China - Gansu Provincial Development Project : Part 3 Industrial Diversification Component

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 16423-CHA IMPLEMENTATION COMPLETION REPORT CHINA GANSU PROVINCIAL DEVELOPMENT PROJECT (LOAN 2812-CHA/CREDIT 1793-CHA) PART III-INDUSTRIAL DIVERSIFICATION COMPONENT March31, 1997 Environment and Municipal Development Operations Division China and Mongolia Department East Asia and Pacific Region 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.  CURRENCY EQUIVALENTS Currency Unit = Yuan (Y) 1988 $1 = Y 3.71 1989 $1 = Y 3.71 1990 $1 = Y 4.72 1991 $1 = Y 5.22 1992 $1 = Y 5.38 1993 $1 = Y 5.45 1994 $1 = Y 8.70 1995 $1 = Y 8.31 1996 $1 = Y 8.30 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS GEC - Gansu Economic Commission GEMI - Gansu Economic Management Institute GFB - Gansu Finance Bureau GITC - Gansu Investment and Trust Company GPC - Gansu Planning Commission GPIO - Gansu Project Implementation Office ICR - Implementation Completion Report PBC - People's Bank of China SAR - Staff Appraisal Report SDBC - State Development Bank of China TTA - Training and Technical Assistance TVEs - Township and Village Enterprises Vice President Jean-Michel Severino, EAP Director Nicholas C. Hope, EA2 Division Chief Jane Loos, EA2EM Staff Member Helen Chan, Operations Officer, EA2EM  FOR OFFICIAL USE ONLY FORWARD 1. Project Background. The Gansu Provincial Development Project comprises three components for agriculture, education and industrial diversification. The Project was identified based on the findings of a 1986 Bank study, Growth and Development in Gansu Province, carried out to assist the Central and Provincial Governments in developing an overall strategy for income growth and poverty reduction. In the early 1980s, 41 percent of Gansu's population lived in poverty, compared to 13 percent nationally, and rural per capita incomes were the lowest nationwide. The Bank study identified a range of issues facing the province but found three problems acute. First, incomes and living standards in the province's upland region of Dingxi were found particularly low. Dingxi had 30 percent of the provincial population -- almost all employed in agriculture, a larger proportion of rural poor, irrigation of only 13 percent of the cultivated area and a shortage of drinking water, and an urgent need for land rehabilitation to counter erosion of the loess soils and to introduce appropriate agricultural production systems. Second, restrictions on labor mobility combined with unsustainable pressure on the province's fragile natural resource base argued for the development of labor-intensive rural industries relying on low-cost labor. Third, improvement of the educational system, particularly of teacher training in basic education, was identified as critical, in view of international experience showing education's prime role in allowing mobility to more remunerative nonagricultural employment, adoption of improved agricultural technology, and -- for women -- fertility reduction, improvement in family health and retention of children in school. 2. Project Design. To address these problems, three separate projects were prepared and appraised. However, when the amount of Bank Group assistance for education and industrial diversification had to be scaled back to reflect provincial repayment capacity, the three operations in different sectors were processed together as components of a single Gansu Provincial Development Project, financed by Ln. 2812/ Cr. 1793-CHA. The agriculture component received $130 million equivalent of credit proceeds, the education component $20 million equivalent of IDA funds, and an IBRD loan of $20 million and credit proceeds of $500,000 equivalent went to industrial diversification. 3. The project's agriculture component comprised construction of the technically challenging 57,000-ha Yindaruqin irrigation scheme, settlement of the irrigated area by 15,000 poor farm families from nearby resource-poor areas, land improvement over 75,000 ha in Dingxi's Guanchuan River Basin, and institutional support. The education component included upgrading of facilities for training primary school teachers, expansion of facilities for training lower secondary school teachers, increased in-service teacher training via expansion of television training facilities, improved science education in 400 lower secondary schools in poor counties, and support to enhance education administration and management. In support of industrial diversification, the project provided a $20 million line of credit to finance small- and medium-sized subprojects in rural and light industry, as well as training and technical assistance for the enterprises This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ii assisted and the project financial intermediary, the Gansu Investment and Trust Company (GITC). While the province assumed the interest rate and exchange rate risks on the Bank loan, GITC bore the commercial risk. 4. Project Outcome. The project's agricultural and education activities were, overall, successfully implemented, although a two-year extension of the credit was required to complete the agriculture component's Yindaruqin Irrigation Subcomponent. That subcomponent, entailing major tunneling works with difficult site conditions and complex engineering, suffered from poor performance by some contractors, lack of counterpart funds, and bureaucratic land settlement processes. Some on-farm works and land settlement activities are still ongoing with local funding. The Guanchuan subcomponent in Dingxi raised farmers' incomes by almost 250 percent three years after completion of works, while net incomes of farmers in the Yindaruqin area have eventually increased by 136 percent for the low-income group and by 55 to 60 percent for others. The land rehabilitation program tested under this and other projects has been subsequently refined and used in the Loess Plateau Watershed Rehabilitation Project (Cr. 2616), among others. 5. The education component, the first Bank Group education operation focused on only one province, increased the number of qualified primary and lower-secondary school teachers, improved the quality of science teachers and education in poor counties, and improved the capabilities of education administrators in the design, development, and implementation of educational programs. The capacity building for educational administrators and managers was important for continued improvement of the system. The administrators and managers trained under this project helped design and implement the subsequent Third Basic Education Project (Cr. 2831 -CHA). 6. The industrial diversification component attempted to raise rural incomes in resource-poor areas with limited agricultural potential and a population surpassing the carrying capacity of the land. Since labor migration in China at the time was allowed only in the context of limited, officially sanctioned programs like the one under this project's agriculture component, the project attempted to provide in-situ assistance to the rural poor by promoting nonagricultural employment. While the provincial study cautioned planners "to look carefully at the policy and institutional environment that would facilitate development of productive nonagricultural jobs in Gansu" (para. 3.01), implying inadequacy in the current environment, the severity of rural poverty in Gansu, where some parts of the population had to rely on government provision of grain, water and fuel relief, was considered adequate justification for piloting limited support to employment diversification. 7. Implementation of the component showed the project's goals in the sector to be overambitious and the study's warning to be justified. While 17 subprojects received funding for modern equipment and technology and small civil works, financial performance of the beneficiaries -- 55 percent of which were non-state rural enterprises -- suffered from many problems. Among these were subborrowers' inexperience in enterprise management, shortages of counterpart funds during implementation and of  iii working capital during production, and economic reforms introduced during the project period that caused enterprise costs to rise significantly and demand for their products to fall. With most project enterprises still producing at less than 50 percent of capacity, their loan repayment to GITC suffered as did GITC's financial condition. Positively, however, technical assistance and training provided under the project introduced provincial planners to the concepts of financial and economic analysis of investments, and this appreciably improved local planning capabilities. 8. Assessment of Project Strategy. The project responded appropriately to provincial needs as identified in the Bank Group study. It also provided experience with various types of sectoral interventions aimed at poverty alleviation. Although this project predates introduction of the current Bank Group poverty alleviation strategy in China, with its targeting of whole operations to specific poor counties identified by the central and provincial governments, the agricultural component was well focused by emphasizing the Dingxi Region. The education component addressed the province's general need for better qualified teachers and did target poor counties for improved science teaching. Moreover, it was followed by the poverty-targeted basic education project series, including the Third Basic Education Project which covers Gansu and six other provinces. The industrial diversification component required about half of the subprojects to be in rural areas. 9. The issues with respect to rural industrial development are its difficulty as well as its value relative to other possible interventions for poverty alleviation. Experience internationally indicates a high failure rate in town and village enterprises, and the ongoing China Southwest Poverty Reduction Project (Ln. 3906/Cr. 2744-CHA), a well planned, integrated multi-sectoral initiative in Guangxi, Guizhou and Yunnan Provinces, has in its first year disbursed little for a small township and village enterprise development component. This suggests the difficulty in using rural industrial development as a poverty alleviation tool. 10. The Gansu Provincial Development Project's highly successful land development component in Guanchuan proved the effectiveness of using a package of measures to improve loess soils. In much of the Loess Plateau, covering 640,000 square kilometers of Gansu, Shaanxi, and Shanxi Provinces and the Autonomous Regions of Inner Mongolia and Ningxia, good new land can be readily and cost-effectively created by mechanized and manual terracing of the soft soil, where slopes are not too steep and population has not yet exceeded carrying capacity. Using the approach tested under this project, the Bank Group-financed Loess Plateau Project (Cr. 2616-CHA) being carried out in several provinces including Gansu, the Shanxi Poverty Alleviation Project (Cr. 2834-CHA) and the Gansu Hexi Corridor Project (Ln. 4028/Cr. 2870-CHA) are raising agricultural productivity and the incomes of very poor farmers over a wide area of the Yellow River basin. 11. Summary. Although the Gansu Provincial Development Project lacked some of the design sophistication now brought to the Bank Group's poverty reduction efforts in China, it significantly improved the incomes of very poor farmers, enhanced educational  iv quality in poor and other areas of the province, and demonstrated the difficulty of rural enterprise development. The land improvement package tested under the project proved a highly effective means of raising agricultural productivity and reducing poverty. The follow-up Loess Plateau, Shanxi Poverty Alleviation and Gansu Hexi Corridor Projects are now replicating and building upon the significant achievement of the earlier initiative.  CONTENTS PREFACE .......................................................... iii EVALUATION SUMMARY ..........................................................v PART I: PROJECT IMPLEMENTATION ASSESSMENT .................................1 A. Project Objectives and Description ..........................................................l1 B. Achievement of Project Objectives ........................................................3 C. Implementation Record and Major Factors Affecting the Project ...............5 D. Project Sustainability ......................................................... 10 E. Bank Performance .......................................................... 10 F. Borrower Performance ..1............................................. I G. Assessment of Outcome .......................................................... 11 H. Future Operation ......................................................... 12 I. Key Lessons Learned ......................................................... 12 PART II: STATISTICAL TABLES ........................................... 14 Table 1: Summary of Assessments .......................................................... 14 Table 2: Related Bank Loans/Credits ......................................................... 15 Table 3: Project Timetable ......................................................... 16 Table 4: Loan/Credit Disbursement: Cumulative Estimate and Actual ....... 16 Table 5: Key Indicators for Project Implementation ..................................... 17 Table 6: Key Indicators For Project Operations ............................................ 17 Table 7: Studies included in Project .......................................................... 18 Table 8: Project Costs and Financing .......................................................... 19 Table 9: Economic Costs and Benefits ......................................................... 20 Table 10: Status of Legal Covenants ....................................... 21 Table I1: Compliance with Operational Manual Statements .. 22 Table 12: Bank Resources: Staff Inputs ......................................................... 22 Table 13: Bank Resources: Missions ....................................... 23 ANNEX A: BORROWER'S CONTRIBUTION TO THE ICR ........................... 25 ANNEX B: ICR MISSION'S AIDE MEMOIRE ................................................... 40 ANNEX C: LIST OF SUBPROJECTS/SUBLOANS-AMOUNTS DISBURSED ......................................................... 53 ANNEX D: GITC-COMPARATIVE (ACTUAL AND PROJECTED) FINANCIAL STATEMENTS FOR YEARS ENDING DECEMBER 31,1987 TO JUNE 1996 ............................................... 54   - 111 - IMPLEMENTATION COMPLETION REPORT CHINA GANSU PROVINCIAL DEVELOPMENT PROJECT (LOAN 2812-CHA/CREDIT 1793-CHA) PART III-INDUSTRIAL DIVERSIFICATION COMPONENT PREFACE This is the Implementation Completion Report (ICR) for the Industrial Diversification Component of the Gansu Provincial Development Project in China, for which Loan 2812-CHA in the amount of $20 million and Credit 1793-CHA in the amount of SDR 410,000 ($500,000 equivalent) were approved on May 12, 1987 and made effective on January 19, 1988. The loan and credit were closed on June 30, 1996. They were fully disbursed, and the last disbursement for the industrial diversification component took place on October 27, 1994. The ICR was prepared by Helen Chan (Task Manager) in the Environment and Municipal Development Operations Division, China and Mongolia Department of the East Asia and Pacific Region, and Naiqin Lu, Operations Officer, in the Resident Mission of China, and reviewed by Ms. Jane Loos, Chief, EA2EM and Yo Kimura, Project Advisor, EA2DR. The borrower provided comments that are included as an appendix to the ICR. Preparation of this ICR began during the Bank's final supervision mission in June 1993, and an ICR mission visited the Province in August 1996. The ICR is based on material in the project file. The borrower contributed to preparation of the ICR by contributing views reflected in the mission's aide-memoire, preparing its own evaluation of the project's execution and initial preparation, and commenting on the draft ICR.   CHINA GANSU PROVINCIAL DEVELOPMENT PROJECT (LOAN 2812-CHA/CREDIT 1793-CHA) PART III-INDUSTRIAL DIVERSIFICATION COMPONENT EVALUATION SUMMARY Introduction 1. Gansu, in northwestern China, is one of the poorest provinces in the country. Until the mid-1980s, the province's industrial strategy had almost exclusively emphasized development of heavy industry using Gansu's considerable natural resources in petroleum, metal ores and coal. But starting in the mid-1980s and in line with economic reform programs in China at that time, the Gansu Provincial Government began to pay attention to two other major resources that had not been fully utilized: its underemployed rural labor force and abundant local agricultural products. A Bank study, Growth and Development in Gansu (Report No. 6064-CHA), supported this shift in policy. The study concluded that a concerted effort to develop labor-intensive industries and services, based on relatively low economic costs of labor and indigenous resources, would provide a stimulus for rural and light industries and diversify the economy. These considerations formed the basis for the Gansu Provincial Development Project's industrial diversification component (hereafter referred to as the project). Project Objectives 2. The project was designed to: (a) diversify Gansu's economy by supporting technological transformation of rural and light industrial enterprises; (b) assist the Gansu Investment and Trust Company (GITC) to develop into a viable financial institution; (c) develop local capacity to use economic analysis in investment decisions and sectoral analysis in planning; and (d) promote a sustainable local training capability. 