Argentina - Second Agricultural Credit Project

Document of The World Bank FOR OFFICLL USE ONLY Report No. 14740 PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT II (LOAN 2970-AR) JUNE 29, 1995 Natural Resources and Rural Poverty Division Country Department I Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used bv recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit at Appraisal - Austral (A$) Currency Unit at Closing - Peso (A$) EXCHANGE RATE In October, 1987, a two-tier exchange rate system was announced. Commercial Fixed Rate (Official) US$1.00 = A$3.50 A$1.00 US$0.29 Free Market Rate (December 1. 1987) US$1.00 A$4.19 A$1.00 US$0.24 At project Closing (September 2, 1993), the following rates prevailed: US$1.00 A$0.99950 A$1.00 = US$1.0005 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES The metric system has been used throughout this report. ABBREVIATIONS AND ACRONYMS ASL Agriculture Sector Loan BNA Bank of the Argentine Nation (Banco de la Naci6n Argentina) CB Central Bank CRF Currency Risk Fund Fl Financial Intermediary GOA Government of Argentina IDB Inter-American Development Bank IFAD International Fund for Agricultural Development IMF International Monetary Fund ME Ministry of Economy PRONAGRO National Program for Agriculture (Programa Nacional Agropecuario) SAR Staff Appraisal Report SAGyP Secretariat of Agriculture, Livestock and Fisheries SOE Statement of Expenditure USE Monitoring and Evaluation Unit (Unidad de Seguimiento y Evaluaci6n)  FOR OFlCLAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 29, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Argentina Agricultural Credit Project II (Loan 2970-AR) Attached is the Project Completion Report (PCR) on the Argentina-Agricultural Credit project II (Loan 2970-AR, approved in FY88), prepared by the Latin America and the Caribbean Regional Office. The Borrower did not submit a Part II, but did write its own completion report which was used as a source for Parts I and III. The project's principal objective was to increase agricultural growth by financing the modernization of the farm machinery pool, livestock development, and the adoption of efficient technology by farmers. A secondary objective was to foster increased participation of private and provincial banks in sectoral lending. The Inter-American Development Bank cofinanced the operation, matching the Bank's $105 million on-lending line. The PCR does a good job in describing the successful performance of the lending program, which included the financing of tractors and other machinery (65 percent), breeding stock (14 percent) and other capital improvements. The average sub-loan size was $17,000, and the principal clients were-as planned-the small- and medium-scale, export-oriented commercial farmers of the Pampa. The bulk of the loan was disbursed in three years, twice the speed anticipated. Interest rates remained positive throughout. The PCR describes these farm investments as appropriate and sustainable. Progress toward the institutional objective was much less visible. The borrower was the Banco de la Naci6n Argentina (BNA) which served as a rediscounting apex bank as well as a retail bank. BNA was expected to encourage other banks to access the project's term-lending facility. For several reasons brought out in the PCR, the other banks played only a minor role and BNA ultimately lent about 90 percent of all funds disbursed. At project closing, in the absence of new external support, the BNA as well as the other banks substantially reduced their term lending portfolio for agriculture. Thus, institutional development is rated as negligible. The PCR describes the project experience in terms of the Bank's current policy (established in the late 1980s) for rural finance. It recognizes the strong impact on production that this well-managed farm lending program by BNA achieved. But, the PCR also calls on subsequent operations to promote adjustments in the macro-economic, regulatory and institutional environment that would encourage all banks to use their own resources to expand their portfolios of term credit. Nevertheless, since the dominant objective of this operation was to enhance growth inducing investment in agriculture, the project outcome is rated as satisfactory and overall sustainability as likely. No audit is planned. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not othenvise be disclosed without World Bank authorization.   PROJECT COMPLETION REPORT FOR OFFICIAL USE ONLY ARGENTINA AGRICULTURAL CREDIT PROJECT II (Loan 2970-AR) TABLE OF CONTENTS Page Preface ....i Evaluation Summary .......................................... PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE. 1 Project Identity .................................... 1 Background. 1 Project Objectives and Description. 3 Project Design and Organization. 3 Project Implementation. 7 Project Results and Benefits .13 Project Sustainability .16 Institutional Performance .............................. 16 Audit and Covenant Compliance .17 Project Documentation and Data .17 Findings and Lessons .17 PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE .21 PART III: STATISTICAL INFORMATION 1. Related Bank Loans .23 2. Project Timetable .24 3. Loan Disbursement .24 4. Project Implementation .25 5. Project Cost and Financing .25 6. Project Results .26 7. Status of Loan Covenants .27 8. Use of Bank Resources .29 9. BNA - Numbers of Loans, Amounts Financed and Rate of Interest Financed, by Index, December 1988 - June 1990 .30 10. Banks Participating as Retailers under Ln. 2970-AR .31 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.  Page 11. Exports of Agro-Livestock, Industrial and Energy Products, 1988-1992 . 32 12. Agro-Livestock Financing 1988-1993 ........ . . . . . . . . . . . . . . 33 13. Growth in the Agro-Livestock Portfolio, 1988-1993 ...... . . . . . . . . 34 Figure 1. Subloan Demand in Relation to US Dollar Rates. . 35 MAP: IBRD 20837  PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT II (LOAN 2970-AR) Preface 1. This is the Project Completion Report (PCR) for the second Agricultural Credit Project, for which Loan 2970-AR in the amount of US$106.5 million was approved by the Board on June 23, 1988. Cofinancing of US$105.0 million was provided by the Inter- American Development Bank (IDB). The project was closed on September 2, 1993, almost three years ahead of schedule. Total disbursements amounted to US$106.5 million. There was no undisbursed balance. 2. Parts I and III were prepared by the Natural Resources Management and Rural Poverty Division of Country Department I of the Latin America and the Caribbean Regional Office. They are based on the Staff Appraisal Report, the Loan Agreement, supervision reports, the correspondence record, internal Bank memoranda and interviews, and a Completion Report prepared by the Borrower. Information from the Borrower's Completion Report has been integrated in Part I. 3. A draft Part I was sent to the Borrower for review in June 1994, but no response was received. There is accordingly no Part II Borrower contribution.   - iii - PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT II PROJECT (LOAN 2970-AR) Evaluation Summarv 1. Background: The Agricultural Credit II Project in Argentina was prepared and implemented in a climate of macroeconomic uncertainty. While the agriculture sector was performing better than the overall economy, it was clearly falling well short of its potential. A range of disincentives caused farmers to pursue low-input, low-risk agriculture marked by foregone productivity and depleted soils. Lower world prices and loss of markets for Argentina's principal exports called for modernization of farming methods, and diversification of production and exports where possible. Credit was an indispensable ingredient in this picture. 2. The project complemented two other important Bank loans. First, the Banking Sector Adjustment Loan (2923-AR) sought to increase sectoral confidence and deposit mobilization, improve credit allocation, and reduce its cost. The credit project was to support these efforts by establishing a rediscount facility independent of the Central Bank, and the credit would be allocated by market demand and by the efficiency of participating private banks. Second, policy requirements of the Agricultural Sector Loan (2675-AR) were expected to intensify agricultural production and investment, for which long-term credit was a pre-requisite. 3. The project was co-financed with the Inter-American Development Bank (IDB). The Banco de la Naci6n Argentina (BNA), the largest bank in Argentina and the main provider of agricultural credit, had the dual role of Apex bank and credit retailer. Some 80% of credit funds were available on a first-come-first-served basis while the remaining 20% were reserved for participating financial intermediaries (FI). The project featured an innovative Currency Risk Fund established and maintained by payments of a cross currency exchange risk margin to meet the actual cross currency obligation of the Borrower. Lending rates to FIs were cost-based with freely-determined intermediation spreads on retail rates to sub- borrowers. BNA chose to offer subloans in US dollars or local currency with monetary correction based on the cost of living index or the farmer's primary producer product price index. Private FIs only offered subloans in US dollars. 4. Objectives and Description: The objectives of the project were to: increase agricultural growth by financing the modernization of the farm machinery pool, livestock development and the adoption of cost-effective, efficient technology consistent with growth,  - iv - diversification and soil conservation; foster increased participation of private and provincial banks in sectoral lending; and improve the Borrower's capacity to monitor and evaluate agricultural lending. A Bank loan of US$106.5 million equivalent financed medium- and long-termn credit for agricultural subprojects through BNA and provincial and private banks; and a monitoring and evaluation unit in the Secretariat for Agriculture, Livestock, and Fisheries (SAGyP). 5. Implementation Experience: Despite acute uncertainty in financial markets and the general economy in 1989 following the collapse of the Government's stabilization plan, credit demand was exceptionally strong. This resulted from pent-up demand for capital investment financing and the complete lack of alternative term funds. The credit line was 82% disbursed by the end of its second year, almost exclusively by BNA, since private FIs faced barriers to their participation. The macroeconomic crisis combined with hyper-inflation caused concern in the Bank over the creditworthiness of participating FIs, in view of the collapse of many banks. Supervision and monitoring were consequently stepped up. The project was fully disbursed three years earlier than its planned closing date (June 1996), but it took FIs from 1991 to 1993 to commit the share reserved for them (the Loan Agreement set aside 20% for lenders other than BNA but the Bank ultimately permitted BNA to share part of this) even after actions to ease their participation. The prominent issues of implementation are set out below. 