China - Fourth Rural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY zZ L 4F2. - H 9 Report No. 8387-CHA STAFF APPRAISAL REPORT CHINA FOURTH RURAL CREDIT PROJECT OCTOBER 9, 1990 Country Department III Asia Regional Office Agricultural Operations Division This document has a resticted dtibutdon ad may be used by recmients only In the perfonuan of their officiiil duties. Its contents may not otherwise be discosed without Worid Bank authozation.  CURRENCY EQUIVALENT (Effective December 15, 1989) Yuan (Y) 1.00 - USS 0.21 Y 4.72 = US$ 1.00 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer = 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 AMC - Agricultural Bank of China AMP - Area Management Planning BOC - Bank of China BOCOM - Bank of Communications CDC - Citrus Development Center, Ganzhou CIB - China Investment Bank CITIC - China International Trust and Investment Corporation CREC - China Refrigeration Engineering Company DRI - Development Research Institute EPA - Environment Protection Agency FTC - Foreign Trade Corporations FSR - Financir. Sector Review IBRD - International Bank for Reconstruction & Development ICBC - Industrial and Commercial Bank of China MOA - Ministry of Agriculture MOF - Ministry of Finance NBFI - Nonbank Financial Intermediaries NGFAs - Non-governmental Financial Institutions ORREA - Office of the Rural Reform Experimental Areas PBC - People's Bank of China PCBC - People's Construction Bank of China PMCs - Project Management Committees PO - Project Office PU - Project Unit SAA - State Audit Agency SMCs - Supply and Marketing Cooperatives TCW - Tianjin, Wuhan and Changchun (ABC Training Institutes) TEG - Technical Expert Group TVEs - Township and Village Enterprises RCCs - Rural Credit Cooperatives  FOR OFFICIAL USE ONLY CHINA FOURTH RURAL CREDIT PROJECT Table of Contents Page No. Credit/Loan and Project Summary ............ .. ................. (iv) I. BACKGROUND .......... ................................ 1 A. Intruduction ........ ............................. 1 B. The Rural Sector ....... .......................... 1 C. Sectoral Objectives and Bank Group Operations ..... 3 D. Experience with IDA Lending through ABC .......... 4 E. Rationale for Bank Group Involvement .. ........... 5 II. AGRICULTURAL BANK OF CHINA (ABC). 6 A. Reform of the Banking System and ABC. 7 B. Rural Financial Market Reform. 9 C. ABC: Institutional Aspects .10 D. ABC Operations .12 E. Overview .17 III. THE PROJECT AREAS ..18 A. General .18 B. Climate and Land Use .19 C. Recent Agricultural Performance .20 D. Agricultural Support Services .21 IV. THE PROJECT .21 A. Objectives and Scope ...... ....................... 21 B. Project Features .22 C. Crops .22 D. Livestock .25 E. Fisheries .27 F. Agro-processing .28 G. Technical Assistance ................ ............ 29 H. Cost Estimates & Financing ....................... 30 I. Procurement .31 J. Disbursement .33 This report is based on the findings of a preappraisal mission and an appraisal mission which visited China during August and November 1989 respectively. The preappraisal mission included R. Deshpande. H. Kim, Bi Ming Jian (Bank Group) and C. Cronberg, R. Zweig, P. Gilchrist, Paul Liou, W. Baier, and E. Bayer (Consultants). The appraisal mission comprised of R. Deshpande, H. Kim, W. Wickrema, Bi Ming Jian (Bank Group) C. Cronberg and D. Sheehy (Consultants). H. Eisa, W.P. Ting and L.S. Tay (Bank Group) assisted the mission in the review of selected subprojects. Mr. Hong Gao (Consultant) assisted in the financial and economic analysis. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  (ii) V. PROJECT IMPLEMENTATION .............................. 34 A. Project Organization & Management .... ............ 34 B. Institutional development ..... ................... 37 C. Subproject Implementation ..... ................... 38 D. Project Beneficiaries ...... ..................... 38 E. Onlending Terms and Conditions ..... .............. 40 F. Accounts & Audit ................................. 42 G. Monitoring, Evaluation and Reporting .... ......... 43 H. Environmental Effects ...... ...................... 43 VI MARKETS AND PRICES ....... ........................... 44 A. Market Prospects ................................. 44 B. Marketing Channels ...... ......................... 46 C. Prices ........... ................................ 47 VII BENEFITS, JUSTIFICATION AND RISKS . .48 A. Production & Benefits .48 B. Employment, Income & Poverty Alleviation 49 C. Environmental Benefits .50 D. Financial Analysis .50 E. Economic Analysis .51 F. Project Risks .52 VIII AGREEMENTS REACHED AND RECOMMENDATION .52 TABLES IN THE TEXT 4.1 Project Cost Summary 4.2 Procurement Arrangements ANNEXES ANNEX 1. Table 1: Structural Change in the Rural Economy, 1982-88 ANNEX 2. Table 1: Structure of the Financial System (1988) Table 2: ABC Organization - National and in Project Areas Table 3: Interest Rates on Deposits, Bonds and Interbank Operations, 1982-90 Table 4: Interest Rates on Loans, 1982-90 Attachment 1: Financial Appraisal of ABC Table 5: Consolidated Balance Sheet of ABC, 1986-89 Table 6: Coirsolidated Income Statements of ABC, 1986-89 Table 7: Maturity Structure of ABC's Loan Portfolio Table 8: ABC's Loan Collection Performance, 1986-88 Table 9: Cunsolidated Balance Sheet of ABC's project branches, 1986-88 Table 10:Consolidated Income Statements for ABC's project branches, 1986-89  (iii) Table 11: Consolidated Balance Sheet of RCCs, 1986-89 ANNEX 3. Table 1: Basic data on Inner Mongolia, Jilin and Liaoning Table 2: Basic data on Shaanxi, Jiangxi, Guangdong, and Beijing Table 3: Basic data on Hubei, Hunan, Fujian, and Guangxi ANNEX 4. Indicative Investment Program (by activity and province) ANNEX 5. Technical Guidelines: Apple Planting and Rehabilitation ANNEX 6. Technical Guidelines: Citrus Development in Jiangxi and Guangdong ANNEX 7. Technical Guidelines: Green Tea Rehabilitation in Jiangxi ANNEX 8. Pasture-based Livestock Development: Area Management Planning (AMP): Concept and Organizational Arrangements ANNEX 9. Technical Assistance for InstituLional Development of ABC ANNEX 10. Estimated Disbursement Schedule ANNEX 11. Onlending Terms and Conditions and Criteria for Subloan approval ANNEX 12. Table 1: Farm Gate Prices for Trade Inputs Table 2: Selected Conversion Factors ANNEX 13. Financial and Economic Rates of Return and Sensitivity Analysis of selected subprojects (Tables 1 to 11) ANNEX 14. Documents and Data Available in the Project File CHARTS Chart 1: ABC's national organization Chart 2: ABC Head Office Organization Chart 3: Organization for Project Implementation Chart 4: Implementation Schedule MAPS IBRD 22151 IBRD 21792 IBRD 21793 IBRD 22129  (iv) CHINA FOURTH RURAL CREDIT PROJECT Loan/Credit and Project Summary Borrower: People's Republic of China Beneficiary: Agricultural Bank of China (ABC) Amount: IBRD Loan: US$ 75 million equivalent IDA Credit: SDR 143.7 million (US$ 200 million equivalent) Terms: IBRD Loan: Repayable over 20 years including five years of grace, at the Bank's standard variable rate IDA Credit: Standard, with 35 years maturity Onlending Terms: (i) From Government to ABC: 15 years, including five years of grace. On proceeds of Bank Group funds onlent to ABC in foreign exchange, government to charge interest at the prevailing IBRD rate or such other market-based rate acceptable to the Bank Group; and on Bank Group funds onlent in Renminbi, at a non-subsidized rate which shall be based on ABC's weighted average interest costs of long-term domestic funds (currently at about 8Z); commitment fee on IBRD Loan and IDA Credit (if any) to be borne by ABC; (ii) From ABC to subborrowers: Interest at ABC's prevailing rates currently ranging between 9.362 to 13.42 for one to ten year loans; and 15-17Z for 10-12 year loans; when ABC uses RCCs, RCCs' prevailing interest rates which are slightly higher than ABC rates, will apply; interest spreads to ABCIRCCs on project lending of at least 2.5Z p.a. (after payment of income and adjustment taxes); subloan interest rates to remain positive in real terms;l/ (iii) Exchange risk: On proceeds of Bank Group funds onlent to ABC in foreign exchange, ABC to bear exchange risk; on subloans disbursed by ABC in foreign exchange, ABC to pass on the exchange risk to subborrowers; Proiect Obiectives and Description: The main objectives of the proposed project would be: (a) to stimulate growth and diversification of agriculture by financing investments by farmers, collectives, and enterprises; and (b) to promote efficiency of rural financial intermediation through introduction of sound, market-oriented policies, and development of the main institutions concerned with rural savings mobilization and lending. ABC would use the project funds to provide subloans to expand production of commercial agricultural products including crops, livestock and fisheries, and for agroprocessing and 11 PBC prescribed rates effective as of August 21, 1990.  (v) marketing facilities mainly in the Autonomous Region of Inner Mongolia, five provinces of Shaanxi, Liaoning, Jilin, Jiangxi and Guangdong, and Beijing municipality where ABC has already appraised a substantial part of the lending program. ABC would also use a part of the Bank Group assistance in other areas, mainly those covered by earlier IDA-assisted credit projects Including Guangxi Zhuang Autonomous Region and the provinces of Fujian, Hunan and Hubei. ABC's lending program would be flexible so that it could change in response to subproject appraisals including market and credit risk analysis. The proposed project would also provide technical assistance to ABC to continue its institutional development, focussing on broader issues in financial management, loan policies and procedures, management information system, and human resource development, and make important contributions to special emphasis areas including environment protection and poverty alleviation. Benefits and Risks: At full development, the value of the project's incremental output would be about $600 million per annum. The project would help reduce seasonal unemployment and underemployment by generating equivalent of 90,000 full-time jobs. No major risks are anticipated in project-assisted investments and steps would be taken to reduce institutional risks in lending operations. Estimated Costs: Local Foreign Total ------- (US $ million)------ Crops 130.2 32.6 162.8 Livestock 113.4 28.4 141.8 Aquaculture 63.8 5.5 69.3 Agroprocessing & Mktg. 121.2 51.9 173.1 Technical Assistance 1.2 1.8 3.0 Total 429.8 120.2 550.0 Financing Plan: IBRD 42.2 32.8 75.0 IDA 112.6 87.4 200.0 ABC/RCCs 110.9 0.0 110.9 Subborrowers 164.1 0.0 164.1 Total 429.8 120.2 550.0 Estimated Disbursements: FY 1991 1992 1993 1994 1995 Annual: 30.0 50.0 70.0 70.0 55.0 Cumulative: 30.0 80.0 150.0 220.0 275.0 Sconomic Rate of Return: 27?  CHINA FOURTH RURAL CREDIT PROJECT I. Background A. Introduction 1.1 The Government of China has requested an IBRD loan of US$75 million equivalent and an IDA Credit of SDR 143.7 million (US$200 million equivalent) to finance a Fourth Rural Credit Project proposed by the Agricultural Bank of China (ABC). In line with the earlier three IDA-assisted operations with ABC, the main objectives of the proposed project would be to stimulate growth and diversification of agriculture by financing profitable investments by households, collectives and enterprises, and to promote efficiency of rural financial intermediation through introduction of sound policies and development of the main institutions concerned with rural savings mobilization and lending. The project would finance mainly investments in production and processing of high value-added food products in accordance with profit-oriented decisions by local entities, based on recognized local comparative advantage. The project would be placed through ABC in the context of an ongoing broader dialogue with the government on financial sector policy and development, and would support ABC to increase its institutional capabilities for undertaking financial intermediation for real sector development more efficiently. B. The Rural Sector 1.2 For the past decade, China's rural sector witnessed impressive growth and structural change as a result of a package of economic reforms including the introduction of the well-known production responsibility system (PRS), increased producer prices and the enlarged role of the market (Annex 1. Table 1). During 1980-88, the rural economy grew by more than 10X p.a. or at least three times the average rate for the previous 25 years. China's agriculture (including crops, livestock, forestry and fisheries) provides sustenance to over one billion people and is a major source of income to some 190 million farm families. Since only about 137 million ha 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. Foodgrains account for about 80Z of the crop land and about 65Z of the total output. This intensive system of food production has allowed China to meet the basic food requirements of its population (about 22Z of the world's total) from less than 11Z of the world's arable land. 1.3 While economic reforms have significantly revitalized the agricultural sector, the government's central concern in recent years has been stagnating grain production, which peaked at 407 million tons in 1984 (rising from 305 million in 1978), declined to 371 million tons in 1985, and which has thereafter ranged between 391-407 million tons. Adverse weather conditions and stronger incentives to farmers to produce high-value nongrain crops, contributed to this decline. Recent government strategies have focussed on stabilizing grain production through irrigation expansion and rehabilitation, and introducing partial reforms in grain procurement, distribution, prices and subsidies. Local governments in particular have also placed high priority on investments in uplands, natural pastures, and water surfaces for expanding production and productivity of nonstaple food and  2 commercial crops to meet the growing demand for these commodities, increase local entity profits and farmer incomes, and help alleviate the pressure on the demand for grains. Unlike in the past, government policy increasingly emphasizes that cropping must be commercially oriented and matched with local agro-ecological conditions. This has enabled China to achieve significant increases in the sown area, productivity and output of major industrial crops including cotton, oilseeds, fibers, silk and tea. Production of all major fruits including apple, citrus, and pears has also recorded remarkable increases. 1.4 During the past decade, China's livestock production (pork, poultry, beef and mutton) has more than doubled from 7.8 million tons to over 20 million tons. Livestock accounts for about 27Z of the Gross Value of Agricultural Output (GVAO) in 1988 compared to 15% in 1978. Besides producer incentives provided by the economic reforms, this growth was made possible by breed improvement, increased feed supply (through increased grain production), construction of processing and market infrastructure and an improved network of veterinary services. Farmers are increasingly recognizing the benefits of scientifically formulated feed. However, feed supply has lagged behind demand especially in corn deficit provinces in the south. This underscores the need to increase livestock production in the northeast to limit exposure to high feed costs, and also alleviate the current constraints to transporting corn from surplus regions of the northeast to the south. The government also attaches high priority to the rehabilitation and modernization of rangeland livestock production to reduce demand pressures on feedgrain, and relieve the high incidence of poverty in the rangelands. 1.5 China is the largest producer of freshwater fish in the world and the third largest fishing nation after USSR and Japan. Increases in marine production have been achieved through innovative use of undeveloped inshore resources, exploitation of new fishing grounds, development of high-sea and ocean-going fisheries and artificial propagation of natural fishery resources. Major strides have been made in expanding production of its culture fisheries (from 1 million tons in 1978 to 4.4 million tons in 1988) by integrating fish farming with animal husbandry, forestry, and grain production and by introducing cage culture in large and medium-size lakes and rivulets. China's coastline, which provides 10 million ha of tidal mud flat land is still marginally exploited (600,000 ha) and affords vast scope to expand production of domestic species of prawns, scallops, and shell fish. Much emphasis is being given to increase the proportion of high value fish in total production, and develop fisheries in remote areas where fisheries infrastructure is weak. The fisheries contribution to China's exports (about US$ 1 billion in 1989) is increasing, dominated largely by prawns and shell fish. 1.6 China's agroindustrial enterprises generally process their own or locally available raw materials from crop farming, livestock, fisheries and forestry products to realize the benefits of value added by serving both domestic and export markets. Some of the township and village enterprises (TVEs) have developed industrial production such as manufacturing of construction materials, textiles, food processing, carpet weaving, and leather processing. The improved policy environment since 1979, especially the relaxed restrictions against nongovernmental or private enterprises (an outgrowth of the production responsibility system) contributed to a phenomenal growth of China's rural nonfarm commercial activities and rural industry. The TVE sector's dynamism is reflected in its ability to take advantage of market opportunities, diversity in institutional arrangements and  3 flexible management, competitiveness vis-a-vis the state sector, outward orientation in terms of product markets, and strong community ties through ownership and other linkages with local governments. An adequate legal and regulatory framework for enterprise organization, management and operations is, however, still in the process of evolution. C. Sectoral Objectives and Bank Group Operations. 1.7 Given China's shortage of arable land (0.1 ha per capita), development planners have focussed on the need to increase the productivity of existing cropped areas and develop efficiently the remaining underutilized land. Steps are being taken to stabilize grain output, increase production and quality of animal feed, livestock, fruit, and industrial crops, and promote agroprocessing to raise value- added in the farm sector. In developing agroindustry, the government emphasis is on introducing modern technology appropriate for domestic and export markets, promote more efficient use of by-products, ensure protection of the environment and create more nonagricultural jobs in rural areas to increase and sustain rural incomes and alleviate poverty. 1.8 The Bank Group's lending to China's agricultural sector is designed to support Government efforts to raise and diversify agricultural production through more efficient use of land, water and labor resources and through improvement of support services such as credit, research and agricultural education. Bank Group agricultural lending to date has comprised 26 operations amounting to $2.6 billion and has covered the full spectrum of geographic areas and subsectors, with an overall focus on land development, irrigation, and drainage (5 projects), upgrading agricultural support services including agricultural research, education, credit and seeds improvement (7 projects), developing specialized subsectors including forestry, rubber, livestock, fruits, and fisheries development (8 projects) and area development projects (5 projects). In recent years, the Bank Group has supported a series of provincial development projects in which an area development approach is being applied, with responsibility for proposing and preparing the investment proposals and repaying project funds resting with provincial and lower level governments, thus supporting the increasing delegation of development planning and implementation. The rural sector adjustment loan (Cr. 1932 CHA/Ln. 2967 CHA), which was processed during 1988 (since completed), contributed to the articulation and strengthening of the reform process. 1.9 Implementation of most ongoing Bank Group assisted projects in the agricultural sector is on schedule. Physical works have been completed on time or ahead of schedule. Disbursements for agricultural projects in China generally outpace those in other countries and sectors. Notable features of all the projects are the high standards of project management, enthusiastic participation of farmers and the effective collaboration of government authorities at all levels. Two projects which supported land development and agricultural intensification (North China Plain Agriculture Project (Cr. 1261 CHA) and Heilongjiang Land Reclamation Project (Loan 2261/Cr. 1347 CHA)) and the First Rural Credit Project (Cr. 1462 CHA: para. 1.11) have been completed. The pro4ect completion reports for the two land development projects indicated that project implementation was successful, the economic rates of return reached or exceeded the appraisal estimates, and the technology used for land development and drainage was sound and appropriate for wider application.  4 D. Experience with IDA Lending through ABC 1.10 Rural Credit I, II and III projects (Cr. 1462, 1642, and 1871-CHA) were designed to supplement ABC's longer term resources and assist in expanding medium- and long-term lending to farm households and enterprises for investments in crops (mainly tree crops), livestock, aquaculture and agroprocessing. The projects also provided technical assistance for ABC's institutional development with a focus on et,abling it to respond efficiently to its changing role from a fiscal agent of the government to a more autonomous financial institution responsible for resource mobilization and allocation. Implementation of the three projects has been satisfactory. l/ 1.11 Rural Credit I Project (FY84, $50 million) which financed ABC's credit program in Guangxi Zhuang Autonomous Region, was fully disbursed in November 1988, about six months ahead of the appraisal estimate. The IDA supervisions and the project completion report (PCR) prepared by ABC and IDA, indicate that this project made a significant contribution to the region's economy through increased production, employment and incomes, and to Guangxi ABC's institutional development. With this project, ABC introduced in Guangxi province internationally accepted techniques of financial and economic analysis through a Project Appraisal Manual prepared by ABC with assistance from IDA. ABC later used this manual for Rural Credit II and III projects and as a teaching material in its national training institutes. The project also helped Guangxi ABC to secure local technical bureaus' assistance in introducing sound technical standards and extension support for ABC- financed investments, and upgrade credit management techniques including subproject supervision, follow-up, and risk management. The project financed training of some 11,200 staff in investment appraisal techniques, monitoring and evaluation (M & E), accounting, and general banking, with about forty staff receiving overseas training. The financial rates of return for project-assisted investments, recalculated for PCR, were close to the appraisal estimate of 25%, while ERRs ranged between 17Z-26Z, slightly lower than the appraisal estimate of 27Z due to changes in international prices of some of the project inputs and outputs. ABC's subloan collection performance under Rural Credit I project has been higher than that for its lending outside the project: with collection of principal due exceeding 100Z (ranging between 942 for agroprocessing, 115% for livestock, and 135-1402 for crops and aquaculture). Overall, Rural Credit I was a successful project with considerable demonstration effects on branches in other provinces. 1.12 Rural Credit II project (FY86, $90 million) assisted ABC's lending in the provinces of Hunan and Fujian and provided technical assistance for staff l/ A similar type of project assisted by an International Fund for Agricultural Development (IFAD) loan of $25 million (FY84) was implemented by ABC in Hubei province. The project was completed in November 1989. A final supervision report and PCR prepared by the Bank Group noted that both real sector and institutional development components of the project were successfully implemented. The project's institutional development component focussed on improved subproject appraisal and management from which ABC's other lending outside the project also benefitted. The PCR concluded that future rural credit projects should focus on upgrading ABC's overall financial management and lending program planning.  