Yugoslavia - Macedonia Agriculture and Second Agroindustries Project

Damo.st of The World Bank FOI OMCIAL USE ONLY Reput NIL 5998 PROJECT COMPLETION REPORT YUGOSLAVIA - AGRICULTURE AND AGROINDUSTRIES II PROJECT - MACEDONIA (LOAN 1371-YU) December 26, 1985 Europe, Middle East and North Africa Region Agriculture III Division IIh dme. w a rIesuid d~rbbfIem d inmy be mod by m hIiu only iun thw purIsemm j I tdel .chI dud.. lb OMsSeEM VAm s&hwwuin be ituclmi wifth WorM Bu 1bd  ABBREVIATIONS AND ACRONYMMS BOAL - Basic Organization of Associated Labor EEC - European Economic Community GMP - Gross Material Product GNF - Gross National Product ICB - International Competitive Bidding LCB - Local Competitive Bidding PCR - Project Completion Report SBS - Stopanska Banka Skopje SRM - Socialist Republic of Macedonia  FOR OMCIAL USE ONLY PROJECT COMPLETION REPORT YUGOSLAVIA - AGRICULTURE AND AGROINDUSTRIES II PROJECT - MACEDONIA (LOAN 1371-YU) Table of Contents Page No. Preface ................................ i Basic Data Sheet *****............ .......................... ii Evaluation Summary ................... ........ **** ** ........iii I. INTRODUCTION ........... ... .....ooo ......... *... 1 II. PROJECT FORMULATION AND PROCESSING ........ .......... 2 A. Project Background ............... ............... 2 B. Identification ... ......................... 3 C. Appraisal *. *.........*...............0........ 3 D. Negotiations.. . .0....... 000**** ..... .. 4 E. Board Presentation and Effectiveness .......... ... 5 F. Project Objectives and Description ....... ...... 5 III. IMPLEMENTATION ..... ................ ..... 8 A. Start-up ................. 8 B. Revisions ...***............*..................*. 8 C. Physical Implementation ........................ 10 l. Social Sector ........... ............. 10 2. Individual Sector o .....*... o.o ...... ..... .. 12 D. Quality of Project Works ...*. . ....... 14 E. Procurement ........ . . ............ ......... 14 F. Project Cost ........ o ........................ 14 G. Financing .............. ........ ...... 17 H. Compliance with Loan Covenants ....... o ....... 19 I. Disbursements .. ................. .... 19 IV. AGRICULTURAL IMPACT ..... oo ...................... 20 A. Crop Yields and Incremental Production ..0......0 20 B. Agronomic Practices and Inputs .......0......... 21 C. Food Processing .... ........ ............... 21 D. Raw Material Supply ....... o.o..o..o.o.. 0......o 25 E. Marketing and Markets o ....o............. 25 V. FINANCIAL RESULTS AND RE-EVALUATION ...........000 0... 28 A. Social Sector: Agroindustries . ..... o ... 28 B. Individual Sector .......... o.o..o .. ........... 32 C. SBS ...................................... 33 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 discksed without World Bank authorization.  Table of Contents (Continued) Page No. VI. ECONOMIC IMPACT * *......... .. *.......... ........ 34 VII. INSTITUTIONAL PERFORMANCE .............. ............ 36 A. Institutional Design and Performance and Institution Building .. ......................... 36 B. Performance of the Bank ..... ................... 37 VIII. CONCLUSIONS AND RECOMMENDATIONS .................... 38 Annexes 1-5 CHART: Implementation Schedule Hap: IBRD No. 18941  PROJECT COMPLETION REPORT YUGOSLAVIA - AGRICULTURE AND AGROINDUSTRIES II PROJECT - MACEDONIA (LOAN 1371-YU) PREFACE This is the Project Completion Report (PCR) of the Agriculture and Agroindustries II - Macedonia Project, for which Loan 1371-YU in the amount of US$24.00 million was approved on February 22, 1977. The original closing date was June 30, 1982. The closing date was extended to June 30, 1983. The final disbursement was made on January 18, 1984 and the remaining balance of US$2.34 million was cancelled. The project is the fifth Bank loan for agri- culture and agroindustries in Yugoslavia and was prepared by Stopanska Banka Skopje. It was followed by the Macedonia Agriculture III Project (2039-YU) which was approved on July 14, 1981. This PCR was prepared by the Europe, Middle East and North Africa Regional Office following a mission to Yugoslavia from February 5 through 13, 1985, and is based in part on a draft Project Completion Report prepared by the Borrower (Stopanska Banka Skopje), a review of the Staff Appraisal Report (No. 1316a-YU), the President's Report (No. 1943a-YU), the Loan and Guarantee Agreements dated March 10, 1977; a review of relevant Bank files, including correspondence with the Borrower, internal Bank memoranda on project mis- sions, minutes of the Board's discussions, Bank supervision reports, quar- terly project progress reports prepared by the Borrower, as well as inter- views with officials both in the Bank and in Yugoslavia who have been asso- ciated with the project. A copy of the draft report was sent to the Borrower on October 10, 1985. A statement received from Stopanska Banka-Udruzena banka is in Annex c. This project has not been subjected to an audit by OED.  - Li - PROJECT COtPLETIoN REPORT YUCOSLAIVIA - AGRICULYlLE AND AGROINDUSTRIES 11 PROJECT - KACEDONIA (LOAN 1371-YU) BASIC DATA SHEET KEY PROJECT DATA Actual or Actual as- Appralsal Eactinted of Appraisal Estimtte Actual Emtiute Project Casts (USS milLoot) 56.0 49.7 89 Los Amount (USS milLion) 24.0 24.0 100 Disbursed (USS miltLon) 24.0 21.66 90 Cancelled CUSS milIio,) - Z.34 Date of board Approval - 02/22/77 Loan Agreement Date - 03/10/77 Date of Project Effectiveness 07127/77 07/27/77 100/s Date Physical Components Conpleted 12/81 12/83 1417_ Proportion Then Completed (t; 100 100 Loan Closing Date 06/30/82 06/30/83 :191a Economic Rare of Return (Z) 26 IS 58 Financial Rates of Return (t) Social Sector 14-17 5-21 71 Individual Sector 18-28 13-46 130 Institutional Perfor.nce Satisfactory Production (primary) Performance Satisfactory Processing Performance Mixed Number of Direct Beneficiary Fee.' Les 910 1.8soc 198 CUMULATIVE DISBURSEMENTS FY78 FY79 FY80 FY81 FY82 FY83 Appraisal Estimate CUSS million) 3.6 13.5 22.2 23.6 24.0 - Actual (USS miltion) 0.5 1I1 3.1 9.6 16.0 21.5 Actual as I of Appraisal Estimate 13.9 8.4 14.0 60.7 66.7 89.6 Date of Final Disbursement JAnuAry 16, 1984 MISSION DATA Date No. of Mands'-s Specializations Performance Types of Mission (mo./yr) Persons in Field Represented lb Rating /c Trerdtd Problems/e Identification Preparation 02/7h Appraial (l6/76 6 61) 2b,c.2d.e Supervision I 05/77 3 I5 3d I 2 - Supervision Z 09/77 2 4 2d I 2 M Supervision 3 05/78 1 4 d 2 3 M Supervision 6 IZ17R 2 22 d.e 2 2 I.F Supervision 5 015/79 2 22 2d 2 2 F.M Supervision A 11/7a 2 2n d.. 2 2 F.H Supervision 7 04/80 2 4 d.- 2 1 F.M Supervision 8 10/891 2 8 2d 2 2 F.M,T Supervision q 06/81 2 8 c.d 2 1 F.M Supervision Ilt 03!P2 2 10 b.d 2 2 F." Supervii.on 11 10182 2 14 b.d 2 2 F.M Supervi ion 12 04153 2 10 b.d 2 2 F.MHT OTHER PROJECT DATA Borrower: Stopanska Banks Sknpje tuarantor: Socialist Federal Republic t Yugoslavia Executing Agency: Sropaneks Banka SkopJe Fiscal Year if Borrower: January I to December 31 Name of Currency (Abbreviation) Dinar (Din) Currency Exchange Rate: Appraisal Year Average USSI.OO - Din 18.00 l;terven!ng Years Average USS1.00 - Din 25.28 Completion Report Year Average IISSI.00 - Din 90.84 Follow-on Prol)ect: Namne Macedonia Agriculture III Loan dnumber 2C139-Tu Loan mount (USS million) 5n.0 Date of Loan Agreement 07/14/81 Is Calculated In ters of months from date of Board approval. /b a - Agriculturist; b - agricultural economist; c - ftinncial snayst: d t technical specialist: e - general. /c I - problew-free; 2 - moderate problem; and 3 - mjor probles. /d I - irproving; 2 - stationary: and 3 - deteriorating. 7; f - financlial; a - managerial: t - technical.  - iii - PROJECT COMPLETION REPORT YUGOSLAVIA - AGRICULTURE AND AGROINDUSTRIES II PROJECT - MACEDONIA (LOAN 1371-YU) EVALUATION SUMMARY Introduction The project represented the fifth Bank operation principally involved with the agriculture sector in Yugoslavia and the third supporting agroindustries; it was the second in this subsector in Macedonia. It responded to opportunities for development of production in the individual sector and to the perceived need to expand agro-processing capacity in the social sector. Objectives The project was to provide credit to support Macedonia's long-term objectives of self-sufficiency in and increased exports of agricultural pro- duction. It was to make funds available through Stopanska Banka of Skopje (SBS) for credits to six social sector enterprises and some 910 individual sector farmers for investments in agricultural processing facilities and pri- mary production. Processing investments were to include cold storage, vege- table and fruit processing, tobacco drying, dairying and slaughtering facili- ties; in primary production the project was to finance the establishment of vineyard and fruit plantations, as well as investments in livestock, plastic greenhouses for vegetable production, and on-farm mechanization. The project also aimed at strengthening the organization and appraisal and supervision capacity of SBS. Implementation Experience Project implementation was expected to begin in 1977 and to be com- pleted by mid 1982; however, delays in procurement and construction of the processing facilities caused an extension of the closing date by one year. All construction was completed by late 1983. Processing plants had been ope- rational for one year at the time of the PCR mission with the exception of the dairy plant, which was not yet operating because of lack of a source of energy. The individual sector component was completed in time and the demand for on-farm development satisfied. At completion, total project cost amount- ed to US$50 million, representing a reduction of about 11% from US$56 million estimated at appraisal. The dinar devaluation of about 460% between 1977 and 1983 compared to a domestic inflation rate of about 370% over the same period caused the reduction of project cost in US dollar terms. In dinar terms the total project cost was about 1002 higher than estimated at appraisal because project components were carried out two to four years later than anticipated and inflation during the entire period was considerably higher than projected at appraisal. Such difficulties could not be foreseen at appraisal.  - iv - Results Most of the production targets of the subprojects in the individual sector component appear to have been met. Vegetable and wheat production exceeded eppraisal estimates because of more farm mechanization than expected while orchard production was lower than expected. Beneficiaries of the proj- ect include the approximately 1,800 farm families who received sub-loans through the project plus the 500 full-time employees in the social sector. Foreign exchange earnings are estimated for 1985 at about US$13 million equivalent and this represents a significant increase in exports for the Republic of Macedonia. The re-estimated economic rate of return of the proj- ect is 15% against the appraisal estimate of 26%. This reduction is due to delays in investment and the increase in input prices relative to the increases in output prices. All the agroindustries financed under the loan face financial prob- lems. With the exception of one, the plants have been able to cover their operating costs in 1984. However, they could not repay the interest and principal on loans and they have all requested rescheduling of their debts. The financial difficulties stem from two sources: rapid devaluation of the dinar in a situation where the plants carry the foreign exchange risk on the World Bank-financed portion of their subloans and markets which do not offer prices sufficient to cover their debt servicing. All the plants need addi- tional financing to cover their cash flow deficits at the same time that they must improve financial planning and develop improved marketing strategies. Sustainability The main uncertainties facing the project relate to developments in prices and markets. With current relative input-output prices, most agro- industries would suffer long-term financial difficulties. Markets need to be explored and developed, under appropriate marketing strategies, in order to maximize capacity utilization of plants and revenues. One major factor determining the industries' financial viability is the future performance of the country's relatively depressed economy. Findings and Lessons A number of revisions were made in the design of project facilities, most of which, but not all, with the Bank's approval (paras. 