China - Third Rural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY C /f'7-C7 H Report No. 6903-CHA STAFF APPRAISAL REPORT CHINA THIRD RURAL CREDIT PROJECT December 28, 1987 Agricultural Operations Division China Department Asia Region This document has a restdcted ditribution and may be used by redients ony in the performance of their ofiil duo Its contents may not othevise be dicosed wout World Bank authodzaton.  CURRENCY EQUIVALENTS Yuan (Y) 1.00 = US$ 0.27 Y 3.7 = US$ 1.00 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES i meter (m) = 3.28 feet (ft) 1 kilometer (km) - 0.62 miles 1 hectare (ha) - 2.47 acres = 15 mu 1 kilogram (kg) 2.2 pounds (lb) - 2 jin 1 ton (t) = 1,000 kg = 2205 pounds ABBREVIATIONS AND ACRONYMS USED ABC - Agricultural Bank of China ATM - Agricultural Trade Market BOC - Bank of China CIB - China Investment Bank FCMD - Foreign Capital Management Division (of ABC) MAAF - Ministry of Agriculture, Animal Husbandry and Fisheries MOF - Ministry of Finance PBC - People's Bank of China PMC - Project Management Committee PO - Project Office PU - Project Unit SMCs - Supply and Marketing Cooperatives RCCs - Rural Credit Cooperatives  - i - FOR OMCIAL USE ONLY CHINA THIRD RURAL CREDIT PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. Credit and Project ....... 000.000..,.. 0000000000 v I0 BACRGROUND ..O.O.O...............OOOOOOO.......O...O.....OOO..O.. 1 The Agricultural Sectoro........... eeoo............ 00000 1 Sectoral Objectives and Bank Group Operations............ 2 Project 4....................... 0 0. 4 II. AGRICULTURAL BANK OF CHINA ................ *******00000000 5 Reform of the Banking System............................. 5 ABC Organization, Staffing and Training.................. 6 ABC Operations ........... 0*0*****e.....................*0 7 ABC and RCCs ...ooooeo 9 Accounting Systems and Auditing.........................O 10 III. THE PROJECT PROVINCES .................................... 1l General .OOOoO.o00000000000000000000000000 *000 11 Southwest Provinces ..........oo ........ e .oooooo..oooo. 11 North Central Provinces 00e000000000 .................... 12 Agricultural Support Services........................,.. 12 ABC Organization and Operations.......................... 14 Objectives and Scope..................... e 16 Project Features.000000000 ...00 00**** ,******,*.0*00..* 16 This report is based on the findings of a preappraisal mission and an appraisal mission which visited China during November 1986 and April 1987 respectively. The preappraisal mission comprised Messrs. R. Deshpande, J.Doolette, J. Brown, A. Ody, A. Piazza, Bi Ming-Jian, Ms. P. Harrell (IDA), Messrs R. Harrison and J. Blencowe (Consultants). The appraisal mission comprised Messrs. R. Deshpande, A. Piazza, Bi Ming-Jian (IDA), R. Van Wagenen, C. Cronberg, R. Thomas, S. T. Koh and R. Nathaniel (Consultants). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without WorId Bank authorization.  - ii - Page No. Tree Crops ........ *. . 16 Livestock....0.... ..... ....o0 * ....... 18 Aquaculture. . ......... ......... .. ... ......... .. . , 20 Agro-processing 20 Pilot Program for RCCs o0....o ..................0..... , 22 Technical Assistance........ .,.*.......o......... ,. ,.. 22 Cost Estimates and Financingo..........................., 23 Procurement .e...................... *@go00*00o o*0 00**,* 24 Disbursement ......... .., 26 V. PROJECT IMPLEMENTATIONP............. o......ooo.......... 28 Project Organization ........................... , .... .. 28 Subproject Im plementation 31 Onlending Terms and Conditionse.......................... 31 Accounts and Adt 33 Monitoring, Evaluation and Reporting..o......o.......o... 33 Enviromental Effects 34 VI. MARKETS AND PRICES..,..*E..*.... 35 Market Prospects ..... 35 Prices...... ...................... .... ............ .... *.. 36 VII. BENEFITS, JUSTIFICATION AND RISKS.................IS K .S. 39 Production Benefi.i............ ........................ 39 Employment and I n c o m e s 39 Financial and Economic Analysisa l y si..so...............s. 39 Subproject Cash Flows 40 Risks...... ................. ~ 0.00...,... 000 41 VIII. AGREEMENTS REACHED AND RECOMMENDATION................... 42 TABLES IN THE TEXT 4.1 Project Cost Summary 4.2 Procurement Arrangements 6.1 Current and Projected Consumption and Trade Status 7.1 Summary of Rate of Return Analysis  - iii- ANNES 1. Table 1S Consolidated Balance Sheet of the Agricultural Barnk of China, 1984, 1985 and 1986. Table 2: Consolidated Income Statement of the Agricultural Bank of China, 1984, 1985 and 1986. 2. Table 1: Consolidated Balance Sheet of Rural Credit Cooperatives, 1979, 1982, and 1985 3. Table 1: Basic Data on Project Provinces i:'* the Southwest Region - Cuixhou, Sichuan, and Yunnan Table 2s Basic data on Project Provinces in the North Central Region - Anhui, Henan, and Hubei 4. Table 1: ABC Organization in the six Project Provinces Table 2s Balance Sheet of the Agricultural Bank of China for the six Project Provincest 1985 and 1986 Table 3: Income Statement of the Agricultural Bank of China for the six Project Provinces, 1985 and 1986 5. Indicative Investment Program for the Project 6. Rehabilitation of Tea in Yunnan Province: Technical Guidelines for Subproject Implementation 7. Review of Gallnut Production in Cuizhou: Terms of Reference 8. Review of Pasture Development and Sheep Breeding Program in Guishous Terms of Reference 9. Pilot Project for On-lending through RCCs: Criteria for RCC access to project funds and on-lending terms 10. Project-assisted Staff Training Program Table 1: Training of project-related staff Table 2s ABC's Training Institutions Table 3s Training in ABC proposed for project support Table 4: Foreign Exchange Component of ABC Training 11. ABC In-house Studies in Systems Improvement: Terms of Reference 12. Estimated Disbursement Schedule 13. Table 13 Economic Prices for Traded Goods, 1987 and 2000 Table 2: Selected Conversion Factors for Inputs  - iv - 14. Financial and Economic Rates of Return: Table 1: Rubber Replanting Table 2: Litchi Table 3: Tea Rehabilitation Table 4: Lean Meat Pig Table 5: Pasture Development Table 6: Fish pond Development Table 7: Cannery Table 8: Vegetable Oil Processing Table 9: Sensitivity Analysis 15. Documents and Data Available in the Project File CHARTS Chart 1: ABC Head Office Organization Chart 2: Implementation Schedule Chart 3: Organization for Project Implementation MR2S IBRD 20243 IBRD 2S0244  CBI A CHINA THIRD RURAL CREDIT PROJECT Credit and Project Summary Borrower: People's Republic of China Beneficiaryt Agricultural Bank of China (ABC) Credit Amount: SDR 123.8 million (US$170 million equivalent) Credit Terms: Standard, with 35 years maturity Relending Terms: From Government to ABC: 20 years, including five years of grace, with interest at 4.5Z and commitment fee of 0.5Z p.a. From ABC to subborrowers: Interest at ABC's prevailing rates currently ranging between 7.21 and 10.81 p.a. Exchange risk to be borne by the Government, except that in cases where subloans are disbursed in foreign currencies, ABC would pass on the exchange risk to subborrowers. ABC would bear the exchange risk on foreign exchange used for staff training program. Project Objectives and description: The main objectives of the proposed project would be to (a) stimulate growth and diversification of agriculture by expanding availability of medium-and long-term credit, and (b) increase ABC's operational efficiency through institutional development. ABC would use project funds to provide subloans to households, cooperatives, collective enterprises, state-owned enterprises and state-collective partnerships for investments in tree crops, livestock, aquaculture, and agro-processing. ABC lending would be in six of China's poorer provinces: Guizhou, Sichuan and Yunnan in the southwest and Anhui, Henan and Hubei in north central region. The project's technical assistance for institutional development would be used to strengthen ABC's in-house staff training capability, and o conduct studies of ABC and RCC operations. The project would also include a pilot program to introduce rural credit cooperatives (RCCs) to longer term lending. The focus of the institutional development program is to assist in Government's effort to reshape ABC's role consistent with the ongoing reform of the financial system. At full development, the value of the  - vi - project's incremental output would be about US$245 million per annum. The project would improve living standards and income levels for 150,000 households and generate additional employment equivalent to 326t000 full-time jobs. No major risks are anticipated. Estimated costs: Local Foreign Total ---- (US $ million) ----- Tree crops 103.4 11.5 114.9 Livestock 44.4 11.0 55.4 Aquaculture 30.8 2.7 33.5 Agroprocessing 79.4 52.8 132.2 Technical Assistance 2.5 1.5 4.0 Total Project Cost 260.5 79.5 340.0 Financing Plan: IDA 90.5 79.5 170.0 ABC 69.2 0.0 69.2 /a Subborrovers 100.8 0.0 100.8 Total 260.5 79.5 340.0 Estimated Disbursements: IDA FY 1988 1989 1990 1991 1992 1993 Annual 14.0 16.0 40.0 50.0 40.0 10.0 Cumulative 14.0 30.0 70.0 120.0 160.0 170.0 Economic Rate of Return: 242 /a About US$8 million of IDA credit equivalent is expected to be onlent by ABC to selected RCCs, in which case participating RCCs would contribute about US$3 million equivalent to the project costt correspondingly reducing ABC's contribution.  CHINA THIRD RURAL CREDIT PROJECT I. BACKGROUND Introduction 1.1 The Government of China has requested an IDA Credit of SDR 123.8 million (US$170 million equivalent) to finance a Third Rural Credit Project. The proposed project would expand the availability of credit in six of China's poorer provinces as a means to stimulate growth and diversification of agriculture. Project funds would be channeled through the Agricultural Bank of China (ABC) in the form of medium- and long-term loans to farm households and enterprises for the development of tree crops, livestock, aquaculture and agro-processing. The project would provide technical assistance to strengthen ABC's in-house training capability, to develop a pilot project in medium-term lending for selected rural credit cooperatives (RCCs), and to help improve ABC's operational systems and procedures in line with current banking system reforms. The Agriculture Sector 1.2 Agriculture in China, including crops, livestock, forestry and fisheries, provides sustenance to over one billion people, is a major source of income for some 190 million farm families, and accounts for about 35% of the country's GDP. Only about 137 million of China's 960 million ha are arable. Farming systems are intensive, with large inputs of labor, chemical and organic fertilizers and water. Nearly half of the arable land is irrigated. Food grains occupy about 70% of the crop land and account for about one-third of total agricultural output. This intensive system of food production has allowed China to meet the basic food requirements of its population (about 22% of the world's total) from less than 8% of the world's arable land. 1.3 Major revisions in farm policies since 1979, most importantly, a shift from communal to family farming and major increases in farm prices, have led to rapid growth and diversification in agricultural production. The system of contracting production to small-scale family farms, within the framework of collective or state ownership of land and major fixed assets, has given farmers more flexibility in determining what crops to grow, how much to produce and where to market their output. Results have been dramatic: production increased by 10% per year over the period 1980-85 compared with an average of 3% per year in the preceding 23 years. Grain output reached a record 407 million tons in 1984, 34% greater than in 1978, despite a reduction in the area sown with grains. 1.4 In 1985, the Government began a new phase of reform, replacing compulsory procurement quotas with voluntary contractsp adjusting procurement  - 2 - prices and greatly enlarging the role of the market. These measures contributed to a decline in grain and cotton output and hectarage as farmers increasingly shifted production into livestock and industrial crops. As the current reforms are extended, a challenge to China's agriculture will be to maintain an adequate growth rate while accommodating the continued shift in consumption patterns in response to increasing per capita incomes and population growth. Chinese planners project a rapid increase in the demand for fruits, vegetables, meat, poultry, fish, and dairy products with a corresponding decrease in the share of direct grain consumption. Sectoral Objectives and Bank Group Operations 1.5 The Government's long-term objectives in the agricultural sector are (1) to increase and diversify the production of food, feed and industrial crops to meet requirements created by population and income growth, and (2) to raise employment opportunities and incomes in rural areas. Given China's shortage of arable land (0.1 ha per capita), emphasis must be placed on increasing the productivity of existing cropped areas and developing efficiently the remaining unutilized land. Steps are also being taken to increase production and quality of grain, livestock, fruit, fish, and industrial crops, and to expand agro-processing activities so as to raise value-added in the rural sector. Although maintaining the balance between producer and consumer interests and phasing out budgetary subsidies requires a gradual approach, the Government intends to strengthen the rural reforms by (a) fully implementing the system of contractual procurement and enlarging the role of private trade; (b) adjusting contract producer prices to achieve a desired production balance among grain, cash crops, and other agricultural products; and (c) promoting the growth of rural agro-processing, transport and commerce under multiple forms of ownership and management. 1.6 The Bank's strategy for lending in China's agriculture sector has been to support the Government's efforts as outlined above. Lending to date has included two land development projects (North China Plain [Cr. 1261-CHA), Heilongjiang Land Reclamation (Ln. 2261-CHA/Cr. 1347-CHA]), five projects for upgrading agricultural support services (Agricultural Training and Research [Cr. 1297-CHA], the Second Agricultural Research Project (Cr. 1516-CHA], Rural Credit I (Cr. 1462-CHA] and II (Cr. 1642-CHA], and the Seeds Project [Cr. 1577-CHAI), and three projects to strengthen specialized product subsectors (the Rubber Development Project (Cr. 1417-CHA, SP-5-CHA], the Forestry Development Project (Cr. 1605-CHA], and the Freshwater Fisheries Project [Cr. 1689-CHA]). Recent projects (the Pishihang-Chaohu Area Development Project [Ln. 2579/Cr. 1606-CHA], the Red Soils Area Development Project (Cr. 1733- CHA], the Xinjiang Agricultural Development Project (Cr. 1764-CHAj and the Cansu Provincial Development Project [Ln. 2812/Cr.1793-CHAJ ) have focussed on area development. The area development approach generally targets difficult agro-technical development problems and combines in a single project, assistance to crop and livestock development and the strengthening of various support services. It is suited to most areas of China where much of the infrastructure already exists but further improvements are needed to increase productivity and farm incomes. The lending program will continue to support projects in subsectors which are large and diverse--e.g., livestock, agro- processing-or in subsectors which support the development of household-based  - 3 - farming and rural industries--e.g., rural credit. Implementation of ongoing Bank Group financed projects in the agriculture sector is on schedule. Notable features of all the projects are the high standard of management at the central, provincial and county levels and the enthusiastic participation of households and collectives. 1.7 Experience with IDA Lending through ABC. The First and Second Rural Credit Projects are supplementing ABC's resources for medium- and long-term lending to farm households and enterprises for investments in Livestock, aquaculture, tree crops and agro-processing in the Guangxi Zhuang Autonomas Region (Rural Credit I) and Fujian and Hunan Provinces (Rural Credit II).` Both projects include a technical assistance component designed primarily to strengthen ABC's subproject appraisal capabilities. Total project costs for a.ural Credit I were estimated at about US$142 million, of which IDA financed $50 million (352), ABC $30 million (21%), the Government $20 million (14%) and subborrowers $42 million (30%). Implementation of the project, which is scheduled to be completed by the end of June 1988, is proceeding well and project lending is ahead of schedule. As of September 30, 1987, the credit disbursements amounted to US$38 million, exceeding the appraisal estimate of about US$26 million. Rural Credit II, which has a completion date of June, 1991, is providing funds for investment estimated at US$25i million, with IDA financing amounting to US$90 million (35%), ABC financing US$90 million (35%) and subborowers financing US$77 million(30%). Good progress is being made in project implementation; and credit disbursements as oi September 30, 1987 amounted to US$33.5 million, compared to the appraisal estimate of US$10 million. Subprojects financed by Rural Credit I include mainly those for development of citrus, fish ponds and feed mills. In Rural Credit II, subprojects approved so far relate to development of orchards for citrus and other fruits, inland and coastal fisheries, and poultry. The two Rural Credit projects are also making a favorable impact on improving savings mobilization at the branches involved in project implementation because of increase in farmer incomes and farmers' improved access to banking services offered by ABC. 1.8 In the course of the first two credit projects, considerable progress has been made in strengthening project appraisal work in Guangxi, Fujian and Hunan. This has been accomplished in large part through issuance of a Project Appraisal Manual, prepared by ABC with IDA assistance, which outlines standard techniques of financial and economic analysis. The Manual is now used by the project staff of the three provinces in subproject appraisal. It is also being used by ABC's Senior Staff colleges in courses on investment analysis (para. 4.21). 