5 development in the two provinces. This project, as for Rural Credit I, is likely to be fully disbursed about six months ahead of the appraisal estimate (December 1990). Major investments financed included fruit, coastal and inland fisheries, feed mills and other agroprocessing activities needed by local economies. As in Rural Credit I, the project encouraged local technical bureaus to strengthen support services to farmers and ABC to improve its subproject appraisal. 1.13 The Rural Credit III project (FY88. $90 nmillion) is much broader in geographical coverage (six provinces of Guizhou, Sichuan, and Yunnan in the southwest and Anhui, Henan and Hubei in north central region), as well as in the scope of the institutional development component. It is financing investments in tree crops (rubber, tea and fruits), livestock (pigs, cattle, sheep and goat), fisheries (mainly cage fisheries) and a broad mix of agroprocessing investments. The institutional development program focuses on strengthening ABC's nationwide, in- house training capability through training of trainers at ABC's national and lower level colleges, and training of project-related staff in the six provinces. The project has also supported preparation of technical manuals on sheep production and agroprocessing; and studies in ABC operations and system reforms (including deposit mobilization, credit planning, lending policies and procedures, enterprise financing, transaction costs of ABC lending, development of rural credit coopetatives) which have been used for designing the institutional development component of the proposed project. Concurrently with these studies, ABC also completed a nationwide review of its loan portfolio to establish a basis for improved financial management. 1.14 Experience with the first three Rural Credit projects showed that ABC's mainstream credit departments should be involved more actively in project implementation instead of leaving this task entirely to its International Business Department, to increase the project's impact on ABC's overall institutional development; ABC should build up core technical capabilities within its organization or have access to independent consultant services, to upgrade the quality of technical supervision of subproject implementation instead of relying entirely on government technical bureaus; and ABC should have greater flexibility and authority to change subloan interest rates to ensure that they remain consistent with general increases in interest rates in the economy, and positive in real terms. These aspects are being addressed through the ongoing Rural Credit III and the proposed project. E. Rationale for Bank Group Involvement 1.15 ABC is a specialized bank for China's rural sector, undertaking mainly commercial banking functions. Through its nationwide network of branches and business relationship with township level rural credit cooperatives (RCCs), ABC has the capability of reaching deep into rural areas for resource mobilization and real sector development. Using this unique status, ABC is in the process of increasing its long term lending for rural sector development. Also, as a part of ongoing developments, the role of the government budget in financing commercial investments in agriculture and agroindustry (among others) is rapidly decreasing, with the banking system assuming a predominant role in the mobilization of financial savings  6 and channeling of those savings to efficient investments. 2/ Accordingly, ABC is introducing a series of system reforms and human resource development programs to increase its capabilities to expand and efficiently administer investment credit, in addition to its traditional commercial banking functions including provision of short-term working capital loans. The past IDA-assisted projects are assisting ABC in this effort by introducing financial, economic, technical and enterprise appraisal criteria in provinces chosen for project implementation and to rapidly spread their use in ABC's entire organization through training of trainers in national and provincial institutes, and of senior credit staff (para. 1.13). ABC being mainly a commercial bank with expanding resources, it has the capacity to provide a portion of deposit funds for longer term investment lending (currently about 152), and also the financial resilience needed to manage a long term loan portfolio. ABC thus provides itself as a satisfactory financial intermediary for Bank Group assistance, both for rural financial sector development and real sector development. ABC is also an important institution for the Bank Group-assisted agricultural development projects other than credit projects, in which ABC is usually responsible for management of project funds and cost recovery. 1.16 The Bank Group has been assisting China, through sector work and lending operations, in developing a coherent strategy for financial sector development. 3/ The Bank's recent Financial Sector Review report (June 1990) recommended institutional development of specialized banks as one of the key areas that must be addressed, which this project aims to do for ABC and its affiliate rural credit cooperatives (RCCs). As for the project's investment program, the Bank Group assistance would support diversification and productivity improvements in agriculture and agroindustry, with emphasis on technology transfer, environment protection, export promotion, employment creatiun, increasing rural incomes, and poverty alleviation. II. AGRICULTURAL BANK OF CHINA A. Reform of the Banking System and ABC 2.1 Background. The Agricultural Bank of China (ABC) was reestablished in 1979 to take over rural banking functions from the People's Bank of China (PBC). This was the first major initiative which the government took to begin restructuring of the country's monobank system which was organized in the 1950s to serve the specific needs of a centrally planned economy. Under the monobank system, the PBC 2/ The proportion of bank loans in financing China's domestic fixed investments (including investments by SOEs, collectives, and individuals), increased from 12.72 in 1981 to 20.3Z in 1988 and that of budget declined from 28.1? to 9Z. The share of retained earnings and extrabudgetary funds increased from 55.5Z to 65Z. 3/ The World Bank, "China: Finance and Investment' and "Financial Sector Review: Financial Policy and Institutional Reforms", Reports Nos. 6445 dated June 11, 1987 and 8415-CHA dated June 29, 1990. The main recommendations of the recent Financial Sector Review are discussed in Chapter II, para. 2.4.  7 and two other specialized banks, namely the Bank of China (BOC) and the People's Construction Bank of China (PCBC) acted primarily as fiscal agents (cashiers) to the Government, transferring budgetary funds to state enterprises in accordance with the state plan. Clearly, this narrow role was unsuited to the government's new economic reform program which focussed on decentralizing investment decision-making, and shifting much of the budgetary (grant) financing to bank (loan) financing. The government, therefore, began in 1979, but more concertedly since 1985, the reform of the banking system to expand its role in resource mobilization and allocation. 4/ 2.2 Generally, the government's banking refonms aimed at establishing the role of the People's Bank of China (PBC) as the central bank of the country with responsibility for monetary policy and for supervisory powers over retail banks previously administered by MOF; at greater competition among the specialized banks to improve efficiency of their operations; opening new full service banks and trust and investment corporations to broaden the financial market; improving the range of financial services, instruments and access to clients; and initiating a process of transforming the specialized banks from government administrative organs into enterprises fully responsible for their profit and loss. 2.3 The scope of the banking reforms has been wide-ranging although their impact on raising the overall efficiency of the banking system has yet to achieve its full potential. In 1981, the government established the China Investment Bank for financing industrial enterprises. 5/ In 1984, coinciding with the launching of the industrial reforms, the government established another specialized bank, the Industrial and Commercial Bank of China (ICBC), to take over PBC's urban banking functions, as ABC did in 1979 in regard to rural banking functions (Annex 2, Table 1). This was followed by the establishment in 1987 of two multi-functional banks (BOCOM and CITIC Industrial Bank). Investment banking and trust operations which started in 1979 with CITIC have significantly expanded since, with 15 regional and some 600 smaller financial corporations now operating in the country. Along with 61,000 rural credit cooperatives (reorganized in the 1950s) as the main banking institutions in the countryside, the government has permitted households and enterprises to establish cooperative banking institutions in urban areas to supplement the services provided by the specialized banks. Some 3300 urban credit cooperatives have so far been set up in major cities. Besides this major structural expansion and diversification, the specialized banks (including ABC) introduced, during the past six years, new financial instruments such as bonds, stocks, certificates of deposit, commercial bills (in selected cities), and inter-bank and inter-branch borrowings for developing regional and national money markets. 2.4 Recent Bank Group Review of China's Financial Sector. The Bank Group's recent Financial Sector Review (FSR) indicated that the steps taken during 1978-89 helped the emergence of a broader financial market providing alternative financing sources for government, enterprises, households, and financial institutions. Taken 41 For a discussion on China's financial sector reform, see Bank Group reports referred in para. 1.17. 5/ CIB has been an implementing agency for five industrial credit projects involving total Bank Group assistance of $945.6 million (Ln./Cr. 2226/1313, 2434/1491, 1663/2659, 1763/2783 and Ln. 3075)  8 together, the reforms have helped to provide alternatives, first to budgetary financing of enterprises and, second, to the reliance of enterprises on the specialized banking system. However, the ten years of reform and deepening have been less than fully successful in changing the bank-only structure of the financial system and in fostering competition among financial institutions. Although the role of interest rates in resource mobilization and allocation has considerably increased since 1979, the annual investment and credit plans still remain the main vehicle for credit allocation. Additional reforms are needed to enable banks to become full financial intermediaries, in the following key areas. (a) The Banking Law. A comprehensive banking law should be introduced defining the operations of all institutions in the financial sector including the central bank (PBC), specialized and other banks, Trust and Investment Corporations (TICs) and other intermediaries. This law should also focus on prudential regulations to ensure safety, soundness and stability of the financial system; (b) Strengthening Bank Management. The second major area essential for sectoral development is the strengthening of bank management which should be achieved through clearly defined financial objectives linked to management incentives, greater autonomy over lending decisions and greater flexibility in the establishment of interest rates on loans and deposits, and further strengthening of credit rist; management, internal audit, and financial management including replenishment of bank capital to enable the write-off of accumulated bad debts. (c) Competition and Mix of Financial Institutions. Competition is another important ingredient of financial sector development, which can be enhanced by increasing the range of financial services offered by the sector, and by allowing entry of new institutions into the financial system through removing intra-industry entry barriers. In order to expand the financial sector in a safe and sound manner, sufficient prudential regulation and supervision would be essential. (d) Monetary, Credit and Interest Rate Policies. To achieve its growth and inflation objectives, monetary policy tools should be further strengthened. Specifically, the scope of credit plans should be substantially broadened to cover all sectors of the economy including the government; over time, credit ceilings and controls should be replaced by further reliance on indirect methods such as interest rate and reserve ratio changes; while at the present time, it is not feasible to replace the existing system of administered rates by a system based on market rates, further improvements in the levels and structure of interest rates should be introduced to promote greater demand for financial instruments and improve allocative efficiency; interest rates (both for deposits and loans) should be adjusted more automatically and regularly, on the basis of inflation trends and expectations; lending rates should provide adequate spreads over the banks' cost of funds; and differences among interest rates for different purposes and maturities should be rationalized to avoid creating distortions in resource allocation. In response to these Bank Group recommendations, MOF and PBC, the main agencies responsible for financial sector development, have begun preparation of a technical assistance project for Bank Group assistance, which is expected to focus on reforms in six specific areas including the payments system, bank supervision, accounting of financial institutions, legal framework for banks, strengthening of PBC's research department and PBC's fiscal agency and market regulation role.  9 Against this background, the proposed project would be placed through a financial intermediary in the context of a broader sector dialogue with the government while advancing important sustainable development programs in agriculture. The project was thus appraised keeping in view the financial sector review findings; and its financial covenants and technical assistance component have been designed to advance the review's recommendations as they pertain to ABC. B. Rural Financial Market Reform 2.5 Rural Financial Institutions. Recent banking reforms have benefitted the urban sector more than the rural sector. Some of the major reforms have been introduced mainly in larger cities and selected regions (special economic zones). leaving a large part of the rural financial system still untouched. ABC with its nationwide network of branches down to township level, and affiliate RCCs which operate at the township level and below (para. 2.3) continue to be the principal constituents of China's official rural financial system. RCCs, which are collectively owned by farmers, play a pivotal role in providing banking services to rural households. 6/ Over 80% of all farm households have become RCC members. RCCs accept savings and time deposits and lend to individuals and rural enterprises. Deposits of individual farmers with RCCs have risen very rapidly reflecting the growth in rural incomes and now account for 82% of RCC's total deposits of Y149 billion. RCCs are required to redeposit about 12-20% (reduced from 20-30Z over the past three years) of their total deposits with ABC as a reserve against their deposit liabilities; as of December 31, 1988, RCCs' reserve deposits with ABC amounted to Y28 billion (8% of ABC's total resources), and together with RCCs' deposits of surplus funds (Y29 billion), RCC system's total funds with ABC amounted to Y57 billion (38Z of RCCs' total resources and about 17% of ABC's total resources). 7/ 2.6 China's rural financial market, however, is rapidly becoming dualistic in nature with the emergence of informal monetary transactions between households and enterprises, and establishment of nongovernmental financial associations (NGFAs) or credit unions which accept deposits from and provide credit to their members. In China, informal (noninstitutional) credit transactions in the form of usury are illegal. However, with the spread of economic reforms, especially the shift from the communal to the household (family) production system, and the establishment of numerous TVEs and private businesses, the demand for financial services (deposit taking and provision of credit) has enormously increased, which the official rural financial system (ABC and RCCs) have been unable to fully satisfy despite their major expansion and diversification. The Bank Group has been assisting China in the review of two Regional Reform Programs for NGFAs, through the Rural Sector 6I The current status of the RCC system and ABC's role in RCC development are reviewed in Annex 9 and the consolidated Balance Sheet of the RCC system is given in Annex 2, Table 11. 7/ Provisional data indicate that as of December 31, 1989, RCC deposits with ABC at Y65.8 billion accounted for about 25Z of RCCs' total deposits and 17% of ABC's total resources.  10 Adjustment Loan (para. 1.8). 8/ These experiments have indicated that to develop a viable non-governmental financial market, it is required to establish a legal framework for registration, ownership and management of NGFAs. The Bank Group will continue to monitor and advise on this process through rural financial sector work and lending operations with the government, but it would obviously require some time for China's NGFAs to become suitable intermediaries for large-scale agricultural development programs. The government has agreed to carry out with the Bank Group, a study of rural investment and finance as a part of this project (para. 4.26). C. Agricultural Bank of China: Institutional Aspects 2.7 Objectives and Functions. ABC is a national institution, with the main task of mobilizing rural savings and provision of loans for agriculture and rural development. It is the second largest specialized bank accounting for over a quarter of the total assets of all the specialized banks (Annex 2, Table 1). ABC acts as a banker and financial agent to the national and lower levels of the government, and manages state funds allocated for agriculture, including for procurement of grains and other products for the government and management of major poverty alleviation programs. In addition, under the authority delegated by PBC, ABC supervises RCC operations and manages their deposit reserve funds. ABC provides financial guidance to collectives and TVEs, and supervises their cash and working capital management. With the reduced role of the government budget in financing investments of a conmercial nature, rural enterprises are increasingly relying upon ABC to provide longer term loans to them for financing fixed assets and machinery and equipment. 2.8 Organization, Staffing, and Training. ABC is represented at all administrative levels down to townships (Chart 1). At the end of 1988, ABC had 29 provincial (or equivalent level) offices with the Head Office located in Beijing; 303 central subbranches at the prefecture level; 209 business offices in major urban centers; 2173 subbranches at the county level; about 30,045 business offices at the township level; and 17,182 savings offices mainly in townships and villages, state farms, and enterprises financed by ABC. ABC plans to convert its Head Office and provincial level branch offices, which currently function mainly as administrative offices, into regular banking offices primarily to provide improved access to lower level branches to broader financial markets, to undertake foreign exchange business, and to tap urban deposits (Annex 2, Table 2). 2.9 ABC functions under the general administrative guidance of MOF which is the sole contributor to its equity (capital or credit funds). On monetary policies including credit planning and interest rates, ABC is governed by the policies set by PBC. ABC's Head Office is primarily responsible for formulation of national and regional policies and procedures concerning ABC's business including credit planning, resource mobilization, loan approval and collection, accounting and audit, consolidation of balance sheet and income and expenditure accounts, profit allocation, staff training and computerization. ABC HQ staff often visit the provincial and lower level offices and actively participate in the local reviews concerning ABC's business goals and operations. Provincial and prefecture level 8/ The World Bank, "China: Rural Sector Adjustment Loan", Loan Implementation Volume (II), Working Paper No. 7: A Review of Rural Financial Markets and Institutions.  11 branches play a crucial role in ABC operations: these offices are responsible for preparing business goals for areas under their jurisdiction and liaising with local governments for credit planning, resource mobilization, grain procurement plans, rural development funds management, and supervision and auditing of the county and lower level offices which handle most of ABC's banking business. 2.10 ABC's Head Office has 18 main departments, including Agricultural and Commercial Credit; Industrial Credit; Planning; Funds Mobilization; Finance and Accounting; Personnel; Staff Training; General Administration; Audit and Supervision; Systems Reform; Research; International Business; and Trust and Investment operations (Chart 2). Organized along the lines of the Head Office, the provincial and prefecture level offices have fewer departments depending upon the local needs. Z.ll ABC operates under the direction of a president who is generally chosen from among the presidents of ABC's provincial branches. He is assisted by the President's Council comprising himself and Vice Presidents (4). Most policy decisions are taken collectively in the President's Council. The President's appointment is made by the State Council on the recommendation of MOF; he usually has the rank of a deputy minister. According to government employment regulations, provincial ABC Presidents are formally appointed by local governments but these appointments require prior approval of ABC headquarters. 2.12 To handle the expanding volume of business, ABC staff has increased from about 387,000 in 1986 to 444,000 in 1988, which compared to the strength in 1979 (183,000) has more than doubled (Annex 2, Table 2). ABC staff at the Head Office, provincial and prefecture level branches is small (about 500, 6250, and 22,000 respectively) indicating the decentralized character of the bank. Much of the staff increase has been in county, business and savings offices. Recruitment of staff is handled mainly at the county and provincial levels from four major sources including: public recruitment (usually from middle and senior school graduates) through entrance examinations organized by the state; from universities, colleges and junior colleges (through interviews but no written examinations); demobilized servicemen assigned to ABC by the government; and staff nominated by local government agencies which need specialized services from ABC. The proportion of staff recruited from universities and professional colleges is increasing in recent years (Annex 2, Table 2). ABC is relatively a young institution: age-wise, about 52Z of ABC staff is less than 30; 22Z between 31-40; 142 between 41-50, 72 between 51-55 and 42 between 56-60. 2.13 About 124,000 or 282 of ABC's total staff (444,000) are women and some 802 Gf them hold professional titles. They hold important positions in ABC including general managers (5), presidents/vice presidents at the provincial level (6), division chiefs (192), section chiefs (2300), and professionals (98,000). 