Colombia - Agricultural Diversification Project

Document of The World Bank FOR OFFICIAL USE ONLY 04 C c9, Report No. 4966-CO STAFF APPRAISAL REPORT COLOMBIA AGRICULTURAL DIVERSIFICATION PROJECT June 5, 1984 Projects Department Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENT Currency Unit - Colombian peso (Co1$) US$1.00 = Col$ 95.0 Col$ 1 = US$0.01 Col$ 1 million = US$10,526 WEIGHTS AND MEASURES Metric System ABRREVIATIONS Caja Agraria - Caja de Credito Agrario, Industrial y Minero (Agricultural, Industrial and Mining Credit Bank) COMERCAFE - Comercializadora Agricola Cafetera (Coffee Growers' Agricultural Wholesale Agency) FEDERACAFE - Federacion Nacional de Cafeteros de Colombia (National Federation of Coffee Growers of Colombia) FEDEKACAFE/ - Programa de Desarrollo y Diversificacion de Zonas PRODESARROLLO Cafeteras, Departamento en FEDERACAFE (Coffee Zones Development and Diversification Program, A Department within FEDERACAFE) FFAP - Fondo Financiero Agropecuario (Agricultural Financing Fund) FFI - Fondo Financiero Industrial (Industrial Financing Fund) Coffee Fund - Fondo NacionaL del Cafe (National Coffee Fund) ICA - Instituto Colombiano Agropecuario (Colombian Agricultural Institute) LICA - Instituto Interamericano de Cooperacion Agricola (Inter-American Institute of Agricultural Cooperation) IL)iS - Inter-American Development Bank SENA - Servicio Nacional de Aprendizaje (National Apprenticeship Service) GOVERNMENT OF COLOMBIA FISCAL YEAR January 1 - December 31 NATIONAL FEDERATION OF COFFEE GROWERS OF COLOMBIA FISCAL YEAR January 1 - December 31  FOR OMFCUL USE ONLY COLOMBIA AGRICULTURAL DIVERSIFICATION PROJECT Table of Contents Page No. Loan and Project Summary . . . . . .. .-. . . . . . . . . v I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . 1 A. The Agricultural Sector* . e .. . . . . .a. . . . . . . . 1 B. Agricultural Credit. . . . . . . . . . . . . . . . . . . 1 C. The Coffee Economy . . . . . . . . . . . . . . . . . . . 2 D. Past Diversification Efforts . . . . . . . . . . . . . . 4 E. Government Strategy for Agricultural Production and Diversification . . . . . . . . . . . . . . . . . . 5 F. Bank Strategy . . . . . . . . . . . . . . . . . . . . . 6 II. THE PROJECT AREA . . . . . . . . . . . . . . . . . . . . .. 8 A. Location, Climate and Soils . . .a. .. .. a * .. . 8 B. Land Use, Tenure and Farm Size . . - . . .-. . .- - . . .- -8 C. Farming Systems . . . . .-. . . . . . . . . . . . . . . 9 D. Physical and Social Infrastructure . . . . . . . . . . 9 E. Agricultural Services . . . . . . . . . . . . . . . . . 9 F. Diversification Activities: 1963-1983 . . . . . . . . . 10 (II. THE PROJECT . . . o . . . . . . . . . 9 . . o . . . . . . 11 A. Objectives and Brief Description . o . .o . . . . . . . 11 B. Detailed Features . . . . . . . . . . . . . . . . . .. 12 - Agricultural Production Coomponent . . . . . . . . . . 12 - Marketing Component.. .. . . m m . . . .a. . . . . . 12 - Agroindustries Component .. ... . . . m. . . . 13 - Support Services Cobponcnt . a . . .. ... . . . . 14 C. Project Cost . . o . . a . . a . a . . . . 16 D. Financing . . . . . . . . . . . . . . . . . . . . . . . 16 E. Procurement . . . . . . . . . . . . . . . . . . . . . . 19 F. Disbursements . . . . . . a o a o o . . 19 This report is based on the findings of an appraisal mission which visited Colombia in October 1983. The mission was comprised of Messrs. A. Uhlig, V. Ferrer, R. Simsolo; Ms. A.C. Wee (Bank); and Messrs. A. Ballantyne, and J.J. Gariglio (Consultants). F doc=M Ms a resuuild disuibom ad may e ted by mecWits wily in dhe perfoanane of if < ^'" " b e _ d dudes.Its cmzets may nt oUzewie be diinud withot WON Bak authizio  - ii - %-V Page No. IV. PROJECT IMPLEMENTATION . . . . ........... . .. 21 A. Organization and Management ......... ..... 21 B. Lending Policies an4 Procedures . . . . . . . . . . . . 21 C. Lending Terms and Conditions see...... .... 23 D. Accounts and Auditing ........... .... . . 25 E. Monitoring, Progress Reporting, and Evaluation . . . . . 25 V. PRODUCTION, MARKETING AND PRICES .. . . . . . ... . . . . 26 A. Production, Marketing and Markets . . . . . . . . . . . 26 B. Prices . . . . . . . . . . . . . . . . . . . . . . . 27 VI. ECONOMIC ANALYSIS AND RISKS .a. . . . .. . .. ... .. . 27 A. Financial and Economic Rates of Return . . . . . . . . . 27 B. Employment Impact . . ................. 30 C. Environmental Impact .t.... ....... . 30 D. Project Risks . . . . . . . a. . . . . . . 30 VII. SUMMRY OF AGREEMENTS REACHED AND RECOMENDATION . . . . . . 31 TABLES IN TEXT 3.1 - Project Cost Summary. ................... 17 3.2 - Project Financing ..................... 18 3.3 - Disbursement Percentages by Category . . . . . . . . . . . . 20 3.4 - Disbursement Schedule . .. . . . . . . . . . . . . . . . . 20 4.1 - Lending Terms Summary .... .. . ..... . . ... . 