Philippines - Third Rural Credit Project

.. CIRCULATING COPY FILE COPY v .PETURNEO TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1456-PH REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE CENTRAL BANK OF THE PHILIPPINES TO BE GUARANTEED BY THE REPUBLIC OF THE PHILIPPINES FOR THE THIRD RURAL CREDIT PROJECT May 30, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit = Peso (P) US$1 = P 6.78 p 1 = US$.1475 P 1,000 = US$147.50 P 1,000,000 = US$147,500 Fiscal Year - July 1 to June 30  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE CENTRAL BANK OF THE PHILIPPINES TO BE GUARANTEED BY THE REPUBLIC OF THE PHILIPPINES FOR THE THIRD RURAL CREDIT PROJECT 1. I submit the following report and recommendation on a proposed loan for an equivalent of US$22.0 million to the Central Bank of the Philippines to be guaranteed by the Republic of the Philippines. The Central Bank would relend the proceeds of the loan to participating banks which would in turn lend the money to farmers and entrepreneurs for pur- chasing equipment and machinery for agriculture and fishery productions. The loan would have a term of 14 years including 4 years of grace with interest at 7-1/4% per annum. PART I - THE ECONOMY 2. The most recent Economic Report - "Current Economic Position and Prospects of the Philippines" (No. 78-PH of April 20, 1973) was circulated to the Executive Directors on May 2, 1973 (R73-85). An economic mission visited the Philippines in April and its preliminary conclusions are incorporated below. The full report of the mission will be distributed to the Executive Directors in due course. Annex I contains country data. Recent Developments 3. Since 1972, the Government has re-formulated its development strategy by introducing a number of important and potentially far-reaching economic and social reforms through decrees in such areas as agrarian reform, taxation, customs administration and tariffs, banking and government organi- zation. These reforms provide an opportunity to improve the performance of the Philippine economy. Aided by the recent commodity boom in the inter- national markets, economic activity in the Philippines has increased consid- erably. The growth in real GNP, which had been about 5% a year for more than a decade, is estimated to have doubled and reached 10% in 1973. However underemployment and unemployment remain quite high, and in common with most other countries the rate of inflation has incr'eased appreciably in the past year. These problems and the long-term implications of the energy crisis for domestic production, the balance of payments, costs and employment are now being examined by the economic mission. 4. The strong recovery of the economy in 1973 resulted from increased agricultural production, a recovery in the industrial sector including manufactured exports, a boom in export incomes and an expansion in public and private investment. The agricultural sector, which had suffered from adverse weather conditions during the previous three years grew by 11% ini 1973. Rice production in the present crop year is estimated to have increased by 30% over the level of the previous year when floods reduced production levels. This increase has been mainly due to favorable weather conditions,  - 2 - increased use of fertilizers, more supervised credit and increased investments in supporting rural services as part of a general drive for rice self-suffi- ciency. The Government has vigorously implemented a program of agrarian re- form among rice and corn tenants concentrating mainly on the larger holdings in the first phase. Titles are being transferred to tenants and supporting services improved. 5. The increased activity in agriculture has provided the base for renewed expansion of the industrial sector. The growth of industrial produc- tion for exports has also been stimulated by the Government's industrial export drive which included a range of export incentives. Nontraditional industrial exports, which have been increasing since 1970, are estimated to have doubled in 1973 to about $200 million. The prospects of increased profitability are attracting a large amount of new investment into industries such as plywood, textiles and garments, handicrafts, light consumer durables and electronics. 6. The growth in production was also assisted by the sharply acceler- ated public development outlays in 1973 made possible by a significant im- provement in the financial position of the Government. The Government has implemented a series of long-needed tax reforms and improvements in tax administration, such as customs and tariff reform, tax amnesties, reforms in corporate and local taxation, continuation of the export tax, and increased taxation on luxury items and on gasoline. These reforms resulted in a 37% increase in tax revenues in FY 1973, and an estimated 40% this fiscal year. As a result the ratio of Central Government tax revenues to GNP has increased from an average of 9% in recent years to an estimated 12% this fiscal year. 7. high prices for the Philippines' chief exports, including coconut products, sugar, copper and wood products, were largely responsible for an increase in merchandise receipts of almost 70% in 1973. The merchandise trade account recorded a surplus of about $270 million, as compared with a $120 million deficit in the previous year. International reserves rose by $594 million during the year and stood at $876 million, equivalent to about five months of imports, at the end of the year. 8. However, in the latter part of 1973 inflation emerged as a major problem in the Philippines. Since mid-1973 consumer prices have been rising at an annual rate of more than 40%. This has been caused by the higher rate of world inflation, by higher export prices, by domestic food shortages, and more recently by the increased cost of petroleum. Provided the Government obtains sufficient cereal imports for the coming July-September lean period for domestic supplies, and provided there is a good harvest later in the year, the rate of inflation should moderate in 1975, but it probably will take 1-2 years for the price effects of thie energy crisis to work themselves out fully. The rapid inflation has also exacerbated the decline in real wages which fell by a total of about 25% between 1969 and 1973. The urban wage earners have been most affected. In the past year, agricultural incomes have improved very substantially, while, with some exceptions, entrepreneurs have been able to pass on increased costs. Money wages will have to be raised in the near future if further deterioration in the living standards of wage earners is to be avoided.  -3- The Ener gyCrisis 9. Imported petroleum provides some 93% of the Philippines' total energy requirements. In 1973 the equivalent of 71 million barrels of petroleum crude and other petroleum products were imported at a cost of about $230 million c.i.f. When the energy crisis developed late last year, it looked as though economic activity in the Philippines would be severely disrupted. There were temporary dislocations while reduced quantities of petroleum were available, but the Government moved quickly with conservation measures to reduce non-essential consumption. By March these problems had been overcome and the Philippines is now obtaining sufficient petroleum for its needs. In 1974 imports of petroleum and products are likely to be about 73 million barrels at a cost of about $820 million c.i.f. 10. In response to the energy crisis the Government has decided to accelerate the development of local energy sources, especially hydropower and geothermal energy. These will be supplemented with nuclear energy in the 1980's. The transport sector, which now accounts for 40% of total energy consumption, is likely to continue to be the major consumer of energy. The growth in demand for energy will therefore be influenced by policies that affect the pattern of expansion in this sector. In any event, total demand for energy is expected to grow at about 10 percent a year, and even with more rapid development of natural power sources, petroleum would still account for 85% of total energy needs by 1980. The Philippines does not have any commercial oil fields, but the Government has recently taken steps to encourage more exploration. Growth Prospects 11. Earlier this year the Government decided that, despite the energy crisis and rapid inflation, the growth momentum built up last year should be maintained, to provide for a continued increase in employment and to ensure that export income expands rapidly enough to meet most of the country's for- eign exchange needs. The labor force will continue to grow at almost 3% a year for another decade. Providing half a million new jobs a year as well as dealing with unemployment and underemployment will be a major task. 12. The economy has the potential to continue growing at 7-8% a year in real terms. This growth is not likely to be seriously constrained by lack of foreign exchange, for despite the big increase in the cost of petroleum and other imports, continued high prices for major export commodities will result in another overall balance of payments surplus this year. Moreover, the rapid increase in export prices at a time when external debt has not been changing, has resulted in a sharp fall in debt service from 23% of export earnings in 1972 to an estimated 14% this year. There has also been a sub- stantial improvement in the climate for private investment in the Philippines, especially in exports. Unless there is a calamitous drop in export prices, the Philippines should be able to maintain a reasonable balance of payments position throughout the rest of the decade. There will probably be a substan- tial increase in financing requirements, but with rising domestic incomes and a substantially improved capacity to borrow abroad, it should be possible to mobilize the needed resources.  -4- 13. A substantial increase in both public and private investment to support the growth and employment strategy is required, with priority being given to increasing food production, tc, export ventures and to selective import-replacing investments. The Government plans to spend about P 17 bil- lion on infrastructure and other public investments during FY 1974-77; about 40% of the proposed investment program would be allocated to the transport sector, 21% to power and 13% to irrigation. This would mean doubling the pro- portion of these expenditures to GNP from 1.7% in FY 1968-72 to about 3.5% in FY 1974-77. To finance this program, the ratio of taxes to GNP would have to be increased to 15-16%, and public savings would have to be raised from the present level of 1.4% of GNP to beyond 2% in the next few years. With the Government's program for further tax reforms, there are reasonable prospects for achieving these objectives. Even so, it would mean continued heavy reliance on public borrowing from the local market and from abroad. Implementing this program would also call for continued improvements in public sector management which has already been strengthened by the Govern- ment reorganization. 14. The improved climate for private investment is attributable to the strong performance of the economy in 1973 after three years of stagnation, the current higher prices for many commodities, and the efforts of Govern- ment to attract more foreign investment. A number of big projects are pro- posed in mining, wood processing, fertilizer, steel, aluminum and other industries which seem likely to push up the private investment rate from recent levels of about 16% of GNP to perhaps 22% by the latter part of the decade. A large portion of the funds for these projects is likely to come from abroad. Even so, the supply of long-term funds from domestic sources will need to increase substantially. Balance of Payments 15. Because of continued high prices for major export commodities, export receipts are expected to increase by 33% this year to $2.5 billion. Merchandise imports are likely to increase by about 66% to $2.6 billion, largely because of the increased cost of petroleum. In response to the energy crisis the Central Bank negotiated a series of standby credits with various foreign commercial banking groups earlier this year. However, be- cause of the improved outlook for export receipts, these standby credits may not be used this year. The economic mission estimates that the overall balance of payments will record a surplus of about $250 million this year, with international reserves increasing to about $1.1 billion, the equivalent of about 3-1/2 months of imports. With export prices continuing at relatively high levels, a small deficit in the overall balance of payments is likely in 1975. 