2.14 Training of staff poses a major challenge for ABC management because of their diverse education levels and background. All staff including those seconded by the military receive a minimum of three months in-service or pre-service training. University and college graduates who usually possess skills and professional qualifications in accounting, finance and banking are assigned for field work of 1-2 years before they are appointed to regular positions. ABC places high priority on the training of its professional staff. It has established 170  12 banking schools, 55 secondary vocational schools, 112 staff training schools, and 3 RCC secondary vocational schools for upgrading the general standard of education of ABC and RCC staff. The three national training colleges at Tianjin, Changchun (Jilin), and Wuhan (Hubei) primarily train teachers for lower level schools and senior managers in more advanced finance, accounting and banking courses. ABC also makes use of broad programs available through local colleges, the People's Bank of China and Television University. 2.15 In 1988, ABC became the first among China's specialized banks to introduce on a nationwide basis a contract system which linked profit retention by branches and bonuses to staff to performance indicators relating to preset business goals. The contract system though not perfected yet, is an important step toward transforming ABC into an independent economic entity. Under the contract system, ABC management agrees with the Ministry of Finance (MOF) on a number of targets including the annual income-tax to be paid. If ABC exceeds the agreed targets, it can retain up to 90Z of the excess profits to build up its business development funds and pass on a part of the profits to employees through higher bonuses. The government, however, does not yet allow ABC to retrench nonperformers and redundant staff or even transfer them to other branches. Lack of labor mobility and social welfare perquisites, which are general characteristics of the economy, have constrained ABC's effort to improve in-house productivity up to the desired level. 2.16 ABC organization in project areas. In all the provinces, ABC's organizational structure is similar: a branch office at the provincial capital, central subbranches at prefecture (league) level, subbranches at the county levels supported by a network of business and savings offices at the level of townships and the state farms. ABC's organization and staffing in the six project provinces and Beijing municipality where the bulk of the 3roject-assisted lending program would be implemented are shown in Annex 2, Table 2. / Inner Mongolia, Shaanxi, Guangdong and Jiangxi have, based on their administrative structure, a relatively larger network of county level offices (80-105) compared to Jilin and Liaoning (45-55). The number of business and savings offices which undertake lending operations and savings mobilization at centers below the county level is also larger in Guangdong (2,917), followed by Jiangxi (2,232), Liaoning (2,101), Shaanxi (1,818), Jilin (1,446), and Inner Mongolia (1,404). ABC Beijing covering a relatively small geographical area has 167 field offices. ABC offices in the above six project provinces and Beijing employ about 110,000 staff ranging from 27,800 in Guangdong to 13,580 in Shaanxi (and about 4440 in Beijing). D. ABC Operations 2.17 ABC's Financial Appraisal. Annex 2, Attachment 1, briefly presents the financial appraisal of ABC and reviews recent trends in ABC's financial structure and performance. The proposed project specifically focusses on making improvements in ABC's financial management and in support of this effort, the Bank Group arranged 9/ Details of ABC's organization in Guangxi Zhuang Autonomous Region, and Fujian, Hunan and Hubei provinces are available in Staff Appraisal Reports nos. 4849-CHA dated April 9, 1984, 5810-CHA dated November 25, 1985 and 6903-CHA dated December 28, 1987. In line with national trends, the business and staffing at these branches have substantially increased.  13 a financial appraisal of ABC's operations in two representative provinces, namely Jiangxi and Liaoning (both included in the project) through a consulting group from France. lo/ The main objective of the financial appraisal was to update the Bank Group's understanding of the recent developments in ABC operations, to reconfirm ABC's financial solvency given the recent deflation of the Chinese economy, to identify specific problem areas that must receive government's and ABC management's attention, and outline specific measures that ABC should take to upgrade its financial management. This work was supplemented by ABC's in-house studies (initiated under ongoing Rural Credit III project) which addressed key aspects of ABC's operations. Concurrently with the studies, ABC also launched in 1987 a nationwide review of its (and the RCC system's) total loan portfolio, which was completed during 1989 with reference to outstanding loan balances as of December 31, 1988. Preliminary findings of ABC's loan portfolio review have been used to determine ABC's financial condition (para 2.27). 2.18 Lending Policies. ABC's annual lending targets are set by credit plans prepared by ABC on the basis of proposals received from the grassroots levels, and approved by the People's Bank, MOF, SPC and the Stat_ Council (para. 2.7). The credit plan mechanism is a part of the government's budgetary processes and is required to be prepared by all financial institutions. Using the credit plans submitted by individual banks and taking into consideration the government's objectives for GNP growth, inflation, investment, and fiscal deficit, PBC puts together the annual credit plan for the financial system as a whole for approval by the State Council. Within the limits set by this credit plan, however, ABC has considerable flexibility in approving individual subloans to respond to micro-level situations. ABC also enjoys powers to reject a loan request even if it is a part of the credit plan. In order to ensure economic rationality in lending decisions, ABC has placed during the last two years, strong emphasis on upgrading loan approval and credit risk management procedures. One of the important objectives of the proposed project is, therefore, to strengthen ABC institutionally to handle these processes effectively and minimize the rigidities or distortions that may be produced in an environment of 'directed credit" in which banks in China still operate. 2.19 ABC has diverse mandates from the government, including provision of funds for procurement of grains, cotton, rapeseed and other products for the government distribution system. This accounts for almost 60Z of ABC's annual lending. The main beneficiaries include grain bureaus and supply and marketing cooperatives (SMCs). ABC loans for investment and production in agriculture and rural industry are extended mainly to local collectives (e.g. village and township cooperatives), state farms, TVEs, joint ventures and state-owned enterprises in the rural sector; its direct lending to individual households, which mainly deal with RCCs, is relatively small. ABC also handles, on an agency basis, the national government's poverty alleviation funds. 2.20 ABC has established comprehensive procedures for subloan approvals at 10/ The consultants' report and draft reports on ABC's six in-house studies are available on project file. The ABC study reports would require further collaboration which would be done at the financial management symposium which ABC would organize in March 1991 as a part of the proposed project's technical assistance component (para. 4.25).  14 all levels which include: loan applications by subborrowers indicating the purpose of the loan, subloan guarantors, recommendations of sponsoring agencies and the benefit-cost analysis of the proposed investment. ABC's internal processes involve review and recommendations by the credit, accounting and legal departments, which is followed by an on-site inspection to verify the legal status and credit-worthiness of a subborrower, financial performance of ongoing activities, performance prospects of the proposed activity and availability of minimum down payment (normally 30%, but now increased to 50% in some cases). 2.21 As a part of the process of decentralization in decision-making initiated by economic reforms, ABC branches have considerably more authority regarding lending decisions than they did several years ago: county level offices can approve subloans up to Y2 million (US$425,000), central sub-branches (prefecture level) up to Y5 million (US$1.06 million), and provincial branches, up to Yl0 million (US$2.12 million). All subloans above Y 10 million are referred to the headquarters for prior approval or post-approval information (on a no-objection basis), depending upon the purpose of loan and source of funds. ABC subloans are guaranteed in the case of individual households, by village leaders; in the case of collectives, by joint and several guarantees from the members of the collective; in the case of TVEs, by local governments or other profit-making enterprises in the locality; in the case of state farms, by the state farm bureaus (only for fixed asset loans); and in the case of state-owned enterprises, by the sponsoring bureau. 2.22 Interest Rates. Interest rates on deposits and loans are set by PBC, in consultation with the government (MOF). PBC's current interest rate policy is designed to serve multiple goals with emphasis on promoting financial savings and reducing the investment rate in the economy to contain inflationary pressures. Generally, PBC sets the lending rates on the basis of average cost of resources to financial intermediaries, priority of credits, and the expected transaction costs of financial intermediation. However, in spite of the series of adjustments since 1979, interest rates per se are still not powerful instruments of credit allocation, and the annual credit plans remain the main vehicles for channeling credit to various activities. At this stage of China's financial market development, replacing the existing system of administered interest rates by a system based on market forces is not feasible but clearly improvements in the structure of interest rates are possible, and are under consideration of the government (paras. 1.17 and 2.4). As the credit plan mechanism would remain a dominant tool for resource allocation in the Chinese economy at least in the medium- term, upgrading of lending decision-making processes in the banks must receive high priority, which the proposed project aims to do in ABC. With the interest rate revisions in September 1988, the government for the first time introduced the system of indexation of deposits and bonds with maturities of three years and more which had a positive effect on sustaining the level of deposits with the banking system. This revision was followed by major increases in interest rates on deposits in February 1989. Lending rates which were also concurrently increased were, however, negative for much of 1938-89 but the success of the anti-inflationary effort has again placed the interest rate structure on the positive side. The inflation rate during the last quarter of 1989 was about 7.4% while for 1990, the projected annual inflation rate would be about 4X. In April and August 1990, PBC, therefore, lowered the interest rates on deposits by 0.5Z-4Z and on loans by about 2Z-8Z p.a. (Annex 2, Tables 3 and 4).  15 2.23 Demand deposits now earn about 2.16% annually and time deposits from 6.482 for a six-month deposit to 13.682 for deposits with eight-year maturity. Loans up to one year maturity carry an interest rate of 9.36%, while loans over one year to three years, 10.082, three to five years, 10.80%; five to ten years, 11.16%, and over ten years at a rate based on compound interest for one year loans which ranges from 17% for eleven year loans to 20Z for fifteen year loans. Agricultural development loans currently carry low rates of 9.362 to 10.82 but ABC enjoys flexibility to charge higher rates, generally 20% above the prescribed rate/s for all loans and 30-50Z over the prescribed rates, if necessary, to cover deposit indexation costs. Interest rates over three years to ten years could range between 10.08% to 13.4%, ABC is currently able to fully cover its overheads including deposit indexation costs. However, adequacy of interest spreads to sustain ABC's profitability, and increase its ability to make provisions for bad debts would be closely monitored under the proposed project (para.2.30). 2.24 Sources and Uses of Funds. ABC's deposit mobilization during the past decade has been impressive, comparable with overall trends in the financial system and the growth in China's domestic savings rate which increased from 31% of GNP in 1980 to over 38% in 1987. Annex 2, Attachment 1 provides the analysis of ABC's sources and uses of funds for 1986-88. 11/ As of December 31, 1988, ABC's total resources at Y318.9 billion included deposits, Y171.3 billion (53.8%), loans from PBC, Y99.4 billion (31.2Z), MOF contribution, Y24.5 billion (7.6%), and others (including retained profits and fixed assets fund), Y23.6 billion (7.42). Major sources of deposits were: individuals, Y59.4 billion (34.62), supply and marketing cooperatives, Y25.3 billion (15%), rural credit cooperatives, Y28.7 billion (16.7Z), RCC reserve fund for deposits, Y 27.8 billion (Y16.22), state farms, Y9.2 billion (5Z), TVEs, Y6.2 billion (3.6X), industrial enterprises, Y2.89 billion (2Z), and collectives, Y1.5 billion (0.9%). 2.25 ABC's annual subloan disbursements in nominal terms increased from Y329 billion in 1986 to Y509 billion in 1988; in real terms the increase was about 41%. ABC's total outstanding loans at the end of 1988 amounted to Y263.15 billion, compared to Y199 billion in 1986 and Y232 billion in 1987, increasing nominally at an annual average rate of 152. Short term loans to supply and marketing cooperatives and grain bureaus account for 49% of the total loans followed by loans to TVEs at Y40.7 billion (15Z), industrial enterprises Y15.4 billion (4.8%), state farms, Y13.4 billion (5%). Overall, about 80% of ABC loans are for short term working capital or procurement purposes. Its longer term loans, mainly for agricultural infrastructure development and TVEs have grown from about 9% of cotal loan portfolio in 1986 to 112 in 1987. 2.26 Structure of Assets and Liabilities. ABC's short-term assets account for nearly 78% of its total assets and longer term resources exceed longer term investments by more than twice (Annex 2, Attachment 1, para. 2). Liquid assets account for about 9.52 of total assets. While ABC was able to maintain a 11/ Comments on ABC's financial position relate to December 31, 1988, based on financial statements that were available at the time of the project appraisal in November 1989. During negotiations, ABC provided its financial statements for 1989, which have been incorporated in Annex 2, Tables 5 and 6.  16 satisfactory liquidity position during the past three years, it was clearly tighter in 1988 compared to 1986 as a result of stricter credit policies, which required ABC branches to make more efficient use of available resources (Annex 2, Attachment 1, para. 2(iv)). 2.27 Loan portfolio Assessment. After two years of effort, ABC completed in 1989, the enormous task of assessing, loan-by-loan, the quality of its total loan portfolio and thus began the proct-ss of cleaning its balance sheet by segregating nonperforming assets, introducing specific measures to collect, restructure and write off nonperforming assets, and upgrade overall financial management and profitability (Annex 2, Attachment 1, paras. 11-18). The review focussed on collection of overdue loans and arrear interest through legal actions, sale of mortgaged properties, requiring sponsoring agencies to honor their loan guarantees, and by providing incentives and rewards to subborrowers and staff. Preliminary estimates indicate that bad (or irrecoverable) loans accumulated since 1979 would amount to about 3X of the total outstanding loans as of December 31, 1988 or about Y8 billion. It is estimated that in addition to this amount about Y5 billion, or roughly 30-402 of sticky loans (i.e.loans in arrears over two years as of December 1988) might go bad over the next several years and should be provided for (Annex 2, Attachment 1, para. 14). 2.28 Until recently, by government policv, China's banks including ABC were not allowed to make any explicit provisions for bad debts. The banks usually transferred their annual profits to the budget, retaining relatively small amounts for staff welfare (bonus), business development and transfer to credit funds (equity). In the past, the banks generally wrote off bad debts directly by using the credit funds or seeking specific budgetary contributions. This situation is now changing as the banks have begun to change from primarily administrative agencies into independent economic entities. Recent government guidelines allow specialized banks to make provision for bad and doubtful debts at the rate of 0.1% to 0.2Z of outstanding loans. In 1988, ABC for the first time, made an explicit provision of Y300 million for bad debts. 2.29 At the currently low rates of 0.1-0.2% of outstanding loans, it would take several years for ABC to build up the funds necessary to write off the accumulated bad debts. ABC and the government must, therefore, find other ways to make provisions including recapitalization of ABC. Currently, (given the fungibility of resources) bad debts can be assumed to have been financed from MOF's contribution to credit fund (equity) of Y 26 billion (inclusive of retained earnings). If the accumulated bad debts estimated at about Y13 billion (about 5Z of the total outstanding loans) are notionally written off from the equity, the reduced amount of equity at Y13 billion plus the fund for fixed assets at Y5.1 billion (created from profit allocations), would be about 62 of ABC's total assets. The proportion of the reduced equity plus the fund for fixed assets, to risk assets would be about 7Z, and to external liabilities about 62. (Annex 2, Attachment 1, para.18). Though these ratios are close to international standards, the government and ABC must pay attention to increasing the provision for bad debts and/or recapitalization of ABC to provide increased cushion against future bad debts and improve ABC's profitability. 2.30 Profits and Profitability. Within the current framework of China's financial system, ABC presents itself as a profit-making, reasonably liquid and  17 viaLle institution (Annex 2, Table 6 and Attachment 1, para. 18). ABC earned a net profit of Y5.6 billion (after payment of business tax) or 1.75Z of total assets in 1988 compared to Y4.3 billion in 1987 (1.56% of total assets) and Y3.5 billion in 1986 (1.5% of total assets). Amounts transferred to welfare and development funds from profits amounted to Y1.5 billion in 1988 and were much higher compared to YO.6 billion in 1987 and YO.7 billion in 1986. ABC's gross income from loans increased from Yl1.5 billion in 1986 to Y20.2 billion in 1988 mainly on account of increases in subloan interest races, which was the main source of incremental profitability. ABC's operational costs also increased from 0.95% of total assets in 1986 to 1.4z in 1988 due to inflation and expansion in staff and number of offices but since ABC's gross spread ranged at about 3Z, it could finance the incremental cost without much difficulty. There are no unusual government subsidies in ABC's resource generation and if any government subsidies are provided for policy lending, these are, by and large, explicit and charged directly to the budget. 2.31 Accounting Systems and Auditing. ABC has a well-established accounting and audit system. ABC has recently established an Internal Audit Department within the Head Office and provincial and prefecture branches, which would be strengthened under the project. MOF, PBC and the State Audit Agency (SAA) established by the State Council carry out the audit in their respective areas on a random basis. MOF and PBC are responsible to monitor ABC's overall profitability and liquidity. The Bank Group is assisting SAA through training programs and seminars for its staff to introduce management audit concepts in its operations. The SAA has demonstrated a high degree of competence, autonomy, and thoroughness particularly in auditing Bank Group-financed operations. E. Overview 2.32 Through its vast network of branches, ABC reaches every corner of the country. The State Council has assigned an important role to ABC (and to its affiliate RCC system) in rural financial intermediation and real sector development. ABC, therefore, is an important institution for the Bank Group's agricultural operations in China. Although ABC is predominantly a commercial bank for the rural sector (with some agency functions for the government), it is in the process of increasing term lending for rural development, for which it is keen to extend to as many branches as possible, standard techniques of project appraisal and management using the Bank Group's experience and support (paras. 1.11 and 1.15). In the sphere of financial management, ABC is the first among the specialized banks to carry out a nationwide review of its loan portfolio, and pay increased attention to making improvements in portfolio management. Although ABC still operates within the framework of an overall credit plan set by PBC for macroeconomic management (para. 2.18), it has considerable autonomy in decision-making on individual loans and is committed to use Bank Group-assisted projects to introduce technical, financial, economic and enterprise appraisal criteria in subloan decision-making and to provide necessary training to its staff to use these criteria so that they can take economically rational decisions, responding to market signals and an in-depth assessment of credit risks.  18 III. THE PROJECT AREAS A. General 3.1 The project's credit program would be implemented mainly in the Autonomous Region of Inner Mongolia (Nei Mongol), five provinces including Shaanxi in the northwest, Jilin and Liaoning in the northeast, Jiangxi and Guangdong in central and south China, and Beijing municipality. ABC has already appraised numerous subprojects in these areas, and many major proposals have been appraised by by the Bank Group. ABC's choice of these areas was influenced largely by the availability of abundant potential for the production of profitable food and commercial crops and agricultural products. ABC also wanted to extend the benefit of the project's institutional development measures, and of Bank Group methodology and approach to investment decision-making to these seven regional clusters of its branches. Modern methods of technical and economic appraisal are becoming increasingly important because of ABC's growing role in investment financing. This role is likely to expand rapidly during the upcoming Eighth Five Year Plan (1991- 95). 3.2 Consistent with the emerging line of credit approach to Bank Group- assisted credit projects in China, ABC could also use a part of the Bank Group assistance (about US$75 million equivalent) in areas served by the earlier three IDA-assisted projects including Guangxi Zhuang Autonomous Region (Cr. 1462-CHA), Fujian and Hunan (Cr. 1642-CHA), and Hubei (one of the six provinces covered by Cr. 1871-CHA and IFAD project) which are located in the south east, south-and northcentral China, and such other areas that may be selected by ABC in consultation with the Bank Group. ABC branches in these provinces have an established organization and trained staff to implement the project (paras. 1.10-1.13). As a part of preparation for implementing the proposed (fourth) project, ABC headquarters has strengthened its capability to prepare, appraise and supervise subprojects and for this purpose, has established a Technical Expert Group (TEG) to assist in the technical evaluation of investments (para 5.5). 3.3 In the seven new regional clusters (para. 3.1), the project would be implemented in about 152 counties including 50 counties (over 30Z of the total) which have been classified by the national and provincial governments as poor on the basis of rural per capita incomes ranging between Y200-Y250 (US$ 54-68). In these areas, the proposed sites for ABC lending are distributed fairly evenly except in Inner Mongolia, where the bulk of the investments would be in sheep and cattle located in the northeastern Hulunbaer League, which has unexploited pasture resources. Site locations are shown on IBRD Maps 22151, 21792, 21793 and 22129 (attached). In the four provinces currently served by the IDA-and IFAD assisted projects (Guangxi, Fujian, Hunan and Hubei), about 302 of new investments are expected to be in processing and marketing facilities in support of production activities financed by the earlier projects, with priority given to poor counties. Areas served by the three earlier IDA-assisted projects are indicated in IBRD Maps Nos. 17483, 18971 and 20243 and 20244 provided in the respective SARs.12/ Basic data on project areas are given in Annex 3, Tables 1 and 2. 