24 5.1 - Estimated Annual Incremental Agricultural Production at Full Development . . . . . . . . . . . . . . . . . e e . . 26 6.1 - Farm Investment Models: Summary of Development Impact and Rates of Return . . . . . . . e. . . . .. . . . . . . 29 6.2 - Harketing and Agroindustrial Investment Models: Rates of Return . . . . . . . . . . . . . . . . . . . . . . 30 ANNEXES 1 - Project Area, Coffee Subsector and Past Diversification Efforts . . . . . . . . . . . . . a . . . . . . . . v . . . 33 2 - Project Implementing Institutions . . . . . . . . . . . . . 39 3 - Project Physical Parameters, Cost and Financing . . . . . . 55 4 - Illustrative Farm Models and Financial and Economic Prices . 70 5 - Related Documents and Data Available in Project File . . . . 90  - lil - Page No. TABLES IN ANNEXES ANNEX I - Project Area, Coffee Subsector and Past Diversification Effort . . . . . . . . . . . . ............. 33 Table I - List of Project Departments and Municipalities. . . . . . 33 2 - Land Use - Coffee Zone ................. 35 3 - Area of Coffee Farms Distributed by Altitude . . . . . . 36 4 - Coffee Farms Distribution b7 Size, Type of Operation and Land Tenure . . . . . . . . . . . . . . . . . . . . . 37 5 - Diversification Program: Activities Financed 1963-1982 . 38 ANNEX 2 - Project Implementing Institutions . . . . . . . . . . . . 39 Table 1 - Summary of Balance Sheets.. ...... . ...... 46 2 - FEDERACAFE Agricultural Credit Operations for Diversification through PRODESARROLLO . . . . . . . . . . 47 3 - PRODESARROLLO Agricultural Credit Operations. . . . . . . 48 4 - Banco Cafetero: Balance Sheets 1980-82 . . . . . . . . . 49 5 - Banco Cafetero: Analysis of Loan Portfolio by Sector . . 50 6 - PRODESARROLLO's Debt Service under the Project. . . . . . 51 7 - PRODESARROLLO's Cash Flow under the Project . . . . . . . 52 ANNEX 3 - Project Physical Parameters, Cost and Financing . . . . . 55 Table 1 - Areas by Crop - Phasing . . . . . . .a. . . . . . . . . . 55 2 - Livestock Production Units - Phasing . . . . . . . . . 3 56 3 - Indicative Crop Yields (Excluding Harvest Losses) . . . . 57 4 - Livestock - Production and Sales per Unit . . . . . . . . 58 5 - Land Use With and Without Project . ...... ... 59 6 - Total Cost by Component - Phasing (Including Contingencies) . . . . . . . . . . . . . . . . . . 60 7 - Agricultural Production Cost - Phasing . . . . . . . . . 61 8 - Harketing Component - Phasing and Cost . . . . . . . . . 62 9 - Agroindustrial Component - Phasing and Cost . . . . . . . 63 10 - TrainingCost -Phasing................. 64 11 - Applied Research Cost - Phasing . . . . . . . . . . . . . 65 12 - Marketing Information Service Cost - Phasing. a . . . . . 66 13 - Increnental Staff Cost - Phasing . . . . . . . . . . . . 67 14 - Support Services - Total Cost (Including Physical and Price Contingencies) . . . . . . . . . . . . . . . . . . 68 15- Lending Program and Financing . ................ .....a 69 ANNEX 4 - Illustrative Farm Models and Financial and Economic Prices . . . . . . . . . . . . . . . 70 Table 1 - Distribution of Farm Investment Models - Phased . . . . . 70 2 - Farm Investment Model I (7 ha) - Physical Parameters . . 71 3 - Farm Investment Model I - Investment Analysis andCash Flow Projections . . .9. ................. 72 4 - Farm Investment Model II (55 ha) - Physical Parameters. 73  - iv - Page No. 5 - Farm Investment Model II - Investment Analysis and Cash Flow Projections .. ..... . . . . . . . . . . 74 6 - Farm Investment Model III (10 ha) - Physical Parameters 75 7 - Farm Investment Model. III - Investment Analysis and Cash Flow Projections .. ....... ... .... 76 8 - Farm Investment Model IV (20 ha) - Physical Parameters. 77 9 - Farm Investment Model IV - Investment Analysis and Cash Flow Projections . . . o.............. 78 10 - Farm Investment Model V (15 ha) - Physical Parameters * 79 11 - Farm Investment Model V - investment Analysis and Cash Flow Projections . . . . . . ......... 80 12 - Farmers' Producer Organization Model - Cash Flow Projections . . . . . . . . . . . . . . . . . . . . . . 81 13 - Primary Collection Center Model - Ceash Flow Projections 82 14 - Regional Collection Center Model -Cash Flow Projections 83 15 - Supermarket Fruit and Vegetable Section Model - CashFl oje ron ections ................. 84 16 - COMERCAFE Model - Cash Flow Projections . . . . . . . . 85 17 - Frozen Vegetable Plant Model - Cash Flow Projections. . 86 18 - Milk Pasteurization Plant Model - Cash Flow Projections . . . . . . . . . . as. ... ... 87 19 - Financial and Economic Prices - Farm Gate . .o -.. .. . 88 20 - Sensitivity Analysis - Switching Values . . . . . . . . 89 CHARTS WB26224 - Organization Chart of National Federation of Coffee Growers of Colombia . . . . ;. . . . . .. . * * * .. 53 WB26223 - Organization Chart of Coffee Zones Development and Diversification Program (PRODESARROLLO) . . . . . . . . 