, with a potential of over 93,000 MW, can satisfy all of the country's electri- city needs well into the twenty-first century and possibly beyond, though only 6% has been developed or is under construction. Likewise, the opportunity for expanding agricultural productivity and production through irrigation and drainage is considerable -- it is estimated that the irrigation potential is a number of times the existing facilities which account for less than 3% of the total land in agriculture. Through river regulation, inland shipping could provide economic transport for a vast array of bulk cargo, particularly minerals. The harnessing of water resources and improving the efficiency of their use are of major significance for the development of the country's agriculture, energy infrastructure and transport system. Forests, Soils and Erosion 26. Most major Colombian rivers and their tributaries originate in the Andean mountains where steep, geologically immature slopes predominate. Because of the area's proximity to the equator, the tree line is high, often above 4,200 meters, and large portions of the Andes had been covered with forest. The major soil forming rocks are granite and syenite, which resulted from volcanic activity in the tertiary and quaternary periods, interspersed with layers of ash and dilapidated material. With the exception of the alluvial valleys dividing the three major North/South mountain ranges, the soil cover of the mountainous areas is fragile. When vegetative cover is removed, intensive rains, which are common throughout the mountainous region, wash away the top soil, causing at times mass movement and avalanches. 27. With the growth of the economy and population, new and often more marginal lands are being opened up higher up mountain sides. The first step of colonizers has normally been the slashing and burning of the forest  - 10 - and, in its place, the planting of crops and pastures which are less effective in protecting the soils. The nearby forests (on land whose slopes are too steep or which are at too high an altitude) are also gradually being depleted as they supply firewood and lumber to the settlers. In addition, the expanding urban areas, through their increasing demand for wood, have been contributing to the process of deforestation. It is estimated that during the past 20 years, Colombia's forest resources have been reduced by approximately 10.5 million hectares, corresponding to almost 20% of the approximately 55 million ha that existed in 1960. 28. With the loss of forests, the natural protective cover of the soil is being removed. The water retention capacity of soils declines with the loss of vegetation, resulting in either torrential flows of water or in leaching. The effects of dry seasons are more severe, for the changed structure of the dry soils make them more susceptible to being washed away. The practice of farmers to crop and graze intensively further speeds the erosion of surface soils and reduces the long range agricultural potential of the soils. Where the farming has been too intensive, the land returns even- tually to a bush fallow. In some cases where rainfall is low, such as in parts of one of the three subwatersheds under the proposed project, the land turns 4r.t3 virtual desert. In other situations, where production is continued by increasing applications of fertilizers, pesticides and fertilizers are washed down the river along with soil, sometimes into the water supply systems of urban areas downstream. The rapidly growing cities in turn do their share of silting and polluting of waters further downstream.-The revival of gold mining in certain areas of the country is also contributing to soil erosion. The resulting erosion from all of the above sources causes siltation of waterways, flooding and reduced storage capacity of dams. Government Strategy 29. While the problems resulting from the denudation of forested hillsides and the consequent, erosion and water pollution have been recognized for a long time as critical national concerns, it was not until recently that Colombian leaders began to address the need for concerted action to prevent further deterioration. The increasingly evident, adverse results of siltation, including more frequent flooding, shorter life of dams and reduced water flows for hydropower generation and water supply systems, contributed to the urgency of taking appropriate measures. Furthermore, protection of water basins is considered by the Government to be essential from an economic standpoint by virtue of the heavy investments in the development of hydroelectric resources envisaged. Nationwide electricity rationing over the past year, has contributed to the awakening of public interest to the need for watershed conservation and management. 30. Several power companies have been reforesting on a small scale some lands close to dams and recognize that the effort must be intensified. The national electricity company, Interconexion Electrica (ISA), has contract- ed consultants and INDERENA to formulate and carry out programs of reforestation and watershed management in its project areas. Additionally, under the two most recent power loans (1953-CO and 2008-CO), The Electricity Companies of Bogota and Medellin (EEEB and EPM) have undertaken to carry out programs of  - 11 - watershed management in the areas of influence of the projects.However, the major institution building efforts must necessarily be aimed at the proposed Borrower, INDERENA, which has the primary role in watershed protection. 