12/ Staff Appraisal Reports Nos. 4849-CHA (April 1984), 5810-CHA (November 1985) and 6903-CHA (December 1987).  19 B. Climate and Land Use 131 3.4 Agroclimatic conditions and land use patterns in the project areas vary widely, characterized by diverse natural endowments. Inner Mongolia is a major range-land livestock production center, accounting for 301 of all rangelands in China. Of the total area of 114 million ha, nearly 86 million ha (75z) are rangelands. Climatically, Inner Mongolia is characterized by extremely low winter temperatures, a short growing season (90-150 days) and precipitation decreasing from southeast to northwest with northeast receiving average annual precipitation of 400- 500 mm and the western deserts receiving little or no precipitation. Agriculture in Inner Mongolia, therefore, centers around herding. To the south of Inner Mongolia is Shaanxi which climatically and geographically is really three provinces. Shaanxi's northern region has harsh climate with extreme summer and winter temperatures and meager rainfall (300-500 mm), the central region is much more hospitable with continental monsoon climate, irrigated by Wei river and by 500-600 mm of rainfall, and the southern region is a part of a mountain range where climate is subtropical, winters seldom freeze, and farmers enjoy a 260-280 day growing season. Only 17? of Shaanxi's total area (206,000 sq. km) is arable of which over 45? is mountainous, located predominantly, in the northern and southern regions, with elevations over 1000 meters. Grasslands extend to 60,000 sq. km. or 28.72 of the total. Shaanxi's agriculture accordingly varies from pastoral animal husbandry in the grasslands of the north to tea, mulberry, and fruit in the south. 3.5 Jilin is known as the "granary of China". It has a continental monsoon climate with cold winters but without much snow, with average temperatures of -16 degrees celsius. Summers are relatively mild with an average temperature of 20 degrees celsius. Of the total area of 180,000 sq. km., arable land is about 29? with corn and soybean as the dominant crops; some 492 of the total is under forest, mostly in the east and south, where the province grows and processes ginseng, Chinese herbs and other forestry products for export and domestic markets. Grasslands, which account for 14? of the total land, mostly located in the northeast, have the potential for more efficient use for livestock development. Bordering Jilin in the south, Liaoning is C'nina's second most industrialized province, with a large urban population. Relatively high per capita incomes have led to a rapid diversification of Liaoning's agriculture, with the province a net importer of grains. Liaoning has mild temperatures (about 10 degrees celsius in winter) with warmer weather in the coastal areas; it is endowed with 2,100 km. of coastline with good fishery resources and potential for shrimp production. Thirty per cent of Liaoning's total area is arable, and over two-thirds hilly and mountainous, located mainly in the central and eastern parts, which has large untapped pasture and forestry resources. Liaoning is known for its apple production, with about 70? of China's apple crop. In Beijing, winters are cold, dry and blustery, with temperatures averaging about -5 degrees celsius; summers are hot and dry with temperatures averaging 25 degrees celsius. Rainfall in Beijing averages only 550-650 mm per year. 3.6 In the south, Jiangxi is a river drainage basin (the Gan River) 13/ Details of climate, geographical features and land use in Guangxi, Fujian, Hunan and Hubei, which are mostly subtropical, are available in Staff Appraisal Reports referred in footnote 12.  20 surrounded on three sides by mountains and bordered by the Yangtze River in the north. Climatically, Jiangxi is subtropical. Of Jiangxi's total area, 36Z is mountainous, 42Z hilly, and 222 flat and under water surfaces. Rice is the principal crop, often double-cropped and alterneted with wheat, rapeseed, and soybean. In the north and east, tea is the major crop. West Jiangxi is characterized by sparsely populated forest areas, while southern Jiangxi is known for its excellent citrus. Poyang Lake, the Yangtze, and the Gan River provide abundant potential for freshwater fisheries and waterfowl production. Bordered by the South China sea, over three-fifths of Guangdong's total area is mountainous and hilly, and the rest is plains and plateau. Agriculture in semitropical Guangdong is dominated by rice, accounting for llZ of China's total rice production and 80Z of the province's total agricultural production, with forestry, upland fruit crops including citrus, pineapple and pomelo, vegetables, animal husbandry and inland and coastal fisheries contributing the balance. C. Recent Agricultural Performance 3.7 Rural development strategies in the project areas have, by and large, focussed on supporting a mix of investments in land management, crop production, animal husbandry, aquaculture, horticulture, forestry and agro-processing. However, consistent with the national trends, during 1985-88, gross value of agricultural output (GVAO) increased at a slower rate (5.3%) compared to the gains recorded in the immediately preceding four-year period (9.9Z p.a.) which was characterized by a rapid expansion of the production responsibility system, price increases, and the expanding role of free markets. In Shaanxi, the growth in agricultural output during 1985-88 was contributed mainly by commercial crops including vegetables, peanuts, fruits, mulberry production, livestock (except pork), and fisheries; in Inner Mongolia by increased wheat production but dominantly by pasture-based livestock including meat, wool and milk products. In Jilin, grair. production during 1988 increased only by 1I, with corn production declining by 1Z over 1987. However, in response to market incentives, production of beet, tobacco, and ginseng increased sharply, over 55-88Z and wool production by 23%, while forestry products (ginseng and Chinese herbs) have become important sources of rural employment and income. In Liaoning, major gains were made in fruits, livestock and fishery production (mainly cage culture and shrimp), with production of oil bearing crops declining sharply. In Beijing municipality, grain output has increased in spite of severe water shortages but increases in farm incomes have been derived principally from livestock products and vegetables. 3.8 In Jiangxi, during 1988, grain production decreased by about 3% over 1987 (compared to the average increase of about 3.6Z p.a. during 1980-86), as did the production of major commodities including cotton, oil-bearing crops, and sugarcane, mainly due to drought. Much of the increased production in Jiangxi was from poultry, pigs, and fish. In Guangdong, where price liberalization and market orientation are perhaps most advanced in China, there has been a clear shift to nongrain crops in response to market forces. Animal husbandry production has continued to grow steadily. During 1985-88. in Fujian, Hunan and Guangxi, the growth in GVAO was much stronger ranging foom 6.5Z to 9% p.a. compared to only 3.5Z p.a. in Hubei. Much of the growth was achieved in non-crop activities (except for fruit production), contributed by livestock, fisheries, and sideline production which in Hubei was partially offset by reduced grain production. In all provinces, TVEs continued to grow rapidly during 1985-88, though at a slower pace than during  21 1979-85, to take advantage of value added in processing and to provide employment to surplus labor especially in the grain sector. D. Agricultural Support Services and Rural Infrastructure 3.9 Research and Extension. In the project areas, ABC's lending program would be supported by local governments' technical bureaus and the research and extension system, through the mechanism of interagency leading groups and contractual arrangements between ABC, the bureaus, and subborrowers. China has generally a well-established agricultural research and extension system, and improvements are under way to make the system more responsive to the changing structure of agriculture, with households instead of communes as the production units. In the project provinces, as elsewhere in the country, the Provincial Academies of Agricultural Sciences (PAAS) and their associate research institutes undertake research appropriate to local needs. PAAS, administratively attached to the local bureaus of agriculture, operate under the guidance of the Chinese Academy of Agricultural Sciences (CAAS) which is the national institute attached to Ministry of Agriculture. CAAS through its 31 specialized research institutes covers all major areas including rice, vegetables, oilseeds, jute, sugar beet, tea, fisheries, sericulture, citrus and other fruits, grasslands, and animal husbandry, and specialized fields such as germplasm resources, atomic energy application, veterinary medicine and local plants utilization. At the national level, operating directly under the State Council, is the Chinese Academy of Science (CAS), the nation's premier institute responsible for basic and applied research, which has established some 122 research institutes in different parts of the country to handle specific research needs. Additionally, several agricultural colleges/universities participate in the research programs. The extension system is operated by the Ministry of Agriculture. County level agro-technical extension centers supported by a network of township and village level stations and demonstration households assist farm households in the application of recommended practices. 3.10 Transport and Power. In locating subproject sites, local ABCs pay ,particular attention to ensure that these are served by adequate road networks linking villages, townships, county towns and provincial capitals, and where large quantities of inputs or outputs would have to be transported, also by the rail system. In northern Shaanxi and Inner Mongolia, in pockets where transport' constraint is evident, ABC has asked local governments to assume the responsibility of providing minimum feeder roads before subptoject construction begins, while including some critical investments in the project. In the case of agroprocessing investments, availability of power is ensured, where necessary by upgrading the distribution system. IV. THE PROJECT A. Objectives and Scope 4.1 In line with the earlier rural credit operations with the Agricultural Bank of China (ABC), the main objectives of the proposed project would be: (a) to stimulate growth and diversification of agriculture by financing profitable investments by farmers, collectives, state farms and enterprises; and (b) to promote efficiency of rural financial intermediation through introduction of sound, market-  22 oriented policies, and development of the main institutions concerned with rural savings mobilization and lending. The project would provide funds to ABC for a long term credit program in crops, livestock, fisheries, agroprocessing and marketing facilities, and for technical assistance in continuing ABC's institutional development. The project has been processed in the context of an ongoing dialogue with the government on the recent Bank Group review of China's financial sector, and would support key recommendations of this review by focussing on broader issues in ABC's overall financial management, loan policies and procedures, management information system and human resource development (paras. 2.4 and 2.32). 4.2 The proposed operation is based on an appraisal of an indicative investment (lending) program prepared by ABC's provincial and lower level branches with support from ABC Headquarters, local government technical bureaus and consultants in the Autonomous Region of Inner Mongolia, five provinces of Shaanxi, Jilin, Liaoning, Jiangxi and Guangdong, and Beijing municipality (Annex 4, Part A). About $200 million of Bank Group assistance would likely be used for financing investments in these regions. ABC could also use a part of the Bank Group assistance ($75 million) for financing investments mainly in crops, livestock and agroprocessing and marketing facilities, in Guangxi Zhuang Autonomous Region and three provinces of Fujian, Hunan and Hubei served by the earlier IDA-assisted projects, and with prior consultation with the Bank Group in other areas (paras. 3.1-3.2 and Annex 4, Part B). Given the line of credit nature of the project, ABC would have the flexibility of modifying the lending program in response to subproject appraisals including market analysis and an assessment of credit risks. B. Project Features 4.3 The main emphasis of the project would be to expand the production of commercial agricultural products and support investments in agroprocessing and marketing (para.1.3). The project would focus on increasing the productivity of natural pastures, underutilized uplands and water surfaces through commercial investments mainly in tree crops, high value cash crops and vegetables, livestock, and fisheries based on recognized local comparative advantage. ABC subloans would include start-up or initial working capital requirements of the subprojects. Starting from the ongoing Rural Credit III project (Cr. 1871-CHA), ABC has begun to use RCCs, on a pilot basis, for onlending of project funds. For the proposed project also, ABC would selectively use RCCs for onlending project funds to individuals and households (para. 5.18). The project would also finance consulting services to assist ABC in implementing the project's lending program, and ABC's institutional development program. Subprojects would be appraised by ABC using criteria acceptable to the Bank Group (para. 5.12). C. Crops 4.4 Apple Planting and Rehabilitation. Investments expected to be financed by ABC would introduce new varieties of apple suitable for longer storage and export, and carry out rehabilitation of old orchards by improving soil conditions, providing comprehensive treatment for diseases and pests, pruning, improving irrigation and fertilizer application and strengthening fruit management including storage. Investments in new apple orchards would take place mainly in Yanan, Huangling, Luochuan, Fuxian and Yichuan counties of Shaanxi (3800 ha) and in seven suburban counties of Beijing municipality (4,000 ha). Rehabilitation of apple  23 orchards would be financed, about 1000 ha each in Shaanxi and Beijing and about 2,000 ha in Liaoning (Shuizhong county and Jinzhou state farm). Per ha cost of new plantings would be about Y6,000 to Y8,000, and of rehabilitation, between Y3,500 and Y5,500, with variations by province and subprojects depending upon the nature of development proposed and estimated incremental yields. Though the area to be financed by the project would be small relative to the area already planted to apple in China, the inclusion of these investments in the proposed project would help focus local governments' attention on a number of critical aspects of apple orchard development and management, particularly variety selection, nursery development and management, crop husbandry, fruit handling, packaging and storage, and technical standards for rehabilitation of old orchards. Technical guidelines for planting and rehabilitation of apple orchards, which would require a case-by-case appraisal of subprojects by ABC, were agreed to at negotiations (Annex 5). 4.5 Citrus Development in Jiangxi and Guangdong. China's citrus subsector has rapidly developed in recent years. However, this development is based mainly on planting of navel (winter) varieties which means that harvesting of most citrus fruit is concentrated in winter creating enormous transport, storage and marketing problems. Summer oranges are in short supply and command attractive prices. In support of the government's strategy to diversify the citrus sector, the proposed project would finance mainly planting of summer (Valencia) varieties on 1067 ha in seven counties of Ganzhou prefecture of Jiangxi. By recycling of the project funds at the county level, ABC expects to support planting of Valencia varieties on about 5,000 ha. In Guangdong, the project would finance planting of 2000 ha of Hongjiang (summer) orange which is a relatively new variety developed by local research institutes and state farms following the discovery of a mutant in the early 1970s. Further research is under way to reduce the number and size of seeds. However, in spite of this weakness, Hongjiang variety has strong demand in local and Hongkong markets. In Jiangxi, the project would also finance three citrus packing houses, with a capacity of 3-5 tons per hour for grading, washing, fungicidal treatment, waxing, sizing and packing of fruit. This would be the first phase of a long term plan which envisages building up of a number of such facilities in southern Jiangxi to avoid transporting of unpacked fruit over long distances, and reduce delays between harvest and treatment of fruit. Technical criteria that would be applied in the two provinces for citrus planting and in Jiangxi for post-harvest handling of citrus were agreed to during negotiations (Annex 6). 4.6 In Jiangxi, the Citrus Development Center (CDC), recently set up by the Ganzhou prefectural government would play a key role in project implementation including nursery development, provision of technical services to farmers, and integration of production, processing, storage, packaging, transport, and marketing services. CDC is currently administered by the prefectural government which has agreed with ABC to provide for orange growers' participation in CDC management and to operate as a cooperative, performing marketing functions similar to that performed for orange growers in the US and other countries. 4.7 Other Fruits. Investments in fruit trees other than apple and citrus, would be mainly in Jilin (applepear), Shaanxi (kiwi and walnut), Liaoning (apricot), Guangdong (pomelo rehab.), Jiangxi (yellow peach and pear) and Beijing (pear and peach). Apple pear is a mutant of the pear species which is much sweeter in taste than common pears and is shaped like an apple. In Jilin, some 5,600 ha have already been planted to apple pear of which 52Z is in production. Current production is  24 sold out soon after the harvest and future demand is expected to be strong to absorb the incremental production from the existing and proposed investments. An additional 1,000 ha would be planted to applepear using lands unsuited to other crops and with an improved technical package. Areas to be planted to other fruits would vary from 100 ha (kiwi) to 1600 ha (pear and peach). 4.8 Green Tea Rehabilitation. Jiangxi teas are well known for their quality in both domestic and international markets and fetch relatively high prices. However, the productivity is low (394 kg/ha), compared to the national average of 644 kg/ha and the world average of 1125 kg/ha. Only 6,667 ha or 152 of total productive tea area in Jiangxi could be considered as an economically viable activity. With assistance from the proposed pzoject, ten poor counties, six in Shangrao and four in Yichuan prefectures in northern Jiangxi, would undertake rehabilitation of about 5,900 ha of green and oolong tea. Rehabilitation of teas would be done through one of the following three ways depending upon the status of existing tea bushes and the nature of rehabilitation required: pruning, rejuvenation and replacement planting. Technical guidelines for tea rehabilitation which were reviewed during appraisal, were agreed with ABC and the government during negotiations (Annex 7). Pruning would be done on 4694 ha (Y8,640/ha), rejuvenation on 293 ha (Y8,800/ha) and replacement planting on 880 ha (Y11,200/ha). At full development, the average yield is expected to increase to 1875 kg/ha. The Shangrao prefectural government has established a Tea Bureau to provide technical assistance to farmers undertaking rehabilitation of tea and similar arrangements are being established within the Agriculture Bureau of Yichuan. 4.9 Mulberry Planting and Silk Cocoon Production. Mulberry planting and improvement, and facilities for silk worm rearing would be financed in Shaanxi, in the hilly areas of south-eastern Ankang prefecture (2,267 ha in three counties) and in Jiangxi on lands along the river beds which are subject to seasonal flooding and, therefore, unsuitable for growing rice or other crops (2,800 ha in seven counties). Mulberry plants have proven to withstand such floods. The proposed investments would be an important measure to reduce underemployment and poverty as five out of ten counties in the program have been classified as poor by the national and local governments. In Shaanxi, one of the poorest provinces in China, the beneficiaries currently depend mainly on upland corn and undertake silk worm rearing as a sidelinei activity. In Jiangxi, generally low income farmers with surplus labor would be given lands for mulberry planting. Additionally, the project would provide subloans to households to construct new sheds or expand existing sheds for rearing silk worms and purchase of equipment and in Jiangxi for supplementary irrigation facilities. Both Shaanxi and Jiangxi have established nurseries to supply improved varieties of mulberry but extension systems need to be considerably upgraded. Provincial governments of Shaanxi and Jiangxi have undertaken to strengthen the extension system, issue technical packages for mulberry planting suited to local conditions, and outline construction standards for silk worm housing appropriate to the project areas in consultation with the Sericulture Research Institute of the Chinese Academy of Sciences (CAS). This understanding was confirmed by ABC and the government at negotiations. 4.10 Vegetables, Mushrooms, Fungi, Ginseng and Bamboo. To meet the expanding demand for vegetables in the capital cities of Shenyang (Liaoning) and Beijing, commercial vegetable production would be undertaken mainly in four counties of Liaoning province (101 ha) and in outer areas of Beijing municipality (about 1000  25 ha). In Liaoning, new green houses would be established while in Beijing, development would focus on providing improved irrigation facilities and management in existing green houses. Per ha cost of development would be about Y 12,000 in Liaoning and Y3,750 in Beijing (mainly for improved irrigation). Vegetable production would be on a year-round basis to serve the free markets in the two capital cities. The project would help establish organizational arrangements for supply of quality seeds and other inputs (including recurring supply of plastic materials), extension services through contractual arrangements with government and private technicians, and collection and marketing of vegetables. 4.11 In Shaanxi, Jilin, Liaoning, and Guangdong, the project would finance production of mushroom, fungi, traditional and American ginseng, and Chinese herbs for domestic and export markets, and in Guangning county of Guangdong province, bamboo planting and rehabilitation. ABC through local forestry and environmental bureaus would ensure that timber needed in fungi production in Liaoning and Shaanxi (mostly branches of 8-10 cm dia.) is drawn from regulated commercial wood production and not from indiscriminate cutting of forestry resources by subborrowers. Also, the government and ABC would ensure that clearing of the land used for planting ginseng is within the global limits on ginseng area set by the Jilin government, and that subborrowers fulfill their obligations to undertake reforestation after the harvest. As regards bamboo, the Guangning county has undertaken to strengthen the extension service and issue technical guidelines to farmers. This was confirmed at negotiations. 