China - Third Rural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY C4Z /77/ ' - Report No. P-4615-CHA MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 123.8 MILLION (US$170 MILLION EQUIVALENT) TO THE PEOPLE'S REPUBLIC OF CHINA FOR A THIRD RURAL CREDIT PROJECT December 28, 1987 This document has a resticted distribution and may be used by recipients only in the perfonrance of their official duties. Its contents may not otherwise be disclosed without Wodd Bank authorzation.  CURRENCY EQUIVALENTS Yuan (Y) 1.00 = US$ 0.27 Y 3.7 = US$ 1.00 FISCAL YEAR January I - December 31 WEIGHTS AND MEASURES 1 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 = 2,205 pounds ABBREVIATIONS AND ACRONYMS USED ABC - Agricultural Bank of China SMCs - Supply and Marketing Cooperatives RCCs - Rural Credit Cooperatives  FOR OMCIAL USE ONLY CHINA THIRD RURAL CREDIT PROJEC. Credit and Project Summary Borrower: People's Republic of China Beneficiary: 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 4.5% and commitment fee of 0.5% p.a. From ABC to subborrowers: Interest at ABC's prevailing rates currently ranging between 7.2% and 10.8% p.a. Exchange risk to be borne by the Government, except that in cases where subloans are disbursed in foreigr. 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'8 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 to 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 consister with the ongoing reform of the financial system. At full development, the value This document has a restricted distribution and may be used by recipients only in the peffonnan --- -- of their offlicial duties. Its contents may not otherwise be disclosed without World Bak authorization.  - ii - of the 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 326,000 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 SLoborrowers 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: 24% Staff Appraisal Report: Report No. 6903-CHA /a About US$8 million of IDA credit e4uivalent 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 cost, correspondingly reducing ABC's contribution.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF CHINA FOR A THIRD RURAL CREDIT PROJECT 1. I submit the following memorandum and recommendation on a proposed credit to the People's Republic of China to help finance a Third Rural Credit Project. The Credit of SDR 123.8 million (US$170 million equivalent) would be on standard IDA terms with 35 years maturity. 2. Background. The proposed project would expand the availability of institutional credit in six of China's poorer provinces as a means to stimulate growth and diversification of agriculture. The six provinces include Guizhou, Sichuan, and Yunnan in the southwest and Anhui, Hubei and Henan in the north central region. Project funds would be channeled through the Agricultural Bank of China (ABC) in the form of medium and long-term loans to households and enterprises for the development of tree crops, livestock, aquaculture and agro-processing. The project would also provide technical assistance for ABC's institutional development to increase its operational efficiency. 3. Agriculture in China, including crops, livestock, forestry, and fisheries, provides sustenance to over one billion people, is the source of income fot some 190 million farm households, and accounts for about 35% of the country's GDP. Major reforms in farm policies since 1979, especially the shift from communal to household-managed farming, increases in farm prices, and enlarging the role of the market, have helped stimulate and diversify agricultural production. During 1980-85, Chini's agricultural production increased dramatically, by about 10% p.a. in comparison with the average of 3% p.a. over the past two decades. 4. The Government's main objectives in the agricultural sector continue to be to: (i) increase and diversify agricultural production to meet the requirements created by the expanding population; (ii) accommodate a continued shift in consumption patterns in response to increasing per capita incomes; and (iii) raise employment opportunities and incomes in rural areas. Given the shortage of arable land (0.1 ha per capita), the GCvernment's emphasis is on increasing the productivity of existing cropped areas, developing efficiently the remaining unutilized land, and promoting the growth of rural agro-processing and support services to achieve the above objectives. 5. The Bank Group's strategy for lending in China's agricultural sector has been to support the Government objecti-es outlined above (para. 4). Lending to date has included 14 operations involving a total assistance of about $1 billion for land development; support services including agricultural training, research, credit and seed production; development of specialized product subsectors including rubber, forestry and fisheries; and area development projects combining crop and livestock production, agro-processing and support services. Implementation of these projects is generally on schedule. Future Bank-Group lending would continue to support projects in large and diverse subsectors, e.g., water resources development, livestock, agro-processing, and rural credit which supports a broad range of activities.  6. The Bank Group involvement in the project would also assist in the Government's reform efforts in the financial sector, an area in which the Bank Group and Government recently reviewed the evolving processes of mobilization, intermediation, allocation of j7vestment resources, and the interrelationships of the various policy reforms._ Future reform measures in the sector 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, the financial institutions are expected to become more autonomous and responsible for their own profits and losses. The proposed project would contribute to the ongoing process of reshaping the role of the rural banking system in line with the changing financial sector environment. 