3.05-3.09). Procurement problems, resulting from inexperience of local staff and late changes in designs by investors. caused implementation delays (paras. 3.11, 3.21-3.23). A mcnitoring and evaluation system was established by Stopanska Banka. While some useful monitoring activities were undertaken, the experience with the evaluation function was disappointing (paras. 3.30 and 7.01-7.02). Marketing efforts in support of project activities were inadequate (paras. 4.18-4.20). The project adversely affected the Borrower's financial position, and the financial performance of sub-borrowers in the social sector was poor (paras. 5.01 and 5.12-5.14). One of the most important lessons learned is  the need for financial discipline with respect to establishing and maintain- ing prudent capital structures for the investments and for the sub-borrow- ers. Guidelines as foreseen in the loan documents for equity contribution and cashflow requirements need to be monitored and respected throughout the project period. Any future Bank investment in agroindustries in Macedonia should be preceded by a portfolio review by SBS of its agroindustrial sub- borrowers to come up with a program outlining actions to improve performance (procurement, processing, management and marketing) and realistic estimates of long-term financial viability (paras. 3.27-3.29, 5.05, 7.08 and 8.02- 8.03). In addition, any future Bank involvement with the Borrower should be preceded by a review of its internal procedures for managing its portfolio and should be based on a program to improve its portfolio management (para. 8.04). The individual sector farmers clearly responded to project opportunities. Mechanization investments produced the highest financial returns and attracted the most interest among private farmers (paras. 3.18, 5.10-5.11). Given the importance of the individual sector and its relatively low level of productivity, considerable potential still exists for further, development. This could be done through improvement of infrastructure and irrigation, land reclamation, and greater availability of credit (para. 8.06).  YUGOSLAVIA AGRICULTURE AND AGROINDUSTRIES II - MACEDONIA LOAN 1371-YU PROJECT COMPLETION REPORT I. Introduction Agricultural Sector in Macedonia The Yugoslav Economy 1.01 Despite an impressive record of economic and social development since World War II, Yugoslavia over the past five or six years has faced a difficult economic situation. The repercussions of the 1979 oil shock are still being felt today. Inflation has increased from 22% in 1979 to 55% in 1983 and 60% in 1984. Agricultural and industrial production declined, merchandise exports dropped and the international debt grew to US$19.0 billion. The value of the dinar, which had been stable since 1971 at US$1.0 = 17-19 dinars through 1979, fell rapidly to US$1.0 = 50 dinars in 1982 and 124 dinars by 1984. As of February 1985 the value was US$1 = 220 dinars. The deteriorating economic situation caused the Government to introduce in 1982 a series of stabilization measures including restrictive monetary and fiscal policies, promotion of exports, efforts to curb imports and strengthening social sector operations. It was in this economic environment that the Second Agriculture and Agroindustries Project was implemented, between 1977 and 1983. 1.02 The Socialist Republic of Macedonia (SRM) is located in southeastern Yugoslavia. With a 1982 per capita income of US$1,875, or about 67% of the national average, it is one of the less developed areas of Yugoslavia. The active agricultural labor force has decreased since 1966 at a rate of about 1.5% per year, while agricultural production has increased at about 4Z annually. Fruit and vegetable production grew most rapidly, encouraged by rising relative prices and improved technology and irrigation, especially in the social sector. Agricultural production in the social sector grew at about 7% per year between 1971-1980, compared to about 2n in the individual sector.- This is because of higher investment, greater use of modern technology, possession of better quality and irrigated land and better availability of skilled manpower. Almost 75% of the cultivable land and 90% of the livestock in SRM are, however, 1/ The individual sector in agriculture consists of farmers who farm their own land as opposed to those who are members of basic organizations which farm socially owned lands. Individual secto.- farmers may enter into production/marketing contracts with the social sector, by which they receive inputs in exchange for a guarantee of sale of their produce; or they may not enter into such contracts. Those who do are "associated" farmers. Under this project, all individual sector beneficiaries were associated farmers. About 15% of project cost involved the individual sector.  -2- owned by the individual sector. In 1980, agriculture, excluding agroindustries, contributed about 171 of gross national product (GNP) in SRM and absorbed about 341 of the active population. It contributed about 7% to Yugoslavia's total agricultural production. In spite of the growth in agriculture and agricultural activity since 1966, the relative share of agriculture in GMP has steadily decreased because of the faster growth in other sectors of the economy.l/ In addition, unemployment in Macedonia was estimated in 1974 to be about 86,000 people. 1.03 Out of a total area of 2.6 million hectares in SRM, about 251, or 655,000 ha, are arable. About 550,000 ha are cultivated and as of 1976 roughly 65,000 ha were irrigated. Irrigation potential is considerable however and could cover the entire arable area. 1.04 The Agriculture and Agroindustries II Project, Macedonia (Loan 1371-YU), was the fifth Bank loan for agriculture in Yugoslavia-' and the second Bank loan to Macedonia for development of agriculture and agroindustries. The objectives of the second project were to continue to expand primary production, particularly in the individual sector, and to modernize and expand food processing capacity in SRM, both for domestic production and for export.- These objectives were consistent with those of previous and ongoing projects to remove constraints to individual sector agricultural performance through the provision of credit and of market outlets for the production and to improve the productivity of the agroindustrial subsector. 1.05 At the time of appraisal, in mid-1976, the economy of Yugoslavia had been growing at a rate of 6Z per year, per capita incomes in SRM were increasing at 41 per year, tourism and urbanization were on the rise, domestic inflation was projected at 10-12Z and the dinar had been stable at 17-18 dinars = US$1.0 since 1971. With a healthy market demand expected for both the fresh and processed production, the investments were judged to be financially viable and economically sound, and the social sector investors took the foreign exchange risk on their subloans. II. Project Formulation and Processing A. Project Background 2.01 The Bank by 1973 had made 32 loans totaling about US$1,021 million to Yugoslavia. The Bank lending was generally conce-itrated on infrastructure I/ In the early 1970s, agriculture employed about 471 of the active population and contributed about 30% of the Republic's GMP. 2/ Previous Bank loans in agriculture were: Loan 894-YU - Agricultural Industries Project, 1973 Loan 1129-YU - First Agricultural Credit Project, 1975 Loan 1360-YU - Metohija Multipurpose Project, 1976 Loan 1370-YU - Agriculture and Agro-Industries Project-Montenegro, 1977. 3/ Most of the primary production - milk, grapes, tomatoes from greenhouses -was for domestic consumption and most of the agroindustries' output (except for dairy products and beef and mutton) - spring lamb, dried and processed fruits and vegetables - was for export.  -3- projects, including transportation, power, telecommunications, and multipurpose projects, which included agricultural components for irrigation and agricultural credit. Nine loans had been made for industry, two for tourism, and one for agricultural industries in Macedonia. The Bank was alao prQvivling technical assistance to Yugoslavia in several areas. B. Identification 2.02 In June 1973 the Federal Secretary of Finance submitted a list of projects for the Bank's consideration. The list included agroindustrial proposals in the less developed regions of Kosovo, Bosnia Herzegovina, Montenegro and Macedonia. The proposals formed the basis of the preparation for a follow-up project to the Agricultural Industries Project (Loan 894-YU) in Macedonia. 2.03 On the basis of feasibility studies prepared by several Basic Organizations of Associated Labor (BOALs) the Department of Agriculture of Stopanska Banka Skopje (SBS) prepared, in April 1976, a preliminary report on the Agroindustrial Project "Macedonia" phase 1I. The list of projects included primary production (two pig fattening farms, and 23 fruit production subprojects, 1,000 ha vineyards and 1,000 ha orchards) and seven processing facilities (for fruits, vegetables, potatos, milk, tobacco, and meat) in the social sector and primary production (livestock, off-season vegetable, orchards and vineyards) as well as mechanization in the individual sector. The Project was reviewed by the concerned BOALs. SBS informed them of IBRD general loan conditions and also proposed the project to the Federal Secretariat of Finance for their agreement. C. Appraisal 2.04 In May/June 1976, the Bank appraised the Project in conjunction with the appraisal of Agriculture and Agricultural Industries Project Montenegro (Loan 1370-YU)- SBS, the Borrower, presented some thirty subprojects in the social and about as many subprojects in the individual sector, at a total project cost of US$79.5 million. The mission, after appropriate analyses,' recommended: inclusion of six of the agroindustrial proposals, with the potato processing plant to be replaced by a potato cold store and the addition of four tobacco driers to be financed in the individual sector. Tne mission agreed to include credit to the individual sector for the development of vineyards, orchards, off-season vegetable, on-farm mechanization and livestock development and financing of an irrigation study as follow up to the study under Loan 894-YU. Total Project cost was estimated to be US$56.0 million. The Republic of Macedonia conveyed to the appraisal mission its disappointment at the sn.qller project size and the proposed Bank contribution of only US$15 million. 1/ Including, in particular, market considerations, and availability of raw material supply.  -4- 2.05 The only important issue in the issues/decision process was interest rates. The mission recommended a uniform interest rate structure for on-lending under the proposed sub-projects while the existing rates in Macedonia varied between 3Z and 8Z depending on the purpose of the loan and the source of funds for lending with most of the lending done at 5-6%. Under the Maccionia Agricultural Industries Project (Lean 894-YU, approved in 1973) agreement was reached on a uniform onlending interest rate of 8.25X for both IBRD and local funds. However, under the First Agricultural Credit Project (Loan 1129-YU, approved in 1975) and the Second Industrial Credit Project (Loan 1277-YU, approved in 1976) only the interest rate charged on Bank funds was fixed; the prevailing domestic rates, different for certain activities and for differfvnt sources, were accepted by the Bank. In addition, the exchange risk fur lending to the social sector was passed on to the social sector subborrowers; for the individual sector under Loan 1129-YU, it was assumed by the Government. 