China - Tarim Basin Project

Domt The World: FOR OMFCIAL m- E Repr No. P-5475-CHA MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 93.8 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE TARIM BASIN PROJECT JULY 31, 1991 Thi document ha a restricted distibution and may be asd by reipiets oniy in the perfonrmae of their official dies Its contents may not othendse be dilosed without World Bank authorization.  CURRENCY EQUIVALENTS (As of May 20, 1991) Currency Unit - Yuan (Y) US$1.00 = Y5.22 Yl.0O = US$0.1916 FISCAL YEAR January 1 to December 31 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 cubic meter (cu m) 35.31 cubic feet (cu ft) 1 kilometer (kir) = 0.62 miles (mi) 1 hectare (ha) = 2.47 acres 1 mu = 0.067 ha 1 ton (t) 1,000 kilograms (kg) - 2,205 pounds (lbs) 1 kg = 2.2 pounds (lbs) ABBREVIATIONS AND ACRONYMS GDP - Gross domestic product ICB - International competitive bidding l,CB - Local competitive bidding O & M - Operations and Maintenance PHO - Project Management Office  FOR OmCAL USE ONLY CHINA TARIM BASIN PROJECT Credit and Proect Summary Borrowers People's Republic of China Beneficiary: Xinjiang Uygur Autonomous Region Amount: SDR 93.8 million (US$125 million equivalent) Termst Standard, with 35 years maturity Onlendina Terms: From Ministry of Finance to Regional Government for 20 years including 5 years of grace with interest at 4.3 percent per annum. The foreign exchange risk will be borne by the Regional Government. On-lending rates to productive enterprises will be no less than Agricultural Bank of China charges for loans for similar purposes and terms. Financing Plan: Local Foreign Total --- (US$ million)- Central, Regional/Prefecture Govts. 38.7 11.8 50.5 County/Townships and farmers 24.4 12.2 36.6 IDA 58.5 66.5 125.0 Total 121.6 90.5 212.1 CM___ : Inmw Economic Rate of Return: 34 percent (overall) Yerqiang Component: 36 percent Weigan Component: 33 percent Staff Appraisal Report: Report No. 9338-CHA MaPSS IBRD Nos. 22308R and 22309R This document has a restricted distibution and may be used by recipients only in the perfom, ince of their official duties. Its contents may not otherwise be diclosed without World Bank authori;,zmnr?  MEMORANDUM AND RECONMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE TARIM BASIN PROJECT 1. The following memorandum and recommuendation on a proposed credit for SDR 93.8 million (US$125 million equivalent) to the People's Republic of China ts submitted for approval. The proposed credit would be on standard IDA terms with 35 years maturity and would help to finance agricultural development in the Xinjiang Uygur Autonomous Region. Proceeds of the IDA credit will be onlent by the Ministry of Finance to the Xinjiang Uygur Autonomous Region at an interest rate of 4.3 percent, with repayment over 20 years, including a five year grace period. On-lending rates to productive enterprises will be no less than the Agricultural Bank of China charges for loans for similar purposes and terms. Foreign exchange risk will be borne by the Regional Government. Part Is COUNTRY POLICIES AND BAK GROUP'S ASSISTANCE STRATEGY 2. This section discusses China's development problems and prospects, the key reform priorities at the macroeconomic and sector levels, and the Bank Group's assistance strategy. A country economic report "China: Between Plan and Market' (No. 8440-CHA) was distributed to the Executive Directors on May 9, 1990. A new Country Economic Memora.lum, based on a mission to China in June 1991, is being prepared. Background 3. The decade of economic system reforms, introduced after periods of local and regional experimentation, has magnified the growth impulse of China's historically high rate of capital accumulation. During the 1980s, GDP growth was rapid, averaging about 9.5 percent annually. Industrial modernization and improved incentives increass A the competitiveness of China's manufactures in the international market anu total merchandise exports grew to almost 13 percent of GDP. State industrial, commercial and transport enterprises now have greater freedom to determine the composition and pricing of output, to retain after-tax profits and decide on the disposition of retained earnings. Fiscal reforms have, in turn, allowed resources previously absorbed by the Government to be retained by enterprises; this, together with a large degree of fiscal decentralization, has given provincial authorities -are discretion in taxation and resource allocation. Administrative decentralization has also transferred more authority to plan and manage economic activity from the Central Government to provincial and local bodies, more responsive to local conditions and more motivated to promote development, although in some cases with short-run or limited horizons. Direct central control over the economy has been substantially scaled back by reducing the number of commodities subject to mandatory plan targets and the share of key products distributed through state-controlled channels. 4. China remains an economy where public ownership is dominant, but an increasingly important share of economic activity is accounted for by other forms of ownership (e.g., private, collective, foreign joint venture, etc.). Product markets have been created, first in the rural areas and then in the  -2- urban sector, which allow producers to trade their above-plan output at freely determined prices. Financial reforms have dismantled the old monobanking system and increased the variety of financial institutions, as well as the volume and scope of financial transactions and instruments. The pronounced shift away from budgetary support of investment has reinforced the importance of the financial sector in mobilizing and allocating resources. Lastly, esternal trade and exchange rate reforms have had a significant impact, and the creation of several Special Economic Zones and legislation governing foreign investment and the rights of overseas businesses, paralleled by fiscal and wage incentives and gradually improving infrastructure provision, have helped ettract a large volume of foreign capital. 5. Since the inception of the reforms, the Government has emphasized the role of incentives and market forces, especially prices, in improving economic efficiency. In agriculture, a large proportion of output Is sold at prices that are free. In the industrial sector, the Government has allowed a growing proportion of products to be sold at market prices outside the plan, and it has raised the prices of major industrial inputs, including energy. This has meant that, at the margin, most decisions are being based on prices which reflect relative scarcities. This is especially true of the collectives and the township and village enterprises (TVEs). This liberalization of prices has contributed significantly to the rapid growth of the agricultural and industrial sectors in the post-reform period. 