31. The concern for protecting water resources and the environment generally extends beyond the power companies and the particular watersheds in which their projects are located. With respect to forests, the National Planning Department (DNP) has prepared a National Forestry Plan which contem- plates a major reforestation effort for soil protection as well as for commercial exploitation; the bulk of the program would be carried out by the private sector with credit provided by financial institutions and rediscount- ed with the Central Bank. Regional forest corporations have also become more active and the Integrated Rural Development Program financed in part by the Bank (Loan 1352-CO), IDB and CIDA, as well as the Federation of Coffee Growers are encouraging farmers to plant trees. The Government, through the Central Bank, also makes available funds on favorable terms to industrial firms for pollution control. Studies are also underway for controlling pollution of the Cartagena Bay and for rectifying the silted and polluted Bogota River. 32. Nearly all of the above programs are recent, many require the resolution of fundamental issues -- e.g., the source of financing for the forestry program -- and most need further study and preparation. There is little experience with mobilizing the various residents and water users in watersheds and managing each area to maximize the long-term economic potential of the soils and water. To approach the subject in a systematic way, the Institute of Renewable Natural Resources and the Environment (INDERENA), with the endorsement of the Government, proposes to initiate a small-scale pilot program to develop and test technologies and organizational arrangements for carrying out a massive program in the future. The pilot program constitutes the proposed project and would be carried out in the densely populated, upper portion of Colombia's most important river, the Magdalena. Bank Role and Sector Lending Strategy 33. The Bank's efforts in assisting Colombia in the protection and management of river basins is also recent and aimed largely at developing the institutional capacity necessary to carry out programs and works on a national basis in the future and on building more widespread support for such an endeavor. An initial step has already been taken in connection with the aforementioned power loans (paragraph 30). The proposed project, which would be the first in Colombia concerned exclusively with water resource management and environmental protection would be the principal vehicle for achieving these objectives. It would upgrade INDERENA's technical and organizational capability and and aim to build the institution's capacity to deal countrywide with watershed management. Further hydropower generation projects will continue to have watershed management components in an effort to bolster the concern of power companies in the protection of water basins. The results of the various programs will be followed closely in order to build on the experience gained, to apply them to future projects and to seek least-cost means of preserving Colombia's abundant water resources.  - 12 - The Borrower - INDERENA 34. Established in 1968, INDERENA is one of the many decentralized agencies reporting to the Minister of Agriculture, who serves as Chairman of its Board. As the name suggests (paragraph 34), the entity is responsible for preserving and maintaining the country's renewable natural resources and protecting the environment. It is responsible for the protection and rational use of the country's 45.5 million ha of forest reserves as well as forestry research and development. At the same time, INDERENA is the watchdog of Colombia's wildlife and oversees development of fisheries and related research. With the Institute of Hydrology and Meteorology (HIMAT), it shares responsibi- lity for supervising and maintaining the country's rivers and streams. Where strong regional corporations have been developed, such as in the Department of Valle and around Bogota, maintenance and protection of rivers and forests have been transferred to those corporations. However, policy formulation and leadership within the natural resources sector remains in the hands of INDERENA. 35. The entity is managed by a General Manager, who is appointed by the President of the Republic. It is organized into divisions responsible for forestry and flora, fisheries and fauna, environmental protection, development, and administration. The technical staff numbers over one thousand. Approximately 87% of INDERENA's resources are budgetary contribu- tions from the Government with the remainder coming mostly from sale of wood and water use fees. Its total volume of operations in 1980 amounted to about US$23 million equivalent. By the nature of its operations, INDERENA can be expected to continue relying heavily on Government funding for its operations. 