54 MAP IBRD 18034 - Colombia - Coffee Growing Areas  v COLOMBIA AGRICULTURAL DIVERSIFICATION PROJEft LOAN AND PROJECT SUMMARY Borrower: National Federation of Coffee Growers of Colombia (FEDERACAFE) Guarantor: Republic of Colombia Amount: US$50.0 million equivalent, including capitalized front-end fee. Terms: 17 years, including four years of grace, at the standard variable interest rate. Project Description: The project would support the Government's and FEDERACAFE's policy of diversifying agricultural production in the coffee areas through increased production, marketing and processing of non-coffee commodities. This strategy would lead to substantial increases in food production and a reduction in the economy's vulnerability to price changes and market constraints on coffee, thereby assisting the country in reducing overproduction and costly stock build-up of coffee. The project would accelerate significantly the borrower's ongoing diversification efforts and help make diversification a more self-sustaining process through provision of: (a) credit for agricultural production, processing, and marketing; and (b) related support services, including technical assistance, applied agricultural research and a price and marketing information system. As a result, the share of crops other than coffee in the land-use pattern would increase from about 10% to approximately 20%. Incremental annual production at full development would be about 3% of the value of national agricultural production in 1983. Direct project beneficiaries would be some 13,600 farmers, whose income is expected to increase by about 50% at full development, about 40 private agroindustrial enterprises, and about 170 marketing entities in the coffee areas. Project Risks; There would be little technical or managerial risks, since FEDERACAFE, a private producer organization, is efficient and commands a well developed physical and organizational infra- structure in the proposed project area, which would be suitably strengthened for meeting the needs of the expanded diversification effort. Also, the principal banking windows  - Vi - under the proposed project, Banco Cafetero and Caja Agraria, have consistently performed well in granting,credit and should have no difficulty in providing the banking services required under the project. However, the pace of project execution would critically depend on (a) efficient marketing of project output and (b) the Government continuing to maintain reduced incentives for coffee production, which is its declared policy. These two aspects would be monitored through FEDERACAFE's marketing intelligence system to be strengthened under the project and the introduction of a review mechbnism regarding diversification incentives. Local Foreign Total --- (US$ million) - Estimated costs Credit 189.2 47.1 236.3 Support services 12.1 2.0 14.1 Subtotal 201.3 49.1 250.4 Contingencies:a/ Physical 1.2 0.2 1.4 Price 1.0 0.6 1.6 Total project cost 203.5 49.9 253.4 b/ Front-end fee - 0.1 0.1 Total financing required 203.5 50.0 253.5 Financing plan Beneficiaries 53.8 - 53.8 FFAP 90.1 - 90.1 FFI 6.5 - 6.5 FEDERACAFE 53.1 - 53.1 Bank - 50.0 50.0 Total financing 203.5 50.0 253.5 Estimated ---------------- USS millions -------------- Disbursements: Bank FY 1985 1986 1987 1988 1989 1990 1991 Annual 5.0 9.5 10.5 10.0 7.5 4.5 3.0 Cumulative 5.0 14.5 25.0 35.0 42.5 47.0 50.0 a/ Applied only to support services. b/ Including local taxes of US$7.4 million.  - vli - Rate of Return: 23-25% 1/ Staff Appraisal Report: Report No. 4966-CO, June 5, 1984 IBRD MAP: No. 1804 1/ On the basis of illustrative investment models for farm development, and marketing and agricultural processing subprojects.  I. BACKGROUND A. The Agricultural Sector 1.01 Agriculture remains the most important sector in the Colombian economy, accounting for roughly one-quarter of GDP. Within the sector, crops and livestock products contribute about 53% and 40%, respectively, to the gross value of production; the rest comes from forestry, fishing and other rural activities. Agriculture provides employment for some two million people, or about 27% of the national labor force. The sector's share in the country's total registered merchandise exports fluctuated between 68% to 75X in recent years. In the past two decades, agriculture grew at an estimated annual rate of nearly 4%; while this was about 1% below the growth rate for the economy as a whole it was considerably higher than in most developing countries. Since 1979, however, this rate has slowed down to 2-3% annually, and is estimated at 0.5-1.0% for 1982, the lowest figure registered in many years. During the last two decades, 55-60% of output growth was derived from area expansion, except for coffee for which growth resulted primarily from yield increases. Yields of major export crops are comparable with international levels, but for many other commodities, especially food crops, they are low and the scope for improvements is substantial. The performance of the livestock subsector has been disappointing over the last decade, and only small productivity increases were achieved. 