6. Since 1979, the average incomes of China's 900 million rural population more than doubled and absolute poverty receded nationwide. Infant and child mortality declined, the rate of population growth was slowed and universal five-year primary education was achieved. China's attempts at transforming its complex economy in a fairly short span of time have inevitably resulted in macroeconomic and sectoral as well as institutional imbalances.. In recent years, the Government has experienced difficulties in combining its growth, poverty alleviation and reform objectives with maintenance of economic stability. China's success in achieving growth targets was accompanied by emerging structural imbalances, but as long as fiscal and monetary policies remained under control, rapid growth coexisted with stable prices. 7. As the 1980s progressed, however, China experienced cycles in economic activity of increasing severity, associated with she transition from a centrally planned system to one where plan and market coesist. The lag between administrative decentralization and the creation of an institutionalized capacity for macromanagement gave rise to excessive monetary expansion over the 1985-88 period. This stoked inflation. Without new fiscal measures to offset the decline in traditional revenue sources, the budget deficit gradually widened from 0.5 percent of GNP in 1985 to 2.9 percent in 1990. The level of state food subsidies to urban consumers, combined with rising state enterprise losses, have been important factors in China's budgetary difficulties. The dual pricing system that has evolved with the emergence of free markets, apart from introducing distortions, continues to help shelter enterprises from competition by 'softening" their budget constraints. Slow progress towards more competitive markets that discipline enterprise behavior has allowed decentralized provincial bureaucracies to push ahead with unsustainable rates of expansion. As yet, China has been unable to enforce financial accountability on the state enterprises, so that the effects of market forces to rationalize capacity or achieve efficient resource  allocation have been blunted. Underlying the soft budget constraint of the state firms have been employment concerns, heightened by the heavy reliance on enterprises to provide pensions and housing, and the limited development of unemployment safety nets. Increasing recognition of the importance of these lnterconnections has helped move housing and social security reforms towards the top of the Government's asgenda. Industrial and economic development in Chbna has also been constrained by inadequate infrastructure. Investments in transportation, telecomiuncations and energy have lagged behind those in industry; poor pricing policies contributed both to inefficient use of capacity and to financing difficulties. As a result, serious bottlenecks in these key sectors became apparent in the latter part of the 19809. 8. It was against this background of partial reforms that demand pressures become pronounced in the first half of 1988, pushing the economy to the limits of its productive potential. For 1988 as a whole, GDP grew by 11.2 percent, led by Industrial growth of 20.7 percent, and the consumer price index rose nearly 20 percent. When, in mid-1988 under these overheated conditions, the authorities announced plans for a major price reform, i"flation soared as consumers switched from financial assets into durable consumer goods. Faced with this crisis, the Government postponed further price liberalization and, in late 1988, adopted a series of stabilization measures, with inflation control becoming the most important policy goal for 1989. The main elements of a medium-term stabilization strategy were translated into actions by early 1989 and continue to be implemented. 9. During the last two years, China's macroeconomic policies have been primarily devoted to addressing these inflationary conditions. Underlying the imbalances were excessive monetary expansion and rising price and enterprise subsidies. The anti-inflationary policies included cuts in state investment, tightened control over credit expansion, and higher interest rates, as well as incentives to enhance exports. This policy response is broadly consistent with recommendations in the World Bank's earlier 1989 Country Economic Memorandum (7483-CIA), which emphasized the need tot a credible stabilization policy but cautioned against a hard and prolonged application of austerity measures that, in the Chinese context, could result in dislocation and large production losses, threaten economic vitality and risk stagflation. These policies proved successful in reducing inflation from 18 percent per annum in 1988 to 2.1 percent in 1990, but they also slowed real GDP growth to 3.9 percent in 1989. Unemployment also increased somewhat in this period, with several million transient urban workers being forced to return to the countryside. Macro policy was eased in the second half of 1990, and growth for the year as a whole picked up to 5 percent. A devaluation of the renminbi in late 1990, together with a series of price adjustments accommodated by credit expansion have also pushed up the rate of inflation in early 1991. 10. On the external side, deflationary policies in conjunction with import controls and an initial devaluation in December 1989 promoted export growth and enabled China to attain a trade surplus of $11.3 billion in 1990 as against a deficit of $4.3 billion in 1989. China's foreign exchange reserves have increased by an estimated $11.6 billion in 1990 to $29.6 billion, equivalent to about 8 months of 1990 imports, while exchange and gold reserves together totaled about $34.5 billion. The subsequent further devaluation to Y 5.21$ in November 1990 should allow China to continue to maintain a trade  -4- surplus for the immediate future. China's foreign debt in 1990 was $46.8 billion, only slightly higher than the end-1989 level. 11. Although economic performance has strengthened markedly since mid-1990, the number of loss-making state enterprises, inventory build up and sluggish retail sales warrant attention. The fiscal situation also remains worrisome since Central Government r'venue is highly inelastic while expenditures show a tendency to expand under the pressure of financing enterprises' losses and price subsidies. 12. These issues once again bring to the foreground the need for China to address, through reform, the fundamental distortions and imbalances in the economic system. Over the medium term, the sustainability of maintaining acceptable rates of economic growth in the coming decade hinges upon China's comuitment to further reform and the openness of its economy, as discussed in the recent CEM. The major challenge ahead is to maintain a sustained pace of economic expansion while ensuring that the measures to foster recovery do not lead to a reemergence of inflation. A major policy priority, therefore, is continuation of reforms which address the difficulties of enterprises, and enhance the role of market signals in guiding resource allocation. 