3. The project had two components: (a) a line of credit of $20 million to finance small- and medium-size projects in rural and light industrial enterprises; and (b) training and technical assistance (SDR 410,000 or $500,000 equivalent) for capacity building in local implementing agencies. Implementation Experience and Results 4. Line of Credit. The $20 million was fully utilized by GITC to support 17 subprojects, 14 by rural enterprises receiving 55 percent of the total loan amount and three by light industrial enterprises receiving 45 percent of the loan. Modern equipment  - vi - and technology and some small civil works were financed. The subprojects were selected from 36 project proposals previously endorsed by the Gansu Planning Commission (GPC) and most were jointly appraised by GITC, the Gansu Project Implementation Office (GPIO), and GPC. While GITC lacked full autonomy in project selection, it carried subproject credit risks and was responsible to supervise subproject implementation. The beneficiary enterprises were spread in 14 towns and cities, with over half in poor and remote areas in the province. The average subloan size was $1.2 million. Incremental employment totaled 4,500 with a cost per job of about $6,700 (at the current exchange rate). 5. All subprojects were completed, but with a delay averaging two years owing to serious counterpart funding problems. By 1995, 16 subprojects were in commercial operation, although production capacity utilization was much below appraisal estimates. All subloans were in the repayment stage by 1995, and currently one subloan is fully repaid, two are repaying after rescheduling and the rest are in arrears. Three subprojects have created serious environmental and health hazards. Some of the remaining 11 subprojects have technical, managerial or marketing problems. In their current condition, these subprojects cannot be considered successful. Economic and financial rates of return (ERRs and FRRs) calculated by the borrower for the four larger subprojects, accounting for about 50 percent of the $20 million credit line, indicated FRRs ranging from 5 to 13 percent, compared to the 19 to 27 percent estimated at appraisal, and ERRs from 8 to 18 percent compared to the 25 to 47 percent originally estimated. 6. The original expectation of developing financially sound industrial operations in remote areas of one of China's poorest provinces is considered to have been unrealistic. In the early 1980s, when the project was initiated, China's reform process was still relatively new, the macroeconomic framework for the type of industrial development attempted was largely lacking, and enforcement of environmental regulations suffered as the country strove for economic development. Further, to be successful, the subproject enterprises would have needed technical, managerial, financial and environmental support that were locally unavailable. 7. The project's expectation that GITC would become an independent and viable commercial financial institution during the implementation period, and as a result of project support for only a small part of GITC's overall activities, was similarly unrealistic. In the mid-1980s, investment decisions in the province were normally not determined on economic and financial viability, and financial reforms were at a very early stage of development. Only in 1994, as a result of nationwide financial reforms that provided autonomy and imposed asset/liability requirements on all nonbank financial intermediaries, did GITC get full autonomy in its investment decision-making and begin to make progress toward financial independence. 8. Under the project, GITC's application of subproject appraisal procedures and selection criteria was insufficiently strict, in part due to its unfamiliarity with commercial practices and in part due to its lack of autonomy in decision-making. Subproject  - vii - appraisal assumptions for financial projections, capacity utilization and repayment terms were often unrealistically unattainable. GITC lacked the capacity in fully assessing the enterprise management ability, market situations and technical capacity. Furthermore, subloan agreements lacked adequate financial performance targets, e.g., disallowing borrowers from incurring any new debt unless an agreed debt/equity threshold had been met, and failed to indicate specific legal obligations of the guarantors. 9. The project did, however, lay a basis for GITC's future development. During project preparation, the Bank provided considerable managerial and financial training for many GITC managers and operational staff. During project implementation, GITC continued to receive training from the project's technical assistance. Since its adoption of a Policy Statement and business strategy in June 1988, GITC has developed from a government disbursing institution to a nonbank financial institution depending more on sound credit analysis. Nonetheless, its institutional development has a long way to go to become satisfactory. 10. GITC's financial position remained weak during project implementation due mainly to its existing aging portfolio and further aggravated by the poor repayment record of subprojects under the project. Marginal improvement occurred in 1995 and 1996 due to GITC's intensified collection efforts and revised business strategy adopted in 1994. Net income after tax as a percentage of total assets increased from virtually zero in 1994 to 2.2 percent on June 30, 1996. The collection rate increased from 10 percent in 1994 to 22 percent in 1995. Based on financial results in the first half of 1996 and its intensive collection efforts since 1995, GITC's financial position could further improve in future if it adheres strictly to ratio management requirements set out by the Central Bank (the People's Bank of China), improve its portfolio quality and establish a corporate management system. At the request of the ICR mission, GITC and the Provincial Finance Bureau jointly prepared a restructuring program for subprojects and the aging nonperforming portfolio. 11. Technical Assistance. Most activities were completed satisfactorily. Five agroprocessing studies and associated economic analyses were undertaken by GPC and the Gansu Economic Commission to serve as the basis for strategic subsector planning in the Province's Eighth Five-Year Plan. A variety of training programs were offered and trainees came from implementing agencies in another Bank-supported health project in Gansu, implementing agencies for all components of this project (including agriculture and education), beneficiary enterprises in the industrial component and many other rural enterprises that were not project beneficiaries. With the management information system established with Bank assistance, the GPIO coordinated project activities and managed project implementation generally efficiently. Periodic progress reports submitted to the Bank were timely and complete. 12. Bank Supervision. As a small component in a project aimed primarily at agricultural development and, to a lesser degree, social services support, the project's small industrial component suffered from inadequate support from Bank management.  - viii - The Bank's supervision budget went mainly to the larger components, to the detriment of the industrial activities. The Bank's method of allocating supervision resources played a major role in the low level of supervision during some periods of project implementation. Summary of Findings, Future Operations, and Key Lessons Learned 13. The project outcome must be considered unsatisfactory. Although it succeeded in developing the local government's basic capacity to use economic and financial criteria in investment planning, this modest intervention did not succeed in establishing well- performing rural industries or in transforming GITC into a well-functioning, commercial financial intermediary. Even now, industrial and financial reforns constitute some of the major remaining and most difficult items on China's reform agenda. This one operation should not have been expected to introduce such changes in one of the country's least developed areas at an early stage in China's reform process. 14. The sustainability of project interventions is uncertain. GITC's future prospects will depend on the success with which it carries out the subproject and portfolio restructuring program developed with Bank assistance. Under the program, buttressed by a new business plan and supervision by the provincial branch of PBC, GITC is attempting to revitalize its asset stock, intensify collection to improve portfolio quality and to diversify risks by engaging in new product lines. If the program is carried out with full support from the relevant government departments, GITC and the participating enterprises-most of which have good business potential-may, in time, internalize the reforms introduced under the project. 15. The following major lessons were learned under the project: (a) Financial and industrial reforms are very difficult undertakings, which cannot be effected in one operation and without a supportive macroeconomic and institutional framework. The expectation that project support for financial system and industrial development in one of China's most disadvantaged areas at a time when such reforms were at their earliest stages in China was overoptimistic; (b) Financial intermediary operations need to have well-defined and strictly applied procedures for subproject appraisal, adequate and realistic criteria (technical, institutional, financial and economic) for subproject selection, relevant expertise of the financial intermediary in all aspects of the appraisal, and subloan agreements with appropriate financial performance requirements and specification of guarantors' legal obligation. These prerequisites were largely absent in Gansu and in China as well. GITC, and all other Gansu banks, lacked adequate capabilities in project analysis and credit risk management; assumptions used in GITC's financial projections for the industrial subprojects were unrealistic; and the small rural enterprises funded under the project received little of the technical and managerial support needed for the envisioned development; and  - ix- (c) In multisectoral projects, the Bank must be willing to allocate sufficient supervision resources to all project components, no matter their relative size. Bank supervision of this project's industrial activities suffered from resource constraints associated with having three independent components in one project, but without allocating resources for each component as if it were a separate project. (d) The industrial diversification component finances small rural enterprises in one of the poorest and most remote provinces in China. Past experience in other projects in China and in other countries shows that rural enterprise development is a particularly difficult undertaking, which involves long- term commitments from both providers and recipients of such assistance, and a supportive macroeconomic framework. The expectation that small rural enterprises in remote poor provinces in China are to perform satisfactorily with virtually no institutional support is destined to be disappointing.   - 1 - CHINA GANSU PROVINCIAL DEVELOPMENT PROJECT (LOAN 2812-CHA/CREDIT 1793-CHA) PART III-INDUSTRIAL DIVERSIFICATION COMPONENT PART I: PROJECT IMPLEMENTATION ASSESSMENT A. PROJECT OBJECTIVES AND DESCRIPTION 1. Background. Gansu, in northwestern China, is one of the poorest provinces in the country. Until the mid- 1980s, the province was overwhelmingly rural, with agriculture the main source of livelihood for the population. The provincial strategy for the industrial sector almost exclusively emphasized the development of heavy industry using Gansu's considerable natural resources in petroleum, metal ores and coal. In line with the economic reform program in China, Gansu's government began to pay attention to two other major resources that had not been fully utilized: the underemployed rural labor force and abundant local agricultural produce. A Bank study, Growth and Development in Gansu (Report No. 6064-CHA), supported this shift in policy. The study indicated that the near-exclusive emphasis on development of mineral-based heavy industry would do little to increase nonagricultural employment and improve the low productivity in agriculture. The study concluded that a concerted effort to develop labor- intensive industries and services, based on the relatively low economic costs of labor and indigenous resources, would provide a stimulus for rural and light industries, help diversify the economy, increase its overall growth rate as well as alleviate poverty. These strategic considerations formed the basis for the industrial diversification component (hereafter called "the project") of the Gansu Provincial Development Project. 2. Project Objectives. The project was designed to: (a) diversify Gansu's economy by supporting technological transformation of rural and light industrial enterprises for improved labor productivity and by creating industrial employment in rural areas to alleviate poverty; (b) assist the Gansu Investment and Trust Company (GITC) to develop into a viable commercial financial institution by introducing credit decision criteria based on financial and credit risk analysis; (c) develop the local capacity to use economic analysis in investment decisions and sectoral analysis in planning; and  - 2 - (d) promote sustainable local training capacity through a variety of training programs. Objective (a) was fulfilled in only a very narrow sense, in that enterprises were developed or expanded under the project and people were employed. However, since most enterprises are not financially sound and their sustainability is uncertain, the development impact expected from the project cannot be considered achieved. Objective (d) relating to training was successful in the sense that people were trained as expected, but sustainability of the training programs will depend on continued budgetary allocations. As to objective (b), given the lack of financial reform in China in the mid-1980s, it was unrealistic to expect this single operation to make GITC a financially viable institution. Objective (c) is considered achieved since the project raised provincial planners' awareness of the importance of economic analysis, yet development of local capacity is a long-term goal and a continuous process. 3. Project Description. The project had two components: (a) a $20 million line of credit for the financing of small- and medium-size projects in rural and light industrial enterprises, particularly the town and village enterprises (TVEs) in the rural areas; and (b) training and technical assistance (SDR 410,000 or $500,000 equivalent) for capacity building in local implementing agencies' to: (i) strengthen GITC as a financial intermediary to facilitate and ensure the effective use of investment funds; (ii) support the Gansu Planning Commission (GPC) and the Gansu Economic Commission (GEC) in the preparation of agroprocessing studies and associated economic analyses; (iii) assist Gansu Province in implementing its various training programs; and (iv) finance purchase of essential office equipment for agencies involved in the project. 4. The People's Republic of China was the borrower of the Bank loan and IDA credit. The proceeds of the credit were extended to Gansu Province for technical assistance activities. The proceeds of the loan were relent to GITC for 20 years including a grace period of 5 years, with GITC allowed to roll over the funds. GITC's subloans Gansu Planning Commission (GPC), Gansu Economic Commission (GEC), Gansu Finance Bureau (GFB), Gansu Economic Management Institute (GEMI), Bureau of Light Industries and Bureau of Rural Industries, Gansu Investment and Trust Company (GITC), Gansu Project Implementation Office (GPIO), rural and light industrial enterprises, particularly for subproject entities under the project.  - 3 - were normally not to extend beyond 7 years, and not more than 12 years. Foreign currency subloans carried a fixed interest rate of 8.5 percent. Subborrowers assumed the US dollar exchange rate risk, while the province carried the interest rate risk and the exchange risk between the currency pool and the US dollar. Local currency subborrowers paid a variable interest rate based on loan rates of the Agricultural Bank of China (ABC) and the Industrial and Commercial Bank of China (ICBC) to rural and industrial enterprises. The province carried all foreign exchange and interest rate risks on local currency subloans. GITC was allowed a minimum 4 percent interest rate spread on the subloans to cover its cost. 5. Eligibility Criteria of Subloans. The subprojects financed with the Bank loan were to meet the following eligibility criteria: (a) minimum financial and economic rates of return of 12 percent; (b) subborrowers to finance at least 10 percent of investment cost of the subprojects; and (c) a minimum of four subprojects in the light industrial sector with loans totaling to $8 million and a minimum of 18 subprojects in rural industries with loans totaling not less than $12 million. B. ACHIEVEMENT OF PROJECT OBJECTIVES 6. Physical Objectives. The major objectives were partially achieved. The line of credit was fully utilized, supporting 14 rural enterprises and 3 light industrial enterprises. The 17 subprojects were selected from 36 proposals endorsed by GPC. The loan financed modem equipment and technology and some small civil works. Subproject implementation suffered delays of one to three years, lack of counterpart funds, technology problems and deficient managerial capability. Of the 17 subprojects, 16 were completed and are in commercial operations, although with production much lower than subproject appraisal estimates. One subproject did not go into commercial operations. The enterprises' economic and financial returns were also lower than anticipated at appraisal due mainly to increasing input prices and declining product prices. One subloan was fully repaid, two are repaying after rescheduling and the rest are in arrears. Three subprojects have created serious environmental and health hazards. Some of the remaining 11 subprojects have technical, managerial or marketing problems. But overall, these subprojects have good business potential. They have already contributed to the local economy by creating industrial employment in rural areas, raising rural income, utilizing indigenous raw materials, creating value-added to local agricultural products, leading to proliferation of supporting industries and services in the vicinity of the subprojects, and developing managerial and technical skills in rural areas. 