Argentina - Agricultural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3699 PROJECT PERFORMANCE AUDIT REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) November 30, 1981 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ABBREVIATIONS BNA Banco de la Nacion Argentina - State Bank of Argentina CB Banco Central - Central Bank IDB Inter-American Development Bank INTA Instituto Nacional de Technologia Agropecuaria - National Institute of Agricultural Technology PB Participating Banks PC Project Committee SAG Secretaria de Agricultura y Ganaderia - State Secretariat for Agriculture WEIGHTS AND MEASURES Metric System 1 quintal (q) in Argentina = 100 kgs. GOVERNMENT OF ARGENTINA FISCAL YEAR January 1 to December 31 FOR OFFICIAL USE ONLY PROJECT PERFORMANCE AUDIT REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) TABLE OF CONTENTS Page No. Preface .....................*.....* * * **..................................i Basic Data Sheet ......................................................ii Highlights ............................................................ iv PROJECT PERFORMANCE AUDIT MEMORANDUM I. PROJECT SUMMARY .................................. 1 II. A CHRONOLOGICAL SUMMARY OF THE PROJECTS EVOLUTION ...... 2 III. MAIN ISSUES .......................................... 7 A. Sector Content ................................... 7 B. Government and Bank Options ..................... 10 Annex: Comments by Banco de la Nacion Argentina ............... 16 PROJECT COMPLETION REPORT I. BACKGROUND ............................................. 19 The Agricultural Sector ............................. 19 The 1976-78 Program of Economic Restructuring .......... 19 The Project ............................... .......... 20 Previous Bank Involvement in the Agricultural Sector ... 21 Sources of Information ................................. 21 II. PROJECT IDENTIFICATION/PREPARATION AND APPRAISAL 22 A. Identification/Preparation ......................... 22 B. Project Appraisal .................................. 24 C. Project/Loan Proposal Presented at Negotiations .... 25 Project Description and Objectives ............... 25 Project Cost .................................. 25 Financing ..................................... .. 26 On-lending Terms ............................. 26 Project Implementation ........................... 27 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. TABLE OF CONTENTS (continued) Page No. D. Negotiations, Loan Approval, Loan Effectiveness .... 27 Negotiations ..................................... 27 Loan Approval .................................. . 28 Loan Effectiveness .......................... ... . 28 III. PROJECT START-UP AND CANCELLATION ...................... 28 Start-up ... ............................... .......... 28 Loan Cancellation .................................... . 30 IV. CONCLUSIONS ........................... 31 Annex - Aide Memoire ........ ...... .33 Map - IBRD 13337 PROJECT PERFORMANCE AUDIT REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) PREFACE This is a performance audit of the Agricultural Credit Project in Argentina for which Loan 1564-AR was approved in May 1978 in the sum of US$60.0 million. The loan was cancelled, at the request of the Government, on April 14, 1980, almost two years after its approval. The audit report consists of an audit memorandum prepared by the Operations Evaluation Department (OED) and a Project Completion Report (PCR) dated April 29, 1981. The PCR was prepared by the Latin America and the Caribbean Regional Office. The audit memorandum is based on a review of the Appraisal Report (No. 1918a-AR), dated April 25, 1978, the President's Report (No. P-2304-AR) of April 26, 1978, the Loan Agreement dated June 29, 1978, and the PCR; correspondence with the Borrower and internal Bank memoranda on project issues as contained in relevant Bank files have been consulted and Bank staff associated with the project have been interviewed. The draft report was sent to the Borrower on August 18, 1981, and comments received have been attached as an annex to the audit memorandum. On the basis of this abbreviated review process, the audit finds that the PCR covers adequately the project's principal achievements and shortcomings. In addition to summarizing the objectives and results of the project, the audit expands on several points because of their importance to this as well as other future projects in Argentina.  - ii - PROJECT PERFORMANCE AUDIT REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) KEY PROJECT DATA Appraisal Actual or Item Expectation Current Estimate Total Project Cost (US$ million) 161.7 -Ia Underrun or Overrun (%) - -a Loan/Credit Amount (US$ million) 60.0 Disbursed/ - 0. oL Cancelled (April 14, 1980) - 60.0 Repaid to./M 31, 1981 - 0.Q-/C- /b May31 98 Outstanding toL_ ) - 0.0 Date Physical Components Completed 12/31/82 -/a Proportion Completed by Above Date (%) 100 - Proportion of Time Underrun or Overrun (%) - -/a Economic Rate of Return (%) 29 -7a Financial Performance Good -7- Institutional Performance Good -a Cumulative Estimated and Actual Disbursements (US$ million) FY79 FY80 FY81 FY82 FY83 Estimated 5.2 23.7 41.7 53.7 60.0 Actual /a 0.0 o.oLb. - - - Actual/Estimated (%) 0 0 - - - OTHER PROJECT DATA Original Actual or Item Plan Revisions Estimate Actual First Mention in Files or Timetable - 01/04/72 Government's Application - - 06/13/76 Negotiations 03/28/78 03/28/78 03/28/78 Board Approval - 05/09/78 Loan/Credit Agreement Date - 06/29/78 Effectiveness Date 10/30/78 01/15/79 02/14/79 Closing Date 06/30/83 06/30/83 /b Borrower The Argentine Republic Executing Agency Ministry of Economy Fiscal Year of Borrower January 1 - December 31 /a No data on actuals are given as the Loan was cancelled before it became operative. /b Cancelled on April 14, 1980. 7- Commitment charges amount to US$732,500.  - iii - MISSION DATA Sent Month/ No. of No. of Man- Date of Nature of Mission by Year Weeks Persons weeks Report Identification/Preparation HQ 02/72 2 1 2 04/18/72 Identification/Preparation HQ 12/72 0.5 2 1 12/13/72 Identification/Preparation HQ 02/73 5 1 5 03/30/73 Identification/Preparation HQ 06/73 1 1 1 06/19/73 Identification/Preparation HQ 06/74 1 2 2 07/01/74 Identification/Preparation HQ 10/75 2 1 2 10/28/75 Identification/Preparation HQ 06/76 2 1 2 06/22/76 Identification/Preparation FAO/CP 09/76 3 2 6 10/15/76 Identification/Preparation HQ 11/76 2 1 2 01/04/77 Identification/Preparation HQ 03/77 1 1 1 04/11/74 Identification/Preparation FAO/CP 05/77 3 1 3 06/29/77 Identification/Preparation HQ 06/77 1 2 2 07/06/77 29 Preappraisal HQ 07/77 1 1 1 08/16/77 Appraisal HQ 10/77 3 5 15 11/11/77 16 Supervision HQ 06/78 1 3 3 07/20/78 Operational HQ 08/78 1 1 1 09/06/78 Supervision HQ 12/78 1 1 1 01/05/79 Supervision HQ 04/79 1 1 1 05/07/79 Supervision HQ 04/79 1 2 2 15/23/79 Supervision HQ 03/79 1 1 1 04/10/79 Monitoring HQ 15/79 1 1 1 06/25/79 Supervision HQ 10/79 1 2 2 10/29/79 Supervision HQ 10/79 1 1 1 10/30/79 Supervision HQ 02/80 1 1 1 03/10/80 18 Total Manweeks 63 COUNTRY EXCHANGE RATES Name of Currency (Abbreviation) Peso ($a) Year: Exchange Rate: Appraisal Year Average US$1 = $a 380 (June 1977) Completion Year Average US$1 = $a 1,960 (Dec. 1980) b - iv - PROJECT PERFORMANCE AUDIT REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) HIGHLIGHTS The project, originally conceived as a follow-up to the Balcarce Livestock Development Project (Loan 505-AR), was never implemented, mainly because it did not fit the agricultural sector context prevailing at the time, while alternative financing was available at more advantageous conditions. The project had a long and troubled history. The project was first discussed in early 1972 and more than five years were required for its preparation. Appraised in October 1977, the project became effective only in February 1979 and was cancelled a year later in April 1980. No disbursements were made. However, an estimated US$732,500 in commitment charges were incurred. Slow progress of the Balcarce Livestock Development Project, Bank- Government discussions about indexing of subloans, reduced demand for agricul- tural credit and changes in Government agricultural policies all contributed to lengthy project preparation. Changes in project design were furthermore induced by a fall in beef prices and an increase in grain prices reflecting a change in external market conditions. Originally conceived as a successor to the Balcarce Livestock Development Project, in the end, only 29% of project investments were destined for livestock and crop production. As appraised, the Argentina Agricultural Credit Project was to provide medium- and long-term credit for on-farm investments for: (i) live- stock and crop production in selected areas of the Pampean and Mesopotamian regions; (ii) a weed control program in an extensive area of the Pampean region infested with noxious weeds; and (iii) a land clearing program in the northern part of the country. The project was designed to increase produc- tivity within the Pampean region and also expand the agricultural frontier thereby accelerating the growth rate of agricultural production and exports. Project costs of US$161.7 million were to be financed by Loan 1564-AR (US$60 million or 37%), participating banks (US$70.1 million or 43%), and sub- borrowers (US$31.6 million or 20%). The estimated rate of return on all project components, weighted by amount, was 29%, although the audit believes that this figure was probably optimistic (PPAM, paras. 20-25). Onlending would be on the basis of positive interest rates through adjustment of outstanding loan balances in accordance with variations of the Wholesale Price Index (PPAM, para. 16). In July 1979, the Bank agreed to a floating interest rate option (quarterly interest payments determined by prevailing commercial rates established in the free market). In October of 1979, Government indicated its preference for a third interest rate option: indexing on the basis of the US dollar foreign exchange rate. Subsequently, - v - the Central Bank, however, decided not to allow the project to offer peso subloans indexed to the US dollar foreign exchange rate. At the same time, Banco de la Nacion Argentina (BNA) withdrew as financial project adminis- trator. These decisions by BNA and the Central Bank, coupled with reduced demand for agricultural credit, especially for indexed loans, led the Govern- ment in April 1980 to request cancellation of the loan. The major conclusion is that the Agricultural Credit Project could not have been successfully implemented given the high liquidity of the Argentinian Banks and availability of other international financing at more favorable terms (PPAM, para. 31 and PCR para. 3.03), the availability to sub-borrowers of funds offered at more attractive terms than Bank subloans and the depressed demand for agricultural credit in general due to the agricul- tural policies prevailing at the time. Other points of interest are: - the Government intended to improve the agricultural terms of trade, upon which the attractiveness of the technologies being financed depended, but subsequently found it politically diffi- cult to sustain high agricultural prices, and it is doubtful whether any Government would be able to achieve the abrupt shift in agricultural terms of trade which was envisioned (PPAM, para. 20-23, 26); - the Government efforts to attract short-term foreign financial flows after 1976 resulted in an unusually liquid situation in 1978-79 for the commercial banks, and agricultural credit was usually available (short-term) at negative real interest rates; in such a context, where Bank funds are proposed to be onlent at uncompetitive conditions (loans were to be fully indexed to achieve a 6% real interest rate) it is not surprising that no demand for such onlending was forthcoming (PPAM, paras. 29-31); and - in an economic structure which has been based on low agricul- tural prices with subsidized credit, the principal tool by which agricultural investment has been encouraged, it is difficult if not impossible to lend for agricultural investment on the basis of expectation of substantially higher agricultural prices and positive real interest rates (PPAM, paras. 