4.12 Irrigation facilities. ABC proposes to use the project's technical assistance to establish appraisal and subloan approval criteria for small-size, bankable, irrigation investments because of increasing demand for such loans from farmer groups. In the past, such investments were funded mainly by local government budgets, supplemented by ABC resources. For the proposed project, ABC has identified some eight irrigation subprojects with command areas ranging from 1,000- 2,000 ha including one in Inner Mongolia, three each in Shaanxi and Liaoning, and one in Beijing, mainly for production of high value crops including fruits. ABC would send to the Bank Group for prior review, appraisal reports on two relatively larger subprojects (Daletqi in Inner Mongolia and Shuizong in Liaoning), addressing all aspects including engineering designs, organizational arrangements for subproject implementation and management, cost recovery schemes, financial and economic analysis and ABC branches' ability to collect subloans and handle related credit risks. This was confirmed at negotiations with ABC and the government. D. Livestock 4.13 The project would support both pasture-based and feed-based livestock development. Pasture-based development (cattle and sheep) has been proposed mainly in Hulunbaer and Zhelimu Leagues of Inner Mongolia and Baichen prefecture in Jilin province. Smaller programs using grasslands are also proposed for cattle (Yijun county) and cashmere goats (Jianxian county) in Shaanxi and for cattle, sheep and goats in various counties in Liaoning province. Feed-based development would be undertaken mainly for production of pigs, chicken and ducks in Jilin, Liaoning, Beijing, and Jiangxi. 4.14 Pasture-Based Livestock Development. Development of livestock in Inner Mongolia and Jilin would provide an opportunity to effectively address issues in  26 sustainable agricultural production, including livestock, in a region where current agricultural policies seem to have potential to cause deterioration over a vast rangeland ecosystem. Chinese leymus and stipa rangelands in both eastern and western regions of Hailar municipality (Hulunbaer League) are in good-to-excellent condition and have generally remained underexploited (as this was once a restricted border security zone), except in areas with high density human population. However, two other subproject areas, namely, Zhelimu league of Inner Mongolia (Zhurihe state farm) and Baichen prefecture of Jilin, are already in a region of intensifying desertification caused by 'resource mining" by agricultural and rangeland livestock production systems. This resource mining is caused mainly by the lack of integrated resource management planning; inability of the government agencies to cross organizational barriers and make rational decisions leading to sustainable resource use; and local communities' or households' short-term agricultural responses to internal and external pressures (i.e. increasing consumption needs, income incentives, or government quota requirements) that have met only their immediate needs but failed to take account of long-term impacts on the resource or the production system. Creating sustainable livestock development requires that these constraints must be addressed, which this project would begin to do, for the first time in China, by introducing a mandatory, ecologically-sustainable, rangeland planning system (Area Management Plan) to the staff of local agricultural bureaus and ABC. Using UNDP's technical assistance, ABC has recently trained some 35 project-related staff in the application of AMP concepts to appraisal of grassland- based livestock subprojects (Annex 8). 4.15 The key element of the Area Management Plan (AMP) is to establish a formal, monitorable, agreement between villageitownship and higher level governments and ABC that stocking rates would not exceed those permitted by existing grassland resources. The local governments would take the responsibility to ensure that these agreements are honored. Three research institutions including Rangeland Research Institute of Hulunbaer League, Grassland Research Institute (CAAS), Inner Mongolia, and Institute of Grassland Science of Northeastern Normal University, Jilin would participate in this exercise under technical assistance contracts with local ABCs and provincial governments. Provincial ABCs have formalized organizational structures and cost sharing arrangements with local governments for introduction of AMP. To review the effectiveness of the organizational arrangements for subproject! implementation including use of AMP, during the summer of 1991, the Inner Mongolia and Jilin ABCs, with the assistance of the local animal husbandry bureaus and grassland research institutes, would review progress in introduction of AMP and subproject approval processes using this concept and report the findings to the Bank Group. 4.16 For smaller grassland-based cattle, fine-wool sheep and goat programs in Shaanxi and Liaoning, ABC would use AMP concepts with assistance from local grassland research institutes, to establish stocking rates feasible in the subproject areas. At negotiations, an assurance was obtained from the government and ABC that grassland-based livestock development in Inner Mongolia, Jilin, Shaanxi and Liaoning would be carried out using AMP concepts and that ABC would conduct an assessment, in accordance with Terms of Reference acceptable to the Bank Group, of the use of AMP concepts in the subprojects financed, and review the results of such assessment with the Bank Group by December 31 of each year during project implementation. In such reviews, ABC would ask provincial grassland research institutes to participate (Annex 8).  27 4.17 Feed-based livestock. Major investments would be in dairy enterprises, pig development, poultry, and breeding stock for layers, broilers and ducks. Through this project, local authorities would address major aspects of livestock development including feed availability (Jiangxi and Liaoning); nutritional assessment of feed resources (Shaanxi), genetic selection policy concerning sheep and cashmere goats (Shaanxi and Liaoning); design of poultry sheds and housing standards (Inner Mongolia); expansion of poultry breeding farms and duck production in Beijing; and veterinary training needs of the extension staff in most project areas. An innovative smallholder dairy development program would be introduced in Jilin to increase supply of fresh milk to the capital city of Changchun and the local factory producing milk products and baby foods. Some 1,000 dairy farmers in the outskirts of Changchun city are expected to participate in the project. Local animal husbandry bureaus and ABC's project offices would monitor technical aspects of all major feed-based livestock subprojects. E. Fisheries 4.18 The project would finance diverse investments in fisheries in Inner Mongolia, Jilin, Liaoning, Shaanxi, and Guangdong including freshwater fish farm development, pond improvement, fish cage culture, extensive lake and reservoir fisheries, improvement of coastal pond shrimp culture, and off-shore scallop rearing in suspended lantern cages. In addition, support infrastructure would be financed, including fish hatcheries, water supply and drainage networks; electrical power supply, fingerling nursery ponds, and fish feed processing mills. Investment items in new ponds would include excavation of pond areas, drains, canals, pond lining, pipes, sluice gates, pumps, and infrastructure such as farm roads, electrical transmission and distribution lines. Improvements to existing farms would involve deepening and reshaping ponds and provision of filling and drainage facilities. 4.19 Through subproject appraisal and implementation, a number of aspects of fishery development would be addressed. For example, in fish pond development, the provincial ABCs would require subborrowers to standardize pond dimensions; review water system designs requiring separate canals for water supply and drainage; take measures for pollution abatement by diverting pond water to crop irrigation, and not allowing pond water to enter directly into adjacent natural waters or rivers; ensure soil profile analysis for each pond, and review feed constraints and costs in selection of species. In fish cage culture, feed availability (particularly fish meal) and costs are critical factors, since feed accounts for an average of 60Z of production costs. Subborrowers of cage fisheries would also be required to adhere to the established standards of "cage area to open water area" in the reservoir to ensure that water quality degradation does not occur. Provincial fisheries bureaus have been asked to establish suitable guidelines to address any environmental questions. 4.20 In shrimp culture, Liaoning has a comparative advantage in terms of good local feed availability including small fish captured along the coast which reduces dependence on expensive fish meal (from the usual 30-35Z to 1OZ of total feed). In view of expected decline in world prices for prawns, Liaoning province has already ceased bringing new areas under shrimp; the project would focus on rehabilitation of existing ponds to improve their productivity and competitiveness in the domestic and international markets. Scallop culture is rapidly expanding in China (though  28 initial investment costs are high), mainly because scallops derive all of their feed from natural sources in the sea. However, being an off-shore activity, scallop culture systems are highly susceptible to damage and loss due to storms. Risk analysis so far done in Liaoning or in other provinces is limited. This is a sectoral question which would be further analyzed through subproject studies under this and other projects financed by the Bank Group. Currently, subborrowers obtain insurance cover against possible losses from the Insurance Corporation of China; however, the risk factor would be appropriately reflected in the economic analysis of the investments. F. Agroprocessing & Marketing 4.21 Investments in agroprocessing and marketing facilities would amount to about 30Z of the total lending program. This would be the particular focus of ABC's lending in Guangxi, Fujian, Hunan and Hubei. All subprojects would be subjected to careful analysis to ensure that the proposed capacities are critically needed and would serve clearly identified markets. Given the export orientation of some of the investments, ABC would subject each such investment to detailed analysis in terms of technology selection, hygiene and quality control standards, packaging, and procurement of machinery and raw materials. Broadly, the project-assisted program would support establishment of processing and storage facilities for a wide range of products including green tea, cereals and crop residues, meat and other animal products, fish and other aquatic products, fruits and vegetables, forestry products, oil seeds and animal and fish feed. In evaluating individual investments, ABC's focus would be on using modern technology appropriate for producing quality output consistent with market requirements, ensuring efficient use of by-products and protection of the environment. 4.22 Tea Processing. The project would expand and rehabilitate 129 small- size preliminary processing factories to accommodate incremental crop production as well as to ease current shortages in processing capacities. ABC has proposed to expand 24 factories by 12.5 tons, 46 factories by 25 tons and 59 factories by 50 tons each. The expansion of factory capacities would be backed by a plan showing leaf production zones that would be served by individual factories to be expanded or rehabilitated, the potential leaf production in the zones, existing processing capacities in the zones, and the need for additional capacities (Annex 7). Optimal use of existing capacities owned by collective or government farms through contractual arrangements with individual households would be required before establishing new capacities. In Jiangxi, there are some 2,000 preliminary processing factories. Reduction in this number is not feasible since the terrain is mountainous and transport over long distances is not practicable due to poor road conditions. Some 50-60Z of the annual crop is harvested usually in the spring making storage of leaf in large quantities and over longer periods logistically difficult and also technically undesirable since this would reduce leaf quality. The project would also finance two final processing factories, one each in Shangrao and Yichuan prefectures. Expansion in the processing capacities would be phased in such a manner that the program matches the envisaged crop increases under the project-assisted tea crop rehabilitation program (para. 4.8). 4.23 Slaughterhouses and cold storages. Proposals have been made for nine slaughter and cold storage facilities in the provinces of Shaanxi, Liaoning, Inner Mongolia, Jilin and Jiangxi for cattle, sheep and poultry. As a measure of  29 technical assistance to subborrowers, ABC Head Office would arrange review of the designs and layouts including environment protection and health standards for all major investments in slaughter houses through China Refrigeration Engineering Company (CREC), an enterprise of the Ministry of Commerce, which is a member of ABC's Technical Expert Group (TEG). ABC Head Office would send a report to the Bank Group on the recommendations made on the first five subprojects already identified including those in Shengli, Jurihe in Inner Mongolia, Shangzhou, Xixiang and Yujun in Shaanxi, Jinxi, Zhangwu and Chagtu in Liaoning and Guang Qing in Jiangxi and any new proposals that may later be included in the project. This measure is expected to ensure that investments financed by ABC would comply with acceptable technical, environment and health standards; include efficient use of by-products, provide for waste water handling, and include training of staff and management in handling machinery and products. it would also servP the purpose of exposing ABC staff to detailed technical appraisal of such investments. ABC would use technical assistance from the proposed project (financed by subloans for specific investments) to hire overseas expertise for this activity. 4.24 Other agroprocessing investments. Other major agroprocessing investments would include corn processing for starch and glucose (Shaanxi and Inner Mongolia); processing of forestry products and Chinese medicines (Jilin and Liaoning), manufacturing of particlelfiber boards (Jilin and Shaanxi); processing of livestock products (Shaanxi, Liaoning and Jiangxi), fruit storage and processing (Jiangxi and Shaanxi); bamboo and vegetable processing (Shaanxi and Jiangxi); and feed mills that are needed to support major production programs in livestock and fisheries. Most subprojects included in the lending program in Inner Mongolia, Shaanxi, Jilin, Liaoning, Jiangxi and Guangdong were reviewed by local and Bank Group technical experts during project preparation and appraisal, in terms of technical designs proposed, availability of raw materials, and market prospects for the final outputs. In approving individual subloans, ABC would take into consideration specific suggestions made by the technical experts. G. Technical Assistance 4.25 The main elements of the technical assistance component are reviewed in Annex 9 and summarized in Table 1 of Annex 9. The project's focus is to enable ABC to better serve its goals as a major commercial and development bank for China's rural sector with due regard to financial viability, liquidity, and profitability, and respond more effectively to its changing role from a fiscal organ of the state to that of a full financial intermediary in line with the recommendations of FSR (para. 2.4). Specifically, the project would assist ABC in various activities aimed at the following: (i) upgrade ABC's financial management; (ii) develop ABC's longer term lending strategies and programs, coinciding with the national Eighth Five Year Plan; (iii) review ABC's lending policies for major client groups (TVEs, state farms and beneficiaries of poverty alleviation programs); (iv) define and upgrade ABC's management information system; (v) provide office technology and equipment to improve ABC's operational efficiency; (vi) provide training to ABC's senior staff in financial management, foreign exchange operations, modern accounting systems and internal audit; (vii) strengthen trainers' training in ABC's three national colleges initiated by the Third Rural Credit Project; and (viii) provide special courses in project appraisal, management, monitoring and agro-industry financing to senior- and middle level staff at ABC headquarters and provincial branches.  30 4.26 In upgrading ABC's financial management, the project would focus on ABC's long-range business planning; credit plan formulation and preparation; lending policies and procedures; monitoring of loan portfolio; assets and liabilities management; assets valuation; internal audit and controls; introduction of internationally accepted formats for financial reporting; the contract system; and financial management of the RCC system. This would be done through a national symposium in ABC (March 1991), follow-up workshops at the provincial level, senior staff training and a mid-term evaluation of the specific initiatives taken by ABC as a part of this effort. This review would be done by ABC in association with the Bank Group as a part of project supervision. The government has also agreed to carry out with the Bank Group, a study of rural investment and finance on TORs satisfactory to the Bank Group, including reviewing the role and functions of RCCs and NGFAs in the provision of financing for the agricultural sector. 4.27 The project would also assist ABC in the formulation of its medium-and long-term lending program and future project preparation by supporting specific subsectoral studies. In recent years, ABC's lending to township and village enterprises (TVEs) and the state farm system has increased significantly. Since 1984, ABC also started playing an important role in poverty alleviation programs when the government began to provide to ABC special funds for concessional loans to poverty groups. ABC faces institutional, financial and policy questions in regard to lending for each of these categories. The project would, therefore, assist ABC to review and reshape its lending strategies for each of these major clients. The project's technical assistance would also support a review of ABC's management information system in light of international practices and experience, suggest improvements especially in regard to its ongoing program of computerization (hardware acquisition and software development) and develop technology options and longer term strategy for its computerization program. Building upon the initiatives supported by the earlier projects, this project would strengthen the trainers' training program at ABC's three national and provincial staff training colleges, training of its headquarters staff, and of credit staff in project and other provinces in project appraisal, monitoring and evaluation, and agro-industry financing. The project would also finance some basic facilities such as telex and facsimile machines and office equipment at ABC Headquarters and provincial branches to improve their operational efficiency. H. Cost Estimates and Financing 4.28 Cost Estimates. The total project cost, based on the indicative investment program (Annex 4) is estimated at US$550 million including US$120.2 million equivalent or about 22Z in foreign exchange and US$43.8 million in related taxes and duties (Table 4.1). Estimates are based on August 1990 prices and do not include price contingencies as it is expected that any cost changes would lead to an adjustment in the number of subloans. 4.29 Financing. The proposed IBRD Loan of US$75 million equivalent and IDA Credit of SDR 143.7 million (US$200 million equivalent) would contribute about 50Z of total project cost, including taxes, or about 54Z of total costs net of taxes. The IBRD Loan and IDA Credit would finance 10O? of the foreign exchange requirements plus 36t of local costs. The remaining project cost would be financed up to about 20? by ABC ($110.9 million) and 30? by subborrowers ($164.1 million). Retroactive financing of SDR 17.96 million ($25 million) would be required for expenditures  31 incurred after January 1, 1990 and before Loan and Credit signing, for subloans disbursed by ABC consistent with the project's terms and conditions. Expenditure eligible for retroactive financing relates mainly to subprojects for which an early startup was considered essential for mobilizing local resources especially by using underemployed labor available in project areas during winter months, and for maintaining the momentum of project preparation and implementation. Table 4.1 : PROJECT COST SUMMARY -----------------------------------------------------------------__---------- Local Foreign Total Local Foreign Total F.Ex. (Y million) ($ million) z ------------------------------------------------------------------__-------- A. ABC/RCC Subloans Crops 614.6 153.6 768.2 130.2 32.6 162.8 20 Livestock 535.4 133.8 669.2 113.4 28.4 141.8 20 Aquaculture 300.9 26.2 327.1 63.8 5.5 69.3 8 Agro-processing 572.1 245.2 817.3 121.2 51.9 173.1 30 Subtotal 2023.0 558.8 2581.8 428.6 118.4 547.0 22 B. Technical Assistance Staff training 2.3 2.4 4.7 0.5 0.5 1.0 50 Consultant services 0.2 2.1 2.3 0.1 0.4 0.5 80 Equipment 1.9 3.3 5.2 0.4 0.7 1.1 64 Others 0.9 1.0 1.9 0.2 0.2 0.4 50 Subtotal 5.3 8.8 14.1 1.2 1.8 3.0 60 Total 2028.3 567.6 2595.9 429.8 120.2 550.0 22 --------------------------------------------------------------------__-------_ I. Procurement 4.30 Machinery and Equipment. The procurement arrangements for this project are in line with previous Bank Group practice for agricultural credit projects (Table 4.2). Since this is a credit project, procurement of machinery and equipment would be made directly by numerous subborrowers, spread over a period of three years. Each package would, therefore, be too dispersed and small scale to be suitable for International Competitive Bidding (ICB). Prudent shopping procedures would be used to procure vehicles and smaller machinery and equipment for on-farm development, farm support and agro-processing facilities, staff training and modernization of business offices; such procurement would be mainly from local machinery companies and suppliers and the increasing number of representatives of foreign suppliers in China. However, larger investments in tea, meat and other livestock product processing, corn processing, oilseeds, fruit and forestry product processing and feed mills would be procured in accordance with prudent shopping, local competitive bidding (LCB) and limited international bidding procedures (LIB) acceptable to the Bank Group. The aggregate of all contracts for procurement of machinery and equipment involving shopping procedures would not exceed Y226 million  32 ($48 million), LCB procedures, Y165 million ($35 million), and LIB procedures Y165 million ($35 million). The procedures for procurement of machinery and equipment are summarized as follows: (a) Contracts for items and groups of items aggregating up to US$ 50,000 would be awarded on the basis of comparison of price quotations from at least three qualified suppliers; (b) Contracts for items and groups of items aggregating from US$50,000 up to US$100,000 would be awarded on the basis of local competitive bidding (LCB) procedures acceptable to the Bank Group; however, if the relative item or groups of items is/are to be used for processing of products for the export market and are valued in excess of US$50,000, LIB procedures would be used to ensure more technology options to subborrowers; (c) Contracts for items or groups of items with costs exceeding US$100,000 would be awarded through LIB procedures. Individual contracts in this category are not likely to exceed US$500,000. (d) Contracts exceeding US$500,000 would require prior review by the Bank Group, which would represent about 8Z of the total Credit. However, the Bank Group would review the first three LCB or LIB contracts to ensure that proper procurement procedures are followed. Also, ABC would keep copies of contracts exceeding US$300,000 up to US$ 500,000 at the headquarters in Beijing for review during the Bank Group supervisions. 4.31 Civil works. Civil works would be small, labor intensive, and scattered over a wide area and would not be of interest to foreign bidders. The construction of earthworks and structures for support facilities, would be undertaken mainly by households individually or as members of the collectives or state farms using their own labor up to an aggregate amount of Y132 million ($28 million). Other civil works estimated at Y321 million (US$68 million), especially construction of buildings by state-owned enterprises and state farms would be assigned to local construction teams following local competitive bidding procedures (LCB) acceptable to the Bank Group. These procedures specify criteria to be applied to qualifying bidders; methods for bid advertisements to secure a satisfactory number of bidders; procedures for verification and award of bids; and the rights and obligations of the parties involved. ABC would require subborrowers to follow these procedures as a condition of subloan approval; ask subborrowers to inform ABC of the method of procurement used; and verify compliance during supervision. 