36. INDERENA has been the environmentalists' voice within the public sector. Initially, it received only limited backing from the Government, and its leadership has been generally weak, suffering from frequent manage- ment changes. The current Government, however, has provided increased support and has appointed strong leaders to manage INDERENA. The present management is reorganizing the institution, working towards streamlining its administration and taking a balanced approach to preserving and exploiting natural resources in a rational manner. To be effective in this endeavor, INDERENA requires further strengthening, particularly with respect to project execution and management. Through training, technical assistance and guided operational experience, the proposed project would assist INDERENA in developing a capability in the field of watershed management while, largely through its own efforts along with project supported consultants (paragraph 61), INDERENA is improving its overall operational capacity. PART IV. THE PROJECT Background, Objectives and Brief Description 37. The project was prepared by INDERENA with the assistance of some participating institutions and two Bank missions. It was appraised by the Bank in February and April 1981. Negotiations were held in Washington, D.C. in November 1981, with a Colombian delegation led by Ms. Leonor Montoya and Mr. Cesar Ocampo Palacio, Director General of Public Credit of the Ministry  - 13 - of Finance and General Manager of INDERENA, respectively. In view of the experimental nature of the proposed project, this section is somewhat expand- ed and serves in lieu of the Staff Appraisal Report. 38. The principal objective of the project is to develop, within four years, viable tarming and tree crop systems as well as institutional mechanisms for carrying out soil conservation and erosion control and maximizing the long-term economic use of the soils and water. The project would test production and conservation measures (reforestation, civil works, modifying land use practices, forest protection measures) to determine feasible and low cost ways of introducing soil conservation to farming systems and to the watersheds. The project would also provide the necessary information to prepare a follow-up, larger project covering the entire Upper Magdalena River Basin. An integral part of the project would be the determination of incentives required to motivate land users to adopt conservation practices and an appropriate role for the public sector to play in protecting the country's water resources. 39. The project would be carried out over five years and would include: (a) investments in the three sub-watersheds aimed at conserving soils and reducing erosion; (b) research and studies to be carried out in part to evaluate investments in the three sub-watersheds, but also to serve as inputs for future watershed management projects; and (c) preparation of the second-stage project. In about a four-year period, the investments and research would provide a firm basis for managing the entire Upper Magdalena watershed. Project Area 40. The Upper Magdalena River Basin covers the departments of Huila and Tolima as well as parts of Cauca and Cundinamarca. The basin includes 23 major tributaries formed in the high central mountain range (Cordillera) and the lower eastern range and covers more than 5.5 million hectares. The valley is the principal rice production area of the country and the area is dotted with potential hydroelectric schemes (included on Map IBRD 15847). The geology and soils are similar to those of the Andean region of Colombia (paragraph 26). 41. The three subwatersheds selected for the pilot project were chosen for their economic importance and their representativeness. In total, they cover nearly 200,000 ha. The two larger rivers (Rio Combeima and Rio Yaguara) are in the Central Cordillera and originate in two snow-capped mountains, while the third (Rio Las Ceibas) rises in the Eastern Cordillera. Rios Las Ceibas and Combeima are the principal sources of water for two cities of roughly 150,000 and 300,000 each, respectively, while Rio Yaguara is expected to provide about 10% of the water to the Rio Magdalena dam for the 500 MW Betania Hydroelectric Plant, already under construction. Each of the three rivers supports some irrigated agriculture, with Rio Combeima providing water for up to 5,200 ha per year. 42. The three watersheds differ substantially in the extent of their erosion and the nature of the agriculture they support. The Las Ceibas watershed is the smallest, with about 15,000 ha, including nearly 1,000 ha of cocoa and a mixture of crops in the lower portions and livestock at higher  - 14 - elevations. Yaguara, the largest of the three watersheds (135,000 ha), is by far the most eroded; sediment-laden, brown-colored water flows to the Magdalena during the rainy season. Its climate is dry and it supports little beyond extensive livestock ranching. The Combeima catchment area by contrast is a lush area with rainfall averaging about 2,000 mm per year. It includes about 300 ha of coffee (and 2,000 ha more with some coffee) and well over 5,000 ha of other crops. Holdings average 25 ha, with the better lower elevation land generally held in very small parcels. This watershed, covering 30,000 ha, has been the subject of numerous partial studies which have provided useful data on this watershed -- records on rainfall have been kept since 1946. While reliable data do not exist, older people within the water- shed claim that water flows during the dry season have declined over the past 50 years. By contrast, few data exist for the other two watersheds; one of the first tasks of the project, therefore, would be to set up stations to measure water flows and precipitation. Detailed Project Features A. Investments in Soil Conservation 43. ^n--farm investments. The project would provide credit to farmers for improving soil conservation practices along with increasing production. The objective of the component would be to aid farmers in planting high return tree crops on lands vulnerable to erosion as a partial substitute for crops and pasture where they are major contributors to soil erosion and