6. Private bank participation was negligible until 1991 and slow thereafter. BNA's administration of the project was efficient and effective; however, it dominated project sublending as a first-tier bank, and took advantage of its Apex role to discourage the active involvement of other FIs. The FIs could not compete with BNA's low retail interest rate, which the Bank believed resulted from political rather than commercial decisions. They were also reluctant to mobilize their 18% contribution in the local, very short-term, US dollar deposit market and relend for the much longer periods required by the IDB (but not by the Bank). Further, they were not prepared to assume the foreign exchange risk resulting from an obligation in dollars lent on the basis of production indices chosen by sub- borrowers, as BNA did in the early months of the project. While acknowledging these barriers, healthy skepticism about long-term lending in a period of macroeconomic instability, combined with an underlying, continued shaky commitment to agricultural lending, may also have been factors deterring private FIs. 7. Following rapid commitment of the 80% not reserved for private FIs, BNA sought permission to use the rest, which was disbursing slowly. The Bank initially refused on the grounds that increased private bank participation in agricultural lending was a project objective still worth pursuing, and because there was substantial evidence that BNA had deterred their participation. BNA was later permitted to share the reserve, on a paE passu basis with FIs, and by raising its interest rate to a level the Bank considered more realistic. 8. Extensive use of product- and livestock-based subloan indexation in the initial months of the project caused BNA substantial losses due to sharp oscillations in those indices relative to the exchange rate. Record inflation distorted relative prices, increasing BNA's obligation to the Bank/IDB far beyond the appreciation in subloan principal. Following this initial period, distorted movements in the indices turned the tables on sub-borrowers to BNA's  - v - advantage. Sub-borrowers purchased farm equipment priced in US dollars, causing them to owe more than the market value of the collateral securing their subloans. These swings in the indices at one period or another implied either insoluble obstacles for sub-borrowers, or the temptation to divert funds. To resolve this situation, product-based indexation was eliminated by BNA, while sub-borrowers using these indices were offered a one-time opportunity to convert to a dollar-based index to relieve escalating debt under hyperinflation. Longer-term, BNA came out ahead of what it would have done lending only in dollars during that period. 9. Speculative demand for subloans under the project became an issue in 1990 due to macreconomic instability and exceptionally strong demand for farm machinery and equipment. Analysis by a supervision mission showed a striking correlation between subloan demand and cheap dollar exchange rates, raising concerns about resource allocation under the loan. BNA refuted the Bank's analysis in a detailed response, asserting that the demand pattern was based on rational decisions in a hyperinflationary period, that most sub- borrowers had chosen product-based, not dollar-based indices, and that high demand arose from the almost complete absence of other sources of term financing. 10. Establishment of the Currency Risk Fund (CRF), an important loan covenant, experienced serious delays. The GOA did not fully accept the need for the fund and a new Government re-opened aspects of the fund agreement already negotiated. Informal suspension of disbursements in May 1990 by the Bank and IDB prompted rapid resolution by the Borrower. Once established, the CRF maintained a positive balance and operated without problems until project closing. 11. The monitoring and evaluation (M&E) component was implemented promptly and successfully and functioned well throughout. The M&E unit (USE) produced high quality data, coordinated with BNA, effectively tracked and analyzed project progress, and assisted the Under-Secretariat of Agriculture to study policy alternatives and prepare new projects. Its success prompted SAGyP in 1993 to establish a permanent Agro-Livestock Finance Unit (FINAGRO) to sustain and build on the functions of the USE in sectoral credit. 12. Project Results and Benefits: Some 14,800 subloans totalling US$257.9 million were granted by BNA and other FIs for a large amount of modern machinery and equipment. BNA granted around 90% of these subloans. While the project was not targeted, most of the subloans went to smaller- and medium-sized farms devoted to traditional, export-oriented activities, chiefly mixed grains and livestock, concentrated in the Pampa Region. This was the inevitable result of BNA's dominant participation, since BNA has traditionally served such clients, who are less attractive to the private commercial banks. While many were relatively small-scale producers, they were not poor farmers however, and all had collateral, good repayment prospects and commercial viability. Poor, small farmers did not participate. About two thirds of the financing went to machinery and the remainder to capital improvements and breeding stock. Producers self-financed about 45 % of investment costs. End of project arrears data show arrears on dollar-denominated subloans (about 99% of the portfolio) as 8%, and on peso-denominated subloans, 21 %.  - vi - 13. Looked at pragmatically, the project had a number of successes. It demonstrated strong demand for term credit, that term credit can be lent effectively, and that it can be efficiently monitored and repaid. The project heightened producer confidence in government, and this has been further reinforced by important actions benefitting agriculture under Government's macroeconomic reform process. It also contributed to the re- capitalization of the sector without market distortion. Project financing upgraded the sectoral machinery pool and enabled other improvements which will have long-term impact on production efficiency, costs, and soil conservation. The project is credited with revitalizing the capital equipment industry, especially farm machinery. The project also made a modest contribution to a lengthening of maturities in domestic markets, while the credit line developed the institutional capacity to do longer-term lending (which is a separate issue from the capability of the capital market to provide longer-term savings on its own). The project did achieve greater private bank participation in agricultural lending, but only for the duration of the loan, and with great difficulty. 14. Sustainability: On the productive side, project sustainability is good based on the quantity and type of machinery, equipment and capital improvements made. On the institutional side, however, withdrawal of the Bank has been compensated by only a small increase in private bank involvement in sectoral lending, and it is not clear whether this resulted from the project. Bank funds were not recycled longer-term after the loan closed. Several private FIs who had built up and trained staff in long-term lending regretted closure of the loan, but an argument could also be made that Fl commitment to agricultural lending was never firm. The project did not address market failure in terms of measures to develop the financial, legal and regulatory conditions conducive to private bank interest in the sector, and the macroeconomic situation was, in any case, hostile to such efforts. Project institutional and financial sustainability is thus negligible. 15. Findings and Lessons: This project addressed market failure in very limited terms, which were unlikely to have substantial impact, especially under conditions of macroeconomic crisis and hyperinflation, and uncompetitive practices. The project sought, unsuccessfully, to inject some competition into sectoral credit, but it was not intended to be a full-scale financial sector operation. Financial sector reform is slow and needs a fairly long process of incentives development, including policy, legal and regulatory changes, to promote certain forms of lending and generate longer maturities. The latter are more an independent function of the macroeconomic confidence of savers than project design, and it is only recently that such confidence has begun to emerge. The argument for Bank involvement in such credit lines remains the provision of temporary financing, a form of safety net, ideally to bridge a period in which more comprehensive financial sector reforms are being implemented. The project developed institutional capabilities to do longer-term lending but the system did not develop sufficient long-term savings to sustain matched lending after the project closed. Ongoing Bank loans are supporting important efforts to inter alia, extend the maturities of financial instruments. 16. Public banks continue to dominate agricultural lending and the Borrower Completion Report leaves no doubt that BNA intends to further reinforce its "dominant lender" status in the sector. Small, poor farmers continue to be almost completely excluded. Commercial banks are generally averse to lending to farmers for reasons which, in the Argentine case, it  - vii - is now understood, go beyond perceived risks and high transaction costs, to include commercial code restrictions on repossession of moveable goods pledged as collateral, antiquated property registries and lack of credit reporting systems. 17. The main lessons from 2970-AR are the following: (a) A well-designed sectoral credit operation can, over the limited term of the project, effectively channel medium- and long-term credit for productive investment; (b) Future credit projects, in order to achieve more sustainable benefit, should move beyond their predecessors, in the sense that they directly complement and deepen the financial sector reform process, i.e., in the absence of an appropriate macroeconomic and financial sector environment, the sustainability of increased private bank participation in sectoral lending is unlikely; (c) To develop private bank participation, project ground rules should mimic private markets, e.g., private FIs should not be required to match the maturity of Bank or IDB funding when short maturities of bank liabilities are an economy-wide problem. If private banks cannot mobilize matching term funds, their share might be permitted in the form of associated working capital; (d) Co-financing arrangements need to ensure the compatibility of respective institutional processes as they apply to the Borrower; the rules of one institution should not impede project implementation. This is especially relevant given the likely increase in Bank/IDB co-financing; (e) Credit projects need to balance their normal preoccupation with demand, by looking carefully at potential supply-side constraints. This implies developing good data on, and communication and relationships with, all participating lending agents; (f) Apex banks should not, as a general rule, be used as retailers except in special, carefully-defined cases; should such an arrangement be unavoidable, the Apex-as-retailer should be subject to the same qualification criteria as its peers, and not be allowed to follow anti-competitive actions against other FIs; (g) Credit terms and conditions should be structured flexibly in volatile economies; projects might consider including a feature which suspends commitments in periods of macroeconomic crisis. Risk assessment needs to be realistic, comprehensive and forward-looking, given the magnification of risk inherent in such economies; and (h) While the project had no targeted clientele, clearly small, poor farmers did not participate and this remains an issue for follow-up projects; such farmers  - viii - require different mechanisms for obtaining credit, which might be based on several successful models of informal credit in other regions.  PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT II (LOAN 2970-AR) PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE 1. Project Identity Project Name: Agricultural Credit Project II Loan Number: 2970-AR RVP Unit: Latin America and the Caribbean Region, Country Department IV Country: Argentina Sector: Agriculture Subsector: Rural Credit 2. Background 2.1 Agriculture in the Economy. In the mid-1980s, the Argentine agricultural sector was generating 70 percent of foreign exchange earnings, 16 percent of GDP and 17 percent of employment. While the sector was performing better than the overall economy, which was entering a prolonged period of stagnation, it was widely acknowledged to be performing below potential. Economic uncertainties, a policy enviromnent which penalized agriculture, declining prices and frequently high positive real interest rates caused farmers to minimize input use. Scarcity of investment capital saw a progressive deterioration of the farm machinery pool. The aggregate effect of these disincentives was a low-input, low-risk agriculture marked by foregone productivity and depleted soils. Lower world prices and loss of markets for Argentina's principal exports revealed the need to modernize farming methods, and diversify production and exports where possible. Credit was an essential ingredient to achieve this. 2.2 Sector Objectives. The Government had prioritized agricultural production and exports as a central element in its economic recovery effort. It had also adopted a medium-term Agricultural Development Program (PRONAGRO) to establish sectoral priorities and strategy based on increased production of cereals and oilseeds, expanded agricultural exports, regional economic development, employment generation and natural resource conservation. Complementary rail and deepwater port development programs were also underway to enhance efficiency in transport, goods handling and exports. 2.3 The Banking Sector and Agricultural Credit. Repeated economic crises and policy reversals had undermined the banking sector, which was characterized by high administrative costs, weak loan portfolios and low profitability. The Central Bank (CB)  - 2 - dominated credit allocation, recycling funds derived from high reserve requirements and forced investments, mostly to public banks in the form of re-discount lines for mandated purposes. 2.4 Banco de la Naci6n Argentina (BNA), owned by the Government, was the largest bank in Argentina, and the main provider, along with provincial banks, of agricultural credit. GOA policy was for BNA to become the "dominant lender" to the sector, reducing its involvement in other sectors. BNA was described in the Staff Appraisal Report (SAR) as a relatively efficient and profitable institution, with an acceptable level of financial solvency despite the deterioration in its loan portfolio since the mid-80s, a reflection of the poor economic conditions. 2.5 Bank Strategy and Lending for Arriculture. The project reflected the Bank's efforts to assist Argentina to boost agricultural growth, expand export earnings, and foster structural adjustment. It was also consistent with the CEM of 1987 which recommended a moderate increase in investment in non-inflationary finance and resource mobilization to complement broad structural reforms. The supply of medium and long-term credit had been constrained for a decade. A loan by the Inter-American development Bank (IDB) for agricultural credit was committing rapidly and strong demand indicated the need for alternative sources. 2.6 The rationale for Bank involvement was that without its assistance, insufficient resources would be available to finance the level of modernization needed to achieve the GOA's production and export goals; and, that the involvement of private banks in long-term agricultural credit would not otherwise occur. In terms of financial sector objectives, the Apex program was to diversify the supply of agricultural credit; at a more fundamental level, the objective was to re-capitalize the sector which had been under-capitalized for years, and to do it without distorting the market. 2.7 Periodic economic and sectoral difficulties and weak institutional capacity had created a daunting context for project implementation, causing the Bank to limit its lending for agriculture to three investment projects and one sectoral adjustment loan.' The first Agricultural Credit Project, approved in 1978, intended to provide medium- and long-term financing for on-farm investment, was cancelled without disbursement in 1980 due to high inflation and the over-valuation of local currency, and large inflows of competitive, low-cost capital from foreign commercial banks. 2.8 The Banking Sector Adjustment Loan (Ln.2923-AR), approved by the Board of the Bank in March 1988, sought to increase sectoral confidence and deposit mobilization, improve credit allocation, and reduce its cost. Agricultural Credit II was to support these efforts by establishing a re-discount facility for the banking sector independent of the Central Bank. Credit would be allocated by market demand and by the efficiency of participating financial internediaries (FIs). I. Balcarce Livestock Development Project (Ln. 505-AR); Agricultural Credit Project (1564-AR); Grain Storage Project (1521-AR); and the Agriculture Sector Loan (2675-AR).  - 3 - 2.9 The project was also designed to support the US$350 million Agriculture Sector Loan (ASL, 2675-AR, approved 1986) in the expectation that the new macroeconomic framework would favor investment in agriculture, particularly for export. The central policy objective of the sector loan was the substitution of agricultural export taxes by a land tax, which was expected to intensify agricultural production and investment for which long-term agricultural credit was identified as a pre-requisite (see para. 4.5). 3. Project Objectives and Description 3.1 Objectives. Project objectives as stated in the SAR were: (a) to increase agricultural growth by financing modernization of the farm machinery pool, livestock development, and adoption of cost-effective, efficient technology consistent with growth, diversification, and soil conservation; (b) to foster increased participation of private and provincial banks in sectoral lending; and (c) to improve the Borrower's capacity to monitor and evaluate agricultural lending. 3.2 Description. The project had two components: (a) Part A The financing of specific development projects through rediscounting of loans for investment enterprises within the agricultural sector; and (b) Part B A program to improve the Borrower's capacity to monitor and evaluate, through the Secretariat for Agriculture and Fisheries (SAGyP), agricultural lending (including the project) and its impact on the agricultural sector. 3.3 Dated covenants defined the timetable to implement a Currency Risk Fund and Agreement, review interest rates, and furnish progress reports. 3.4 Project Cost and Financing. Total project cost was estimated at appraisal at US$355.5 million equivalent, comprising credit-assisted investments (US$354.0 million equivalent) and monitoring and evaluation (US$1.5 million equivalent). The foreign exchange component (US$71.6 million) represented 20 percent of total cost. External financing was a fairly high 60 percent,2 shared equally between the Bank and the IDB. Retail banks were to finance 12.5 percent (18 percent of subloan amounts), and sub- borrowers at least 15 percent of each subproject (on average, 28 percent of the project). 4. Project Design and Organization 4.1 Conceptual Framework. The project started out as a soil conservation operation for the Humid Pampa but evolved into a general credit line for diverse agro- livestock activities. Demand was evidently large but private banks expressed customary reservations relating to transaction costs and risk. 2. The high percentage was justified in terms of the chronic shortage of counterpart funds resulting from heavy external debt servicing, and the banking system's urgent need for investment capital.  - 4 - 4.2 The thrust of the project was to enhance farm profitability through cost- reducing innovations (mainly machinery replacement), with the complementary adoption of better farming practices. Despite low export prices for major Argentine commodities at the time, the GOA felt its stabilization program had been well-received by farmers, and that their growing confidence was reflected in strong demand for an IDB credit line for agrochemicals, machinery and livestock.3 4 4.3 Project Preparation. Several issues focussed discussion during preparation. The GOA was preoccupied with raising the proportion and absolute amount of external assistance to set precedents for future lending.5 Accordingly, a jointly-financed (Bank/IDB/IFAD) project of US$700 million was proposed, with 80 percent external financing and the lowest-possible GOA participation (to comply with IMF requirements), stressing the shortage of counterpart funds and modest Bank commitments to Argentina at that time. The Bank on the other hand, believed that the project scope and scale should reflect the uncertain credit demand situation, and planned for a project of US$300-400 million. 4.4 Lack of progress on the policy requirements of the ASL posed a dilemma for the credit project. The IEPS states that if the ASL failed to secure passage of the land tax (which was to substitute for elimination of the agricultural export tax), the Bank would have to reassess whether to proceed with the proposed credit operation, based on estimated farmer returns on relevant investments. The Bank's "normal policy at the time" precluded going to the Board with the project until the conditions for release of the second tranche were met.6 While the GOA supported the linkage between investment credit and policy change (under the ASL), it resisted any attempt by the Bank to link further processing of the credit project to resolution of major problems under the ASL. 4.5 The Loan Committee discussion, however, reflects the shift which occurred in what the Bank was willing to accept for release of the second tranche of the ASL, and thus Board presentation of the credit project. Passage of the land tax was unlikely and so the lifting of quantitative restrictions on agricultural machinery imports and tariffs on chemicals became the last remaining policy issue to be resolved. The meeting agreed that these were the critical conditions for Board presentation of the credit project.7 By the time the credit 3. The IDB US$60 million loan was declared effective in 1985, had already disbursed US$38 million by end of 1986 and was expected to be fully-disbursed by December 1987. 