36-37). PROJECT PERFORMANCE AUDIT MEMORANDUM ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) I. PROJECT SUMMARY 1. The Argentina Agricultural Credit Project, to be partially financed by Loan 1564-AR for US$60 million, was to provide medium and long-term credit for on-farm investments for: (i) livestock and crop production in selected areas of the Pampean and Mesopotamian regions; (ii) a weed control program in an extensive area of the Pampean region infested with noxious weeds; and (iii) a land clearing program in the northern provinces of the country. The project was designed to increase productivity within the Pampean region and also expand the agricultural frontier, thereby accelerating the growth rate of agricultural production and exports. Higher exports were expected to overcome the recurring balance of payments difficulties that hampered Argentina's economic development during the last half century. 2. The Argentina Agricultural Credit Project had a long and troubled history (for further details, see section II below) and then was cancelled by the Government before implementation began. The project was first discussed by the Government and the Bank in early 1972, and prepared by the Government with Bank staff assistance. A total of 60 man-weeks was spent in Argentina by 24 Bank missions during the project preparation and "implementation" period (see basic data for mission details). 3. The difficulties encountered in this project were in many ways similar to, and affected by the problems previously encountered in the Argentina Balcarce Livestock Development Project supported by Loan 505-AR, which in fact was its predecessor. The Balcarce Livestock Development project (Loan 505-AR) was appraised in 1966, became effective in 1967, and was closed in 1980.1/ 1/ A Project Performance Audit Report is under preparation. Much of the information contained therein is relevant to the current report, particu- larly the discussion of the difficulty of introducing intensive agricul- tural technologies in the Argentine context, the conflict faced by the Government with respect to higher agricultural terms of trade, and the lengthy struggle between the Bank and the Government over a proper in- terest rate policy for agricultural loans (see PPAR - Argentina Balcarce Livestock Project, OED Report expected to be distributed to the Board in December 1981). - 2 - II. A CHRONOLOGICAL SUMMARY OF THE PROJECT'S EVOLUTION 4. The Agricultural Credit Project was first discussed with the Government in January 1972. It was then conceived as a livestock project to promote further development in Buenos Aires province, and new development in the Northwest, i.e., the provinces of Salta, Jujuy, Tucuman, Santiago del Estero and Catamarca, and also in Southern Santa Fe. The definition of the project changed numerous times, however, before assuming its final form, and project preparation also started and was halted on several occasions. 5. The Bank refused to continue discussion of the second project until indexing of project subloans had been implemented in the Balcarce Livestock Development Project (Loan 505-AR) and accepted as a condition for the second project. Once agreed, in late 1972, project preparation was initiated in Argentina. A Bank-financed consultant visited Argentina in September 1972, and again in February/March 1973 to assist. He was to return for three months in June-August 1973, but a change in Government in May 1973 resulted in the project being deferred pending the new Government's definition of its policies on livestock and agriculture, and the Bank-s future participation in such development. 6. The Government delayed discussions until August 1974, when it indicated tentative interest in a project which would extend the Balcarce Livestock Development Project (Loan 505-AR) in Buenos Aires province, initiate new livestock activities in Corrientes province and develop intensive live- stock under irrigation in the North. Little preparation had been done on the two latter components at that time.. The Government also expressed interest in agricultural development on mixed agricultural/livestock farms, focusing on units smaller than 500 ha. The Bank was interested in smaller units, perhaps in the Northwest, but received little response from the Government. 7. The appointment of a new Minister of Economy in October 1974 led to personnel changes throughout the Ministry, including the Secretariat of Agriculture and the National Institute of Agricultural Technology (INTA), further delaying discussions of the second project until October 1975. During this intervening year, however, a crisis in international beef markets, resulting from the closure of the European Economic Community to beef imports, drastically reduced demand for subloans in the Balcarce project. Thus, instead of expecting that funds in the Balcarce project would imminently be committed, it appeared this would not occur, and the follow-up project then became less urgent. 8. In October 1975, the Bank was informed that INTA was preparing a second livestock project along the lines of the Balcarce Livestock Development Project (Loan 505-AR), including a slightly expanded area. Grain and mixed farming, and dairy farming models were to be added; the rate of return on grain production development was substantially greater than for beef develop- ment at that time. However, in separate discussions, the Secretary of Agri- culture informed the Bank that he believed the project should not include the - 3 - previous Balcarce project area, suggesting either Entre Rios, Corrientes, San Luis or La Pampa provinces instead, the crescent of land surrounding the pampas. This approach would permit a shift of livestock production outside the pampas area, and a consequent increase in grain production within the pampas. 9. Shortly before, the Government had for distributional reasons indicated a desire to focus on smaller farmers outside the pampas instead of the larger farmers within the pampas. However, this need was then largely satisfied by five loans from the Inter-American Development Bank (IDB), totalling US$150 million, packaged in one overall loan called the Agricultural Technology Improvement Project. This package included: (i) a loan for US$30 million for livestock development by small and medium sized farmers, signed in May 1975, which was to cover both the Northeast, the Northwest, and parts of Cordoba, San Luis and Buenos Aires provinces; and (ii) a loan for US$60 million for financing tractors, and farm equipment and machinery for both crop and livestock farmers throughout the country, without restrictions on farm size or income. These IDB loans appeared to limit coverage of the proposed Bank project to medium and large-sized farmers. 10. In March 1976, a new Government assumed power in Argentina. The Bank held discussions with the Government in June 1976, when the Government indicated its conviction that agricultural production and agricultural ex- ports, particularly cereals, had to be increased. To achieve this, Government planned to increase agricultural prices to international levels, reduce export taxes and maintain a realistic exchange rate. The Government also believed that a higher land tax would be conducive to more intensive land use, and that the proposed policy changes would stimulate the demand for agricul- tural credit, particularly for grains and oil seeds production. This would make the second project attractive, and allow design by INTA along much the same lines as discussed with the Bank in October 1975 (PPAM para. 8). The Government indicated its intent to reduce inflation (then about 500% per year), and to reestablish positive interest rates (interest rates on agricul- tural credit were then 60-100% in nominal terms). 11. In September 1976, the Government proposed an agricultural credit project including three components: (i) farm development for livestock (1,500 farms) and mixed farm produc- tion (460 farms) in Buenos Aires province and in some surrounding provinces; (ii) a weed control program for cereals, directed at about 10,000 farmers and covering about 1 million ha; and (iii) land clearing operations, mainly in the North, to expand the crop- ping area of about 1,700 farmers by 300,000 ha. The main issue expected to require negotiation between the Bank and the Government was thought to be interest rates. Although the new Government shared the Bank's view that interest rates should be positive, lengthy consid- eration was given to the various alternative mechanisms for meeting this objective since the system eventually selected would greatly affect the level of future demand for credit. The Bank was hopeful that the project could be implemented through a number of participating banks, with the Central Bank (CB) operating as a rediscount agency. However, CB did not wish to so oper- ate, and, as no other commercial bank had such powers, it appeared that the Banco de la Nacion Argentina (BNA), a state-owned bank with an extensive branch network and a large agricultural credit portfolio, would replace CB to act as the lead bank of a group of participating banks.!/ 12. Although the project was presented by Government with a total cost of US$298 million, and a foreign exchange component of US$110 million, the Minister of Economy subsequently reduced the project's scale in late 1977.1' He stated that he wanted to retain the structure of the project, but indicated that: (i) local banks would find it difficult to provide the counterpart funds required by a larger project, and (ii) because agricultural prices were depressed, he doubted there would be a strong demand for agricultural credit at positive interest rates in the immediate future. He suggested a total project of US$110 million, with a Bank loan of US$40 million. The Bank agreed, but suggested that a price contingency be included. The project was ultimately designed with a total cost of US$161.7 million, and a Bank loan of US$60 million. 13. The Appraisal mission itself had the following to report on demand for agricultural credit in Argentina.!/ Inflation was still over 100% per year in Argentina, but down significantly from the previous year; credit was indexed to the wholesale price index or lent at nominal, but positive rates; and the demand for credit was said to be strong. However, the mission indi- cated that this demand was almost exclusively for short- and medium-term loans, to four years at most, and indicated that it was not clear there would 1/ For more details, see Report No. 1918-AR, dated April 25, 1978, Staff Appraisal Report, Argentina Agricultural Credit Project, paras. 5.05-5.10. 2/ During discussions at the annual meeting (September 27, 1977). 3/ Issues paper, dated November 11, 1971. - 5 - be demand for long-term loans for livestock production in the existing situa- tion. Nevertheless, the Bank decided to continue the processing of the loan in the light of the mission's finding that there would be strong demand, provided, as then expected, that fiscal measures would continue to favor the agricultural sector and that inflation would continue to decline. 14. The project was appraised in October 1977, negotiated in March 1978 and signed in June 1978. The project did not become effective by October 30, 1978, the date set in the loan agreement, because: (i) the execution of the subsidiary Loan Agreement between the Borrower (Government) and BNA had not yet been signed by the Minister of Economy; and (ii) the legal opinion of the Tribunal de Cuentas/ had not been signed. The date of effectiveness was first postponed to January 15, 1979, and then further extended to February 14, 1979, when the project became effective. The Bank never received a totally satisfactory explanation for this delay, and the audit concludes that Government wished to postpone the project as the demand for agricultural credit was low and liquidity in the commercial banks high (PPAM paras. 26-28). 15. Moreover, in March 1979, the Government (Ministry of Economy, BNA, INTA, and the Project Manager) informed the Bank that demand for credit was very low in the agricultural sector. Indeed, because of slow disbursements, Government had cancelled US$70 million of the five IDB loans (PPAM para. 9). Agricultural prices were low, primarily the result of Government's policy to allow the peso to appreciate in real terms, i.e., devalue at a slower rate than the difference between internal and international inflation. This was partly an effort to reduce inflation and partly the result of an effort to allow the free market to determine the exchange rate. During 1978, the cost of living/wholesale price index increased by about 160%, while the peso was devalued only 100%. International prices had increased for beef and oilseeds, though beef prices remained moderate by historical levels, but wheat and sorghum prices were stable, so that the overvaluation of the peso was fully felt. Thus, the profitability of investment in grains and in beef was low, and farmers were pessimistic. 