13. While recent political and economic developments have affected China's credit rating and raised borrowing margins, China's debt indicators have not been significantly affected, as both GNP and exports have risen rapidly. The debt service-to-exports ratio has remained at about 7-9 percent, well below China's official policy ceiling for this ratio of 15 percent, with the total debt-to-exports ratio at about 68.9 percent. Past trends and the current assessment suggest that the country's growth as well as export potential are substantial, and that savings behavior is likely to remain stable. The projected current account trends described above, even in a low case scenario, do not raise the specter of payment difficulties in the future. China's creditworthiness for international lending should not therefore be in question unless there are major changes in the external trade environment. 14. For the future, with continued incremental reforms and macrostability, China's growth prospects are good. The Government's intention is to achievo an annual growth rate of 6 percent during the Eighth Five Year Plan (1991- 1995). At this rate of expansion, China should be able to experience single digit inflation, and, assuming domestic savings remain high, have only modest current account deficits in the later years of the plan. This rapid income growth would be reflected ir. higher living standards for the general population, as economic gains will not be eroded by population growth. Projections based on current assessments of external trends suggest exports can grow at some 6-8 percent p.a. over the 1990-96 period, with imports growing at about the same rate as GNP. The current account deficit under this base scenario could rise to $5 billion, which is under 1 percent of GffP. 15. Development Strategy. China's long-term development strategy remains to increase the role of the market for resource allocation purposes while maintaining public ownership as the dominant form of asset control. Also in place is the goal of doubling per capita income again by 2000 and achieving middle-income status by the middle of the 21st century. Despite impressive progress over the last decade in moving toward market management, China faces formidable structural problems which cannot be divorced from the issue of  state control over industrial assets. The cbsllenge is to make further progress toward market management without slipping on social development. This is important since China remains a poor country, with an annual per capita income of $360 and pockets of hard-core poverty covering nearly 70 million people, generally in remote and resource-poor areas. In order to absorb surplus labor from rural areas, and assuming some slippage in China's population program, sustained, broad-based economic growth will be needed over the Eighth and Ninth Five Year Plan periods (1991-95 and 1996-2000) to generate productive employment for a growing, increasingly urban workforce. Building on the lessons of the 1980s, China will need to develop strategies to encourage non-inflationary growth while avoiding the stop-go cycles of the last decade. To achieve this, China will have to make continuous progress in a number of areas. 16. The Eighth Five-Year Plan. Three policy goals underlie the recently- approved Eighth Plant stability, development and reform. These goals in turn point to three areas that need priority attention during the plan period: fiscal and financial reforms, price reform and trade reform. All three would contribute to addressing the key challenge of the Plan: the structural adjustment of the industrial sector and, in particular, of the large- and medium-sized state-owned enterprises (SOEs). While investments in technical transformation projects, improvements in the contract management system, promotion of enterprise groups and use of the shareholding system are important, no real success can be achieved without improvements in the performance of SOEs both at the central and provincial levels and changes in the environment in which they operate. This means addressing the pricing and planning systems they face, the burden of social welfare services they currently provide, the rigor of financial discipline exerted by banks, and competition from non-state enterprises and imports. If these reforms can be promoted within the context of a sound macroeconomic environment, a reasonably optimistic view of the future of China's economy in the next decade can be adopted. 17. Fiscal and Financial Reforms. Measures adopted in 1990 to contain the fiscal deficit only partially addressed the underlying causes, and shifted the bulk of these obligations to the banking system. These problems can best be addressed by major and comprehensive tax reform, dealing with the underlying structural weaknesses in China's public finances--an inelastic revenue system (tax contracting) and the heavy burden of enterprise and consumer subsidies, together with rising welfare, defense and administrative expenditures. The stabilization program, which relied mainly on administrative measures, did not advance enough the development of mechanisms and institutions of indirect macroeconomic management and the emergence of more autonomous financial institutions. The need for strengthened capacity to manage the economy via indirect means bears repeating. In particular, money supply growth must be brought under control, and kept at more reasonable levels if inflation is to be avoided. 18. Price Reform. China had begun to address the question of price reform in a serious way before the heating up of the economy in 1988. Since then, the move toward price liberalization slowed down but recent changes in grain and edible oil prices and upward adjustments in railway freight charges and fares among others suggest that price reform is back on the agenda. Price reform is called for by the need to improve economic efficiency and to contain  - 6 - the budget deficit. Until markat signals are clearly established, the scope for resource misallocation will remain significant. Price reform must mean more than adjusting administered prices, necessary as this may be as a first step. It should also include new methodt of price formulation via the market, and the creation of appropriate market infrastructure. This is an area where more urgent attention is needed. If price reform can t. combined with sourtd macroeconomic policies, excessive inflation can be avoided, although compensation for some of the losers in such reforms may be needed. 19. Trade Reform. Recent adjustments in the exchange rate (China is now operating a quasi-crawling peg arrangement) and reduction in exoort subsidies are bound to improve the long-term efficiency of the sectors of the economy with strong external links. A liberalization of the trade regime, by removal of current administrative restrictions on imports, could contribute to sustaining macroeconomic balance in the domestic economy and mitigate the stop-go swings in demand management. More importantly, over the long-rup the stimulus of competition from imports has the potential to spur greater efficiency in China's industrial sector and to promote the higher product quality increasingly needed for continued growth in export 'ialue. Should China move along these lines, of course, its current very positive balance of payments and reserve situation could weak_n as a side effect of the use of trade policy to improve the quality of growth. 