4.32 Agricultural Inputs. Farm households, collectives, state farms, and state-owned enterprises will purchase agricultural inputs including chemical fertilizers, seeds, and animal feeds from SMCs which have a network of branches throughout the country. Any bulk procurement of inputs, especially chemical fertilizers, would be made through national procurement agencies following procedures acceptable to the Bank Group. No single package is likely to exceed $50,000 equivalent but, in the unlikely event, if any single procurement exceeds $ 5 million, such procurement would be made using ICB procedures. The Credit and Loan agreements provide for this possibility. 4.33 Consultants. Consultants would be selected in accordance with the Bank  33 Group's guidelines for the Use of Consultants on terms and conditions satisfactory to the Bank Group. About 1000 staff-days of internationally recruited consultants and 2000 staff-days of local consultants would be required for the financial management symposia and workshops, preparation of medium-and long-term lending programs, review of lending to special client groups, a review of ABC's management information system, trainers' training and training programs for ABC's staff (Annex 9, Table 1). 4.34 ABC offices would keep a record of all procurement decisions involving contracts for purchase of machinery and equipment, construction of civil works and agricultural inputs for amounts exceeding $50,000. Table 4.2 : PROCUREMENT ARRANGEMENTS (US$ million) -------------------------------------------------------_-------__------- Project Element ICB 1/ LIB LCB Others 2/ Total --------------------------------------------------------------------__-- Machinery and equipment - 35 35 48 118 (35) (32) (37) (104) Civil works - - 68 28 96 (52) (19) (71) Agricultural inputs - - 32 301 333 (21) (77) (98) ABC staff training, and consultant services - - - 3 3 (2) (2) ---------------------------------------------------------------------__- Total - 35 135 380 550 (35) (105) (135) (275) -------------------------------___-----_-------_----------------___----- I/ The Loan and Credit Agreements will provide for ICB, per para. 4.32. Procurement arrangements would include ICB if any single procurement of agricultural inputs for a group of subprojects exceeds $5 million. 2/ Includes shopping procedures and local procedures acceptable to the Bank Group. Figures in parentheses are approximate amounts expected to be financed by the Bank Group. J. Disbursements 4.35 ABC is expected to approve most of the subloans under the project within about two-and-half years, i.e. by the end of 1992. Disbursements under the approved subloans are expected to be completed by June 30, 1995. The closing date of the project would be December 31, 1995. A schedule of estimated disbursements is given in Annex 10. Disbursement is expected to be faster than the Bank-wide and regional averages, since ABC has already identified a large proportion of investments suitable for project-financing, and appraised a significant number of subprojects. The disbursement estimate is in line with experience under the previous rural credit projects. 4.36 Disbursement of IBRD Loan and IDA Credit proceeds would be as follows: (a) 71Z of project subloans disbursed by ABC and 1002 of ABC  34 disbursements to RCCs for RCC subloans; (b) 100% of expenditures for overseas fellowships and consultant services; (c) for machinery and equipment under the technical assistance component, 100% of foreign expenditures, 100X of local expenditures (ex-factory) and 75Z of local expenditures for other items procured locally. 4.37 Disbursements against subloans extended by ABC would be made on the basis of statements of expenditure (SOEs) listing subloans made. Disbursements for overseas training of staff and for consultants would be made on the basis of SOEs certifying that the expenditures were incurred on the basis of a training program agreed with the Bank Group and that the consultants have been employed in accordance with the Bank Group's guidelines for use of consultants. 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 Bank Group staff for review during supervision missions. 4.38 In order to provide for efficient disbursement of the Loan and Credit proceeds, a Special Account would be set up in US dollars in a bank acceptable to the Bank Group with an initial deposit of US$17 million. The proposed initial deposit would represent the estimated average disbursement of the Loan and Credit for anv four months. Applications for replenishment of the Special Account would be submitted monthly, or whenever the Special Account is drawn to 502 of the initial deposit, whichever comes first. V. PROJECT IMPLEMENTATION A. Prolect Organization and Management 5.1 General. ABC's provincial branches would be primarily responsible for implementing the project's credit program. At headquarters, ABC recently reconstituted Credit Pivision I (in the International Business Department) which was responsible for the previous IDA-assisted projects into an independent and upgraded Project Office. This Project Office would provide general guidance to the provincial and Beijing branches, and serve as the main link with the Bank Group. Besides managing Bank Group-assisted projects, the new Project Office would participate in the development of ABC's nationwide medium-and long-term lending strategies and programs, and institutional development initiatives. This new role of the Project Office would provide an important link between Bank Group-assisted projects and ABC operations outside these projects. Also, commencing with this project, ABC would take new initiatives to prepare itself to implement broader, market-oriented rural development programs of national significance, for which it expects to seek multilateral and bilateral assistance in coming years (paras.5.3- 5.8). 5.2 Project Organization. Chart 3 shows the organization for implementation  35 of the proposed project. As for the earlier projects, the provinces and counties participating in the proposed project would appoint Project Management Committees (PMCs) to coordinate the work of ABC and the government's administrative and technical bureaus. Project Offices at the provincial levels and the Project Units (PUs) at the county level would manage the day-to-day aspects of project lending. 5.3 Leading Group at Headquarters. Earlier IDA-assisted rural credit projects were managed entirely by the International Business Department, with very limited participation by ABC's mainstream departments. Under the new organizational set up, overall responsibility for project implementation would be that of a Leading Group chaired by a Vice President (in charge of International Business and Credit Departments), which would include the heads of ABC's departments of planning, agricultural and commercial credit, industrial credit, finance and accounting, staff training, and RCCs. The Leading Group's main functions would be to provide policy directions for and coordinate the project implementation. The Leading Group would function as an operational body, recommending specific actions to the President's Council, with day-to-day work handled by the Project Office. 5.4 Project Office at Headquarters. The Project Office would function as an executive arm of the Leading Group. Headed by a director (instead of a division chief as was the case for the erstwhile Credit Division I), the Project Office would have two main divisions: one dealing with the Bank Group-assisted projects and the other with ADB projects. In its upgraded role, the Project Office will participate in preparing ABC's medium-and long-term lending program nationwide, carry out related special studies, arrange technical support to ABC's mainstream credit departments, and undertake selected M & E activities. It would be responsible to arrange counterpart funding, prepare documentation on subloans requiring Bank Group approval, arrange withdrawal of project funds, review project accounts and subloan approvals, oversee audit of project accounts and SOEs, compile semi-annual progress reports and undertake monitoring of project implementation. The Project Office currently has a total staff of 20. Additionally, ABC has placed seven experienced staff from credit departments at the disposal of the Project Office on a part-time basis. However, in light of its expanded functions, the Project Office may have to be strengthened through staff recruitment, redeployment, and training. These aspects would be reviewed as a part of the staff training program for headquarters staff (Annex 9, Table 1, item 7), the proposed review of TEG performance (para. 5.6) and Bank Group's project supervision. 5.5 Technical Expert Group (TEG) at Headquarters. Until recently, for technical appraisal of its lending program, ABC depended mainly on local government technical staff. However, not infrequently, the local government staff lacked an overview of broader technology or sub-sector issues and ABC had no ready access to high caliber expertise to independently assess the technical feasibility of subprojects financed. In some provinces (covered by Rural Credit III project), ABC developed consultant rosters to enable the branches to hire suitable expertise. ABC branches participating in the proposed project would similarly develop consultant rosters for their provinces. Also, as a part of the proposed project, ABC has established at the headquarters, a Technical Expert Group comprising senior experts from within ABC and outside to assist ABC's operational staff in the review and supervision of ABC's agricultural lending operations; interact with national line ministries and provincial bureaus on sectoral development policies and programs; and liaise with the Bank Group in appraisal and supervision of subprojects.  36 5.6 Experts on TEG are from the Fisheries Bureau of the Ministry of Agriculture, Agro-economic Research Institute of the Chinese Academy of Agricultural Sciences, National Animal Husbandry and Veterinary Station, Food Science Department of Beijing Agricultural University, Scientific and Technical Bureau of National Environment Protection Agency, and Refrigeration Engineering Consulting Corporation of the Ministry of Commerce. ABC would gradually broaden TEG to include additionaI experts and also take steps to establish stronger linkages with MOA on policy and technical matters. ABC would also have to appoint middle-level technical staff with sound theoretical training and practical experience to interact with TEG, provide day-to-day guidance to ABC's operational staff, and participate in subproject supervision. By the end December 31, 1991, ABC and the Bank Group would jointly review the steps taken by ABC to strengthen TEG and recommend any additional measures needed to upgrade technical support to ABC operations; This was agreed to with the government and ABC at negotiations. 5.7 Project Organization in Provinces. The Project Management Committees (PMCs) at the provincial level with vice-governors in charge of agriculture as chairmen and local ABC Presidents acting as vice-chairmen, would include heads of the planning and finance departments, and technical bureaus including agriculture, animal husbandry, fisheries, TVEs and rural industry and environment protection agencies (EPA). Major PMC functions would be to provide technical expertise in assessing subproject feasibility; assist in procurement of materials and services for subproject implementation; arrange supply of production inputs and counterpart funds, and arrange training to extension workers and subborrowers. PMCs would function as advisory bodies, with ABC responsible for lending decisions. 5.8 Provincial Project Offices. Provincial POs would be the key agencies responsible for day-to-day aspects of project implementation. Usually headed by an experienced ABC official of the rank of a division chief, a typical PO consists of carefully selected financial and accounting personnel drawn from different ABC departments and technical staff in different fields including agriculture, animal husbandry, fisheries and agro-industries nominated by local government bureaus. POs would also invite local EPA representatives to review individual subprojects. POs' main functions would be to assist county branches' credit sections and Project Units (PUs) in subproject identification, appraisal and supervision, and administer training programs for project-related staff. POs would maintain subloan disbursement records for withdrawal of Bank Group funds, review subloans above the free limit set for county PUs/credit sections, oversee subloan repayments, and monitor the project's progress and its impact. Concerned provincial branches would establish inter-departmental leading groups so that POs could interact with and receive support from all major departments in ABC provincial branches. 5.9 County Project Units and PMCs. ABC's county level branches, through PUs and credit sections, would be responsible to carry out subproject appraisal with technical support from local bureau staff, assist subborrowers in project implementation and supervise subloan use. The county branches would establish Project Management Committees (PMCs) if these are corsidered essential to ensure inter-departmental coordination for processing and supervision of subloans and subloan collections. PMCs would act in an advisory capacity. The county branches would establish PUs if the size and complexity of the lending program warrants such a separate office; otherwise, their regular credit sections would handle the project  37 lending. Where necessary, the county branches would hire independent experts to review subloan requests and supervise subproject implementation. The county branches would maintain separate subloan accounts, collect subloans, and prepare progress reports for information of the provincial POs. Given county branches' important role in project implementation, ABC places considerable emphasis on training of their staff in project appraisal and management. During project preparation, special courses in subproject appraisal were arranged for the county staff. l 5.10 ABC selects only such counties for participation in the project, which have a proven record of efficient loan portfolio management, have capacity to provide counterpart funds, and receive adequate technical support from local and higher level governments. At negotiations, the proposed organizational arrangements were agreed to, and an assurance was obtained from the Government and ABC that each PMC at provincial and county level would include a representative of the local EPA to participate in subproject appraisal and advise on specific actions to safeguard the environment. In counties where PMCs do not exist, ABC would require its county- level offices to obtain approval of each subproject by the relevant EPA prior to financing of such subprojects. B. Institutional Development Tasks: Implementation Arrangements 5.11 Chart 4 shows the schedule for project implementation. Primary responsibility for implementing various tasks proposed for ABC's institutional development (paras. 4.25-4.27) would be that of the Leading Group and the Project Office at headquarters (paras. 5.3 and 5.4). ABC's following departments will participate in carrying out specific tasks: Systems Reform, Finance and Accounting, Training, Agricultural and Commercial Credit (including poverty alleviation and state farm divisions), Information (MIS), and the three National Training Institutes (Annex 9, Table 1). ABC's Systems Reform Office will organize in March 1991 a national symposium on ABC's financial management, followed by at least two seminars at selected provincial branches. The Systems Reform office will also participate in a mid-term review by the Bank Group of ABC's progress in financial management initiatives including the review of financial covenants (para. 5.23). ABC's Finance, Accounting and Internal Audit Departments would be responsible to arrange workshops for their senior staff in bank management and related topics. These departments would also arrange overseas training for their senior staff. The Project Office at headquarters would be responsible for development of medium-and long-term lending programs and related studies and reviews of ABC's lending policies for major client groups (TVEs, state farms and poverty groups) in association with concerned departments/divisions. ABC's Information Department will organize a review of its Management Information System and computerization program through an internationally recruited consultant and procure equipment for ABC Headquarters. Trainers' training and special courses for ABC's middle-level and senior staff would be organized by the Training Department and the Project Office respectively. The Project Office would prepare a semi-annual progress report on the above tasks for review by ABC's President's Council and forward a copy of this report to the Bank Group together with a record of actions approved by the President's Council for information and comment. This was agreed to at negotiations. As regards the rural investment & finance study, at negotiations an assurance was obtained from the government that the study would be completed by June 1992 and that ABC would  38 participate in this study. The Bank Group would work with the State Council's Office of the Rural Reform Experimental Areas (ORREA) and the Development Research Institute (DRI) for this study. C. Subproject Implementation 5.12 Annex 11 summarizes ABC's onlending terms and conditions and criteria for subloan approval. Based on the recommendations of technical experts (in most situations concurrently with the technical feasibility studies), ABC staff would carry out financial and economic appraisal of subprojects using standard techniques outlined in ABC's project appraisal manual which was developed with IDA assistance under Rural Credit I project. Most subproject proposals are reviewed by provincial POs who also consult provincial technical bureaus on subprojects involving large amounts and new technologies. Subprojects involving irrigation or other infrastructure development are prepared by local governments' water resources bureaus and construction agencies. As for agroprocessing subprojects, the 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. 5.13 Generally in crop production, livestock and fisheries, the majority of subborrowers would be specialized households, collectives and state farms. Collectives and state farms allocate subloans pro rata to their member households under contracts undertaking that subloans would be used for approved purposes and repaid according to the prescribed schedule. These subprojects are executed by borrowing households themselves with the help of construction teams. Starting with the proposed project, ABC would mobilize expertise needed to independently oversee the technical aspects of its lending operations through TEG (para. 5.6) and by hiring independent consultants. 5.14 Subloans in excess of $3 million would require the Bank Group's approval before being finally approved by ABC to assist ABC in reviewing whether the appraisal methodology has been properly applied and sectoral or technical issues have been adequately addressed. An assurance to this effect was obtained at negotiations. About 25 subprojects, including some reviewed during appraisal, are likely to be referred to IDA for prior approval. D. Project Beneficiaries 5.15 Subborrowers would include individuals, individual and specialized households, collectives, cooperatives, township and village enterprises, state farms, supply and marketing cooperatives, state-owned or registered enterprises (set up by the state farms, local government bureaus, and supply and marketing cooperatives). State-owned and registered enterprises would play an important role in project implementation, by performing one or more of the following functions: channelling ABC credit to and collecting subloans from individual households and enterprises; establishing enterprises for processing of project output; and providing technical and marketing services to households and enterprises. Operating as independent economic entities, enterprises and intermediary companies would enter into contractual arrangements with participating households, and charge fees for their services. By current estimates, about one-third of the project funds would go  39 directly to individual, specialized households, cooperative organizations, one-third to households and enterprises within the state farms and TVEs, and the balance to state-owned or intermediary companies directly or through them to participating households. 5.16 Enterprise A2praisal. In support of the ongoing enterprise reforms and as a part of the project lending procedures, ABC's provincial and county branches would carry out an appraisal of the participating state farms, TVEs, and intermediary companies to ensure that these entities are financially viable, and are managed efficiently. Main elements of the enterprise appraisal are indicated in Annex 11 (Attachment 1). This appraisal would review, among others, the nature of enterprise organization and legal status, financial condition, financial projections for 3-5 years, management capability, subloan guarantees, arrangements for financial audit, and that the contractual arrangements between households (producers) and enterprises, and staff and enterprises (including participation in ownership, management and profits) are fair and equitable. Enterprise appraisals so far completed have been found very useful by ABC branches in spearheading management and financial reforms in concerned enterprises and it has accordingly been decided to introduce enterprise appraisal in all ABC branches as a part of subloan decision- making procedure. 5.17 State Farms and State-sponsored companies. Since 1984, there has been much decentralization in the management of the state farms. Individual households in state farms now operate under the responsibility system and directly borrow money from ABC. Enterprises sponsored by the state farms operate as independent economic entities responsible for their profit and loss, and also borrow money directly from ABC for working capital. Borrowings by enterprises for purchase of fixed assets, however, require prior approval of the sponsoring state farms' parent body but the state farms are no longer liable to repay ABC loans unless these are explicitly guaranteed. Most state farms no longer receive any government budgetary funds, which has increased their reliance on ABC loans and brought greater financial discipline in their operations. Accordingly, ABC's appraisal of the state farms would cover the following main aspects: the status of reforms introduced, sources and uses of funds, financial condition of the state farms and of the enterprises sponsored by the state farms, and the state farms' overall management efficiency. (Annex 11, Attachment 1). 5.18 ABC would use RCCs and Supply and Marketing Cooperatives (SMCs) to perform agency functions for which they are particularly suited. Traditionally, individuals and households deal with rural credit cooperatives (RCCs) for their short-term production credit, and for small loans up to three years for farm improvement, sideline activities, and consumption needs. ABC concentrates on providing larger subloans to specialized households, collectives, and organized entities. However, wherever feasible (especially in area development programs like tea and bamboo planting and rehabilitation, and rangeland-based livestock development, ABC would use RCCs for onlending project funds using the guidelines developed under Rural Credit III project, making sure that RCCs selected are financially sound and have the necessary managerial capability (Annex 11). ABC would use SMCs in the project areas for their traditional function of providing inputs to farmers, arranging marketing of project output, and collecting subloans for ABC on an agency basis.  