16. In addition, BNA had altered its interest rate policy during the one and one-half years following appraisal, and in March 1979 borrowers had access to other credit lines where two options were available. Either the principal was indexed at the wholesale price index, or a floating interest rate was permitted, where each quarterly payment was determined by the rate commercially established in a free market. It was assumed by the Bank that private banks would not lend indefinitely at negative interest rates, so that the second option also would result in positive interest rates over the long 1/ The official body responsible for auditing government financial accounts. - 6 - run. The second option required very high payments in the short term, how- ever, which the Bank thought would be unacceptable to investors with invest- ments paying off only over the long-term. Nonetheless, when the Bank was asked by Government to consider various interest rate options for subloans, the Bank agreed to do so. 17. The Bank agreed to the floating interest rate option and so informed the Government in July 1979.1/ In October 1979, Government also indicated a desire for a third option, indexing on the basis of the US dollar foreign exchange rate. This option was then very attractive in Argentina because the rate of peso devaluation had been substantially lower than the rate of in- ternal inflation for some time and, correctly or not, indexing on this basis appeared inexpensive. It was argued that a significant devaluation would increase the prices of export goods (assuming the export duties were not simultaneously applied), so that the exporter would be compensated for his subsequently higher nominal debt by higher revenues. The audit believes that 1/ At appraisal, it was envisaged that Government would on-lend the proceeds of the Bank loan to BNA and other participating Banks (PBs) in local currency equivalent, assuming the foreign exchange risk. However, the principal outstanding for loans to PBs and for subloans made by the PBs to project sub-borrowers would be adjusted in accordance with variations of the General Wholesale Price Index prepared by the National Institute of Statistics and Census following the general guidelines established by the CB. Government lending to PBs would be made at an annual interest rate of no less than 2.75% over the adjusted balances. Annual interest rates charged by PBs to sub-borrowers would be at least 6% on the out- standing balances of subloans adjusted. Any changes in interest rate structure would maintain the minimum rates indicated and ensure a minimum spread of three percentage points to PBs. Key on-lending characteristics as envisaged at appraisal can be summarized as follows: - Sub-borrower's minimum contribution to investment costs ...... 20% - Proportion of investments to be financed by PB subloans ...... 80% - Proportion of PB subloans to be financed by Government ...... 46% - PBs' contribution for subloans .............................. 54% - Minimum annual interest rate from Government to PBs .......... 2.75% - Minimum annual interest rate from PBs to sub-borrowers ....... 6% - PBs' minimum spread over Government loans ...... ................. 3% Staff appraisal report, Argentina Agricultural Credit Project, Report No. 1918a-AR, dated April 25, 1978, paras. 5.08 and 5.09 (see also PCR, para. 2.12). - 7 - this index would not have worked.!V Simultaneously with the request for the third interest rate option, Government informed the Bank that BNA had with- drawn from the project, leaving the project without an intermediary. The Bank made an effort to put together a consortium of private commercial banks, but without success. The CB also refused to permit indexing subloans to the US dollar exchange rate. 18. Finally in April 1980, Government requested the Bank to cancel the loan on three grounds: (i) reduced demand for agricultural credit, especially for loans with outstanding balances adjusted by the wholesale price index; (ii) the Central Bank's decision not to exempt the project from prevail- ing credit policies; and (iii) the withdrawal of BNA as financial project administrator. The Bank accepted Government's request. III. MAIN ISSUES A. Sector Content 19. The project was originally conceived as a second livestock project which would continue developments initiated under the Balcarce project. Such a livestock component was maintained throughout the long discussions with the Government regarding identification and preparation, although this component eventually comprised less than one-third the total project. The declining importance of the livestock component during preparation reflected: (i) the mediocre experience of the Balcarce project; (ii) the much more favorable markets for grain than for beef prevailing at appraisal; and 1/ In other indexing schemes, when one indexing option led to lower adjust- ment and was selected for this reason, complaints subsequently emerged from producers and Goverment to permit a mid-stream switch to the other option, which was cheaper at that moment. The switch was almost always permitted, resulting in an imperfect adjustment. While this solution is not required, the political pressures to accept are great, and this is precisely why it has appeared attractive to Governments and to borrowers. Indexing on the basis of US dollar foreign exchange rate also had to be abandoned in the case of the Jamaica Second Agricultural Credit Project - see PPAR, OED Report No. 3521, dated June 26, 1981. (iii) a desire by both the Bank and the Government toward increased lending for smaller ranchersl/ and other regions. 20. The evidence available at appraisal did not suggest that the tech- nological package introduced in the Balcarce project would find wide accep- tance whether in the Balcarce area or elsewhere in Argentina, so long as price and managerial conditions remained unchanged. The appraisal report neverthe- less assumed that both would change, largely on the basis of expected policy changes to be introduced by the new administration which assumed power in March 1976. Given the frequent political and economic changes in Argentina's recent past, this assumption was generous. The appraisal report also esti- mated that the expected financial rates of return for the six livestock models would average 27%. However, these models were optimistic, assuming a physical production impact significantly exceeding that achieved in the Balcarce project2/ and also assuming higher future producer prices. The price esti- mates were based on the world market prices projected by the Bank. These projections indicated that beef prices would recover substantially through the late 1970s and early 1980s, a trend which has been partially borne out. Nonetheless, the appraisal report did not expect that rising international beef prices would be largely offset by Government policy changes, such as the overvaluation of the peso (PPAM para. 22). This, in fact, is what took place so that the producer price did not increase in line with international prices. Government had used similar measures to influence domestic producer prices during implementation of the Balcarce project. 21. The Government which assumed power in March 1976 indicated that a strong emphasis was to be placed on agricultural development, largely by improved relative prices for agricultural products. The Bank assumed that 1/ In the end, and mainly due to the IDB loan for small farm livestock development (PPAM para. 9), the project beneficiaries were expected to be larger farmers, and the project was justified on productivity grounds and on the basis of its impact on the balance of payments and on re- structuring Argentine agriculture more closely in line with its compara- tive advantage. 2/ This impact had been measured accurately only in a sample survey by the project unit in 1978/79, but other similar evidence was previously available: Gimenez Dixon, Jorge Joaquin, "An Economic Analysis of Range Improvements in the Cattle Breeding Area of Buenos Aires Province," Ph.D dissertation, Michigan State University (East Lansing; 1969), and de Obschatko, Edith S., "Factores Limitantes a la introduccion del cambio tecnologico en el sector agropecuario, M.S. dissertation, Escuela para Graduados en Ciencias Agropecuarias (Castelar: 1971). For further details on these studies, see PPAR - Argentina, Balcarce Livestock Development Project, OED report expected to be distributed to the Board in December 1981. - 9 - the Government would be able to follow up with corresponding price, fiscal and exchange rate policies, especially, because the Bank had long believed that many of the policies discussed with this Government were highly de- sirable. Therefore, the Bank was eager to assist. The Bank also commissioned a major consultant's report on the Argentine agricultural sector in 1977/78, and this report detailed the necessity for identical policy changes which the Government was in fact discussing, and indicated that such policies were expected to have a positive impact. Thus, considerable enthusiasm was gen- erated, in expectation that the Argentine agricultural sector might finally begin to produce the output of which many economic experts have long believed it capable. Similarly, with higher export revenues, the industrial sector would be freed from the foreign exchange constraint, and might also grow more rapidly. 22. Nonetheless, this Government, as other past administrations, could not maintain the improved agricultural terms of trade on which the project was designed, and on which the financial rate of return estimates for different components were based. International beef prices did improve in 1979 and 1980, to levels exceeding the average of the 1965-1980 period. But these were wholly offset by Government policies, quite the opposite of Bank expectations. The appraisal report rates of return were based on the assumption that export taxes would not be applied to beef exports, which was the case at appraisal when international beef prices were low, and that exports would continue to be free of tax as beef prices rose (as predicted). Exports did remain largely free of tax, but the increasingly overvalued peso achieved the same depressing effect on the domestic producer price. Thus, the demand for agricultural credit, particularly livestock credit, remained depressed until the project was cancelled. 23. Appraisal should not be faulted excessively, as the Bank had spe- cific understandings with the Government. But it should be noted that it is extremely difficult politically for any Argentine Government to permit a significant sustained increase in agricultural terms of trade. The audit believes that policies might be designed to engineer such a change gradually over an extended period, but it doubts that any Government will be able to achieve the abrupt shift in the agricultural terms of trade which was envi- sioned at appraisal. Future project design should focus on this issue. 