16. After allowing for continued reserve accumulation and repayment of loans, the total foreign exchange requirements for the period 1975-79 would be about $7 billion. About $2.5 billion would be provided by remittances, official grants, direct investment, and short-term trade finance. The re- maining $4.5 billion would have to come from foreign borrowing. Last year the Bank estimated total requirements for 1974-78 at about $4 billion. In  June 1973 the Consultative Group for the Philippines met and accepted the need for rising levels of commitments for development projects to support the Philippines' increased development program. The increased estimate of requirements reflects the effects of inflation, the more optimistic outlook for growth in the Philippines, and the improved capacity to carry foreign debt. 17. Borrowing on this scale would not pose serious problems for balance of payments and external debt management. At the end of 1973, the Philippines' medium and long-term external debt stood at about $1.9 billion, of which pub- lic debt was 44%. Because the Government has exercised strict control over the amount and type of new external borrowings, the total amount of debt out- standing has not increased much since 1970, and the maturity structure has improved. Moreover, the debt service ratio is expected to remain at about 14% in 1975. With this moderate debt burden the Philippines will be able to contract substantially larger amounts of external debt which would probably lead to a small increase in the debt service ratio, perhaps to about 14-15% by the early 1980s. 18. The Philippines' development program will continue to require re- sources in excess of the foreign capital which will become available for fi- nancing the import component of development projects.. Some financing of local currency expenditures will be justified, especially for projects of economic and social importance which need only limited amounts of foreign exchange. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 19. The Philippines has received 23 Bank loans and three IDA credits totalling $394 million, net of cancellations. About 56% of the Bank/IDA lending or about $225 million has been for infrastructure projects in power, transportation, water supply and for education. The remainder has been divided between agriculture and industry. About $104 million of this has been for irrigation, livestock, fisheries, rice processing and rural credit and about $65 million for industry in three loans to the Private Development Corporation of the Philippines. There has been a marked improvement in the way Bank Group projects in the Philippines have been executed in the last two or three years compared with experience in the 1960's when shortages of peso counterpart funds combined with poor administration caused serious problems. Apart from the rice processing project, where the scope of the project has been revised because of changed circumstances (see Annex II), all our projects are now going well. Annex II contains a summary statement of Bank loans and IDA credits as of April 30, 1974 and IFC investments as of March 31, 1974, and notes on the execution of ongoing projects. 20. The size of the Bank's lending program will increase substantially this year reflecting the ambitious development program of the Government and its improved capacity to prepare and implement projects. With the loans for the proposed project and for the industrial investment project being presented  - 6 - to the Executive Directors in June, our lending in FY 1974 would be $165.1 million, co-npared to an average of about $30 million a year in the previous five years. Future Bank lending will continue to concentrate on public in- frastructure and agriculture. We will also continue to help industry and provide more assistance for projects in the social sectors. 21. The following projects are among those which may be ready for Board consideration in FY 75 - Population, Power VI, Inter-Island Shipping, Tarlac Irrigation, Mindoro Rural Development and Small Industry. The population project would strengthen the delivery of family planning and other health services to the rural areas, mainly by constructing and staffing new rural health units. The sixth power loan would help the National Power Corporation (NPC) to expand its power generating and transmission facilities in Luzon, while the loan for inter-island shipping would be relent through DBP to private shipping companies for the acquisition of new and used ships and con- version and repairs of existing ships of the inter-island fleet. The Tarlac Irrigation project would help rehabilitate irrigation systems in a heavily tenanted area of Central Luzon, while the Rural Development project would help finance a range of rural investments designed to promote the integrated development of the island of M4indoro. The small industry loan would provide funds for relending to small firms and technical assistance to help strengthen the institutions serving these firms. 22. Since 1972 the Philippines has received a limited amount of assist- ance from IDA, but on the basis of a reappraisal of the prospects for the Philippines' balance of payments in the light of changes in commodity prices, and in view of the sharply increased needs of the poorer members of IDA for concessional assistance, further IDA lending to the Philippines does not appear to be justified. The Philippines now has the capacity to borrow larger amounts abroad to meet the needs of the increased investment program now planned. The Bank's share in this higher level of foreign borrowing will be reviewed in the light of the findings of the recent economic mission. At present, the Bank/IDA share in total debt outstanding is about 9% and its share in debt service is about 5.5%. Since the Philippines will have the capacity to service more commercial debt in future, it is unlikely that the Bank's share in debt service will rise even with a higher level of lending. 