1/ A similar type of project assisted by an International Fund for Agricultural Development (IFAD) loan of $25 million, is being implemented by ABC in Hubei province. The project is expected to be completed by June 1988.  -4- Project Rational, 1.9 The proposed project would continue Bank Group support to ABC for modernization and diversification of agriculture, in line with Government objectives in the sector (paras. 1.5 and 1.6). The Bank Group involvement in the project would also assist in the Government's reform efforts in the financial sector, an area which the Bank Group and the Government recently reviewed to assess the evolving processes of mobilization, intermediation and allocation of in estment resources, and the interrelationships of the various policy reforms. - Future reform measures would focus on the development of financial institutions which would be increasingly responsible for mobilization of financial savings and channeling of those savings to efficient investments. To achieve this latter objective, :he financial institutions are expected to become more autonomous and responsible for their own profit and losses. Against this background, the proposed project would contribute to the ongoing process of reshaping the role of the rural banking system in line with the chianging financial sector environment. 1.10 ABC and its affiliated rural credit cooperatives (RCCs) are the main rural financial institutions responsible for deposit mobilization and provision of credit. ABC and RCC loans to date have been mainly short term, working capital loans. Changes in rural institutions since 1979--namely, the shift from communal to small-scale, household farming--have led to accelerated growth of farm output, higher per capita rural incomes and savings, and increased demand for institutional credit, including longer term loans for development of rural enterprises. Given the recent change in the Government approach to enterprise financing, which requires enterprises to finance capital investments from loans rather than budgetary grants, ABC and RCCs are in the process of taking on the additional function of development banking. For ABC and RCCs to become effective in their role as development bankers, they will need to increase resources Mnd expand the range of services, including provision of medium- and longwr term credit, and upgrade staff skills particularly in techniques of investment analysis. 1.11 The Rural Credit I and II Projects are addressing these needs within the context of ABC's operations in Guangxi, Fujian and Hunan. Good progress has been made to date in stimulating investments in agriculture and agro- p:ocessing and training local ABC staff. The proposed project would be broader in geographic scope, covering six provinces in two major regions, southwest and north central China. Increased attention would be given to regional issues of poverty alleviation and a sectoral approach to stimulating growth of production and agro-processing. It would also give broader coverage to issues of institutional strengthening, including measures to improve appraisal capabilities in the six project provinces; and a review of ABC's loan policies and procedures across-the-board; enterprise financing; savings mobilization; RCC development; and a program to upgrade ABC's staff training institutions at both the central and local levels. 2/ The World Bank, " China: Finance and Investment", Report No. 6445-CHA dated June 11, 1987.  - 5 - II. AGRICULTURAL BANK OF CHINA Reform of the Banking System 2.1 In the highly centralized economy operating before 1979, China's banks acted primarily as fiscal agents of the Government, transferring budge- tary funds to state enterprises in accordance with the state plan. This role began to change in 1979 when the Government, in an effort to stimulate produc- tion, moved towards a more market-oriented, decentralized economy. In this new environment, greater attention was given to using banks to mobilize savings from enterprises, other agencies, and individuals, and to channel these resources into high-return investments. To promote efficiency in resource flows to various sectors, the Government has, in recent years, introduced significant changes in the financial sector. The People's Bank of China (PBC) has been reconstituted as a separate central bank by assigning its rural banking activities to the ABC which was reestablished in 1979, and urban commercial banking activities to the newly created Industrial and Commercial Bank of China (ICBC) in 1984. PBC as China's central bank is now responsible for overall monetary policy and supervising the banking network. The People's Construction Bank of China (PCBC), which was created in 1954 to serve as the Government's fiscal agent for budgetary transfers for capital construction investments, began in 1980 to carry interest charges and extend loans with funds mobilized through enterprise deposits. The Bank of China (BOC), estab- lished in its present form in 1949, was until recently the state monopoly handling all foreign exchange operations and international payments. Although on a limited scale, other financial institutions can now engage in foreign exchange business. The financial sector which until recently comprised mainly the above specialized banks, is now allowed to expand through a growing network of urban and rural credit cooperatives, and investment and trust companies. Other relatively new institutions include a regional bank (the Shanghai Communications Bank) and the China Investment Bank (CIB). CIB has been an implementing agency for four industrial credit orojects involving total Bank Group assistance of US$645.6 million (Ln./Cr.2226/1313, 2434/1491, 1663/2659, and 1763/2783). 2.2 Expansion and diversification of financial institutions have been accompanied byt (1) a shift towards decentralized investment decision-making whereby banks can modify or even reject projects; (2) greater competition among banks to promote expansion in the range and efficiency of services offered; (3) expansion in lending activities to include longer-term along with short-term lending and non-state (private, joint venture) as well as state enterprises; and (4) a shift from grant to loan financing, the latter increas- ingly at positive real interest rates. The Government's long-term goal in banking reform is to complete the transformation of banks from administrative organs closely allied with local governments into independent, competitive enterprises fully responsible for their profits and losses. Monetary control would increasingly depend on indirect policy instruments in place of direct controls, and interest rateg, which have been increased several times in recent years, would become an important means of limiting the demand for credit as well as an incentive for both increased financial savings and their use in more productive investments. These major changes imply a host of  - 6 - institutional adjustments such as replacing the system of profit remittance to the Government with taxation, giving increased decision-making powers to bank managers, developing a legal framework for settling obligations, introducing modern accounting and auditing systems, and training bank staff in techniques of investment analysis and risk management. ABC Organization, Staffing and TraininA 2.3 The ABC is the major bank in China handling rural savings and providing development finance for investments in agriculture and rural indus- try. It is the second largest specialized bank, accounting for 12% of all deposits at the end of 1985 and 27% of total bank lending. ABC has extensive national coverage with a network of about 37p000 offices at all administrative levels. At the end of 1986, there were 37 ABC branch offices in the provinces (28), autonomous regions (2), and special economic zones and cities (7); 298 central sub-branches at the prefectural level; 2,419 sub-branches at the county level; 28,217 township offices; and 6,342 savings offices. 2.4 The ABC Head Office, located in Beijing, has a staff of 471 and 17 departmentst including: Agricultural Credit; Commercial and Industrial Credit; Personnel Management and Training; General Administration; Funds Planning; Accounting; External Affairs; Research; RCC Development; Trust Management; Audit; and Information (Chart 1). Its chief officers are a president and three vice presidents, all of whom are appointed by PBC in consultation with the State Councial and Ministry of Finance. The Head Office is primarily responsible for formulation of policy and procedures concerning such matters as credit planning, loan approval and loan collection; and for overall design and management of ABC staff training. A System Reform Office, recently established within the Research Department to conduct in-house studies of ABC's current operations, is expected to play a key role in the planning for the future development of ABC. 2.5 The provincial branch offices are organized along the lines of the Head Office, with a president and vice-presidents appointed by the provincial governments in consultation with the ABC Head Office, and similarly designated departments to handle such areas as staff recruitment and training; credit planning, operations and supervision; funds management; RCC development; and research. These provincial offices coordinate ABC lending activities with local governments, supervise operations at the county level and below, and provide periodic reports on business operations to ABC Beijing. ABC's actual banking transactions are handled mainly by the prefectural, county and town- ship offices. Over 70% of ABC loans go to Supply and Marketing Cooperatives (SMCs) and the rest to farm households, collectives, township and village enterprises, rural industrial and commercial enterprises, and state farms. 2.6 To handle an expanding volume of business and a variety of credit services, ABC staff size has been increased in the past few years. ABC staff nationwide totalled about 387,000 in 1986 (36% more than 1982). Most of the recent recruits are graduates of specialized secondary schools with some additional training in banking and accounting. Of those hired before 1983, about half have lower secondary (lower middle) school education, a quarter upper secondary (upper middle) school, and a quarter are graduates of  specialized secondary institutes, colleges and universities. ABC estimates that over half of its total staff have been involved in rural banking for more than 20 years. 2.7 ABC accords high priority to staff training. Since 1983, ABC has provided pre-service and in-service training, much of it in the form of short- term (2-3 month) courses, to an estimated 25% of its staff nationwide. ABC itself has established 170 banking schools: 55 secondary vocational schools, 112 staff training schools, and 3 RCC secondary vocational schools for upgrad- ing the general standard of education of ABC and RCC staff and providing them specialized training in banking and related subjects. The three national- level Senior Staff Colleges at Tianjin, Changchun (Jilin) and Wuhan (Hubei) primarily train teachers for lower level schools and senior management person- nel. These colleges are financed and operated directly by the ABC Head Office. Since the training capacity of the ABC-sponsored schools cannot meet current training needs, ABC also makes broad use of programs available through local colleges, the People's Bank of China and the Television University. Though training opportunities for ABC staff are many and diverse, the quality of training varies widely, with most programs giving inadequate coverage to such topics as appraisal methodology, enterprise management and market analysis which are essential to modern banking. ABC Operations 2.8 Lending Procedures. ABC local branches have considerably more authority regarding individual investment decisions than they did several years ago. According to current practice, ABC's provincial and county level offices prepare annual credit plans in consultation with local planning, technical and financial agencies. Provincial credit plans require prior approval of the ABC and PBC Head Offices. The credit plans specify an overall loan amount expected to be available for agriculture, rural industry and commerce. The ABC branches have the discretion to allocate these resources among different types of projects and different areas and townships. Loan applicants include specialized households and, as defined in the 1985 ABC Loan Contract Regulations, "economic entities with the status of legal persons" such as collective enterprises (mainly township and village enterprises), state-owned enterprises (principally state farms and enterprises run by prefectures and counties), state-collective joint ventures and cooperatives and other kinds of farmer associations. By far the largest categories of borrowers are collective and state-owned enterprises and cooperatives, which together account for 90% of all loans. 2.9 ABC has recently revised subloan review and approval processes in order to reduce delays and clarify accountability in subloan decisions. At present, ABC offices at the township level and on state farms have authority to approve agricultural loans of up to Y 1,000 for individuals/households, up to Y 10,000 for collectives, and up to Y 50,000 for township and village enterprises. ABC's sub-branches at the county level may authorize loans of between Y 50,000 and Y 200,000. Loans larger than this require approval of either prefectural or provincial branches. As a part of the national policy to decentralize financial responsibility, provincial branches have been authorized to approve loans up to Y 10 million. Loans above Y 10 million are referred to the Head Office for approval.  - 8 - 2.10 Interest Rates. In the context of recent economic reforms, includ- ing banking system reforms, interest rates have been raised significantly and are now positive in real terms. Current rates are generally 7.92% for one- year working capital loans and range from 7.92% to 10.8% for short and medium- term fixed asset loans. For longer-term development loans, such as those to be financed by the proposed project, the rates are 6.48% p.a. for 1-3 year loans, 7.2% for 3-5 year loans, and 7.92% for loans above five years. Demand for credit has expanded markedly in recent years in response to the introduc- tion of production responsibility system and the Government's efforts to shift from grant to loan financing of rural development projects. The Government is seeking to expand the availability of medium- and long-term funds for high- return investments in various resource development programs which, prior to reforms, were generally financed by grants from the budget. Currently only 3% of ABC's total loans are on terms of more than one year. ABC is constrained from expanding longer term lending because of the limited availability of longer term resources which are currently supplied largely from PBC and foreign financial institutions. ABC must find ways to expand the core of its longer term funds through increased deposits and possibly the issue of long- term bonds. Such proposals are now under consideration by PBC and the Ministry of Finance (MOF). The scope for further expansion of longer-term lending by ABC would be a major focus of the systems improvement studies to be supported by the project (Annex 11). 2.11 Interest rates on deposits from individuals range from 7.2% for one year deposits to 10.44% for eight year deposits. These rates are positive in real terms relative to a projected domestic inflation rate of 6.5% p.a. through 1990 and 4.51 in 1991-95. Interest rates on short-term deposits (under one year) from individuals range from 2.88X to 6.12% p.a. Interest rate on sight deposits of enterprises is 1.8% p.a. while interest rates on enterprises' one to three year deposits range between 4.32% and 5.76%. Future reforms of the interest rate structure are expected to ensure that interest rates become more progressive in relation to the term of deposits and that rates on longer-term deposits from individuals continue to be positive in real terms. The question of increasing rates on deposits of enterprises is currently under review by MOF and PBC. 2.12 Sources and Uses of Funds. ABC's sources of funds comprise share capital from the Central Government, loans from PBC, and deposits. Total resources in 1986 were Y 205 billion, over two and a half times the 1982 figure. The Government's capital contribution totalled Y 22 billion and PBC's loans about Y 58 billion. Major deposits were those of RCCs (Y 50 billion), rural commercial and industrial enterprises (Y 22 billion), individuals and households (Y 26 billion), and rural collectives (Y 5 billion). Deposits have grown at an average of 32% annually since 1982. Enterprise deposits have increased sixfold and deposits of individuals and households nearly fivefold. 2.13 ABC's total loans outstanding as at the end of 1986 amounted to Y 200 billion, up 220% since 1982. The portfolio consists mainly of short- term loans (under one year) to SMCs and other enterprises for rural production and marketing, Y 124.2 billion (62%), industrial enterprises, Y 10 billion (5X), township enterprises, Y 28.8 billion (141), rural collectives, Y 8 bil- lion (4%), state-owned enterprises, Y 9 billion (4Z), households, Y 6 billion  -9- (3%), and RCCs, Y 4 billion (2%) (Annex 1). ABC lending to collectives (former communes and brigades) is declining with a corresponding increase in loans to individuals and households, a reflection of the Government's encouragement of individual household-managed agricultural activities as a means to stimulate growth. 