4. The record notes that GOA preferred Bank financing for a follow-up credit project because GOA wished to obtain reforms in technology and conservation, which it felt were unlikely given the tendency for IDB conditionalities and design to be less demanding. 5. Minutes, pre-appraisal review meeting, October 19, 1987. 6. Memorandum, February 8, 1988. 7. Minutes, Regional Loan Committee Meeting, February 18, 1988. Remaining conditions related to trade liberalization of tractors, agricultural machinery and chemicals. The GOA refused to remove the (continued...)  - 5 - project was approved by the Board of Directors, dialogue was well underway for the Trade Policy Loan (2996-AR, US$500 million) which the credit project was also intended to complement. 4.6 Producers preferred subloan indexation through agricultural product-based indices, while the Bank and IDB, concerned about the possibility of individual sub-borrower cross-subsidization and distortions in resource allocation, preferred the wholesale/retail price index, and Austral/US dollar exchange rate. The Bank recommended, on the basis of substantial analytical work, that agricultural product-based indices be used only if they maintained parity with the benchmark and if deviations arose, that they be remedied through special interest spreads. The GOA would not permit the use of spreads. Both BNA and farmers experienced serious losses at various periods of implementation due to distorted movement in the product-based indices relative to the exchange rate.8 4.7 In order to give the FIs a known cost of funds, the Bank proposed that external loan funds be transferred to FIs in Australs denominated in US dollars with a special spread, payments of which could be put into a currency risk fund. The spread would be periodically reviewed and adjusted. Such a fund had few precedents in Bank lending, and was an innovative aspect of the project. BNA agreed only reluctantly to the fund. Prolonged delay in its establishment after effectiveness indicated continued resistance to the idea in government, and led to the Bank and IDB informally suspending disbursements until GOA acted to establish and regulate the fund. 4.8 The preparation record describes technical assistance (TA) as an "emotionally- charged" issue, reflecting in part the intense pressure GOA was under to secure new Bank commitments. While not debating the need for TA in Argentine agriculture, the Bank and IDB felt it was not germane to project objectives and investments.9 An ongoing IDB research and extension (R&E) project, while not disbursing well, was believed a more appropriate vehicle. However, the GOA insisted that the R&E project was fully-committed and that new financing was needed; the proposed component (some US$30 million) was nevertheless dropped. 4.9 GOA's intention to have BNA serve as "dominant lender" to agriculture raised concerns in the Regional Loan Committee about whether, by existing or planned Government regulations or by actual practice, financial institutions other than BNA would be effectively barred from providing term credit to agriculture. The likely existence of such barriers was an issue which would have to be resolved "in order for the loan to go forward". (The Loan Agreement (Section 3.08 (a)) merely states that BNA would take actions to promote 7.(. . .continued) import surcharge on agro-chemicals imposed in mid-1985, because of IMF standby constraints, and instead raised the tariff. 8. The Convertibility Law (1991) prohibits the use of subloan indexation. 9. A preparation BTO of March 5, 1987, however, stresses the importance of a strong focus on soil conservation and promotion of INTA's program for perennial crops.  -6 - participation of financial intermediaries). The pre-appraisal Aide Memoire mentions that the eligibility criteria for private bank participation were under revision to ensure that private bank demand was not constrained by BNA acting as second-tier lender. Nevertheless, a reading of the criteria suggests BNA could prevent a bank from participating even if it was eligible, and in practice BNA did take advantage of its dual role to discourage other FIs. Other factors were also important, however, including the pervasive impact of the economic crisis on all forms of financial activity at the time, and, this report suggests, shaky commitment to the Apex concept and term lending for agriculture on the part of FIs. 4.10 BNA's dual status under the project needs explanation. The project was initiated at a time when the Bank and GOA were involved in active discussions of a financial sector reform, with the Central Bank's charter and apex role under review and the National Development Bank (BANADE) bankrupt and under liquidation. Financial sector objectives had started out basically as an intention to avoid market distortions, but evolved into a two- tier apex mechanism to bring private banks into sectoral lending. The Bank felt obliged, in the absence of viable alternatives, to give the apex role to BNA as a public sector bank already lending to agriculture. BNA had traditional links to the Central Bank (CB) and GOA; it operated as the CB's financial agent, had extensive relationships in the market, and had the largest retail banking network and largest market share of agricultural lending. 4.11 The interest rate structure of the loan reflected the Bank's subsidy avoidance policy in Argentina. Lending rates to FIs were cost-based with freely-determined intermediation spreads on retail rater to sub-borrowers. In practice, however, the interest rate formula gave BNA leeway to undercut rates at retail. BNA's assurances that this would not occur were accepted at face value. The record contains minutes of a meeting in October 1987 to discuss the SAR annex on the BNA; the annex was to detail the extent to which BNA was receiving subsidized funding from the GOA and Central Bank, but this was not done, although former project staff assert that as part of Appraisal it was confirmed that BNA received no subsidy."0 The Agreed Minutes of Negotiations also contain wording which may have inadvertently sent BNA a signal on rates: BNA was to provide evidence (should it wish to use some of the 20 percent of loan funds reserved for private banks) that inter alia it was, as retailer, "charging the lowest spread possible". 4.12 Project Risk Assessment. The project risk analysis concentrated on demand and participating FIs' liquidity. The demand analysis correctly forecast the extent to which the acute need for capital replacement and scarcity of alternative credit would override insecurity about the macro environment. However, potential demand through banks other than BNA was not considered at appraisal, and in the case of those banks, demand was only one side of the equation. " Dialogue with private FIs does not appear to have been sufficient to fully understand, or plan for, constraints which might inhibit their participation. The possible conflict of interest inherent in BNA's dual role as wholesaler and retailer is not mentioned, although it was discussed exhaustively at the working level. While the project 10. Memorandum, October 27, 1987, containing minutes of meeting to discuss content of SAR annex on BNA. 11. SAR, para. 3.17 (a) (ii).  - 7 - was expected to foster increased participation of private and provincial banks in sectoral lending, there was no action plan to sustain this beyond project closing, reflecting perhaps the norms of an earlier generation of credit projects (although this project did have one foot squarely on new ground). The project rationale that without Bank involvement, private FIs would not lend to agriculture, was also a forecast of the project's financial market development prospects once the project closed. The closing of the project essentially cut off the only source of long-term funds for the sector. 4.13 Project Organization BNA was the Borrower, bore the foreign exchange risk, and functioned as a first and second-tier credit facility, committing loan proceeds through an Apex (rediscounting) unit established in its Finance Department. BNA evaluated the institutional capability of FIs on the basis of pre-established eligibility criteria. BNA re- discounted 82% of subloans granted to its own retail clients and to clients of qualifying intermediary banks. Eighty percent of loan funds were available on a first-come-first-served basis, while the remaining twenty percent of funds were reserved for rediscounts from financial intermediaries other than BNA. SAGyP implemented the monitoring and evaluation component, establishing a Monitoring and Evaluation Unit (the USE). 5. Project Inplementation 5.1 Despite acute uncertainty in financial markets and the general economy following the demise of the Spring Plan (early 1989) and a subsequent six-month period of hyperinflation, the credit line was 82% disbursed by the end of its second year (1990), almost exclusively by BNA since private banks faced significant barriers to participation. Rapid disbursement resulted from the tremendous pent-up demand for term finance for capital investment, and the lack of other term financing options. The macroeconomic crisis caused some anxiety in the Bank concerning the financial status of participating FIs, in view of the collapse of many banks at the time, and supervision and monitoring were stepped up. The project disbursed fully some 3 years before its targeted closing date of June 30, 1996. Even so, the private FIs took from 1991 to 1993 to commit their share, even after actions to ease their participation, and with BNA being permitted by the Bank to use part of it. The main issues of implementation are discussed below. 5.2 Private Bank Participation. Increased involvement of private and provincial banks in agricultural lending was a project objective whose importance is reiterated in the record (albeit with more conviction in recent periods).'2 Moreover, institution-building through the Apex lending process was an expected project benefit. However, by end of 1990 when BNA had exhausted its share, only two of the private FIs had made subloans (about US$3.0 million) even though eighteen had signed agreements with BNA to participate. 5.3 Signing a Participation Agreement with BNA and actually initiating sublending activities implied certain difficulties. BNA dominated project lending as a first-tier bank and took advantage of its role as Apex lender to discourage the active involvement of other FIs 12. Its real importance became evident at a much later stage in project execution; the lack of analytical and design substantiation suggests it was not a serious objective at the outset. Alternatively, it may have been a function of lack of experience in both banks in designing truly market-based credit projects.  - 8 - (refer to paras. 4.9-4.10). BNA had little incentive to bring in other banks. It adopted a largely passive role in dealing with them, despite assertions that it was fully engaged in promoting their participation, and largely relied on Bank supervision missions to recommend changes that would make the credit line more attractive to other FIs.13 5.4 BNA was responsible for evaluating the eligibility of FIs using agreed selection criteria, but retained the right to reject banks even if they met the criteria (barring objection by the Bank and IDB).'4 On the one hand, it was inappropriate to give this responsibility to BNA as a competing retailer under the project. However, evidence suggests this authority to reject FIs despite their apparent eligibility based on the balance sheet and income statement, was eminently practical. BNA was well placed to know which banks were solid and which were not, in a volatile financial situation involving many bank failures. Further, it was taking 100% of the risk and rightly wanted a say. In practice, BNA did its job well. Many banks failed, but BNA-qualified banks under the project were not among them. 5.5 Finally, BNA's low interest spread to final sub-borrowers was insufficient for private FIs to cover costs and compete. BNA had made a political decision not based on financial information about its costs, since it did not have it (para. 5.18). While BNA was charging just over 12%, private FIs were charging 14-16% (see Part III, Table 9 for BNA rates). However, while BNA was an impediment, it was not the only one. 5.6 A key reason for FIs' lack of participation was an IDB requirement that they contribute their 18% portion of each subloan par passu with Bank/IDB funds and receive repayment at the same maturity. The FIs (unlike BNA) were only interested in making US dollar-indexed subloans, as this would be their liability to BNA under the project. FIs were reluctant to mobilize their contribution in the local, very short-term (one to two weeks), US dollar deposit market and relend them for the periods required by the IDB. The Bank, in contrast, had no policy requirement that FIs make a funding contribution to each subloan, or that the maturity of the local contribution match the life of the subloan. IDB rules appear to have driven the discounting process and lacked a market logic consistent with achieving the objective of the project. BNA had done nothing to change these rules, claiming that IDB had tied its hands. The problem was resolved by discussions between the main parties, whereby IDB agreed to interpret its policy on local contributions more flexibly to allow FIs to make their contributions to subloans as short-term loans with a minimum maturity of six months. 5.7 Private FIs were not interested in absorbing the foreign exchange risk resulting from assuming an obligation to BNA in dollars and lending on the basis of indices chosen by sub-borrowers. The loan foresaw that the risk could be covered by an interest rate sufficient to cover operating and financial costs. However, due to the variability of the indices, it was impossible for FIs to determine a fixed rate for this purpose. The only way they would 13. Memorandum and BTO Report, October 3, 1990. 14. See memorandum of August 30, 1988 with attached "Criteria for the Selection of Financial Entities" (p.3).  - 9 - participate was to provide loans solely with a dollar-based index, which matched their obligation to BNA. 5.8 Other constraints deterred Fl participation. Reimbursement delays of ten days by BNA posed an added interest rate risk for the FIs who financed their interim activities with Austral funds at high interest. FIs were unable retroactively to finance investments related directly to the proposed subproject but already sunk before the credit application. Finally, FIs had difficulties establishing subloan amounts in dollars due to the large variation of prices in Australs. 5.9 The Loan Agreement required financial evaluation of private FIs by BNA (para. 5.4). Several problems were evident: Fl profitability had fallen and their net worth had declined; the ability of FIs to service short-term obligations was in doubt based on the very high reserve requirements of the Central Bank; and, in the climate of hyperinflation, quarterly analyses of FIs' financial capacity became outdated before they were completed. The appraisal mission together with BNA had developed financial criteria for FIs which were strict enough to qualify only the top one-third of FIs in the banking system. This assumption that the top one-third would survive any shock to the system, proved correct during implementation. Supervision and monitoring were intensified in this period and BNA adopted a firm, responsible stance in this effort. 5.10 BNA Use of the Reserve. A Loan covenant (Schedule 1, para 2(d)) reserved 20 percent of loan funds for financial intermediaries other than BNA, but subsequent negotiations left the door open for additional BNA re-discounts if BNA could prove that it had tried hard to recruit participants, was charging a reasonable spread on its own retail subloans, and despite these, future demand by other banks was unlikely to justify the 20% reserved share. BNA cited efforts to encourage private bank participation (the Credit Regulations were modified to facilitate this), unsatisfied demand on the part of its own clients, and the need to pay commitment fees on the reserved balance, and requested an exception to the Loan Agreement to use part of the reserved 20 percent. 5.11 The Bank and IDB refused to waive the loan covenant, reiterating that key objectives of the project were the introduction of Apex lending into the sector and involvement of financial intermediaries other than BNA in term lending to the sector."5 This reflected the internal shift in the Bank towards market-based credit lines and private sector delivery, and the realization that BNA had contributed to the problem of low participation. The Bank maintained that these objectives were still "justifiable and achievable" and that "their fulfillment would be viewed by Bank management as a necessary precedent for any future consideration of a new lending operation for agricultural credit in Argentina". BNA was urged to continue exploring ways to achieve the participation of registered banks, but progress was slow. 5.12 With continuing slow commitments by FIs, the Bank subsequently re-thought this decision to avoid cancellation of needed resources because of an objective (financial 15. Telex to Borrower, May 17, 1990.  - 10 - sector development) "which cannot realistically be met through this operation under current circumstances" 16 However, the conviction that BNA continued to impede private FL participation in subtle ways, persuaded the Bank to persist. Moreover, changes were occurring in local financial markets, and private FIs were increasing their interest and confidence in participating."7 A compromise was formulated whereby BNA would be eligible for half of the remaining reserved funds, i.e. US$10.5 million of Bank funds. Access for BNA was made contingent on prior commitments by other Fls, and BNA had to increase its retail lending rate in US dollars from 12.5% to 14% to more adequately cover its full costs. 5.13 Subloan Indexation. The extensive use of product-based subloan indexation in the initial months of the project caused BNA serious losses due to the large disparity between movements in that index, and the type of exchange rate used. With record inflation, distortion in relative prices had grown; BNA's obligations (to the Bank and IDB) had grown in tandem with the dollar, while subloan principal had appreciated at the rate of the livestock index. A subloan granted in January 1989 had increased BNA's obligations to the Bank and IDB some fifteen-fold, while the subloan principal value had grown by a multiple of less than two. (For BNA the greatest risk was pre-payment by sub-borrowers on the livestock index"8). Following this initial period, distorted movements in the indices turned the tables on sub-borrowers to BNA's advantage. Sub-borrowers used their loans to buy farm equipment priced in US dollars, causing them to owe more than the market value of the collateral securing their loans. Oscillations in the indices at one period or another implied either insoluble obstacles for sub-borrowers, or the temptation to divert funds. 5.14 BNA clients who received their disbursements in the first four months of 1989 benefited by US$20 million (a loss for BNA), while those receiving their loans in later months owed US$32 million equivalent more (a gain for BNA). BNA estimated that its clients owed it some US$12 million more than the US dollar value of the same disbursements. To resolve this situation, BNA eliminated product-based and livestock-based indices,'9 to be applied equally to all participating FIs. Further, sub-borrowers who had product-indexed subloans were offered a one-time opportunity to convert to a dollar-based index to relieve debt escalation under hyperinflationary conditions. 16. Memorandum, September 11, 1990. 17. Memorandum, October 3, 1990. FIs were starting to lend deposits for six months, and recent changes in the project regulations allowed them to contribute the required local counterpart for a minimum of 180 days. Several banks had restored liquidity lost as a result of the mandatory conversion in 1989 of short-term, high interest deposits into long-term dollar bonds (Bonos Externos - external bonds), and could make six month lending commitments in local currency. Further, the CB amended its regulations to allow banks to make dollar-denominated loan contracts, in addition to Australs with US$ monetary correction. Project regulations were also amended to allow lending in US$. 18. Aide Memoire, July 10, 1989. 19. Letter from BNA, December 21, 1989.  - 11 - 5.15 Other conditions of this solution included a "give-back" limited to 85% of the difference between the original index and the US dollar, and no pre-payment of the new debt until 1991. The one-time cost to BNA was estimated at some US$50 million. BNA felt able to make this offer because it believed that its loss on disbursements made in the first four months of 1989 would even out over time. It needed to address the credit problem of clients whose debt had escalated beyond the value of their collateral, and its own liability at retail was in US dollars.20 The Bank did not view this as debt relief, but rather an accommodation in a difficult situation. Longer-term, BNA did come out ahead of what it would have done if it had lent only in dollars at that time. 5.16 Resource Allocation. Speculative demand for subloans under the project became an issue in mid-1990, although it must be said that speculation was commonplace in the existing economic and financial conditions, and demand for farm machinery and equipment was exceptionally strong. Analysis by a Bank consultant showed a striking correlation between subloan demand and cheap dollar exchange rates (see Part III, Figure 1), which raised questions about resource allocation under the loan from mid-1989 until mid- 1990. Farmers decided to buy agricultural equipment when its relative price was artificially depressed because of the Government's stabilization plan.2" The analysis asserted that to some extent, the project's role in practice had been to make available long-term financing to farmers to take advantage of that distortion. The highly depressed dollar exchange rates had pushed subloan demand higher, especially in October-December 1989, and May-June 1990, causing BNA's loan share to be almost completely disbursed in one year and a half. Corrective action was difficult to assess and in any case, was too late to have much effect on the project. The recommendation was that any subsequent project include a feature which would stop commitments in situations of high macroeconomic distortion.22 5.17 BNA refuted these assertions in a detailed response, stating: (a) that the demand pattern was based strictly on rational economic decisions in a hyperinflationary period; (b) that most sub-borrowers, in 1989 at least, chose product-based not dollar-based indices, and were not in a position to take advantage of the dollar/relative price distortion; and (c) that high demand also resulted from a complete lack of alternative sources of medium and long-term financing.23 5.18 Currency Risk Fund. Establishment of the Currency Risk Fund (CRF)24 experienced serious delays and following several extensions of time based on BNA and 20. Supervision Back to Office Report, January 4, 1990. 21. The GOA freed the exchange rate, and stopped interest payments on the foreign debt to international private banks, causing demand for dollars to be reduced. As a result, the market exchange rate lagged considerably behind the general price index. 22. Technical Annex (to supervision report), July 20, 1990. 23. See "Comentarios al Informe Tecnico sobre el PCGA del Consultor del Banco Mundial", November, 1990. 24. Loan Agreement, 4.03 (b) and Guarantee Agreement, Section 2.02 (c).  - 12 - Ministry of Economy (ME) assurances, led to informal suspension of disbursements by the Bank and IDB to prompt GOA action.25 A change of Government further complicated matters by re-opening aspects of the agreement already negotiated. Apparently fundamental differences existed between ME and BNA over the requirement for automatic debits (never actually required) from the Treasury's general account to cover shortfalls in the CRF. Some 18 months after effectiveness the required currency risk agreement was still pending, and the record gives a flavor of the bureaucratic complications characteristic of many Bank projects in Argentina at that time.26 Shortly after the informal suspension of disbursements (May 1990), signed CRF documents were received by the Bank. The CRF maintained a positive balance and operated without problems until project closing. 5.19 Interest Rates. BNA was wholesaling project funds to FIs at 11.5% p.a. in Australs (US dollar corrected), about 4% above the cost of Bank funds to BNA, and retailing to its own clients at 12.3% p.a. in Australs (US dollar corrected). BNA's own implicit spread above the 11.5% nominal cost of retail funds was thus 0.8% p.a.27 FIs maintained that such a spread did not come close to covering either their opportunity costs or risks of long-tern lending, and that their own spreads of 3-4% minimum far exceeded those of BNA, and therefore they could not compete. BNA claimed these higher rates reflected inefficiency and that it had no obligation to increase its final rate to match; further, it had a long tradition in rural areas, which FIs did not have. 5.20 Analysis showed that BNA was not required to pay dividends to the Government, and given its high equity levels, such a policy artficially reduced its cost of capital, and introduced a distortion vis a vis the private FIs under the loan. BNA was asked to analyze the structure and level of interest rates applicable to its subloans, including its financial and operating costs and opportunity cost of capital, and to explain the divergence in its rates with the private banks. BNA provided a brief document justifying its low spreads, but claimed that details and methodology for its cost structure were not available.28 BNA increased its retail rate to 14 percent soon afterward. 5.21 What was the context for this situation? BNA saw itself as a market leader on interest rates. The CB traditionally used BNA to signal rate adjustments, e.g., BNA would be assigned the task of keeping rates low when GOA was under pressure from farrn groups. BNA essentially charged the minimum rate permissible under the Loan Agreement, which was both politically and competitively convenient. Whether BNA was subsidized or not may 25. CRF would provide resources to the Borrower to cover any amounts to be paid by the Borrower as a result of differences between the adjustment of principal of the Participating Loans and similar loans under the IDB Loan made by the Borrower, and the amounts to be paid to the Bank and IDB under the Loan. 26. Memorandum, May 17, 1990. 27. The Loan Agreement, Schedule 5, para. 1(c), states that "the interest rate applicable to each Participating Loan shall be equal to the cost of funds plus a spread equal to not less than 2 and not more than 4 percentage points...'. 28. BNA document commenting on Bank consultant report, November 1990.  - 13 - be a matter of definition; private banks in any case were charging 3-4 points more than BNA and were able to detail their costs. Whether private FIs were inefficient is debatable; certainly their subloan processing was much faster than BNA, and producers were willing to sacrifice a point or two in their interest rate in order to get rapid approval of applications. 5.22 Monitoring and Evaluation (USE). Conceptually, the USE was seen as an independent monitoring unit to ensure that project funds were used correctly and not as fungible financing for non-authorized purposes. The stated objective of this component was to strengthen the capacity of SAGyP for ongoing and future project planning and evaluation of agricultural activities. The USE was established promptly and functioned well throughout project execution, producing high-quality data29 and coordinating credit management smoothly with BNA, which had set up its databases in the USE. The USE did a good job of tracking and analyzing project progress, and in assisting the Agricultural Under-Secretariat to study policy alternatives and prepare new projects. Its success prompted SAGyP in 1993 to establish a permanent Agro-Livestock Finance Unit (FINAGRO) to sustain the functions of the USE in matters of sectoral credit. FINAGRO has been important in the design, implementation and promotion of new credit lines, and in data collection and evaluation of credit demand and markets.30 5.23 The Special Account. In the first year of effectiveness, BNA's project unit was unable to provide the Bank with Statements of Expenditure (SOE) in the required format on computer disks. Consequently, the Bank's Loan Department (LOAEL) held up further disbursements pending action by BNA. Strong demand for credit caused BNA to deplete the US$10.5 million Special Account (SA) and to use its own short-term funds to continue the project for some five months without Bank reimbursement. BNA withdrawals from the Special Account exceeded the 90-day rule (OMS 3.30, Annex A), limiting the use of historical exchange rates for disbursement to those expenditures occurring within 90 days preceding the withdrawal claim from the SA. Dramatic devaluations made the application of historic exchange rates especially important at this time to preserve the value of BNA's disbursements. Senior Bank management granted a waiver of the 90-day rule to permit Bank disbursements to catch up with expenditures, and the Special Account was doubled to US$20 million. 6. Project Results and Benefits 6.1 Some 14,800 subloans totalling US$257.9 million31 were granted by BNA and other FIs for a large amount of modern agricultural machinery and equipment. BNA 29. The USE produced data which indicated a large number of long-term loans for livestock which supervision staff found were being used for fattening cattle rather than the permitted breeding stock, a practice which was rapidly terminated. 30. Pro2rama de Credito Global Aeropecuario, Agricultural Credit II Proiect (Ln.2970-AR), FINAGRO/SAGyP, November 1994. 31. BNA data show a sub-borrower contribution of another US$69.9 million for a total project financing of US$327.8 million. The Borrower Completion Report (prepared by SAGyP/FINAGRO) cites a total "disbursed" of US$440 million for 15,000 subloans, but provides no breakdown.  - 14 - accounted for around 90% of these subloans. Average subloan size overall was around US$17,000; subloans from private FIs averaged US$35,000, while those from BNA averaged less than half that amount at US$15,300. 6.2 While the project credit was not targeted, most of the subloans went to small- and medium-sized farms devoted to traditional export-oriented activities, chiefly mixed grains and livestock, concentrated in the Pampa Region (as envisaged at project initiation).32 This was the inevitable result of BNA's dominant participation, since BNA has traditionally served such clients, who are less attractive to the private, commercial banks. While many were relatively small-scale producers, they were not poor farmers however, and all had collateral, good repayment capacity and conmmercial viability. Poor, small farmers did not participate, while larger-scale producers gravitated, as usual, towards the private FIs, among other reasons, because BNA is slow and bureaucratic in its loan processing. Finally, producer associations, cooperatives, acopiadores (informal lending agents) and rural contractors made up less than 10% of credit beneficiaries. 6.3 FINAGRO data shows 65% of financing going to machinery (mostly tractors, harvesters, and bailers), about 16% for capital improvements (storage, fencing, outbuildings etc.), and around 14% for the purchase of breeding stock. The remainder went for perennial pasture, agroindustry and other uses. Some 80% of subloans were for terms of 5 years. Producers saw the credit as complementing their own funds and to reduce their business risk, on average, self-financed 45% of investment costs, a much higher proportion than required under the project (minimum 15%). Data provided by FINAGRO shows arrears on US dollar-denominated subloans as 8% and on peso-denominated subloans, 21 %.3 6.4 The Loan Agreement (Section 3.01 (d)) called for BNA to recycle Bank funds on similar terms and conditions. The Borrower maintains that this did occur up to loan closing, but the Borrower's Completion Report shows only gross amounts recycled through May 1993, without specifying terms and conditions. 