23. IFC has made commitments in the Philippines totalling $68.0 mil- lion for investments in ten companies in the fields of development banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibers. Of these investments, as of March 31, 1974, $18.2 million have been sold, $0.4 million cancelled and $1.6 million repaid, leaving a net portfolio of $47.8 million. On the same date $13.2 million was undisbursed. Preliminary proposals have been received for an aluminum smelter and other projects in the pulp and paper, dinner ware, metal alloys and shipbuilding fields.  - 7 - PART III - THE AGRICULTURAL SECTOR 24. Agriculture is the predominant sector in the Philippine economy generating approximately one-third of the gross national product, accounting for one-half of total employment and about three-quarters of export earnings. Over 60% of the total land under cultivation is taken up by cereals, of which rice and corn are the most important. The remaining land is primarily taken up by the major export crops: sugar, coconuts, abaca, pineapples and tobacco. 25. During the first half of the last decade, agricultural production increased by only 2.4% a year. However, with a breakthrough in rice produc- tion following the increased use of high-yielding varieties, fertilizers and irrigation in the sixties, the sector was growing at a rate of almost 7% a year by the latter part of the decade. During the past three years the sector has suffered from adverse weather conditions including severe typhoons. These disasters slowed progress towards self-sufficiency in food crops and imports of about 600,000 tons of rice were needed in 1972 and 1973. However, due to favorable weather conditions and a crash rice production program called "Masagana 99", 1/ a harvest of 3.7 million tons of milled rice equiv- alent is expected this year - an increase of 30% over the 1972/73 harvest. In this past year, fertilizer use on food crops (mostly rice) tripled and supervised credit increased almost eight fold. 26. The major export crops have not been seriously affected by the natural calamities and have provided increasing foreign exchange revenues mainly because of favorable world commodity prices. Livestock and poultry production, which accounts for about 15% of agricultural output, is not suf- ficient to meet the demand for meat, requiring imports of about $6 million a year. 27. The performance of the rural-agricultural sector will be crucial in determining whether the Philippines can increase incomes both rapidly and equitably. At present, the domestic market for industrial products is limited by relatively low rural incomes. Problems of poverty and income maldistribution are particularly acute in the rural areas. Of the 15 mil- lion people in the bottom 40% of the income scale, 12 million live in rural areas. This represents 45% of the rural population. The Government is aware of these problems and is moving in the right direction by stressing self-sufficiency in cereals, laying the base for future diversification, reforming the tenancy structure, and increasing institutional support to agriculture. 1/ "Masagana 99" is a drive by Government with a target of achieving 99 cavans of paddy per hectare (4.4 tons/ha) country wide. In Tagalog "masagana" means abundant.  28. Achieving self-sufficiency in cereals, particularly rice and maize, is a major Government objective which is important not only to strengthen the balance of payments, but also as a means of raising incomes for an im- portant segment of the rural population. Most increases in rice production will have to come primarily from the present land under cultivation since the scope for area expansion in rice is very limited. Thus, attaining self- sufficiency before the end of the pr2sent decade will depend largely on in- creasing yields through expansion and rehabilitation of the area under irri- gation, increased use of fertilizers and agro-chemicals, and provision of adequate credit and other supporting services. At present, only 900,000 ha or less than 30% of all land under rice cultivation is irrigated. Invest- ment in irrigation is therefore of high priority. According to the Bank's Philippines Agricultural Sector Survey of May 2, 1973, meeting the domestic demand for rice by the end of the 1970's will require a program of irrigation rehabilitation and new construction in rice lands involving 50,000 ha a year for the remainder of the decade. 29. Apart from rice, considerable potential also exists in feed grain and corn production, livestock, fisheries and forestry development. Diversi- fication is important not only to meet the growing domestic demand for food and raw materials, but also to improve incomes in poor areas less suited to rice production. Better conservation of natural resources can be achieved by developing the livestock and forestry potential of uplands not suitable for cultivation. 30. Institutional support for agriculture will involve greater atten- tion to rural credit, agricultural extension, research and development of infrastructure. There has been considerable progress in developing institu- tions to provide credit for small farmers, most notably the rural banks and, after many years of slow progress, the Government is giving high priority to agrarian reform. The present program concentrates on rice and corn tenant farmers, who number about one million, and includes the transfer of titles from landlords to tenants, an expanded program of rural credit, and increased investments in supporting rural services. In the first year of the new program the Government has concentrated its efforts on the large tenanted estates. It has issued 205,000 land transfer certificates to about 143,000 tenant farmers who cultivate about 255,000 hectares of land. More has been accomplished in this year than in the previous 10 years when a total of 55,000 tenants were converted to leasehold status and 3,000 to freehold status. The Government faces some difficult problems in dealing with small landholdings which are tenanted. Some 82% of land owners have 7 ha or less and 34% of all rice tenants are on these holdings. The latest directives suggest that small landowners who cultivate part of their holdings would be expected to enter into cooperative arrangements with their tenants. It is not yet clear how far the Government will go in requiring small ab- sentee landlords to transfer their land to their tenants. Since over 80% of all farms are under five hectares, the future growth in agriculture which would result from the expansion of irrigated land would directly benefit the small farmers.  - 9 - 31. According to the Government's Four Year Plan (1974-77) projections the agricultural sector, after two successive poor rice crops in 1972-73, is expected to post significant gains in 1974 with a 4.8% growth rate. By the end of the Plan period, agricultural production is expected to be growing at 4.5% per annum. Export crops are expected to perform well. However, the recent increase in the price of petroleum with its effect on the price of fertilizer and the amount available poses a difficult problem for the Govern- ment. The use of fertilizers on rice alone increased from 44,000 on the wet season crop in 1972 to 162,000 tons in 1973. Prices were held at the 1972 level by subsidy. Based on planned programs for rice and cozn, fertilizer requirements will rise perhaps by 250,000 tons most of which will represent additional import requirements. Government officials indicate that most of the 1974 fertilizer requirements have been contracted for, and the price of fertilizers has doubled despite the subsidies. The impact on the farmer of this increase has partly been cushioned by an increase in the support price of paddy by 50% to F 40 for 50 Kg. In order to maintain the incentives for increased use of fertilizers by farmers, the Government may have to raise paddy prices further and/or increase the subsidies. In addition more credit will be needed as a result of higher fertilizer prices. The Government has therefore decided to increase the level of credit to food farmers under the "Masagana 99" program from P 570 per hectare in 1973 to P 900 in 1974 - an increase of about 40%. This increase does not apply to fertilizers used for export crops because of continued high international prices of these crops. PART IV - THE PROJECT 32. The project is the third rural credit project to be financed by the Bank. The first one was in 1965 when the Bank made a loan of $5.0 mil- lion equivalent (432-PH). This loan was fully disbursed by 1968. In June 1969, the Bank made a loan of $12.5 million equivalent for the second rural credit project. This loan is expected to be fully disbursed by mid 1974. Both projects have progressed satisfactorily although disbursement under the second project was slow at the beginning. The proposed project was prepared by the Department of Rural Banks and Savings and Loan Associations, Central Bank of the Philippines. A Bank mission appraised the project in November/ December 1973 and negotiations were held in Ma 1974. The leader of the Philippine negotiating team was Mr. A. P. de Roda, Under-Secretary of Finance. The Appraisal Report (No. 428a-PH) on the project is being cir- culated separately to the Executive Directors. Annex III provides a loan and project summary. The Rural Banks 33. The Government has over the years actively encouraged and promoted rural banks in order to provide rural areas with banking facilities. The Philippines is the only country in Asia that has this type of rural banking system. Rural Banks are private banks established with authority of the Central Bank. At present the Government holds 40% of their stock with  - 10 - individuals holding the balance. Rural Banks sources of funds are from paid up capital, deposits from the public, borrowings from the Central Bank and profits from lending operations. In addition, they have rediscounting facilities with the Central Bank for short term agricultural lending. Through these facilities the Central Bank rediscounts promissory notes up to 80% under ordinary schemes and 100% under supervised production schemes (rice, corn and sugar) at 3% a year up to a limit of 300% of the borrowing bank's net worth plus 50% of its monthly average savings deposits over the preced- ing four months. 34. The rural banking system, with its large number of outlets, is well equipped to meet a substantial part of the farmers' growing needs for short, medium and long term credit. Of the P 361.0 million short term credit provided to about 400,000 farmers under the Government's "Masagana 99" program in 1973 (see para 16 above), 45'% was provided by rural banks, 50% by commercial banks, mainly the Government owned Philippine National Bank, and 5% by the Agricultural Credit Administration. Rural banks are the pre- dominant source of long term development credit for small and medium size farmers in the one to ten hectare range. 35. The first and second rural credit loans have supported the Central Bank in its efforts to strengthen the rural banks by requiring them to oper- ate at appropriate standards, and by providing them with technical assist- ance. The loans, therefore, played a significant role in building up these lending institutions. A unique aspect of the rural banking system has been the mobilization of local personnel of different backgrounds who, after periods of training and supervision, have been transformed into satisfactory bankers. 