2.14 ABC reported a profit of Y 1.7 billion for 1986 (subject to audit), about 48% higher than the figure for 1982 (Annex 1). Revenues (Y 22.5 billion) were derived mainly from interest earnings, agency fees and interest from redeposits. Expenditures (Y 20.8 billion) were mainly for interest paid on deposits and administration, including salaries. The increase in profits was accounted for mainly by the transfer to ABC's loan portfolio of subloans previously disbursed by ABC on an agency basis for PBC and ICBC. ABC's overall liquidity and profitability are closely monitored by PBC and MOF. Profits are remitted to MOF which then allocates an amount to ABC to cover capital expenditures (for establishment of new branch offices, improved services, etc.) and write-off of bad debts. In recent years, ABC's average loan collections are stated to be about 80% of the amounts falling due and it takes ABC about three to four years to collect the overdue amounts. A sub- stantial part of the arrearages is, however, the result of loans made during the Cultural Revolution (1966-1976) when appraisal and supervision of loans were not adequate. ABC is focussing attention on improving loan collection procedures. As a short-term measure, ABC is offering bonuses to its agents for collection of loans in arrears. With its gradual shift to the status of an independent enterprise, ABC would be required to write off bad debts directly from profits. Strengthening ABC's ability to deal with bad debts would be a focus of the systems improvement studies to be supported by the project (Annex 11). ABC and RCCs 2.15 The rural credit cooperatives (RCCs)--financial institutions collectively owned by farmers--play a pivotal role in providing banking services to rural households. In 1985, some 60,000 county RCCs, staffed with 350,000 full-time employees and another 340,000 part-time agents, operated through 32,000 branches and 360,000 deposit and credit delivery stations at the township and village level. About 80% of all farm households have paid the Y 5-10 fee to become RCC members. 2.16 RCCs accept savings and time deposits from and lend to individuals and rural enterprises. At the end of 1985, savings and time deposits accounted for 90% of the RCCs' total resources of Y 80 billion. The balance (10%) comprised ABC loans and shareholders' contributions. Since 1979, deposits have increased at an annual average of about 40%. Deposits of individual farmers have risen very rapidly, reflecting the growth of rural incomes, and now account for 78% of RCCs' total deposits (Annex 2). RCCs are required to redeposit about 20-30% of their total deposits with ABC as a reserve against their deposit liabilities; as of December 31, 1985, redeposits of the RCC system as a whole amounted to 55% of its total deposits and about 23% of ABC's total resources.  - 10 - 2.17 RCC loans (Y 40 billion) are mainly to individual farmers and households (48X), followed by township enterprises (41X), and collectives (11%). RCCs provide loans for all types of agricultural, industrial and commercial activities at the village level, including crop production, animal husbandry, forestry, fisheries, handicrafts, and service enterprises. Interest rates are about 0.25%-0.50% higher than those of ABC. In 1985, about 80% of the RCCs recorded a profit; RCCs showing a loss were for the most part located in poorer areas where per capita incomes were rauch below the national average of $142 (for 1985). 2.18 ABC has specialized departments at the county, prefecture, and provincial levels to supervise RCC operations. In the past few years, in line with development of a more competitive banking environment (para. 2.2), the Government has encouraged ABC to give more autonomy to the RCCs in their role as the major grassroot lending institutions. RCCs are now permitted to select their own management staff, determine membership fees and policies, and develop annual credit plans independent of ABC approval. To facilitate transfer of funds and expansion of credit services, they are allowed to form county and city RCC associations, each managed by an independent board of directors accountable to a council of representatives from participating RCCs. To help improve RCC services, ABC has expanded the number of places for RCC staff in its various training programs. New RCC staff are now recruited through examination and must be upper secondary school graduates to qualify. Accounting Systems and Auditing 2.19 ABC requires accounts to be balanced daily at each office. Summaries are reported by township offices every two weeks by telephone to the county offices and township accountants come to county offices once a month to reconcile accounts. County offices report monthly accounts to provincial offices which in turn send detailed accounts to the Head Office every six months. Data on loan operations in relation to loan targets in the credit plan, forwarded to provincial levels on a similar schedule, show types of investments financed, geographic location of subprojects, an,! expected incre- mental production. 2.20 Recently-established internal audit departments within the Head Office and provincial and prefectural branches are responsible for conducting an annual audit of accounts handled by units at the next level below. The MOF carries out a random audit of Head Office accounts; local bureaus of finance conduct a similar check of provincial and other local branch accounts. The State Audit Agency (SAA), established in 1985, has begun an independent audit of selected ABC offices which will be extended to more offices as SAA builds up necessary staff capabilities. The SAA, which is directly accountable to the State Council, is now responsible for auditing all projects financed by the Bank Group and other multilateral agencies.  - 11 - III. THE PROJECT PROVINCES General 3.1 The project would be located in six provinces: Guizhou, Sichuan and Yunnan in southwest China and Anhui, Henan and Hubei in the north central region. Guizhou, Sichuan and Yunnan cover 1.15 million sq km, 12% of China's total land area, stretching about 1,000 km from Qinghai and Gansu in the north to the Burma-Laos-Vietnam border in the south. The project-supported ABC lending program in these three provinces would focus on about 130 counties, a third of the totaL (384), mostly in northern Guizhou, central Sichuan, and central, southern, and western Yunnan. Anhui, Henan, and Hubei provinces encompass an area of 0.48 million sq km lying between the Yellow and Yangtze Rivers. Proposed sites for ABC lending activities are distributed fairly evenly throughout Henan and Hubei and, in the case of Anhui, are concentrated in the northernmost counties bordering Henan. Some 180 counties, nearly three-fourths of the total number (253) in these three provinces, would be included in the project. Site locations are shown on IBRD Maps 20243 and 20244 and basic data on each province are shown in Annex 3. Southwest Provinces 3.2 Climate and Land Use. Guizhou, Sichuan and Yunnan lie in a sub- tropical zone of high plateaus and mountainous or hilly terrain penetrated by major river systems. The climate is typically mild and humid with a 8-9 month growing season and average annual rainfall of 1,200 mm. Soils in the region are mainly deep and well-structured red and yellow soils which are suitable for growing a wide range of tropical and subtropical crops. Though climate, rainfall, and scil conditions are favorable, farming is constrained by the limited availability of land of reasonable slope (up to 20 degrees) for crop cultivation. About 10% of the total area is currently under cultivation at crop yields which are typically (excluding the Sichuan Basin) below the national average. Most of this consists of plains and valleys where the major crops are rice and wheat, or terraced hillsides planted with tea, tobacco and other cash crops, as well as grain. Most of the remaining area is steep terrain unsuitable for agriculture. No more than about 3 million ha of hilly land could be developed for farming, and much of this has marginal economic value. This limited amount of arable land must support large populations. Sichuan alone has 102 million people--75% of them living in the fertile Sichuan Basin--and the combined population of the three provinces is 166 million or 16% of the national total. 3.3 Strategy for Growth. To stimulate economic growth in the southwest region, the Government in recent years has sought to diversify agriculture by exploiting large tracts of umderutilized land located in sparsely-populated uplands and adjoining mountains where conditions are favorable for planting tree crops, feed crops, pasture and commercial forests. Though overall agricultural production grew eit 9-10% annually over the period of the 6th Five Year Plan (1981-85), the region's shift to a more diversified agriculture and expansion of agro-industries kas been slow, largely because of a shortage of technical and management skills and the inadequacy of funds for longer term  - 12 - investments. Guizhout Sichuan, and Yunnan remain among China's poorest provinces2 In 1985, rural per capita income for Guizhou was Y 288 ($103 at the then prevailing exchange rate of Y 2.8 = $1), tor Sichuan Y315 ($113) and for Yunnan Y338 ($121), compared to a national average of Y 398 ($142). North Central Provinces 3.4 Climate and Land Use. The north central provinces of Anhui, Henan, and Hubei are dominated by broad alluvial plains traversed by the Yellow, Huai, and Yangtze river systems. Fertile soils in combination with a moderate climate and adequate rainfall (800-1,200 mm) have created an environment favorable to productive agriculture. However, the variability of rainfall, deficient in spring but torrential in late summer swelling the rivers which course over the low, flat terrain, has exposed the area in the past to devas- tating floods and drought. Construction of large-scale irrigation and flood control works since the 1950s has brought much of the flood and drought-prone land under stable production. Currently as much as 40% of the total land area of Anhui and Henan (29 million ha) and 25% of the area of Hubei (19 million ha) is under cultivation at cropping intensities that range from 1.7 crops per year to more than 2.0. The iegion's agriculture must support 178 million people, 17% of China's total population, in a situation of increasing scarcity of arable land, the result of population growth and the loss of land to non- agricultural construction. 3.5 Strategy for Growth. Rural development strategies in the already intensively-farmed north central regior. call for diversification of farm production and increased output from agro-processing and other non-farm activities. All three pro3ect provinces have made recent strides in diversi- fication, shifting from grain to other crops and from crops generally to livestock, fisheries and forestry. In terms of non-farm production, Anhui and Hubei have grown faster than the national average since 1979, Henan at a slower rate. However, non-farm production in 1985 in all three provinces contributed only 31-38% of rural social product (GVAO plus gross output value (GOV) of rural industry, construction, transport and commerce) compared to 46% nationwide. Taking agricultural growth overall since 1979, all three provinces have exceeded the national average, thus narrowing the gap between rural per capita income figures for these provinces and the national average. Already, per capita incomes in Anhui and Hubei approximate the national figure of Y398 ($142). Henan, which with an income figure of Y329 ($117) ranks with Guizhou, Sichuan, and Yunnan as one of China's poorest provinces, is lagging behind largely because of low farm productivity in drought prone areas and less diversified sources of rural income. Agricultural Support Services 3.6 Transport. Proposed sites for ABC subprojects in central Sichuan and central Yunnan are served by an adequate road network linking villages, townships, county towns, and the provincial capitals of Chengdu and Kunming. In most of Guizhou and southern and western Yunnan, the road system is satis- factory though some roads would be constructed as part of the project in support of area development investments. The southwest rail network consists of two north-south trunk lines cutting across eastern Sichuan, eastern Yunnan  - 13 - and central Guizhou and connecting the three provincial capitals (Chengdu, Kunming, and Guiyang). These lines link up with two lines running eastward to the coast: the Lanzhou-Lianyungang (Jiangsu) line and the line from Kunming to Shanghai. 3.7 All subproject sites in Henan, Hubei, and Anhui are served by a well-developed network of rural, secondary, and main roads providing access to town and city markets. The rail network, which is expected to continue to dominate freight traffic, especially between provinces, consists of the Beijing-Guangzhou and Beijing-Shanghai rail lines, the former running through central Henan and eastern Hubei, the latter through Anhui. Zhengzhou, the capital of Henan, lies at the intersection of the Beijing-Guangzhou and Lanzhou-Lianyungang lines. The rail network in Anhui and Henan is being extended: two new lines recently opened and three additional lines, one a local Henan line, one between ShaAgqiu (Henan) and Fuyang County (Anhui), and the third connecting Xuancheng (Anhui) and the coastal city of Hangzhou, are planned for completion by 1990. 3.8 Power Facilities. Proposed sites in the three southwestern provinces have access to electricity supplied mainly by local power grids which are connected to the southwest regional power grid. Electric supply is generated principally by small (50-100 kW) hydropower plants. Sites in Anhui, Henan, and Hubei would be served by existing electrical transmission and distribution lines which are part of local grids connected to the East China (Anhui) and Central China (Henan and Hubei) regional power grids. Coal-fired thermal power plants are the major source of electric supply. 3.9 Research. Each project province has a well-established institu- tional structure for agricultural research in all of the major subsectors targetted by the ABC lending program. The leading research organization in each province is the provincial academy of agricultural sciences, a locally- funded branch of the Chinese Academy of Agricultural Sciences administered by the Ministry of Agriculture, Animal Husbandry and Fisheries (MAAF). The provincial academies operate a network of prefectural and county institutes specializing in various aspects of crop and livestock research. The Sichuan Academy of Agricultural Sciences, for example, has a number of affiliated institutes specifically concerned with pig breeding and production. MAAF also supports other smaller research agencies--e.g., the China Aquatic Sciences Research Institute and the Tropical Crops Research Institute--which similarly have provincial affiliates supervised by technical agencies--in this case, the provincial bureaus of aquatic products and state farms. Research and field experiments on rubber and other tropical tree crops are carried out by the Yunnan Tropical Crops Research Institute, a Tropical Crops Research Institute affiliate located in Xishuangbanna, Yunnan Province. Ministries other than MAAF sponsor specialized research as well. The Ministry of Forestry, for example, supports the Forestry Research Institute in Guizhou, the unit respon- sible for much of the current research on gallnut production (para. 4.5). Overall design and funding of research programs is coordinated by the provin- cial science and technology commissions. Funds for specific research projects are channeled through the appropriate technical agencies which are also involved in dissemination of research results.  - 14 - 3.19 Extension. Though specific arrangements vary from county to county, all counties participating in the project have in place systems of extension and training to channel improved technology and research results to farmers. In some cases, the county research institutes play the lead role in carrying out demonstration work and farmer training, while specialized services (plant protection, soil testing, supply of seeds, etc.) are provided by a number of separate agencies under various local government bureaus. A more recent trend is to consolidate the range of extension and training services into a single county agro-technical extension station. In this case, the agro-technical station is responsible for conducting field experiments and demonstration trials, introducing farmers to new technologies and providing diagnostic and breeding services to farmers in townships and villages within its jurisdic- tion. In some localities, the agro-technical station is being set up as a self-supporting unit, with fees charged for the various extension services and for participation in training classes. In many cases the stations also are expanding their functions beyond the technical aspects of production to include provision o& market information and assistance to farmers in arranging financing for new production activities. 3.11 Marketing. Sale of agricultural products is organized through state and private marketing systems. The state system includes state food companies which manage bulk procurement and inter-provincial trade; supply and marketing cooperatives (SMCs) which do business with about 80% of farmers through a hierarchy of local agencies, and state food markets handling retail sales at government-determined prices. Private marketing is a recent phenomenon, taking its present form only after the 1985 reforms. A major feature is the agricultural trade market (ATM), a permanent urban market where merchants lease space on a long-term or daily basis at rates which cover the cost of utilities provided by the city. ATMs are usually divided into several sections--e.g., meat, poultry, aquatic products, vegetables, fruit, grains, and edible oils. Prices for goods sold in the ATMs are more flexible than those prevailing in the state food markets, being determined by considerations of supply and demand. Increases in the scale of household production and the complexity of marketing channels have encouraged proliferation of private middlemen to assist farmers in marketing their products. These intermediaries are increasingly specializing in various aspects of the marketing process such as procurement, transport, wholesaling or retailing. To facilitate sales, particularly in situations where buyers and sellers are geographically distant, the Ministry of Commerce is setting up a national market information service. ABC Organization and Operations 3.12 ABC's organization, staffing, financial operations and performance in the six project provinces are shown in Annex 4. In all provinces, ABC's organizational structure is similar: a branch office at the provincial capital, subbranches at the prefecture and county levels supported by a network of business and savings offices at the level of townships and state farms (para 2.3). Of the three southwestern provinces, Sichuan has the largest ABC structure (3,042 offices), followed by Yunnan (1,523 offices) and Guizhou (802 offices). As for the north central provinces, ABC Henan has 2,949 offices, Hubei, 1,866 and Anhui, 1,135. The RCC system is relatively  - 15 - less developed in the southwestern provinces compared with the north central provinces, reflecting the differences in per capita incomes and savings potential.. ABC offices in the project provinces together employ about 108,000 staff, ranging from about 10,000 in Guizhou to 27,000 in Sichuan, and increas- ing at an annual rate of about 3-5%. Following the national pattern, about 50% of the staff have had education up to or below lower secondary school (grades 7-9). Through short courses (2-3 months) and two year courses at the staff training and secondary vocational schools, ABC branches are attempting to upgrade the general educational level and professional skills of their staff (para. 2.7). 