6.5 Incremental production was not estimated since no target groups or regions were identified and since a substantial part of the benefits was expected to come from reduced costs of production rather than increased volumes of production.34 The project also sought to generate foreign exchange to help the crisis on external account and since most of the credit went to export-oriented producers, and FINAGRO data shows exports of both primary and secondary agricultural products rising 43% and 22% respectively, in the period 1988-1992, it can be inferred that this was a benefit (Part III, Table 12). 6.6 Looked at pragmatically, this project had a number of successes. It demonstrated strong demand for term credit, that term credit can be lent effectively, and that it can be efficiently monitored and repaid. The project sent a signal from Government that 32. No breakdown of subloans by farm size was provided. 33. Some 99% of the portfolio was denominated in dollars. 34. Memorandum of March 2, 1988, responding to questions from the US Executive Director.  - 15 - the agriculture sector could have confidence in Government, and this has been further reinforced by important actions benefiting agriculture under Government's macroeconomic reform process. The project re-capitalized the sector without distorting the market. Project financing upgraded the machinery and equipment pool of the sector and this will have a long- term impact on efficiency, costs and soil conservation, e.g., the credit-financed purchase of bailers, a technology not previously used, and which enabled farmers to feed livestock over the winter; and minimum tillage equipment. Finally, the Borrower's Completion Report credits the project with reactivating the capital equipment industry, especially agricultural machinery. 6.7 The project did boost the participation of private banks in agricultural lending, but with great difficulty and with limited lasting effect. Relative shares of the agricultural credit market from 1988 to 1993 show an interesting shift: provincial (public) banks dropped from 41% of the market to 26%, being largely replaced by BNA which increased its participation from 30% to 43%, while private banks showed a modest increase from 25% to 29% (Part III, Table 13). It is not clear whether the latter resulted from the project. Agriculture's share of the total credit portfolio rose from 7% to 12% in the same period (Part III, Table 14). The share of agriculture in the financial portfolio also increased. 6.8 While the participation of private banks showed only a modest increase, there is value added in giving a substantial number of them an experience in such lending. Ironically, these banks complained during the final mission that they had geared up to handle rural lending by training teams of good people and improving their loan processing practices only to find financing terminated.35 The project also made a modest contribution to a lengthening of maturities in domestic markets, while the credit line developed the institutional capability to do longer-term lending (which is a separate issue from the capability of the capital market to provide longer-term savings on its own). 6.9 BNA Reorganization. The Bank initiated a Japanese grant-financed, reorganization study of BNA in 1990 in response to BNA's continued high operating costs and low profitability (although, while BNA is expected to earn a profit, profitability has not been a primary objective). Its operating costs in 1990 reached almost 10 percent of its total loans. The organization has tended to be top-heavy, overstaffed and lacking incentives for productivity. 6.10 Since 1991, BNA has been implementing comprehensive reforms with the assistance of management consultants. These included reductions in staff and administrative costs; organizational measures including a productivity-based compensation scheme and fewer managers; and steps to modernize information systems and office technology. Productivity in the branch system has also been addressed. BNA has sought to more clearly define its role, stress efficiency and competitiveness, and diversify its services. 35. While the obstacles to their participation are a recurring theme in the project record, nevertheless an argument could be made that their commitment to participate was never wholehearted.  - 16 - 7. Project Sustainability 7.1 On the productive side, project sustainability is good based on the quantity and type of machinery and equipment financed, and the capital improvements made. On the institutional side however, withdrawal of the Bank has been compensated by only a small increase in private bank involvement in sectoral lending, and it is not clear whether this resulted from the project or other stimuli. The project did not address market failure in terms of measures to develop the financial, legal and regulatory conditions conducive to private bank interest in the sector. Project institutional and financial sustainability is thus negligible. 8. Institutional Performance 8.1 Bank. The Bank believed the project was an important tool for restoring producer confidence in government and re-capitalizing the sector and in this regard, substantial gains were made. Nevertheless, misgivings on the part of the Loan Committee concerning the wisdom of giving BNA a dual role (para. 4.9) were proven right. The Bank's vision of BNA's potential performance as first and second-tier lender was a practical solution but an inappropriate signal in view of project's objective of greater private bank involvement, and this had serious consequences for the participation of private FIs and the sustainability of the project. Further, the very low percentage of loan funds reserved for private FIs also sent the wrong signal, both to them and to BNA. 8.2 The project benefitted from the sense of staff ownership derived from continuity of personnel throughout the project cycle. Difficult circumstances in Argentina required high-quality supervision, and this was provided consistently. The Bank's relationship with IDB was constructive and responses to problems were well-coordinated. 8.3 IDB. The project was fairly advanced when the IDB entered, at the GOA's request, to mitigate counterpart funding difficulties. IDB's participation did enable the client to secure a larger credit line that could finance a greater percentage of each subloan. The working relationship with the Bank was good. Supervision by the IDB field office was thorough and effective. IDB procedures, however, were a hindrance during preparation and implementation. Future co-financing arrangements need to ensure the compatibility of respective institutional processes and requirements as they apply to the Borrower. 8.4 BNA. BNA did a very good job of administering the project and its relationship with the Bank was cordial and productive. Nevertheless, evidence suggests it impeded full realization of Apex lending, taking advantage of the trust implied in being chosen by the Bank for a dual role. 8.5 The Borrower's Completion Report leaves no doubt that BNA intends to reinforce its "dominant lender" position in the sector, and notes that BNA's rates of interest remain the lowest in the market. Future credit projects seeking to broaden private bank participation should, nevertheless take advantage of BNA's extensive branch structure and willingness to lend to the sector while ensuring, as a condition of its participation, that subsidies and regulatory impediments to greater competition among sectoral lenders are  - 17 - eliminated. Project design should anticipate potential crowding out of private lenders by BNA, and a reasonable cap should be placed on its participation to maximize the leeway for important and desirable changes. 8.6 Participating Banks. The FIs benefited institutionally from the project, developing useful experience for term lending to the sector and to clients somewhat smaller than usual, as well as gaining a better idea of the Bank's requirements. Their participation might have been smoother had the Bank (and IDB) understood their needs better at the outset, and been more realistic in its evaluation of BNA's objectives and likely performance in its dual role. However, their own commitment is also open to question and may have been a factor. 9. Audit and Covenant Compliance 9.1 Audit compliance encountered problems. Government decisions as a result of macroeconomic difficulties complicated the audit process in 1989 and 1990.36 Evidence of expenditures was also a problem (periodically) on many subloans of BNA, mainly due to poor quality invoices. BNA remedied deficiencies. Bank audit experts worked closely with BNA to make the external auditors aware of Bank needs. BNA internal auditors uncovered a lack of documentation for some subloans made by FIs, but these deficiencies were quickly corrected. 9.2 Covenant compliance was satisfactory. The exceptions were protracted delays in fulfilling the Bank's time-bound requirements for establishing the Currency Risk Fund; and the covenant concerning BNA's responsibility for ensuring the participation of private FIs. If this covenant meant securing participation agreements with potential FIs, BNA complied, but if it also meant promoting their active involvement in sublending, BNA did not adhere to the spirit of the covenant and its compliance was profoundly delayed. 10. Project Documentation and Data 10.1 The twice yearly reports required under the Loan Agreement, and monthly reports, were of high quality although their scope was narrow. The format for the reports was established by IDB. Supervision reports were comprehensive and analytical. Despite shortage of funds and personnel, and at Bank urging, the Borrower did finally prepare a Completion Report which provided useful input for this report. 11. Findings and Lessons 11.1 This project addressed market failure in very limited terms, which were unlikely to have substantial impact, especially under conditions of macroeconomic crisis and hyperinflation, and uncompetitive practices. The project sought, unsuccessfully, to inject some competition into sectoral credit, but it was never intended to be a full-scale financial 36. The Government froze bank deposits at the end of 1989 and ordered their mandatory conversion to BONEX certificates. Banks were not permitted to close their accounts at year end, causing delayed audits.  - 18 - sector operation. Financial sector reform is slow and needs a fairly long process of incentives development, including policy, legal and regulatory changes, to promote certain forms of lending and generate longer maturities. The latter are more an independent function of the macroeconomic confidence of savers, than project design, and it is only recently that such confidence has begun to emerge. The argument for Bank involvement in such credit lines remains the provision of temporary financing, a form of safety net, ideally to bridge a period in which more comprehensive financial sector reforms are being implemented. The project developed institutional capabilities to do longer-term lending but the system did not develop sufficient long-term savings to sustain matched lending after the project closed. Ongoing Bank loans are supporting important efforts to inter alia, extend the maturities of financial instruments.37 11.2 Public banks (principally BNA since provincial bank involvement has dwindled) continue to dominate agricultural lending, and small, poor farmers continue to be almost completely excluded. Commercial banks are generally averse to lending to farmers for reasons which, in the Argentine case, it is now understood go beyond perceived risks and high transaction costs, to include commercial code restrictions on repossession of moveable goods pledged as collateral, antiquated property registries and lack of credit reporting systems. 