to reduce erosion through improved animal husbandry and crop cultivation practices. Credit would be made available for an estimated 200 ha each of cocoa and fruit trees, 900 ha of wood-lots for fuel and other domestic needs and 700 ha of coffee. By far the most important agricultural activity in the watersheds and a major contributor to erosion is cattle raising. Consequently, the largest effort would be devoted to improving livestock management in order to reduce the effects of overgrazing on soil erosion. Credit would be made available for cattlesheds, for pastures for silage and hay, and for improved cattle breeds on about 3,400 ha. The credit would be conditional upon the farmer following appropriate soil conserving animal husbandry practices, including limiting the number of cattle per hectare and regulating the period of grazing. 44. Although the areas to be covered would account for only a small percentage of the agricultural lands in each of the watersheds, they would be concentrated in the areas most vulnerable to erosion and would provide an adequate test of the suitability of the particular farming systems and their acceptability to farmers. In order to do so, the project would provide credit to farmers, regardless of farm size and land tenure status. The agri- cultural technologies in themselves, are financially viable -- preliminary estimates carried out on one ha farm models suggest that all investments have financial rates of return greater than 15%. INDERENA would refine its farm models and submit them to the Bank as a condition of effectiveness (3.01 (j) and 7.01 (e) of the draft Loan Agreement). These models would assist INDERENA  - 15 - in planning training programs and identifying foregone farmer earnings from conservation investments. Under the proposed farm models, the short-term returns are normally lower than alternative investments, while the investments, particularly in labor, are usually more costly, because of the requirements of soil conservation practices. Consequently, to ensure the adoption of adequate soil conservation measures, including changes in land-use patterns, an incen- tive/subsidy program would be established (paragraphs 66 and 67). Using principally resources from a fund of the Central Bank, three specialized agricultural banks -- Caja Agraria, Banco Ganadero and Banco Cafetero -- would lend to farmers (paragraphs 64 and 65). 45. Extension and Training. Extension agents would transmit soil conserving technologies to farmers. To receive credit under the project, farmers would be required to draw up a farm plan with the assistance of an extension agent trained under the project. The agent would also supervise the farm investments to ensure that the farmer is carrying out the investments and practices agreed upon. Training in soil conservation techniques would be provided to a selected group of extension agents with appropriate technical backgrounds as well as to farm groups in the three watersheds. The project would finance incremental operating costs, vehicles, equipment and training programs. The National Agricultural Institute (ICA) and Federation of Coffee Growers (FEDECAFE) would supply the extension agents, while the National Apprentice Service (SENA), with the cooperation of INDERENA, would run the training programs. Curricula for training are under preparation and the first program is planned to start before mid-1982. Initial training programs would be evaluated and modified accordingly with experience. By April 30 of each year, INDERENA would send to the Bank for comment an evaluation report of training programs during the previous year and proposals for modifying curri- cula and training courses (Section 3.01(i) of the draft Loan Agreement). Training would also be carried out domestically and abroad for the purposes of improving the skills of project staff and developing the capacity of INDERENA to carry out the second phase project. Terms of reference, satisfactory to the Bank, and a program for training the necessary staff to carry out the second stage project are to be prepared by December 31, 1982 (Section 3.01(g) of the draft Loan Agreement). 46. Public Works. Approximately 660 ha of forests would be planted on publicly owned lands for commercial exploitation and protection of the water- sheds. Local and exotic species already tested in the area would be used, while research into new varieties is being undertaken (paragraph 50). In addition, a number of civil works for regulating river flow and reducing sedimentation and flooding would be carried out and tested for cost effectiveness. The structures would include gabions, soil cement layers and precast flexible mats. INDERENA would contract the civil works to experienced local private construction firms and the management and operation of the forest plantations to regional forest corporations and other entities with appropriate experience. 47. Protection and Control. INDERENA would maintain two environmental protection and control units to monitor and protect the major forest reserves in the watershed areas of rivers, to enforce existing environmental laws, and to manage two national parks established for their protection. Forest control for Las Ceibas and Yaguara would be handled by one unit to avoid  - 16 - extra infrastructure costs. The project would finance field equipment, vehicles, offices, trails, shelters and incremental operating costs. B. Research and Studies 48. Hydrometereology. Planning and evaluating soil conservation programs require baseline data on rainfall, sedimentation, river flows and water quality. The project would develop that data base immediately in the three sub-watersheds and determine the minimum requirements and install an equipment network for the entire Upper Magdalena. The project would provide the equipment, buildings and instrumentation requirements along with the incremental costs for operating, maintaining and analyzing the output from the network. The program would be carried out by HIMAT, which specializes in this activity. 