36. In 1965 when the Bank made the first loan for a rural credit project, there were 300 rural banks. By 1969, with the second loan, the number had increased to 400 and now there are over 600 of them. It is planned to establish 100 rural banks per year between now and 1977. Some 140 of these institutions participated in the first loan and just over 200 are now participating in the second loan. About 250 are expected to par- ticipate in the proposed third loan. 37. Arrears of participating banks under the first and second IBRD financed Rural Credit Projects have been deteriorating. In 1971 overdues under the on-going project amounted to P 0.6 million out of a total port- folio of P 15.2 million. The corresponding figure for 1973 (as of September) was P 4.5 million out of P 80.0 million. To qualify as participants, the overdues of a rural bank had to be less than 25% of its loan portfolio and most banks were able to qualify as their portfolio kept expanding. As the banks portfolios have been expanding rapidly, this ratio is no longer satis- factory as a measure of the rate of collection of loans as they fall due. Under the proposed project, the participating banks would be required to have arrears not exceeding 25% of demand, arrears being defined as "amounts due at the end of a twelve-month period as a percentage of demand" and demand being defined as "principal and interest falling due during the period plus overdues at the beginning of the period". This formula requires collections  - 11 - to be improved markedly, and, if applied immediately, a large number of rural banks would be disqualified. The new formula would, therefore, come into effect on April 1, 1975. Before that date, each participating bank would be required to demonstrate, on the basis of its accounts for the previous calen- dar year or of its subsequent monthly financial reports, that its arrears were 25% or less of demand. If it failed to demonstrate this, the bank would be disqualified until it was able to reduce the arrears to the required level or below. The applicable maximum rate of arrears would be reduced to 20% of demand effective a year later, on April 1, 1976. During the transition period until the effectiveness of this new requirement the current formula for maximum arrears, defined as 25% of total loan portfolio, would continue to apply. Stock Savings and Loan Associations 38. The Central Bank has proposed that certain Stock Savings and Loan Associations be permitted to participate in the project. These institutions are registered with the approval of the Central Bank. Unlike rural banks, they can open branches. They accept deposits from the public and make loans. Savings and loan associations have so far concentrated on financing real prop- erty and there are now 35 of them including 14 in Greater Manila and 7 with branches. Twenty of the existing savings and loan associations are interested in broadening their operations to include medium and long term lending to agriculture for productive purposes, arnd the Government is keen that they should do so in order to increase the number of outlets providing institu- tional crenit to farmers. Since they would meet the standards required for rural banks to participate in the project, the Bank agreed with the Central Bank's proposal that these institutions be permitted to participate in the project. Description of the Proiect 39. The purpose of the project is to finance investment in a range of agricultural and rural activities throughout the Philippines. The farmers who would borrow under the project would be mainly those cultivating between two and ten hectares. Large farmers owning or cultivating over 50 hectares would not be eligible to borrow under the project. The project would finance the following activities: (i) Farm Mechanization. This category would include about 1,800 imported four-wheel tractors of up to 80 BHP with accessories and implements, and 1,000 domestically manu- factured power tillers. They would be mainly used in sugarcane and irrigated rice farming areas, and on some upland corn farms. It would help sugarcane farmers to increase their yield, rice farmers to increase their cropping intensity, and corn farmers to extend their land under cultivation. Benefits would accrue not only to owner/operators but also to small farmers using their services.  - 12 - (ii) On-farm Tranpo rtation. This category would include about 250 new and 200 imported reconditioned trucks to alleviate the existing shortage of farm transport. The trucks would help increase the recovery of rice and sugar from paddy and sugarcane by reducing the waiting time before milling, and improve farmers' bargaining position vis-a-vis middlemen. (iii) Farm Support Facilities and Equipment. This category would include 250 privately owned farm machinery repair shops and purchase of minor farm equipment such as sprayer/dusters, tractor and power tiller implements and attachments, grain driers, and threshers of up to 13 tons per day, and the construction and equipping of small scale private irrigation facilities and storage. (iv) Coastal and Inland Fisheries. Fishery development would cover the construction of inland fishponds and fishpens, and purchase of about 300 small coastal fishing boats and equipment. Boats would be bought by local entrepreneurs, and crewed by local fishermen, who would share the catches. (v) Small Scale Livestock Development. Small-scale poultry, swine and dairy farm development would include the construc- tion of pens and sheds, and the purchase of initial stocks. (vi) Cottage Aro-Industries. This category would include a limited number of cottage agro-industries for production of fishmeal for import substitution, and labor-intensive woodcraft products for export. It would help the rural banks diversify their lending operations into cottage indus- tries. (vii) Evaluation StuLdy. The project would include finance for a study to be undertaken by a group of qualified local experts, under terms and conditions acceptable to the Bank, to review the progress and assess the economic and financial impact of the first, second and this project. Project Execution 40. As in the previous two projects the Central Bank, through its Department of Rural Banks and Savings and Loan Associations, would administer the project. The Department is competently managed by a Director and an Associate Director and has a staff of about 500. The Department's Special Agricultural Projects Division assisted by loan teams and technicians in the field, would process and sanction loan applications submitted through the rural banks and savings and loan associations. It has currently 62 ag- ricultural and 12 fisheries technicians in the field. Ten of the fisheries technicians, who are seconded from the Fisheries Commission, would be re- tained by the Central Bank through project implementation in order to process  - 