2.06 The estimated average financial blend cost of local funds to the banks was 5X. Assuming the cost of IBRD funds at 8.85Z, the blend cost of funds was estimated to be 6.5Z. A preliminary estimate of spread to cover costs and risk indicated 1.75Z. The mission recommended a uniform on-lending rate of 9Z for all subloans in the Project, which would be closer to the rate of inflation in Yugoslavia at that time (and estimated to be 12S p.a. for 1976-1980). 2.07- At the time of the decision meeting a study on interest rates in Yugoslavia was being carried out under the First Agriculture Credit Loan, to be followed by the Bank's study of investment decision-making at the enterprise level. It was felt that there was not enough evidence that Yugoslavia had accepted a policy change from multiple to uniform interest rates and it was, therefore, decided that the appraisal report should be prepared on the basis of existing rate systems in Yugoslavia. However, a dissenting opinion was recorded in the De ision Memorandum of July 16, 1976 included the suggestion that a decision await the outcome of the study whose basic purpose would have been undermined by a decision in favor of multiple interest rates, and requested further management guidance. This issue was resolved by the Loan Committee (para 2.09). 2.08 A revamping of the FY77 Lending Program made it possible to allocate additional Bank financing from a proposed US$15 million to US$18-19 million. It was decided to increase the size of, and the Bank's contribution to, the individual sector portion, and Bank funds would therefore cover the full foreign exchange costs of the project. It was later agreed, in November 1976, on the basis of a change in the Bank's lending policy, to include financing the interest during construction, and thus the Bank loan increased in size to US$24 million. D. Negotiations 2.09 The Loan Committee met on August 3, 1976 to consider the interest rate issue. It decided to consider the findings of the interest rate study to be available by about October 1976 and in the context of the Loan Committee  -5- submission of the proposed loan. Later, when a review of the preliminary draft of the Yugoslav study revealed that the study would not add much to the Bank's knowledge, the Loan Committee, without meeting, decided that on-lending terms for Bank funds be 12% p.a. which would approximate market costs of foreign borrowings. to Yugoslav investors and also provide an adequate spread for SBS. On the portion financed from local loans, the Bank had no objection to the multiple interest rate system in this project. 2.10 Negotiations took place in Washington, D.C. from December 13 to 18, 1976. Only two changes emerged from negotiations. One was agreement on an on-1r::ing rate of 11% for Bank funds, instead of 12Z proposed by the Loan CoamiGttee; and the Macedonia delegation agreed to maintain an adequate spread on their local funds to cover all administrative and other expenses related to subloans as stipulated in the Supplemental Letter No. 8. The second was that the US$100,000 originally proposed to finance retroactively the extension of an irrigation study begun under the First Macedonia Agricultural Industries Project would be used for a feasibility study for the design, construction and operation of a wholesale market center for agricultural products, with no provision for retroactive financing. 2.11 It was also agreed that SBS would not carry any foreign exchange risk (Loan Agreement para 5.07) but that the social sector subborrowers would bear the full foreign exchange risk for their own investments and SRM wuuld bear it for the subloans to the individual sector (Supplemental Letter No. 4). E. Board Presentation and Effectiveness 2.12 The Executive Directors approved a loan of US$24 million on February 22, 1977. The theme of the loan presentation was the importance of Agriculture in the development of Macedonia. The loan was signed on harch 10, 1977. The original loan effectiveness date was June 30, 1977 and it became effective on July 27, 1977, after the Bank had received evidence of the Loan and Guarantee Agreements' ratification by the Yugoslavia's Federal Assembly. F. Prciect Obiectives and Description 2.13 The project -;s to provide credit to support Macedonia's long-term objectives of selL-_-.fficiency in and increased exports of agricultural production. It was to make funds available through SBS for credits to six social sector enterprises and some 910 individual sector farmers for investments in agricultural processing facilities and primary production. Processing investments were to include cold storage, vegetable and fruit processing, tobacco drying, dairying and slaughtering facilities; in primary production the project was to finance the establishment of vineyard and fruit plantations, as well as investments in li-estock, plastic greenhouses for vegetable production, and on-farm mechanization. The project also aimed at strengthening the organization and appraisal and supervision capacity of SBS.  -6- 2.14 The project as appraised included : SubproiectlSubloans No. of Capacity /1 Subproject Cost Subloans (US$ million) I. Social Sector Dairy Plant 1 40,000 1/day 2.371 Cattle/Sheep Slaughterhouse 1 300,000 sheep p.a. & 12,000 cattle p.a. 4.429 Potato Cold Store 1 5,000 t 3.034 Fruit & Vegetable Processing Plant 1 expansion from 12,000 t to 20,000 t 4.894 Vegetab'le Drying Plant 1 50,000 t p.a. 9.453 Apple Processing Plant 1 10,000 t p.a. 8.018 Subtotal 32.199 II. Individual Sector Fruit 220 220 ha ) Vegetable (plastic greenhouses) 20 20 ha )1.823 Mechanization 120 subloans 2.360 Livestock-heifers 50 total:300 cows ) -ewes 500 total: 20,000 ewes )2.393 Tobacco Drying- Facilities 4 drying sheds at 200 t each 2.182 Subtotal 8.758 III. Market Center Feasibility Study 0.100 TOTAL (at 1976 Prices) 41.057 Contingencies Physical (5Z) 1.891 Price (30.4Z) 13.048 TOTAL PROJECT COST 55.996 /1 In a situation of processing units with strong seasonal elements, it is not possible to have a durable and constant definition of capacity. Thus, during the course of project implementation, as seasonal availability and variety of products increased, stated capacities if sce&e of these plants changed. This is reflected in the discussion below.  -7- 2.15 Social Sector A new milk processing plant of a capacity of 40,000 liters/day was to be built in Prilep in replacement of an existing obsolete plant of 10,000 liters/day. The new slaughtering plant for 300,000 lamb and sheep and 12,000 cattle per year was to be built in Gostivar to replace an existing obsolete abattoir, representing an increase in capacity of abQut 30%, and was to include facilities for processing edible and inedible by-products. The new 5,000 ton potato cold store was to be built in Delcevo, with basic facilities for washing, grading, sizing and bagging the potatoes. In Gevgelija, the fruit and vegetable processing plant was to be expanded from about 12,000 tons per year to 20,000 m tons. This involved construction of a new building with a new line for processing tomatoes and increasing the capacity of the existing lines for processing fruits. A new plant was to be built in Sveti Nikole to produce tomato paste and dehydrated vegetables such as onions, peppers, carrots. leeks and parsley. The capacity of the plant was to be about 50,000 tons of vegetables annually, of which 30,000 tons were to be co'mctoes- A new processing plant for apples of an annual capacity of 10,000 tons was to be built near Resen, to process reject grade apples into products such as apple juice concentrate, pure nectar, concentrated aroma and distilled alcohol. 2.16 Associated Individual Sector-l/ Subloans were to be provided to about 220 farmers for on-farm development of about 1 ha each o' orchards and vineyards, for peaches, apples, apricots and sour cherries. Investments included land preparation, planting materials, fertilizer and labor. About 20 farmers were to receive subloans for the construction of plastic greenhouses to develop labor intensive, early vegetable production, mainly tomatoes, peppers and cucumbers. Investments included tubing, plastic for covering and other construction items. About 120 subloans were to be made to farmers to finance tractors and implements such as trailors, ploughs, tillers, rollers, and harrows. Farmers were expected to cultivate, apart from their own land, neigizburing farms against service charges. The project was also to provide about 50 subloans for the purchase of a total of 300 in-calf heifers and dairy cows, and 500 subloans for purchase of a total of 20,000 ewes. The subborrowers wer'.e to purchase the animals from social sector enterprises. Investments were also to include construction of winter housing, feeding facilities and pasture improvement to increase fodder production. Credit was to be provided for the construction of four tobacco drying sheds of 200 ton drying capacity each of Virginia tobacco. 2.17 Market Center Feasibility Study. The marketing study undertaken under the First Agricultural Industries Project--Macedonia (Loan 894-YU) recommended the establishment of a wholesale market center for agricultural products. The Government of Macedonia accepted the proposal and intended to build a marketing center in or near Skopje, to collect from various parts of Macedonia mostly fruits, vegetables, meat and dairy products, process the produce and market it in Yugoslavia and abroad. Under this project US$100,000 were provided to finance the foreign exchange cost of the feasibility study for the construction and operation of the market center. 1/ All individual sector farmers participating in this project were associated farmers. For definitions, see para 1.02, footnote 1.  -8- 2.18 Total project costs were estimated at Din 1,088 million (US$56 million) of which Din 378.4 million (US$21 million) would have been the foreign exchange component. The Bank loan of US$24 million equivalent to SBS was for a term of 15 years including a three year grace period, at an annual interest rate of 8.5% and was to finance the total foreign exchange costs of the project and interest during construction on the Bank loan. Cooperatives and social sector enterprises were to carry out project investments under agricultural credit subprojects administered by SBS. III. Implementation A. Start-up 3.01 Within the first year of implementation, from July 27, 1977 through June 1978 SBS had approved four subloans for the social sector investments with a total cost of US$ 24.9 million and six subloans for the individual sector with a total cost of US$ 1.4 million. Thus almost half of the total investment of US$ 56 million had been committed. The two remaining agroindustry investments were expected to be approved by August 1978. 3.02 At the same time, progress on staffing SBS was a bit slower. According to the Loan Agreement (Section 3.02), SBS was required to establish by September 1, 1977 a Project Coordination Unit, and to hire an agricultural marketing specialist, an agroindustries specialist, and a procurement specialist. The Project Coordination Unit had already been established by May 23, 1977. An agroindustries specialist was appointed on September 1, 1977, resigned in April 1978, and was eventually replaced in January 1979. For the marketing specialist, the Bank agreed in January 1979 that the Assistant Director of SBS' Agriculture and Forestry Department would satisfy the requirements. By September 1978 SBS had hired a firm as procurement consultants and a procurement seminar had been conducted (stipulated in the Loan Agreement, Section 3.07, to have been done March 1, 1978). 3.03 For the preparation of a feasibility study on a marketing center to be established in Skopje, SBS had contracted consultants July 1977. Following a May 1977 Bank supervision mission SBS accepted the Bank's recommendation that the consultants be assisted by a specialized consultant firm experienced in the design and operatior, of wholesale market centers. A contract was signed in 1979 with such a specialized firm. 3.04 According to the Loan Agreement, para 3.05, SBS was responsible for putting into effect by March 1, 1978 both a supervision system for technical and financial aspects of the subprojects and a monitoring system to evaluate the benefits and assessing the economic impact of the subprojects. In a supervision report of May l979 it was reported that these requirements were complied with one year late, by March 1979. It is not clear, however, that an effective evaluation system ever actually produced results (paras 7.01-7.02). B. Revisions 3.05 Macedonia's tobacco production of about 28,000 tons in 1974 was roughly half of Yugoslavia's total production. Virginia tobacco is mainly  -9- grown in irrigated areas and exclusively on individual farms. The First Agroindustry Project Macedonia, Loan 894-YU, had already financed tobacco driers for Virginia tobacco. In that project, however, driers of ten tons were proposed for the individual sector. By 1974 the proposals were changed for economic reasons to 50-100 ton driers for the social sector, of which five were constructed. At the time of appraisal in 1976, the mission proposed four drying sheds of 200 tons drying capacity each, for the individual sector. In fact dryers of this size would have to be constructed and run by collectives of farmers and thus be part of the social sector. 3.06 By May 1979, one of the four dryers had been constructed but no further interest was shown.1' On the basis of technical and economic grounds, SBS requested and the Bank agreed to finance instead small 3-ton units for individual farmers. About 560 subloans were approved for the construction of small tobacco driers, which ultimately benefited about 1,000 tobacco growers. 3.07 The potato cold store was to be built with a 5,000-ton capacity. In August 1978, however, SBS requested a storage capacity for fruits and vegetables instead of potatoes because a potato processing plant that was to be built had been cancelled and demand for potato storage was limited. Meanwhile, the Investor had begun fruit orchards whose output would require storage. After considerable correspondence the Bank agreed to the modifications in February 1979. After the cold store had been contracted, however, the Investor requested a reduced storage capacity of 3,500 tons. Since the cold store was constructed in 1981 it has been used primarily for apples, of which 60Z comes from within the same basic organization. 3.08 Dry Vegetable Plant. The appraisal planned for a dry vegetable plant to process about 50,000 tons of raw material, a' readily available in the region of Sveti-Nikole, for processing into tomato paste and dehydrated vegetables (onions, leeks, peppers, etc.). The plant that was built has a capacity of 17,000 tons of throughput, all in dehydrated vegetables. The tomato line, representing 25,000-30,000 tons, or 60Z, of the throughput, was not constructed, but otherwise the plant followed the appraisal design. The rationale for this change was that the market for tomato products had changed and that another plant under the project was to produce tomato products. This was accepted by the Bank. 3.09 Associated Individual Sector. Under this project SBS onlent funds to kombinats and cooperatives, which in turn made subloans to individual farmers associated with them. After two years of project implementation, in June 1979, SBS requested and the Bank agreed to a reallocation of the Bank's loan that gave more emphasis to on-farm mechanization. SBS justified this request with a shift in demand and its obligation for timely project implementation. I/ It is interesting to note that the PCR for Loan 894-YU estimated a 1X rate of return to the larger driers. This PCR estimates a 15Z rate of return to the smaller driers. 2/ The appraisal report described a 50,000 ton plant, but tables on its operations showed only 40,000 tons throughput.  -10- Table 1 below shows the revision. Table 1: Allocation of Associated Individual Sector Loan Funds /1 Appraisal Revised ---Percent- Fruit & Vegetable Production 30 9 (including plastic houses) On-farm Mechanization 35 82 Livestock Production 35 9 Total 100 100 /1 See Table 3 for details. 3.10 The closing date was postponed once from June 30, 1982 to June 30, 1983 because of implementation delays (paras 3.12 - 3.17). C. Physical Implementation 3.11 PbyRical implementatinn of the project is shown in Chart I, in which actual performance is compared to appraisal schedule for each major component. Design changes, cost overruns and procurement problems in the social sector delayed implementation. Details by project component are described in the following paragraphR. (i) Social Sector 3.12 The Dairy Plant at Prilep was initially delayed because the Bank questioned the inclusion of equipment to process aseptic milk because of its high investment cost. SBS and the investor reappraised the subproject, excluding the aseptic milk line. Then the turnkey contract became effective one year late because the foreign subcontractor had problems obtaining an import license for equipment. Although due to be completed in 1980, it was only by mid-1983 that the dairy plant construction was near completion. By June 1985, however, it was still not operating because it did not have a source of power. The plant had originally planned to take its energy from the nearby malt plant, but it was subsequently discovered that the malt plant and its generator would be closed every year for maintenance. The dairy was therefore installing its own boiler. Because the technical analysis of energy sources was not properly worked out, the dairy plant has lost several years of operation. 3.13 For the slaughterhouse at Gostivar the lowest evaluated bid showed a considerable cost increase (39% above Bank appraisal and 23% above SBS appraisal). Negotiation of some performance requirements also delayed implementation and during this next delay costs increased further to about 60Z higher than appraisal estimates. Construction finally started in November 1979 and was completed in August 1982, compared to an appraisal date of 1980, with an overall cost overrun of 40L. Test runs began in October 1982 and the guarantee was fulfilled by early 1983.  -11- 3.14 The potato cold store at Delcevo was delayed because of the change in concept (para 3.08) and was completed in September 1981. 3.15 For the fruit and vegetable processing plant at Gevgelija, a reconstruction of an existing vegetable processing plant, the original tender documents had to be revised to add a price adjustment provision and several months were added to the ususl bid time to give biddeis enough time to study the existing plant. Once bids were received and evaluated, however, the Bank agreed to the rejection of all the bids because (i) all oids substantially exceeded the engineers' estimate, (ii) none of the bids were responsive and (iii) market prospects for tomato products had changed since appraisal in 1976. With the help of the consulting firm the technical specifications were re-written, and a new processing line was included in the existing building to reduce the amount of civil works required. Re-bidding took place in December 1980 and the contract was signed in June 1981. Civil works completion was delayed for the rehabilitation and expansion of the fruit and vegetable plant while the grape concentration plant was completed in late 1982. After some technical modifications the fruit and vegetable plant was put into operation in late 1983. 3.16 The dehydrated vegetable plant at Sveti-Nikole In the draft contract for construction the Bank discovered inconsistencies with the original tender documents. The proposed contract did not include the tomato processing line which represented about 60P of the total production capacity (para 3.08). The Bank also objected to the Investor's intention to sign two separate contracts, one for civil works and one for equipment because the Bank believed that a turnkey contract for this imported technology would be more efficient.X/ The bidding was repeated on modified tender documents in early 1981. The contract was signed in June 1981 with a bidder different from the winner of the first tendering. This led to an arbitration case between the investor and the winner of the first tender at the Paris Chamber of Commerce. ' Construction was completed in time for testing in fall 1983. 3.17 For the apple processing plant at Resen bids were received in November 1978 and their evaluation took more than six months. Another delay of several months occurred in the summer of 1981 due to some minor parts missing on the boilers. Tests were run in March 1982 and in summer 1982 the Plant became operational. I/ The Loan Agreement, Schedule 4 (para 2), specified that contracts for all social sector investments, except the tobacco dryers, would be awarded under turnkey contracts. 2/ The arbitration took place after the Loan closed and the files contain no record of the result.  -12- (ii) Individual Sector 3.18 No major problems were experienced in the implementation of the individual sector subloans. In '1977 and 1978 SBS had approved 207 credits to subborrowers for the plantation of orchards and vineyards and the erection of plastic greenhouses for off-season vegetable production, altogether about 128 ha (see Table 2 below). About 155 subloans had been approved for livestock development, most of them between 1977 and 1979, financing the purchase of 150 heifers and cows and about 12,000 sheep. With these as well as with the subloans for fruits and vegetable production, SBS reported the demand for on-farm development to be satisfied. About 880 subloans were made for the purchase of tractors and accessories between 1977 and 1982. The 556 tobacco dryers were approved in 1979 constructed between 1980 and 1982. See Table 3 for full summary of appraisal vs. actual use of individual credit. Further comment on the credit delivery system is in para 7.04. Table 2: Individual Sector Sub-loans Type of Sub-loan 1977 1978 1979 1980 1981 1982 Total Mechanization 78 261 277 - 161 96 873 Greenhouses. 59 59 Mini-sheep farms 41 12 37 33 123 Dairy farms 7 20 5 32 Orchards 5 3 1 9 Vineyards 13R 1 139 Tobacco driers 556 556 Total 131 493 872 161 134 1,791 Market Study 3.19 This Loan provided funds to do a detailed feasibility study for a market center. The study was carried out in 1979 at an eventual cost of about US$460,000 instead of the US$100,000 estimated at appraisal, and it recommended location of a wholesale market center in Skopje. SRM did not include investment for such a center in its Development Plan for the Republic (1981-85) because of the expense, estimated in 1979 at about $68 million, and therefore there has been no follow-up of the study. In the context of this project, the lack of marketing facilities does not appear to be a constraint on the marketing of primary products.  Table 3: Credit to Individual Sector (in '000 dinars) APPRAISAL ACTUAL No. of No. of Cost Total No. of No. of Cost Total Investment Sub- Ha/Head per Loan CostLl Sub- Ha/Head per Loan Cost borrowers (total) ----('000 dinars)--- porrowers ----'000 dinars--- 1. Plastic greenhouse 20 20 ha 674 13,480 59 7 2S8 1,807 2. Vineyard 110 110 ha 104 11,461 139 116 86 12,018 3. Orchard 110 110 ha 86 9,513 9 5 51 4S7 4. Mini-sheep farm 500 20,000 head 70.9 35,438 123 11,891 243 29,867 5. Mechanization LI 120 na 372 44,617 873 na 161 149,863 6. Dairy cows 50 300 '196 9,791 32 167 146 4,673 7. Tobacco driers - - - - 556 1,668 LA 140 77.562 276.237 Li Constant 1976 prices. LI most loans actually made in 1978 and 1979, except for tractor sets. See footnote 3. LI Number of tractor-set loans made as follows: 1977: 78; 1978: 261; 1979: 277; 1980: 161; 1982: 96. LA 3-ton capacity x 556 driers = 1,668 tons (output) capacity.  -14- D. Quality of Proiect Works 3.20 The quality of project works appears satisfactory. The civil works are of generally good quality and above average design, with the exception of some uneven work noted in the Dairy Plant. The processing equipment is sophisticated and very high quality. E. Ptocurement 3.21 The procurement procedures stipulated in the Loan Agreement comprised ICB with turnkey contracts for processing facilities for the social sector and advertising in accordance with local procedures (LCB) for contracts of US$50,000 or more or negotiated purchase in accordance with LCB for contracts less than US$50,000 for goods and works to be procured for individual sector subborrowers. About one year after effectiveness procurement consultants were employed and a procurement seminar held. 3.22 In spite of these arrangements, the procurement for the Social Sector investments took an unduly long time. The Borrower complained about the considerable time it took to procure agroindustrial processing plants through ICB, but admits that Investors' modifications of designs and prolonged selection of lowest evaluated bidders contributed to the delays. These procurement delays were largely responsible for commissioning plants only at the end of the project implementation period. 3.23 Turnkey contracts were required by the Loan Agreemenk (para 3.16. FN 1/). The Bank felt that for installing equipment of the latest technology, a turnkey contract would ensure that design and construction of the civil works would be properly coordinated with the requirements of the equipment. The Bank recognized, however, that in cases where local contractors had sufficient experience and expertise a two-contract system was acceptable, ' and was prepared to make an exception to the turnkey contract requirement. This sometimes meant, however, as is the case of Sveti-Nikole dry vegetable plant (para 3.16), further delay in awarding contracts as the Bank and the Borrower discussed the issue after the bid evaluation had already taken place. The delays could have been avoided by agreeing before tendering that a two contract system would be acceptable provided the civil works contractors were prequalified. For the future agroindustrial subprojects, turnkey contracts should still be specified, with exceptions made on a case by case basis. F. Project Cost 3.24 The total project cost was 100% higher in dinar terms than estimated at appraisal, but lower in dollar terms by about 11% (see Table 4 below). The reasons for the dinar cost overrun were that the components were carried out two to four years later than anticipated and inflation during the entire 1/ This two-contract system had been used in several.subprojects in the first project (Loan 894-YU) with good results and the PCR recognized that on e case by case basis the two contract system was acceptable.  -15- project period was higher than projected at appraisal.l/ At the same time,however, the dinar was devalued by about 400% between 1977 and 1983 (Table 4, FN 2). The largest cost overruns were in the Gostivar slaughterhouse, at 276S, and the vegetable processing extension at Gevgelia, at 236X. Both of these investments were due to be made in 1978-79 and were, in fact, carried out mainly in 1982 and 1983 1' (paras 3.12-3.17). 3.25 In the individual sector, the deviation of actual costs of credit from appraisal estimate was due mainly to the different uses of credit. For example, for tractors, subloans were made for about 870 tractor sets because farmers showed a particular interest in them, while the appraisal expected only about 120 subloans for this purpose. The cost of the tractors was in fact somewhat lower in dinar terms than projected, but this may be because the additional equipment purchased with the tractors was less than foreseen at appraisal. For credit to individual farmers for fruits and vegetables, on the other hand, only about 130 hectares were developed compared to 240 hectares expected at appraisal. I/ 1977 1978 1979 1980 1981 1982 1983 -- -----2 per annum-- Projected domestic inflation: 12 12 12 10 10 10 10 Actual domestic inflation: 16 13 20 32 42 32 41 (Cost of Living Index) 2/ The slaughterhouse was started in 1979.  -16- Table 4: Total Project Costs: Appraisal vs Actual Appraisal /1 Actual Cost Component '000 Dinar % of '000 Dinar 2 of Over- Total Cost Total Cost run Social Sector Dairy plant-Prilep 61,863 6 165,197 8 167 Slaughterhouse-Gostivar 106,757 11 401,595 20 276 Cold Store-Delcevo 78,622 8 147,621 7 88 Dry vegetable plant-- Sveti Nikole 228,135 23 296,225 15 30 Fruit and vegetable processing--Gevgelia 118,278 12 397,143 20 236 Apple processing--Resen 193,919 19 308,614 15 59 Tobacco driers - - 13,026 1 - Subtotal 787,574 78 1,729,421 86 120 Individual Sector Fruits and vegetables 45,000 4 14,200 1 -68 Mechanization 58,000 6 149,800 7 158 Livestock 60,000 6 35,000 2 -42 Tobacco driers 55,000 5 77,580 4 41 Subtotal 218,000 22 276,580 14 27 Market Center Study 2,320 1 8,800 1 279 TOTAL PROJECT COST 1,007,900 100 2,014,801 100 100 US$ Equivalent ('000) /2 55,996 49,659 -11 /1 All contingencies included. /2 Appraisal exchange rate: US$1.0 = 18. Actual average exchange rate: 1977 US$1.0 = 18.28 dinars 1978 18.49 dinars 1979 19.06 dinars 1980 23.22 dinars 1981 33.19 dinars 1982 47.43 dinars 1983 90.84 dinars  -17- 3.26 Comparing appraisal estimates of investment costs by year in terms of percentage expenditure with actuals shows the delays in investment: 1977 1978 1979 1980 1981 1982 1983 Appraisal /1 4 34 90 100 Actual 1 4 7 18 35 71 100 /1 Appraisal specified only Year 1, 2, etc., and may have anticipated Year I as starting July 1, 1977. Thus the figures are shown at mid-year. The period from 1981-83 represents 65% of actual expenditure, whereas appraisal estimated that by mid-1981 the project would be essentia;'; completed, except for a performance guarantee period on the processing equipment. Project costs by year by activity are in Annex 2. G. Financing 3.27 The original financing plan, excluding interest during construction, showed that the investors would contribute 20% of the project costs and SBS 43X. This arrangement was also stated as part of the Operations and Policies for the Project in the Loan Agreement (Schedule 5, para 3(A) Terms of Subloans). In the event, however, the subborrower's contribution (excluding the capitalized interest during construct,ton) was about 17 and SBS' was 39X, with the remainder coming from IBRD (40S) and other foreign sources (see Table 5 below).  YUGSLAV PROJECT COMPLETION REPORT LOAN 1371-YU Table 5: Financina Plan Apnraisal Actual Sub- Local Bank IBRD Total Sub- Local Bank Other IBRD I/ Total borrowers -SBS borrowers -SBS Sources ---------------------------------------Million Dinar------------------------------------------ Social Sector Li 157.5 334.4 295.7 787.6 240.1 572.6 65.7 859.8 1,738.2 Individual Sector 43.7 93.9 82.7 220.3 56.9 114.9 - 104.8 276.6 Total Project Costs 201.2 428.3 378.4 1,007.9 297.0 687.5 65.7 964.6 2,014.8 ----------------------------------------US$ million--------------------------------- -- Total Project Costs LI 11.2 23.8 21.0 56.0 8.5 19.6 1.9 19.8 49.7 I (Percent of Total) (20) (43) (37) (100) (17) (39) (4) (40) (100) "4 Interest during Construction 3.2 3.0 6.2 - - - 1.9 - Total Financing 11.2 27.0 24.0 62.2 8.5 19.6 1.9 21.7 51.7 (Percent of Total) (18) (43) (39) (100) (16) (38) (4) (42) (100) -------------------------------------------million dinar------------------------------------------ LI Social Sector Financino: Dairy 24.8 39.6 100.8 165.2 Slaughterhouse 42.6 201.6 20.9 136.5 401.6 Cold Store 52.0 46.6 49.0 147.6 Vegetable Processing 33.7 97.1 266.3 397.1 Ory Vegetable Processing 44.7 95.6 156.0 296.2 Apple Processing 35.8 83.4 44.8 144.6 308.6 Tobacco Drier 2.6 5.6 4.8 8.8 Market Study 3 9 3.1 - 1.8 8.8 LI Exchange rates used to convert dinar amounts to dollar equivalent depend on time of expenditure/disbursement: the average exchange rate for the entire project period is US$1.0 41 dinars; since disbursement from IBRO typically lagged expenditure by 3-6 months, the average exchange rate for disbursement of IBRD funds was US$1.0 = 49 dinars. l/ These amounts reflect the rates of exchange at the time of disbursement The Dinar value of these investments are, as of 1985. about four to seven times greater because of devaluation.  -19- 3.28 The Loan Agreement stipulated a minimum of 20% contribution to project costs from subborrowers, the maintenance of not less than 75% to 25% debt/equity ratio by social sector subborrowers and sufficient cash flow to meet all their financial obligations. However, the social sector subborrowers failed to meet their cont: ibution or to maintain the agreed debt/equity ratios (see para 5.05 and Annex 3). The cost overruns experienced in all agroindustry subprojects (see Table 4 above) were financed by resorting to more borrowing from Federal and Republic Funds, local banks, from the World Bank and other foreign sources. This lack of financial discipline at a time of rapid inflation and devaluation of the dinar, has left all social sector subborrowers in a precarious financial condition (see Annex 3). 3.29 For the borrowed funds from foreign sources (mainly IBRD, but 42 from others), the social sector subborrowers assumed the foreign exchange risk, as required in the Loan Agreement (para 2.11). At the time of appraisal and negotiations (1976-77) the dinar had been stable since 1971, showing a total devaluation of about 6S, and the risks appeared minimal. The lack of financial discipline described above (para 3.28) compounded by a ten-fold devaluation of the dinar has resulted in social sector subborrowers being unable to meet their debt service obligations (see para 5.06). As a result all social sector subborrowers have requested and received from SBS a refinancing of their loan repayments which has also affected SBS' own ability to repay the IBRD loan (paras 5.12-5.13). During the course of construction of subprojects, the Borrower has failed to keep under constant review the financing plans and cashflow requirements of social sector subuorrowers in accordance with the Loan Agreement (Loan Agreement Schedule 5 paras 2(B)(c) and (d)). This failure of the Borrower was not discussed in the imk's supervision reports. H. ComDliance with Loan Covenants 3.30 Aside from the important loan covenants mentioned above (para 3.28 & 3.29) that were not fulfilled, the other loan covenants were fulfilled, although some of them with a delay of up to one year. Among them was the recrui-meut of procurement consultants hired 11 months late. Had they been hired on time, procurement delays and cost overruns could perhaps have been avoided to a certain extent. The position of the marketing consultant was filled about 15 months later than stipulated. The monitoring system was established one year later than stipulated but systematic evaluation of the individual sector did not take place (paras 7.01-7.02). I. Disbursements 3.31 Throughout the project, dis:.ursements lagged behind appraisal estimates and, except for one quarter, were never more than 53% of the original estimates. The Loan closing date was extended from June 30, 1982 to June 30, 1983. Final disbursement was January 18, 1984 at which time there were still US$2.34 million undisbursed. This amount was cancelled. The estimated and actual disbursements schedule is at Annex 1.  -20- IV. Agricultural Impact A. Crop Yields and Incremental Production 4.01 The project's annual incremental primary production in the individual sector is summarized in Table 6 and livestock and crop yields in Table 7. The information is based on a combination of the Borrower's PCR and mission field visits. Systematic farm surveys apparently were not done, so mission assumptions included the following: incremental production of vegetables and wheat came mainly from the mechanization component, which exceeded appraisal estimates. It was assumed that each subloan for tractor and equipment was used for production on 10 hectares (5 of the farmers' own and 5 of the other farmers who rented out the tractor services), and the 10 hectares were planted to wheat, barley, tomatoes and cabbage. Incremental production came from both an expansion of the area that could be cultivated with tractors and from higher yields from more intensive use of fertlizers and chemicals.L' For the sheep farms, the meat yields are less than appraisal because the lambs are sold quite young, at about 15 kg liveweight, rather than the 25-35 kg expected at appraisal. Table 6: Incremental Primary Production /a (Individual Sector) Full Development Estimated Estimated (PCR) Appraisal as S of - -m tons Appraisal Vegetables /b 12,000 8,000 150 Wheat/Barley 2,100 - - Fruit & Grapes 2,000 3,800 53 Meat 87 477 18 Milk 670 2,700 25 Wool 17 29 59 Tobacco 1,868 800 234 /a Since no farm surveys were done, both project yields and incremental production estimates are based on the Borrower's PCR, mission field visits and mission assumptions. /b Tomatoes and cabbage (from mechanization and greenhouse investments). 1/ The appraisal figure of 3.5 tons/ha of wheat appears quite high for unirrigated land. It was more likely at about 2 tons/ha on unirrigated and 3.5-4.0 tons/ha on irrigated.  -21- Table 7 Average Yields (Full Development) Estimated Estimated as X of (PCR) Appraisal Appraisal Dairy Farm per cow per year milk - liters 4,000 3,150 127 progeny culled 0.8 1 80 Sheep Farm per 100 ewes per year milk - liters 4,000 3,000 133 progeny culled 81 72 112 meat - kg 1,460 2,600 56 wool - kg 150 230 65 Orchard - peaches tons per ha 20 20 100 Vineyard - grapes tons per ha 12 12 100 Plastic Greenhouses per ha - tomatoes 45 45 100 Vegetables - cabbage tons per ha 15 - Wheat tons per ha 2.4 3.5 B. Agronomic Practices and Inputs 4.02 Iatensified agricultural production is the project's major impact in the individual sector with mechanization as the main cause. According to mission field visits, use of tractors was accompanied by increased use of fertilizers, irrigation and extension services. For livestock production, intensive forage production replaced pastures. The extension service (see para. 7.03) assisted in replacing grain production with more intensive crops like fruit and vegetable. With early vegetable and/or late forage crops preceding and/or following the main crop, multicropping systems were introduced. C. Food Processing 4.03 The first full year of production for most of the plants was 1984. Thus, except for the slaughterhouse, none was operating yet at full capacity-L- although all had plans to approach that level in 1985. The plants were generally well designed, with good layout and equipment, and on 1/ Even assuming single shift operations during "peak season", these new plants were not operating at full capacity.  -22- the basis of 1984 performance they appear to have good potential to be efficiently run from a technical point of view, except for the dry vegetable plant (para 4.15). Financially, the firms are doing badly and revenues do not in general cover the full costs of production (para 5.05). The managers were generally dynamic and informed and were well aware of the operatiunal, financial and marketing problems they faced. 4.04 Slaughterhouse at Gostivar. The first full year of production was 1983 and by 1984 the slaughterhouse was operating at over 100% capacity by doing part of a second shift. Instead of the 350,000 head total capacity, the slaughterhouse had a throughput of 420,000 head of lamb and 8,000 head of cattle. The plant is able to sell the full amount of fresh meat produced, of which about 70% is exported to Italy and Greece and Arab countries in Northern Africa and the Middle East. The plant is arranging raw material supply to expand its operations up to 625,000 head. The managers felt coniLdent that they had an adequjate market because they have been in the business for about twenty-five years and have well established customers and markets, particularly abroad. 4.05 The project also financed equipment for canning, vacuum packing and sausages which has to date not been operated. The staff have had several training sessions on the technology required for use of the new equipment, and the management has asked the Institute of Meat Technology (Belgrade) to help them in product testing. Since the plant does not now have an important supply of low grade meat nor were-there indications that the margins would be greater than for fresh meat, it was questionable whether the plant should be devoting energy and resources to this new equipment. It further raised the question of the rationale for including the equipment at appraisal in a slaughterhouse whose primary activity was production of fresh meat, in which the slaughterhouse was well experienced and from which they made an adequate margin from exports as well as domestic sales (financial results para 5.05). 4.06 Tobacco Drier at Debar. According to the Borrower's PCR and visits with the farmers using the 200-ton tobacco drier, it is operating at full capacity, with a throughput of 1,200 tons green Virginia tobacco to produce 200 tons dried tobacco, about 70% of which is exported (to Germany and Austria) and the rest sold domestically. With the recent increases in purchase price of green tobacco (reported to be about 100% in the last two years, now up to 35-40 dinars/kg) and the selling price of processed tobacco increasing by less, the margins on the drier's operations have been squeezed. Data were insufficient to estimate the profitability of the drier. 4.07 Apple processing plant at Resen. At appraisal, the market looked promising in West Germany for processed apple and apple products and sufficient raw materials were available in the region to supply a 10,000-ton plant. The intention was Lo produce in bulk for the export market. The larger 18,000-ton plant was commissiovsd in November 1983k' and 1984 was the 1/ The Bank had agreed to a proposal to expand apple processing capacity to 12,000 tons/year. A supervision mission discovered that during construction, the Investor agreed with the contractor to make minor design changes to allow processing of other fruits and some vegetables (cherries, blackberries, pears, apricots, onions and garlic). This extended the season and thus total intake capacity to the 18,000 tons now stated by plant management.  -23- first full year of production. Of the total capacity to process 18,000 tons and produce 8,500 tons (average input:output ratio of about 2:1), the plant processed 15,000 tons in 1984; most of the fruit was apples (13,500 tons). The output was only 3,500 tons giving an input:output ratio of 4.3:1, because the plant produced mainly concentrates.which have a higher input-output ratio than other products such as juices, nectars, and purees. 4.08 The plant was run reasonably efficiently, with some improvements possible in cleanliness and quality control. The plant needs to hire consultants to determine its real technical capability, the actual performance, and to develop proposals for improving the performance. In addition, because the price of raw materials has increased more rapidly than the output prices and poses financial problems for the plant (para 5.02 and TabLe 8), the plant should organize its procurement of raw materials into contract arrangements, buying fixed quantitiev at prices fair co both the suppliers and the plant. The nanagement is well aware of the marketing and profit margin problems the plant faces and is considering options to improve ics financial situation. 4.09 Dairy Plant at Prilep. At appraisal, it was estimated that sufficient daily raw milk supplies were available in the Prilep valley to serve a 40,000 liter/day plant, but that the main constraints to increased milk production were a lack of organized milk collection and low yielding cows. The plant management did not supply any data, however, on specific plans for collecting the raw milk supply, or on likely availability, except that they were planning to purchase about 500 in-calf heifers for sale to the associated individual and social sectors to increase the milk supply.l/ 4.10 In the absence of actual experience and data on supplies, the expected capacity utilization is uncertain. For the financial results below (para 5.07), the mission made estimates based on discussions with the plant management. 4.11 The major problem already facing the old dairy plant is that because the seiling price of fresh milk has been regulated it has not covered even the variable costs of production. At the same time the purchase price of raw milk has increased about 400% since 1981. The selling price of processed fresh milk has been deregulated at a Federal level since January 1, 1985 and unless the Republic or commune changes the situation, the market will determine the price. This should improve margins somewhat. In addition, the managers of the sew dairy plan to produce yogurt, sour milk, cheese and butter, which have higher margins. The old plant does not, however, produce these products, so that although Prilep area shops have these products from elsewhere in Yugoslavia the market ability to absorb 3,600 tons of yogurt and 2,000 tons of sour milk, plus smaller amounts of cheese (550 tons) and butter (40 tons) is uncertain. Financial results are ar^e discussed in para 5.05. 1/ This would add a total of 4,000-5,000 liters/day of milk.  -24- 4.12 Vegetable Processing Plant at Gevgelia. The first full year of operation was 1984 and it operated at about 65% capacity (of a total output capacity of 10,200 tons,-/ the plant produced 6,600 tons). The plan is to increase output to 95% of capacity in 1985. 4.13 As expected at appraisal sufficient raw material supply is not a problem, although the organized, timed procurement needs improvement. The appraisal expected most of the product to be exported, mostly to Western Europe, but in fact so far 80% of the sales have been on the domestic market and the plan for 1985 is to continue this pattern. (Financial results are in para. 5.05). 4.14 Cold Store at Delcevo. By 1981 a 3,500-ton cold store for apple storage had been built. In 1984, about 3,200 tons of apples were stored for about six months and small amounts of tea (100 tons) and cheese (30 tons). The manager plans to increase the capacity utilization by using the slow freezing chambers to store other fruits. The cold store does not buy and sell the apples but stores them on behalf of the producers, the most important one being an orchard within the same basic organization. The revenue to the cold store comes only from the storage charge of 0.8 dinars per kilo per month. Because the total capacity of the store is actually 3,500 tons x 12 months, or 42,000 tons, it operated in 1984 at about 45% capacity. The cold store needs to seek actively other products to increase its capacity utilization. Financial results are in para. 5.05. 