49. Microwatershed. Small tributaries would be selected in each of the three sub-watersheds to study in depth and quantify the soil erosion process and the effects of different land uses and practices on erosion and sedimentation. This research program would be carried out with control microwatersheds and sample plots and is expected to provide an important basis for quantifying benefits under a larger, follow-up project. Project financing would be provided for equipment, vehicles, small buildings and incremental operating costs. The program would be led by a research coordinator and carried out jointly by INDERENA, HIMAT and ICA, with technical assistance from local and foreign consultants. With the assistance of other entities, INDERENA would prepare by June 30, 1982, a detailed implementation program, satisfactory to the Bank, which would include inter-alia, detailed methodology for the research, sites selected and work schedule (Section 3.01(h) of the draft Loan Agreement). 50. Forestry Research. The project would support a program to test the performance of various fast-growing timber and fodder species from a soil conservation as well as commercial economic perspective. This research is necessarily long-term and is unlikely to yield results before the second phase project. Nevertheless, this component can have a major impact on management of the watershed over the long term and, therefore, would be supported with nurseries, technical assistance, research personnel and infrastructure. The National Forestry Research Corporation (CONIF) would be responsible for the component's execution and would prepare a research plan by June 30, 1982 (Section 3.01(g) of the draft Loan Agreement). 51. Policy and Economic Studies. Since water resource management is a fairly recent concern in Colombia, there is little basis for establishing a policy and legal framework for its management. The areas to be studied would include: alternatives to meeting the energy needs of the watershed population, marketing of various fruits, methods of enforcing forest protec- tion laws, the need for water legislation and methods of recovering invest- ments in watershed management. The methodology and work plan for each of the studies have not yet been developed; the terms of reference for each study, satisfactory to the Bank, along with a program for carrying out the studies would be completed by September 30, 1982 (Part C 5 of Schedule II  - 17 - and Section 3.01(g) of the draft Loan Agreement). INDERENA's reses- dinator would also lead this program and would be assisted by consultants. The project would finance local consultants and office equipment. 52. Technology Development. An INDERENA unit of specialists from various disciplines would work with different specialized institutions in aligning the research to the needs for applying improved watershed manage- ment technologies developed in other parts of Colombia and abroad. As an integral part of the Management unit, its role will also include keeping project personnel abreast of developments in watershed management elsewhere in Colombia and abroad. C. Preparation of Phase II 53. A major goal of the project is to assist Colombia in developing appropriate techniques and system for carrying out large-scale efforts in watershed management programs in the future. In line with this, preparation of a second, larger project would be carried out under the proposed project. The pertinent studies would be initiated in early 1983 and would serve to monitor the results of the proposed project. The preparation of the second project is to be carried out jointly by INDERENA and mostly local consultants. Specialized foreign consultants would be engaged as needed and would be used to provide training to INDERENA staff. In order to prepare the necessary manpower to carry out large-scale watershed management activities, short- and long-term training would also be provided under the project (paragraph 45). Costs and Financing 54. The total cost of the project (net of taxes) is estimated at US$27.3 million equivalent, of which US$9.9 million equivalent (36%) corres- pond to the foreign exchange costs. Physical contingencies amounting to 15% for civil works, studies and equipment have been included in the estimates. Price contingencies amount to 17% of base costs and are based on forecasts of yearly domestic and international price increases. (Project costs by compo- nent are presented in the Loan and Project Summary.) By type of expenditure, project costs are as follows: Local Foreign Total -- (in US$ million)-------- Contracts for Civil Works and 1.5 0.4 1.9 Reforestation Vehicles, Equipment and Scientific 0.8 2.1 2.9 Instruments Consultant Services, Training 1.0 1.0 2.0 Studies and Extension-- 4.4 1.7 6.1 Operational Costs 1/ Project Administration 1.2 0.5 1.7 On-farm Investment 5.3 1.8 7.1 Base Costs 14.2 7.5 21.7 1/ Includes research and studies to be carried out by public sector agencies, equipment requiring periodic replacement, maintenance of vehicles, etc.  - 18 - Local Foreign Total