7. Institutional Objectives. The project provided technical assistance to help capacity building in local implementing agencies in three major areas. (a) Strengthening of GITC. The expectation that GITC (only the International Departments was involved in the project) would become a viable commercial financial institution did not materialize. During project preparation, the Bank provided substantial managerial and financial  -4- training for many GITC managers and operational staff dealing with international operations. After project effectiveness, GITC continued to receive training under the project's technical assistance activities. GITC's adoption in June 1988 of a Policy Statement and a business strategy helped it to develop from a governnent disbursing institution to a nonbank financial institution depending more on credit analysis. Yet this achievement was limited, with the particular problem that until 1994 (and to some extent even now) the provincial government influenced GITC's investment decisions, despite the latter's nominal autonomy. (b) Studies. Five subsector studies (on sugar beet, vegetable oil processing, wheat straw pulp and paper, fruit and vegetable bottling and canning, and soybean derivatives) were completed by February 1990, and were well prepared. GPC found the studies very helpful in its policy and investment decisions during the Eighth Five-Year Plan (1990-95). To some extent, the studies helped the agroprocessing industries take advantage of Gansu's comparative advantage in certain agricultural crops and improve value- added of its produce. For instance, the crop planting areas of sugar beet, flax and soybean were appropriately increased; as such, food processing became the pillar subsector of TVEs, accounting for nearly 30 percent of TVEs' output value in 1994. In addition, agroprocessing promoted the integration of agricultural production and application of science and technology. The dissemination and application of the studies were, however, affected by Gansu's harsh natural conditions, difficulties in adopting new concepts in Gansu, and constraints posed by China's evolving reform environment. The economic studies2 conducted by GPC and GEC were incorporated into the subsector studies with agreement of the Bank in 1989. Economic analysis was also used in the selection and appraisal of the subprojects under the line of credit. Both the financial and economic analysis introduced in the Province by the project were integrated into investment analysis and decision-making, although assumptions used in both analyses were usually too optimistic to be attainable. This nevertheless represented significant progress in the province, which for the first time used economic and financial analysis in its decision-making process. (c) Training. Course evaluations indicate that the various training programs3 financed under the project were very helpful to both project 2 The economic studies considered shadow pricing, economies of scale, capacity utilization, employment creation, efficiency of operations, administered prices, subcontracting, and trade and payments. 3 The training programs included: project evaluation, management and supervision; financial management; business accounting and finance; computer applications; foreign language; and rural enterprise management.  - 5 - implementation agencies and subproject entities. The programs were conducted by several training institutes in Gansu and other provinces, using different teaching methodologies. The Gansu Economic Management Institute (GEMI) was the chief organizer and conducted most of the training. Case studies with on-site plant visits were ranked best by the approximately 1,000 participants from agencies implementing all three components of the Gansu Provincial Development Project, another Bank- assisted health project, and rural and industrial enterprises. Some 300 participants were from rural and light industrial enterprises, including many nonproject beneficiaries. GEMI's overall capability has been greatly enhanced by incorporating teaching materials developed by the Bank's Economic Development Institute (EDI), inviting domestic and foreign experts as lecturers, organizing various training programs, and upgrading teaching facilities. C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT 8. Loan Effectiveness and Implementation Schedule. The Gansu Provincial Development Project was approved by the Bank's Board on May 12, 1987. The Loan/ Credit and Project Agreements were signed on September 14, 1987 and became effective on January 19, 1988. Project completion and loan closing were scheduled for December 31, 1993 and June 30, 1994, respectively. The last disbursement for the component was in October 1994. The project's closing date was extended twice to June 30, 1996 because of delays in the agricultural component. 9. Subproject Characteristics. The average subloan size was $1.2 million. Eleven of the 17 subprojects were larger than $300,000, requiring economic rate of return calculations. Of the loan amount, 55 percent went to nonstate rural enterprises and 45 percent to light industrial enterprises, a minor deviation from the appraisal estimate of 60 and 40 percent, respectively. There was only one foreign currency subloan, amounting to 10 percent of the line of credit. Total investment cost of the subprojects amounted to about $60 million equivalent, reflecting the project's significant local counterpart funding requirement. The subprojects were widely distributed in 14 cities and towns, over half in poor and remote areas in the province. Incremental employment totaled 4,500 with a cost per job of about $6,700 (at the current exchange rate). 10. Subproject Implementation. Subproject selection was delayed due in part to the time needed by GITC and GPIO to complete economic and financial evaluations required for subproject selection. Even though the analyses were undertaken properly, the underlying assumptions were overly optimistic. Subproject implementation was delayed because most enterprises failed to obtain necessary counterpart funds. As of June 30, 1996, construction of all 17 subprojects was completed, with 16 starting commercial operations. Due to technical and procurement problems, one subproject did not go into commercial operations with the intended products, but was producing some peripheral products in the past two years. Six of the 17 subprojects (35 percent) were completed  - 6 - according to schedule, nine (53 percent) were delayed for one to two years, and two (12 percent) for up to three years. 11. Of the 17 subprojects, one subproject doubled production capacity from its project design and fully repaid the loan by early 1995. One subproject did not go into commercial operations and GITC is currently resorting to legal action for subloan recovery. For most of the remaining 15 subprojects, production was much lower than subproject appraisal estimates. Three subprojects were producing at between 70 and 92 percent of installed production capacity, six at 30 to 55 percent, three at 16 to 28 percent, two at less than 10 percent, and two were not producing the intended products. Of the latter two, one had ventured into some peripheral production and was not successful as well. Another one had diverted its production to different products while using the same equipment and was expected to do well in the next two years. The six subprojects producing at 30 to 55 percent of installed capacity have the potential to increase production in the next few years. 12. Major factors contributing to slow implementation and low capacity utilization included: (a) failure to obtain sufficient counterpart funds as scheduled during the construction stage; (b) shortage of working capital during the production stage due to triangular debts4 and tight credit policy; (c) lack of technical support resulting in poor technology and equipment choice, affecting production during commercial operations; (d) cost overruns during the construction period, further aggravating problems of insufficient counterpart funds; (e) lack of proper project and enterprise management, particularly for small rural enterprises; (f) change of project designs during implementation; (g) insufficient indigenous raw materials, while imported raw materials (from outside Gansu) were too expensive to be affordable; (h) a longer than planned testing period leading to delays in start of commercial operations; and (i) market changes during a prolonged implementation period in an increasingly open and competitive market, which resulted in product sales prices much lower than appraisal, raw material prices much higher and products not marketable. To be successful, the subproject enterprises would have needed technical, managerial, financial, marketing and environmental assistance that were locally unavailable. 13. A few subproject beneficiaries are profitable, a few are marginal, but most have financial difficulties. This has affected subproject repayments. In addition to delays in project implementation, some enterprises, already heavily indebted by the subprojects, ventured into new capital investment without prior consultation and agreements with GITC. GITC's ability to properly supervise the subprojects and enforce financial obligations of even the financially solvent enterprises was also limited. The local Investment and Trust Companies (ITCs) that were supposed to help GITC in supervising subprojects as well as GITC's own local administrative offices were closed in 1994 under the new regulations of PBC for nonbank financial institutions. Thus, GITC was left with 4 Debts with its input suppliers and its sales channels.  - 7 - no supervisory network. It would have been difficult as well as expensive for GITC to effectively supervise these subprojects and to improve loan collection as the subprojects were scattered all over Gansu. 14. A few subprojects in remote areas caused environmental problems and were allowed to continue production, ignoring existing environmental regulations. They neglected the environmental protection measures indicated in their investment plans due to inadequate counterpart funding. However, required remedial measures would need substantial additional investment, which may not be financially and economically viable to both the enterprises and to the Gansu economy. 15. Remedial Action Plan. Most of these problems are beyond GITC's ability to solve. During the ICR mission, the Bank requested GITC and the provincial government to prepare a joint remedial action plan to solve these problems. GITC and the provincial government agreed to examine the three projects with environmental problems and solve the issues either by stopping production, or installing necessary pollution control equipment. For the few subprojects that perform poorly and have no chance of operating profitably in the future, GITC, with support from local government, will turn to legal actions for repayments from subborrowers and their guarantors. For subprojects with a reasonable chance of performing satisfactorily in the long run, GITC will seek assistance from local government and their guarantors for technical and managerial assistance. GITC has already introduced the remedial actions. 16. Subloan Repayments. At appraisal, subproject repayment capabilities were overestimated. The delay in project implementation further weakened enterprises' ability to repay. By the end of 1995, all 17 subprojects entered into the repayment stage according to their original schedules, which were unduly optimistic. As of June 30, 1996, one subloan was fully repaid; two subloans have been repaying; two subloans had been rescheduled; and one was under legal pursuit of subloan recovery. The remaining 11 subloans were in arrears. Poor repayment was due to: (a) delayed implementation; (b) low capacity utilization; and (c) repayment funds diverted to other capital and working capital expenditures. In mid-1996, the collection rate based on original project subloan agreements was only 12.5 percent, even lower than GITC's average collection rate of 22 percent in 1995. Arrears as a percentage of project loans outstanding were 62 percent, also much higher than GITC's average arrears ratio of 39 percent in 1995. Based on the remedial action plan (para. 15), GITC and provincial and local authorities have worked out a rescheduling program for the subprojects that were in arrears. Depending on its enforcement and monitoring efforts, the collection rate could be increased to 40 percent and the arrears ratio decreased to 13 percent by the end of 1997.  - 8 - COLLECTION AND ARREARS POSITION: SUBPROJECTS UNDER LOAN 2812-CHA (As of June 30, 1996) Principle (Y million) Number of Original Contract After Rescheduling Subprojects Foreign Local Foreign Local 1. Cumulative Amount Due 17 2.1 53.1 - 19.2 2. Cumulative Amount Paid 4 - 7.6 - 7.6 3. AmountofArrears 13 2.1 45.5 - 11.6 Ratios (percent) 2/1 23.5 0 14.3 - 39.6 3/1 76.5 100.0 85.7 - 60.4 17. Economic and Financial Rates of Return. GPC and GITC calculated ex-post financial rates of return (FRR) and economic rates of return (ERR) on four subprojects, two rural industries and two light industries, accounting for about half of the $20 million in subloans. The ex-ante FRRs ranged from 19 to 27 percent while the ex-post FRRs ranged from 5 to 13 percent. The ex-ante ERRs ranged from 25 to 47 percent while the ex-post ERRs ranged from 8 to 18 percent. Actual results were lower than original estimates because: (a) input prices increased substantially while product sales price remained relatively low due to competition; and (b) low utilization of production capacity led to high production cost. 18. Training and Technical Assistance. This component included five agroprocessing subsector studies and associated economic analyses, various training programs, and the purchase of office equipment for agencies involved in the industrial diversification component. * The subsector studies, carried out by GPC and GEC, were well prepared and accepted by Gansu authorities. They provided an analytic basis, with essential financial and economic criteria, to help restructure the related subsectors during Gansu's Eighth Five-Year Plan. The sugar beet and wheat straw studies were particularly instrumental in sectoral planning. * Around 1,000 personnel from enterprises and government agencies benefited from different types of training programs. About 40 percent of the trainees were from relevant government departments, and 60 percent from subproject entities and rural and industrial enterprises. It is estimated that 90 percent of the trainees were managers. GEMI's teaching capability has been greatly  - 9 - improved through organizing and offering various training programs, and upgrading its teaching facility. The Management Information System (MIS), financed under the project, was completed in 1993 for GPIO and GITC. GPIO used it efficiently to manage and monitor financial affairs, contracting and procurement under the Gansu Provincial Development Project and the industrial subprojects. GITC could have utilized the MIS more effectively in monitoring the physical and financial performance of the subprojects and its other operations as well. 19. Financial Performance of GITC. A comparative summary of GITC's financial statements during 1987-96 is shown in Annex D. The financial position of GITC remained weak during project implementation due mainly to its existing aging portfolio, which was not performing well, and further aggravated by the poor repayment records of subprojects under the project. The project's expectation that GITC would become a viable, independent and commercial financial institution during the implementation period was unrealistic. In the mid-1980s, investment decisions in the province were normally not determined on economic and financial viability, and financial reforms were at a very early stage of development. Only in 1994, as a result of nationwide financial reforms that provided autonomy and imposed asset/liability requirements on all nonbank financial intermediaries, did GITC get full autonomy in its investment decision-making and begin to make progress toward financial independence. 20. Following PBC's 1994 regulations and in line with its strategic business plan, GITC in 1994 started to diversify from long-term lending operations to short-term lending, leasing, bonds and trust businesses. These have resulted in marginal improvements in GITC's financial position in 1995 and 1996. Net income after tax as a percentage of total assets increased from virtually zero in 1994 to 2.2 percent at June 30, 1996. In 1994, it provided counterpart funding of Y 237 million for the Yindaruqin irrigation scheme in the agriculture component of the project. Funds were relent from the State Development Bank of China (SDBC). In early 1996, GITC absorbed the provincial fiscal revolving funds of Y 70 million in its accounts, pushing the total debt/equity ratio from 1.1 at the end of 1995 to 1.45 at June 30, 1996, almost reaching the 1.5 loan covenant. Based on financial results in the first half of 1996 and its intensive collection efforts, GITC's financial position could be further improved in the future if it adheres strictly to PBC's ratio management requirements, improves its existing portfolio quality and establishes a corporate management system. 