7. ABC and its affiliated rural credit cooperatives (RCCs) are the main institutional sources of credit for the rural sector. Loans to date have been mainly short-term, for working capital purposes. Generally, ABC provides loans to Supply and Marketing Cooperatives (SMCs), county and township enterprises and specialized households. RCCs lend to village enterprises and individual farmers. Both ABC and RCCs are now attempting to respond to the increasing demand for credit, especially longer term investment funds, brought about by the shift from communal to household-managed farming (para. 3). Recent changes in the Government approach to enterprise financing have also increased the demand for longer term loans from ABC and RCCs. To ensure efficiency in resource allocation and cost recovery, an important element of the ongoing referms, the Government now requires that capital investments by enterprises should be increasingly financed by loans rather than by fiscal grants as in the pi-t. ABC and RZCs are in the process of taking on this additional function of development banking. To become effective in this new role, they will need to increase resources and expand the range of services, including provision of medium-and longer term credit, and upgrade staff skills, particularly in techniques of investment analysis. ABC's longer term lending and institutional development are being supported by the ongoing IDA- financed Rural Credit I and II Projects (Cr. 1462 and 1642-CHA) which are being implemented satisfactorily. The two Rural Credit Projects are also beginning to make 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. 8. Project Objectives and Description. The main objectives of the project would be (a) to stimulate growth and diversification of agriculture by expanding the availability of medium- and long- term credit, and (b) to increase ABC's operational efficiency through institutional development. The project would supplement ABC's resources for longer term loans to households, cooperatives, collective enterprises, state-owned enterprises, and state- collective partnerships for investments in tree crops, livestock, aquaculture, and agroprocessing. The project's technical assistance would be used for strengthening ABC's in-house training capability, and to conduct systems improvement studies of ABC and RCC operations. The project would also include a pilot program to introduce selected RCCs to longer term lending. 1/ The World Bank, "China: Finance and Investment", Report No. 6445-CHA dated June 11, 1987.  - 3 - 9. Credit Component. With the assistance from the provincial goveri,ments technical bureaus, ABC has developed an indicative investment program for the project (1988-92) in tree crops, livestock, aquaculture, and agro-processing in line with government strategies in agriculture (para. 4). The project would focus on making use of underutilized land, generally in remote areas, for tree crop development and pastures. Tree crops would chiefly include plantingfreplanting of rubber and rehabilitation of tea in Yunnan, planting of sumac trees for gallnut production in Guizhou, and orchard development for a variety of fruits in Sichuan, Anhui and Henan. Tea rehabil- itation would be financed on the ground that the project areas, located in poorer areas of Yunnan, have very limited alternatives to tea growing. As most tea 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 ereaLon which is a serious problem in the project area. Much of the incremental black tea production (20,000 tons) is likely to be consumed domestically and only marginal amounts would enter the export market with little long-term impact on world tea prices. 10. Livestock investments would focus on increasing the efficiency of pig production in Sichuan, Hubei, and Henan; pasture development for sheep raising for wool in Guizhou and cattle production in Guizhou and Henan; and goat production in Henan. The project would support construction of fish ponds mainly in Henan, Sichuan and Guizhou. The project-financed investment program would support establishment of storage and processing facilities for a wide range of products including fruits, oilseeds, rubber, tea, animal and fish feed, meat and other animal products, and fish and other aquatic products. 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. 11. ABC would use about $8 million equivalent of project funds to implement the RCC pilot program in Henan, Hubei, Anhui and Sichuan. The main focus 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 households and enterprises (para. 7). The main elements of the pilot program would be training of RCC staff in project appraisal and introducing a refinancing mechanism between ABC and RCCs. 12. Technical Assistance Component. The project would support ABC's institutional development mainly by implementing a staff training program and providing consultancy services for ABC's in-house studies in support of its systems reform activities. The staff training program would help ABC to upgrade the faculty and facilities at ABC's three national-level Senior Staff Colleges which in turn would train the teachers of lower level schools and management personnel in key subjects including project appraisal, market analysis, township and village enterprise management, modern banking practices and teaching techniques. Several new courses would be introduced and existing courses upgraded at the three colleges and staff training schools. Through improved instruction, ABC's provincial and lower level staff training schools would 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 including lending decisions.  -4- 13. The project-assisted studies would focus on the following topirs: ABC's loan approval policies and procedures, (including resources for longer term lending), subloan collect.on and write-offs, transac-ion costs of ABC lending, enterprise financing, increased deposit mobilization and institutional development of RCCs. In the past, banks in China opere'.ed essentially as fiscal agents facilitating and supervising the implementation of resource allocation decisions by the Government. In their new role, the banks would be responsible for mobilization of resources and aliocating those resources to activities which promise highest economic returns. The focus of the proposed studies would be to assist ABC in its ongoing systems reform effort to be able to fulfill this function effectively (para. 6). 14. Rationale for IDA supeort. The proposed project would continue and expand Bank Group support to ABC for modernization and diversification of agricultural production and processing for increasing rural productivity, employment and incomes (paras. 4 and 5). IDA funds would augment ABC capability to extend longer term loans, the demand for which is growing in the course of the recent economic reforms. Project support to ABC's institutional development would assist the Government in reshaping ABC's role conpistent with the current financial sector reform in which the Bank Group is actively collaborating with Chinese authorities (paras. 6 and 7). 15. Agreed Actions. Compared with IDA-assisted Rural Credit I ind II projects, the proposed project would be a much larger operation in terms of geographical coverage, size of the lending program, and the number of activities to be financed. The project's technical assistance component would also be much broader in scope than in earlier IDA-assisted operations, aimed at upgrading ABC's staff training institutions at both the central and local levels. To ensure effective implementation of the project, the Government and ABC have agreed to the following: (i) the Government would ensure that ABC receives at least a 2% spread (or such higher 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; (ii) 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. The first such review would be completed by December 1988; (iii) the Government would maintain Project Management Committees and ABC would maintain Project Offices for the six provinces during project implementation; (iv) the Government and ABC would implement the tea rehabilitation program in accordance with technical guidelines agreed to with IDA and complete the proposed reviews of gallnut and pasture development and sheep breeding programs in Guizhou by the end of 1989; (v) ABC would implement the RCC pilot program and review its implementation during 1989; (vi) ABC would appoint additional staff in the Head Office for project implementation; (vii) ABC would obtain the prior approval of IDA for subloans in excess of US$3 million; and (viii) ABC and Government would ensure that subproject activities would conform to appropriate guidelines on environmental control issued by the provinces and acceptable to IDA. The prior approval of IDA (item vii above) is intended to assist ABC to ensure that subloans which are large and/or involve new technology are properly appraised. Such subloans would account for about 15% of the project funds. In addition, subloans for $1 million and  above, involving about 30% of the project funds, would be reviewed by ABC Head Office and reported to IDA for monitoring purposes. This would provide adequate supervision by ABC and IDA over the project lending. 16. Benefits and Justification. At full development, the value of annual incremental output from project investments would be about $245 million per annim. The project would increase the production of higher value foods which are in short supply and for which demand is growing rapidly. The project would benefit directly some 150,000 families through increased production and incomes. The annual demand for labor would increase by about 92 million work days, equivalent to 326,C00 full-time jobs, thereby absorbing part of the surplus rural labor force. ABC would benefit from institutional strengthenirg through improvements in the efficiency of its overall operations including lending decisions. The financial rates of returrn (FRR) of the project components based on typical subprojects would range from 17% to 22%. Their economic rates of return would vary frrm 15% to 39%. For the project as a whole, the FRR and ERR are estimated at 20% and 24% .espectively. 17. Risks. No hajor risks are anticipated. The financial and economic analysis of typical investments indicates that the project could sustain significant increases in costs and reductions in revenues and still provide satisfactory rates of return. Institutional risks associated with channeling of longer term investment funds would be addressed through staff training and upgrading ABC's and participating RCCs' procedures for portfolio management. Only those RCCs which comply with minimum financial standards would parti- cipate in the project. Government's agreement that ABC and RCCs would receive a spread of not less than 2% p.a. (currently at about 2.5% p.a.) on project lending, would ensure that their transaction costs Pre fully covered. Adequacy of the interest spread to ABC and RCCs would be reviewed by the Covernment, ABC and IDA as necessary. All major subloans would be backed by local government guarantees to ensure technical support to project investments and assistance to ABC and RCCs in subloan collection. ABC's operations have been consistently in profit. Its financial condition and liquidity are monitored by the Ministry of Finance and the People's Bank of China. 18. Recommendation. I am satisfied that t'ie p:aposed Credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve the proposed Credit. Barber B. Conable President Attachments Washington, DC December 28, 1987  -6- Schedule A CHINA THIRD RURAL CREDIT PROJECT Estimated Costs and Project Financing Category Local Foreign Total.