24. The loan, as signed does not appear to have been excessive in size. The livestock on-farm development componentl/ contained six investment models for an estimated total of 1,550 farms. Total costs for this component were estimated at US$35 million, slightly more than the amount which had been disbursed by the BNA for the Balcarce project over the previous 13 years. However, because the project was expected to encompass a larger area and an 1/ Other components were weed control in the Pampas region (US$39 million) and land clearing in the northern provinces (US$53 million). - 10 - expanded INTA extension system, and because the US dollar had depreciated significantly in value between 1966 and 1976, the amount does not seem un- reasonable. One could ask, however, whether Argentine ranchers would be willing to pay 6% real interest rates for large, fixed investments. Based on the experience of participants in the Balcarce Project, it seems doubtful to the audit that producers expected these investments to yield a return suffi- ciently high to justify this interest rate. 25. The audit, on the basis of the abbreviated procedure used, finds it difficult to judge the suitability of the other two components, those which would have financed weed control in the Pampas region, and land clearing in the Northern provinces. The expected rates of return on investments in weed control were very high (33%-41%), and those on land clearing quite reasonable (19%-20%). Again, however, the returns depended on the assumption that Government policy would provide for higher producer prices. In addition, the audit is surprised that private investment in these two activities was not already fairly high, given the attractive rates of return expected. Two reasons seem possible. First, each activity required 4-5 years for a cash flow to appear, and many Argentine ranchers may be unwilling to make such long-term investments unless the return is exceptionally high, given that these ranchers are accustomed to an environment where price conditions change so rapidly. Second, the incipient investment activity of this type which was present at appraisal appears to have been dependent in large part on a loop- hole in the then existing tax legislation permitting tax deductions for certain types of land improvements. Both land clearing and weed control, apparently, were eligible for such deductions when the project was appraised but subsequently both types of investments were excluded from this benefit. Changes in the actual, or expected, tax laws may therefore have been another element which made it appear at first as if these components would be attrac- tive, and subsequently made them less so. B. Government and Bank Options 26. From the first discussions between the Bank and the Government until the project's ultimate cancellation, the project's history gives the sense of the Bank and Government in search of a suitable project in support of agriculture and the policies established by the new administration. The Bank wanted to help develop Argentina-s agricultural sector and felt that substan- tial capital would be required to realize the existing production potential if and when producers were given the proper incentives. The Bank saw that the agricultural technologies being used in Argentina provided much less output per unit area than that achieved in agricultural sectors in other countries possessing inferior natural conditions. Argentina, therefore, seemed to "need" large amounts of capital. The Bank tried to identify new technologies which would be appropriate to Argentina, cooperating fully with INTA in identifying projects to increase production. The Balcarce Livestock Develop- ment project (Loan 505-AR), however, indicated fairly clearly that projects involving large amounts of investment capital were not likely to be finan- cially attractive to producers unless the price structure was changed. The - 11 - Bank wanted to convince the Government that such incentives should be pro- vided, but did not spend much effort on an analysis of the political-economic impact of higher agricultural prices on the non-agricultural sectors and inflation. The Bank also spent much effort trying to convince Government that it should ensure positive interest rates on agricultural credit, a policy change which would have reduced agricultural investment rather than increased it. The audit believes that the Bank did not appreciate the close relation- ship between the price issue and the political difficulty in Argentina to sustain improved agricultural terms of trade. But without such improved terms, there were simply few projects which could be financed at a positive rate of interest. 27. The Government wanted assistance from the Bank, but was wary of Bank involvement in its economic policies, as it did not wish to be constrained in its choices, let alone be dictated to. The Government must have remembered the strained relationships during implementation of the Balcarce Livestock Development Project (Loan 505-AR) which occurred as a result of the Bank's efforts to force the indexing of subloans, with the very clear threat that lending would otherwise cease. In addition, Bank-financed projects were small relative to total demand for agricultural credit in Argentina, which itself was a small proportion of total national credit. The Government which assumed power in 1976 indicated its general agreement with the Bank on economic policies, including higher agricultural terms of trade and positive interest rates, but it too soon felt constrained and had to soften its position. And as it did, the Bank's loan became less attractive. 28. The ambiguity of the Government's position appears in the negotia- tions. The Government did not want to cut its ties with the Bank, but neither did it really want the loan. A project was eventually identified and pre- pared, but shortly after preparation the Minister of Economy intervened (PPAM para. 12) to have it sharply reduced in size, to about one-third of the previously planned level. In taking this decision, he emphasized the reduced demand for agricultural credit at positive rates, and indicated that he expected this situation to prevail for the intermediate future. This sug- gested a determination by Government to restrain agricultural prices. Follow- ing approval of the loan, at the reduced level requested (although the Bank had increased the loan from US$40 million to US$60 million, including a price contingency), project effectiveness was delayed (PPAM para. 14). To the audit, this suggests again that the Government did not give high priority to implementation of the loan. Finally, the decision of BNA to withdraw from the project, and Government's decision to cancel the loan, partially based on the BNA's withdrawal, again suggest that the loan was not seen as crucial assis- tance. 29. Internal Argentine developments, both economic and bureaucratic, also have played a role in the cancellation of the project. First, Government consciously attempted to attract additional foreign capital after 1976, principally short-term flows channelled through commercial banks, which were permitted to pay relatively high interest rates on the foreign currency - 12 - borrowed. However, as capital entered Argentina, and combined with unusually strong Argentine agricultural exports in 1977 and 1978 - which also improved the domestic foreign exchange situation - Government allowed the peso to depreciate less rapidly than the difference between domestic and international inflation. This policy reduced real domestic agricultural prices and thus, or so the Government reasoned, permitted some relief from inflation. It also made additional foreign borrowing attractive. Foreign capital entered Argen- tina with the expectation that this policy would provide a high real return in foreign currency (so long as the loan could be withdrawn prior to major devaluation). And Argentine borrowers were eager to obtain US dollar de- nominated loans because so long as the exchange rate was changed at a rate lower than the difference between domestic and international inflation, continued domestic inflation meant that their real interest rate was extremely low. Again, the attractiveness of such credit depended on the borrower's being able to determine when a greater devaluation would occur. 30. As greater foreign borrowing by Argentines occurred, the domestic monetary base expanded, creating greater inflationary pressures. Government's response was to devalue somewhat more slowly, hoping to use the announced foreign exchange rate table as an indicator of expected inflation, and thus to convince the populace that inflation would decline. Instead, the gap between the rate of domestic inflation and the rate of peso devaluation (plus international inflation) simply widened, making real interst rates appear larger to the foreign lender and lower to the domestic borrower, both in their respective currencies. Eventually, the situation had to cease, but in the early heady days which corresponded with the initiation of the Agricultural Credit Project, it was in full force. 31. Thus, the commercial banks found themselves in an unusually liquid situation, depending largely on the inflow of foreign capital for relending to Argentine borrowers rather than on the flow of domestic savings. And the foreign capital was available, again partly because of the recycled oil funds, at unusually low rates. Indeed, with international inflation rising and Eurodollar rates roughly constant, the real rate of interest on dollar loans was very low, if not negative. In contrast, the Bank's lending rates in 1978-79 were slightly above LIBOR rates, so the Bank's loan was financially unattractive, and unneeded. Foreign exchange was abundantly available in Argentina, and agricultural credit, when borrowed by producers, was usually available at nominal rates which proved to be negative - as had been the traditional practice in Argentina. There was simply no demand for the funds supplied by the Bank's loan in this case. 32. Second, internal bureaucratic factors in Argentina were also impor- tant during this period. BNA originally supported the Bank loan enthusias- tically, but then was instrumental in its cancellation. BNA, the principal Government bank, operates more as an official institution in support of - 13 - Government policy than as a profit maximizing commercial bank.l/ Histori- cally, the power of BNA is the provision of loans at negative interest rates to preferred clients, and as a public bank, BNA is better able to offer subsidized credit. However, if BNA would be forced to charge positive in- terest rates, its clientele would be reduced. Thus, BNA has an interest to oppose the introduction of positive interest rates, which will reduce its bureaucratic importance and its power vis-a-vis that of other commercial banks. It also has an interest to ensure that Bank funding passes through BNA, ensuring control over potential competitors. 33. BNA depended for its preeminence largely on several Government- provided advantages over private commercial banks. These privileges included exemption from some banking taxes paid by private banks, and the requirement that Government agencies place their deposits with BNA, providing the latter with a source of inexpensive capital for relending. The Government in 1976 apparently sought to change this situation, placing BNA in a situation more equal to that of other commercial banks. When the profitability of BNA was so reduced, however, BNA responded by indicating that it did not want respon- sibility for costly Government projects, such as the Agricultural Credit Project. BNA did not believe that its action as a discounting agency for other commercial banks would be profitable, and feared that the project would aid its competitors just at a time when it was forced to compete more fiercely. Similarly, it believed that its own freedom of operation would be constrained by the necessity to work with INTA on ranch technical planning and supervision, and by the need to submit regular reports to the Bank. 34. It is unclear to the audit what factors were most important in BNA's decision to withdraw,12 or even whether BNA was urged to withdraw by the Ministry of Economy, to whom the project also began to appear less desirable. But all factors moved in the same direction. Further, the Government was still expected to pay a commitment charge to the Bank on the loan funds.3 While not huge, there seemed to be no reason for the Government to incur these charges since other funds were then so readily available. 1/ BNA stresses that although "it is required by law to ensure that its activities are compatible with the economic and financial policies of the national Government, it operates essentially as a commercial bank and though no longer receiving the benefit of tax exemptions, it remains the leader in the Argentine market and is the soundest financial institu- tion in this market." See Borrower comments in the attached annex. 2/ BNA points out that the most important factor in its decision not to participate in the project was the lack of demand for investment credit in the agricultural sector. See Borrower comments in the attached annex. 3/ The amount actually paid by Argentina totaled about US$732,500. - 14 - 35. Throughout this period, the Bank attempted to be cooperative with Government, offering, when requested, a variety of interest rate options for sublenders (see also PPAM para. 17 and PCR paras. 