3.13 ABCs in all six project provinces reported profits during 1985 and 1986. Total loans outstanding as of the end of 1986 amounted to about Y 49 billion. Reflecting the national trend (para. 2.13), during 1985, loans for rural production and marketing activities accounted for 75% of the total, and loans to township and village enterprises 19%. The remaining loans supported rural collectives, state-owned enterprises, households, and rural credit cooperatives (Annex 4).  - 16 - IV. THE PROJECT Objectives and Scope 4.1 The main objectives of the proposed project would be (a) to stim l-_ ate growth and diversification of agriculture by expanding the availabilit of medium-and long-term credit, and (b) to increase ABC's operational efficie..cy through institutional development. The project would finance investments in tree crops, livestock, aquaculture and agro-processing in three provinces in southwest China (Guizhou, Sichuan, and Yunnan) and three provinces in the north central region (Anhui, Henan, and Hubei). The project would also finance a development program for ABC's three national staff colleges. A training component would introduce ABC staff to modern methods of investment analysis, provide local and overseas courses for faculty of ABC's staff colleges, and supply teaching equipment and materials to these colleges. The project would also include consulting services to assist in conducting studies of ABC and RCC operations and a pilot program to introduce RCCs to longer term lending. Project Features 4.2 Each provincial ABC has developed an overall program for project investments (Annex 5) which accords with current growth strategies outlined in the 7th Five Year Plan. In Yunnan and Guizhou, project-supported ABC lending would emphasize making use of underutilized land, much of it in remote upland areas, through establishment and rehabilitation of tree crops and development of pastures. Investments in tree crops would include chiefly rubber planting/ replanting, rehabilitation of tea and planting of sumac trees for gallnut production. In Sichuan, ABC lending would focus on increasing value-added through processing, mainly of meat, oilseeds and fruits, and on improving the efficiency of pig production, a subsector in which the province already ranks high nationally. The lending program for Anhui, Henan, and Hubei would focus primarily on development of agro-processing; these investments would account for about half of the total program in each province. Additional subloans would expand the area devoted to fruit production, increase the efficiency of livestock production, and make use of presently underutilized land to estab- lish pasture areas for ruminant animals and to construct fish ponds. Indivi- dual subloans would be appraised by ABC taking into account overall production trends in the commodities financed, market prospects, availability of inputs, and the status of support services including storage, transport, and technical assistance. Tree Crops 4.3 Rubber. Sites for rubber development would be located mainly in Xishuangbanna Autonomous District in southern Yunnan near the Burma border. This is a high rainfall, moderate elevation (500-1000 m) tropical area, particularly well-suited to growing rubber. In 1986, Xishuangbanna accounted for about 70% of Yunnan's total rubber production of 38,000 tons. Over 90% of Xishuangbanna's rubber was produced on 47,600 ha managed by the Yunnan State Farms and Land Reclamation Bureau. Although yields and output in the area are high overall (about 1.5 t/ha), an estimated 11,000 ha are planted with old,  - 17 - low-yielding trees. Another 7,500 ha of currently unutilized land have been identified as suitable in terms of slope, rainfall, and soil conditions for new planting. New planting would be on lands below 800 m. altitude, with good soils and less than 25% slope. The project-supported investment program in rubber would provide for the replanting of about 10,000 ha on state farms in Xishuangbanna and new planting of 2,700 ha on collective farms in Xishuangbanna, Simao and Jiancang prefectures. The main investment costs would be for land preparation (clearing, levelling and terracing), planting material, fertilizers, intercropping, hand tools and labor and infrastructure improvements such as construction of farm access roads. The per ha cost of new planting is about Y 15,000 and that of replanting Y 12,000. High yielding rubber clones would be available from local state farm nurseries. The projected yields would be about 1.1 t/ha to 1.8 t/ha during the years 10-16, and about 2.1 t/ha during the years 17-25. 4.4 Tea. The project would finance tea rehabilitation on 16,700 ha of farms in the collective sector, in Baoshan, Simao and Jiancang prefectures, the mountainous areas in western Yunnan which specialize in black tea produc- tion. Though natural conditions in these areas are suitable for tea cultiva- tion--Yunnan as a whole accounts for 7% of China's total tea output and 11% of black tea output--yields of primary processed tea are Low (270 kg/ha) mainly because of inadequate plant renewal, poor cultural practices, and inefficient processing techniques. The project would finance this component as an excep- tion to the Bank Group's current restrictions on lending for tea, on the grounds that the project areas, located in poorer regions of Yunnan, have very limited alternatifes to tea growing. As most producers are small-scale, relatively low income farmers, the proposed development is critical as a poverty alleviation measure. In addition, tea as a perennial crop, would provide better protection against soil erosion which is a serious problem in the project area, than any alternative crops which can be grown there. Costs of tea rehabilitation would be about Y 2,800/ha and would include land prepa- ration and planting, planting material, low pruning, and fertilizers for the first two years. The project would also finance construction of preliminary processing factories to handle incremental tea production (para.4.15), and provide overseas consultancy services to advise extension staff and farmers on improved cultural practices and processing technology. At negotiations, an assurance was obtained from the Government and ABC that tea rehabilitation would be carried out in accordance with the technical guidelines acceptable to IDA. These guidelines were reviewed and agreed upon during negotiations (Annex 6). In Baoshan, the project would also finance new arabica coffee plantations on state farm lands (1,300 ha) and on collective farms (400 ha). Coffee development costs would be about Y4,300 /ha to cover land preparation, planting material, fertilizers and labor. 4.5 Gallnut. Investments in gallnut production would be made initially in three counties in eastern Guizhou. China accounts for about 80% of world production of gallnut, with more than a third of China's output produced in Guizhou. Gallnut is a tumor-like tree growth which yields tannic acid and tanning extracts. Tannic acid and derivatives of tannic acid such as gallic acid, propyl gallate, trimethoxy, benzoyl, and hydrazine, which are used in the pharmaceutical and leather industries, have high domestic and export demand. Harvesting wild gallnut is now carried on as a sideline activity by  - 18 - poor farmers in sparsely-populated upland areas. Project-supported invest- ments would increase gallnut production by providing for systematic planting of sumac (Rhus Chinensis), a hardy, fast-growing tree whose sensitivity to invasion of the gall aphid causes the excrescence known as gallnut. Sumac, in combination with a moss cover to serve as the winter host for the invading aphid, would be planted on forest lands with moderately dense undergrowth and no remaining trees of any significant growth. There would be no clear-felling and the use of deforested areas for which no other financially attractive investment has been identified, would help restore the forest cover with additional benefit of an improved environment. The Forestry Research Institute in Zunyi has provided the technical package for sumac planting and gallnut production based on a pilot program implemented by the provincial Forestry Bureau. Investment items would include land preparation, planting material, hand tools and support services, estimated at Y 300/ha. Initially, the proposed project would finance gallnut development on 5,000 ha with about 500 households participating. In mid-1989, ABC, with assistance from Guizhou's Forestry Bureau, would review this program with the aim of extending it to about 40,000 ha in eastern Guizhou. At negotiations, an assurance was obtained from the Government and ABC that the review of the gallnut production program would be completed by the end of 1989 on terms of reference acceptable to IDA, and that ABC would consult IDA on the size and phasing of the expanded program (Annex 7). 4.6 Fruits. The program of investments in fruit tree development would focus mainly on southern Yunnan, northern Henan and southeast Sichuan. Although Yunnan's climate and rainfall conditions favor production of a wide variety of fruits, the area currently under fruit cultivation is limited and most of it is in need of improvement. In 1985, total fruit output in Yunnan was only about 212,000 tons or 1.8% of the national total. Yunnan imports approximately 30% of current production (64,000 tons in 1985) from other provinces to meet provincial demand. Southeast Sichuan, similarly favored in terms of climate and rainfall, has become one of China's major citrus- producing areas. Further investments in citrus would be limited to late- maturing varieties and rehabilitation of existing plantations. There is considerable scope for opening up new areas for growing semi-tropicLl fruits such as litchi and longan which are currently in short supply. Northeast Henan has traditionally been a major producing area for dates, apricots, and apples, but most orchards are now in need of plant renewal and soil improve- ment. Project investments in fruit tree development would provide for the establishment of new plantings and improvements to existing plantings amount- ing to some 37,500 ha. Average investment cost for fruit rehabilatation and development would range between Y 1,000 - Y 10,000/ha for land preparation (clearing, levelling and terracing), establishment of cover crops, irrigation works and equipment, planting material, fertilizers, pesticides, spraying equipment, hand tools and labor. Until the initial crop is produced, production inputs would also be financed. Livestock 4.7 Pig Production. The project would support a program of investments in pig, sheep, goat, poultry and cattle production. Pig development would be financed in feed-surplus areas where there is potential for high return on  - 19 - investments. In line with the Government's "lean pork policy", investments in the pig industry would aim to increase production of cross-bred or exotic pigs which have a higher lean-to-fat ratio than native breeds. The project would finance importation of exotic breeds, infrastructure for breeding farms and household investments in breeding sows, pig pens and initial working capital. The project would also finance investments in artificial insemina- tion (AI) centers and veterinary facilities which would be operated on a commercial basis. 4.8 Pasture and sheep development. Investments in pasture development for raising semi-fine wool sheep would take place primarily in eight counties in northwestern Guizhou along the Yunnan border, a hilly area which lies at an altitude of between 800 and 2,900 m, and which has adequate rainfall and a nine-month growing season for good quality pasture species. Major investment items would include pasture establishment, at an average cost of Y 400/ha, provision of improved animal breeds from abroad (2,000 pure bred sheep) and from other provinces (20,000 breeding ewes), and construction of sheep shelters. A technical package developed by the provincial Agriculture Department and the Bureau of Animal Husbandry, with technical assistance from New Zealand, would be used for the proposed development. During early 1938, the Agriculture Department and Animal Husbandry Bureau would also issue a Technical Handbook for use by ABC and government staff implementing the project. Initially, during 1988 and 1989, the project would finance pasture development and sheep breeding on about 11,500 ha of class I and II lands (classified mainly by nutrient quantity requirements for productive pastures). During mid-1989, the Guizhou ABC would arrange, through the provincial Agriculture Department and the Bureau of Animal Husbandry, a review of the technical package and the organizational arrangements for the first- phase subprojects, with a view to extending the program to an additional 20,000 ha. This review would also evaluate suitability of class III lands (requiring an annual input of 150-300 kg of urea per ha) for pasture develop- ment. During negotiations, an assurance was obtained from the Government and ABC that the review would be completed by the end of 1989, on terms of reference acceptable to IDA, and that ABC would consult IDA on the size and phasing for the expanded program (Annex 8). 4.9 Cattle, Goat and Poultry Production. Investments in cattle and goat production would be based on making efficient use of underutilized resources primarily in northern Henan, southern Guizhou, and northern Anhui. This would ;ncrease the supply of meat for domestic consumption and of skins mainly for export. Cattle subprojects in Guizhou would combine pasture development on about 8,000 ha of class I and II lands (para. 4.8). In total, about 100 family ranches with grasslands of 20 ha each would be established for beef cattle breeding and some 1,000 family farms, with 2.5 to 7.5 ha of grasslands, for cattle fattening and goat breeding. In Henan, the project would support breeding of local, dual purpose, yellow cattle in four counties which have been designated as specialized bases for this activity. Investments in goat production in Henan and Anhui would take advantage of large quantities of wheat straw available in the province which, when ensiled with urea, can be fed to goats. Major investment items for cattle and goat subprojects include pasture development, silage bunkers, animal shelters, initial breeding stock, roads, and water supply facilities. The cattle development program,  - 20 - especially in southern Guizhou, would be implemented by ABC in phases and subject to periodic review of the pasture performance, and underlying techni- cal parameters including sustainability of reproductive rates. The Bureau of Animal Husbandry and the Agriculture Department would participate in this review. In Sichuan and Henan, the project would also finance establishment of hatcheries and commercial production of poultry. Aguaculture 4.10 The program of investments in aquaculture would focus on developing fish ponds to expand production of freshwater fish, mainly grass, common, silver and bighead carp and tilapia. About 2,000 ha of new ponds would be constructed and improvements would be made to about l,000 ha of existing ponds. The greater part of the program would take place in Henan along the Yellow River, in Sichuan on the floodplain near Chengdu, and in Guizhou in the narrow valleys near the city of Guiyang. Sites for fish pond construction would be swamps, marshes, or low-lying, poorly drained crop lands which are marginally productive. Investment items for new pond construction would include excavation of pond areas, drains, canals, pond lining, pipes, sluice gates, pumps, and infrastructure such as farm roads and electrical transmis- sion and distribution lines. Improvements to existing ponds would involve primarily deepening and reshaping ponds and provision of filling and drainage facilities. Investments would also cover production equipment such as work- boats, nets, and aerators and the purchase of fingerlings, organic manure, cheAIcal fertilizers, and feed required to produce the first harvest from the ponds. Average cost for construction of new ponds would be about Y 13,000/ha and for pond improvement, Y 6,000/ha. Agro-processing 4.11 Though growth of agro-processing has been a notable feature of economic development in the six project provinces in recent years, existing capacities are not adequate to cope with the expanding production and diversi- fication of raw materials. Many processing facilities, established during 1950s and 1960s, are outmoded in equipment and inefficient in design and operations. The project-financed investment program would support establish- ment of processing and storage facilities for a wide range of products includ- ing rubber, tea, fruits, meat and other animal products, fish and other aquatic products, animal and fish feed and oilseeds. The focus would be on using modern technology appropriate for producing quality output consistent with market requirements and on ensuring efficient use of by-products and protection of the environment. ABC subloans would finance technical assis- tance that is needed by subborrowers for design and construction of processing facilities. In addition, provincial bureaus of rural industry, national and provincial design institutes and suppliers of machinery and equipment would provide technical assistance to subborrowers for preparation of designs and feasibility studies, technology selection, and staff training in operation of plants and product marketing. 4.12 Rubber and Tea Processing. Investments in the rubber industry would be used to construct and equip four centralized rubber processing factories on four state farms in Xishuangbanna, Yunnan. Production capacity would be about  - 21 - 40 t/day of standard grade rubber. Each factory would be equipped with a rubber testing laboratory to handle grading of factory products. The Kunming Standard Rubber Laboratory would be provided with additional equipment to carry out quality checks of all rubber processing factories in Yunnan. Project funds would also be used to finance construction of a rubber compound- ing factory which would produce semi-processed rubber compounds for domestic manufacturing industries. The Bureau of State Farms has proposed that the project-supported program of investments in rubber include establishment of a rubberwood utilization plant and a rubberseed oil extraction plant. Detailed studies of the technical feasibility of these plants and the marketability of their products would be prepared by the Yunnan Bureau and submitted to ABC for review and evaluation as a basis for subloan approval. Feasibility studies would include detailed designs for treatment of rubber effluents. Investments in tea processing in Yunnan would include establishment of 25 new factories at an average cost of Y 150,000 and expansion and rehabilitation of 60 existing plants for primary processing of tea. During negotiations, an assurance was obtained that ABC would forward to IDA for review, the design specifications of typical rubber and tea processing plants before the first subloan in each such category is finally approved by ABC. 4.13 Meat Processing. Investments in meat processing would focus on establishing about 50 small-and medium-capacity slaughterhouses to handle about 80,000 tons liveweight, comprised primarily of pigs in Sichuan and Hubei, goats in Henan and Anhui, and sheep and cattle in Guizhou. The equip- ment would include mechanical dehiders, mobile high pressure cleaners, blast freezing and cold storage, and packaging of meat and meat products. Plants would be designed to modern standards and would include facilities for effluent treatment. Investment funds would also be used to develop modern fish storage and processing plants, tanneries, and wool processing plants. 4.14 Fruit and Oil Seeds Processing. Investments in fruit storage and processing would establish facilities for cold storage, sorting, grading and waxing of fruit; fruit juice extraction, bottling, canning and concentration; and packing of dried fruits. Most of the plants would be small to medium capacity (annual throughput of 2,000 to 10,000 tons) and would be equipped to handle a variety of fruits as they come into season. Subloans for oil proces- sing would be used to construct and upgrade small to medium- scale (1-2.5 t/hr) plants to extract oil from sesame, soybean, rapeseed, cottonseed, peanuts and other seeds. The plants would be equipped with solvent extraction and oil neutralization units and machinery for bleaching, deodorizing, and hydrogenation. The oil extraction rate achieved in the new plants would be significantly higher than in existing plants and the refined oil would be of better quality in terms of flavor, storage, and nutrition. 4.15 Feed Mills. To support expanded pig and fish production, the project would provide funds fir investments in feed mills. Most feed mills would be small (1.5-2.5 Ahr); larger car ity mills would be established in the grain surplus provinces of Sichuan, Henan and Hubei to support expanding pig production. Most feed mills would produce concentrate feeds to supplement other ingredients available to farmers locally. They would be equipped with laboratories for analysing raw materials to determine optimal feed composition with respect to nutrients and price. A number of agencit;- are involved in  - 22 - establishing new capacities in feed milling and the overall coordination of the development program would be the task of Feed Offices of the Provincial Economic Commissions. ABC would finance investments in feed mills after obtaining a clearance from the provincial Feed Offices. Pilot Program for Longer Term Lending through RCCs 4.16 The project would support ABC's pilot program to introduce longer term lending practices to selected rural credit cooperatives (RCCs) in Henan, Hubei, Anhui, and Sichuan. The main objective of this program would be to establish a model for longer term lending by RCCs in response to the growing demand for such resources from individual households and enterprises (para. 1.9). The main elements of the pilot program would be training of RCC staff in project appraisal and introducing refinancing mechanisms between ABC and RCCs and possibly involving PBC, in support of RCCs' longer term lending. While RCCs, with their extensive network of branches and agency arrangements at the village-level, are fitted organizationally to handle smallholder loans, lack of resources and skills in longer term credit management have limited their portfolio to date to short-term working capital loans (para. 2.17). ABC itself would not be able to meet the growing demand for longer-term credit from individual households unless these are part of larger-scale collective enterprises, because for ABC, the costs of handling numerous small loans at the village level would be much higher than those for RCCa. 4.17 The pilot program would start with Anhui and Hubei and following a review during 1989, it would be extended to Henan and Sichuan in 1990. About 100 RCCs from the four provinces are expected to participate in the project. At negotiations an assurance was obtained from ABC that the pilot program would be implemented in accordance with criteria and lending terms acceptable to IDA (Annex 9). Technical Assistance 4.18 The project would assist ABC in implementing its staff training program and provide consultancy services for ABC's in-house studies in support of its systems reform activities. Details of project-assisted training activities are given in Annex 10 and of in-house studies in Annex 11. The training program would have two main elements: upgrading and expansion of the staff training facilities at ABC's three national-level Senior Staff Colleges; and training of ABC's credit and technical staff from the six project provinces to meet the requirements of the proposed project. 4.19 Upgrading of Staff Training Colleges. ABC's three senior national- level Senior Staff Colleges at Tianjin, Wuhan (Hubei), and Changchun (Jilin) are responsible for the training of ABC's management personnel and of teachers for ABC's 170 secondary vocational and staff training schools which offer training to its operational staff. The main emphasis of the project-assisted training program would be on upgrading the faculty and facilities at the three colleges, which in turn would train the managerial staff and teachers of lower-level schools in key subjects including project appraisal, market analysis, small enterprise management, modern banking practices and teaching  - 23 - techniques. Several new short-term courses would be introduced and existing courses upgraded at the three colleges and vocational and staff training schools. Through improved instruction, ABC schools would gradually turn out better trained managerial and operational staff, thus helping to improve the range and quality of ABC services, and contributing to more efficient internal management. 4.20 Specifically, the project would include: (a) overseas training for selected faculty members of the three colleges (including ABC senior management staff who often teach at these colleges); (b) visits of overseas teachers (consultants) to assist the three colleges in designing and teaching new courses; and (c) purchase of equipment, library resources and facilities for reproducing training materials (Annex 10, Tables 3 and 4). At negotia- tions, an assurance was obtained from ABC that staff training would be carried out in accordance with a program agreed upcn with IDA which would be reviewed on an annual basis. The program for calendar year 1988 was reviewed and agreed upon during negotiations. 4.21 Training of Project-related staff. Training of ABC staff in the six project provinces is currently well under way. During 1987, before the commencement of the project, some 2,000 staff will have completed training in the project appraisal course scheduled to be held by ABC's provincial branches. During the first year of the project (1988), an additional 1,350 staff would be trained in project appraisal. Curricula and case studies for these courses have been developed under the Rural Crdit I and II projects. ABC staff with training and practical experience in project appraisal would teach these courses. ABC would also conduct about 10 courses in project monitoring and evaluation for key staff in the six provinces, using the recently-developed manual for the Rural Credit I and II Projects (para.1.8). 4.22 Consulting services for in-house studies, ABC has already iuitiated in-house reviews and studies in support of its systems improvement program. As a part of this effort, the project would assist ABC by providing local and international consultancy assistance to carry out in-house studies in key topics including the following: ABC's loan approval policies and procedures (including resources for longer term lending), subloan collection and write- offs, transaction costs of ABC lending, enterprise financing, increased deposit mobilization, and institutional development of RCCs. Consultants would help ABC in designing the proposed studies, carrying out data analysis, and formulating recommendations. ABC's Research Department would carry out the studies with support from the research staff at the provincial branches. The studies would be phased into ABC's Research program starting in 1988. At negotiations, an assurance was obtained from ABC that the studies would be carried out in accordance with terms of reference and timing agreed to with IDA (Annex 11). Cost Estimates and Financing 4.23 Cost Estimates. The total project cost is estimated at US$340 million including US$79.5 million equivalent or about 23% in foreign exchange and US$20 million in related taxes and duties (Table 4.1). Estimates are based on November 1987 prices and do not include price contingencies as it is  - 24 - expected that any cost changes would lead to an adjustment in the number of subloans (Table 4.1). Table 4.1: PROJECT COST SUMKARY Local Foreign Total Local Foreign Total F.EX Z ---- (Y million) ---- ---- ($ million) ---- A. ABC Subloans Tree crops 382.5 42,5 425.0 103.4 11.5 114.9 10 Livestock 164.3 40.7 205.0 44.4 11.0 55.4 20 Aquaculture 114.0 10.0 124.0 30.8 2.7 33.5 8 Agro-processing 293.6 195.4 489.0 79.4 52.8 132.2 40 Subtoal 954.4 288.6 1,243.0 258.0 78.0 336.0 23 B. Technical Assistance ABC Staff training 5.9 4.4 10.3 1.8 1.2 3.0 40 Consulting services 2.6 1.1 3.7 0.7 0.3 1.0 30 Subtotal 8.5 5.5 14.0 2.5 1.5 4.0 37 Total 962.9 294.1 l.257.0 260.5 79.5 340.0 23 4.24 Financing# The proposed IDA credit of SDR 123.8 million (US$170 million equivalent) would contribute about 50% of total project cost, including taxes, or about 53Z of total costs net of taxes. The IDA credit would finance 1OOZ of the foreign exchange requirement plus 352 of local costs. The remaining projett cost would be financed up to about 20% by ABC ($69.2 million) and 30% by subborrowers ($100.8 million). About $8 million of the IDA credit is expected to be onlent by ABC to selected RCCs (para. 4.16), in which case, those RCCs would contribute about $3 million equivalent to the project cost, correspondingly reducing ABC's contribution. Retroactive financing of SDR 4 million (about US$5.5 million) would be required for expenditures incurred after June 1, 1987 and before effectiveness for subloans disbursed by ABC, consistent with the project's terms and conditions. Procurement 4.25 Machinery and Equipment. The procurement arrangements have been evolved in line with the Bank Group guidelines for credit projects (Table 4.2). Procurement of machinery and equipment, spread over six provinces and  - 25 - carried out over five years, would be too dispersed and small-scale to be suitable for International Competitive Bidding (ICB). Vehicles and smaller machinery and equipment for on-farm development, farm support and agro-proces- sing facilities, and staff training would be procured from local machinery companies and suppliers and the increasing number of representatives of foreign suppliers in China, by prudent shopping procedures acceptable to IDA. To facilitate technology transfer, larger investments in fruit storage and processing; meat, other livestock products and oilseeds processing; and feed, tea and rubber processing would be procured in accordance with prudent shopping and limited international bidding procedures (LIB) acceptable to IDA. Contracts for procurement of machinery and equipment involving shopping procedures are expected to amount to Y 148 million ($40 million) and LIB procedures Y 111 million ($30 million). Arrangements for procurement of machinery and equipment ar4 summarized as follows: (a) Contracts for purchase of machinery and equipment items or groups of items aggregating up to US$100,000 would be awarded on the basis of comparison of price quotations from at least three qualified suppliers;\ (b) Contracts for purchase of investment items with costs exceeding US$100,000 would be awarded through LIB procedures in accordance with the procedures sct out in the "Guidelines for Procurement under IBRD Loans and IDA Credits". This would be done on the basis of evaluation and comparison of bids invited from at least four qualified suppliers, from at least three different countries. Individual contracts in this category are not likely to exceed US$4 million; and (c) Award of contracts exceeding US$500,000 would require prior review by IDA. 4.26 Civil Works and Agricultural Inputs. Civil works and agricultural inputs would be procured under local procedures acceptable to IDA. Civil works, including earthworks and construction of structures for support facili- ties, would be undertaken mainly by households and collectives using their own labor. Some of the civil works, especially construction of buildings by collective and state-owned enterprises would be assigned to local construction teams (work brigades) primarily on the basis of their ability to carry out the job satisfactorily and within the specified time. Government policy is to encourage local competitive bidding (LCB) for ensuring more efficient, cost- effective construction. Recently, the State Planning Commission has issued model LCB guidelinLes for use by all provinces. These guidelines, inter alia, specify criteria to be applied to qualifying bidders; methods for bid adver- tisement to secure a satisfactory number of bidders; procedures for verifica- tion and award of bids; and the rights and obligations of the parties involved. All provinces are expected to adopt these guidelines in the near future. ABC would be asked to forward a copy of sample bid documents that would be used by subborrowers in the six project provinces for information and review by IDA. ABC would require subborrowers to follow these guidelines and it would verify their compliance during supervision. Civil works involving LCB contracts are expected to amount to Y 185 million (US$50 million). Most  - 26 - contracts would be small and scattered over a wide area and would not be of interest to foreign bidders. 4.27 Farm households, collectives, state farms and state-owned enter- prises purchase agricultural inputs including fertilizers, seeds, and animal feeds from SMCs which have a network of branches throughout the country. These organizations serve as intermediaries for retailing of items distributed through national or provincial wholesale systems. With the growing market orientation of the economy, household and collective enterprises have begun to undertake purchase and sale of agricultural inputs at the local level, thereby filling any gaps in, and providing some competition to, the cooperative distribution system. 4.28 Consultants. Consultants would be selected in accordance with the Bank Group's guidelines and on terms and conditions satisfactory to IDA. About 900 staff-days of internationally recruited consultants and 500 staff- days of local consultants would be required for staff training and studies in ABC and RCC institutional development. Table 4.2: PROCUREMENT ARRANGEMENTS (USs million) LIB LCB Others /a Total Machinery and equipment 40 - 30 70 (30) (10) (40) Civil works and inputs - 50 218 268 (40) (89) (129) ABC staff trng. and consulting services - - 2 2 (1) (1) Total 40 50 250 340 (30) (40) (100) (170) /a Includes shopping and local procedures acceptable to IDA. Figures in parentheses are approximate amounts expected to be financed by IDA. Disbursement 4.29 ABC is expected to approve most subloans under the project within about three years, i.e. by the end of 1991. Disbursements under the approved subloans are expected to be completed by December 1992. The closing date of the project would be June 30, 1993. A schedule of estimated disbursements is given in Annex 12. The disbursement rate is expected to be higher than the Bank-wide and regional averages, since ABC has already identified most  - 27 - investments suitable for project-financing, and appraised a significant number of subprojects in each of the six project provinces. It is also in line with disbursement experience under the First and Second Rural Credit Projects. 