40 E. Onlending Terms and Conditions 5.19 As in earlier projects, the Government would make IDA and IBRD funds available to ABC for onlending to subborrowers and for its institutional development under a Subsidiary Loan Agreement which would be concluded as a condition of Loan/Credit effectiveness. A draft of this agreement would be reviewed and agreed to with ABC and the government before it is concluded. The subsidiary loan would be repaid in the currency used (in the case of IDA Credit, SDR equivalent of foreign currency used) over 15 years, including 5 years of grace. Under the earlier projects, the MOF loan to ABC carried a term of 20 years, which has been reduced by MOF to 15 for this project, as a measure of financial discipline. Starting with this project, interest rates on IBRD and IDA funds onlent by MOF to ABC in Renminbi will be brought in line with the average weighted cost of ABC's long term domestic funds (fixed term borrowings, time deposits, deposit certificates, bonds and similar resources with maturities up to 5 years, and not more than 20Z of total demand deposits). Inclusion of 20Z of demand deposits in longer term funds is intended to promote term transformation of short-term funds; already about 15Z of ABC's short term resources are deployed in long term lending. The government would also ensure that the interest rate on Bank Group funds onlent in local currency is not lower than the interest rate charged by the government or PBC to other specialized banks for similar loans for similar purposes. The interest rate to be charged by the government to ABC on Renminbi loans would be determined by the government at least annually and applied prospectively. The IBRD Loan and IDA Credit funds onlent by MOF to ABC in foreign currencies would carry a rate not lower than the prevailing variable IBRD loan rate or such other market-based rate acceptable to the government, ABC and the Bank Group. This would ensure that onlending rates for Bank Group funds remain consistent with the prevailing market rates for longer term resources and eliminate any explicit or implicit subsidies to ABC operations. While the DCA and IBRD Loan Agreement provide for a market-based, foreign exchange lending rate as an alternative to the IBRD lending rate, because the current pattern of China's foreign borrowings does not provide a rate that would reasonably reflect the market cost of foreign currency loans potentially available to ABC, the government, for the present, would not use this option. During project implementation, the government, ABC and the Bank Group should seek ways to ra.ionalize ABC's general interest rate structure for households, collectives, state farms and TVEs, by purpose (production and investment loans) and subloan maturities. This would be done through project supervisions while related issues are considered by the proposed study of rural investment and finance (paras. 4.26 and 5.11) and the project's mid-term review (para. 5.23). 5.20 ABC would have the option of borrowing the proceeds of the IBRD Loan/IDA Credit from MOF either in Renminbi or in foreign exchange according to its needs and ability to cover foreign exchange risk. On Bank Group funds onlent by MOF to ABC in Renminbi, the government would carry the foreign exchange risk. However, for some subprojects, ABC would extend subloans in foreign exchange to enable subborrowers to import equipment, breeding stock, and other essential inputs, in which case ABC would borrow the Bank Group funds from MOF in foreign currencies and pass on the exchange risk to subborrowers. On the amount of IBRD LoanJIDA credit used by ABC in foreign exchange for staff training programs, overseas study tours and purchase of equipment, etc., ABC would carry the exchange risk. An assurance was obtained at negotiations that government would make available the amount of foreign exchange needed for project implementation to ABC and subborrowers.  41 5.21 ABC would onlend project funds to subborrowers to cover not more than 70% of the cost of any subproject. Minimum contribution by subborrowers to subproject cost would be 302, which is in accord with PBC's current credit regulations. Repayment periods for subloans would vary between three to ten years, and would not generally exceed 12 years, based on the cash-flow estimates for typical subprojects. 5.22 Based on the current interest rate structure (pars. 2.22-2.23), ABC's interest cost of project funds would work out to about 7.4% while the weighted average yield on project subloans would be about 11.6%. 14/ This would provide ABC a gross spread of about 4.22. Allowing for ABC's operational costs at 1.6Z (including administrative costs, business tax, welfare and development funds and depreciation), ABC would receive a net spread of about 2.62 (before tax). ABC pays about 62Z of net profit toward income and adjustment taxes leaving about 1% for provision of bad debts or transfers to equity (credit funds). Of this spread, about 0.3% is retained at headquarters and the balance of 0.7Z jy the branches. ABC's interest spread on project lending after payment of income and adjustment taxes (i.e.4.22 minus 1.6Z) would be about 2.5% as contemplated bv che project's onlending terms and conditions. 5.23 During negotiations, an aosurance was obtained from the government and ABC that interest rates charged on project subloans would not be lower than the prevailing interest rates for similar loans for similar purposes, and would be sufficient to permit ABC to retain an interest spread of at least 2.5% (after payment of income and adjustment taxes to MOF). or such other spread as may be agreed between the Government and the Bank Group, and that ABC would be given authority to increase interest rates to subborrowers to ensure a minimum spread of 2.5Z on project lending. Currently, ABC is authorized to charge interest at rates 20% higher than the rates prescribed by PBC depending upon the sources of funds and the purpose of subloans. In addition, at negotiations, an assurance was obtained from the government and ABC that interest spreads on ABC's total lending operations (including commercial and policy-based lending) would be sufficient to maintain its overall financial viability and profitability, including provisioning for bad debts on the basis of criteria acceptable to the Bank Group (para. 2.32). During negotiations, the government and ABC agreed that ABC's equity (including MOF contribution, retained profits and provisions not in the nature of liabilities external to ABC) would not be less than 5% of its risk assets (loans) and that ABC 141 Interest cost of ABC's project funds is based on: (a) weighted average cost of its domestic funds (29Z) currently at 62 p.a.; and (b) cost of Bank Group funds (71% of subloans) onlent by MOF to ABC, at the current IBRD rate of 7.72Z for foreign currency loans and about 8% on Renminbi loans, i.e. the rate comparable to the average cost of domestic long-term funds, plus a commitment fee on IBRD loan. The weighted average yield on project subloans has been calculated on the basis of the expected composition of the loan portfolio by subsectors (crops, 302; livestock, 26%; aquaculture, 13%; and agroprocessing and marketing, 31Z) and the maturity structure of the loan portfolio comprising 1/3 of the subloans for 1-3 years, 1/3 for 3-5 years, and 1/3 for over 5 years. On at least 50% of the total loan portfolio, ABC would charge interest at rates 20% higher than the prescribed rates.  42 would establish, by the end of December 1991, a recapitalization plan including mechanisms for equity replenishment and a time-table for implementation. Recapitalization mechanisms would include: allowing ABC to retain a larger proportion of annual profits toward reserves and provision for bad debts, reducing taxation rates. and making direct contribution to ABC's equity. This recapitalization plan would ensure that ABC's risk-weighted capital adequacy ratio would rise to about 8Z, in line with the prevailing international standards within a reasonable period. The government has also agreed to carry out, by December 31, 1992, a mid-term review with the Bank Group, of the progress of implementing overall financial sector reform, including credit and interest rate policies, rationalization of the interest rate structure, and banking regulation and supervision; and of implementation of the project and ABC's institutional development, including ABC's risk-assets ratio and recapitalization plan, and the credit and technical assistance program under the project. 5.24 With projected inflation (CPI index) of 4Z during 1990, 9X in 1991, 82 in 1992 and 5% during 1993-95, the proposed interes,. rates are expected to remain generally positive. However, at negotiations, an assurance was obtained from ABC and the government that ABC would lend project funds to subborrowers at rates which would be positive in real terms. 5.25 ABC onlending of IBRD Loan and IDA Credit to the project areas would be broadly as follows: Inner Mongolia: $25 million; Shaanxi: $29 million; Jilin: $30 million; Liaoning: $32 million; Jiangxi: $34 million; Guangdong: $23 million; Beijing municipality: $25 million; Guangxi and Hubei: $10 million each; Fujian and Hunan: $15 million each and other areas about $25 million. Since the indicative investment program for the project is flexible, ABC Headquarters and project areas could modify this allocation as necessary for efficient implementation of the project. About US$12 million of Bank Group funds are expected to be channelled through eligible RCCs for subloans conforming to terms and conditions similar to those for ABC subloans (Annex 11, para. C-6). F. Accounts and Audit 5.26 County and provincial branches (the municipal branch in case of Beijing) would maintain separate accounts for project subloans and expenditures. These records would be forwarded to the provincial POs which would maintain consolidated accounts including subloan disbursement data that would be used by ABC headquarters for withdrawal of the IBRD Loan and IDA credit. At ABC headquarters, the Project Office would consolidate the accounts for the project as a whole including the expenditures incurred under the technical assistance component. Experience with maintenance and audit of accounts for the earlier projects is generally satisfactory. The Bank Group has made specific suggestions to the State Audit Agency (SAA) which would do the audit of ABC branches and headquarters and the project accounts, for improving the content of the audit to make it more useful to ABC's management, to which SAA has agreed. Assurances were obtained from the Government and ABC at negotiations that ABC headquarters and branches would maintain separate accounts for project subloans and expenditures and these would be audited by independent auditors acceptable to the Bank Group, according to guidelines acceptable to the Bank Group. These guidelines, which have been communicated to SM under Rural Credit III project, would introduce management audit concepts and seek SAA opinion on adequacy of interest spreads on project lending, subloan collection  43 performance and provisions for bad debts. ABC would forward to the Bank Group the audited project accounts together with duly audited annual accounts (balance sheets and income statements) of ABC's provincial and municipal branches and of ABC's total operations, within six months of the close of each financial year. The audited accounts would include details of withdrawals from the IBRD Loan/IDA Credit Accounts made on the basis of SOEs and the auditors' opinion as to whether such withdrawals were against expenditures eligible for reimbursement by the Bank Group. Assurance on audit of project accounts and submission to the Bank Group of audit reports on project accounts and ABC's audited annual accounts was obtained at negotiations. G. Monitoring, Evaluation and Reporting 5.27 The project's physical and financial progress would be monitored through progress reports that would be sent by county branches/PUs to the provincial POs and by the latter to the Project Office at the headquarters. Each PU or county branch would prepare a monthly progress report on subloans disbursed (for purposes of withdrawal of IBRD Loan/IDA credit); and quarterly reports showing subloan approvals and disbursements; progress in subproject construction; problems encountered in subproject implementation and the steps taken to resolve them; subloan collection performance; cash flow projections for typical production and agro-processing enterprises; and an overall review of the county ABC operations. County PUs and branches would present the monthly and quarterly reports to the local PMCs and to the provincial POs. ABC has developed a manual for monitoring and evaluation which is being tested in the field and through workshops for the project, the first one of which was conducted in July-August 1989 with EDI participation. Another workshop was held in March 1990. Guidelines for monitoring and evaluation for the proposed project would be firmed up by the end of June 1991. ABC would submit semi-annual reports to the Bank Group within two months following the end of each reporting period. This was agreed at negotiations. 5.28 Within six months of the completion of the Loan/Credit disbursements, ABC headquarters would prepare for submission to the Bank Group, its part of a Project Completion Report (PCR). The PCR would assess the project's impact on ABC's institutional development and changes in incomes and employment levels in the project areas, financial and economic rates of return on representative investments compared to appraisal estimates, effects on upgrading production technology, performance of different subborrower organizations and ABC's project organization, problems experienced in subproject implementation and lessons learned. H. Environmental Effects 5.29 Project investments in fruits, mulberry planting, green tea rehabilitation, and rangeland-based livestock development would clearly have beneficial effects on environment, especially by reducing soil erosion (paras. 4.5- 4.10). Other project investments are not anticipated to generate adverse effects on the environment. Environmental aspects of several subprojects were reviewed during appraisal and a few subprojects which were unlikely to conform to Bank Group environmental standards with the technology and investment proposed, were dropped. For specific subprojects referred in paras. 4.11 and 4.19, the government and ABC have agreed to take measures necessary to protect the environment. Thi- was confirmed at negotiations. To address any potential dangers, local EPA representatives would participate in subproject feasibility studies and reviews at  44 county to provincial levels, and advise on specific actions conforming to appropriate provincial and national guidelines on environmental control. Additionally, an assurance was obtained from the government and ABC at negotiations that all subproject activities would conform to appropriate guidelines on environmental control issued by the provincial and national governments and acceptable to the Bank Group. Similar arrangements under the earlier project (Rural Credit III) have performed satisfactorily. VI. MARKETS AND PRICES A. Market Prospects 6.1 Market prospects for the project's incremental outputs are good, particularly for meat, wool, egg, milk, fish, fruit, vegetables, tea and Chinese herbs. These products generally face high income elasticities of demand, and their demand has been continuously increasing as China's per capita income has grown. The historical growth of production and per capita consumption of major commodities and the per capita incomes and their growth rates for China and the project provinces are summarized in Table 6.1. Table 6.1 Output *nd Consueption of Major Farm Producte and Income Growth totween 1980-1988 Production Con-u ption -- _ ; -- - - -- - - _U _--___---__-___---___-___ __ ___ 1980 1988 (X) b/ 1980 1988 (S) Orain (an tone) 321 894 2.61 (kcapita)27 260 01 Oil Crop (an tone) 7.7 13.2 7.01 Ve9etables 127 130 0.3O Mulberry Silkworm Edible Oil 2.5 4.8 8.5S Cocoon (O00tone) 250 394 5.91 Meat d/ 7.8 10.7 4.0- Tea (0OOtone) 304 54S 7.61 Poultry 0.7 1.3 8.01 69 E 1.2 2 3 8.51 Fruit (000tone) 6793 16661 11.9S Figh and Shrimps 1.1 1.9 7.11 of which Apple 2363 4344 7.91 Income Growth e/ Citrus 713 2560 17.31 ------------------ (Yuan/capita) 1980 1988 (1) Cattle (millon heads) 72 98 3.91 ---------------------- ----------- Hug Stock (an sde) 305 342 1.41 China 191 545 14.01 Hog elaughtered(an ,ide) 199 276 4.2% Beijing 290 1063 17.6S Meat (QOOtone) 12054 21936 7.8% Ounngdong 274 809 14 S, Millk (OO0ton) */ 1618 3660 14 6X Li oning 273 699 12 5X Fine Wool (000tons) a/ 202 222 1.61 Jilin 236 628 la0 Cashere (OOtons) a/ 4 4.7 2.71 Inner Mongolia 181 499 13.51 Jiangxi 180 488 13.31 Freshwater Fish (O0Otons) 1480 3938 17.71 Shaanxi 142 404 14.01 Shrimps. Prawns (000tone) 469 1033 14.11 Guann,i 174 424 11.81 Hube, 170 408 14.41 Hunan 220 514 11.21 FuJ ian 172 613 17.211 */ 1982-1988 b/ Annual avergt growth rate. e/ Rural per capit consumption d/ Pork, b*ef and mutton. The urban per capita consumption of "eat in 1988 wae 19.75 kg. e/ Agriculturel household Incom per capita. Source: China Statisticel Yebook 6.2 Domestic Demand. The project would focus on production of high value agricultural commodities and processing to capture additional value added. Most of the commodities concerned under the project are currently in short supply. Domestic demand for these commodities has risen rapidly in response to increases in disposable incomes both in urban and rural areas and to changes in diet which have been moving towards a more balanced composition. Expected increases in income at an annual rate of about 6% in real terms during the Eighth Five Year Plan(1991-1995) would result in further increase in demand for livestock products, fish and fruit as consumers continue to vary diet intake while reducing direct consumption of cereals and tubers. China's per capita human consumption of grain of 260 kg is already one of the highest in the world. Given rising income levels, a continuous  45 diversification of China's diet is expected to occur. Local consumption of poultry, meat, eggs, dairy products, and fisheries products has been constrained by supply limitations. Per capita consumption of these commodities, while growing, is still low compared to the world average and other developing countries. Pork dominates meat intake with over 80% of total consumption. However, poultry has been and will continue to increase its share at the expense of pork. China is the major consumer of tea but its per capita consumption of 0.3 kg still lags far behind Hong Kong(l.73 kg), Japan(1.5 kg) and Taiwan(I.2 kg). China's tea consumption is expected to increase *-o 0.5 kg by the year 2000. 6.3 Export potential and import substitution. While partially filling the gap created by growing domestic demand, the project would promote exports and encourage efficient import substitution. The recent official devaluation of the Yuan from Y3.71 to Y4.72 per US$ in December 1989 has already helped to reduce the import bias created by the previously overvalued currency, and encourage exports. China is a net exporter of all products produced by the project except raw wool and paper. China's share in international trade in some of these commodities is substantial and has been growing due to robust international demand. For example, China's silk and cocoon export constitutes 902 of the world traded volume. On the import side, China is also a main player; one third of the world's wool trade is accounted for by China's imports which the project would help partially to substitute. In addition, the project would substitute for imports of plywood and paper. Good export potential would continue to exist for China provided cost competitiveness is maintained and higher product quality is achieved. Toward this end, the project would emphasize improved productivity, technology selection, machinery procurement and enterprise management, 6.4 Among the major project outputs, export prospects are particularly promising for Chinese traditional medicines, herbs, exotic vegetables, eel, bamboo shoots, cashmere and other high value cash crops. These special products would add to already successful exports such as poultry, beef and scallop. An exception to this would be shrimp, whose supply has expanded rapidly particularly from Asian countries including China, and whose world market prices have been on the downward trend recently. However, the current market trend seems to indicate that the price drop is more or less stabilized as keen competition in the world market is streamlining the imbalance in supply and demand. China, in general, is a relatively low cost producer of shrimp, and hence has been able to weather the adverse shrimp market trend. This project would support only rehabilitation of existing shrimp farms with an objective of improving yields while reducing cost of production. Liaoning, one of the major shrimp producers, is richly endowed with wild marine feed, which gives the province a competitive edge over other producers (para. 4.20). The past export performance of some of the project products is summarized in Table 6.2. 6.5 Changing Consumer Preference: The project would also respond to changes in consumer preference for increased convenience by canning, bottling, and dehydrating of vegetables and fruit, and providing improved storage facilities which would allow for year-around supply of perishable commodities and enhance financial profitability by capturing the high off-season prices. While processors would benefit from increased supply of seasonal products during off seasons by getting higher prices and capturing value added, producers and consumers would also benefit as farmers are able to sell their products more readily to processing industries and  46 consumers are able to buy seasonal products all year-round. Table 6.2 ? rath of Export of Selected Project Commodities 1981 1988 Crowth rate (1) (US11 m;ilIlon) __ - -- __- - ------------------ EXPORT V. It uantity Value Quantity Value Quantity Value Poultry, frozen 00tons 38.0 44.0 26.0 43.5 -4.81 -0.21 Pork, frozen 000tone) 71.3 115.8 78.3 117.8 1.41 0.8% goof, frosen 000ton. 8.4 12.5 57.4 107.9 31.61 36.1s Aquatic products 000tcne 115.7 352.7 264 932.9 12.51 14.91 Vegetables 000tone 470.8 214.8 765.7 476.1 7.2% 12.01 Dried Muslhrooe 00Otona 0.7 4.6 5.1 49 36.21 40 2% Edible Funi; C00tone 0.9 10.8 1.9 14.8 11.31 S.31 Oranges 000tons 33.4 12.2 74.7 38.3 12.21 17 81 Apple* 000tons 63.9 20.7 87.9 39.4 4.71 9 61 Toe o.tone) 89.8 19,7 198.3 401.9 12.01 53.01 Raw silk .O00tene 8.3 152.2 9.4 300.7 0.51 10.61 Caheer-e tone) 2.4 60 7 22 190.6 181 17.61 Source: Chlne' Cuetoee Statlatice B. Marketing Channels 6.6 Most of the project outputs and inputs are traded in free markets. The exceptions are fertilizer, pesticides and plastics used in cultivation; in some provinces, local governments set urban ration amounts for pork, grain and sugar, which are purchased through the government procurement system for distribution through government shops. Free market trading has become increasingly important over the last decade in response to price deregulation, and the lifting of quotas and restrictions on long-distance trade. Nationwide, the number of free markets more than doubled since the introduction of the reforms in 1979 and the value of farm products sold in these markets increased more than six fold. Commodities not subject to quota are marketed directly by farmers or through contracts with distributors. Transportation to and from the wholesale market sites is currently constrained and mostly dependent on small scale hauling on bicycles, animal driven carts, or wagons. At the local level, farmers transport 50 to 100 kg of fresh produce on bicycles, carts and even on buses to urban or suburban wholesale markets to market the products themselves. The distance travelled varies between 20 to 100 km. Often farmers use middlemen to market products. Farmers and vendors lease stalls at a daily fee of about Y2 and also pay varying percentages (usually 2Z) of their daily sales value as a fee. While the existing wholesale markets are working fairly efficiently in large cities and suburbs, they are operating at full capacities with no room to expand. The wholesale markets serve an important function of aggregating goods for sale both inside and outside of the provinces and providing outlets for distributing imports. The government attaches high priority to the development of wholesale markets. 