3.04 and 3.05). None- theless, the Bank made it clear that it expected subloan interest rates to be positive and not to provide a subsidy to the subborrower. This made it clear to the Government that there was no middle ground for discussion on the most crucial issue. Few intelligent Argentine farmers would accept an interest rate option designed to provide positive rates over the long run. It was much more sensible for them to borrow short if necessary, postponing long-term investments, because the investment climate was both bleak and uncertain in 1980. The Bank reiterated its belief that the loan should be implemented, and tried rather than cancelled. There is justification to this desire, but the Government believed that there would be little demand in the intermediate run and that the costs, both financial and organizational, were too great to justify maintaining the loan dormant for a lengthy period.1/ 36. The question might be asked from this discussion whether the Bank realistically can lend to Argentina for agricultural development. The eco- nomic situation recently has changed rather dramatically, so that the (now new) Government may be interested again in additional Bank loans. But the audit believes that similar problems are likely in the future because the Argentine economic structure has been and currently is so rigidly based on low agricultural prices, with subsidized credit the principal tool by which agricultural investment (albeit on an extensive fashion) has been encouraged. The situation is not immutable, but it will surely be difficult to change. Moreover, the Argentine agricultural sector is remarkably well developed, even if the particular production techniques used are extensive rather than inten- sive. The productivity per person in agriculture is equal to that in the urban sector, a high proportion of agricultural output is produced by large and relatively wealthy farmers who are well educated, who have easy access to information, both technical and financial, and who borrow and adopt technology when it is financially attractive to do so. The financial system is also sophisticated, albeit distorted, and most of the larger farmers are accustomed to being heavily in debt precisely because negative interest rates have provided them with an important subsidy historically. Thus, their extensive production systems ought not to be taken as a symbol of their lack of finan- cial capital. Whether the Bank would have a role as a major supplier of credit to the financial system for agricultural investment if the price and credit context were changed is a question beyond this audit, the first ques- tion is whether the Argentines will wish to shift this context. 37. Finally, some Government officials have indicated a desire to work with the Bank in areas other than agriculture, believing that Bank loans would be more suitable for large infrastructure projects in the public sector, like 1/ Note that the Government also cancelled a large part of the IDB agri- cultural loan package which had been signed in 1975 and which was still largely undisbursed in 1979 (PPAM paras. 9 and 15). - 15 - power and railroads, rather than small, atomistic projects in the private sector such as the agricultural credit projects. The larger projects are relatively more difficult to finance internationally, requiring specific amounts of capital for specific purposes. And control over these projects remains largely with the public sector. Here, the issues of conflict between the Bank and the Government might be somewhat smaller. Questions of the price to be charged on state provided services can also be tendentious, but these may seem small compared to the discussion over the proper terms of trade and interest rates for agriculture. -16 - ANNEX PROJECT PERFORMANCE AUDIT MEMORANDUM ARGENTINA AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) COMMENTS FROM BORROWER Translation of incoming cable from Banco de la Naci6n Argentina, Buenos Aires to the World Bank, Washington, D.C. Date: October 30, 1981 Attention: Mr. Shiv Kapur, Director, Operations Evaluation Department I have no comments on the Project Performance Audit Report on Argentina Balcarce Livestock Development Project (Loan 505-AR). Regarding the Project Performance Audit Report on Argentina Agricultural Credit Project (Loan 1564-AR), I cannot agree with the statement that the Banco de la Naci6n Argentina operates in the manner of a bureaucratic insti- tution.AlWhile it is true that it is required by law to ensure that its activities are compatible with the economic and financial policies of the National Government, it operates essentially as a commercial bank and though no longer receiving the benefit of tax exemptions it remains the leader in the Argentine market and is the soundest financial institution in this market, showing very acceptable profit margins. I also feel it important to point out that of the many different factors involved at that time, some of which were mentioned in the report, the most influential and the one that ultimately prompted Banco de la Naci6n Argentina's decision not to participate in the project was the lack of demand for invest- ment credit in the agricultural sector. Estimates prepared on this aspect by Banco de la Naci6n Argentina on the strength of its experience and consulta- tion with its branches were borne out by results. The above are strictly my own personal comments regarding BNA's partici- pation. They are not intended as any judgment on the interpretation of the policies of the national authorities. Jose Manuel Ros Secretary of the Board of Directors 1/ This comment has been reflected in the final audit report. - 17 - PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT LOAN 1564-AR April 1981 Latin America and the Caribbean Projects Department Agricultural Division I  - 19 - ARGENTINA AGRICULTURAL CREDIT PROJECT - LOAN 1564-AR PROJECT COMPLETION REPORT I. BACKGROUND The Agricultural Sector 1.01 Argentina's endowment of extensive land area (about 160 million ha under agricultural use), with excellent soils and low population density, has accounted for the traditional adoption of an extensive pattern of produc- tion for beef, grains and oilseeds. Though yields of the main agricultural export commodities are well below their potential under an intensified production system, and lower than those of the main beef and grain producing countries, Argentina's low production costs provide it with a comparative advantage in feedgrains, oilseeds, beef and, probably, dairy products. In spite of past Government policies which discouraged intensive agriculture, this sector has provided sufficient food and fiber for domestic use, as well as large surpluses for exports. 1.02 Historically, the agricultural sector has played a fundamental role in the country's development. During the 1930s, Argentina was one of the largest exporters of agricultural products, with exports of maize accounting for 50% of total international trade in that commodity. The country was the third largest producer of wheat and one of the world's main beef suppliers, its exports averaging over 600,000 tons from 1935 to 1940, but after the Second World War, due to a series of adverse circumstances, the situation began to deteriorate rapidly. In recent years, even though Argentina is still the world's second largest exporter of coarse grains and the fourth largest wheat exporter, its share of international trade has dropped substantially. Similarly beef exports dropped to an average of 475,000 tons for 1971-1976. The traditional exports have been wheat, corn, beef, wool, mutton, pork, hides and skins, lard and tallow as well as animals for breeding and slaughter. During the past three decades, exports of increasing value have been sorghum, vegetable oils; oilseed cakes and meals; milling by-products; and, very recently, cotton, sugar, and soybeans. The 1976-78 Program of Economic Restructuring 1.03 The economic crisis, which came to a head in 1976, began in 1970 when large increases in public investment, nominal wages and credit resulted in strong inflationary pressures, temporarily suppressed by price controls. Growth of domestic output, together with a fixed exchange rate, led to rapidly increasing imports. In mid-1974, poor weather, falling world grain prices, and an EEC ban on beef imports halted export growth. Deterioration of the foreign sector coincided with an intensification of domestic economic and socio-political conflict. Attempts to improve the external sector situation through devaluation and adjustment in public sector prices failed, as labor and other powerful interest groups reacted to maintain their respective income shares. With the economy caught up in a wage-price spiral, - 20 - inflation rose to over 350% in 1975 and accelerated to an annual rate of almost 1,000% in the first quarter of 1976. A rapidly increasing external debt and a drastic fall in foreign exchange reserves brought the country close to defaulting on its external obligations. The Government seemed incapable of regaining effective control over the economy and, under the circumstances, the military intervened. 1.04 The new administration, which came to power in March 1976, immediately started implementing a stabilization and economic program aimed at halting hyper-inflation and at restructuring the economy by accelerating development of those activities in which Argentina had an international comparative advantage. 1.05 The basic thrust of agricultural policy of the new Government was to improve the sector's position in international markets by reducing or eliminating internal non-market distortions and allowing international prices and effective internal competition 'to stimulate both production and investment in the sector. To these ends, export taxes and price controls were reduced or eliminated, differential exchange rates were unified, subsidized lines of credit were eliminated and a provincial land tax was instituted to encourage more efficient use of productive resources. 1.06 Most relevant to the outcome of the Agricultural Credit Project, the subject of this report, is the impact of the Government measures concerning inflation and credit during the period 1976-79. Monetary and fiscal policies, supported by wage controls, succeeded in bringing the rate of inflation down from 780% during the year ending in April 1976 to 150% a year later. No further progress was made, however, in reducing inflation during the remainder of 1977 and 1978, despite continued attempts to reduce the public sector deficit and to contain wage increases. From the point of view of resources required for the extension of credit, it is important to note that measures such as lowering export taxes and raising interest rates had an immediate positive effect on the balance of payments and thus the inflow of external capital. Exports exceeded imports by over US$1.5 billion in 1977 and by US$2.5 billion in 1978. The current account surplus was accompanied by substantial capital inflow. At the beginning, the public sector was the primary borrower, but starting in 1977 high domestic interest rates induced the private sector to borrow abroad on an increasing scale. Although the authorities introduced some controls in 1978, long-term capital continued to flow into Argentina, and, by the end of that year, gross foreign exchange reserves stood at US$6 billion, compared with less than US$100 million in March 1976. The Project 1.07 The Argentina Agricultural Credit Project, partially financed by Loan 1564-AR for US$60 million, provided for medium- and long-term credit for on-farm investments for livestock and crop production; a weed control program; and a land clearing program. The project was designed to help implement the Government's policies aimed at increasing productivity and expanding the agricultural frontier to accelerate the - 21 - growth of agricultural production for export in order to overcome the traditionally recurring balance of payments difficulties that have hampered Argentina's economic development during most of the post-war period. 1.08 The project was prepared by the Government with Bank staff assistance during the first eight months of 1977; field appraisal took place in October 1977; and the loan was approved by the Bank in May 1978. Although the loan became effective in February 1979, implementation encountered a number of difficulties, described under chapter III of this report, and thus, at the Borrowers' request, the Bank cancelled the loan the 14th of April 1980. Previous Bank Involvement in the Agricultural Sector 1.09 In July 1967, the Bank approved Loan 505-AR to help finance the Balcarce Livestock Development Project, designed to provide long-term credit and technical assistance to medium- and large-scale livestock producers in the Balcarce region of the Buenos Aires province. The project also financed a study of soil and drainage in an important area of the Pampean region and equipment for the National Institute of Agricultural Technology (INTA) research station in Buenos Aires. Due to a series of unfavorable developments, the original closing date of July 1972 was extended to July 1977, later to July 1979, and, finally, to October 30, 1980 to permit full disbursement of an outstanding balance that had been pending since January 1978 and representing about 5% of the loan amount. Among the main reasons for the extended period of implementation apparently have been: (a) unfavorable terms of trade for beef production, mainly from late 1966 through 1969; (b) availability, until mid-1976, of credit from the National Bank of Argentina (BNA) and other banks on terms at least as favorable as those under the project but without project appraisal and supervision requirements; (c) the closing of the EEC beef market and the collapse of international prices in 1975; (d) changes in Government policies which favored beef producers; and (e) the introduction of indexing of project subloans under soaring inflation rates. A project completion report has been prepared and will be followed by a Project Performance Audit Report. Sources of Information 1.10 This completion report is based on information drawn from: (a) Argentina: Reconstruction and Development Bank Report No. 1645-AR, dated August 1977; (b) Economic Memoranda on Argentina-Bank Reports No. 2208-AR and No. 2988-AR, dated November 1978 and July 1980, respectively; (c) the Project Preparation Report Presented by the Ministry of Agriculture dated September 1977; (d) the loan documents related to Bank Loan 1564-AR; (e) project files, including correspondence and various papers prepared by Bank staff from time to time; and (f) conversations with certain Bank staff involved in the Project at various stages. - 22 - II. PROJECT IDENTIFICATION/PREPARATION AND APPRAISAL A. Identification/Preparation 2.01 In October 1971, the Bank and the Government started communicating with each other regarding the preparation of a livestock development project to follow up the Balcarce Livestock Project, financed by Bank Loan 505-AR approved in July 31, 1967. Between January 1972 and October 1975, six different Bank missions, expending a total of about 15 man-weeks, visited Argentina to assist the Government in project identification and preparation. However, political instability translated into constant changes of Government authorities responsible for setting policies and those responsible for imple- menting them, prevented conclusive decisions from being made with respect to the scope or nature of the project under consideration. 2.02 As reported in November 21, 1975 by a Bank mission returning from a visit to Argentina, the only positive result of the Government/Bank efforts up to that time was that INTA, the agency responsible for execution of the Balcarce Project (Loan 505-AR), was at that time preparing a Second Livestock Project, mainly along the lines of the Balcarce project, including the same geographical area plus five additional counties of the Buenos Aires province. However, as the report added, the Secretary of Agriculture was of the opinion that the proposed project should have a broader scope and that it should be extended to other provinces, such as Entre Rios, San Luis and La Pampa, the crescent of land which surrounds the fertile pampa area. His reasoning was that Government strategy should be aimed at increasing livestock production outside the pampa area and at increasing grain production within that area. 2.03 Definitive project identification/preparation is traced back only to the Bank's reconnaissance mission for the agriculture sector (June 1976) which discussed the subject with the military Government that took power on March 26, 1976. As a result of that mission (report dated June 22, 1976), the Bank agreed with the Government to establish a local Project Preparation Committee, which, assisted by a FAO/CP mission, would prepare an Agricultural Credit/ Livestock Project. Following the visit of an FAO/CP mission to Argentina for about two weeks in September 1976 and, as result of discussions at the Ministry of Economic Affairs and the Secretariat of Agriculture and Livestock (SAG), it was decided that an agricultural credit project would be prepared with a lending program that would include the following three components: (a) a farm development component for livestock and mixed farm production in the province of Buenos Aires and surrounding provinces. The preparation of this component, on which INTA had been working, was by then fairly well advanced; (b) a program for the control of two weeds (sorgho de Alepo and Gramion) that were affecting the achievement of the yield potential of maize and wheat in an extensive area of the best grain land in the country. The problem had been under study by INTA for a long time and preliminary proposals were prepared during the mission's visit; and - 23 - (c) land clearing operations ("desmonte"), mainly in some of the northern provinces to expand the agricultural frontier by some 300,000.ha. The Secretariat of Agriculture had this project component under preliminary preparation. 2.04 Besides spelling out possible project scope, the FAO/CP mission report (October 1976) highlighted the following points: (a) interest rates would be the main issue. Following a period of extremely high inflation and highly negative interest rates, the new Government shared the Bank's view that interest rates should be positive. There were various mechanisms under consideration in view of the fact that the system eventually selected would greatly affect the level of future demand for credit; (b) Banco de la Nacion Argentina (BNA), the biggest bank in the country, which from the beginning had pressed to be the exclusive project's credit agency, had indicated its willingness to accept the Government's request to channel Bank funds, acting as the lead bank for a consortium of participating provincial and private banks; and (c) assuming that loan presentation to the Bank Board would be advanced from FY80 to FY78, project preparation could be accelerated for possible appraisal by May 1977. 2.05 Following the FAO/CP identification mission (September 1976), INTA and SAG under three different working teams continued the preparation of the three project components proposed for the project. However, because of the lack of a coordinating authority for the three project teams, the absence of a participating credit institution essential to project implementation and other reasons, project preparation suffered a delay of six months. Therefore, the FAO/CP preparation assistance mission originally scheduled for January 1977 did not go until May/June 1977, and the appraisal mission was, in turn, rescheduled from May to October 1977. In the first week of July 1977, the Government established a Project Preparation Coordinating Team headed by a representative of SAG, with the participation of BNA, INTA, and SAG staff. The coordinating team, following technical notes left by the FAO/CP mission and specific project preparation guidelines provided by Bank staff missions of June and July 1977, prepared a consolidated Project Report (dated September 22, 1977) which was delivered to the Bank by the Argentine delegation to the Bank's Annual Meeting in Washington on September 27, 1977. 2.06 In brief, the most relevant features of the project, as presented by the Government, were the following: (a) the project would consist of an agricultural credit project that would provide medium- and long-term subloans for (i) on-farm investments for livestock and crop production in selected areas of the Pampean and Mesopotamian regions; (ii) a weed control program in - 24 - an extensive area of the Pampean region that was heavily infested with noxious weeds; and (iii) a land clearing program in the northern provinces of the country; (b) total project cost was estimated at US$291 million, at prices and exchange rate ($a 381 to US$1) of June 1977; (c) the foreign exchange component of the project was estimated at about 38%, or US$110 million; (d) proposed financing of project costs called for the Bank to finance the foreign exchange cost amounting to about US$100 million (38%); BNA, US$123 million (42%); and sub-borrowers, US$58 million (20%); (e) the Government of Argentina would be the borrower and BNA would act as its financial agent; (f) project administration would be carried out by a Project Committee consisting of representatives of the participating entities, SAG, BNA and INTA; and (g) the economic rate of return of the entire project was estimated at 42%. 2.07 It is relevant to indicate that, while the project as presented to the Bank (September 27, 1980) proposed Bank's financing of the foreign exchange cost amounting to US$100 million, the Minister of Economy of Argentina, at a meeting that took place at the Bank on the occasion of the Bank's annual meeting (September 27, 1977), expressed doubts regarding the proposed loan amount. He felt that the demand for a US$100 million loan had not yet been established and that the participating banks would not be able to come up with the necessary counterpart funds. Bank staff pointed out that the recent economic report suggested rapid growth in demand for agricultural credit as a consequence of the new agricultural policy of the Government and that the proposed Bank loan would not require incremental funds but increased use of existing resources of the participating banks to augment their agricultural credit lines. The Minister indicated that a loan of about US$40 million would be appropriate under the circumstances, and suggested that a repeater loan could be considered later depending on the outcome of this operation. The Bank took the position that the Minister's proposal appeared reasonable and that the Bank certainly did not want to argue in favor of a higher loan amount in view of the apparent doubts and constraints mentioned by the Minister. B. Project Appraisal 2.08 A Bank appraisal mission visited Argentina for about three weeks in October 1977. The mission considered the project to be technically sound in general and was of the opinion that there were no major issues. The only issue reported by the mission in the Issues Paper (November 12, 1977) was a minor one related to a discrepancy regarding the proportion of project costs - 25 - that constituted the foreign exchange component. The mission estimated it as 35% but the country preparation team insisted that it was of the order of 37 to 40%. Since there were no major issues, a decision meeting was not considered necessary and the Bank advised the Argentinian Government that it was prepared to consider a loan of US$57 million, which represented the foreign exchange (35%) portion of the total project cost, estimated at US$160 million, including price contingency over a five-year investment period. C. Project/Loan Proposal Presented at Negotiations Project Description and Objectives 2.09 As conceived during the identification/preparation missions, the project would finance, over a three-year commitment period, medium- and long-term agricultural credit to finance on-farm development investments for livestock and crop production in selected areas of the Pampean and the Mesopotamian regions; weed control in an extensive area of the Pampean region, now heavily infested with weed; and land clearing in the northern provinces of the country. The project would help implement Government's policies aimed at accelerating the growth of agricultural production for export to overcome the traditionally recurring balance of payments difficulties that had hampered Argentina's economic growth during most of the post-war period. Specifically, the project was designed to accomplish the following objectives: (a) increase the productivity of ranches and farms dedicated to the production of livestock and agricultural products in the Pampean and Mesopotamian regions; (b) restore the productive capacity of an extensive area of the Pampean region, which was heavily infested with Johnson grass and Bermuda grass; and (c) extend the country's cropping and pasture area by clearing substan- tial portions of unproductive wooded land in the northern provinces. Project Cost 2.10 The total project cost including price contingencies and expressed in mid-1977 prices was estimated at US$161.7 million of which US$60.0 million, or 37%, represented foreign exchange costs net of import duties and taxes. The project costs are summarized in the following table: - 26 - Investment Category Local Foreign Total Exchange -------(US$ million)------- ---(%)- 1. On-farm development 28.2 7.8 36.0 22 2. Weed control 28.0 12.0 40.0 30 3. Land clearing 25.5 28.0 53.5 52 4. Technical assistance 0.8 0.7 1.5 50 Baseline total cost 82.5 48.5 131.0 37 Price contingencies 19.2 11.5 30.7 37 Total project cost 101.7 60.0 161.7 37 Financing 2.11 The proposed Bank loan of US$60.0 million would finance the entire foreign exchange cost, which was estimated at 37% of the total project cost. Project beneficiaries would finance US$31.6 