21. Operational Performance. Under the project, GITC's application of subproject appraisal procedures and selection criteria was insufficiently strict, in part due to its unfamiliarity with commercial practices and in part due to its lack of autonomy in decision-making. Subproject appraisal assumptions for financial projections, capacity utilization and repayment terms were often unrealistic. GITC placed insufficient importance on enterprise management ability, market situations and technical capacity. Furthermore, subloan agreements lacked adequate financial performance targets, e.g., the  - 10- agreements were insufficiently specific by lacking (a) debt/equity thresholds to prevent borrowers from incurring too much new debt, (b) specific legal obligations of the guarantors; (c) financial and physical progress reporting requirements; and (d) standard procurement procedures. 22. Arrears Situation of GITC. GITC's poor appraisal procedures resulted in poor collection performance, which bottomed at 10 percent in 1994. Thereafter, through intensive efforts collections increased to 22 percent in 1995. Correspondingly, arrears as a percentage of total loans outstanding decreased from 46 percent in 1994 to 39 percent at the end of 1995. About 67 percent of its arrears were overdue loans of more than two years. The Bank suggested that GITC undertake a detailed portfolio review in assessing the recovery possibility of these arrears and to take decisive actions in writing off noncollectible bad loans, such as loans extended to enterprises that no longer existed or were not in operation. Given the arrears ratio and its aging profile, GITC's 2 percent bad debt provision is clearly insufficient to cover unrecoverable bad loans. Based on the portfolio review, GITC should seek agreement from relevant authorities to increase its general bad debt provisions to an appropriate level consistent with its experience with bad loans and to include "specific" provisions based on the status of each existing loan account that was in default for over one year. D. PROJECT SUSTAINABILITY 23. Project sustainability is uncertain. Although value-added of project-related agricultural production to the local economy is considerable and project technical assistance benefited Gansu substantially in some areas, the outcome of the main project components supporting GITC and the industrial subprojects remains in doubt. The project's ultimate results will depend on GITC's ability to implement the subproject remedial action plan with full support and coordination from local government agencies. With two thirds of the subprojects likely to reach reasonable installed production capacity and provide value-added to local agricultural production in the next few years, the invested capital would continue to provide industrial employment in some of the poorest and remote areas of China while permitting viable operations of subprojects. E. BANK PERFORMANCE 24. During project identification and preparation, the Bank played an important role in the formulation and design of the project. The Bank contributed enormous resources over 100 staff-weeks during the 18-month period when the project was prepared. After project effectiveness, the Bank provided continual advice with the reviews of subproject appraisal reports and agroprocessing studies, reviews of procurement and disbursement matters, and discussions during supervision missions. Through subproject reviews, the Bank assisted GITC and GPIO to become familiar with project analysis and helped to improve their appraisal standards. With the Bank's support, GITC was allowed by PBC in 1993 to conduct foreign exchange business and to increase its provisions for bad loans to a higher level than the rate applied to other financial institutions at that time. In  - 11 - addition, the Bank advised GITC to strengthen subproject and portfolio management, recommended remedial actions on specific issues affecting several subprojects, and suggested that GITC prepare a strategic business plan to guide its development as a commercial financial institution. 25. Nonetheless, Bank supervision activities on the project could have been more effective had additional staff resources been allocated. In view of the difficulty of the project activities, which were completely new to Gansu's rural areas, much more supervision was required. Project supervision was directed mainly at preparation of subproject assessments in 1989. Implementation of the subprojects in subsequent years received 6.4, 7.5, 1.6 and 3.4 staff weeks of supervision in 1990-93, respectively. Supervision in the field was infrequent, with missions spaced more than a year apart. Had additional staff resources been allocated, the Bank could have affected the timely handling of emerging problems in both the subprojects and GITC. Although the industrial component was only one part of the Gansu Development Project, it was a project on its own and should have received a supervision budget on that basis. The Bank's system of allocating supervision budgetary resources based on the number of operations and the increasingly tight budget situation since the early 1990s were largely responsible for the inadequate project supervision. Even so, the Bank's expectations to improve substantially the quality of Gansu's investment with sound project appraisal and to develop a viable financial institution within the span of a single operation were unduly optimistic. F. BORROWER PERFORMANCE 26. The local institutions involved in the project supported its implementation as well as they could, but during the implementation period, many constraints experienced by them were beyond their control, including the general lack of industrial and financial reform in China. The Gansu government attached significant importance to the project, GPIO was generally efficient in project coordination and management, and, within the evolving financial reforms and investment environment in Gansu, GITC made a substantial effort to improve its portfolio, strengthen collection efforts and diversify its operations to improve profitability. GEC and GPC also completed the agroprocessing studies satisfactorily and GEMI managed the training programs effectively. To some extent, the implementing agencies could have improved their performance in providing more timely counterpart funds, enforcing environmental standards and regulations more strictly, devoting more manpower and time to subproject supervision, and resolving enterprise technical and repayment problems more diligently. The borrower's overall performance is therefore rated marginally unsatisfactory. G. ASSESSMENT OF OUTCOME 27. The project's physical outcome is rated as less than satisfactory, despite generally good implementation of subsector and economic studies and various training programs that assisted the province improve its subsector investment planning. The project met its  - 12- objectives in only a narrow sense. Incremental industrial employment was provided in remote and poor rural areas, value added to local agriculture production increased, rural poverty alleviated to some extent, and managerial capabilities were developed in many government and enterprise beneficiaries. However, project implementation was slow and problem-ridden, GITC's financial performance was poor, a number of subprojects financed under the line of credit continue to face financial, technical, managerial and marketing difficulties, and three subprojects have created environmental problems that remain unaddressed. If GITC carries out its remedial action plan and gains the full support and supervision of relevant government departments, the developmental and financial prospects of most subprojects would improve. But as matters now stand, the industrial development activities in Gansu cannot be considered to have achieved their intended effects fully. H. FUTURE OPERATION 28. The provincial planners will continue to use the economic and financial planning skills they acquired under the project, and others who received project training are expected to further improve their capabilities. GITC and 15 of the subproject enterprises will endeavor to achieve financial viability in the next few years. The one already successful subproject enterprise is expected to continue operating satisfactorily. GITC is expected to operate as an independent nonbank financial institution with its new business plan and under the supervision of the provincial PBC. It will continue its efforts to revitalize its asset stock, intensify collection to improve its portfolio quality and to diversify risks by engaging in new products lines. The Gansu government will work closely with GITC to ensure that the remedial action plan discussed in para. 13 would be carried out with sufficient support from all agencies. I. KEY LESSONS LEARNED 29. The following major lessons were learned under the project: (a) Financial and industrial reforms are very difficult undertakings, which cannot be effected in one operation in one province and without a nationwide supportive macroeconomic and institutional framework. The expectation that project support for financial system and industrial development in one of China's most disadvantaged areas at a time when such reforms were at their earliest stages in China was overoptimistic; (b) Financial internediary operations need to have well-defined and strictly applied procedures for subproject appraisal, adequate and realistic criteria (technical, institutional, financial and economic) for subproject selection, relevant expertise of the financial intermediary in all aspects of the appraisal, and subloan agreements with appropriate financial performance requirements and specification of guarantors' legal obligation. These prerequisites were largely absent in Gansu and in China as well. GITC, and all other Gansu banks, lacked adequate capabilities in project analysis  - 13 - and credit risk management; assumptions used in GITC's financial projections for the industrial subprojects were unrealistic; and the small rural enterprises funded under the project received little of the technical and managerial support needed for the envisioned development; and (c) In multisectoral projects, the Bank must be willing to allocate sufficient supervision resources to all project components, no matter their relative size. Bank supervision of this project's industrial activities suffered from resource constraints associated with having three independent components in one project, but without allocating resources for each component as if it were a separate project. (d) The industrial diversification component finances small rural enterprises in one of the poorest and most remote provinces in China. Past experience in other projects in China and in other countries shows that rural enterprise development is a particularly difficult undertaking, which involves long- term commitments from both providers and recipients of such assistance, and a supportive macroeconomic framework. The expectation that small rural enterprises in remote poor provinces in China are to perform satisfactorily with virtually no institutional support is destined to be disappointing.  - 14 - PART II: STATISTICAL TABLES TABLE 1: SUMMARY OF ASSESSMENTS A. Achievement of Objectives Substantial Partial Negligible Not Applicable Macroeconomic policies x Sector policies x Financial objectives x Institutional development x Physical objectives x Poverty reduction x Gender issues x Other social objectives x Environmental objectives x Public sector management x Private sector development x B. Project Sustainability Likely Unlikely Uncertain x C. Bank Performance Highly Satisfactory Satisfacto_y Deficient Identification x Preparation assistance x Appraisal x Supervision x D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation x Implementation x Covenant compliance x Operation (if applicable) x E. Assessment of Outcome Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory x  - 15 - TABLE 2: RELATED BANK LOANS/CREDITS Loan/Credit No. Title Year of Status Purpose Approval Ln. 2226-CHA/ To assist CIB in meeting the need for foreign exchange 1983 Completed Cr. 1313-CHA for industrial financing, improving investment efficiency, First Industrial Credit and organizing and improving CIB's capacity for project Project ($71.5 million) design, selection, appraisal and technology transfer. Ln 2434-CHA/ To continue the institutional building efforts of the first 1984 Completed Cr. 1491 -CHA project, including expanding branches, assist in appraisal Second Industrial Credit of larger projects and meet CIB's resource requirements. Project ($183.2 million) Ln 2658-CHA/ To assist CIB in financing productive facilities and 1986 Completed Cr 1663-CHA resources in China to contribute to the country's eco- Third Industrial Credit nomic and social development; to provide CIB with funds Project ($103.6 million) needed to develop its operations and carry out its Charter and Statement of Policy and Strategy. Ln 2783-CHA/ To assist the govermnent in promoting and implementing 1987 Completed Cr 1763-CHA technology upgrading and modernization in industry, to Fourth Industrial Credit build up sound institutions and procedures for project Project ($300 million) appraisal and investment financing and to improve inter- mediation practices; specifically, to continue institutional assistance to CIB and provide a general line of credit for industry. Ln 3075-CHA Continuation of activities under the Fourth Industrial 1989 Completed Fifth Industrial Credit Credit Project Project ($300 million)  - 16 - TABLE 3: PROJECT TIMETABLE (for Industrial Diversification Component) Steps in Project Cycle Date Planned Date Actual/Latest Estimates Identification May 1986 May 1986 Preparation July 1986 July 1986 Appraisal October 1986 October 1986 Negotiations March 1987 March 1987 Board Presentation April 1987 May 12, 1987 Signing June 1987 September 14, 1987 Effectiveness August 1987 January 19, 1988 Completion of Component December 31, 1993 June 30, 1994 Loan Closing June 30, 1994 June 30, 1996 TABLE 4: LOAN/CREDIT DISBURSEMENT: CUMULATIVE ESTIMATE AND ACTUAL ($ million) (For the Loan only. The SDR 410,000 is together with the agriculture and education components) Bank Fiscal Year and Semester Estimated Cumulative Actual Cumulative Actual % of Estimated 1988 December31, 1987 1.40 0.00 0 June 30, 1988 1.20 0.00 0 1989 December 31, 1988 3.60 0.00 0 June 30, 1989 5.80 5.31 91 1990 December31, 1989 8.80 9.31 106 June 30, 1990 12.20 12.77 105 1991 December31, 1990 15.20 13.22 87 June 30, 1991 18.20 14.00 77 1992 December 31, 1991 20.00 16.35 82 June 30, 1992 17.54 n.a. 1993 December31, 1992 18.47 n.a. June 30, 1993 18.78 n.a. 1994 December 31, 1993 19.86 n.a. June 30, 1994 19.87 n.a. 1995 December 31, 1994 20.00 n.a. Date of Final Disbursement: October 26, 1994  - 17 - TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION As a line of credit, the main indicator of project implementation was the timing of subloan commitment and disbursement. The line of credit was originally expected to be fully committed by June 30, 1990 and disbursed by June 30, 1992, but implementation delays postponed full commitment to December 1993 and completion of disbursement to October 1994. Completion of the project's agroprocessing studies was essentially as planned. TABLE 6: KEY INDICATORS FOR PROJECT OPERATIONS The key indicators for project operations provided in the SAR were in terms of project loan operations and financial performance of GITC, level of provisions for bad debts, and debt/equity ratios. The comparison of project and actual results is indicated in Annex D.  - 18- TABLE 7: STUDIES INCLUDED IN PROJECT Study Purpose as defined at Status Impact of Study appraisal/refined Agroprocessing: All subsector and analytical studies were intended to be used by Gansu authorities to apply economic appraisal methodology for policy formulation and for planning industrial development and diversification Sugar beet Completed Expand beet planting, increase 12/89 production of sugar and its by- products. Cooking vegetable oil - Completed Increase cooking oil, develop 12/89 food industry used gelatin. Wheat straw pulp and Completed Strengthen raw material con- paper 12/89 struction base, build several paper and pulp plants, integrate pulp production but divert paper manufacturing to avoid the pollution. Fruit and vegetables Completed Expand the vegetable and fruit bottling and canning 02/90 canning and bottling, develop fruit and vegetable drinks and dewater vegetable processing. Soybean derivatives Completed Expand soybean planting, 02/90 increase the variety of bean derivatives. Analytical: Included in agroprocessing studies as agreed with the Bank in 1989 Shadow price analysis Economics of scale Capacity utilization Employment creation and labor use Efficiency of opera- tions Administrated prices Subcontracting Trade and payments  - 19- TABLE 8: PROJECT COSTS AND FINANCING (Loan Only) During appraisal, the line of credit under GITC was expected to cover the greater of 50 percent of agreed subproject cost or 100 percent of foreign exchange costs. Total subproject costs were not estimated as most subprojects were not yet identified at time of appraisal. Amount Percent of ($'000) Total Investments Total investments 59,700 100.0 foreign currency 2,080 3.5 local currency 57,620 96.5 GITC (World Bank subloans) 20,000 33.5 Commercial bank loans: 20,000 33.5 GITC (non-World Bank subloans) (0) (0.0) (Other bank loans) (20,000) (33.5) Local government funds 11,040 18.5 Enterprise funds 8,660 14.5  - 20 - TABLE 9: ECONOMIC COSTS AND BENEFITS 1. No financial rate of return (FRR) or economic rate of return (ERR) for the industrial component was calculated at appraisal because this was an IDF operation. However, ERRs were calculated by GPC for the subloans at or above $300,000, and FRRs were calculated by GITC for individual subprojects. Both ERRs and FRRs were required to be above 12 percent, according to the Project Agreement. Based on a sample of four subprojects, the ex-post FRRs and ERRs were lower than originally estimated due mainly to increasing input prices and decreasing output prices. The input raw material prices were substantially higher than subproject appraisal estimates while the product sales prices were lower than anticipated. 