13 - fisheries loans. A Technical Support Evaluation Unit would be established as a Division in the Department. Its ftnction would be to keep in touch with agencies and research institutions concerned with agricultural and fisheries development, collect information on project development, dissemi- nate such information, provide technical guidance to management and field staff, monitor project operations, and evaluate the results at the farm level. In order to encourage small loans by speeding up processing, sim- plified procedures requiring less work by the Central Bank field staff and less paperwork for final Central Bank approval, would be introduced for loans of up to P 10,000 ($1,400). Prq,iect Cost and Financinp, 41. The total project cost for the proposed three year lending pro- gram is estimated at $44 million equivalent with an estimated foreign exchange cost of $22 million. The Bank would finance 50%, the Government 30%, the participating rural banks and Savings and Loan Associations 10% on average - new rural banks and savings and loan associations with lim- ited resources would be permitted to contribute a minimum of 5% - and the beneficiaries 10%. The Central Bank would combine the proceeds of the loan (other than a small amount -- $90,000 -- required for a study to evaluate the economic and financial impact of the project) with loans from the Government covering 30% of project cost, and relend the funds to quali- fied rural banks and savings and loan associations at an interest rate of 7% per annum. The Government loans to the Central Bank carry an interest rate of 5% per annum. The relending rate of 7% on the combined proceeds gives the Central Bank a margin of about 0.6% per annum. The rural banks and savings and loan associations would in turn lend the funds to bene- ficiaries at an interest rate of 12% per annum and on terms ranging from three to ten years, including a grace period if required. Given the size of the individual rural banks, the relatively large number of small loans and the need to provide the banks with an incentive to participate in the project, this 5% spread is reasonable even when account is taken of serv- ices proviced by the Central Bank. The Central Bank would carry the foreign exchange risk. Procurement. 42. As in the second project, machinery and equipment, including trucks and irrigation equipment, and engines and equipment for fishing boats would be purchased locally from firms representing major international manufactur- ers, who maintain branches and dealers throughout the Philippines. Compe- tition is keen, and services and repair facilities are satisfactory. The firms submit their selling prices regularly to the Department of Rural Banks and Savings and Loan Associations, which advises participating lending insti- tutions and farmers on prices and mark-ups. Farmers would choose the firm they prefer for their purchases. 43. Sufficient private contractors are available for construction of farm buildings and boats. Building materials, including lumber and cement, are produced locally. Farmers and fishermen would choose their contractor  - 14 - for construction and for equipment supply. The size of individual contracts would be too small for international competitive bidding to be practicable. Sub-projects would be widely dispersed in different regions and spread over time so that bulking would not be workable. Disbursements 44. Disbursements would be made to the Central Bank against 56% of loans to beneficiaries (maximum of 50% of investment cost) as disbursed by rural banks and savings and loan associations upon submission of documen- tation by the Central Bank. In addition the ,ank would disburse 100% of the cost of the evaluation study. Documentation of disbursements certified by Central Bank Loan Officers would be retained on file at the Central Bank, or a designated local depository. Since the second rural credit loan was almost fully committed for sub-projects by the end of March 1974, eligible sub-loans made after April 1, 1974 would qualify for retroactive disbursement from the third loan in order to avoid holding up lending operations at a time when the regular planting season is approaching. This retroactive financing would not exceed $500,000 and would be provided only for sub-loans which are eligible urnder the conditions of both the second and third rural credit projects. Collateral for Loans 45. Loans to agrarian reform beneficiaries who cannot provide colla- teral comparable to freehold title fully acceptable to the lending insti- tutions would be guaranteed by the Agrarian Reform Fund (ARF). The fund would also guarantee loans for fisheries development. Economic Justification 46. The direct benefit from the proposed project would derive from the increase in production resulting from the various investments. For example, farm mechanization would help increase rice production and hence move the Philippines closer to self-sufficiency, and would also increase sugar cane production thus helping to mneet the country's increasing domestic demand and export requirements. The increased production in poultry, pork, dairy and fish products would generate additional sources of income to small farmers and help improve nutritional standards in rural areas. Investments in cottage-agro-industries would stimulate export of woodcraft products and reduce imports of fish meal products. Economic rates of return for the different types of investment range from 33% to over 100%. 