1.02 The sector's growth in the 1970s was, to a large extent, driven by external factors, such as favorable markets and prices for export crops especially coffee. In the 1980s, on the other hand, the international economic environment caused the prices of coffee and other important agricultural export commodities to decline. At the same time, the cost of agricultural inputs, including labor, remained high; consequently, the profits of agricultural producers declined in many instances. To resume higher agricultural growth rates, to create additional income and employment, and to stimulate exports, improvements in the productivity of land and labor through the diffusion and adoption of new technologies are needed as, the potential for increasing production through expansion of agricultural land is limited. In addition, the unrealized potential for agricultural diversification in the coffee areas needs to he tapped in order to reduce the country's heavy dependence on coffee whose market constraints and price prospects appear unfavorable. B. Agricultural Credit 1.03 Two principal sources, Caja de Credito Agrario, Industrial y Minero (Caja Agraria) and the Fondo Financiero Agropecuario (FFAP), account for most of the agricultural credit in Colombia. Caja Agraria is the main agricultural bank with an extensive network of some 850 branch offices, and about 500,000 clients. FFAP is a rediscount windnw of the Bank of the Republic from which funds are on-lent by banking institutions mostly to commercial farmers. FFAP's resources are obtained principally from low yielding bonds which banking institutions are required to hold in lieu of reserves. FFAP has crop-specific lending limits per hectare that are revised semiannually and generally cover only betweeq 25% and 65% of investment  -2- costs, with the rest having to come from the borrower. In addition, there are other sources of agricultural credit, such as the Ban_co Ganadero and Banco Cafetero, which finance principally livestock and colfee, respectively. Agricultural credit is generally linked to technical assistance; farmers need to have approved farm plans by authorized extension agents to qualify for credit. Interest rates for agriculture vary considerably depending on the institutions involved and the ,specific purpose of a given credit line. On average they are generally lower for agriculture than for other productive sectors. Since 1983, given the decline in internal inflation, the interest rates are slightly positive in real terms. For agroindustrial and industrial lending, most of the funds are provided by commercial banks, development finance corporations, and the above mentioned-agricultural banks. Their direct lending is supplemented by rediscounting funds of the Fondo Financiero Industrial (FFI) of the Bank of the Republic, funded in part out of the reserve requirements of the banking systems. For marketing credlt, no major specialized credit lines exist. C. The Coffee Economy 1.04 Coffee continues to be of central importance In the economy, heavily influencing agricultural growth and producing major macroeconomic effects. After 1975, coffee represented 5-9% of total GDP and contributed about 46-66% to merchandise exports, while within the agricultural sector these shares have been about 21-31Z of GDP and 71-85% of exports. The sub- sector generated about 7.5% of Government's current revenues in the period 1974-81; it now employs some 600,000 people, equivalent to about 30% of total agricultural employment or about 8% of the national labor force. About two million people, or one-quarter of the rural population, live on coffee farms. 1.05 Coffee is grown in the mountainous areas of the country by some 300,000 farmers on about one million hectares. Most small coffee farms are using traditional techniques, i.e., low-yielding varieties, low tree density (900 to 1,200 trees per hectare), little or no chemical fertilizers, little weeding and only sporadic pruning and spraying against diseases. The labor input is limited to some 100 man-days per hectare per annum and yields average 500-800 kg per hectare. A new production technology was introduced on many of the medium-sized and larger farms starting in the mid-1960s. Its use continued on a major scale in the early and mid-1970s. The new technology consists basically of the use of a new variety with a high tree density of 3,000-4,000 trees per hectare, heavy use of fertilizer and intensive pruning techniques. Some 200-250 man-days per hectare are required and yields average from 1,500-2,000 kg per hectare depending on whether coffee trees are grown under shade or in sun. 1.06 This new technology has been adopted on about one-third of the area under coffee and generates over half of the total coffee output. It has fundamentally altered the Colombian coffee economy-at least until recently when coffee rust appeared for the first time in Colombia--by (a) making it substantially more capital- and management-intensive; (b) reducing production cost per unit of output; and (c) increasing production by more than 50% from some 7-8 million bags (of 60 kg) a decade ago to about 13 million bags at present. The adoption of new technology was facilitated by relatively high International and domestic coffee prices during the latter psrt of the  -3- seventies and resulted in a shift of coffee production from the small traditional coffee farms to the more entrepreneurially mapaged medium-sized and larger coffee farms with access to capital. In addition, it led to a build-up of stocks equivalent to about one year's exports since Colombia's annual export quota is limited to about 8.5 million bags under the International Coffee Agreementl/; its domestic demand is less than two million bags and inelastic. 4,ircumstances under which such large stocks could become economically useful seem unlikely, yet they are costly to carry (US$30 million in 1982). 1.07 The dominant institution in all aspects of coffee production, marketing, exports and policy is FEDERACAFE, a private, non-proflt association of coffee producers. The only requirements for becoming a member of it are to have an annual production of 375 kg of coffee, or to cultivate at least one hectare under coffee. Created in 1927 to protect the interests of the coffee industry and to promote its development, it has been charged with the management of coffee policy under a series of ten-year government contracts. Under these contracts, FEDERACAFE controls domestic and export marketing and advises on rates of taxation and prices. Through its well-developed physical and organizational infrastructure it also provides agricultural inputs and extension services and is responsible for the preparation and implementation of rural development projects, including diversification efforts. FEDERACAFE has sponsored the establishment of a strong cooperative movement which is represented in most municipalities where local cooperatives perform the functions of input supply and purchases of coffee and also offer social services such as medical care. In addition, the Federation sponsors and administers an agricultural coffee research center and a foundation for agricultural education and training. Over the years, the institution has diversified its coffee related activities. Today it partially owns or administers coffee storage facilities, general warehouses, an export company, a shipping company and a coffee processing company. Finally, FEDERACAFE administers the Government's National Coffee Fund, the main instrument for regulating the supply and the price of coffee. All taxes levied on the coffee industry accrue to this fund and are used to: purchase all the coffee grown at a guaranteed price, finance the stocks that are being held, and promote the wider interests of the coffee subsector. The remainder accrues to the Government at a rate that averaged about 7.5% of total government revenues during the period 1974-81. 1.08 FEDERACAFE is directed by the following statutory bodies: the National Coffee Growers' Congress, and the National, Departmental and Municipal Coffee Growers' Comnittees. Its decentralized structure allows the 1/ The latest International Coffee Agreement (ICA) was signed in 1983. The two key elements of the Agreement's provisions are export quotas with a fixed and variable portion and trigger prices. The fixed 70% of the quota is to be determined by periodic negotiations among producing countries and the remaining 30Z is determined by the stocks in each country. Colombia's share of the ICA of 1983 (total annual quota - 52.9 million 60-kg bags) has been set at 16.28% or 8.5 million 60-kg bags. Short- and medium-term world coffee price projections in constant terms show a slight decline over their present levels and only in the long run (by 1995) ore they expected to regain their present levels. _ _  -4 - latter to bring to the attention of the National Coffee Committee local needs for rural development activities (rural roads, electricitc potable water supply, health facilities, etc.). This makes the institution responsive to the concerns of coffee producers, and, in turn, allows it to influence significantly the economic activities of its members. FEDERACAFE is efficient in addressing agricultural production and marketing problems. The fact that overall the coffee growing area in Colombia enjoys a higher standard of living and better physical and social infrastructure than the rest of the rural areas can, in large part, be attributed to the efforts of this institution. 1.09 Internally, FEDERACAFE is managed by a general manager who operates through four sub-managers in charge of general administration, planning and coordination, commercial activities, and technical activities. The technical department, besides being responsible for coffee extension and research is also in charge of FEDERACAFE's coffea zone development and diversification .program (FEDERACAFE/PRODESARROLLO). Created in 1963, FEDERACAFE/ PRODESARROLLO's role is to promote agriculture diversification through the provision of technical advice and credit (Annex 2). D. Past Diversification Efforts 1.10 Limited agricultural diversification efforts designed to reduce the negative effects of coffee monoculture go back to the 1940s. In 1946, the first contract was signed between the Government and FEDERACAFE to promote the production of non-coffee crops in the coffee zones and over two decades annually about US$150,000 were spent on these efforts. In the early sixties a special private fund (Fondo de Desarrollo y Diversificacion de Zonas Cafeteras) was created to provide technical assistance and credit for agri- cultural diversification in Caldas, one of the main coffee producing departments. In 1968, this fund was incorporated as a public entity under the Ministry of Agriculture to meet Colombia's diversification obligations under the International Coffee Agreement of the same year, and contracted with FEDERACAFE the execution of the diversification program. From 1973 onwards, Colombia, independently of other coffee-producing countries, continued with its limited diversification efforts, and provided from 1963 to 1982 credit totalling about USS146 million to finance about 99,000 ha, 46 marketing projects and 41 agroindustrial enterprises. During these years, FEDERACAFE gained valuable experience in agricultural diversification and has built up a technically competent staff. However, its diversification efforts in the past were hampered by the high relative profitability of growing coffee versus other crops and the lack of sustained Government support. Consequently, the diversification endeavor to date did not have a major impact on non-coffee production in the coffee zones. At the same time, the -need for diversification in the past was never as critical as today. Supply and demand were basically in balance, and the country did not have serious coffee stock build-up problems. Also, there was ample room for increasing the country's food production in other areas to meet the demand that has been growing at around 3-4Z per annum. Therefore the Government did not accord high priority to agricultural diversification.  E. Government Strategy for Agricultural Production asd Diversification 1.11 In its strategy to revitalize the economy, the present Government has accorded high priority to agricultural developmert and has substantially strengthened the policy formulation and planning capacity of the Ministry of Agriculture and its decentralized agencies. In order to help realize the sector's potential, especially in terms of foreign exchange earnings, income and employment generation, and restoration of its competitiveness in international markets, the Government is accelerating the exchange rate de- preciation. Coffee production is not affected by this exchange rate policy because of the Government's off-setting taxes. Agricultural productivity and production are being encouraged through substantial allocations in the 1984 budget. These allocations are well above the levels in previous years, and are projected to increase even further in the future, especially in the following areas: (a) the generation and diffusion of agricultural technology; (b) rehabilitation of existing irrigation lands; (c) provision of credit; and (d) the diversification of agricultural production in the coffee zones. To lower the costs of agricultural inputs, Caja Agraria, the main supplier of agricultural credit and key inputs, such as fertilizers, chemicals and seeds, will be reorganized so as to increase its efficiency and effectiveness. This reorganization is based on a Presidential Decree to be executed by June 30, 1984. To strengthen agricultural marketing, the creation of a special marketing fund is under active consideration and a commission is working in the Ministry of Agriculture to prepare a proposal to Government by the middle of this year. In addition, at the request of the President of the Republic, a study was prepared on the Government-owned marketing institute and the recommendations of this study are presently being analyzed. Also, the formation of marketing cooperatives are being encouraged by the Colombian Institute for Financing and Development of Cooperatives (FINANCIACOOP). Agricultural exports, in addition to the accelerated peso devaluation, are also being encouraged by a recently strengthened system of tax reimbursement certificates which lower the tax liability of exporters; and funds available under official lines of credit for agriculture were increased by about 25% over 1983 levels, or about 8% in real terms. 1.12 The emphasis on agricultural diversification is a reflection of the Government's and FEDERACAFE's awareness that: (a) the International Coffee Agreement with its quota syste-a is likely to continue, and that Colombia's quota cannot be expected to increase by more than 1.5% per annum; (b) the international price of coffee in real terms is expected to decline and only in the long-run may it regain its present level; (c) the present levels of stock build-up cannot be financed indefinitely; (d) coffee production needs to be brought in line with the country's internal consumption, the country's export quota, and export possibilities outside of International Coffee Agreement member countries; and (e) underutilized resources existing in the coffee zones, which have and will continue to increase with the adoption of the new coffee production technology, need to be diverted to alternative uses to facilitate the needed reduction in coffee output while maintaining the income levels of the coffee growers. These underutilized resources are estimated at 10-20% in terms of agricultural land suitable for more intensive use and 10% of underutilized labor, mostly migrant laborers, currently only fully employed during barvest time.  -6- 1.13 The Government and FEDERACAFE have begun to addEess these issues tbrough coffee-related policy measures which include: (a) not allowing the guaranteed domestic price for coffee to increase in real peso terms even in the face of short-term international price increases for Colombian coffee2/; (b) a curtailment of credit for new coffee plantings; and (c) the promotion of diversification activities. More drastic actions, such as coffee eradication in selected instances, have not been ruled out. The Government has also made clear that it will not subsidize coffee activities and that financing of coffee stocks will continue to be the responsibility of the coffee subsector. 1.14 These policy measures have started to gradually shift the balance of incentives away from coffee to the production of other agricultural com- modities. As a result, coffee production has stabilized and many farmers, especially the larger, commercially-oriented ones, have been induced to -experiment with growing alternative crops on a larger scale. However, the scope for pricing policy measures has been constrained by the Government's and FEDERACAFE's objective of maintaining reasonable incomes for the coffee growers. Therefore, the full impact of these policies hinge on the extent to which they are accompanied by measures to develop alternative sources of income for the coffee growers by inducing and assisting them to deploy their underutilized resources for non-coffee production and thereby gradually wean- ing them away from coffee as their sole or major source of income. The appearance of coffee rust towards the end of 1983 may also have a significant effect on the level of coffee production in coming years. While the precise impact of this fungus disease cannot be predicted, it is clear that produc- tion costs on the farms affected will increase significantly and that the less efficient farmers might well be forced out of coffee production, thereby increasing the need for agricultural diversification. Also, the adoption of the hitherto used high-yielding variety (caturra) will be slowed down con- siderably, since farmers will be waiting to see how this variety will stand up to this disease. At the same time, the presence of this disease can be expected to induce many farmers to start diversification since they want to insure their overall income, in case this disease affects their coffee plants. F. Bank Strategy 1.15 Up to 1965, the Bank had made only two loans for agriculture in Colombia, each for USS5.0 million. Since 1966, agricultural lending has intensified, and the Bank made 14 loans totalling USS413.0 million equivalent. Three of these loans have been for agricultural credit, two for livestock development, two for colonization, three for irrigation/drainage, two to support the Government's rural development program, one for a pilot watershed management project, and the most recent one for an agricultural 21 The real domestic price index for coffee, taking 1975 = 100 stood at 83.6 in 1983. In 1977, at the height of the international coffee boom, the index was 162.9 and has been declining since then. It is the Government's policy in setting the producer price for coffee to prevent sudden wide price swings, and to keep them well below their international levels. Since 1970, the producer price of coffee relative to the peso export price has varied from 0.40 to 0.63 and during 1983 was 0.57.  -7- research project. Host of the Projects have focused on iWcreasing productiv- ity, income and welfare of small farmers, and all were eiecuted hy public sector institutions. Project Performance Audit Reports have been issued for five of the nroiects (Loans 502-Cn, Atlantico Irrization; 624-CO, Agricultural Credit; 651-CO, Second Livestock Development; 739-C.0, Caqueta Land Colonization; and 849-C0O, Second Atlantico Developrent) and an Tmpact Evalnation Report on the Atlantico Irrigation Project was !-asued in 19q2. Wbile these proiects were by and large successful, the irrigation and drain- age proiects experienced some technical difficulties and were hampered hy institutional weaknesses of the Colomhian Agrarian Reform Institute. These projects enabled the lank to learn about the leegal and administrative systems operatinz in the sector, particularly the strengths and weaknesses of the different public sector institutions, and the response of aaricultural pre- ducers to different government schemes. Many of the Problems that have been found to he often associated with Projects executed by public sector institu- tions-such as institutional instahility, frequent changes in nolicies and key personnel, poor accounting and monitoring capabilities, and underfunding -should not affect this diversification program, since the executing agency has been deliberatelv selected hecause of its record of consistently solid Performance. FF.DERACAFE Is a well-managed vrivate sector institution with suitahle funding, which has responded to the needs of its membership without being hampered by undue regulatory or institutional constraints. 1.16 In the years ahead, the Bank intends to increase its lending in support of the Covernment's agricultural strategy in its drive to modernize the sector and to maximize its contrihutions to net foreign exchanae, income and employment. Special emphasts will he given to projects with a stronz prodtuction impact and on capitalizing on and developing further the most important public sector institutions. Also, as part of project preparation and execution, agricultural producer organizations are being drawn into the entire process to ensure that these private sector institutions are part of the Planning process and support the ensuing investment programs. In response to needs so identified, the agricultural lending program has been widened to encompass production aspects as well as input supply, processing and marketing, to strengthen producers in these areas. To assist the less advanced small farm subsector, selected rural development efforts will con- tinue to be supported and special attention will be given to technology generation and transfer, and marketing. To provide the necessary analytical and policy framework, agricultural sector work has been intensified. Two reports have been issued: 'Colombian Agriculture: Selected Issues and Some Directions for Strategy,- Report No. 4275-CO, January 1983, and 'Colombia: External Sector and Agriculture Policies for Adjustment and Growth," Report No. 4981-CO, April 1984. Discussions of the findings of these reports have deepened the policy dialogue, and, as a consequence, a wider spectrum of projects are under preparation: (a) irrigation and drainage, with special emphasis on rebabilitation of existing districts and small-scale irrigation schemes; (b) agricultural extension, to follow-up on the recently approved agricultural research project and ensure that research findings reach the farmer; (c) agricultural credit, to improve the efficiency and effectiveness of the country's most important agricultural credit institution; (d) agricul-tural marketing of perishables and meat, to eliminate bottlenecks in key areas of the existing marketing network; (e) watershed management, to followup on the ongoing Upper Magdalena pilot watershed management project; and (f) rural development and colonization efforts, to assist small farmer development and provide continuity to ongoing successful projects. _-  -8-~~~~~~~~% It. THE PROJECT AREA A. Location, Climate and Soils 2.01 Except for Bogota, the proposed project area (IBRD Htap 18034) is congruent with Colombia's coffee production zones which are mainly located in densely populated areas on the slopes of the three north/south Andean ranges dominating the central region of the country. The area covers large tracts of 18 Departments and includes approximately 575 municipalities (Annex 1, Table 1). The topography is predominantly mountainous and soils are mostly of volcanic origin, which in many areas has resulted in deep, well-drained soils of medium-texture, rich in most-nutrients except for phosphorus. Depending on the altitude and latitude, the climatic conditions in the proposed project area vary considerably from cold zones above 1,800 m to temperate in areas between 1,200 to 1,800 m and warm zones below 1,200 m. Average annual temperatures range from 12