2. Subprojects were selected for calculation of ex-post ERRs and FRRs based on the following criteria: (a) enterprises in different sectors; (b) two each from light industries and rural industries; (c) two projects have started repayments and two have not, and (d) one was successful and three less so. The four subprojects accounted for over 50 percent of the loan amount and at least 33 percent by number of subprojects that required ERR calculations. Beneficiary Enterprises FRRs (%) ERRs (%) Ex-ante Ex-post Ex-ante Ex-post Yongdeng Carbon Factory 27.0 12.8 46.8 18.2 Wuwei Textile Mill 27.0 9.1 37.1 14.0 Gansu Antimony Works 19.6 7.6 25.0 13.3 Lanzhou Gelatin Plant 20.9 5.2 24.8 7.9  - 21 - TABLE 10: STATUS OF LEGAL COVENANTS Original Agree- Covenant Present Fulfillment Revised ment Section Type Status Date Date Description of Covenant Comments Project 3.01 (b) I C June30 Submission of audit reports 3.02 (a) 2 C annually Ratio of GITC's debt to equity ratio would not be greater that 1.5 to I Schedule: 3 C 6130/90 6/30/92 Applications of subproject to Extended on February 29, 1991 A, 3(c) the Bank on or before June 30, 1990 5 (a) 5 C 3131/88 Submission of Policy Statement 5 (b) 5 C 6/30/88 Adoption of Policy Statement 6 (i) & 2 CD 12/31/87 GITC to review lending portfo- Bank reviewed portfolio study (ii) lio. Write off bad debts resched- with Ganu over many months uling, increase penalty interest and different actions initiated rate on loan collection and bad debt provision 8 13 C 9130/87 Submission and adoption by GEMI of curriculum on project management and business administration 9 (a) 13 CD 12/31/88 2/28/89 Completed three agroprocessing 1. Sugar beet subsector studies 2. Cooking vegetable oil processing 3. Wheat straw pulp & paper 9(b) 13 CD 12/31/89 2/28/90 Completed two more 1. Soybeans derivatives study agroprocessing substudies and based on results under 9 (a) 2. fruit and vegetables bottling and canning study Covenant Class: I = accounts/audits; 2 = financial performance/revenue generation from beneficiaries; 3 = flow and utilization of project funds 5 = management aspects of the project or executing agency; 13 = other -- studies and training Status: C = covenant complied with CD = covenant complied with delay  - 22 - TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS Three subprojects were not in compliance with Bank Operation Manual Statements 4.01- 4.02, on environmental analysis and environmental action plans. The participating enterprises did not comply with, and the local government authorities did not enforce, the relevant Chinese environmental regulations. TABLE 12: BANK RESOURCES: STAFF INPUTS (Staff-weeks) La FY 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Total Preparation 15.8 15.8 Preappraisal 21.9 21.9 Appraisal 42.2/b 42.2 Negotiations 0.1 0.1 Supervision 7.5 26.5 6.4 7.5 1.6 3.4 1.0 0.0 0.4 1.0 55.3 Completion 7.0/c 7.0 Total 142.3 La From project preparation to completion, the three components were totally independent. There were no combined missions. /b Includes training of project staff by EDI and EA2 to prepare for project implementation. La As of November 1996.  - 23 - TABLE 13: BANK RESOURCES: MISSIONS Performance rating Specialized Imple- Devel- Stage of project cycle Month! Number of Days staff skills mentation opment Type of year persons in field represented Ln status Lb objectives problems Identification Project preparation was preceded by a detailed review of industrial development issues in Gansu as part of the Gansu provincial study in 1985/86 Preparation 05/86 2 14 EC, EN Preappraisal 07/86 6 14 EC, EN, FA, 00, RA Appraisal 11/86 6 20 EC, 00, FA Negotiation 04/87 3 EC, 00, FA Postappraisal-Training 05/87 3 18 00, FA 2 2 Board approval 05/87 Signing 09/87 Effective 01/88 Supervision 1 10/88 3 15 EN, RA, 00 2 2 TA activities slow Supervision 2 11/89 1 7 RA 2 2 TA and subloan commitments slow Supervision 3 02/91 1 5 RA 2 2 TA activities slow Supervision 4 05/93 3 7 EC, 00 'L/ 2 GITC financially bankrupt, subproject procurement problems Completion 08/96 2 11 00 2 3 Same as last supervision /a EC: Economist; EN: Engineer; FA: Financial Analyst; 00: Operation Officer; RA: Research Analyst; /b 1: Highly satisfactory; 2: Satisfactory. /c Ratings were more positive since the subloans had not yet entered into repayment, when poor performance became evident.   - 25 - ANNEX A ANNEX A: BORROWER'S CONTRIBUTION TO THE ICR PREFACE The report is about the completion of Gansu industrial diversification Component of Gansu development project. The project was approved 14 September 1987, getting loan USD 20.0 million equivalent, credit SDR 410,000 (USD 500,000 equivalent) and put into effect on 1 January 1988. According to the Credit Agreement, the loan should be finished on 30 June 1992. Approved by the World Bank two times, the loan was actually ended on 30 June 1994, and was drawn off by the time after the last payment day was made on 26 October 1994. APPRAISAL SUMMARY I. Project Objective Medium and long-term credit would be provided to light and rural industrial enterprises for technological transformation and capital construction, promoting higher output and labor productivity, especially rural areas. The project would also support training and technical assistance for implementing agencies and enterprises on enterprise management, project appraisal and implementation, and economic analysis and planning. A series of studies would be undertaken on economic topics and selected agroprocessing industries. The project would generate employment, expand light and rural industry investment and output, upgrade appraisal procedures to select efficient investments, introduce subsector studies as a basis for strategy formulation, developing implementing agencies, and train individuals in management and technical skills. II. Implementation Experience and Achievement Of the 17 subprojects financed under the loan, 16 subprojects were completed successfully except for 1 subproject, Longdong Vacuum Aluminum Paper Factory (A-7F). That 20.0 million USD was put into the economic construction in Gansu made up for the fund insufficiency. Supported by the loan, enterprises transformed their estate structure were set up, and those with evident financial and economic effectiveness became the main tax revenue enterprises in the local. Meanwhile, a lot of people with managing and financial technology were trained in the local and many of the local people, especially the rural areas, have the chance to become citizen due to the generation  - 26 - ANNEX A employment. The utilization of the natural resources in local strengthened the development in agricultural product procedure. Gansu Investment and Trust Company (GITC) will continue to manage 17 subprojects, try its best to collect the capital and interest due, expand new territory in economic development. New product will be instead of old one on the basis of the improving the management and the technology, which will have the loan achieved the best economic results in Gansu Province. III. Summary of Examination Result, Management in Future and Lessons Learned The most successful experience in project is the subproject selection with two distinguishing feature. 1) Most projects reflect that their setup has given sufficient consideration to utilizing Gansu's resources in minerals, agriculture products and by-products. 2) The projects adopt many domestic and foreign advanced technique and equipment. Compared with the same domestic industry, these projects boast a starting level, which lays an important foundation for their future development. The most important lessons learned is that most of the subproject lost their chances to make profit due to the planning economic policy in China, poor management, domestic matching funds and the postponement of the project construction. The plan of industry project management in future should hold identical views with the development direction in GITC's management. GITC should carry out the various guidelines, rules on balance proportion, policies and financial regulations issued by the government for nonbank financial organization. The company should readjust the structure of its assets, keep its finance healthy, expand its range of business, develop new project and raise the efficient utilization rate of its assets. PART ONE APPRAISAL ON PROJECT COMPLETION I. Background Despite a substantial effort to develop industry in Gansu during the past 35 years, the Province remains overwhelmingly rural, with agriculture the main source of livelihood for the population. In the past, the industry strategy for the province gave near-exclusive emphasis to a buildup of heavy industry using Gansu's considerable natural resources in petroleum and metal ores (copper, nickel, etc.), coal and hydropower. Further development of heavy industry based on natural resources will no doubt continue to take the lion's share of investment capital in the province. But Gansu's planners have also begun to turn their attention to another major resource-the generally underemployed rural labor force whose earnings opportunities are currently restricted to low productivity agriculture work. The Bank's Gansu Provincial Study also lends  - 27- ANNEX A support to this line of thinking. The study points out that continued near-exclusive emphasis on development of mineral-based heavy industry would do little to generate nonagriculture employment and, if accompanied by continued restrictions on labor mobility, would almost certainly result in a significant increase in the agriculture labor force by the year 2000. This would put still greater pressure on the Province's fragile natural resources base since even with major investments in irrigation, the population depending upon rainfed agriculture would remain above the carrying capacity of the land. Yields and output per worker in rainfed areas would probably stagnate or grow very slowly, and the Government would have to continue its grain, water and fuel relief programs. The Study concludes that a concerted effort to develop labor-intensive industries and services, relying on relatively low economic costs of its poverty problem. Such an approach would involve support and stimulus for rural and light industries. These generally require lower overall investment, are relatively more labor-intensive and could distribute the benefits of growth more broadly than an exclusive emphasis on heavy industry. These strategic considerations underlie the industrial diversification scheme that forms the basis for the proposed project. In fact, there has been a significant shift in favor of light and rural industries in recent years, as markets have been stimulated by higher urban as well as rural incomes. II. Project Objective Support is proposed for Gansu Province's efforts to stimulate the diversification, especially in rural areas, with the following components: 1. A fund of US$20 million equivalent for medium- and long-term subloans to support investments in light and rural industry enterprises. 2. SDR 410,000 (US$500,000 equivalent) to finance related training and technical assistance. 3. Several economic policies and charges. A. Rates: In 1993 China gave up the RMB fixed rate loan system and adopted floating rate system. B. Taxes: Our domestic tax system was single tax system in 1987, without any central or local distinctions. Originally a favorable rate policy was made for the industry projects funded by the World Bank's loans, which is called "repayment before tax" policy, i.e., paying sales after the projects put into operation, and exempt from income tax within the  -28 - ANNEX A period of repayment. Now all the projects funded by the World Bank's loan are subject to "local tax" system. C. Price of Commodities: Since China practiced parallel planned economy system and market economy system, the prices of building materials have been adjusted, which also has had certain impacts on the World Bank's projects. In this respect, however, Gansu province adopted a partial favoring policy for the World Bank's projects, i.e., supply building materials within the plan at prices cheaper than the market prices. Now the prices are fundamentally adjusted according to the market. D. Foreign Trade: The equipment imported for the industry projects funded by the World Bank's loans are duty free, the projects' export products are favored with refund of duty. By now, export duty has come down form 17 percent to 9 percent and all of the industry projects have no license to export their product, their foreign trade were done by domestic agent. III. Project Content 1. Credit for Investments A. Current provincial procedures will be used to identify prospective subprojects in agroprocessing, pharmaceuticals, metallurgy, electronics, plastics, machinery, building materials and other sectors by Provincial authorities. B. Light industries, for which the Bureau of Light Industry is responsible, would account for not more than US$8 million for at least four subprojects. Rural industries, within the responsibility of the Bureau of Rural Industry would be supported by subloans totaling at least US$12 million to at least 18 subprojects. C. The loan would cover the greater of 50% of agreed subproject cost or 100% of foreign exchange costs. For subprojects not utilizing foreign exchange subloans, the loan would cover an average of 50% of the agreed costs of these subprojects as a group, excluding the cost of land. Subproject sponsors would provide adequate equity to conform to GITC's customary requirement that subborrowers finance at least 10% of the cost of investments supported by credit. D. The project would expand the capacity for project preparation and evaluation in GPC through the application of modem economic criteria incorporating discounted cash flow methodology. All subproject proposals for which subloans of US$300,000 equivalent or more are requested would be subjected to economic analysis to ensure that they would have an economic rate of return exceeding 12%. Economic analysis would be  -29- ANNEX A performed by GPC, which would give GPC the capacity to apply such analysis to all investment projects, financed by GITC as well as other institutions in the Province. 2. Training and Technical Assistance Objective Training and technical assistance will be provided to promote project objectives in the areas of enterprise management, project appraisal, implementation and economic planning, help the managers in achieving new information and modem financial management. Groups TTA target groups consist of enterprise mangers and cadres from agencies responsible for project implementation, including GITC, Gansu Economic Management Institute and GPIO. Training and Scope Gansu province organized an evaluation group. The Planning Commission and the Economic Commission were responsible for the economic analysis for the group. Study tours with specific objective or themes were organized for project implementation staff. Office facilities were equipped for industrial diversification project organization. Studies and Themes Studies included in project are following agroprocessing: sugar beet, cooking vegetable oil, wheat straw pulp and paper, fruit and vegetables bottling and canning, soy bean derivatives, etc. Analytical included a series of studies of shadow prices, economics of scale, capacity utilization, employment creation and labor use, efficiency of production, administered prices, subcontracting and provincial balance of trade and payments. IV. Objective Achievement 1. Organization and Management The World Bank's Gansu industry loan totals $170,000,000. The province government attached extreme importance to the cooperation and specially set up Gansu Province Execution Committee for the World Bank Loan projects. The governor of Gansu province was appointed as the director of the committee, responsible for directing the process of the projects. GITC is the intermediate financial institution and is responsible for the implementation of the project. The World Bank Loan Office is in charge of the management and examination of the project.  -30- ANNEX A 2. Objective Achievement. A. Choice: 17 industrial projects were chosen by the Planning Committee from 36 prepared projects. B. Appraisal: Gansu province organized a branch projects evaluation group. The Planning Commission acted as go-between and was responsible for the economic analysis for the financial analysis; the Bureau of Towns and Villages and the Department of Light Industry coordinated in the activities of the group. The investment company completed the evaluation report on the first sexen projects, and the last ten projects were done by the Planning Committee and GITC together. All the projects evaluation personnel have been in the economic and financial analysis training course. C. The Projects' Time Schedule: From October 1986 to 1987-the preparatory and evaluation stage. From March 1987 to May 1987-the negotiation stage. From September 1987 to June 1992-the execution stage. June 1992-the post evaluation stage. June 30, 1992-deadline for loan draft. The execution stage was two years later than the predetermined plan, and the investment company and the World Bank Loan Office in Gansu applied two times to the World Bank to postpone the date of draft. In the revised loan agreement, the deadline for draft is June 30, 1994. D. Payment: The first payment for the loan was applied in 1989, and the last one for the loan was approved on 26 October 1994. The payment amount was 100% of the loan in the agreement. E. Design, Invitation for Bid and Purchase: Under the supervision of the World Bank Office and the Investment Company, those leadership and personnel who had been trained for invitation for bid and purchase for the World Bank's loan did the examination work for most key branch projects' design and purchase, Gansu Province Project Equipment Bureau, Gansu Province Foreign Trade Export and Import Company and China Technical Export and Import Corporation were chosen as the agencies for industrial projects. Most of the industrial projects have attained high engineering quality with reasonable price. As for equipment purchase, under the guidance of "Shopping Around," they have also purchased high quality but reasonable priced equipment. Only Wuwei Fengle Flax, Wuwei Huangyang Flax, Tongwei Cigarette Reel Paper and the Longdong Vacuum Aluminum Factory did their equipment purchase themselves, because the new technology and the equipment they chose were produced in single factory in the domestic. But there were something wrong  -31- ANNEX A with the equipment purchase in Tongwei Cigarette Reel Paper and the Longdong Vacuum Paper Factory. F. Investment: The World Bank Loan Office and GITC always follow the World Bank's guiding rules in using the loans, and spent the most of the funds in purchasing the key equipment for the branch projects, and only part of the funds in the main civil engineering construction. The domestic matching funds are mainly used in the projects' prior period construction and part of the supplementary engineering equipment in mid-later period. All the loan projects put together, the ratio between the World Bank's loans and the domestic matching funds is 1:3. With different projects, the channel for raising domestic matching funds are different. The main sources are: People's Bank of China, Industry and Commerce Bank, Agriculture Bank, Construction Bank, Bank of China, Liangxi Investment Company, the Finance Bureau of Gansu Province, and self-raising. G. Result The seventeen branch projects that acquired loans from the World Bank, with the exception of the Longdong Vacuum Aluminum Factory project (A-F), were all completed according to the construction contents of the evaluation reports for the branch projects. The most construction projects passed the completion checking by the department concerned, and were accepted. What is worth of mentioning is that the most engineering work of Yongdeng Carbon Plant, Wuwei Textile Mill, Minqin Sugar Plant, and Xifeng Pigment Plant projects is ranked at provincial-level high quality. The equipment purchased by Wuwei Textile Mill, Lanzhou Rubber Factory and Minqin sugar Plant reached the advanced level of same industry in the country. The project that has problem in construction is Xifeng Longdong Vacuum Aluminum Factory. Because of the failure in purchasing vacuum electroplating aluminum foil production equipment, the project host unit changed the construction contents. The World Bank urged to rebuild this project within the stipulated period, or GITC should redeem the loan in lump sum. The World Bank Loan Office and GITC did a big amount of work to discuss with Qingyang District and Xifeng City, put forward opinions and write up memorandum. But this problem is still not solved, because Qingyang District and Xifeng City are seriously short of funds. H. Beneficial Results: In the seventeen branch projects, some have achieved financial economic results, some will do. These projects mostly have products that enjoy markets demands. The most successful project is Yongdeng Carbon Plant. Calculated according to comparable price, with the price changing factor of the raw material considered, the various economic  -32 - ANNEX A indices of Yongdeng Carbon Plant have already met the requirements of the evaluation and design. In the past six years, the plant's production scale have already doubled, and it also repaid GITC all of the loan principle. The World Bank branch projects that have already gone into commercial production have achieved tax and profit 1025 thousand RMB yuan in 1995. I. Repayment: According to the Loan Agreement, the World Bank's $20,000,000 loan would begin their repayment from the year of 1989. 3. Training and Technical Assistance As training and technical assistance is one of the important part in industrial projects, Gansu province paid great attention to using the $500,000 SDR technical assistance. It was used for the following items for the province: A. Equipment Purchase: Subloans under Credit Line Component was used for office equipment and vehicles which was greatly improved the efficiency of the project implementation. B. Training and Study Tour: Training: Having completed training in the plan, we promised to have more training in different ways with the spare fund. Training made by Gansu Economic Management Institute More study courses were planned after six 60-day GEMI courses in project cycle management were finished. Rural and light industry enterprise managers and supervision were trained to improve and expand in modem project appraisal methodology. About 1,000 people attended the training course, 400 people among them were from industry projects, the rest came from project implementation institution in the province. Short and Long-term Training Staff in GITC and the World Bank Loan Office not only took part in the courses held by GEMI, but also took part in courses in the need of the practical works at the same time. All the courses played an important role in the provincial industry projects and better improved the management of the staff. It also gave an opportunity to GEMI to improve itself.  -33 - ANNEX A According to the statistics, 90 percent of trained people had led an important part in their posts, and 15 percent were raised by the managers. Study Tour The training courses raised the personnel's theoretic and practical operating levels, and observation and investigation in the same industry. The study and investigation abroad widened these people's vision and enabled them to learn matured experience. All the people have greatly benefited from having their trainees' quality raised, which has in turn played an important role in working with the World Bank's loans. C. Management Information System (MIS) MIS was began by the World Bank Loan Office in 1989, and was completed in 1993. MIS made the finance, payment, contract, purchase and supervision in the industry project more scientific systematic and standardization. D. Subproject Study E. Consultant Specialist: With the advice given by the World Bank, consultant specialists were invited from the World Bank, from the Economic Development Institute, Lanzhou University and Gansu Provincial Computer Center. Those specialist offered useful suggestions and guidance for training and execution. They also made contributions to offering information and evaluation, actively helping complete the projects. With their help, we improved us in project investigation, project appraised, contract management, investigation for bidding on construction, loan draft, equipment, procurement, finance management, and project supervisory and information systematic. The World Bank and the Finance Bureau of China were satisfied with us in the way of jointly organizing with Shanghai Finance Institute. V. Implementation Notes and the Main Reasons Affecting the Projects 1. The execution stage was two years later than the predetermined plan. The main reasons for the postponement are: A. The investment company is an intermediate onlent financial institution, which does not have independent authority to select and establish projects and becomes the possessor of credit and debt only, thus leaving the projects selection and evaluation disjointed and an indistinct line drawn between responsibility and right. This affected the progress. B. Lack of strict and scientific project base management system. There had been much change to the listed branch project loans. Some projects that were listed in the  -34- ANNEX A World Bank's plan were not mature, and some were simply not listed. At the time when the projects had to be changed, time was already wasted. C. Some projects, which were already approved by the World Bank, were not ready to be construction, for lack of domestic matching funds. This affected loan draft and construction. D. The loan draft for the branch projects should have been done by the end of 1990, but was practically carried out by the end of 1992. Because this was the first time for Gansu to execute the World Bank's projects, and as a result of the change in the branch projects, the loan draft was delayed for two years. E. In the lastly approved projects, there were some large-scale ones that would take big investment and long time to build, and their loan draft procedures were complicated. 2. There is a general sizable gap between the actual projected at evaluation, which are reflected in: A. The actual sales are less than projected, while the costs are higher than those projected. B. The projects' testing production periods are too long to keep the production costs generally low. C. The time needed to reach the normal designed capacity is longer than projected in evaluation report. D. The financial return rates of the most projects have not met the requirements set out in the projects' evaluation reports. E. The loan repayment period is longer than what is projected at evaluation. The Reasons for the Differences are: A. Some projects, such as Lanzhou Gelatin Plant and Tongwei Cigarette Paper Factor, had to postpone the construction, for not enough domestic matching funds secured. This greatly affected the beneficial results of the projects. B. Some projects were completed as planned, but the raw material and the market situations already had quite a big change, and this affects the beneficial result. Wuwei Textile Mill, for example, cannot run at full capacity, because of the supply of raw material is much less optimistic than projected. The supply cannot meet the demand of production, even the price of the raw material has been doubled. With the pigment plant, its products still have certain problems in sale.  - 35 - ANNEX A C. Since 1987, China's economic system has had a big change, and the prices of many products also have had big changes. This leads to the big difference between the practical and the evaluated productive effectiveness. D. The evaluation reports generally are over optimistic about raw materials and the sale market, and most projects' beneficial results and repayment period are set at a number too far away from being practical. E. Questionable management led to stunted effectiveness. For example, the problem in procurement at Longdong Aluminum Foil Factory affected their construction, and Jingtai Calcium Carbide Plant, the accident of the key equipment was burned by a fired caused a direct economic loss of almost RMB $3,000,000. F. In their test production periods, most projects were subjected to the change in the market. They slowly adjusted themselves to the influence of market competition. 3. The Main Reason for Poor Repayment in Subproject: As of today, only Yongdeng Carbon Factory was fully repaid in 1995. In the 17 subprojects financed under the loan, the main reason for the poor repaid is as following: A. During the construction stage, some enterprises were failure to obtain sufficient counterpart fund as required and agreed in the subproject appraisal reports. Some enterprises were loaded with debts because most of their fund were borrowed from banks. B. During the construction stage, some enterprises diverted their working capital to financial fees due to no sufficient fund. C. After project completion, some enterprise had to operate simply due to insufficient working capital. D. Although subprojects were strengthened that the World Bank had the priority in loan repayment, the collection is still low because GITC has no supervisory measures as the Commerce Banks do. E. Some subprojects were badly deficient, raw material either not available in sufficient quantity or too expensive to be affordable, product not marketable and product sales prices much lower than estimates. F. With insufficient working capital due to traingular debts, fund for repayments are used for working capital purposes and new investment. Measures for Collection: It is too difficult for GITC to collect industry project loan. In the past several years, GITC took the same hits on industry loans as on other overall portfolio of GITC.  -36- ANNEX A Loan collection were done by taking legal procedure, both the industry loans and GITC's overall portfolio. Staff are asked to collect loans at the same time. There was credit risk at the beginning of the project for GITC and the finance bureau of Gansu province. It will be helpful for the economic development in Gansu province and GITC if the loan can turn over three or four times in twenty years. GITC will catch the chance in the rest ten years, the industry loans overdue will be recovered actively to achieve the original target in the business plan. VI. Project Continuation Looking into future, we believe most projects have broad prospects, but they still have the following problems to be solved: Gelatin project: It has the tendency of not being able to meet the demand of its market, although the evaporation and drying equipment it imported ranks the most advanced in China. If the working capital is sufficient, it can expect beneficial before long. Antimony project: After the two major problems-transportatioin of the mineral and insufficient electricity supply-being solved, production of scale will take shape. The product of this project enjoys an excellent market both in China and abroad. Textile project: This project has already produced various high-quality linen yarn, but still cannot meet the demand of the market. It has an excellent prospect. However, the raw material that Gansu province can supply to the plant is only less than 10% of the amount designed, it can only depend on the high-priced material from other provinces, or maintain production by processing supplied material. Calcium Carbide project: This project can produce high-quality calcium carbide, which has a good market. The production was restored in 1995 after a transforner substation had been built. Paper-making project: The problem that merits attention most in this project is guaranteeing the quality of the product. Pigment project: This project can produce the product that will be internationally certified. It has an advanced production line, and its construction is of good quality. What is needs is multichannels through which to make a breakthrough in the market. Fluorite project: It has a good market, but also has the problem of too much accounts receivable. In the following five years, it can run at design capacity. Harvester project: The enterprise has actual strength and high technique. The enterprise has already produced new agricultural machines in the need of the market both domestic and abroad. The enterprise will make a profit of 20 thousand RMB yuan in  -37 - ANNEX A 1996 and the loan under the World Bank will be repaid during the year from 1997 to 1998. Strontium Salt project: The project is lack in technique and the pollution is also serious. GITC suggests that the enterprise must be stopped producing, and be taken back. Packaging Material project: The good-quality product is fairly competitive within the five provinces in the northwest and has a good market. EVALUATION OF THE WORLD BANK The World Bank took the reform of the management and financial system of the Investment Company seriously, which has enriched the Investment Company's operation with the thinking and new pattern, and made the company's management develop in a more standardized and more scientific direction. The World Bank also has offered guidance and joined the work in reducing the company's accounts receivable, remaining its healthy finance, formulating its strategic targets, financial and business plans. In training the personnel, the World Bank offered the utmost concern and support, and in the meanwhile gave good advice on the invitation of the consultants. The World Bank also attaches importance to industry's coordinated development in Gansu province. Instead of simply granting loans, the Bank offers theoretic guidance and strengthens the research work, which is where it is superior to the other foreign investments. In addition, the World Bank takes environment protection and employment problems seriously. The rigorous and serious working attitude and style of the World Bank's leadership and personnel, incorporated with their high efficiency in work and high-level work quality, has positive impact on the Gansu part. EVALUATION OF THE BORROWER 1. The People's Republic of China. The loan agreement is to be signed by Ministry of finance and the World Bank. Ministry of Finance, Gansu Finance Bureau and Gansu Investment and Trust Company are to sign the loan onlent agreement, with GITC as the intermediate onlent institution. The project management branch executing units are Gansu Planning Commission, Gansu Finance Bureau and the World Bank Loan Office. 2. As the intermediate onlent institution, Gansu Investment and Trust Company will remain the only nonbank financial institute in Gansu province. By now, the company's total assets reaches $9.1 hundred million yuan, tax and profits $1.2 hundred million yuan.  -38- ANNEXA A. Business operation in recent 3 years: Financial position of GITC remains weak, GITC has carried out a short-term business plan for the next three years in view of this situation. Firstly, the direction of its operation is to support the development of Gansu provincial economic construction. The company will work hard to enliven its fund inventory. Secondly, readjust the structure of its assets, raise the efficient utilization rate of its assets. Thirdly, work hard to widen its business scope so as to meet the need of the market economy. B. GITC always puts its emphasis on improving its portfolio quality, reducing its overdue loans and safety financial management. The main reason for the weak financial position of GITC is: no scientific appraisal on projects; due to insufficient working capital, enterprises are not repaying even they are financial capable of repayment; triangular debts is the most important reason for overdue loans; managerial capability and lack of leadership make the enterprises in arrears. Overdue loan collection and improvement of its portfolio quality: Firstly, a collection plan has been worked out, 3000-3500 hundred yuan will be recovered per year from 1994 to 1996. Secondly, measures for settlement has been drawn up, including responsibility for guarantees, assess staff with their collect amount, debts cleared up by the law and supervision with the help of the local financial institution. ACHIEVEMENT APPRAISAL Of the 17 subprojects financed under the loan, judged with its management, the first-rate subprojects are Yongdeng Carbon Factory, Wuwei Textile Mill, Minqin Sugar Factory, Jiaojiazhuang Fluorite Concentrating, Xifeng Natural Pigment Factory, Zhangye Reaping Machine. The second-rate are Gansu Antimony Works, Jintai Carbide, Tongwei Cigarette Reel Flax. The third-rate are Wuwei Huangyang Flax, Wuwei Fengle Flax, Jiayuguan Strontium Salts. The fourth-rate is Longdong Vacuum Aluminum Paper Factory. By now, problems is serious in the 17 industry subprojects, but they still are part of developing district in Gansu province. These subprojects have a historic effect on agriculture development, industrial structure adjustment, resource utilization, worker employment, tax income and private personnel income, etc. BUSINESS PLAN IN THE FUTURE To make practice collection plan, GITC is going to renew contracts with enterprise, some of contracts have been done by now. Loan collected will invest on safety and efficient projects for the second time according to the examination and approval procedure of the World Bank.  - 39 - ANNEX A MAIN EXPERIENCE AND LESSONS LEARNED Main Experience The industry projects setup is successful, which has the two following characteristics: 1) Most projects reflect that their setup has given sufficient consideration to utilizing Gansu's resources in minerals, agriculture products and by-products. 2) The projects adopt many domestic and foreign advanced technique and equipment. Compared with the same domestic industry, these projects boast a higher starting level, which lays an important foundation for their future development. It is undoubtedly correct to have determined that the key investment should be in developing light industry and towns and villages enterprise. The textile, calcium carbide, dried bean curd, rubber, carbon, and fluorite enterprises have already gained profits, offering an average monthly income of about RMB $300 to 3,404 direct employees. At the same time those industry concerned, such as service industry, transportation, and mining industry have flourished, bringing along the employment of agriculture population and the increase of its income. Evidently, these enterprises have become the important local economic backbones. The World Bank's industry projects management, which comprises a series of procedures, measures, and principles in project investigation, setup, evaluation, contract management, invitation for bidding on construction, loan draft, equipment procurement, and project target management, plays a supervisory and guaranteeing role in organizing building and executing the industry projects. This industry project management methodology has been used for reference or has been applied in our own loan work. In the execution of the loan projects, a team of industry projects management specialist has been fostered, who are mostly in towns and villages enterprises. These people will become the nucleus in developing Gansu's towns and villages enterprises. Lessons Learned GITC has no total autonomy in project selection, project setup, evaluation, loan draft, project approval, project management and examination, which are conducted in separate departments. In the area of finance: The construction of some projects are postponed, because some projects have not secured domestic matching funds and some projects have not sufficiently estimated the unforeseeable expenditures. Attention should be paid to comprehensive investigation. In the past, projects investigations only emphasized the evaluation of economic results and social results, neglecting observing especially high-level management human resource in the area of technique and finance. Therefore, the industry projects more or less had problems in construction, equipment procurement, test production and sale.  - 40 - ANNEXB ANNEX B: ICR MISSION'S AIDE MEMOIRE An ICR mission' visited Gansu from July 29 to August 6, 1996 to initiate preparation of the Implementation Completion Report (ICR) for the industrial component of the Project. The mission visited seven subprojects in Yongdeng, Wuwei, Mingqin, Zhangye, Jiayuguang and Lanzhou. Disbursement of the component started in 1989 and completed in 1994. Project entities had prepared a draft ICR of the component for mission review and discussions. The draft aide memoire was discussed with Gansu authorities2 on August 6 in Lanzhou. The mission was very appreciative of the Gansu authorities in their efforts in preparing all information required in short notice3 and their cooperation. Subproject status, issues and achievements under the Loan * Of the 17 subprojects financed under the loan, 16 subprojects were completed. One subproject, Longdong Vacuum Aluminum Paper Factory, was not completed due to technology and procurement problems. * As of today, only two subprojects were rescheduled: => The Yongdeng Carbon Factory, doubled its production capacity from project design and the subloan was fully repaid in 1995. Loan repayment was re- scheduled once. => The Jiaojiazhuang Fluoride Concentrates Factory was scheduled once and has started principal and interest repayments. It is producing at 83 percent of its installed production capacity. * The remaining 15 subprojects have also entered into repayment stage according to their original repayment schedules, yet, due to delayed starts after Bank approvals and slow implementation, all are unable to repay GITC and are technically in arrears. Seven have repaid small amount of interest and principal due. All 15 subprojects should either be rescheduled according to their current production and operations status or be considered for more radical remedial actions, such as legal pursue of repayments through their guarantors, repossession and sale of assets, closed I Comprised of Helen Chan, Naiqin Lu and Maoqi Zhang. 2 Gansu Finance Bureau, Gansu Planning Commission, Gansu Rural Industries Bureau, Gansu Light Industries Bureau, Gansu Environmental Protection Bureau, Gansu Investment and Trust Corporation (GITC), Gansu Economic and Management Institute (GEMI) and Gansu Project Implementation Office (GPIO). 3 On July 20, 1996, the mission explained to GPIO and GITC the ICR preparation requirements.  -41- ANNEX B production, etc. As a result of delayed in project implementation, 1995 production of the subprojects were much lower than subproject appraisal estimates: => three were producing between 70 and 92 percent of installed production capacity, => six at about one third of installed capacity, => two at less than 20 percent of installed capacity, => two at less than 10 percent of installed capacity, and = two were not producing the intended output and have ventured into other production which are not successful as well (the Tongwei Cigarette Reel Paper and the Longdong Vacuum Aluminum Paper Factory). * Factors leading to slow subproject implementation: => failure to obtain sufficient counterpart fund as required and agreed in the subproject appraisal reports, > immature technology and lack of technical support, and => lack of leadership and managerial capability * Problems encountered after project completion: > insufficient working capital due to triangular debts, raw materials either not available in sufficient quantity or too expensive to be affordable, > poor procurement leading to equipment not performing as expected, = markets changes-product sales prices much lower than appraisal estimates and products not marketable, and =. poor project and enterprise management * Issues encountered: = some subprojects create serious environmental problems, some enterprises are heavily loaded with debts with low equity base, => some enterprises are not repaying even they are financial capable of repayment. Instead, fund for repayments are used for working capital purposes and new capital investment. => local ITCs which were supposed to help GITC to supervise subprojects were all closed in 1993/94 due to financial difficulties and also because they did not meet the criteria under the new PBC regulations for nonbank financial institutions. GITC tried to set up administrative offices in local areas but all were closed as well in 1994 because of the new PBC regulations. GITC is left with no supervisory network. It would be difficult as well as expensive for GITC to supervise these subprojects as they are scattered all over the Gansu province. * Achievements already accomplished by subprojects that would succeed eventually. There would be about 2/3 of all subprojects, including those that were technically in arrears in 1995. They have been slow in implementation, yet have good business prospects, and are expected to be financially capable to repay GITC in the next two years with revised repayment schedules: =* create industrial employment in agricultural areas,  -42- ANNEX B = raise rural income, => utilize indigenous raw materials and create value-added in agricultural products, = lead to proliferation of other supporting industries and services in the vicinity of the subprojects, and => develop managerial and technical skills in rural areas, Lessons learned * Autonomy-GITC should have total autonomy to make investment decisions and not only choosing investment projects from government selected list. * Project appraisal-Appraisal should pay much more attention to financial evaluation of projects and enterprises, with special emphasis on repayment capabilities; market analysis of both raw material supply and final products; managerial capability of enterprises; technical support from reliable technical sources; confirmed counterpart funding; and economic analysis. Appraisal had been very optimistic on all aspects and the subprojects were expected to reach designed capability soon after completion. Repayment terms were too short for the projects to reach break-even points to have repayment capabilities * Subloan agreement-GITC should revise the agreement to include, inter alia, that the borrower not to incur any new debt unless a pre-agreed debt/equity threshold has been met, legal obligations of guarantors be clearly spelled out, regular submissions of progress reports, financial and physical, to be submitted, procurement to be carried according to agreed procedures, etc. 3 Procurement-Enterprises should entrust procurement to procurement agencies; GITC's concurrence of the agencies would be necessary. GITC should supervise procurement more closely. * Sound investment-GITC should not continue to put good money on top of bad investment and/or inefficient enterprises, even though GITC had invested into the enterprises already. * Reporting-Regular reporting from enterprises should be strengthened to form the basis of effective project monitoring and management. * Free from influence of local government authorities-Tax revenue to the local economy should not be the top consideration in investment decisions. This appeared to be the case with many investment projects in Gansu. * Legal and loan repayment awareness-Gansu authorizes should prormote this awareness through active promotional campaigns.  - 43 - ANNEXB Recommendations * After plant visits, the mission recommended GITC to revisit all subprojects and prepare a realistic remedial work programs for all delinquent subprojects based on their 1995 and 1996 production status and market potentials. For those subprojects that have special problems, more radical actions would have to be considered. GITC may need government assistance in some of the more radical actions, particularly to plants with environmental problems and the two projects (Tongwei Cigarette and Longdong Aluminum) that have serious technical and procurement problems that could not be savaged. Thus, the tables on subproject status in the draft ICR are to be revised accordingly and submitted to the Bank by August 31, 1996. * For those subprojects that have serious environmental concerns (including Wuwei Fengle Flax Mill, Wuwei Huangyang Flax Mill, Jiayuguang Strontium Salts Plant, and there could be others), concerned Gansu authorities, such as the Environmental Protection Bureau, Finance Bureau, Planning Commission, Rural Enterprise Bureau, Light Industries Bureau and GITC should work together in determining whether stopping production would be the best solution by undertaking a careful cost and benefit analysis (Annex 2 for details). A detailed environmental assessment should be carried out immediately. Gansu Investment and Trust Corporation (GITC) * Financial position of GITC remains extremely weak. Collection rate had increased from 10 percent in 1994 to 22 percent in 1995. Arrears as percentage of total loans outstanding decreased from 46 percent in 1994 to 39 percent in 1995. Net income after tax as percentage of total assets had increased from virtually zero in 1994 to over 1.5 percent in 1995. Based on financial results in the first half of 1996, GITC is confident that its financial position would further improve in 1996 and the years ahead. * Due to its extremely low collection ratios, its main emphasis in the past few years had been in loan collection and improvements of its portfolio quality-a strategy reflected very clearly in its business plan submitted to the Bank in 1994. The mission had requested that GITC to send the Bank the results (1994 to 1996) of the initiatives indicated in the 1994 business plan and its business plan for the next three years. The mission shared GITC's expectation that it would turn around financially if the action program initiated was carried out effectively. * At the end of 1995, about 67 percent of its arrears were overdue for more than two years. The mission suggested that GITC to undertake a detailed portfolio review in evaluating the recovery possibility of these arrears and to take decisive actions in writing off noncollectible bad loans, such as loans extended to enterprises no longer exist or in operations, on a timely basis. Given the arrears ratio and its aging profile, a 2 percent bad debt provision is clearly insufficient to cover nonrecoverable bad  -44- ANNEX B loans. GITC should sought agreement from relevant authorities to increase its bad debt provision to about 5 percent to cover possible write-off. The most appropriate percentage would depend on the outcome of the portfolio review. * With PBC regulations on nonbank financial institutions and asset/liability ratio management since 1994, GITC has to adjust to operations in view of its failure to achieve certain assets/liabilities ratios, such as collection and arrears ratios. GITC could not extend any long term loans until it has reached the required ratios. Technical assistance component under the Credit * Subsector studies-Five studies-sugar beet, cooking vegetable oil processing, wheat straw pulp & paper, fruit & vegetable bottling & canning, and soybean derivatives-were completed by February 1990. Economic studies4 originally identified as independent studies during Project appraisal were incorporated into the subsector studies with agreements from the Bank in 1989. In general, the subsector studies were well prepared and the Gansu Planning Commission confirmed that these studies were instrumental in some policy and investment decisions during the Eighth Five-Year Plan (1990-95). The mission asked impact assessment studies to be prepared and sent to the Bank by August 31, 1996. * The mission suggested that the studies be revised and new subsector studies be initiated as the Gansu economy had changed substantially since 1987. Gansu agreed to the idea but indicated that it would take time and financial resources. * Training-All project entities, including project entities from the agriculture and education components of the Project, the Health Project, and all subproject beneficiaries, had benefited from different types of training. All training were free to participants. Training included project evaluation, project management, financial management, business accounting and finance, computer applications, project supervision, foreign language and rural enterprises management. Training were conducted by different training institutes in China with a variety of teaching methodologies. Case studies with on-site plant visits were ranked highest by participants. Course post evaluations indicated that these training were very helpful to both project implementation agencies and beneficiary enterprises. The Gansu Economic and Management Institute (GEMI) was the chief organizer and offered most of the training. GEMI identified a few areas that could make training to be truly instrumental: => educational level of participants to be adequate for the training offered; => right choice of participants to particular courses; and z> selection of appropriate training institutes for selected courses and participants. 4 Shadow pricing, economies of scale, capacity utilization, employment creation, efficiency of operations, administered prices, subcontracting, and trade & payments.  -45 - ANNEX B Proposed schedule in completing the ICR 1996 August 31 Gansu sends revised draft to the World Bank with complete statistical tables Sept.30 Bank team finishes draft ICR and submits to divisional management for review Oct. 15 Bank sends complete ICR draft to Gansu for comments and endorsement Nov. 15 Gansu send endorsements to the Bank Dec. 10 ICR covering all three components: Agriculture, Education and Industry, send to Department management for approval Dec. 20 China Department send ICR to the Board of Directors of the Bank  -46 - ANNEXB Annex 1: Agreed Actions Agreed actions Agencies Date . Impact assessment reports of five Economic Research Institute of August 15, subsector studies Gansu Planning Commission 1996 . Statistical tables with data on subproject GTIC August 31, commitments, disbursement, production 1996 and repayments status * Remedial work plan for 16 subprojects Gansu authorities: Planning August 31, from August 1996 with proposed Commission, Finance Bureau, 1996 revised repayment schedules Environmental Protection Bureau, Light Industries Bureau and, Rural Industrial Bureau; and GITC . Ex-poste FRR and ERR for 4 GITC, Gansu Planning September subprojects /a Commission 15, 1996 . Results of the policy initiatives GITC August 31, indicated in the 1994 business plan and 1996 business plan for the next three years /a Four would constitute about 24 percent by number of subprojects. Selection criteria would be (i) two light industrial and two rural enterprises subprojects, (ii) some successful and some unsuccessful subprojects, (iii) two have started repayment and two have not, (iv) two enterprises financially viable and two not viable, and (v) they should be from different subsectors.  -47 - ANNEX B Annex 2: Impressions and Issues of Subprojects Visited A-02-Yongdeng Carbon Factory * Well managed and lots of initiatives. Production in 1995 was already doubled of its designed capacity. * A success story of the Project. All project objectives were basically achieved: =' create industrial employment (390 jobs created) to absorb abundant labor in the township area; = raise rural income. Its workers averaged Y 5,000 per year as compared to the average income of Y 1,000 in the township; => lead to development of support and service industries in nearby areas. The township becomes the wealthiest township in the county; => improve social enviromnent by donations to renovations and construction of local schools, hospital, irrigation and transportation; =' raise knowledge in management and finances in local areas; and => utilize indigenous raw materials. * Basic success criteria are there, such as: => strong management and technical support from its mother company; adequate equity base-60 percent equity from mother company and 40 percent from the township where it locates. Local people helped built the workshop in exchange for equity and employment; -' market guarantee-it has contractual agreements with its mother company to buy its products at market prices if its products meet required specifications; ~- strict production quality control; =' no new loans prior to reaching its designed capacity; and > prepared to venture into other related production so that it would not be totally dependent on one single product in the long and medium term. * However, its awareness of repayment obligations was the same as most other enterprises. It did not repaid GITC even though it was profitable since 1994. GITC recovered its loan only through legal actions. A-03-Wuwei Textile Mill * Supply of quality flax (its basic raw materials) were insufficient in despite of building two new flax mills by the Wuwei government in nearby areas to ensure supply. Flax purchased locally is generally of interior quality than it needs to produce quality linen threads to remain competitive.  - 48 - ANNEXB * Both domestic and international markets have changed after project has started implementation. Its products-linen threads-are not competitive both in quality and prices. * 40 percent of the cost overrun was due to delay in project implementation. It was very short of working capital. It reached 81 percent of designed production capacity in 1995. . Suggestions-It should diversify its products by looking for joint venture opportunities with linen manufacturers (cloth and/or clothing) in other provinces and foreign countries. It could take the form of subcontracting, joint production, joint stock and other forms of joint ventures. It would bring value added to local economy by manufacturing linen products which would have high profit margins. It would also bring technology, marketing information and management assistance into the company. The mission did not think it is advisable to further invest in linen manufacturing. A-08-Wuwei Fengle Flax Mill * Due to shortage of counterpart fund, pollution facilities were not installed. Water has been discharged directly into nearby areas without treatment, thus seriously polluting water supply and creating heavy odor in local areas. There is a school less than a mile away and the odor is very apparent there. The plant received lots of complaints from nearby residents of the odor that it creates. Due to shortage of water, the plant has constant conflicts with local residents. e The plant was very short of working capital and owed farmers (who provide them with flax) Y 600,000 in 1995. It currently employs 30 workers; other than this, there were no other social benefits. On the contrary, it has created serious air and water pollution. * Quality of its flax is not competitive both in quality and prices. Import flax are of better quality for linen production. * Suggestions-The mission strongly recommended that a comparative cost/benefit analysis to be carried out before any further production and before any new investment extended by the local government or by GITC. Cost and benefits estimates should include: =* installment of water treatment facilities, > treatment of wastewater to reduce odor, z alternative investment in other businesses to absorb current workers of the plant, = additional cash to keep the plant in operations (that means it would continue polluting water in the area and affecting health of local people). =' benefits that it brings to the local economy now and in the future with and without additional new cash inflow, and = investment in deep water wells to assure sufficient water supply  -49- ANNEX B A-11-Jiayuguang Strontium Salts Plant * The plant has serious pollution problem. Due to lack of working capital, pollution facilities had not installed, even though they were originally included in the project design. = Wastewater (with waste deposits from hydrochloride acid and ammonium hydrogen carbonate) was not treated and was discharged directly into underground water, eventually they would be seeped into rivers and streams. Emissions of NO2 and SO2 would lead to acid rain which would create serious harm to agricultural products, plantation, fisheries and erosion of the nearby Ming great wall. => Dust and hazardous gas emission from processing of strontium sulfide. Odor is unbearable. It is a serious health hazardous to workers and local residents. = Smoke emission from buring of raw materials. * Original technology did not work. The plant has been trying to refine/change technology; yet due to lack of technical staff and investment capital, it was not able to find a suitable solution. Production so far was only 1/5 of original production design. However, the plant and local government believe there is a market for strontium carbonate, thus would like to expand production capacity to 5,000 MT from its current project design of 1,500 MT. The plant is currently looking for new capital fund. * The market looks promising on the surface as the larger producers in Germany, the United States and Japan, had stopped production because of serious pollution problems and the costs to control them. China has four large producers in Jiangsu, Shandong, Sichuan and Henan, each with 10,000 MT and above. Each has pollution problems. * Suggestions-The mission strongly recommend local government, the plant and GITC to estimate: > cost to treat the water and air damage already created and the hazardous health effects to its workers, => cost of installing proper and effective pollution control facilities, => cost of technology transfer and new capital fund that are needed to bring the plant into a financially healthy plant, ' its comparative advantage in producing strontium carbonate as compared to other plants, = benefits that the plant would bring to the local economy, => cost to improve its technical and managerial capability in capturing a larger market share with the existence of other larger plants, and => cost of alternative business opportunities to absorb local abundant agricultural labor.  - 50- ANNEX B Only after these estimates and a detail costlbenefit analysis could one decide whether the plant should continue production and raise new investment capital. further. On a macro level, the country should review production of this product nationwide because of the seriousness of its pollution problems should the country sees a market opportunity. A-12-Minqin Sugar Factory * Project was completed in 1993 with a designed production capacity of 12,870 tons of sugar. Project cost was $3.1 million. In spite of severe shortage of equity and working capital, two additional projects were implemented simultaneously in 1993 and 1994: alcohol and feedstock utilizing waste from sugar production. Project cost for these two new projects were about $12.6 million (Y 64.4 million at the exchange rate of 5.13), 90 percent were debt-financed. The Construction Bank provided 51 percent of the financing. 3 The enterprise had not been profitable and has serious liquidity problem. In 1995, sugar production was 46 percent of installed capacity. Coupling with depressed sugar prices and shortage of raw material (beet), the factory suffered a net loss of Y 5.5 million in 1995 and a net loss of Y 9 million for the first six months of 1996. As sugar is not expected to improve substantially from the current Y 3,800 per ton in the near future, the plant would remain financially trapped and had no debt repayment capability in the foreseeable future. Nor does the plant has the repayment obligation awareness. * Technically, it is logical to set up a sugar, alcohol and feedstock production as one comprehensive project so that the by-products are fully utilized to avoid waste and water discharges; thus minimizing pollution problems. The plant has 590 workers and 70 percent of them are from rural families. Their monthly income of Y 300 is much higher than local peasants. However, there are two serious basic issues: > There was a 20 to 30 percent self-financing requirement in project finance in the sugar production project that the Bank helped financed. Yet as soon as the project was approved by the Bank, the enterprise went ahead with the alcohol and feedstock projects. Thus seriously undercut the financing scheme of the project which led to insufficient counterpart funding and delayed project implementation. Local authorities admitted that it was a deliberate plan as the comprehensive project of production in alcohol, sugar and feedstock would cost more than Y 64 million ($12.6 million) and that would require central government approval. By separating the project into three smaller projects of about $3 million each, local authorities avoided the necessity of going through the central government. => Financially, it is impossible for a new enterprise with no equity base to repay loans of Y 64.4 million even if all three projects are profitable.  - 51- ANNEX B * Suggestions-Despite current difficulties, there are prospects for the plant to grow into a viable enterprise as the workshops are well constructed and project designs are basically acceptable. Nonetheless, the enterprise should, as soon as possible: = explore the possibility of converting some government loans into equity to reduce its debt financing obligations, > recruit experience process engineers for both sugar and alcohol production; => increase the yield of sugar by applying more advanced beet process technology; > set up contractual relationships with beet producers to get a stable beet supply; and => analyze the influence of smuggling of import sugar to domestic sugar manufacturers. In this respect, Gansu Planning and Economic Bureaus should coordinate and be in charge of the study with all Gansu sugar manufacturers as active participants. B-03-Zhang Ye Reaping Machine (harvester) Plant * When the subproject was prepared in 1991, market share of smaller harvesters diminished in favor of larger harvesters. The plant had inventory buildup of about 3,000 small harvesters. In spite of this, GITC5 approved the project (not sure whether GITC was aware of the situation) and the subproject was launched to double its production capability. - With declining market and prices, the plant suffered heavy losses in 1993. There was a change in plant management in 1994 and a three-year rectification program was launched to diversify its product mix and to focus on marketing strategy. Diversification is possible because its equipment are general equipment and could be adjusted to other production which the market demands. Production and sales in the first half of 1996 already indicated that the plant could be turn around into a profitable operation by the end of 1996. * The new management team was very impressive and the mission shared the view of GITC that the plant would be able to repay the loan with a reasonable rescheduled repayment term. * This subproject has fulfilled all other project objectives and if the plant repays the subloan on time with the reschedule term, then it could be considered to be a successful subproject. 5 The mission understood that this subproject was basically prepared by the Gansu Planning Commission.   - 53 - ANNEX C ANNEX C: LIST OF SUBPROJECTS/SUBLOANS-AMOUNTS DISBURSED Subloan No. Name of Subproject Amount Disbursed ($) A-1 Lanzhou Gelatin Plant 2,710,000.00 A-2 Yongdeng Carbon Factory 1,341,596.13 A-3 Wuwei Textile Mill 3,311,071.91 A-4 Gansu Antimony Works 2,695,337.58 A-5 Jingtai Calcium Carbide Factory 1,601,714.24 A-6 Huixian Bean Products Factory 249,503.76 A-7 Longdong Vacuum Aluminizing Factory 652,466.13 A-8 Wewei Packaging Material Factory 279,368.08 A-9 Wuwei Fengle Flax Mill 239,931.52 A- 10 Tongwei Cigarette Paper Factory 999,731.77 A-11 Jia Yu Pass Strontium Salt Factory 646,921.09 A- 12 Minqin Sugar Factory 3,099,167.46 A-13 Lanzhou Dunhuang Pharmaceutical Plant 850,195.32 B-1 Wuwei Huangyang Flax Mill 239,429.21 B-2 Jiaojiazhang Fluorite Concentrates Factory 298,090.59 B-3 Zhang Yu Reaping Machine Factory 282,061.06 B-4 Xi Feng Natural Pigment Factory 489,639.50  ANNEX D: GITC-COMPARATIVE (ACTUAL AND PROJECTED) FINANCIAL STATEMENTS FOR YEARS ENDING DECEMBER 31, 1987 TO JUNE 1996 (Y million) PROJECTED ACTUALS 1987 1988 1989 1990 1991 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Income Statements Total Income 18.17 25.41 31.39 33.17 33.51 10.55 12.90 7.91 16.43 14.23 11.12 23.30 22.09 41.93 29.76 Total Expenses 5.61 10.27 15.29 18.95 21.11 1.41 5.03 3.49 4.00 4.11 4.70 4.70 16.93 26.60 6.06 Net Income before Inc. Tax 12.56 15.14 16.16 14.22 12.40 9.14 7.87 4.42 12.43 10.12 6.42 18.60 5.16 15.33 23.70 Income Taxes 6.61 8.02 8.30 7.40 6.79 5.64 4.86 2.93 0.03 0.15 9.56 1.22 2.87 1.37 NetIncome 5.95 7.12 7.80 6.82 5.61 3.50 3.01 1.49 12.40 10.12 6.27 9.04 3.93 12.46 22.33 Balance Sheet Statements Cash/due from banks 9.66 30.12 46.17 70.49 95.25 9.51 31.11 32.75 35.56 30.28 39.24 4.83 36.60 27.91 108.22 Current assets 8.11 8.16 10.21 8.29 68.26 17.70 8.54 7.04 12.80 30.85 55.14 22.18 57.95 106.04 189.54 Investment Loans: -local currency 378.59 427.54 455.88 459.30 462.71 323.83 362.19 372.86 362.85 384.28 384.63 453.27 505.87 625.92 631.04 -foreign currency 38.85 66.50 14.46 -Working Capital loans 10.64 10.21 20.62 26.02 20.26 27.83 26.60 22.11 19.70 20.10 TotallnvestmentLoans 378.59 427.54 494.73 525.80 477.17 334.47 372.40 393.48 388.87 404.54 412.46 479.87 527.98 645.62 651.14 less: Accu. Provisions 1.26 2.56 4.06 5.49 6.94 0.89 4.08 4.73 7.00 9.53 12.15 11.42 11.42 11.40 11.40 Net Investment Loans 377.33 424.98 490.67 520.31 470.23 333.58 368.32 388.75 381.87 395.01 400.31 468.45 516.56 634.22 639.74 Long-term Investments 4.20 5.70 13.20 16.20 19.20 1.90 9.37 9.84 7.45 7.45 7.45 7.30 10.94 30.89 30.89 NetFixedAssets 0.97 0.89 1.51 1.41 1.31 0.96 0.90 0.97 0.84 3.20 3.12 3.44 8.39 8.00 8.11 Other Assets 0.06 1.43 12.72 15.51 TOTAL ASSETS 400.27 469.85 561.76 616.70 654.25 363.65 418.24 439.35 438.52 466.79 505.26 506.26 631.87 819.78 992.01 Deposits: 10.95 20.95 30.95 40.95 55.95 7.86 44.99 51.04 28.53 28.20 39.58 56.69 62.03 69.17 133.17 -local currency 10.95 20.95 30.95 40.95 55.95 7.86 44.99 51.04 28.53 28.20 39.58 56.69 62.03 69.17 133.17 -foreign currency Current Liabilities 6.16 5.70 5.23 5.00 5.00 19.48 25.45 19.08 24.15 43.97 69.31 15.49 31.80 48.11 133.83 Total current Liabilities 17.11 26.65 36.18 45.95 60.95 27.16 70.44 70.12 52.68 72.17 108.89 72.18 93.83 117.28 267.00 Long-term Debts: 33.91 76.82 141.22 170.29 182.23 5.39 8.01 29.26 29.25 29.25 29.25 88.90 167.87 319.78 319.78 -local currency 33.91 76.82 102.57 94.07 79.00 5.39 8.01 29.26 29.25 29.25 29.25 88.90 167.87 319.78 319.78 -foreign currency 38.65 76.22 103.23 Total Long-term Debts 33.91 76.82 141.22 170.29 182.23 5.39 8.01 29.26 29.25 29.25 29.25 88.90 167.87 319.78 319.78 Other liabilities Equity 349.25 366.38 384.36 400.46 411.07 331.10 339.79 339.96 356.59 365.37 367.12 345.18 370.17 382.72 405.23 TOTAL LIAB. & EQUITY 400.27 469.85 561.76 616.70 654.25 363.65 418.24 439.34 438.52 466.79 505.26 506.26 631.87 819.78 992.01 RATIOS: Current Ratio 1.04 1.44 1.56 1.71 2.68 1.00 0.56 0.57 0.92 0.85 0.87 0.37 1.01 1.14 1.12 Long-term debt/equity ratio 0.10 0.21 0.37 0.43 0.44 0.02 0.02 0.09 0.08 0.08 0.08 0.26 0.45 0.84 0.79 Total Debt/equity 0.15 0.28 0.46 0.54 0.59 0.10 0.23 0.29 0.23 0.28 0.38 0.47 0.71 1.14 1.45 Net Income/Equity (%) 1.70 1.94 2.03 1.70 1.36 1.06 0.89 0.44 3.48 2.77 1.71 2.62 1.06 3.26 5.51 As % of total assets: -total income 4.54 5.41 5.59 5.38 5.12 2.90 3.08 1.80 3.75 3.05 2.20 4.60 3.50 5.11 3.00 -netincome 1.49 1.52 1.39 1.11 0.86 0.96 0.72 0.34 2.83 2.17 1.24 1.79 0.62 1.52 1.12 -administrative/other expense 0.55 0.45 0.49 0.43 0.39 0.96 0.43 0.20 1.41 1.10 0.61 1.63 0.14 0.39 n.a. Sources: Actual financial data from 1987 were from GITC's audited reports and projected data from the Staff Appraisal Report of the Industrial Diversification comonent, Gansu Provincial Development Project.   IMAGING Report No.: Type: ICR