11.3 The main lessons from Ln.2970-AR are as follows: (a) A well-designed sectoral credit operation can, over the limited term of the project, effectively channel medium- and long-term credit for productive investment. (b) Future credit projects, in order to achieve more sustainable benefit, should move beyond their predecessors, in the sense that they directly complement and deepen the financial sector reform process, i.e., in the absence of an appropriate macroeconomic and financial sector environment, the sustainability of increased private bank participation in sectoral lending is unlikely; (c) To develop private bank participation, project ground rules should mimic private markets, e.g., private FIs should not be expected to match the maturity of the Bank's credit line when their liabilities are short-term due to economy- wide problems. If private banks cannot mobilize matching term funds, their share might be permitted in the form of associated working capital; (d) Co-financing arrangements need to ensure the compatibility of respective institutional processes and requirements as they apply to the Borrower. The rules of one institution should not impede project implementation. This is especially relevant given the likely increase in Bank/IDB co-financing; 37. Financial Sector Reform Loan, Capital Market Development Loan, and Capital Market Development Technical Assistance Loan.  - 19 - (e) Credit projects need to balance their normal preoccupation with demand, by looking carefully at potential supply-side constraints. This implies developing good data on, and communication and relationships with, all participating lending agents; (f) Apex banks should not, as a general rule, be used as retailers except in special, carefully-defined cases; should such an arrangement be unavoidable, the Apex-as-retailer should be subject to the same retail qualification criteria as its peers, and not be allowed to follow anti-competitive actions against other Fls; (g) Credit terms and conditions should be structured flexibly in volatile economies; projects might consider including a feature which suspends commitments in periods of macroeconomic crisis. Risk assessment needs to be realistic, comprehensive and forward-looking, given the magnification of risk inherent in disrupted economies; and (h) While this project had no targeted clientele, clearly small, poor farmers did not participate and this remains an issue for study in follow-up projects; such farmers require different mechanisms for obtaining credit, which might be based on several successful models of informal credit in other regions.   - 21 - PROJECT COMPLETION REPORT ARGENTINA AGRICULTURAL CREDIT PROJECT II (LOAN 2970-AR) PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE' A draft Part I of this PCR was sent to the Borrower in June 1994 but no comments were received. There is, accordingly, no Borrower Part 11 contribution. However, the Borrower did subsequently prepare a Completion Report (dated November 1994 and available with project files in the LAC Information Center) and this PCR has incorporated information from that report where relevant.   - 23 - PROJECT COMPLETION REPORT ARGENTINA SECOND AGRICULTURAL CREDIT PROJECT (Loan 2970-AR) PART III: STATISTICAL INFORMATION Table 1. Related Bank Loans Project Title/ Year Loan No. Purpose Approved Status 1 Balcarce To encourage adoption of 1967 Closed 1980. Livestock new pasture technology Implemented 1968-80. Development and animal health Experienced adverse Project practices. economic policies and (Ln. 505-AR) conditions non- conducive to sector investment. 2. Agricultural Medium and long-term 1978 Cancelled 1980, Credit Project credit for on-farm without disbursement. (Ln. 1564-AR) investments, to expand export production and ameliorate BOP problems. 3. Grain Storage Assist grain exports and 1978 Closed December Project strengthen the financial 1987. Project (Ln. 1521-AR) position of the Argentine objectives for the most railways. part were not achieved, although project did have some valuable institutional benefits. 4. Agricultural Two-tranche financing to 1986 Fully disbursed. Did Sector Loan support sectoral not achieve central (Ln. 2675-AR) adjustments fostering objectives. increased agricultural productivity and exports.  - 24 - Table 2. Project Timetable Item Date Planned Date Actual Preparation February, 1987 Appraisal May, 1987 May 17, 1988 Loan Negotiations (end) - February 19, 1988 Board Approval - June 23, 1988 Loan Signature - November 18, 1988 Loan Effectiveness - February 1, 1989 Loan Closing June 30, 1996 September 2, 1993 Last Disbursement - September 2, 1993 Project Completion December 31, 1995 September 2, 1993 Table 3. Loan Disbursement ' (US$ Million) Appraisal Actual as % of Fiscal Year 2/ Estimate Actual Estimate 1989 1' 16.5 18.94 114.8 1990 31.9 84.26 268.8 1991 51.2 96.91 189.3 1992 71.4 105.51 147.8 1993 88.2 106.48 120.7 1994 99.1 106.504' 107.5 1995 104.7 - 1996 106.5 1/ Cumulative 2/ June 30 3/ Includes US$10.5 million for establishment of Special Account. 4/ Through December 31, 1993. Source: IBRD Statement of Loans  - 25 - Table 4. Proiect Implementation Indicators' SAR Estimate Actual 1. Loan Disbursements2 100% by June 30, 1996 100% by September 2, 1993 2. Share of subloans through retail 20% 10% banks other than BNA 3. Disbursements for Monitoring 100% by June 30, 1993 100% by January 22, and Evaluation Unit (USE) 1992 '. Indicators as shown in SAR, Annex 7. 2 See Part lll, Table 3 for disbursement record. Table 5. Project Cost and Financing A. Proiect Costs (US$ Million) Appraisal Estimate Actual Category Local Foreign Total Local' Foreign' Total A. Investment Credit 283.20 70.80 354.00 - - 326.30 B. Monitoring and 0.75 0.75 1.50 - - 1.50 Evaluation TOTAL 283.95 71.55 355.50 - - 327.80 '. Borrower data not disaggregated. Source: BNA B. Project Financing (USS Million) Source Appraisal % Actual % Sub-borrowers 99.0 27.8 69.9 21.33 Participating Banks 45.0 12.6 46.3 14.09 IDB 105.0 29.6 105.1 32.06 IBRD 106.5 30.0 106.5 32.52 355.5 100.0 327.8 100.00 TOTAL Source: BNA and IBRD. The sub-borrowers' actual contribution to total costs is understated in this table. The real share was over 40%.  - 26 - Table 6. Project Results A. Direct Benefits 1. Around 14,800 subloans were granted by BNA and 9 private banks for a large amount of agricultural machinery and equipment, and for other purposes. While numbers of items by type were not provided by the Borrower, some 62% of the financing was for machinery, about 17% for breeding stock, and 12% for capital improvements. The remainder went for pasture improvement, agroindustry etc. The project made a substantial contribution to re-capitalizing the sector. 2. Incremental production was not estimated since no target groups or regions were identified, and since a substantial part of the benefits were expected to come from reduced costs of production rather than increased volumes of production. It is also assumed, given that most of the credit went to export-oriented producers, substantial foreign exchange generation was a project benefit. B. Economic Impact 1. The Staff Appraisal Report did not include an economic rate of return calculation.  - 27 - Table 7. Status of Loan Covenants Loan Agreement Section Summary of Ma.jor Covenants Status 3.01 (a) Borrower to provide funds, facilities and Complied. services to carry out Part A of the project. 3.01 (b) Borrower to enter into Subsidiary Complied. Agreement with Guarantor, through SAG, for purposes of Part B of the project. 3.01 (c) Borrower to enter into Participation Complied. Eighteen banks were Agreements with other Financial reviewed and enrolled, but actual Intermediaries (FIs). participation was limited and slow to materialize. 3.01 (d) Borrower to use recycled funds for same Complied. purposes and under similar terms and conditions. 3.01 (e) Borrower to perform all its obligations Complied. under Currency Risk Agreement, Subsidiary Loan Agreement and each Participation Agreement. 3.02 (a) Borrower to maintain an Apex Unit for Complied. purposes of Part A of the project. 3.02 (b) Borrower to support efficient functioning of Complied. Apex Unit. 3.03 Borrower to prepare six-monthly progress Complied. reports. 3.04 Borrower to periodically review interest Complied. rates on Participating Loans and Subloans and contributions to Currency Risk Fund, discuss fundings with Bank and Guarantor, and revise rates if necessary. 3.05 (a) Subloans to be made in accordance with Complied. Schedule 5 of Loan Agreement, and Regulations. 3.07 (b) Borrower to coordinate with SAG Complied. BNA coordinated with preparation of completion report. SAGyP on preparation of draft questionnaire, but no report was produced.  - 28 - Loan Agreement Section Summary of Major Covenants Status 3.08 (a) Borrower, through Apex Unit, to promote Complied, but with major delays. participation of Financial Intermediaries in BNA was prompt in signing up execution of Part A. private Fls to Participation Agreements but did not promote their active participation until 1991 onwards and at the urging of the Bank. 4.02 (a) (i-iii) Borrower to ensure annual auditing of Complied. Special Account and Currency Risk Fund by auditors acceptable to the Bank, furnish audit reports and financial statements to the Bank not later than four months after end of year. 4.03 (b) Borrower to establish by May 31, 1989, a Complied, but with major delays. Currency Risk Fund (CRF). Borrower did not comply until the Bank and IDB informally suspended disbursements. 4.03 (c) Borrower to retain and deposit into CRF Complied. part of the amount collected by the Borrower as interest on participating loans, subloans and loans made under IDB loan, equivalent initially to two percentage points and subject to revision. 4.03 (d) Borrower to manage CRF in accordance Complied. with CRF Regulation. 4.03 (e) Borrower to enter into a CRF Agreement Complied, but with major delays. with the Guarantor by May 31, 1989. 4.03 (f) Borrower to issue CRF Regulation by Complied, but with major delays. February 28, 1989.  - 29 - Table 8. Use of Bank Resources A. Staff Inputs Fiscal Stage of Project Cycle Total Year Through Through Board Through Appraisal Approval Effectiveness Supervision 1986 3.1 - - - 3.1 1987 34.3 - - - 34.3 1988 61.3 10.5 1.3 0.2 73.3 1989 7.0 7.0 1990 17.1 17.1 1991 16.5 16.5 1992 1.5 1.5 1993 - - 1994 27.0 27.0 Total 98.7 10.5 1.3 69.3 179.8 Source: MIS B. Missions Stage of N