20. Inevitably, the reforms and the manner in which they have been implemented have, in spite of their benefits, had some unsettling effects. For 30 years, China sought, and to a large degree achieved, price stability and distributional equity. Since 1979, the status quo has been undermined in many ways: by freeing of agricultural and other prices, by the growth of the collective sector and by the larger autonomy of industrial firms. Reforms have weakened monetary policy, on the one hand, as local governments have been able to circumvent administrative credit controls, and on the other, the only partially reformed nature of the tax system combines with the demand for ongoing subsidies to put pressure on the fiscal accounts. If China is to resume its ascent to prosperous modernity, some of thees problems that have arrived with reforms must be settled. 21. Poverty Strategy. Assuring an adequate minimum standard of living for the rural population and an appropriate level of urban and rural social services will also remain a major challenge, as enterprise and rural communal responsibilities in these areas are reduced. China's recent rapid income growth has led to a decline in the proportion of absolute poor in the total population from 15 percent in 1981 to 7-8 percent in 1988; this proportion is projected to decline further still. The problem of poor and backward rural areas in various parts of the country will continue to require attention. Redistributing financial resources to these areas through the fiscal system and easing restrictions on migration out of the poorest areas are some options for alleviating poverty. With respect to labor policies, inefficient utilization of labor in the state sector of the economy also continues to be a major problem and requires coordinated reforms in labor allocation, the wage system, enterprise management, and social services. Reforms in the system of education and training to further develop China's "human capital" potential are also crucial. And steps to further modernize the industrial sector must include greater efforts--in line with Chinese environmental policy and  - 7 - regulations--to improve energy and resource efficiency and thus protect the natural environment. 22. As incomes rise, there will be major structural changes over the next decade, including a reduction in the share of agriculture, and a rise in the share of light indistry. The rising income levels will also call for greater development of the service sector (whose share of GDP at present is unusually low), best achieved through further liberalizing entry by collective and individual enterprises. The rapid aging of China's population and concomitant demo2r!ahic shifts will also make demands upon resources, especially in the decades after 2000. China has made significant progress in the environmental sphere in strengthening the regulatory and incentive framework and upgrading institutional capabilities. Nonetheless rapid growth continues to exacerbate urban air pollution (directly related to heavy dependence on coal and to inefficient energy utilization), and the pollution of water in both rural and urban areas by largely untreated industrial and household effluents. Greater focus is also needed on the loss of productive land through unsustainable cultivation or grazing practices. Further progress on price reforms e.g. for energy and water, as well as higher pollution levies would be among the more effective means to reduce environmental degradation; this approach also has the advantage of encouraging a better balance between command-and-control regulatory measures and economic incentives to encourage efficiency and discourage pollution or unsustainable resource utilization. 23. Finally, to mobilize the external resources needed for growth, China will need to continue emphasizing export growth and attracting foreign investment and the transfer of technology. Continued borrowing on world capital markets, including increased but cautious commercial borrowing, will be needed through the end of the decade. This highlights the need for China to continue to emphasize export growth and the role that flexible use of exchange rate and pricing policies and trade reform can play in encouraging such growth. 24. In sum, how China's economy fares in the 1990s depends substantially on the institutionsl changes that are already under way and on the steady implementation of reforms already identified and of others to be introduced. The explicit content, phasing and direction of these reforms remains to be detailed. The transition from centralized planning to an effective itategration of plan and market is a difficult and lengthy process. Expectations have been pitched very high and may have to be moderated in the next few years while China attempts to develop appropriate indirect monetary and fiscal instruments, and implement the reform program. China will continue to need external support in its development effort. Even with continued external reforms and good export performance, China will require external capital to finance the current account through the 1990s and access to concessional and official capital will continue to play an important role in sustaining China's growth. Despite its rapid development over the past decade, China is still one of the poorest countries of the world, and its access to concessional capital for financing development and modernization is limited, both in absolute and per capita terms.  lank Group Operations in China 25. Since China's change ln representation in 1980, the fundamental objective of the Bank's lending activities, economic and sector work and associated technical assistance has been to provide analytical and material support to China's economic reform and modernization process. The policies the Bank has supported have been a signifisant force in integrating China's ecoaomy with the rest of the world; and, within China, the Bank's international experience and perspective have made important contributions to both the design and implementation of the country's reform and development efforts. 26. The main elements of our country assistance strategy to date have been: to analyze the options for, and the consequences of proposed reforms, their implementation, and the policy choices that confront the authorities during the transit$on; to support the implementation by the Government of its economic reform program; to facilitate the modernization and rationalizatLon of the productive sectors of China's economy through lending operations with increasing reform content, and by the reorientation of pi,jects in traditional areas such as rallways, highways and power to promote reforms; to assist in the further development of the country's rural and urban infrastructure, specifically in the priority agriculture, energy and transport sectors; to help China provide the safety net for segments of the population likely to be affected by the reforms; and to help remedy environmental degradation. In the next few years, there is a need to strengthen further the links between overall Bank activities and Government reform priorities, as we work to eliminate infrastructure bottlenecks that currently impede full supply responses and stabilization, support China's broader efforts to alleviate poverty, and help the country overcome severe environmental problems. 