6.7 China's foreign trade is handled by several centralized foreign trade corporations (FTCs) organized along product lines. FTCs are regulated by government trade policies and supervised by the Ministry of Foreign Economic Relations and Trade (MOFERT) and its provincial level, Foreign Trade Bureaus (FTBs). Until recently, the national-level FTCs such as the Cereals, Oils and Foodstuffs Import and Export Corporation (CEROILS) and its municipal and provincial branches directly conducted all trading activities ranging from the identification of markets, the negotiation of prices and contracts to the procurement of goods from producers and shipments to buyers. In 1988, and again in 1989, more authority was delegated to selected provinces and their local jurisdictions to manage export marketing directly. These changes allowed more flexible trade regimes, allocated more foreign exchange to exporting provinces and entities, and encouraged export and import marketing organizations more geared towards local needs. This also led, however, to  47 a proliferation of local trading houses, which in some cases were not fully qualified to carry out intensive international trading actLvities. While foreign trade is still largely controlled by the state sector, the recent decentralization allows more immediate contact between producers and foreign buyers, thus facilitating quicker responses to changing market demand. C. Prices 6.8 Since the reforms were introduced in 1979, the main focus has been on: (a) adjusting procurement prices for goods marketed through the state-run system; and (b) reducing the volume and number of goods subject to state monopoly purchase. The Government has also encouraged more open market oriented trading with gradual price decontrol of fruits, vegetables, fisheries and livestock products, and a range of other staple commodities. In response, the prices of these products rose ZO to 40? in the first half of 1980s, and the bulk of them are now being traded on the free market. Notwithstanding this success, high inflation during 1988/89, sharp supply and price fluctuations, and increasing state budgetary expenditure on food subsidies led the Government to defer further price reforms. 6.9 Most of the project's output would be traded at market prices either through private traders or to state agencies with few exceptions. Controlled products would be sold at either contract or negotiated prices. Once producers meet their quotas, the rest would be marketed in free markets. When products are in short supply as is the case for many of the controlled commodities, the negotiated prices are generally close to the free market prices as they tend to follow demand and supply trends in the free market. Free market and state procurement prices have risen steadily over the past few years. Retail prices of meat and aquatic products rose substantially in 1988 and are close to world market prices. In some cases like eggs, poultry, edible fungi, chilies, and ginseng, domestic prices exceed international prices. The details of financial and economic prices of the project's outputs and inputs are given in Annex 12 (Table 1). 6.10 For pork, tea, silk cocoon and ginseng, prices are controlled at both farm gate and processing factory gate. The provincial governments set guidance prices for these products in consultation with various agencies concerned. For example, the state guidance price for meat is set in Liaoning by the Price and Commercial Bureau, and the ginseng prices in Jilin are set by the Price Bureau in consultation with the Bureau of Forestry. Prices of inputs are determined by the Price Bureau and local Supply and Marketing Cooperatives (SMCs). The guidance prices provide price floors and the ranges within which prices can be negotiated between buyers and sellers. Actual price levels vary within the range based on changes in production cost, market conditions, and local policy on nutritional requirements. This guidance price system gives the state some leverage to determine and direct the market prices and at the same time, gives sellers some control over the prices at which they will sell. 6.11 Distribution of farm inputs, especially fertilizer, is regulated by the government often linked with grain and non-grain product procurement. This is done by setting rates of exchange with farmers who would sell their products to the state in exchange for inputs at state-fixed prices. These forms of input subsidies have been reduced since the reforms were introduced. However, input subsidy elements for staple crops which are underpriced on the output side are likely to continue at  48 least in the medium term. Beyond quota amounts, farmers must purchase inputs in free markets paying market prices. VII. BENEFITS, JUSTIFICATION AND RISKS A. Production and Benefits 7.1 Incremental Production. Major benefits of the project would be incremental production and increased rural incomes. At full development, incremental annual fruit production would be about 360,000 tons; vegetable and other specialty crops of 170,000 tons; bamboo 1,000,000 tons; tea production of 40,000 tons; mulberry and cocoon production of 180,000 tons. Incremental animal stocks would be 200,000 head of cattle, 450,000 head of sheep and 21 million poultry. Incremental milk production would be 18,000 tons. Fisheries production would increase annually by 13,000 tons of freshwater fish, 1,800 tons of shrimp and 6,000 tons of scallop. In addition, the project would increase fingerling production to ensure adequate fingerling stock to be available to support the fishery subprojects. At full development, incremental production value of the project is estimated to be about US$600 million equivalent, of which agroprocessing subprojects would contribute US$145 million. 7.2 This incremental production would be attained through expanded scale, improved quality of inputs including fertilizers, irrigation, soil conditioning, high yielding seeds, better rootstocks, adoption of new technologies and production techniques, and improved human resources made possible by training and extension services. Improved breed and feed nutrients, better disease control and animal husbandry, and capitalizing on relatively unutilized rangeland resources in northern Inner Mongolia would enable increased production of livestock. Rehabilitation of the existing shrimp farms to reduce costs and increase yields would enable China to maintain her competitiveness in the world shrimp market. Improved construction of fish ponds and cages would convert waste land to economically productive resources and better water flc. channels and feeding would increase fishery productivity. The project would support diverse agroprocessing subprojects, such as processing of exotic mushrooms and herbs, which would allow the project entities to capture local comparative advantages based on locally available raw materials and in many cases of local native varieties. Forward and backward integration under the project -- e.g. feedmillers investing in livestock raising or large livestock farms investing in feedmills and/or slaughterhouses -- would increase efficiencies in input and output flow and speed up turnover of stock for higher profits. 7.3 Import substitution by many of the projects' subborrowers would save scarce foreign exchange, while the export potentials of many of the products would generate foreign exchange incomes. The project would also enhance the technical know-how of many processing facilities either by improving an existing technology or by introducing a new one. Further, improved cold storage facilities would make seasonal and perishable products available over a longer period of time, hence contributing to the improvement of dietary intake of fresh produce during off- seasons. Improvement in slaughterhouse facilities and their operation would enhance the quality of livestock products.  49 B. Employment, Income and Poverty Alleviation 7.4 Employment Generation: Employment opportunities generated by the project would help reduce existing seasonal unemployment and underemployment among the rural labor force in and around the project areas. Substantial employment generation is expected in the crop, livestock and fishery programs. The project would directly generate around 27 million workdays, equivalent to 90,000 full time jobs. In particular, additional employment would be created in remote mountainous and rangeland areas where alternative job opportunities are limited. 7.5 Income Generation and Poverty Alleviation: The project would have substantial impact in increasing income to project beneficiaries. In most project areas, per capita rural incomes are far below the national average of Y545. Even in the relatively better off provinces, per capita income levels of many of the project counties are far below their provincial average and income disparities among counties are still widening. In Inner Mongolia, Jilin, and Liaoning (mainly in grassland and mountainous areas), Jiangxi (tea areas), and in Guangdong (48 hilly counties in the north), the local governments have designated several counties with per capita incomes less than Y200-250 as poor areas for special development programs. About one-third of all the counties included in the project are classified as poor counties (para. 3.2). With one of the main objectives of the project as poverty alleviation, selection of subprojects and sites has focused on poor, mountainous areas where relative income levels are low and incremental income benefits would be substantial while contributing towards narrowing of income disparities. Thus, the project would supplement government programs in poverty alleviation. 7.6 Women in Development: The major social benefit resulting from the project, besides poverty alleviation, is improvement of women's position in their roles as entrepreneurs, managers, and active participants in labor markets. The borrower, ABC, has a substantial proportion of female high level staff both at headquarters and in provincial branches with close to 28Z of the total bank staff being women. The project would further strengthen women's role within ABC by enhancing training components. In many of the subprojects, particularly in processing activities, the proportion of women in higher managerial positions is high. In subprojects involving individual households (e.g. small scale poultry raising, mulberry and tea planting and primary processing), women play a predominant role in managing production and sales as many of these activities represent side income sources apart from the main grain production work which is mainly tended by men. In China, when a borrowing entity is an individual household, no apparent bias against women in granting credits exists. On the contrary, for these small borrowers in the project, special attention would be paid that whenever financially viable, credit would be provided to farmers irrespective of the borrower's gender. Women would also contribute substantially to project production as laborers. A good example would be tea production in Jiangxi. Traditionally, the labor force in production and processing of tea, collection of mulberry leaves and silkworm rearing, has been predominantly female. In addition, other processing and packing activities including down and feather processing, bamboo shoot processing, meat and fisheries products packing also provide job opportunities for women.  50 C. Environmental Benefits 7.7 The environmental impact of the project would be quite positive. While supporting livestock projects, the project would contribute to restoring of eroded grassland and maintaining presently good grassland in Inner Mongolia by introducing the Area Management Plan (AMP) approach to pasture-based livestock components. If properly implemented, the potential benefits of AMP would be far-reaching beyond the project areas and would have a profound long lasting impact on livestock development in the province. For eel production in Guangdong, which relies on capturing of wild fingerlings, resource management aspects pertaining to use of this depletable resource have been emphasized to avoid a complete depletion of natural eel fingerlings and consequent shutdown of eel production as experienced in neighboring countries. The eel fingerling stock would be periodically reassessed and the production of eel under the project would be adjusted accordingly. In assessment of agroprocessing proposals, inclusion of proper waste water and solid treatments was required. All agroprocessing sub-projects would follow industry specific pollution control measures and comply with the provincial and national environmental regulations on design of the treatment plants and the level of pollution permitted under the law. For all ginseng production and processing components, ABC and provincial governments would ensure that there will not be a net loss of forest due to the project. Although a reforestation program following ginseng harvest already exists, a more formal monitoring system with proper data would be maintained and the Bank would follow up during supervision. This effort as already agreed upon by the local governments would not only benefit the forest areas covered under the project (20 ha, less than 1 Z of the total ginseng areas in Jilin) but also the vast forest areas where ginseng is planted outside of the project area. Grain byproducts processing to make paper would eliminate a need to dispose of huge wastes, and would put them into productive use. D. Financial Analysis 7.8 ABC carried out financial and economic analysis of most of the 160 subprojects currently included in the lending program, following Bank Group procedures. The Bank Group missions selected about 45 representative subprojects for a more detailed analysis. For those activities for which detailed quantitative analysis has not been carried out, the Bank Group staff qualitatively evaluated these with the help of ABC and project staff. Cash flows after debt service are in general strong reflecting the careful selection procedure followed, which included among others, careful technical appraisal of investments and financial appraisal of borrowing enterprises. For the cases where cash flow after financing is negative for the first year or two (mainly because ABC does not allow capitalization of interest on subloans), particular attention was paid to check that the sub-borrowers have own resources or access to other sources of income/loans to pay ABC dues, so that the risk of loan default to ABC could be minimal. Table 7.1 summarizes the financial rates of return (FRR), economic rates of return (ERR) and net present value (NPV) at 122 discount rate for different categories of investment and major sub-projects. These figures would change as the proposed investment may be adjusted and as new investments are added during implementation. For illustration purposes, rates of return for selected subprojects are shown in Table 7.1. Details of the financial and economic analysis are provided in Annex 13.  51 Table 7.1: Summary of Rate of Return Analysis (million Yuan) Value of Investment Rote of Return Not Preoo,t Not Promont (Yuan million) (I) Volluo 0 121 Value 0 21 Financial Economic (F nanc;sl ) (Economic) Crops 524 311 a6n 6So d37 Fruit 238 261 291 248 264 Tom 53 211 m31 39 79 Others 239 381 ses 307 407 llvootock 453 27' 281 374 386 Pi a 41 345 341 SO s0 Sheep 66 281 311 60 66 Goat 24 2816 261 is 14 Cattle 184 33S 341 182 184 Chickon 116 8s 1615 1SS 1t0 Oucks 17 161 16% 12 14 Others 5 3s3 381 7 9 Aquecultur. 198 271 261 219 16 Fishponda 96 311 271 127 116 Cage fisheris 34 261 291 40 43 Pro"n pond rehab. 33 281 221 40 22 Others 3S 211 26S 12 1s Ageroprocessing 315 321 431 325 421 Fruit etorare 42 36% 411 43 s6 Li vetock products 33 221 251 32 38 Feod mills 18 38 451 28 39 Too processing 19 321 4051 14 l1 Forestry product 5 321 15S 7 7 Chinese medicine 83 40S 401 49 49 Others c/ 148 291 4bS 188 214 Incommitted 366 n/s n/. n/. n/a Tot l Project 1490 ;/ 241 271 168S 1944 a/ Total excluding the uncommitted smunt. h/ Total itncluding the uncommitted amount. ci/ IncuIdea Procesing of exotic, vegtables. edible fungi and other special products which command high price In international mrkets. E. Economic Analysis 7.9 The economic analysis for the principal sub-components of crops, livestock, aquaculture and agroprocessing has been carried out in constant 1990 border prices. The World Bank commodity price projections are used for all the applicable commodities. Where Bank projections are not available, the official statistics on actual import and export prices realized by China have been used and assumed to remain constant in real terms unless additional price projection information based on detailed sector studies (e.g. for shrimp) are available. 15/ All investment costs including physical contingencies have been included. A clearance was obtained that none of the project output is subject to Bank Group restrictions. The official exchange rate of Y4.72 per US$ (which is close to current market rates in China's foreign exchange adjustment centers) has been used and all non-tradeable inputs and outputs have been adjusted using specific conversion factors. The selected conversion factors are summarized in Annex 12 (Table 2). ERRs for sub-projects analyzed range between 162 and 482 with a weighted average of 27? for the project. The sensitivity analysis of selected subprojects indicates that most of the subprojects would remain viable with increases in investment or operating costs of 102 or drops in price or yields of 10? (Annex 13, Table 1). Exceptions would be tea processing and production of poultry and prawn. These investments are sensitive to changes in prices or operating costs as is usually the case with such input-intensive investments. For these subprojects, ABC would do case-by-case appraisal of subprojects to ensure that the proposed investments would provide acceptable financial and economic rates of return. 15/ Asia-wide Shrimp Agro-industry sector study, June 1989.  52 F. Project Risks 7.10 The project faces no unusual technical, organizational or financial risks. In the aquaculture component, scallop production, being an off-shore activity, is susceptible to storm damages. Agroprocessing products, particularly of highly specialized nature (e.g. oxytetracycline, pharmaceutical products, etc.), could face market risks as they are not ready substitutes for other products. Technologies to be adopted in agroprocessing are generally of standard designs and proper training would be followed for safe and optimal operations. The project would introduce financial and economic appraisal of subprojects to reduce the risk of subloan default. The Government has agreed that an adequate spread would be allowed to cover ABC's transaction cost as well as the cost associated with risk of bad loans. To reduce transaction costs of project lending, ABC would use RCCs wherever feasible for onlending and subloan collection and SMCs for agency services such as supply of inputs and subloan collection. Financial appraisal of ABC's overall operations including its capacity for project appraisal, has been carried out as a part of the project appraisal and technical assistance would be provided by the project to upgrade ABC's financial management, to reduce institutional risks in channeling long term investments. In addition, enterprise appraisals would be carried out by ABC for all enterprises, intermediary agencies and corporations which will handle subloans, to reduce any institutional and financial risks from other activities they are engaged in (para. 2.4). VIII. AGREEMENTS REACHED AND RECOMMENDATION 8.1 During negotiations, agreements were reached with the government that it will: (a) make available foreign exchange needed for project implementation to ABC and subborrowers (para. 5.20); (b) carry out with the Bank Group, by December 31, 1992, a mid-term review of the progress of implementing overall financial sector reform and of carrying out the project (para. 5.23); and (c) carry out with the Bank Group, by June 30, 1992, a study of rural investment and finance (paras. 4.26 and 5.11); 8.2 With respect te interest rates, interest spreads and ABC's overall financial management and viability, agreements were reached with the government and ABC that: (a) Interest rates charged by ABC on project subloans are sufficient to permit ABC to retain an interest spread of at least 2.5? (after payment of income and adjustment taxes to MOF) or such other spread as may be agreed between the Government and the Bank Group; that interest rates on project subloans are not lower than ABC's (RCCs'in the case of RCC subloans) for similar loans for similar purposes and are positive in real terms; and that ABC will be given the authority to increase the interest rates to final subborrowers to achieve the minimum spread of 2.52 on project lending (paras. 5.23 and 5.24); (b) Interest spreads on ABC's total lending operations (including commercial and policy-based lending) will be sufficient to maintain ABC's overall financial viability and profitability including provisioning of bad debts on the basis of criteria acceptable to the Bank Group (para. 5.23); (c) ABC will ensure that its equity is not less than 52 of its risk assets and  53 that ABC will establish, by the end of December 1991, a recapitalization plan including mechanisms for equity replenishment and a time-table for implementation. This recapitalization plan will ensure that ABC's risk-weighted capital adequacy ratio is at least 8% within a reasonable period of time (para. 5.23); and (d) ABC headquarters and branches will maintain separate accounts for project subloans and expenditures and these will be audited by the State Audit Agency (SAA) according to guidelines acceptable to the Bank Group. ABC will forward to the Bank Group the audited project and annual accounts of total operations of the provincial and municipal branches participating in the project, and ABC's total operations, within six months of the close of the financial year (para. 5.26). 8.3 With regard to subproject implementation, agreements were reached with the government and ABC on the following: (a) criteria for subloan approval (para. 5.12 and Annex 11); (b) organizational arrangements for project implementation including establishment of Project Management Committees at the provincial and county levels with participation of EPA representatives, and a review of TEG performance by the end of December 31, 1991 (paras. 5.6 and 5.10); (c) the government and ABC will take measures to protect environment in specific subprojects reviewed during Bank Group appraisal (paras. 4.11, 4.19, and 5.29) and that all subproject activities will conform to appropriate guidelines on environmental control issued by the provincial and national governments and acceptable to the Bank Group (para. 5.29); (d) implementation details of institutional development tasks (para. 5.11 and Annex 9); (d) technical guidelines for planting and rehabilitation of apples (para. 4.4), citrus planting and post harvest facilities (para. 4.5) and green tea rehabilitation (para. 4.8); (e) strengthening of extension system and issue of technical packages for mulberry planting, silkworm rearing, and bamboo planting and rehabilitation (paras.4.9 and 4.11); (f) area limits on ginseng planting and rehabilitation and related afforestation programs (para. 4.11); prior Bank Group review of selected irrigation subprojects (para. 4.12); (g) grassland-based livestock development in Inner Mongolia, Jilin, Shaanxi and Liaoning will be carried out using AMP concepts (para 4.16); (h) the provincial governments will establish "cage area to open water area' standards for cage fisheries to protect the environment (para. 4.19); and (i) ABC will obtain prior approval of the Bank Group for subloans in excess of US$3 million, before being formally approved by ABC (para. 5.14); 8.4 Conditions of Loan and Credit effectiveness will be: (a) State Council approval of the Loan Agreement and DCA and (b) the execution of a Subsidiary Loan Agreement, acceptable to Bank Group, between the Government and ABC incorporating onlending and repayment terms for proceeds of the IBRD Loan and IDA Credit to ABC (para. 5.19). 8.5 With the above agreements and conditions, the project would be suitable for an IBRD Loan of $75 million at the Bank's standard variable rate, repayable over 20 years with 5 years of grace, and an IDA credit of SDR 143.7 million (equivalent of $200 million) on standard terms of 35 years maturity, to the People's Republic of China.  54 ~~~~~~Annex I Table I FOURTH AURAL CREDT PROJECT Structural Chanos In th. Rural Economy 1062 1908 194 19ow 108 i9 1990 T.Or... NationalPolduct, 19