4.30 Disbursement of IDA credit proceeds would be as follows: (a) 71% of project subloans disbursed by ABC; for the RCC pilot program, 100% of ABC disbursements to RCCs for pilot project subloans; (b) 100% of expenditures for overseas fellowships and consultant services; and (c) for machinery and equipment under the technical assistance component, 100% of foreign expenditures, 100% of local expenditures (ex-factory) and 75% of local expenditures for other items procured locally. 4.31 Disbursement against subloans extended by ABC would be made on the basis of statements of expenditure (SOEs) listing subloans made. Disburse- ments for overseas training of staff and for consultants would be made on the basis *f SOEs certifying that the expenditures were incurred on the basis of a training program agreed upon with IDA and that the consultants have been employed in accordance with the Bank Group's Guidelines for the use of consul- tants, Disbursements against expenditures for machinery and equipment under the technical assistance component would be fully documented for contracts exceeding US$200,000. For contracts up to US$200,000, disbursements would be made against SOEs. Supporting documentation for SOEs would be retained by ABC and made available to IDA staff for review during supervision missions. 4.32 In order to provide for efficient disbursement of credit proceeds, a Special Account would be set up in US dollars in a bank acceptable to IDA with an initial deposit of US$ equivalent of SDR 10.2 million. The proposed initial deposit would represent the estimated average disbursement of IDA Credit for any four months. ABC would submit applications for replenishment on a quarterly basis, or whenever the Special Account is drawn to 50% of the initial deposit, whichever comes first.  - 28 - V. PROJECT IMPLEMENTATION Proe n t 5.1 General. The proposed project would be executed by the six ABC provincial branches under the overall direction of ABC's headquarters in Beijing. As in the case of the ongoing IDA-financed Rural Credit I and II Projects, ABC's Foreign Capital Management Division (FCMD) in the External Affairs Department would provide general policy guidance to the provincial ABCs and would serve as the main link to the Bank Group. Provinces, counties and cities participating in the project have appointed project management committees (PMCs) to coordinate the work of the ABC and specialist bureaus. Project offices (POs) and project units (PUs), established within the provin- cial, and county and city ABCs respectively, would manage the day-to-day aspects of subproject processing and supervision. Chart 2 shows the schedule of project implementation and Chart 3, the organization for project manage- ment. 5.2 Foreign Capital Management Division. In addition to its supervisory and liaison role, the FCMD would arrange counterpart funding, prepare documen- tation for IDA on subloans requiring IDA epproval, review project accounts and subloan contracts, oversee the audit of project accounts and SOEs, and compile semi-annual reports on project progress. It would coordinate the work of other units within the ABC Head Office which are responsible for implementing specific project components: the RCC Department, which would oversee the RCC pilot program; the Department of Personnel and Training, which would adminis- ter the project's training program; and the Research Department, responsible for conducting systems improvement studies (paras. 4.16, 4.18, and 4.22). With the assistance of financial and technical specialists from the Agricultural and Commercial Credit and Industrial Credit Departments, the FCMD would also review subprojects which are above the "free limit" (para. 5.16). To carry out the tasks related to the proposed project, as well as continuing to manage the Rural Credit I and II Projects, ABC would appoint ten new staff members to FCMD by December 1988. An assurance to this effect was obtained from ABC at negotiations. Staffing and organization of FCMD would be further reviewed by ABC and IDA during supervision. 5.3 Project Mana ement Committees and Project Offices. Each provincial government has established a project management committee PMC) to serve as an advisory panel for the project. In the case of Anhui and Hubei, PMCs which are already functioning as part of previous Bank Group/IFAD projects have been given the additional responsibility of implementing the proposed project and their membership has been expanded to cover the concerns of this project. Each PMC is headed by a vice-governor and includes senior representatives from the provincial ABC, the planning commission, and the bureaus of finance, agriculture, livestock, fisheries, water resources, materials supply and rural industries. Major functions of the PMCs are to provide policy guidance in determining the overall pro 'ect lending program and to coordinate planning and execution of subprojects between the provincial ABC and other concerned government bureaus, especially with regard to adequate and timely provision of local cost funding, improved production inputs, technical extension support, and training.  - 29 - 5.4 Each provincial ABC, acting in accordance with recommendations from the PMC, has established a project office (P0) to manage the day-to-day aspects of project implementation. The POs consist of a manager and about ten staff members including financial analysts, economists, and accountants and, as appropriate, agronomists, livestock experts, and agro-processing specia- lists. Their responsibilities include: assisting county and city ABCs in appraisal and supervision of subprojects, maintaining subloan accounts, administering the training program for project-related staff, reviewing subloans aoove the "free limit" for county/city subbranches, overseeing repayment of all project subloans, and monitoring project progress and evalua- ting its impact. 5.5 A similar structure of project management committees acting in an advisory capacity and project offices or units within the ABCs hAndling routine operations, would be established in the 310 counties and 50 cities expected to participate in the project. County/city Project Units (PUs) would work with local technical agencies to prepare feasibility studies of proposed subprojects. These would be sent for review and approval first to the county PMCs and then to the POs and relevant technical agencies at the provincial level. During project implementation, the PUs would assist borrowing entities in drawing up construction contracts, conforming to current design, quality control and environmental protection standards, and arranging for technical assistance from the appropriate local government agency. PUs would also be responsible for maintaining separate subloan accounts, supervising subloan eollection, and reporting on project progress to the provincial P0. At negotiations, an assurance was obtained from the Government that the PMCs would be maintained during project implementation and that each PMC would include a representative of the local Environment Protection Agency (EPA) to participate in subproject feasibility review process and advise on specific actions to safeguard the environment, especially for agroprocessing investments with potential environmental impacts. An assurance was also obtained from ABC that provincial POs would be maintained with staff, func- tions and responsibilities acceptable to IDA and that a PU would be estab- lished and maintained at each of ABC's county and city subbranches participa- ting in the project. Where possible, ABC would use the staff of the POs and PUs for its longer term lending outside the project and after the project completion, it would assign this staff to its Credit and Accounting Deparcments. 5.6 As has been the case in the Rural Credit I and 1I Projects, ABC's provincial and county project organizations would rely on staff from local government technical agencies (livestock, aquaculture, rural industry etc.) for guidance and assistance on the technical aspects of project preparation, appraisal and supervision. However, in the proposed project, these project organizations would make greater use of their own staff as well as hiring outside consultants to carry out independent reviews of subloan requests and to supervise project implementation. This wi_1 become especially usefuL as more and more enterprises apply directly to ABC for loans rather than follow- ing the present practice of routing loan requests through a government techni- cal agency. Each provincial PO is preparing a roster of consultants drawn from enterprises, colleges and universities, and provincial Science and Technology Associations. To assist PO staff and consultants in their review  - 30 - of subloan requests, ABC is preparing a standard checklist of technical considerations which must be addressed in each feasibility study. The feasi- bility study itself would be carried out in accordance with various handbooks of technical coefficients available through MAAF and other agencies and institutes. 5.7 ABC is placing increased emphasis on project supervision and moni- toring. The PUs would undertake regular field visits to supervise the progress of project investments and provide technical support to subborrowers with assistance from local government technical bureaus. This would include assistance to subborrowers to: (a) raise the efficiency of production through better techniques of production, design, layout and utilization of facilities, (b) ensure that construction of facilities meets approved design standards, and (c) improve quality control of both the project inputs and outputs. 5.8 RCC Pilot Program. ABC's provincial branches would be responsible for implementation of the pilot program, under the guidance of FCMD and the RCC Development Department at the Head Office (paras. 4.16-4 17). ABC Anhui and Hubei would carry out the proposed review of the program during 1989, with assistance from the RCC Development Department in Head Office, IDA and project-financed consultants (para. 4.22). 5.9 Staff Training Program. ABC's Department of Personnel and Training which is responsible for planning and implementing nationwide staff training tprograms, would oversee the implementation of the project-assisted training program (para. 4.19). Four divisions in this Department, comprising the college and school office, cadre training office, teaching materials office and TV University center would be involved in this activity. ABC has recently established at the Head Office, a Staff Training Committee, with participation of senior staff drewn from its operational departments, to oversee the staff training activity. This Committee, assisted by the principals of the three national colleges and the Officer-in-Charge of the project's training component, would periodically review the implementation issues and constraints, and recommend remedial measures where needed. In each of the three national colleges, a senior faculty member would be designated to coordinate the project-assisted program concerning his college. During negotiations, an assurance was obtained from ABC that: (a) ABC would maintain the Staff Training Committee in a manner acceptable to IDA, and (b) by June 1988, appoint four additional suitably qualified and experienced staff, one each in the four divisions concerned with staff training. Staffing and organization of the Training Divisions would be further reviewed by ABC and IDA during supervision. 5.10 Systems Improvement Studies. The System Reform Office in ABC's Research Department at the Head Office would be responsible for designing and conducting the studies (para. 4.22 and Annex 11). For field work in connec- tion with the studies, ABC would use the research staff at the provincial branches. At negotiations, an assurance was obtained that ABC would forward the studies to IDA for review and comment.  - 31 - Subproject IMplementation 5.11 ABC expects that, of the medium and long-term loan funds provided by the project, about 10X would be extended directly to specialized households and joint household units, about 602 to collective enterprises, and the remaining 301 to state-owned enterprises, joint ventures and cooperatives. Estimated number of subprojects to be appraised would be about 1,200. Collec- tive enterprises, households, and state farms would be the main units involved in expanded production of tree crops, livestock and aquaculture. Typically, a township would organize 25-100 households into production enterprises of various kinds--e.g., a 50 to 100 ha tea plantation, a 20-50 ha sheep or cattle fattening farm, or a 25-50 ha area of fish pond. The enterprise would borrow project funds from the local ABC on behalf of its member households. The enterprise would in turn enter into contracts with each of its member house- holds specifying the assets contracted (land, equipment, animals), the length o.: the contract period (for land, usually 15-30 years), any agreed production oaotas and purchase prices, and the farmer's contracting fee including agri- cultural taxes, charges on township-supplied inputs and services, and the amount of annual repayments on the ABC loan. Under the current system of guidance planning, farmers generally have the option of using any available channel for purchase of inputs and sale of output. Specialized households and partnerships would enter into similar contractual arrangements with townships on use of land and other assets and deal directly with the local ABC in securing subloans. Most state farms now practice some form of contracting for production with constituent households. In most instances, the state farm, like the township enterprise, would sign the subloan agreement with the local ABC and provide for repayment through contracts with its farm households. 5.12 State-owned enterprises, state-collective partnerships, state farms, and SMCs would be the major borrowers of project funds for agro-processing. Some of these subloans would be for renovating existing enterprises, the rest for establishing new facilities. Enterprises so assisted by the project would be operated as commercial ventures with their output priced generally at competitive market levels. Legally, they would have the status of state-owned etiterprises or companies with charters registered with the appropriate local office of the General Administration of Industry and Commerce defining the scope of their activities, sources and amount of capital, borrowing powers and management structure. Collectives and state-owned enterprises would allocate the subloans pro rata to participating households, which would be jointly and severally responsible for repayment of principal and interest to ABC and RCCs. Onlending Terms and Conditions 5.13 Under a Subsidiary Loan Agreement, to be concluded as a condition of Credit effectiveness, the Government would make IDA funds available to ABC for onlending to subborrowers in the six provinces. The Subsidiary Loan would be repaid in the currency used (either SDR equivalent of foreign currency used or renminbi) over 20 years, including 5 years grace, at an interest rate of 4.51 p.a. with commitment charges of 0.5% to be borne by ABC. During negotiations, an assurance to this effect was obtained from the Government. An assurance was obtained from ABC that funds onlent by the Government from the IDA Credit for subloans would be allocated for credit programs in the six project  - 32 - provinces in amounts acceptable to IDA, according to the following schedule: Guishou, US$15 million equivalent; Sichuan, $40 million; Yunnan, $48 million;, Anhui, $10 million; Henan, $40 million; and Hubei, $15 million. The Government would onlend the IDA credit to ABC mainly in Renminbi, as most subloans under the project would be in local currency. However, ABC would extend some subloans in foreign exchange to enable enterprises to import equipment and materials, breeding livestock, and technical assistance. At negotiations, an assurance was obtained from the Government that it would make available foreign exchange from the IDA Credit or other resotIrces, to (a) sub- borrowers for import of machinery and equipment, breeding stock, technical assistance and other essential inputs, and (b) ABC for meeting the foreign exchange cost of the staff training and consultancy components. The exchange risk on the IDA Credit would be borne by the Government, except for the amount of credit used by ABC for extending foreign currency subloans, in which case ABC would pass on the foreign exchange risk to subborrowers with the provin- cial governments concerned acting as guarantors. The exchange risk on IDA credit onlent to ABC in foreign exchange for its staff training component would be borne by ABC. Assurances on the exchange risk were obtained during negotiations. 5.14 ABC's prevailing rates for development projects range between 6.48% and 7.92%. Loans for equipment purchases would range from 10.08% to 10.80Z. These rates are positive and are expected to remain positive. Subborrowers would be required to contribute about 30S of total project costs. Repayment periods for subloans which would vary in accordance with ABC's cash flow estimates for subprojects, would generally range between 5 and 12 years, and would not exceed 15 years. During negotiations, an assurance was obtained from ABC that it would onlend the project funds to subborrowers at the same interest rates it charges on subloans for similar purposes and with similar maturities outside the project. 5.15 Based on the present cost of its counterpart funds, the cost of IDA Credit at 4.5% and the average lending rate estimated at 8%, ABC would receive a spread of about 2.5 p.a. on project lending. ABC's objective is to restrict the project lending costs (including administration cost at all levels, cost of carrying subloan defaults, and commitment charges on the IDA Credit) to about 2Z through improved operational efficiency including timely collection of subloans. ABC would also review periodically the interest rates for project lending in the context of rising cost of deposit and other funds and of portfolio management, and approach the People's Bank of China, through MOF, for approval of any increases needed in the lending rates. The first such review would be completed by December 1988 and IDA would be informed of the results soon thereafter. During negotiations, an assurance was obtained that the Government would ensure that ABC receives a spread of not less than 2% (or such other spread as may be agreed between the Government and IDA), between the cost to ABC of the project funds (IDA funds and ABC's counterpart contributions) and the project's onlending rates to subborrowers. An understanding was also reached with the Government and ABC that ABC's lending rates would be reviewed with IDA from time to time in light of ABC's cost of funds and profitability and taking into account inflation and other interest rates in the economy in order to ensure that the interest rates to be paid by final beneficiaries are positive in real terms.  - 33 - 5.16 ABC would appraise all subprojects in accordance with the Project Appraisal Manual (para. 1.8). Subloans in excess of US$3 million would require IDA approval before being finally approved by ABC. An assurance to this effect was obtained from ABC at negotiations. The prior approval requirements are intended to help ABC ensure that for all subloans which are large and/or involve new technology, procedures and criteria set out in the Project Appraisal Manual have been followed and correctly applied. It is estimated that about 20 subloans, accounting for about 15% of the total project funds, would require prior IDA approval. In addition, individual subloans in excess of Y 4 million (about $1 million equivalent), involving about 30% of the project funds, would be reviewed by ABC Head Office, with a copy of the evaluation report sent to IDA. This would provide adequate supervision by ABC Head Office and IDA over project lending. Accounts and Audit 5.17 The county/city PUs in the project provinces would maintain separate accounts for project subloans and expenditures. These records would be forwarded to the provincial POs which would prepare consolidated accounts, including records of their own project expenditures, to be submitted to ABC Beijing for review. Assurances were obtained from the Government and ABC at negotiations that the ABC branches in the six project provinces would maintain aeparate accounts for project subloans and expenditures. These accounts including the statements of expenditure would be audited annually by independent auditors acceptable to IDA; as in the case of the Rural Credit I and II Projects, these would be the provincial and lower level units of the State Audit Agency. The audited project accounts together with duly audited annual accounts (balance sheets and income statements) of ABC's provincial branches in the six project provinces, and of ABC's total operations, would be submitted to IDA within six months of the close of each financial year. The audited accounts would include details of withdrawals from the Credit Account made on the basis of SOEs and the auditors' opinions as to whether such withdrawals were against expenditures eligible for reimbursement by IDA. An assurance on maintenance of separate project accounts, audit of project accounts, and submission to IDA of audited project accounts and ABC's annual accounts was obtained during negotiations. Monitoring, Evaluation and Reporting 5.18 The six provincial POs in cooperation with the county/city PUs would monitor the project's physical and financial progress. Each PU would prepare semi-annual reports which would include: progress in subloan approvals and disbursements; loan collection record; progress in subproject construction; technical problems encountered by subborrowers and steps proposed to resolve them; cash flow projections for typical production and agro-processing enter- prises; and an overall review of county ABC (subbranch) operations. This information, available in part through the county ABC's routine loan adminis- tration data and in part compiled from the PUs' separate records, would be forwarded to the county/city PMC and the provincial PO. Each provincial PO would, in turn, prepare a semi-annual report of project progress to be submitted to the provincial PMC and ABC Beijing. The ABC would submit these semi-annual reports to IDA within two months following the end of each  - 34 - reporting period. Guidelines for monitoring and evaluation prepared for the Rural Credit I and II would be modified to include special d'.aracteristics of the proposed project. 5.19 Within six months of completion of Credit disbursements, ABC Beijing would prepare for submission to IDA a Project Completion Report (PCR) in which project results would be compared with appraisal estimates. The PCR would describe changes in ABC's operational methods as a result of the project, changes in the incomes and employment level of subborrowers, changes in production technology, and the broad effect on subsector growth of supplement- ing ABC's longer term lending resources. The economic and financial rates of return on subprojects would be recalculated on the basis of actual costs and reestimated benefits. Environmental Effects 5.20 Project activities are not anticipated to generate adverse effects on the environment, and several of the major activities would have clearly beneficial effects. Much of the land to be developed or improved is hilly land under sparse vegetation which is subject to erosion. Terracing, affores- tation and planting of perennial crops and pasture grasses would provide added protection from wind and surface runoff, thus reducing erosion. Feasibility reports on individual or groups of subprojects would also include a descript- ion of specific actions to safeguard the environment indicating whether these conform to appropriate provincial guidelines on environmental control. An assurance was obtained from the Government and ABC at negotiations that as a part of the subproject review process, the provincial governments and ABC would ensure that subproject activities would conform to appropriate guidelines on environmental control issued by the provincial governments and acceptable to IDA.  - 35 - VI. MARKETS AND PRICES Market Prospects 6.1 Project lending would be directed primarily toward the production of goods with relatively high income elasticities of demand, including fruits, beverages, vegetable oil, rubber, fish, meats, and other animal products. The Bank's recent projections of domestic consumption of these commodities in the year 2000, based on comparisons with consumption patterns of Chinese popula- tions elsewhere in Asia and on the assumption that per capita GNP will increase at the modest average annual rate of 3.5X, are summarized in Table 6.1. These projections indicate that, relative to 1981-83 levels, domestic consumption of fruit and fish is likely to increase more than threefold by the year 2000 and that consumption of vegetable oil, rubber, and meat should almost double. Since it will prove difficult for domestic production to satisfy these large projected increases in demand, the domestic market prospects for incremental project output of these goods are expected to be excellent. Further, in the case of rubber, coffee, and wool, incremental project output would help to reduce the large and growing share of imports in domestic supply. Table 6.1: CURRENT AND PROJECTED CONSUMPTION AND TRADE STATUS Average Annual Domestic Consumption Net (kg per capita) Trade Status /a 1981-83 2000 /b 1983-85 2000 /b Fruit 5.7 25.0 X X Black Tea 0.011 NA X X Coffee 0.002 NA M M Vegetable Oil 3.2 5.7 X M Natural Rubber 0.4 0.7 M M Meat /c 13.6 26.3 X X Fish 4.5 15.0 X X /a "M" indicates net importer. "X" indicates net exporter. 7i Year 2000 projections from The World Bank, China: Agriculture to the Year 2000, Report No. 5206-CHA dated May 22,1985, p. 20; Issues in China's Rural Development Strategy (Beijing: Agricultural Science and Technology Publishing House, 1985) pp. 384 and 582; and Price Prospects for Major Primary Commodities, Report No. 814/86 dated October, 1986, vol. 2, pp. 60 & 62 and vol. 3, pp. 57 & 59. /c Includes pork, beef, mutton, and poultry meat.  - 36 - 6.2 The project responds to growing preferences among Chinese consumers for improved quality and greater variety in foods, year-round availability, and convenience. In response to the emerging preference for higher quality foods, the project would increase production of lean meat pork and superior or improved varieties of fruits, beef, lamb, and mutton. In order to take advantage of increasing demand for greater variety and off-season availabi- lity, subloans would be targeted to: the production of fruits which have long been in short supply on local and regional markets, including litchi, longan, kiwi, and Chinese dates; the promotion of early- and late-ripening varieties; and the expansion of storage capacity. Lastly, the project responds to consumers' preferences for greater convenience by canning, dehydrating, flavoring and otherwise processing fresh fruit and meats, fish, and other raw foods into soft drinks, jam, canned goods, sausages and other meats. Simi- larly, the project's highly refined vegetable oil will have a longer shelf life in addition to improved flavor and nutritional value. 6.3 Project lending would also expand production of a limited number of goods intended for export, including gallnut extracts and canned meats. As for black tea, estimated incremcntal production from the project would be about 20,000 tons (para. 4.4). With available information on China's production, consumption, and exports of tea, it is difficult to determine with precision how much, if any, of the project's incremental production of black tea would be exported. Given the continuing growth in domestic consumption of tea, averaging 14% during 1981-85, it is expected that a significant portion of the incremental production would be consumed domestically and only marginal amounts would enter the export market with little long-term impact on world tea prices. According to the Bank Group's recent projections for the world tea industry, due to a rapid growth in consumption in major producer countries, there are good prospects for world tea prices to increase in real terms from their current low levels. 6.4 In the case of gallnut extracts, much of the production from the first phase of the program would be absorbed in the domestic market (para. 4.5). However, a significant proportion of the production from the second phase of the program would be marketed outside China, where alternative sources of the natural product are not widely available and comparable synthe- tic astringents and detoxicants are generally more costly. Consequently, no difficulties are expected in meeting the project's target of selling between 50% and 80% of incremental output of gallnut extracts on the international market. A more detailed analysis of the export market for gallnut extracts is planned during 1989, before launching the second phase of the project-assisted program (Annex 7). Lastly, exports of canned meats, primarily to southeast Asia, have been increasing at greater than 15% annually in recent years. While the bulk of the project's incremental canned meat production will be marketed domestically, a small share of high quality product would be available for export. Prices 6.5 In recent years, China has implemented a number of agricultural reforms intended to expand the role of markets and prices in directing the production and trade of most commodities. In 1984, the quota procurement  - 37 - system was replaced by a contractual procurement system, with the Government setting contract prices annually in response to changing market conditions. The effect of the new system has been to bring contract prices more closely in line with market prices and to allow farmers somewhat greater autonomy in establishing cropping patterns. The contractual procurement system has not, however, been implemented evenly across all commodities or regions; farmers across the country are no longer obliged to meet procurement quotas for meat, for example, but are still required to meet quotas for wheat and rice in China's key grain commodity bases. In 1985, the government decontrolled both wholesale and retail prices of fruits, vegetables, livestock products, and a range of other commodities. In response, prices of fresh fruit and livestock products rose by 36 and 22% respectively in the first half of 1985. 6.6 As a result of these agricultural reforms, project farmers now face prices which closely approximate world prices for many inputs and outputs and are free to purchase inputs and market their outputs on the open market to a much greater extent than in the recent past. The only significant exceptions to this rule relevant to this project are the prices received by producers for rubber and oilseeds. China has maintained the domestic price of rubber at a higher level than the international price mainly to stimulate production and augment government revenue through import tariffs. However, the disparity has been considerably reduced in recent years, from about 1902 to 60X, as a result of the depreciation of yuan and the absence of any increase in the nominal price of rubber since 1983. The remaining disparity in the domestic price of rubber will likely be further reduced or eliminated before 2000 through expected increases in real prices of rubber and continued depreciation of the yuan. In line with the understanding reached during the negotiations of the ongoing Rubber Development Project (Cr.1417-CHA), the Government is currently examining the efficiency of ru-bber production and the findings of this review would be used by ABC in subproject selection criteria. 6.7 With the partial decontrol of agricultural prices and markets in early-1985, an increasing share of China's vegetable oil has been sold on the free market at above-plan prices. However, since the planned price is now closely pegged to the new free market price, vegetable oil sold through both the official state marketing system and on the free market trades within the relatively narrow band of Y 2.7/kg (plan) and Y 3.0/kg (free market). These high domestic prices exceed world market prices by more than 100%, and are primarily the result of insufficient supplies of vegetable oil relative to consumer demand and government subsidized prices to oilseed producers. Given these disparities in oilseed and vegetable oil prices, project support has been limited to the upgrading of vegetable oil processing through financing the replacement of outmoded and inefficient extraction units with modern processing equipment. Modern mechanical and chemical extraction units will increase oil extraction rates, decrease operating costs per ton of output, and improve the quality of the vegetable oil and oilseed meal. The attractiveness of replacing inefficient expellers with modern mechanical and chemical extraction units is demonstrated by the financial and economic rates of return estimated for a typical vegetable oil processing facility in Sichuan (Annex 14, Table 8). These high rates of return reflect the greater technical and economic efficiency of modern processing equipment and remain strongly favorable with inputs and outputs valued at both financial and international prices.  - 38 - 6.8 Current producer prices for lean uieat pork and lamb procured by Government marketing agencies under contractulal arrangements tend to be lower* in varying degrees in the six project provinces (5-15%), than the current export and free market prices for these products. The impact on project farmers of these official producer prices will be minimal, however, since a large portion of the incremental project output of lean meat pork and lamb will be sold on the free market. ABC would ensure, as a part of the subloan appraisal process, that project-assisted investments in lean meat pork and lamb are financially justified given the prices expected to prevail locally. 6.9 The financial analysis of the project subcomponents has been conducted using 1987 average free market prices and, for rubber, the government contractual price. Future financial price trends for individual commodities remain uncertain, but it is unlikely that official producer prices for basic commodities will suffer significant declines since the government is committed to maintaining agricultural production incentives during the ongoing reforms of the marketing system, and free market prices will generally reflect buoyant demand prospects. For the economic analysis, farm input and output values are based upon Bank Group commodity price forecasts (October 1986 and recent updates), adjusted for international and domestic transport costs and expressed in 1987 constant prices. Conversion factors are used to derive economic prices for items which do not enter into international trade. The current financial wage rate ranges between Y 2.8 per workday in southwest China to Y 3.5 per workday in the central provinces. Given the severe unemployment and underemployment in southwest and central China, the economic value of unskilled labor has been estimated at about 50% of these financial wage rates multiplied by the consumption conversion factor of 1.13. Thus, the shadow wage rates adopted in the economic analysis are Y 1.6 antd Y 2.0 for the southwestern and central provinces respectively. Current and projected financial and economic prices and conversion factors are summarized in Annex 13.  - 39 - VII. BENEFITS, JUSTIFICATION, AND RISKS Production Benefits 7.1 At full development, annual project output is expected to include 250,000 tons of fruit, 25,000 tons of rubber, 20,000 tons of tea, 2,500 tons of coffee, 35,000 tons of lean meat pork, 21,000 tons of beef, mutton, poultry and other meats, 20,500 tons of fish, and additional quantities of wool, timber, and other products. Expressed in 1987 constant dollars, the value of incremental output of tree crops, animal products, and fish would be about US$245 million annually. Utilizing part of this incremental output for a portion of their raw material requirements, project agroprocessing enterprises would at full development produce an additional 90,GO0 tons of soft drinks, jam, and other packaged or processed fruits, 56,000 tons of vegetable oil, and additional quantities of sausages and other prepared meats. Expressed in 1987 constant dollars, total value added by the project's agroprocessing enterprises would be about US$34 million annually. In addition, lending for the establishment of breeding facilities for lean meat pigs, beef and dairy cattle, sheep and goat, poultry, and for fish nurseries would help satisfy the growing demand for improved animal and fish stock in Southwest and Central China. Employment and Incomes 7.2 Employment opportunities generated by the project would help reduce existing unemployment and seasonal un4eremployment among the rural labor force in the three southwestern provinces at.d in a number of poor counties in the three central provinces participating in the project. At full development, the project would lead to a net job creation of about one full-time job for each US$1,030 invested. At full development, annual incremental demand for labor in the tree crop, animal husbandry, and fishery components would be about 92 million work days, equivalent to about 306,000 full-time jobs. In addition, the project's agroprocessing component would create the equivalent of about 20,000 full-time jotbs. Annual income from project related activities for project participants would range from Y 900 for full-time unskilled laborers to Y 1,800 for full-time skilled laborers. These income levels equal or slightly exceed levels for other farm and agroprocessing workers in the rural areas of southwestern and central China, and would represent a significant improvement in the welfare of the mostly underemployed laborers expected to participate in the project. Financial and Economic Analysis 7.3 Financial Analysis. Technical Bureaus of the six project provinces have prepared feasibility studies of over 75 typical subprojects that would be assisted by the project. Based on these studies, ABC's credit staff have appraised as many as 50 subprojects. This analysis is available in the project file. The financial rates of return (FRR) indicated by ABC analysis range between 25X and 35%. Eight representative models in four major categories of investments were reviewed during appraisal, based on 1987 constant prices and the Bank Group's commodity forecasts for 1995 and 2000  - 40 - (para. 6.6). Financial rates of return (FRR) on these investments, summarized in Table 7.1, range from 17% for the tea component to 22% for the sheep component. Since the proposed project would be a credit operation, the actual mix of subprojects, which would be selected over a period of three years would, inter alia, depend upon several factors including market prospects, subborrowers' ability to provide down payment and availability of support services (para. 4.2). Based on the indicative investment program (Annex 5), however, the FRR for the project as a whole would be about 20%. Expected cost benefit streams and annual debt service for each of the representative subprojects are presented in Annex 14. 7.4 Economic Anal sis. Based upon data for eight representative subloans (para. 7.3), an economic analysis was undertaken for each of the project's four major subcomponents. All economic values were converted to local cuirency at the official exchange rate prevailing at negotiations, of Y 3.7 US$1.00. Economic price conversions were applied to major outputs, traded inputs, and labor (para 6.7 and Annex 13). Using these assumptions and discounting costs and benefits over 15-35 years as appropriate, the project's overall economic rate of returq (ERR) is 241, ranging from 15% for the sheep component to 39% for the lean meat pig component (Table 7.1). At a discount rate of 12%, which is considered to approximate the opportunity cost of capital in China, the net present value of the project is Y 1283 million (US$346 million). The FRRs and ERRs for each activity were tested for their sensitivity to increased investment and operating costs (including labor) and shortfalls from projected yields and prices (Annex 14). No single variant proved crucial to the financial or economic viability of the project as a whole or any individual component. Subproject Cash Flows 7.5 A cash flow analysis was performed for each of the project's subcomponents and for the project as a whole. The analysis indicates that most of the subborrowers would require loan repayment periods of 7-15 years, including 1-5 years of grace and assuming onlending to subprojects at an average interest rate of 8.01. Consistent with its current loan policies, ABC would require state farms and state-owned enterprises to pay interest due during the grace period from nonproject resources, especially for rubber development and major agro-processing activities. ABC would have a steady inflow of funds beginning in year 4 and extending through year 15, and would have no difficulty in repaying principal and interest to the Government within 20 years, including a 5 year grace period.  - 41 - Table 7.1: SUMMARY OF RATE OF RETURN ANALYSIS Net Present Value of Investment Rate of Return Value @ 12% (Yuan million) (X) (Y mln) Financial Economic Financial Economic Economic Tree Crops Rubber 140 109 18 19 106 Litchi 15 12 25 27 50 Tea 50 40 17 38 179 Livestock Lean meat pig 62 74 17 39 98 Sheep 49 63 22 15 15 Aquaculture Fishponds 102 57 18 30 84 Agroprocessing Cannery 93 100 24 24 71 Vegetable oil 65 70 20 16 19 t Total Project 1,243 1,169 20 24 1,283 Risks 7.6 No major risks are anticipated. As the financial and economic analysis demonstrates, all typical investments are able to sustain significant increases in costs and reductions in revenues and provide satisfactory rates of return. Institutional risks associated with channeling of longer term investment funds would be addressed through staff training and upgrading of ABC's and participating RCCs' procedures for portfolio management (paras. 4.18-4.22). Government's agreement that ABC and RCCs would receive a spread of not less than 2% (currently at about 2.5%) would ensure that their transaction costs including the risk of a reasonable subloan default are fully covered. Adequacy of the interest spread to ABC and RCCs would be reviewed by the Government, ABC and IDA as necessary (para. 5.15). All major subloans would be backed by local government guarantees to ensure their technical support to project investments and assistance to ABC and RCCs in subloan collection.  - 42 - VIII. AGREEMENTS REACHED AND RECOMMENDATION 8.1 At negotiations, assurances were obtained from the Government on the following: (a) the Government would onlend the proceeds of the IDA credit to ABC for 20 years, including 5 years of grace, at an interest rate of 4.52 p.a. with commitment charges of 0.5Z p.a. to be borne by ABC (5.13); (b) the Government would make available foreign exchange from the IDA credit or other resources to (i) subborrovers for import of machinery and equipment, breeding stock, technical assistance and other essential inputs, and (ii) ABC for its staff training program and studies (5.13); (c) the foreign exchange risk on the IDA Credit would be borne by the Government except that: (i) where ABC extends subloans using foreign currency, it would pass on the exchange risk to subborrowers, and (ii) ABC would bear the exchange risk for foreign exchange used for its staff training program (parae. 5.13); (d) the Government would ensure that ABC receives not less than 2% interest spread (or such other spread as may be agreed between the Government and IDA), between the cost to ABC of project funds (IDA funds and ABC's counterpart contributions) and the project's onlending rates to subborrowers (para. 5.15); and (e) the Government would maintain PMCs for the six provinces during project implementation, and that each PMC would include a repre- sentative of the local Environment Protection Agency (EPA) to participate in subproject feasibility review process and advise on specific actions to safeguard the environment, especially for agro- processing investments with potential environmental impacts (para. 5.5) . 8.2 During negotiations, assurances were obtained from the Government and ABC that: (a) the tea rehabilitation program would be carried out in accordance with technical guidelines acceptable to IDA (para. 4.4); (b) the proposed reviews of the gallnut, pasture development and sheep breeding programs in Guizhou Province would be completed by the end of 1989 on terms of reference acceptable to IDA and that ABC would consult IDA on the size and phasing of the expanded programs (paras. 4.5 and 4.8); (c) as a part of the subproject review process, ABC and the provincial governments would ensure that subproject activities would conform to appropriate guidelines on environmental control issued by the provincial governments and acceptable to IDA (para. 5.20).  - 43 - 8.3 At negotiations, assurances were obtained from ABC that : (a) ABC would forward to IDA for review the design and specifications of typical rubber and tea processing plants before the first subloan in each such category is finally approved by ABC (para 4.12); (b) ABC would implement the RCC pilot program in accordance with criteria and lending rates acceptable to IDA (para.4.17); (c) ABC would carry out the staff training in accordance with the program agreed upon with IDA, which would be reviewed on an annual basis (para.4.20) ; (d) ABC would carry out the project-related studies in accordance with the terms of reference and timing agreed with IDA (4.22) and that it would forward the studies to IDA for review and comment (5.10); (e) ABC would: (i) maintain the Staff Training Committee in a manner acceptable to IDA; (ii) by June 1988, appoint four additional, suitably qualified and experienced staff, one each in the four divisions concerned with staff training (para. 5.9); and (iii) by December 1988, appoint ten additional staff in FCMD (para. 5.2); (f) ABC would establish and maintain Project Offices with staff, functions and responsibilities acceptable to IDA, and that it would establish and maintain a PU in each of ABC's county and city subbranches participating in the project (para. 5.5); (g) ABC would allocate the funds onlent by the Government from the IDA Credit to the six provinces in amounts acceptable to IDA (para. 5.13); (I) ABC would onlend project funds to subborrowers at the same interest rate that it charges on subloans for similar purposes and with similar maturities outside the project (para. 5.14); (i? ABC would obtain prior approval of IDA for subloans in excess of US$3 million, before being finally approved by ABC (para. 5.16); (j) ABC branches in the six project provinces would maintain separate accounts for project subloans and expenditures and these would be audited by the State Audit Agency. ABC would forward to IDA the audited project and annual accounts of the six provincial branches and ABC's total operations within six months of the close of the financial year (para. 5.17); and (k) ABC would forward to IDA half-yearly reports covering the project's progress within two months following the end of each reporting period (para. 5.18).  - 44 - 8.4 Conditions of Credit effectiveness would beS (a) State Council approval of the DCA and (b) the execution of a Subsidiary Loan Agreement, acceptable to IDA, between the Government and ABC incorporating the Government's lending and repayment terms of the IDA Credit to ABC (para. 5.13). 8.5 With the above assurances and agreements, the project would be suitable for an IDA credit of SDR 123.8 million (equivalent of US$170 million) on standard terms with 35 years maturity, to the People's Republic of China.  CHINA THIRD RURAL CREDIT PROJECT Consolidated Balance Sheet of the Agricultural Bank of China, 1984, 1985 and 1986 (as of December 31) (Y billion) /a /a /a /a Sources of funds 1984 1985 1986 Application of funds 1984 1985 1986 Deposits of rural credit cooperative 32.3 40.5 49.5 Loans to rural commercial and Deposits of individuals 10.1 15.5 25.8 industrial enterprises 106.9 124.0 134.2 Deposits of rural commercial and Loans to collectives 23.5 26.4 40.7 industrial enterprises 12.1 17.1 21.6 Loans to state-owned agricultural Deposits of state farms 6.4 6.3 8.4 enterprises 5.0 5.9 9.0 Deposits of collective and local Loans to households 4.4 5.4 6.4 government units 4.3 3.8 5.5 Loans to rural credit cooperatives 3.1 3.3 4.2 Other deposits 7.8 8.5 11.7 Other loans 3.0 4.3 5.3 Subtotal (ABC deposits) 73.0 91.7 122.5 Subtotal, ABC loans 145.9 169.3 199.8 Local government funds 1.0 - - Loans on behalf of other banks State contribution 21.1 22.1 22.5 and organizations 11.8 - - Net interbank balances 65.4 59.3 57.9 Cash 4.5 4.7 4.7 Net surplus 1.8 1.0 1.6 Total 162.3 174.0 204.5 Total 162.2 174.0 204.5 /a Figures for 1985 and 1986 are subject to adjustment after usual internal audit, and verification by the People's Bank and MOF. Source: External Affairs Department, ABC, Beijing.  CHINA THIRD RURAL CREDIT PROJECT Consolidated Income Statement of the Agricultural Bank of China, 1984, 1985 and 1986 Jsnuary 1 - December 31) (Y billion) Income 1984 1985/a 1986/a Expenditure 1984 1985/a 1986/a Interest received on ABC loans 4.35 17.71 21.23 Interest 2.13 } } Agency fees and interest earned Interest paid on loans from PBC /b 16.38 19.26 on deposits 3.73 } and agency fees paid 3.73 1 } 1.31 1.28 } Other income 0.87 } Compensation paid to RCC for losses 0.03 } Administrative expenses 1.02 } 1 1.26 1.56 Other expenditure 0.29 1 Total 8.95 19.02 22.51 Total 7.20 17.64 20.82 Net surplus 1.75 1.38 1.69 /a Figures for 1985 and 1986 are subject to adjustment after usual internal audit and verification by the People's Bank and MOF. /b Most of the agency business previously undertaken by ABC for the People's Bank and other banks is now handled by ABC on its own. Source: External Affairs Department, ABC, Beijing.  CHINA THIRD RMRAL CREDIT PROJECT Consolidated Balance Sheet of Rural Credit Cooperatives (January 1 - December 31) (Y billion) Liabiltities 1979 1982 1985 Assets 1979 1982 1985 Deposits Domestic Credit Rural collective enterprises 9.83 12.10 7.19 Loans to rural collective enterprises 2.24 3.48 4.14 Township enterprises 2.19 3.37 7.21 Loans to township enterprises 1.42 4.23 16.48 Individual deposits 7.84 22.81 56.48 Loans to individuals 1.09 4.41 19.38 > Other deposits 1.72 0.71 1.61 Subtotal (loans) 4.75 12.12 40.00 Subtotal (deposits) 21.58 38.99 72.49 Redeposits with ABC 19.07 29.96 40.14 Loans from ABC 0.51 1.09 3.29 Other liabilties 1.73 2.00 4.36 Total 23.82 42.08 80.14 Total 23.82 42.08 80.14 __~~~c  ANNEX 3 - 48 - Table i CHINA THIRD RURAL CREDIT PROJECT Bssic Data on Project Provinces in the Southwest Region Guizhou Sichuan Yunnan 1980 1985 1980 198S 1980 1985 Pop,latlon (million) Total 27.77 29.88 98.00 101.88 31.73 34.08 Rural 25.73 26.24 90.05 88.97 29.56 29.96 Rural labor force 9.34 11.22 37.37 42.58 12.18 14.38 Agricultural labor force 9.48 10.51 36.91 38.02 12.23 12.97 Land area ('000 ha) Sown area 2,846.49 3,022.84 12,020.14 11,776.48 4,010.00 4,006.07 Irrigated area 456.87 479.26 3,022.87 2,781.73 913.13 964.93 Income per capita (Y) 161.46 287.83 187.90 315.07 150.12 388.34 GVAO (Y billlon) 3.80 7.23 18.27 31.31 4.59 8.89 Crop production Grain Area ('000 ha) 2,419.68 2,213."7 9,952.77 9,393.70 3,595.13 3,320.19 Yield (tons/ha) 2.68 2.69 3.28 4.08 2.41 2.82 output ('000 tons) 6,480 5,946 32,640 3,807 8,565 9,350 Oil-bearing crops Area ('000 ha) 217.11 355.13 545.01 1,021.00 110.52 118.11 Yield (tons/ha) 0.72 0.90 1.31 1.49 0.59 0.92 Output ('000 tons) 156 320 719 1,512 85 118 Livestock | Pigs Total ('000 head) 11,141 12,412 14,742 16,217 15,893 19,021 Meat production ('000) 494 669 494 611 541 967 Sheep/goats Total ('000 head) 3,833 2,155 6,784 6,615 1,890 1,205 Meat production ('000) 18 20 29 34 80 70 Cattle Total ('000 head) 2,409 3,983 3,396 6,099 3,109 3,200 Meat production ('000) 80 25 70 30 50 40 Fisheries (freshwater culture) Area ('000 ha) 290.71 365.73 147.56 163.80 275.35 411.93 Production ('000 tons) 72.81 173.10 29.14 63.70 135.66 374.90  ANNEX 3 - 49 Table 2 CHINA THIRD RURAL CREDIT PROJECT Basic Data on Project Provlnces in t5a sorth Central Region Anhui Henan Hubel 1980 If8S 1980 1985 1980 1985 Population (million) Total 49.56 51.56 73.97 77.13 48.84 49.31 Rural 44.82 44.76 68.16 68.66 41.07 39.27 Rural labor force 16.70 19.74 25.05 29.39 15.52 17.00 Agricultural labor force 16.71 17.27 24.57 25.58 14.33 13.24 Land area ('000 ha) Sown area 7,743.54 8,190.23 10,793.66 11,691.24 7,480.80 7,335.33 Irrigated area 2,438.00 2,106.00 3,536.27 3,189.93 2,345.00 2,293.33 Income per capita (Y) 184.82 369.41 160.73 329.37 169.88 421.24 GVAO (Y billion) 8.88 19.82 15.35 24.15 9.41 19.23 Crop production Grain Area ('000 ha) 6,028.95 3,901.55 8,863.36 9,033.85 5,354.74 5,110.82 Yield (tons/ha) 2.42 3.67 2.42 3.00 2.87 4.34 output ('000 tons) 14,S540 21,680 21,485 27,105 15,365 22,161 Oil-bearing crops Area ('000 ha) 570.68 1,090.34 710.62 794.06 330.90 604.90 Yield (tons/ha) 0.87 0.96 0.65 1.35 0.62 0.98 Output ('000 tons) 498 1,457 462 962 206 730 Livestock Pigs Total ('000 head) 8,957 10,889 51,463 59,163 13,130 17,033 Meat production ('000) 255 473 1,643 2,766 292 544 Sheep/goats Total ('000 head) 2,018 1,474 10,886 8,768 7,468 7,239 Meat production ('000) 70 50 37 32 6 10 Cattle Total ('000 head) 3,795 4,859 9,173 9,396 5,407 7,321 Meat production ('000) 50 80 36 41 10 14 Fisheries (freshwater culture) Area ('000 ha) 5.93 12.00 148.49 164.27 46.73 58.73 Production ('000 tons) 5.40 13.50 52.36 129.00 15.16 26.50  CHINA THIRD RURAL CREDIT PROJECT ABC Organization in Six Project Provinces Guizhou Sichuan Yunnan Anhui Henan Rubei 1985 1986 1985 1986 WT5 1986 1985 1986 1985 1986 1985 1986 ABC Offices Provincial branch I I 1 1 1 1 1 1 1 1 1 1 Prefectural central subbranches /a 9 9 19 19 17 17 16 16 17 17 14 14 County subbranches 82 82 225 185 124 124 82 74 137 135 81 79 ABC units on state-owned farms 6 -/b 2 -- 49 -- 9 - 13 14 112 - Business departments of central subbranches 2 2 5 8 2 3 7 15 9 9 12 18 Business offices 589 586 1,633 1,784 1,356 1,345 705 801 2,044 2.212 1,056 1,259 Savings offices 8 122 674 1,045 21 33 27 228 124 561 94 495 Staff Numbers Provincial brancu 112 135 249 242 212 187 178 185 213 235 204 236 Prefectural central subbranches 422 477 1,433 1,472 744 756 818 814 1,395 1,389 995 1,111 County subbranches 3.440 3,581 10,720 8,117 4.778 4,436 4,011 3,369 8,516 6,360 5,244 4,368 ABC units on state-owned farms 6 - 2 - 215 - 60 - 74 - 775 - Business department of central subbranches 76 88 168 276 142 206 202 397 403 492 369 480 an Business offices 5,490 5,705 15,152 16,842 7,272 7,513 6,733 7,088 14,101 15,926 12,692 13,308