million representing about 20% of the total project cost, and US$70.1 million, or 43%, would be provided by the participating banks from their resources. The Government would be the borrower and would assume the foreign exchange risk. It would on-lend the proceeds of the loan to participating banks which, in turn, would make subloans to project beneficiaries of up to 80% of the cost of farmers' investment plans. Bank loan proceeds, accordingly, would finance 46% of the value of project subloans; the remaining 54% would be financed by PBs. On-lending Terms 2.12 Lending terms and conditions between Government and participating banks and those between participating banks and project beneficiaries would be set in subsidiary loan agreements to be entered into by the Government and each participating bank. The Government would charge no less-than 2.75% to the PBs and PBs would charge no less than 6% to project beneficiaries. Interest rates would be positive in real terms since outstanding balances of the loans would be adjusted by the general wholesale price index of Argentina. Subsidiary loans from Government to PBs would have the same repayment terms as the Bank loan with grace periods of up to four years. Repayment terms of subloans to project beneficiaries which would range from three years to a maximum of nine years, including grace periods of up to four years, would be established for each subloan on basis of the cash flow projections. The minimum rate the Government charged to PBs did not constitute a subsidy under conditions that existed in view of the gliding parity adjustment of the Argentine peso and the proposed indexation of the outstanding balances. The Government was firmly committed to avoid any subsidy and therefore intended, after consultation with the Bank, to raise the interest rate to PBs should changing conditions require it to do so. - 27 - Project Implementation 2.13 Organization and Management. The project would be administered by a Project Committee (PC) composed of representatives of, inter alia, SAG, BNA and INTA, the three main entities directly responsible for implementation of the different project components. Committee members would be qualified staff members of the respective institutions, selected and appointed by the Secretary of SAG, the president of BNA and the president of INTA. The representative of SAG would be president of the Committee. The Committee's main functions would be to supervise and coordinate the project implementation, and it would also serve as the borrower's official representative in dealing with the Bank in all technical, economical and financial matters related to the project. 2.14 A project coordinator, under the Project Committee, would assist, supervise and coordinate the participating entities in carrying out project activities. He would also serve as the liaison officer between the Bank, the Government and other participating entities. The project coordinator would be a qualified professional with experience in agricultural development activities, selected and appointed by the Committee. 2.15 Channels of Financing. Subloans would be channeled through BNA and selected provincial banks in the project area under subsidiary loan agreements with the Government, as represented by the Ministry of Economy, which would route through BNA funds intended for other participating banks. 2.16 Conditions of Effectiveness of the Loan. The following three conditions were requested by the Bank: (a) that the Project Committee had been established; (b) that the project coordinator had been appointed; and (c) that the Government had signed a subsidiary loan agreement, satisfactory to the Bank, with BNA. D. Negotiations, Loan Approval, Loan Effectiveness Negotiations 2.17 Negotiations took place in Washington, D.C. from March 28 to March 30, 1978. The Argentine delegation was headed by the Director of External Finance, Ministry of Economy, and included representatives of BNA and INTA. All the assurances required were obtained and the three proposed conditions for loan effectiveness were accepted. Changes made in the draft Loan Agreement were, in general, matters of form or of minor importance in substance and therefore agreement was reached without problems. Subsequent to negotiations in Washington, D.C., the Government informed the Bank of its agreement on the negotiated Loan Agreement for the proposed loan on April 14, 1978. - 28 - Loan Approval 2.18 The loan was approved by the Bank on May 9, 1978 and signed by the Government and Bank representatives on June 29, 1978. Loan Effectiveness 2.19 The date for loan effectiveness, originally set at October 30, 1978, was not met and had to be extended three times, first to November 30, 1978, then to January 15, 1979, and finally to February 15, 1979. The main reasons for the delays were misunderstandings and complications in obtaining the legal opinion of the Argentine institution responsible for reviewing the Loan Agreement to ensure that it was in accordance with the laws of the country. After protracted correspondence, satisfactory documents were finally received by the Bank and the Loan was declared effective on February 14, 1979. III. PROJECT START-UP AND CANCELLATION Start-up 3.01 On February 28, 1979, the Government wrote to the Bank, providing the names and signatures of five BNA officials authorized to sign reimbursement applications related to the Agricultural Credit Loan (1564-AR). By separate letter of the same date, the Government also informed the Bank that the Project Committee had extended by six months the appointment of the Acting Technical Director, who had originally been appointed for three months to fulfill a condition of loan effectiveness. The Government explained that, due to administrative problems (salary scale) which were yet to be solved, it was not yet able to appoint the project director on a permanent basis. The Bank accepted this temporary arrangement, subject to prompt con- version to a permanent appointment. At the beginning of March 1979, the Project Committee, formed by representatives of the Agriculture and Livestock Secretariat (SAG), the Ministry of Economy, INTA and BNA, started meeting regularly, chaired by the acting Technical Director. Even though BNA had not started lending operations, pending Government decision on the indexing issue (para 3.02), the Project Committee moved ahead with the training of private sector professionals who would provide technical assistance to project beneficiaries. A total of 210 technicians participated in the training sessions that took place over the 60-day period following loan effectiveness. 3.02 In spite of all the efforts on the part of the Bank and high officials of the Secretariats of Agriculture and Economy, the lending program, which was the core of the project, never did become operational. At the outset of project execution, as corroborated by Bank mission reports (dated April 10, May 7 and May 23, 1979), the investment climate in the agriculture sector in Argentina was at its lowest ebb. Two reasons were given for this situation: one was that the Government's economic policies had failed to bring inflation below the 150% level attained during 1977, vis-a-vis the adjustment of the peso/dollar exchange rate of about 70% during 1979; the other was that BNA, which had signed a Subsidiary Loan Agreement to participate in the - 29 - project as leading and participating bank, informed Government authorities that the conditions set out in the Loan Agreement, i.e., interest rates at 6% for beneficiaries and 2.75% for participating banks, with outstanding balances adjusted by the variations of the wholesale price index, made borrowing unattractive. BNA further proposed that the formula should therefore be modified to one of nominal floating interest rates as used by the banking system in its short-term lending operations, or, alternatively, to make subloans subject to repayment pegged to a US dollar equivalent. The Government authorities concerned with the issue informally asked Bank supervision mission members on several occasions whether the Bank would be willing to amend the Loan Agreement to reflect one of these changes and they were told each time that, even though the Bank believed that the system established under the Loan Agreement was the best, it was willing to switch to another scheme, provided that the new scheme would not involve Government subsidy and that interest rates -- on the average -- would be positive in real terms. 3.03 During the last week of September 1979, however, BNA informed the Government that it had decided to relinquish its role of leading and participating bank under the Bank Agricultural Credit Project, as well as under other projects financed by IDB. Even though neither the Government nor BNA elaborated on their reasons for such an unexpected move, Bank mission members who participated in project supervision are of the opinion that BNA withdrew from its commitment mainly because: (a) the then current financial position of BNA had become one of high liquidity; (b) lending terms charged for Bank funds were unattractive, compared to those which BNA could obtain from the international money market; and (c) the Government had recently, in an effort to set equally competitive terms for private and public financial institutions, eliminated BNF's traditional tax privileges. 3.04 Since BNA was expected to channel the bulk of the lending program through its more than 500 branches throughout the country and also to act as the Government's intermediary with other provincial and private banks, it became vitally important to find another institution to take its place as lead agent and, at the same time, to attract provincial and private banks that could cover the large project area, which included 15 provinces. To this end, the Secretariat of Economic Programming and Coordination of the Ministry of Economy and SAG, with Bank assistance, formulated a new flexible system for subloan adjustment and interest rates, under which participating banks and project sub-borrowers would have one of three options: (a) indexing of principal on the basis of the general wholesale price index, as required under the Loan Agreement, except that the interest to be paid by PBs to Government would be reduced from 2.75% to 1.75% and the interest rate to be paid by project beneficiaries would be set by the PBs in accordance with market rates; (b) floating nominal interest rates, freely determined by PBs in accordance with market forces, applied to non- adjusted outstanding balances and repayment from PBs to Government at interest rates prevailing for time deposits; and (c) principal adjusted by the US dollar exchange rate and interest rate to be fixed by PBs in the case of subloans to beneficiaries and 1% above the LIBOR 180-day rate for repayments from PBs to the Government. In the last two options, interest rates could be capitalized during grace period. - 30 - 3.05 On the basis of the new flexible formula, the Secretariat of Economic Programming and Coordination started encouraging contacts with prospective private and official banks, and 24 of them indicated their willingness to participate. However, neither BNA nor the Bank of the Province of Buenos Aires, the two most important banks in the country, was interested and none of the 24 was considered suitable to serve as leading bank. Moreover, the Central Bank, which had refused the role of leading bank, had not yet considered a request for approval of the proposal to make loans in US dollar equivalent repayments when using local resources contributed by the PBs. In the circumstances, the Secretariat of Economic Programming and Coordination addressed a letter to the President of BNA (January 21, 1980), explaining the convenience of the new flexible formula for adjustments and interest rates and the willingness of the several banks to participate in the project. The letter also indicated that, given the need for a suitable institution to administer the Subsidiary Loan Agreements, it was necessary that BNA assume such a role and also to reconsider the possibility of acting as one of the participating banks. During the first week of February 1980, BNA replied that it held to its decision to withdraw from any participation in the project, and about the same time, the Central Bank, which had been delaying consideration of the proposal to permit PBs lending in dollar terms, advised the Government that the proposal was not acceptable under prevailing monetary policies. Loan Cancellation 3.06 On February 21, 1980, faced with the impossibility of finding a leading bank to substitute for BNA and of establishing lending terms satisfactory to CB, BNA and project beneficiaries, the Secretary of Agriculture of Argentina decided to call off execution of the project and informed the Minister of Economy that he would be in agreement with a decision to request the Bank to cancel the loan (1564-AR). A Bank mission that visited Argentina during the first week of March 1980 to make a last effort to get the project implemented was notified informally that the Government was considering asking for cancellation, mainly because BNA would not change its position on relinquishing its role of leading bank, and the Central Bank had not accepted the dollar denomination option for project lending. The mission handed the Vice-Minister of Economy an Aide-Memoire which indicated the reasons why the Bank considered a cancellation at this point highly undesirable and reiterated its willingness to accept the relending formula considered earlier by the Government or any other formula that provided for interest rates which were, on average, positive in real terms, and to modify other minor conditions stated in the Loan Agreement. The Bank also stated its willingness to accept other satisfactory arrangements if BNA would not reverse its position to withdraw from the project. The Aide-Memoire is attached as an annex to this report. 