4.15 Dry Vegetable Plant at Sveti Nikole. The first full year of operation, 1984, had the plant operating at 25% capacity and the major problem with production was that the ratio of input to output was on average 15:1 instead of the planned 10:1. Onions, which the plant has the largest capacity to process (almost 40% of total capacity), had the best ratio, but in fact the largest volume of production was the peppers, with the worst ratio (17:1). The plant management should hire a short-term consultant to examine carefully the processing lines, using a "mass balance" approach which tries to identify the weight loss at each phase of processing to account for the sources of loss. This important technical problem represents a serious financial problem when translated into profit margins. Marketing and financial problems are discussed below (paras. 4.25-4.27 and 5.05). 1/ The appraisal report stated that the old plant had an intake capacity of 12,000 tons. The subproject was to expand this to 20,000 tons. At the time of tendering, however, in 1979, the tender documents stated that the old plant had a capacity of 20,000 tons and that 10,000 tons processing capacity would be added. This is in fact what has happened, so that the vegetable plant is now capable of processing about 31,000 tons to produce 10,200 tons final product.  -25- D. Raw Material Supply 4.16 Raw material supply for the processing plants was also projected to be adequate. The main constraint to increasing agricultural production was stated to be lack of processing facilities, and with an assumed demand for production from the plants, fruit and vegetable output would increase. In fact, as projected, the raw material supply has not proved to be a problem in terms of quantities available for most of the plants, with two exceptions: the cold store (para. 4.14) and the Prilep dairy (para. 4.09). 4.17 The supply of raw materials has not been a problem, although the rapid increase in input prices, shown below in Table 8 have exceeded increases in output prices. In addition, the appraisal analyzed raw material supply at the cost of tonnage delivered, when some plants such as the apple and dairy plants are required to procure their raw material by purchasing from collectives, kombinats, or other points of collection, sometimes beyond a 50 km radius, thus incurring transport costs. In addition, variety, quality and timing of supply have been problems. The dry vegetable plant, for example, may need to procure specific varieties of vegetables to improve its technical performance; the apple processing plant had problems in its first full year of operation with uneven quality of apples and plans to work with farmers on establishing standards; the vegetable processing plant at Gevgelia purchased too many tomatoes at once and has to organize timed procurement better. E. Marketing and Markets 4.18 At the time of appraisal, most of the incremental primary production and about 20Z of the processed products from the project was expected to be marketed domestically. With projected increases in per capita income, urbanization and tourism, market prospects appeared good for both fresh and processed fruits and vegetables. Macedonia already supplied other parts of Yugoslavia with fresh produce and in some cases with significant proportions of a commodity (table grapes, for example), so markets were to some extent established. In addition to the domestic sales, it was expected that the slaughterhouse would provide more fresh lamb for exporting to the Arab countries in the Middle East and North Africa and the processed apple and tomato would be exported to Western and Eastern Europe. Early vegetables from greenhouse production could also be exported. 4.19 For fresh produce, farmers can sell their output through several channels: the green market, various agricultural collectives, kombinats or other market agents acting as wholesalers. The wholesalers sell the produce to agroindustries, to retail shops or to Magro, the marketing work organization for the Republic's umbrella agricultural kombinat, United Kombinat of Macedonia. 4.20 Although it is not the only marketing channel used by producers and wholesalers, Ilagro is reswaoible for exports as wel' as sales to other Republics. It charges a 2% commission for its services and maintains offices and trading contacts in various countries. Magro also sells processed foods, including the output i.-rom this project as well as wine oad other meats. In  -26- spite of the trading network maintained by Magro, it does not appear to take an aggressive approach to marketing and has not developed a clear strategy for dealing in competitive markets. For the fresh meat from this project, this is not a problem and the milk and milk products will be domestically marketed, but the processed fruits and vegetables from the Resen, Gevgelia, and Sveti Nikoli plants do require a special market effort. Magro should play a role in seeking out potential customers, promoting these products, and providing market information to the plants on quality, packaging and other product information that would help the plants export at better market prices. Because a strong export demand for these products was assumed at appraisal, the need to develop an aggressive market strategy was not discussed. With an expanding EEC and increased competition from non-EEC member countries, however, this is no longer the case. A coordinated export strategy is required for Yugoslavia's agroindustrial products, at the Republic level and at the Federal level. Tndividual Sector 4.21 Incremental production attributable to the project from the individual sector would include fresh vegetables from plastic greenhouses, fresh fruits such as table and wine grapes and peaches from investments in orchards, milk, milk products, wool and lambs from mini sheep and dairy farms, and cereals such as wh.eat, corn, or soya from investment in mechanization. 4.22 For fresh produce, Macedonia still enjoys a healthy demand, both domestically and abroad. In 1984, Macedonia exported to Western Europe about US$3 million worth of fresh fruits and vegetables (about 4,500 tons), which represented less than 2. of marketed production in Macedonia. In addition, other Republics rely on Macedonia for supply of certain fruits and vegetables, such as paprikas (red peppers) and for early and later season produce. With the recent completion of the agroindustrial plants under this project as well as those being constructed under Macedonia III (Loan 2039-YUTJ) and already constructed under a previous project (Loan 894-YU financed a wine cellar and wine by-products plant), the demand for Macedonia's fresh produce, of all grades, is not likely to suffer in the near future. For other individual sector output, such as the cereals, Yugoslavia is in deficit (wheat, soya beans, maize), so the market for any surplus is quite strong. Yugoslavia also has a deficit in milk and milk products so farmers' output, in excess of home consumption, should have a ready market. In spite of this, subsidies are required on the farmgate price (para. 4.09), although marketing processed milk should not be a problem. For the market for livestock, the recent construction or expansion of slaughterhouse facilities for lamb in Gostivar under this project and for pigs and cattle in Sveti Nikole under Loan 894-YU ensures an adequate demand for the animals. Social Sector: Agroindustries Output 4.23 Domestic Market. With recent expansion throughout Yugoslavia of fruit and vegetable processing facilities and slaughterhouses and a 1/ Loan 2039-YU is financing cold stores, but with some freezing and packing capacity to produce frozen fruits and vegetables.  -27- simultaneous slowing down of the economy and real income levels, domestic marketing of manufactured fruits and vegetables and processed meats has become problematic. Supplies of bottled and canned juices have increased, while demand has slowed down. Both the apple processing plant at Resen and Gevgelia's vegetable processing plant have difficulty marketing their bottled products domestically. Given the projections on the domestic economy, which include high inflation and low real growth for the next three to five years, neither plant should count on domestic sales of packaged products. The fruit and vegetable plants should explore possibilities of supplying their processed products in bulk to other domestic suppliers, which would eliminate the costly packaging activities. 4.24 The fresh lamb from the slaughterhouse, on the other hand, has a ready domestic market. For processed meat and for milk and milk products, which neither plant has started producing yet, the market is unknown. The processed meat from Gostivar would likely be competing for the same market as the processed meat from the Sveti Nikole plant (financed under Loan 894-YU) and with stagnating or decreasing per capita incomes, demand may not be very strong in general for processed meats. For fresh milk, Macedonia is in deficit, so the Prilep dairy would help satisfy this demand, but other milk products, such as cheese, butter and sour milk, are common items made and consumed at home and thus the market may be limited for these higher-priced items. Also the self sufficiency of Macedonia in milk will reduce the purchases now coming from Serbia and may affect the latter's dairy industry. The problem of supply and marketing in agroindustry must, in future, be reviewed in a broader regional and national context. 4.25 Export Market. The export demand for some of these processed products is strong such as for dried vegetables and processed apple products. Except for the slaughterhouse at Gostivar, these plants are recent entrants to the export markets. Under the project, a program of visits and "training" was organized for the managers of several plants (Resen apple plant, Gevgelia vegetable plant, Delcevo cold store, and several other enterprises financed under other Bank projects) to the United States to acquaint them with similar operations and marketing strategies elsewhere that were relevant to their businesses. Whether as a result of this trailning or whether the managers were in any case outward-looking, they seemed particularly aware of market strategy and competitive demands for quantity, quality, packaging and timing. In this respect, they seemed more aggressive than the official marketing channel for exports, Magro. In addition, at least one purchase contract for a plant's product resulted from contacts made during the training. 4.26 Competition in West European markets is quite strong, particularly from other East European countries. These plants need to develop a market strategy, to develop customers who rely on them to provide a timely, high quality product and to promote their products among several customers, both foreign and domestic, so as to be able to charge higher prices. As in the case with domestic sales (para. 4.23), bulk sales should be attractive to the plants, so plants should explore this export strategy to maximize profits. 4.27 The problem f_-r a11 the exporters in the project was that the export prices received were lower than the domestic price, even after the premium from Government for exporting (see Table 8 below). The plants felt compelled to export, first of all because the demand was there in much larger quantities  -28- than in the domestic market. Second, the exports earned badly need foreign exchange to repay the foreign debts. As the dinar continues to devalue and domestic output prices for processed goods lag behind inflation, the difference between export and domestic prices may decrease in the next few years. V. Financial Results and Re-evaluation A. Social Sector: Agjrcindustries 5.01 The profitability of the agroindustries in the project are seriously threatened by sharply increased input prices (paras 5.02-5.03), technical problems and increased processing and packaging costs in production (para 5.04), the high and increasing cost of loans (para 5.05), and marketing problems which include limited domestic demand and low export prices (paras 4.23 and 4.27). These problems in turn affect SBS' financial situation (para 5.12). Input Prices 5.02 Table 8 shows that since the time of appraisal up to 1984 or 1985 input prices have ilLcreased between thirteen and twenty fold, while the overall increase in the price level up to 1985, measured by the consumer price increase, has been about ninefold. The farmgate price for milk was 3.5 dinars/liter and in 1985 is estimated at 46 dinars/liter (depending on the fat content). Lambs were bought in 1976 for 20-26 dinars/kg liveweight and in 1984 cost the slaughterhouse 350-450 dinars/kg. Fruits and vegetables have increased most dramatically from less than 2 dinars/kg to 30-40 dinars/kg. 5.03 Most output prices have increased by proportionally less compared to their input prices. The clearest example is for the vegetables. Onion input prices have gone up from 0.7 dinarslkg to 35 dinars/kg, where the selling price of a kilogram of dried onions has changed from 28-32 to 330-600 dinars. The plant managers reported that the squeeze between input and output prices has been particularly noticeable in the last few years: while the prices of raw material for the Resen apple plant increased by 180X between 1981 and 1983, the prices of natural fruit juices increased by only 24X. This situation may well be due to the large growth in capacity of fruit and vegetable processors, placing upward pressure from increased demand for fresh produce and downward pressure on prices of finished products from increased supply into a stagnant market demand. 5.04 The problem of irput/ouput price squeezes has been compounded by the increased costs of collecting and processing, particularly the increases in the cost of energy, reported to have increased 240% between 1981 and 1983, and the cost of packaging (bottles and other packing material), up by 260Z during the same period.-' Thus, apart from the heavy burden of their financial debts, the plants are operating in a much worse financial environment than foreseen at appraisal. 1/ Compared to a cost of living increase of 187Z during the same period.  -29- Table 8: Input and Output Prices 1976 and 1984/1985 At Appraisal Actual Commodity/Product 1976 1984 1985 ----dinar/kg or lt- Dar Input: Cow's milk 3.5 NA 46 Output: Pasteurized milk (70% of volume) /1 4.4 37 55 Yogurt (1OZ of volume) /1 12.0 35 72 Cheese (20% in volume) /1 36.0 330 400 Slaughterhouse Input: Lambs - spring 26 450 - fall 20 350 Output: Lamb carcass - export /2 62 560 - domestic 41 750 Apple Processing Plant Input: Apples 13 1.8 32 Output: Apple concentrate - export A4 33 180 - domestic - 230 Output: Aromatic concentrate - export 14 315 180 - domestic 230 Dry Vegetable Processing Plant Input: Onions /3 0.7 35 Peppers /3 1.8 40 Leeks /3 1.5 28 Output: Dried onions - export 28 330 - domestic 32 600 Peppers - export 43.2 660 - domestic 48.0 900 Leeks - export 34.2 420 - domestic 38.0 580 /l 1976 prices are wholesale; 1984 and 1985 are retail. Not entirely comparable. /2 1976 is fob price; for 1984 the price is cif and includes a 30X premium received for exporting. /3 1976 is price delivered to plant; 1985 price is farmgate. /4 1976 is fob price; 1985 price is cif and includes a 21% premium.  -30- Financial Results 5.05 Financial structure of agroindustries. The subloans are provided to a Kombinat, Work Organization or a Basic Organization to undertake the subprojects. The subborrower could be. an existing organization with other activities or a new organization created to undertake the subproject. The Balance Sheets and Income Statements for 1983 and 1984 fL. the subborrowers are given in Annex 3. As seen from the Balance Sheet, given in Annex 3, page 1, all subborrowers are undercapitalized and have negative working capital due to extensive resorting to short-term financing (Bank loans) or inability to pay their obligations (Payables and Accruals). The equity is negative in most cases due to subborrowers' failure to contribute stipulated percentage towards investment costs (see para 3.28 above) and due to foreign exchange losses incurred on foreign borrowing. The Borrower has not reviewed the financial condition and cashflow of the subborrowers as required in the Loan Agreement. Such a review should be immediately undertaken with the subborrowers and the kombinats of which they are members,'/ with a view to restoring a sustainable debt/equity ratio and ensuring an adequate cashflow. 5.06 Debt servicing and loan repayment. Because of the financial structure described above, servicing of both domestic and foreign debt has become the most difficult financial problem faced by all the subborrowers. The situation is further compounded by the rapid devaluation in the dinar which makes the repayment of World Bank and other foreign loans an ever increasing financial burden. As can be seen from the 1983 and 1984 Income Statements given in Annex 3, page 2, all subborrowers except one have failed to generate a positive cashflow.2/ Therefore, subborrowers have been unable to meet repayments (principal) and all World Bank subloan repayments have been refinanced by SBS. The terms for refinancing are ten years repayment at 247 per annum rate of interest. The impact on SBS is discussed in paras 5.12-5.13. 5.07 Financial rates of return. On the basis of the 1984 performance and 1985 plans provided by the plants, estimates were made of financial rates of return in constant 1985 prices. The revenues and costs used were those given by the plants, except for the dairy plant where capacity utilization rates assumed by the plant appeared high. The mission assumed the plant would start operating only in 1986 at 50Z capacity and increase gradually to 85X capacity by 1988. The mix of products for the dairy was as given by t'!ie plant, however. 5.08 The results are in Table 9 below. Or. the cold store, the negative rate of return is a reflection of the limited income earned by the cold store from its storage fee. While it is true that capacity utilization is low, it must be noted that the storage fee is a transfer price assigned to one unit in a larger enterprise. This fee of dinar 0.8 per kg per month compares to the 1/ Work organizations and Basic organizations are members of a Kombinat who pool their financial and other resources for common objectives of the Kombinat. 2/ Interest payments shown in these statements are low compared with the total debt. It is a common practice in Yugoslavia to show in Income Statements only the paid interest. The unpaid interest, although due, is simply left out of the accounts.  -31- increase in the price of apples of 12-14 dinars per kg over six months which is realized by the Basic Organization due to storage. Thus the financial return to storage for the Basic Organization is much higher and the economic rate of return, which considers the benefits of storage of all the apples, including these from the associated individual sector, is about 10%. 5.09 Sensitivity analysis shows that the results are highly sensitive to the assumptions. The revenues of the dairy plant reflect the assumption of the dairy that half of their output will be sold as higher margin products of yogurt and sour milk. If the plant sells only liquid milk a sensitivity analysis shows that the rate of return becomes -9.8Z. Also for the dry vegetable plant, the gross revenues depend on what proportion of output is exported at lower prices (how much lower depends of course on the relative rates of inflation and devaluation). If average prices are 5% lower than projected here, the rate of return on the dry vegetable plant drops to 3.82. The financial rates of returns calculated for all plants are based on actual operations in only one year, 1984, which was also the first year of operation, and on projections based on plans for 1985. At a time of high inflation and devaluation, when margins change every year, the validity of rates calculated on such projections are highly questionable. The Bank may want to reassess results several years from now, after the plants have been in operation for a longer period of time.  -32- Table 9: Financial Rates of Return Appraisal PCR Sensitivitv /4 I. Social Sector Slaughterhouse 17.1 20.7 15.0 Tobacco drier 16.9 n.a. n.a. Apple processing plant 14.1 4.7 4.1 Dairy plant /1 17.4 13.9 -9.8 Vegetable processing plant 17.3 11.0 3.6 Cold store 14.4 -12.5/2 - Dry vegetable plant 16.8 10.0 3.8 II. Individual Sector /3 Vineyard 20.2 13.2 11.8 Orchard (peach) 23.7 n.a. n.a. Plastic house 28.1 46.0 42.5 Mechanization 17.5 30.0 25.3 Dairy farm 19.1 n.a. n.a. Mini sheep farm 26.0 29.0 27.4 Mini tobacco drier - - 15.1 10.2 /1 No actual performance was available. The dairy plant management presented i985 and 1986 plans which the mission felt, based on discussions, were not realistic in terms of capacity utilization. The mission thus made adjustments to capacity utilization (para 5.07). /2 This cold store is part of larger operation that inclules orchards that use the cold store. This low return reflects the transfer price used within the Basic Organization and not the true value of the storage. /3 Based mainly on mission estimates. /4 Sensitivity analysis for each plant was as follows: Slaughterhouse - average sales price decreases by 5X. Apple processing plant - average sales price decreases by 5% Dairy plant - sells only milk. Vegetable processing plant - average selling prices decrease by 5X. Dry vegetable plant - average selling prices decrease by 5%. Individual Sector - Benefits decreasesd by 5X. B. Individual Sector 5.10 Financial rates of return were calculated in constant 1985 prices tor those categories of subloans where information was available or assumptions could reasonably be made. The results are in Table 9 above. From these rates of return, it can be seen why mechanization subloans were so popular: they have one of the highest rates of return.  -33- 5.11 The highest rate of return is on plastic houses. One of the main limiting factorson demand for these subloans, however, is the availability of family labor. While seasonal hired labor is commonly used in fruit orchards at harvest time, the intensity of production in plastic houses precludes using seasonal labor as easily. Thus, while the number of farmers taking subloans for plastic houses was almost triple appraisal estimates (59 vs. 20 subborrowers), the area planted per farmer and total area under plastic houses as well as total amounts borrowed were much smaller than expected at appraisal. These rates of return must also be noted with caution, however. Systematic farm surveys were apparently not carried out and thus yields, returns and operating costs were assumed on the basis of the Borrower's PCR, mission field visits and mission estimates. The rates of return are not as sensitive as in the case of the social sector however: a decrease in benefits of 5X in this sector affects the rates of return by two to five percentage points, rather than the five to seven percentage points in the social sector. One final point: it is clear from the rates of return varying from 13.21 up as high as 46% in constant terms, that individual sector farmers could bear interest rates well above the 11.5S charged to them under this loan. C. SBS 5.12 The impact of the project on SBS' cash flow has not been good. First, the Bank loan amortization schedule in the Loan Agreement (Schedule 3) showed an annual repayment of US$2.0 million every year beginning July 1, 1980. SBS however granted its social sector subborrowers five to six years' grace on their subloans, so that they were due to start repaying the loan only in 1985. The original subproject submissions to the Bank show the three years' grace as stipulated in the Loan Agreement, Schedule 5. It is not clear whether this change in the grace period was ever explicitly discussed with Bank missions, but this situation obviously created financial pressure for SBS. In addition, now that the subloans are due and the investors are unable to cover the costs of their repayments (para 5.05, 5.06 and Annex 3), SBS has agreed to refinance their loans, u