27. Lending Operations. Since China's change of representation in the Bank Group in 1980, 93 projects involving lending of $10.615 billion have been approved. As of June 30, 1991, $3.1 billion of IBRD loans and $2.9 billion of IDA credits have been disbursed. Eleven projects have been completed and fully disbursed and two Project Performance Audit Reports have been distributed to the Executive Directors. Project implementation is generally proceeding well. IFC has made five investments in Chita for a total of $44.0 million: in automobile and bicycle manufacturing, in an investment company, an electronics company, and a solar energy company. 2Z. The sector distribution of Bank lendlng to date has been broad-based and is consistent with China's economic and social development priorities and with the resource transfer needs of the sectors concerned (see table 1). About 35 percent of total Bank Group lending to date has been in the transport and energy sectors, to alleviate the serious infrastructure bottlenecks which must be overcome to sustain economic growth, and just under 30 percent to incresse and rationalize agricultural production. Industry has absorbed about 19 percent of lending, and Bank operations have focussed on improving financial analysis and investment planning through support of financial intermediaries providing credit to state and collective enterprises, and on strengthening important subsectors such as fertilizer and machine tools. The social sectors have accounted for about 16 percent of Bank lending. The shortage of skllled manpower has been addressed through investments in education. In public health, the Bank has supported programs to improve the  - 9 - quality of care and officiency of service delivery, and projects in rural and urban areas to lmprove water supply and sanitation. A emall share of lending has been allocated to technical assistance credits which support investment planning and project preparation. 29. Future country lending strategy and priorities will give more explicit emphasis to operations designod to support or reinforce the implementation of specific policy and lnstitutional reforms, and those with specific environmental, human resource development and poverty alleviation goals. In addition, the Bank's lending priorities will reflect the sectoral priorities which underpin China's plans to improve the economic efficiency of basic sectors and to undertake the restructuring needed to meet its growth targets. An adequate pipeline of social projects is desirable in light of the changes taking place as a resu.t of refonms, and social sectors will continue to receive significant Bank support; nonetheless the bulk of the Bank's commtments are planned for the basic sectors including agriculture, energy, transport and industrial restructuring. 30. One ad ustment lending operation--Rural Sector Adjustment Loan (RSAL)-- an IBRD loan of $200.0 million and an IDA credit in the amount of SDR 72.24 million--was approved in FY88 and has been fully disbursed. A project completion report is being prepared. Table 1: China: Distribution of Lending, FY81-91 (US$ M4illion) Sector Amount S No. of ProJects Agriculture 3,153.0 29.7 27 General Agriculture 2,791.2 25 Irrigation 438.0 2 Industry & Finance 1,985.0 18.7 14 Development Finmnce 945.6 5 Other Industry 1,039.4 9 Transport & Energy 3,724.8 35.1 31 Transport 2,224.8 18 Power 1,030.4 7 Oil & Gas 390.1 5 Coal 79.5 1 Population & Human Resources 1,670.6 15.8 17 Urban & Water 471.2 4 Education 982.4 10 Pop., Health & Nutrition 217.0 3 Other 80.7 0.8 4 TOTAL 10,614.9 100.0 93  - 10 - 31. MO-or issues in sectoral manaRement will be addressed through the orientation of the Bank's lending. The specific reform objectives and the criteria by which progress would be judged will of course vary by sector. In agriculture, future lending would be linked to, and designed to support priority policy objectives identified by recent sector work including reforms aimed at strengthening producer price incentives and liberalizing markets for grain and other farm products. Operations are also planned in a variety of subsectors. Land and water resource conservation and development would be assisted through support for strengthened interregional planning and sustainable on-farm management and development. Lending to provinces is expected to include multicomponent projects which incorporate specific market possibilities as well as efforts to generate off-farm employment and alleviate bard-core pockets of poverty. 32. Energy lending would assist expansion and modernization of both production and transmission systems. Continuation of measures to enhance energy planning and further advance energy pricing reform are key to the success of Bank involvement. In the power subsector, the Bank would assist China in increasing hydroelectric and thermal generating capacity incorporating the latest environmental standards, while improving utility planning and management (including environmental assessment and pollution control) through tariff reform, technology transfer, system planning, staff training and institution building. 33. TransDort operations would be linked to continued improvements in long- term strategic planning of the transport system to better utilize existing capacity, and take advantage of new transport technologies. A crucial issue here is the need to move toward a more efficient balance among the various transport modes. In roads, networks need to be expanded and major changes in organization and financing will be required, through operations selected after screening of several major highway projects that are important investments in the Eighth Plan. In ra!lways, the Bank plans to focus on system planning and management, as well as help modernize railway lines. 34. Operations in industry would continue to support China's enterprise reform efforts. A two-pronged approach has evolved. It has by now become clear that the development of new corporate structures to enhance more diversified ownership cannot proceed fully to its conclusion without action to reduce enteprises' burden of sozial functions; therefore, operational involvement in developing new models for housing and social security reform is being conceived as an important underpinning of the broader enterprise reform effort. Geographic and sector-specific industry operations would be linked to much needed ongoing reforms in investment planning and the development of subsectoral investment strategies consistent with comparative advantage. Following recent sectcr work on long-term structural options for the industrial sector, direct, subsector and provincial operations would help reform enterprise organization and management, upgrade technology, and conserve energy, while supporting environmental assessment and pollution control. 35. Lending in educition would be linked to China's ongoing efforts to raise the quality of teaching, school administration, planning and finance at the provincial level, with special focus on poorer provinces. Bank support in the health sector would emphasize appropriate local technologies and improved  - 11 - operational efficiency and financial management for both chronic noncomiunicable diseases and infectious diseases in poor areas. 36. Bank assistance in the urban sector is now expanding to address urgent Issues of resource mobilisation, urban infrastructure, municipal planning and environmental management. A major program of assistance would address urban management priorities in Shanghai municipality, while urban transport, water and environmental projects are under preparation in Liaoning, Zheijiang and Jilin provinces, as well as Tianjin. 37. An important aspect of Bank support for China is the environment. A multiyear program of World Bank environmental assistance would consist oft (a) environmental sector studies to provide the analyses (especially in regard to underlying causes) necessary for formulating policy, regulatory and institutional action plans, and investment programs for specific problems; (b) technical assistance (from the World Bank Technical Cooperation Credits and bilateral trust funds, as well as project-related technical assistance) to strengthen those institutions in China that are dealing with environmental and ecological matters; and (c) an environment lending proaram to support appropriate investments to further these objectives and to produce measurable (and monitorable) results in improving the efficiency of resource use and in reducing pollution and degradation of natural resources. In addition to the expanding environment work in our urban and industry projects, attention will focus on free standing environment projects, the first of which will be presented to the Board this fall. 38. In the technical assistance area, a FY87 IDA credit provides technical assistance to government agencies working on background studies for the Eighth Five-Year Plan (1991-95), and, building on long-time close collaboration with the IMF, a free-standing technical assistance for China's central bank has been appraised. In addition, the Bank will continue its close association with UNDP, particularly through its role as executing agency for a third UNDP umbrella project in China, and for projects with the State Coumission for the Reform of the Economic Systems and for urban management in Shanghai. EDI activities remain an important element of the Bank's program. In coming years, EDI will intensify its focus on training of trainers in three sector- specific networks of training agencies for agriculture, transport and health, while collaborating with the Country Department to help disseminate the messages of Bank Country Economic Sector Work to senior policymakers (CESW). 39. Economic and Sector Work. The Bank's economic and sector work in China provides a basis for Bank lending and for dialogue with the Government on development options and policies. The state of the policy dialogue is active and open. Officials at high as well as technical levels continue to seek out the Bank's advice on preparing policy alternatives for implementing reforms. In consequence, the Bank's ESW has moved away from the earlier large-scale studies of the Chinese economy to more targeted, issue-oriented studies. Our CESW is now inspired by a number of macroeconomic objectives and concerns that we share with the Chinese authorities. Success at achieving short-term goals- -to maintain the economy on a non-inflationary growth path, narrow the budget deficit and preserve healthy external accounts--will contribute to China's longer term objective of maximizing productive efficiency by strengthening mechanisms that enhance allocative efficiency and technological advancement. These goals accordingly establish four concerns that are central to our ESW  - 12 - programs industrial restructuring to see that China's capital and human resources are put to the best possible use; sustaining resource mobilization and an adequate flow of funds through fiscal channels at all levels; institutional reforms promoting market competition through a freer flow of goods and factors, and greater reliance on market-determined prices; and increasing interprovincial market integration to contain regional income inequality. The program consists of studies aimed at providing timely advice on macrosystemic elements of economic reform, and sector analysis to support the reform process at the sectoral and micro levels. The latter aims to strengthen government sector planning and to underpin development of the Bank's lending program. Specific focuses of recent or ongoing work include the reform of social security and housing policies, and comprehensive analyses of issues in environmental and anti-poverty strategies. "Think pieces" on Important issues help the authorities formulate the details of their reform program. 40. Aid Coordination and Relationships with the IMF. The Bank has frequent exchanges of views with Japan and other bilateral funding sources. Collaboration with the Asian Development Bank has been increasingly strength- ened, with sharing of project and economic information and exchanges on appraisal methodology. Close collaboration with the Fund has been a long-time feature of the Bsank's relations with China, particularly on fiscal and financial sector issues and technical assistance to assist China in reforms in these areas. There has been frequent cross-mission support, with Bank staff participation in the Fund's Article IV Consultations to China, and DMF cross- support to the Bank, particularly on fiscal issues, tax reform and the financial sector.  - 13 - Part Il. THE PROJECT 41. The proposed Credit for SDR 93.8 million would finance agricultural development in the Xingjiang Uygur Autonomous Region, the largest province in China. 42. Background. Agriculture in China provides sustenance to over one billion people; it is an important source of income for 190 million farm families and accounts for about 30 percent of the country's GDP. Only about 157 million of China's 960 million hectares are arable. Farming systems are intensive, involving large inputs of labor, chemical and organic fertilizers, and water. Nearly half of the country's cropped area is irrigated. Food grains occupy about 70 percent of the cropland and account for about one-third of total agricultural output. Intensive farming has allowed China to meet its basic food requirements and to produce a wide range of cash and commercial crops. 43. China's agricultural sector has been stimulated by the rural reform program introduced since 1978. This program has produced impressive growth and structural changes by introducing the production responsibility system, increasing producer prices, and expanding the role of markets. The gross value of agricultural output increased by about 5 percent yearly between 1978 and 1988. Despite this significant growth, the Government remains concerned about stimulating increases in grain production in future years. It has introduced strategies both to maintain grain production and reduce poverty in the inland provinces. 44. The strategies include increasing investment for rehabilitating and expanding irrigation; introducing partial reforms in the procurement, distribution, pricing, and subsidization of grains; encouraging-the development of cash crops such as cotton; and initiating special development programs for poverty areas. Local governments have also targeted the rehabilitation and expansion of irrigation as a means of augmenting production of nonstaple food and commercial crops to meet growing demand and increase farm income. Government policy increasingly emphasizes that the cropping systems adopted must match agro-ecological conditions and that projects must include components to enhance the natural environment. 45. The Bank Group's lending to China's agriculture sector has been designed to support the Government's efforts to expand and diversify agricultural output. These efforts emphasize making more efficient use of land, water, capital and labor resources and improving support services such as credit, research and agricultural education. To date, the sank/IDA have lent US$3.2 billion for 27 separate agricultural operations. These operations cover land development, irrigation and drainage, upgrading agricultural support services (including agricultural research, education and training), credit, seed improvement, and development of specialized subsectors (including rubber, forestry, fruit and fisheries) and areas (combining crop, livestock, agroprocessing and support services). 46. The implementation of ongoing Bank assisted projects in the agriculture sector is proceeding largely on schedule. Three IDA-assisted agricultural projects and two IFAD-funded projects in China have recently been completed - North China Plain Agriculture Project (Cr. 1261-CHA); Heilongjiang Land  - 14 - Reclamation Project (Cr. 1347-CMA), Rural Credit Project (Cr. 1462-CHA)i Hebei Agricultural Development Project (IFAD Ln. 107-CH)), and IFAD Rural Credit Project (IFAD Ln. 153-CH). The project completion reports for all these projects have 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 and other components was sound and appropriate for wider application. 47. Several Important lessons were learned during the implementation of completed projects which have been incorporated in the design of the present project. First, surface and groundwater use must be carefully managed conjunctively in order to effectively control salinity. Second, soil water munitoring systems need to be established in order to detect salinization in time to take corrective measures. Third, cropping with animal husbandry can Increase soil fertility and yields substantially. Fourth, setting up a strong project management office (P10) at the provincial, prefectural, and county levels is vital to successful project implementation. Fifth, adequate counterpart funding must be available in order for the project to be completed effectively. Projects should be scaled to match the projected availability of counterpart funding. 48. Rationale for IDA Involvement. IDA's involvement in the project will make possible a large increase in incomes to farmers in one of the poorest areas in China with a significant minority population. The project design draws on the Bank's extensive experience in integrated agricultural development projects in China to address major constraints to agricultural productivity. The project will promote efficient use of land and water resources and new production technologies by both strengthening research and extension in agriculture, irrigation and drainage facilities, and by training farmers, researchers and extension agents. IDA involvement will help to introduce some advanced technologies, such ass monitoring soil and water to detect and correct salinization in arid zone irrigation; designing and implementing river works to improve soil water regimes for desert ecosystem recovery; monitoring clouds by meteorological techniques, and using active measures to suppress hail formation, which is a natural hazard to farmers. 49. Pro3ect Objectives. The project objectives are to increase agricultural and livestock production bys a) improving and expanding irrigation systems and promoting efficient use of water; b) increasing productivity in existing low-yield farmland and developing unutilized wastelands; c) strengthening high yielding seed production and distribution for cotton and grain crops; and d) improving the extension systems for both crops and animal husbandry down to township level. The project will also support environmentally sound development by incorporating measures to restore natural vegetation along the fringes of the desert to prevent its expansion, and introduce cropping systems combined with agroforestry to achieve sustainable development in the oases of the Tarim Basin. These objectives are consistent with the Government's strategy of making more efficient use of land and water resources, reducing regional income differentials, and ensuring sustainable development in arid areas. 50. ProJect Description. The project has five principal components. The first component will rehabilitate and upgrade irrigation and drainage facilities and will include: lining of about 387 km of canals in Yerqiang  - 15 - Oasis and 349 km of canals in Weigan OaSis; construction of two water diversion structures, and construction and rehabilitation of about 165 km of drainage canals and associated structures in Yerqiang and 262 km of drainage canals and associated structures in Weigan. In addition, there will be construction of 174 tubewells; reclamation of 80,000 ha of wasteland; upgrading of about 120,000 ha of low yielding land in the Yerqiang and Weigan basins; and a monitoring and research component which will address drainage salinity control, irrigation efficiency, water quality and soil fertility maintenance in the two basins. The second component will construct a small hydro-power station (21 Megawatts) and connecting transmission distribution network in the Yerqiang Oasis in order to expand the electrical generating and transmission capacities in the basin for groundwater rumping, agroprocessing and domestic purposes. The third component is an agricultural component in Yerqiang and Weigan Oases for provision ofs improved extension services for about 104 townships; seed multiplication by expansion of seed production area, upgraded seed distribution and processing systems; improved farm mechanization services; a five-year program of agronomic trials for improving production on about 24,000 ha of low yield lands; and a hail suppression system. The fourth component will finance the expansion of livestock services in Yerqiang and Weigan Oases. This involves improved services for: a) animal breed improvement, veterinary services and feed supply development, and research and training to improve livestock extension services; b) improved feed and shelter programs through construction of animal shelters and watering wells for livestock, straw ammoniation stations and development of mixed crop livestock farms; and c) improvement of specialized farms such as sheep stud farms, sheep and goat research stations, and sites for specialized goat production. The fifth component will finance restoration of the natural forest along the part of the Tarim River that borders the Taklimakan Desert. The restoration includes support for establishment of a Tarim River Basin Management Office bys a) construction of roads, office buildings and monitoring stations for hydrology, ecology, and desert research and control gates to maintain river flows; and b) provision of technical assistance, equipment and vehicles for the monitoring stations. 51. The project, to be implemented over five years, will finance civil works, land improvement including shelterbelt planting, vehicles (excluding passenger vehicles), construction machinery, processing equipment, construction materials, training, research and technical assistance. Tho total cost of the project is estimated to be US$212.1 million, including a foreign exchange component of US$90.5 million (42.7 percent). Retroactive financing totaling US$7.5 million has been recommended for project related expenditures incurred after January 1, 1991. Provision of retroactive financing will permit early startup of the project. A cost breakdown and financing plan for the project are shown in Schedule A. Amounts, methods and scheduling of procurement and disbursements are shown in Schedule B. A timetable of key project processing events is given in Schedule C and the status of Bank Group operations in China is presented in Schedule D. Maps (IBRD Nos. 22308R and 22309R) are attached. The Staff Appraisal Report, No. 9338-CHA dated June 24, 1991 is being distributed separately. 52. Agreed Actions. To ensure effective implementation and sustainability of the project, the Xinjiang Uygur Autonomous Regional Government has agreed to the following actions. First, the Regional, Prefecture, and County PHOs and the Bureau Project Executing Units will be maintained and be staffed with  -16 - qualified technical personnel. Second, a panel of experts will be appointed to review all technical aspects of project implementation and will report its findings annually to the PMO and to IDA. Third, an agricultural extension manual for training of extension workers will be prepared and tested for one year and subsequently reviewed with IDA before it is finalized. Fourth, water charges will be collected for irrigation and drainage schemes under the project which will be sufficient to recover all the operations and maintenance and a significant portion of the capital costs. Fifth, incremental grain production under the project will be sold at free market or negotiated prices; and a report will be prepared annually for the Regional Price Bureau and the Association, to review the prices of cotton and production incentives for cotton growers, with recommendations for adjustments in prices and production incentives for the following year. Sixth, a plan will be provided to the Association of the allocation of land reclaimed under the project to low income farmers. 53. Benefits. At full development, the project would produce incremental annual production of 273,000 tons of grain valued at US$42 million net of on- farm costs, 74,400 tons of lint cotton valued at US$80.5 million, and 249,000 tons of vegetables, legumes and other crops valued at US$48.0 million. The annual incremental output of crops and livestock is valued at US$192.0 million. Hydropower investments would produce annually 151 Gigawatt hours, valued at US$10.4 million. The economic rate of return for the project as a whole is 34 percent -- 36 percent for the Yerqiang sub-project and 33 percent for the Weigan sub-project. Average per capita incomes in the project area would increase from about Y481 (US$91) to Y1270 (US$240). These increases in income would benefit some 137,700 of the poorest families operating small farms or working on salinized, low fertility lands. The project would also generate employment opportunities of about 136,000 person-years during the construction period and 135,000 person-years of regular employment after project completion. Other secondary benefits from the project include improved town water supplies, environmental improvements from restoration of the ecology to prevent desert encroachment, and better roads. 54. Risks. The project does not present any significant management or technical risks. The Government of Xinjiang Uygur Autonomous Region is fully conmmaitted to the project, and a project management structure is already in place at the regional and prefecture levels and in most of the project counties. The potential risks have been minimized in several ways. First, the Regional finance departments, at all levels, have participated actively in preparing the project. Counterpart funding arrangements have been carefully prepared. The project has been designed to match the funding levels that can be mobilized by prefecture and county level governments. Second, technical risks have been reduced by adopting technologies (e.g. canal lining) which are well proven within Xinjiang and other provinces in China. Third, a panel of experts will review the project each year and give technical support to project officials. The expected crop yields are realistic and have actually been achieved through large-scale extension efforts elsewhere in the Tarim Basin. Price and production incentives are included in the project to encourage the production of major crops such as grain. cotton and other cash crops. The risk of insufficient operation and maintenance funds for the water management offices has been minimized by recent increases in water fees and by the agreement on water fee adjustments to be made under the project.  _ 17 - 55. Recomendation. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and recomend that the Erecutive Directors approve the proposed credit. Barber B. ConaLle President Attachments Washington, D.C. July 31, 1991  - 18 - SCHONIU A Description Local Forei,tn Total --------(USU Mill ion) --------- Irrigation & Drainage Yerqiang 28.9 18.8 47.7 Weigan 35.2 24.2 59.4 Hydropower 6.5 13.0 19.5 Agricultural Services 14.0 14.5 28.5 Livestock Services 6.1 4.1 10.2 Sco-system Restoration 2.1 2.5 4.6 Total base costs 92.8 77.1 169.9 Physical Contingencies 9.1 7.2 16.3 Price Contingencies 19.7 6.2 25.9 Total project costs 121.6 90.5 212.1 Financins Plan Local Foreign Total ---------