3.07 On April 14, 1980, the Bank received a letter from the Secretary of Economic Programming and Coordination of the Ministry of Economy asking, on behalf of the Government, for total cancellation of Loan 1564-AR. The letter stated that the decision to cancel had come from a proposal of the Project Committee, taking into consideration insuperable problems which precluded the possibility of satisfactory project implementation. Among - 31 - the problems mentioned were: (a) the withdrawal of BNA as fiscal agent and participating bank for financial and technical reasons; (b) the substantial reduction of demand for agricultural investment credit, especially credit that must be adjusted in accordance with the variations of the wholesale price index; and (c) the political decision taken at the request of the Central Bank not to amend existing policies, so as to make it possible to use various alternatives at the option of sub-borrowers to facilitate disbursement of the loan. The letter ended by thanking the Bank for the continuous assistance and understanding it provided while attempts were made to try to find solutions to the issues in question. In accordance with Government's request, the Bank cancelled the loan, in the amount of US$60 million originally approved, as of April 14, 1980. IV. CONCLUSIONS 4.01 Though the Bank was willing to amend the Loan Agreement so as to bring the on-lending terms under the project into line with the changing Argentine situation relative to inflation and interest rates, the Government of Argentina did not attempt to check out the demand for agricultural credit by publicizing the project and making it operational, but sought the cancellation of the Bank loan. The complex of circumstances which led to this decision is fairly clear, even if there is no agreement on the importance attributable to each of these factors. First and foremost, contrary to earlier expectations, no significant progress was made in eliminating inflationary pressures in the Argentine economy, and the environment, therefore, became increasingly unfavorable for investment. Secondly, this sentiment was reinforced, in the case of farmers and ranchers, by the fact that the overvalued exchange rate of the Argentine peso turned the terms of trade against the agricultural exporters. The farmers, therefore, remained skeptical about the future prospects of the sector and relevant Government policies, notwithstanding the euphoria generated earlier by the initial actions of the new administration to reduce or abolish export taxes and price controls on agricultural commodities. Finally, so far as the banking system was concerned, there was a substantial accretion of liquidity, partly as a result of foreign capital inflows. To the extent that there was demand for credit to finance investment in agriculture, it was apparently met by the rollover of short-term credit, based more on bank-client relationships than on well-defined and technically evaluated on-farm development plans. 4.02 Beyond any explanation, in these terms, of the cancellation of the Bank loan, lies the further question as to whether these developments could have been foreseen. It is always difficult to determine, and almost impossible to quantify, the demand for agricultural credit on the basis of sporadic farmer interviews of the kind undertaken by the FAO/CP preparation mission and the Bank appraisal mission but it should be noted that their perception of substantial agricultural credit requirements and, as a corollary, of the need for a Bank-financed project was widely shared, and did receive strong endorsement from various Argentine authorities ranging - 32 - from the Ministry of Agriculture to the Banco de la Nacion. It also appears now, in retrospect, that the Bank was more readily impressed with the supportive stance of Government towards agriculture than the Argentine farm producers who had witnessed many ups and downs in official policies over the years, and awaited more definitive evidence of Government intentions before undertaking loan-financed investment on their farms. As for inflation, it may be recalled that the Staff Appraisal Report had indeed struck a note of caution, pointing out in its section on "Project Risk" (paragraph 9.06) that the demand for project investment loans would depend on the ability of the Government to curb the inflationary trend and on improved world prices for agricultural commodities. The issue could be raised whether the Bank had been unduly optimistic in its assessment of the prospects for checking inflation and stimulating investment in the agricultural sector, particularly in the light of the experience of the zig-zag course of policy and performance under the Bank-financed Balcarce Livestock Project but then it may be noted that there was considerable enthusiasm for the new credit project on the Argentine side too and that the size of the Bank loan was reduced to US$60 million from the sum of US$100 million originally proposed. Nevertheless, with the benefit of hindsight, it does seem that the Bank underestimated (a) the impact of inflation-related uncertainties on farmers' investment decisions, and (b) the extent to which on-farm capital expenditures could be financed through rollover of short-term credit. - 33 - ANNEX AIDE-MEMOIRE AGRICULTURAL CREDIT PROJECT (LOAN 1564-AR) March 1980 Amount: US$60 million Approved by the Bank: May 1978 Signed: June 1978 Effective Date: February 1979 Closing Date: June 30, 1983 1. The Bank has informally been notified that the Government is considering to cancel the loan mainly because Banco de la Nacion Argentina (BNA), which was expected to be project administrator and main financial participant, decided to withdraw from the project. The Bank was also informed that the Central Bank has not accepted the dollar denomination formula that was considered by the Government as an additional relending option. 2. The Bank considers a cancellation of the loan at this point as highly undesirable. As a result of long delays in changing the relending conditions, the project has not yet become operational. The Bank feels that an effort should be made to overcome the institutional problems and introduce new relending policies to give agricultural producers an opportunity to avail themselves of the service the project is offering. Only if there would be no demand for credit under modified on-lending conditions of the project, would a cancellation of the loan be justified. In addition, the Bank fails to assent to the reasons given by BNA for its withdrawal. Since the project offers long-term funds at favorable terms, the decision to participate should not be based only on the current financial position of the potential participant. 3. The Bank reiterates its willingness to accept the relending formulas presented earlier by the Government, or any other formulas that meet the following conditions: (a) interest rates are, on average, positive in real terms; (b) the Government does not provide any subsidy to project beneficiaries; (c) PBs provide 54% of each subloan out of their own resources; and (d) maturity and grace period of subloans are based on farm investment plans, the minimum maturity being three years. - 34 - ANNEX Page 2 In case the Central Bank maintains its position not to accept the dollar denomination formula, the Bank would agree to a system of only the fixed and floating interest rates options together with any other formula that would meet the above criteria. To make the project more attractive to PBs, the Bank would also accept, if required, that PBs recover their 54% share with the first maturities of the subloans with the Bank's share recovered out of the later maturities. 4. While the Bank considers the participation of BNA as lead Bank and project administrator important for the success of the project, it would accept other institutional arrangements should BNA not reverse its position to withdraw from the project, provided, however, that: (a) the whole project area is covered by branches of the PBs; (b) alternative institutional arrangements can be made for project administration and selection of other PBs. Such arrangements could consist in: (a) finding another lead bank and project administrator; for example, the Banco de la Provincia de Buenos Aires; or (b) strenghtening the Project Committee in such a way that it can resume responsibility for project administration. Attachment Communication between Government and Bank on changing the project's relending policies. 1. March 1979: A Bank mission (Mr. von Loehneysen) is asked by the Government whether the Bank would consider floating interest rates as an option offered to sub-borrowers. The response is positive; it is proposed that a supervision mission should analyze the problem in detail. 2. April/May 1979: A supervision mission (Messrs. Uhlig, Glenn and Miyanaga) concludes that the Bank should consider floating interest rates as an option. 3. June 1979: A Bank mission (Mr. Ramasubbu) indicates Bank's willingness to change the Loan Agreement and asks for formal request. 4. July 1979: The Bank writes a letter to the Government asking for a formal request to change the Loan Agreement. 5. July 1979: A Bank mission (Mr. von Loehneysen) reiterates the Bank's willingness to change the Loan Agreement and asks for a formal request. - 35 - ANNEX Page 3 6. August 1979: Mr. Iribarne visits the Bank and indicates that formal request will be submitted shortly. 7. October 1979: A supervision mission (Messrs. Glenn, Miyanaga and von Loehneysen) is told that the Government also wants to propose dollar denomination of subloans as a third option and that BNA has withdrawn from the project. The mission indicates the Bank's willingness to consider also dollar denomi- nation and other institutional arrangements; a corresponding letter, asking for a formal request is sent on October 31. 8. November 1979: Mr. Scherer indicates Bank approval to the proposed change in on-lending rates and legal documents during visit in Buenos Aires. 9. December 1979: Mr. Scherer asks in a cable for a formal request to change the Loan Agreement. 10. January 1980: A Bank mission (Mr. von Loehneysen) discusses the proposed changes again and leaves a draft letter for requesting formally a change of the Loan Agreement. 11. February 1980: A supervision mission (Mr. Bazo) tries to finalize the draft letter for changing the Loan Agreement but then is told that a high level meeting in the Ministry of Economy will discuss the project. Subsequently, Mr. Scherer is told by Mr. Blanco that the Government may decide to cancel the project because of the BNA's withdrawal.  IBRD 13337 68' S' 8' - 2' s 58 D •ARcNS197B S-QJUT B O,t l V I A A/GCNT1NA A M E Rl- A ARGENTINA \ AGRICULTURAL CREDIT PROJECT - 0 a No5P A R A G U A Y AREA Of SM D'S o i C $SA LT A B R A Z L 0 c o ~ ~ ý1 0 #EA C A 'SCION N, HERRERA O WINO jo ' Be ROAAQ0 A RIOJA ( 5åAN 0 ~ NA SAN JUAN i OS 0SANTA 0Fc NcO~I A 02s 0 0RLA SCOOA000 2oza BELL'LLE cI TORIA G U SANTIAGO c 5l T 1ALEGUA MEDZ A ooo - A 0 0 o0o o UENOA 3[3- ---I-r-' AT A OTV ATANO -~ 5 0 0S-OTIAAG0 CAA111 0 0a OCAN sTA RosA0 o cOMPONENT AREAS _ A A Weed ControM D'L B P A Z A l 1nd eveoing 0 0d%VEs 00 c oO MAR DEL PLATA O Bonco Nocion Arge4nn (bronches) B.N A. 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