47. The estimated total annual incremental income accruing to the approximately 8,000 farmers, fishermen and rural enterpreneurs who will borrow under the project would be about P 100 million (US$14.7 million) after paying P 32 million (US$4.7 million) in interest. The average beneficiary's annual incremental net income would be about P 12,500 (US$1,800). About 94,000 small farmers would hire project financed tractors from their owners for land preparation, and would thus profit  - 15 - from custom work at reasonable rates. Most of these hirers are too poor to own buffalo or power tillers, and depend on custom work. Without the proj- ect, custom rates could rise sharply, and hirers would probably have to pay much more than the P 140 per ha for rice farms projected under the project. In addition, the project would create about 2,000 full-time job opportunities for small subsistence fishermen, and equip a further 2,000 with more effi- cient boats and fishing gear. 48. The net employment effect of the farm mechanization component would probably be some increase in the employment of hired labour. In the rice sector, mechanical land preparation is expected to increase cropping intensity and, as a result, to increase overall labour input, particularly hired labour. In total, the investments financed by the project are likely to create about 10,000 new jobs for hired labour under the different compo- nents and also will increase the productivity of about 8,000 existing rural workers. PART V - LEGAL INSTRUMENTS AND AUTIORITY 49. The draft Loan Agreement between the Bank and the Central Bank of the Philippines, the draft Guarantee Agreement between the Republic of the Philippines and the Bank, the Report of the Committee provided under Article III, Section 4 (iii) of the Articles of Agreement and the text of a draft resolution approving the proposed loan are being distri- buted to the Executive Directors separately. The special features referred to in paragraphs 37, 38, 40, 41, and 42 have been embodied in Rules and Regu- lations of the Central Bank which governs the operation of the project and which may not be amended wqithout the agreement of the Bank. Those in para- graphs 39, 40, and 44 are reflected in Sections 3.03 and 3.04 of the Loan Agreement and Section 3.02 of the Guarantee Agreement. 50. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 51. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments   ANNEX I nu - aXgXPPX ae1 of 3 page 297.(0 Om 39J!U (ans72 ha grade .,., FbiliWpne _ M M . A O f if M g) a 210 31.0 210 200 t i;5 i rtb rate (2w thau' ' 102 10 17 10 Crfe death rate ( o? 73 59 *0 / 123 80-90 Laftnt e:or"114 14to t2w Wm d Dbf 73 59 70 k so2 59 Life &A*c%ac&7 at Wth (rsi) 50 La 56 /b 59 50 Grow rat e .2 ** 2.9 5.1 5.0 3.2 FqulStion 3ro Z b *aX 5.0 3.0 5 .2 2.5 3.1 Pep1aUon aph :,a& - urle 4 La. 5 Id d. 5 AV structue' (per t) 13 0-li 46 4. 47 54 15-64 51 55 50 65 gnd over 5 4 5 onoandcy ratio a, 1 5LE 1. 31.f 1.7 0.9 Urban palation &j pFte of tol 30 /d 35 /d 56 453 P_ily pl ig o aaeptors 4law ".* , .. 409 516200 9 lio. of urs ( of married N) 8 9 - 10 atbI-IborfOror I tIkosnds) 9,120 13,220 /r 6, Perontage eamlo-ed in trimll4re 61 56 If 41 55 1 P.rcentago unwitap.o<d 6 7 7 3 na 2 roe ao no t- 1Anm received by b oat 5 29 S 'j 25 i Pere nt of natimns imnoo received by higm NO 56 7KW 54 s,6 Peroent of national. inotm recsived by legt 20 5 7r 4 Ln Feront of national iaoa: roeived by lowt 140 13 12/, D[sjI11 07 LAND 0 s od tpq3 E or , . .. . I owned by raallei 103 of ocuwo M* 9i p pr FhyAci n i,6C0 /2 2,820 2,250 2,000 6,600 Population per mrine perton .. 2,050 2,700 1,400 2,670 Population per hos)itel bad 1,180 /h 910 420 470 1,500 Per capita -.lorie supply an % of require=te 9 80 1 87 /a 89 124 100 Per capita protein cupply, total (grams per day j 48 53 55 76 51/ Of which, animal rd ;lz 19 7i 22 29 19 17 n Death rate 1-1, years L 9 7 gDUcAT1orA Adj;sItd /o pricer) schcazl trollant ratio 91 /o 119 /o 95 70 90 Adjuated Z! aecondary ocshool nrollment ratio 26 49 22 50 13 Years or achooling provided, firat and cond level 10 10 11 12 12 Vocational anroliaont as S of soo. school enrollmnt 14 10 /E 22 /2 i6 13 Adult literacy rate S 72 /1 72 26 70 rvrsre no. of peronas per room (urban) 1.6 Pereent of occupied units without piped oter 8 77 61 Access to electricity (ma % of total population) 20 70 13 /r Percent of tural population connrotod to aloutrility 10 /c 36 i re osivers per 1000 popAlation 22 45 /c 105 132 78 Ps aangar corn per 1000 population 5 8 7 4 5 glectric poer coneuwption (kh p.c.) 110 ,L 229 378 2683 106 Newsprint consumption p.c. kg per year t1.4 1 8t 2.4 1 0 1.2 Fates Figure retor either to the lot_t perio or to ooount of anirourmtal teprature, body wfight, O1 the latast years. Lat4at pariods refor in principle to distribution by ago and eal of national pOpolntisne the years 1956-60 or 196-7; the latest year in prin- Protein standards (requirements) for all eountries asetab- ciple to 1960 ad 1970. 0r oigpificontly differr t liahod by UID 3oonio beoawrh Service proido for a sotiAm periods or years are footnoted separately. anlone of 60 por of total protein per day, and 20 pr_ of /, rho Per Capita alP atimatas for yearo other than 1960 animl ard pulse protein, of whicbh 2D gro Should be animl is at market prioe., oalculated by the o oansrision protein. Those satndards are sombt lr r than tbos of 75 teahniqua as the 172 Wbrld Bank Atla. gram of total protein an 23 amm of arma protein as an /2 Average nuaber of aughtero per un or reproductive average for the world, propoad by FAD in the Ulird World Food age. Survey. / P Ppoulatioe powt reteo ar lbr the dsoadow eing in /7 Som_ studieo have suggitod that crude death rates of shildren 1960 and 1970. egs 1 through 4 may bo used as a first ai miatin indAl of Ratio of under 15 and 65 and ovcr ap brackets to malnutrition. those in labor force bracket of agye 15 tbrouh 64 ZL Peroentage enrolled of eorrewodin population of aoow ae /5 FAO reference atancards represent pbeiologioal re- as defined for each oountry. quirmeents for norwal activity ad health, taking T; iqi.jiq. h 195'570. /2 i9.61 / For tho definition of urhon see 1.I0. Demographic Y,qrrook 1971, p. If. o ftiof pqc.ition under 1I and ;5 %M over to totAl labor force. If 1971. Zj Fplo-.'d Iabor force. /2 1961. I -ut, hold. /2 LDovst quintile, rural population only. A 1962. 7 19560fl2. 1I 1969. /n 1964/66. /o Tncludes cverage etudents. I '; /2 15 yearo and o-er. /2 Doea not include Bangkok metropolitan area where 63% or tle population has access to electricity. 7t lb . it imports only. /u Computed by applying to the 1970 figure the growth rate of OiTP/capita in real terms fr 1960 to 19t0. 77 1971 estimated per capita ONP of $2L0 based on revised national acoounts and includes US inflation. R2 Deceaeor 4, 1973  ANNEX I Page 2 of 3 pages 1/ ECONOMIC INDICATORS / TRDS: