Colombia - Second Caqueta Rural Settlement Project

FILE Copy DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1630-CO REPORT. AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAiN TO THE REPUBLIC OF COLOMBIA FOR THE CAQUETA RURAL SETTLEMENT PROJECT (Phase II) May 2, 1975 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 It may not be published, quoted or cited without Bank Group authorization.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 EQUIVALENTS (as of April 17, 1975) Currency Unit - Colombian Peso (Col$) US$1 - Col$30.03 Col$W - US$0.333 Col$1 million - US$33, 300  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELORENT REPORT AND RECOMMENDATDDN OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF COLOMBIA FOR THE CAQUETA RURAL SETTLEMENT PROJECT (Phase II) 1. I submit the following report and recommendation on a proposed loan to the Republic of Colombia for the equivalent of US$19.5 million to help finance a second rural settlement project in the Caqueta Intendencia of the Amazon Province. The loan would have a term of 20 years, including four years of grace, with interest at 8-1/2 percent per annum. PART I: THE ECONOMY 2. The Bank's most recent economic report (Economic Position and Prospects of Colombia, 138-CO) was distributed to the Executive Directors on May 18, 1973. A note on major developments in the economy since that time is included in Annex I. 3. The Colombian economy has shown impressive gains in the recent past. The rate of economic growth has accelerated to more than 7 percent per annum, and the expansion of non-traditional exports has been remarkable. Such improvements are very much needed in order to accelerate employment generation and to raise gross national product per capita, currently US$5OO, one of the lowest in Latin America, to a more acceptable level. Colombia also needs to spread the benefits from growth more widely in order to surmount problems of poverty and population pressures in both rural and urban areas. Concentration of land ownership, technical backwardness, and under--employment characterize most rural areas. In urban areas, pressures of population growth, compounded by heavy migration from the countryside, have generated serious unemployment and a severe housing deficit. Prospects for coping with these problems seem brighter as a result of the accelerated growth upon which the Colombian economy has embarked in the past several years. 4. Recent Government administrations have reacted to rural poverty and urban unemployment in a more systematic fashion than in the past, but much remains to be done. In spite of the passage of an Agrarian Reform Law and the creation of the Agrarian Reform Institute (INCORA) in 1961, only modest results have been achieved in alleviating rural poverty. Addi- tional legislation has been enacted which lays a better basis for land reform but much remains to be done to raise income in rural areas. In recognition of the problems of urban concentration and unemployment,  - 2 - Colombia's previous Government placed greater emphasis on urban development, particularly in the housing field, but despite such action unemployment continued to increase in most of Colombia's major urban centers. The new Government, which took office in August 1974, is striving to sustain a high rate of economic growth while simultaneously attempting to achieve a more equitable distribution of its benefits, inter alia, through expansion of employment opportunities and increased investment in education, health and agriculture. There is more emphasis on the development of agriculture and industry, and less reliance on the urban construction sector to provide a stimulus to economic growth. Export diversification continues to be a major component of development strategy and the Government is currently rationaliz- ing the export promotion system. These development programs have necessitated and will continue to require a strengthening of the fiscal effort. 5. At the latest Consultative Group meeting held in June 1973, members of the Group expressed the view that growing needs for public investment and other public expenditures called for increases in domestic fiscal efforts. While the Government then expressed the intention to further increase revenues by new tax measures and by increasing the savings of public enterprises, little progress was achieved, and the fiscal situation remained weak. To overcome these problems, Colombia's new Government has instituted a comprehensive struc- tural reform of the fiscal system which includes major modifications of the sales and income taxes, and a strengthening of the fiscal contribution of decentralized public enterprises. Discussions between the Government and the Bank on fiscal issues are continuing. 6. Golombia's efforts to expand exports have been amply rewarded in recent years. Merchandise exports amounted to US$1,334 million in 1973, of which over half came from non-coffee items. Allowing for price increases, this represents a fourfold increase (representing an average annual real growth of 24 percent) in non-traditional exports since 1965-67; flowers, clothing, emeralds, cotton thread and cloth, chemical and pharmaceutical products, sawwood, and wood products enjoyed particularly large gains, al- though raw cotton, sugar, meat, and other agricultural products continued to account for the greatest absolute amounts. Coffee receipts were up largely as a result of high international prices as the volume of coffee exports has increased relatively little in recent years. 7. Rapidly expanding exports accompanied by more slowly rising imports, despite progressive removal of import restrictions, have created substantial balance of payments surpluses. Net foreign exchange reserves of the Banco de la Republica reached at the end of 1973 nearly US$600 million, or the equivalent of about five months' imports of goods and non-factor services at the 1973 rate. This compares favorably with the US$345 million and US$170 million held at the end of 1972 and 1971, respectively, and to the deficit positions that were common prior to 1968. Since early 1974, accelerated import payments resulting from liberalization of import restrictions and lengthening of the lag between export registrations and exchange surrender, together with  lower world prices for coffee, moved the current account of the balance of payments from a surplus position in 1973 to a deficit for the first eight months of last year. Sharply reduced external borrowing by the Government has further lowered the inflow of foreign exchange, and reserves declined by about US$120 million during 197h. Care will have to be exercised in foreign exchange reserve management since world coffee prices may remain weak for some time and prices of several of Colombia's non-traditional agri- cultural exports appear to have peaked, while those of imports are expected to continue to rise. The new Government is aware of the danger posed by the weakening in the balance of payments, and since taking office in mid-August has more than doubled the rate of depreciation of the peso under Colombia's flexible exchange rate policy, moving it ahead of domestic price increases, in an effort to hold down the rapid growth of imports and sustain adequate incentives to exporters. Nevertheless, the Government faces the need to strike a careful balance between facilitating a reasonable level of imports and maintaining an adequate level of reserves without incurring too large a volume of suppliers credits and other short- and medium-term financial obligations. A longer-term problem is that unless appropriate action is taken, Colombia will become a sizable net importer of crude petroleum near the end of the decade, and the pressure on the balance of payments from petroleum imports, should they become necessary, could be considerable. A high-level Energy Council is studying exploration incentives, taxation and foreign-exchange arrangements, product pricing, and other aspects of this problem. 8. The rapid growth of Colombia's GDP in 1972-73 was accompanied by a sharply accelerated rate of price inflation. Consumer prices jumped 22 per- cent in 1973, as compared with 14 percent in 1972,, 12 percent in 1971, and an average of 7 percent yearly in 1967-70. Food prices, which have a weight of about 50 percent in the cost of living index, increased by 30 percent in 1973. The authorities have taken a number of measures to dampen price pres- sures, including liberalization of import controls, reduction of tariffs, and tighter controls on public expenditure, but given the weak state of public finances, inflation continued to be a problem throughout 1974 and was running at an annual rate exceeding 20 percent by year end. To deal with this situation, the new Government invoked emergency economic pow-ers and moved forcefully to implement a comprehensive fiscal and monetary reform aimed at strengthening public finances and at producing a more balanced flow of resources through Colombia's financial system and at providing the authorities with greater monetary control. 9. Colombia's public external debt repayable in foreign currency amounted to US$2.8 billion at the end of 1974L, or US$2.2 billion excluding undisbursed commitments. The Bank's share of this external debt (disbursed only) as of end 1974 was about 26 percent, but this share is expected to decline to 22 percent in 1978 as Colombia relies to a greater extent on other external borrowing. Service on this debt is modest (14 percent of foreign exchange earnings in 1974) relative to other developing countries. Since exports have risen more rapidly than debt service in recent years, there has been a decrease in the debt service ratio at a time when economic growth has accelerated. The debt service ratio is expected to rise moderately and peak in the early 1980's at about 19 percent as a result of greater capital inflows associated with a high growth rate. The Bank's share of total debt service is expected to peak at about 28 percent in 1975 and is likely to  - 4 - decline to 18 percent by 1978. Should economic growth continue at a rapid pace, which appears feasible, and should that growth be accompanied by a further strong expansion of non-coffee exports and the maintenance of sound economic and financial policies, Colombia should find it possible to secure the amounts of external capital it needs and to service the indebtedness that this borrowing would generate. Some of this capital will have to be provided to finance local costs if total foreign assistance is tc be large enough to enable the country to cover its resource gap on appropriate terms and maintain its rate of economic growth at an acceptable level. PART II: BANK GROUP OPERATIONS IN COLOMBIA 10. The proposed loan--the 60th to be made to Colombia--would bring the total amount of Bank loans to Colombia to US$1,147.2 million (net of cancellations). Of the foregoing amount, US$881.4 million is now held by the Bank, excluding one loan of US$5.5 million which is not yet effective. IDA has made one credit of US$19.5 million for highways in Colombia in 1961. 11. Disbursements have been completed on 34 loans and the one IDA credit. IFC has made effective investments and underwriting commitments in 21 enterprises in Colombia, totaling about US$30.3 million of which IFC now holds US$15.7 million. Annex II contains a summary statement of Bank loans, the IDA credit, and IFC investments as of March 31, 1975, and notes on the execution of the 25 on-going projects. SECTORAL COMBOSITION OF BANK GROUP OPERATIONS TO MARCH 31, 1975 (Amounts in US$ millions) Sector Share of Total Sector Number of Loans Total Amount % Agriculture 8 80.8 7.2 Telecommunications 3 46.0 4.1 Education 3 33.8 3.o Industry 8 226.8 20.0 Power 18 344.1 30.5 Transportation 12 229.6 20.4 Water Supply 6 158.6 14.1 Pre-Investment 1 8.0 0.7 Total 59 1,127.7 100.0 12. Since FY 1968, Bank lending in Colombia has become more diversified than in earlier years. All three loans in the education sector have been made since then as were four of the eight agricultural loans, five of the six loans in the water supply sector and four of the loans for industry.  -5- This compares with seven loans since FY 1968 in the sectors where the Bank has been traditionally active, i.e., power and transport. Bank efforts have been focused on production-oriented activities and activities which carry social as well as economic benefits. Projects being developed will seek to combine the objectives of increasing output with maximum benefits in terms of employment and improving the income of the poor, particularly in rural areas. 13. We expect over the next several years to make an increasing con- tribution to the agricultural and industrial sectors, with particular emphasis on projects involving small and medium size farmholdings and industrial enterprises. The other major focus of our activities would be in such social sectors as urban development and water supply. We would continue to support projects in the traditional sectors of Bank lendling-- electric power and transportation--in those cases where support is required for necessary institutional development. Projects are currently in an advanced stage of preparation for industrial finance, agricultural credit, and land reclamation. 14. Given the importance of sustaining a high growth rate in agriculture and the magnitude of the rural poverty problem in Colombia, there is an urgent need for Bank lending in the agricultural sector with the dual objective of increasing output and raising the productivity and income of small-scale farmers. We have moved increasingly into the agricultural sector in the recent past, and we expect to make a substantial further expansion over the next few years, with perhaps as much as one-third of our total lending to be made in the agricultural sector. 15. The operations of external lenders in Colombia are shown in Annex I, pages 3-h. While IBRD, IDB, and AID provided about four-fifths of total external financing to Colombia in the 1961-72 period, their share has de- creased since then. The IDB has assisted projects in low-cost housing, university education, agrarian reform, ports, electric power, water supply, transportation, and industry. AID had shifted the emphasis of its lending in recent years from program to sector loans, particularly for education, urban development, and agriculture. More recently it has moved in the direction of small project loans aimed chiefly at the improvement of income distribution. PART III: AGRICULTURE IN COLOMBIA 16. An exceptional regional diversity in soils and climates enables Colombia to produce a wide range of agricultural commodities for home con- sumption and export. In recent years government policy has been successful in encouraging use of the country's potential to diversify agricultural productior and reduce the excessive dependence on coffee. This, ir., turn,  -6- has contributed to the decline of coffee from about two-thirds to less than half of total exports. The overall rate of growth of the agricultural sector averaged 4.6 percent in real terms during 1965-73, as compared with 2.7 per- cent during the first half of the 1960's. 17. Despite the recent favorable growth performance, the sector is confronted with serious structural problems. Agriculture employs 41 percent of the Colombian labor force. While open unemployment in the sector has been estimated at no more than h percent, underemployment and seasonal un- employment together may raise the overall unemployment average for the sector to as much as 40 percent. Average per capita income in rural areas is only half the level of urban incomes, and rural income distribution is skewed, with the poorest 40 percent of the rural population receiving only 12 percent of total rural income. The distribution of income is related to the con- centration of land ownership: the 1970 census showed that the largest 10 per- cent of farms accounted for 80 percent of all farm land, virtually the same as in 1960. 18. The Colombian authorities have recognized that the problems of rural poverty and unemployment cannot be solved without a change in the structure of the agricultural sector through a production-oriented agrarian reform. Government actions since the establishment of the Instituto Colombiano de la Reforma Agraria (INGORA) in 1961 have aimed at lessening the concentration of land ownership and income through resettlement on publicly owned lands and on unused private land which has been purchased by the Government; by providing irrigation and drainage in areas inhabited chiefly by small farmers; and by granting more land titles to small farmers. In its irrigation and drainage districts INCORA has attempted, with varying degrees of success, to impose legal ceilings on the amount of land that could be retained by one owner once project works were completed. Elsewhere there has been little outright redistribution of productive land, however. 19. A new phase of land reform policies was initiated by the agrarian reform act of 1973. This bill had two main purposes: first, to substan- tially improve compensation for expropriation of well-cultivated land and thus dispel insecurity among landowners able to embark upon agricultural investment programs and, second, to make it easier for INCORA to expropriate. 20. As the agency responsible for agrarian reform, INCORA has granted about 135,000 titles to 3.8 million hectares of public lands and has acquired some 374,000 hectares of privately-owned land of which 190,000 hectares were redistributed to 11,300 families. The public lands are mainly in new frontier regions such as the Llanos and Caqueta. Sixteen irrigation and drainage projects, including some resettlement and small-farm improvement, have been initiated, covering some 500,000 hectares. In addition, amendment of the Agrarian Reform Law in 1968 made it possible for sharecroppers and tenant farmers to claim title to the land they farm, and nearly 80,000 of them have applied to IICORA. Of these, some 45,000 have had their claims recognized.  - 7 - 21. To raise the productivity of small holdings requires substantial inputs of technical assistance and credit. The IDB, through loans for the Instituto Colombiano Agropecuario (ICA), and AID, through its agricultural sector loans, have provided financing for improvements in research and extension services. AID also devoted a substantial portion of its agri- cultural sector loans to supervised credit for INCORA beneficiaries; while these sector loans have been discontinued, as noted above, the Bank is currently considering a loan for agricultural credit. Meanwhile, the Government has directed its agricultural credit policies increasingly toward the problem of the small farmers. For example, an analysis of the lending activity of the Caja Agraria, by far Colombia's largest agricultural lending institution, shows that in recent years it has been relaxing col- lateral requirements and progressively lending more to small farmers. 22. The new Lopez administration is attempting to formulate policies which will give long-range direction to and be supportive of programs in the rural sector. A central part of this process is the development of a national nutrition plan which wculd project the nutritional needs of Colombia and translate them into commodity needs; a separate plan will delineate the agricultural export potential of Colombia. Together these plans would give focus to both rural development and crop diversification efforts. 23. In the formulation of projects in the subsistence sector, there are two trends which are noteworthy. First, there is an increasing desire on the part of the Government that small farmers be dealt with collectively (in farmer groups or associations) if wide-scale development is to occur. The second trend is towards the implementation of multi- agency integrated development projects designed to serve both the economic and social needs of the farmers. 24. The Caqueta II project fits well into the overall policy objec- tives of the Colombian Government and the lending strategy of the Bank. It is also in harmony with the policy of successive Colombian Governments to develop the territories to the east of the Andean region, in the Llanos and Caqueta, as a means of simultaneously increasing agricultural output and ameliorating the problem of rural unemployment and poverty. Provision of social services and other follow-up assistance to established farms in the colonization areas contributes to continued success of the colonization effort by providing these recently developed areas with an adequate base for the growth of output and income. PART IV: THE PROJECT Background 25. Migration to the Caqueta region began during the rubber boom of the 1930's and has been assisted by the Government since 1959, initially through a directed colonization scheme but since 1964, when INCORA assumed  - 8 - responsibility, only in support of spontaneous settlement. In 1971 the Bank made a loan of US$8.1 million to the Republic of Colombia for the Caqueta Land Colonization Project (Loan No. 739-CO). The project, admin- istered by INCORA, was to benefit 8,000 families located in the area through long-term credit for livestock and construction of roads, schools, and health centers. 26. Execution of the first project has suffered from cost increases resulting from inflation, unexpectedly difficult physical condi- tions affecting the road construction program, and other problems mentioned in paragraph 33. Road construction will be approximately 200 km. instead of the 380 km. foreseen at appraisal, and the number of colonists receiving long-term credit will be about 1,700, compared with 4,500 originally projected; however, the amount of credit per settler has been substantially higher in real terms than anticipated. Disbursements totaled US$7.1 million as of April 14, 1975 and are expected to be completed by early 1976. The revised rate of return is estimated at 15 percent, compared with 16.5 per- cent at appraisal. 27. A second loan for the Caqueta Project was requested by the Govern- ment of Colombia in 1973. The project was appraised in January/February 197h on the basis of a feasibility study prepared by INCORA with the help of Colombian consultants. Negotiations were held in Washington on April 14-16, 1975, with a Colombian delegation led by Dr. Cristian Mosquera, Director of Public Credit, Ministry of Finance. 28. A project appraisal report entitled "Colombia - Caqueta Rural Settlement Project (Phase II)" (No. 501-CO dated May 2, 1975) is being circulated separately to the Executive Directors. The main features of the loan and the project are summarized in Annex III hereto. Pro.Ject Description 29. The proposed project, a continuation of the ongoing Caqueta Land Colonization Project, would help finance assistance to settlers in the Caqueta region, but would differ somewhat from the first project in that emphasis would be given to follow-up assistance to established farms, environmental protection, and social services. An estimated 2,850 small farmers would receive medium- and long-term credit in Phase II, and the additional economic and social infrastructure would benefit a large pro- portion of the overall population of the region, which has grown to 12,000 families. As under the first project, loans would be for acquisition of cattle and related expenses, reflecting the fact that the project area has poor soils not suitable for anything but extensive livestock farming. Under Phase II, some 200,000 hectares of pasture would be improved. 30. Project execution would require an estimated four years and would include the following elements: (i) farm development, comprising the clear- ing of land now under forest and establishing pasture, as well as supervised long-term credit, mainly for breeding cattle and other basic farm investments;  - 9 - (ii) supervised medium-term credit for cattle fattening; (iii) road con- struction, upgrading, and initial maintenance; (iv) construction and equipping of schools, health centers, supply stores, and administrative centers; (v) water supply and sewerage; (vi) malaria eradication; (vii) forestation and erosion control; (viii) technical assistance and training; and (ix) supply stores, administrative centers, vehicles and equipment for strengthening of INCORA's project administration. ProJect Execution 31. Responsibility for execution would rest with INCORA as in Phase I, and once again several other official entities would administer project elements under INCORA's supervision./ Long-term farm credit would be channelled through Banco Ganadero. 32. The administrative arrangements for a project of this nature are complex. Firm written agreements between INCORA and the cooperating agencies are essential to insure that each agency would carry out its assigned role in a conscientious and timely fashion. Agreements with Banco Ganadero, COOPERAGRO, Caminos Vecinales, INDERENA, and ICA, would be signed prior to effectiveness (Section 6.01 of draft Loan Agreement). Drafts of these agreements were reviewed during negotiations, and found to be satisfactory. Agreements with the Ministries of Health and Education, which primarily deal with the operation and maintenance of facilities to be constructed Lnder the project, would be signed within six months of the signature of the Loan Agreement (Section 3.03 of the draft Loan Agreement). 33. Some changes in the executing arrangements for the project relate to the correction in Phase II of certain problems encountered. in Phase I. Weaknesses have been noted in the road maintenance, education, and technical assistance elements of the first project. These would be dealt with in the proposed project by (i) providing funds directly to INCORA for road upgrading and maintenance, instead of to the Ministry of Public Works; (ii) providing funds to INCORA for school construction instead of relying on self-help methods; and (iii) providing funds to permit INCORA and ICA to increase their extension staff in the Caqueta region. A Cooperating agencies would be the following: (i) Banco Ganadero', long- term credit; (ii) Cooperativa Agropecuaria del Caqueta, Ltda. (COOPERAGRO), credit for cattle fattening; (iii) Fondo Nacional de Caminos Vecinales of the Ministry of Public Works (Caminos Vecinales), road upgrading and maintenance; (iv) Ministry of Education, supply of teaching materials and operation of schools; (v) Ministry of Health, water supply and sewerage, malaria eradication, and operation of health centers; (vi) Instituto de Desarrollo de los Recursos Naturales Renovables of the Ministry of Agriculture (INDERENA), forestation and erosion control; and (vii) Instituto CoLombiano Agropecuario (ICA), technical assistance.  34. There are certain internal problems of INCORA. The new Colombian Government plans a reorganization of the agency which might affect project execution. The loan agreement, therefore, contains provisions stipulating that events of suspension and default would occur if INCORA should be divested of the powers necessary for the efficient carrying out of the project, or if the basic laws of INCORA should be amended, suspended or abrogated so as to adversely affect the performance by INCORA of its obligations under the Project. (Section 5.01 (e) of the draft Loan Agreement). In addition INCORA does not maintain its accounts in such a way as to readily permit evaluation of the costs and benefits of its programs, or the proper pricing of its revenue-producing services. The necessary improvements in accounting will be made with the assistance of the Bank. 35. Finally, under the proposed project, an evaluation unit would be created in INCORA to conduct a continuous study of farm budgets and the rates and effects of settlement, deforestation, and herd development. (Section 2.13(a) of the draft Project Agreement). The unit would be staffed with an economist, a social anthropologist, and an agronomist-forester. Long-term Farm Credit and the Cattle Fattenina Program 36. About 2,850 settlers with holdings ranging from 30 to 200 ha would receive long-term loans under the project. Some 350 among these settlers would have had a first loan under the Phase I project and another 350 would receive two loans under the Phase II project. Initial loans would have ceil- ings of 10 or 15 breeding cows and one bull, according to farm size. Second loans would not exceed 10 head, and loans to settlers who already owne:d cattle would cover only the number needed to bring the total herd number to 25. On average, acquisition of cattle would make up 70 to 80 percent of the loan amount. The balance of the loan amount would go for fencing, grass seeds, animal drugs, basic supplies for farm constructions, and, in some cases, hired labor for land clearing. Loans would be disbursed directly to suppliers from which the farmer is acquiring the aforementioned inputs and would cover 100 percent of the cattle and supply costs. Farmers woulcL con- tribute labor and materials (mainly wood) available on the farm. 37. The revolving fund started under the Phase I project to expand the cattle-fattening program of COOPERAGRO would be continued under Phase II. Two-year-old animals are purchased for fattening by COOPERAGRO members. After 20 months, the fattened animals are sold under COOPERAGRO's supervision. The revolving fund would provide the capital needed to make about 200 loans a year, averaging 15 head each. Relendinpg TermsL. 38. Long-term credit would continue to be provided through Banco Ganadero according to ongoing procedures, which have proven satisfactory. INCORA's /j Schedule 1 to draft Project Agreement.  field staff receive farmers' applications, and, together with Banco Ganadero's farm planners, prepare farm plans and loan requests. These requests are examined by itinerant loan committees, composed of Banco Ganadero and INCORA staff and a farmers' representative, who determine whether candidates meet the following criteria: (a) have been assessed creditworthy by Banco Ganadero; (b) have no access to other sources of credit on reasonable terms and possess less than 25 head of cattle; (c) have at least 10 ha of land cleared and under pasture; (d) live on and operate a farm of between 30 and 200 ha; (e) own the farm under written land title or land assignation contract; and (f) have agreed to accept INCORA's and Banco Ganadero's supervision of farm development. 39. In support of the long-term credit component of the proposed pro- ject, Bank and Government resources (which INCORA would repay to the Govern- ment in 20 years, with four years of grace, without interest) would be lent by INCORA to Banco Ganadero at 9 percent interest, with Banco Ganadero assuming the credit risk. Banco Ganadero would repay INCORA under an amorti- zation schedule substantially reflecting the aggregate of the amortization schedules of the long-term loans to farmers made by Banco Ganadero. The estimated 2,850 participating farmers would repay Banco Ganadero over 12 years (including a three-year grace period) at 15 percent interest. INCORA would thus have the use of some of these repayments for some time prior to repaying the Government under the aforementioned amortization schedule for the Govern- ment loan to INCORA. These resources, in addition to those resulting from the 9 percent spread which INCORA would receive, would be used for the execution and expansion of INCORA's credit and land reform activities. The 15 percent lending rate to participating farmers compares favorably with an effective rate of 6.25 percent paid by farmers under Phase I, but it is still a negative rate of interest should current rates of inflation--over 20 percent per annum-- continue. However, there is some prospect of deceleration of inflation, and without such assistance beneficiaries with less than 50 ha--above one quarter of the total--would have little incentive to participate in the program, given the modest size of their incremental income. Moreover: (a) there are at present no satisfactory alternative systems of subsidi- zation available to assist the settlers in making a success of their migration to the Caqueta area; several systems, including subsidiza- tion of cattle prices or the purchase of new settlers' grain production at higher than market prices, have been investigated, but they would require complex controls; and (b) the problems posed by the inherent fungibility of credit and possible misallocation of resources are minimized because of INCORA's and Banco Ganadero's close supervision, the benefi- ciaries' lack of fungible resources, and because of the fact that loans are not disbursed to the settlers in cash.  - 12 - Should the Government decide to change the interest rate regulations affect- ing agriculture loans currently in force, the proposed interest rate of 15 percent would be subject to review. If the Bank and the Borrower cannot agree on new conditions of lending within six months, new lending would be suspended until such agreement is reached. (Section 3.04 of the draft Loan Agreement). 40G For the cattle-fattening phase of the project, Bank and Government funds would be lent by 1IECORA to COOPERAGRO at 18 to 20 percent interest per annum. When the animals are sold under COOPERAGRO's supervision after 20 months, the individual farmer would receive 60 percent of the gross profit. (Alternatively, INCORA would be able to make such loans directly to farmers at 20 percent interest per annum). COOPERAGRO would repay the principal of the loan to INCORA in two equal installments at the end of the 20th and 40th month, and INCORA would reinvest in the revolving fund as required to maintain the fund's value. Road Construction 41. About 200 km of roads would be constructed to continue those started under the Phase I project. The construction schedule, calling for completion of an average of 50 km per year, corresponds to performance under the Phase I project during the 1973/74 period. A consulting firm or specialized agency would handle design and supervision. Road standards would be the same as those for Phase I roads except that cuts and embankments would be designed with gentler slopes and protected to prevent erosion. Assurances were obtained from Government that anti-erosion measures would be taken to protect project roads. (Section 4.02(b) of the draft Loan Agreement.) Complementary Road Works 42. Because of the difficulties encountered in constructing roads in the heavy forest, more complementary works are required on them during the first years than on roads constructed in more open and accessible areas. Thus the project would provide for the purchase and operation of machinery for upgrading and maintaining such roads during the project period. The machinery purchased would consist of two motorgraders, one bulldozer, two loaders, one trailer, eight dumpers, and ancillary equipment. It would remain INCORA's property and be pooled with equipment owned by Caminos Vecinales. Annual costs per km for these complementary works would average Col$20,000 (US$780) during year one but decrease to Col$15,400 (US$600) by project year four. Education Services 43. The project would continue INCORA's school construction program by building about 30 primary schools, averaging 150 m2 each. The program  - 13 - would be executed either directly by INCORA or by Instituto Colombiano de Construcciones Escolares (ICCE), a specialized agency within the Ministry of Education. The project would also provide each of the 500 primary schools in Caqueta with sets of teaching aids and a supply of reading materials. Reading materials would also be supplied for adult training courses given by Accion Cultural Popular (ACPO). Health Services 44. Ten health posts and two health centers would be constructed and supplied with necessary equipment at average unit costs of Col$0.5 million and Col$1.0 million, respectively. Some Col$23.8 million would also be provided for a health program focusing on malaria control and improvement of hygienic conditions in rural centers. Forestry and Erosion Control 45. The project would assist an erosion control program to be imple- mented by INDERENA. The program would encompass (a) a nine-month study to identify a suitable pilot project area in the Cordillera where socio-economic effects of anti-erosive measures could be analyzed and (b) the demarcation and protection of a 20,000-ha forest reserve in which to conduct trials to determine the most appropriate species to be planted on eroded river banks and to replace natural forest for commercial exploitation. The reserve would also be the basis for identification studies of future reserves in un- settled areas where larger blocks of forest could be conserved. The establish- ment of this reserve would give INDERENA its first opportunity to test the application of protective measures for forest reserves in the Amazon against settlers' incursions. The problem of overgrazing in the foothills would be reduced by intensifying farmers' technical assistance. Since conservation efforts in other parts of the country have often failed because of lack of financial support, assurances were obtained from the Government that it would allocate to INDERENA sufficient funds to operate and maintain the forest reserve after the end of the project development period. (Section 4.03 of the draft Ioan Agreement.) Technical Assistance 46. A unified extension service that would improve small farmers' Animal husbandry methods and pasture management would be established. Pri- mary objectives would be to reduce overgrazing and increase farmerst income. This project component would be carried out by INCORA with the assistance of ICA and would cover the salaries of U1 animal husbandry and two agri- cultural officers (at Col$120,000 each per year) and 10 additional field agents (at Col$80,000 each per year) during the four project years, as well as their vehicles, training materials, and inputs for 'demonstrations.  Project Administration 47. Project administration costs would cover salaries of INOCRA's Project Manager and five Section Chiefs; headquarter overheads (about two percent of investment costs); salaries of additional staff needed to expand operations, including about 10 credit supervisors; and operations of the evaluation unit. Vehicles and equipment (particularly topographic) would also be provided, and three new offices accessible by road in Curillo, Solano, and Cartagena would be constructed. Finally, three farm input supply stores would be built by INCORA in remote rural centers and trans- ferred on completion to Central de Cooperativas de la Reforma Agraria Ltda. (CECORA). Assurances were obtained that a draft agreement between INCORA and CECORA about these stores would be submitted to the Bank for approval within one year after loan signature. (Section 2.09 of the draft Project Agreement.) ProJect Cost and Financing 48. Estimated project cost is the equivalent of US$37.1 million, of which US$5.3 million is allocated for price contingencies. The proposed Bank loan of US$19.5 million would be made to the Government (which would bear the exchange risk), and the loan would cover 53 percent of total project cost, including estimated foreign exchange costs of US$8.1 million or 22 per- cent of the total and a US$11.4 million portion of local costs. The balance of the local costs would be financed by the Government (the equivalent of US$12.1 million, or 32 percent of the total) and by the settlers themselves (the equivalent of US$5.5 million or 15 percent of the total), in the form of farm labor and materials. Marketing 49. Under Phase II of the Caqueta project some 200,000 hectares of pasture would be expected to be improved, capable of supporting a cattle population of about 226,000 head. This would result in annual sales of some 40,000 head at full development in 1995. The increased output resulting from both Phases I and II together would be approximately 75,000 head annuaIly (30,000 tons liveweight) at full development, or 23 percent over what regional production would be without the project. The cattle-fattening element would add an estimated additional 3,000 steers annually to sales. It should be noted that construction of a slaughterhouse in the region is envisaged by Banco Ganadero. 50. Beef production resulting from the project could be readily absorbed by the domestic marketj which is growing steadily, especially in urban areas. At present the caqueta region produces about 33,000 tons liveweight annually of which about 40 percent is marketed locally and 60 percent absorbed by other regions, mainly Cali.  - 15 - 51. During the early years of the project, as land is cleared, farmers would raise maize, rice, pigs, and other staple food crops. Output would be used mainly for on-farm consumption, but any surplus grain production would be purchased by the Instituto de Mercadeo Agropecuario (IDEMA). Farm Income 52. The proposed project would provide credit and other benefits to families working 30 to 200 hectares. Though the data are not precise, indications are that such families' per capita incomes may average as low as US$70, assuming six to seven people per family. Other very rough estimates indicate that the poorest 140 percent of the Colombian population receive an average per capita income of about US$100. Our projections indicate that with total development costs approximating US$6,600 per family, including the reimbursable loan of US$3,600 per family, per capita incomes of the some 4,700 families directly participating in Phase I and II would be raised at full development after 20 years to the order of US$250 for families working 30 hectares and US$550 for 200 hectare farms. It thus seems clear that the proposed project would serve the Government's objectives of increasing output and improving the income of the poor, particularly in rural areas. Procurement 53. Procurement procedures which have proved satisfactory in Phase I would be continued in Phase II. Road construction and road maintenance equipment would be purchased by international competitive bidding. A 15 per- cent preference in such international bidding would be accorded to suppliers of equipment manufactured in Colombia. Contracts for all other construction and for purchase of equipment and materials would be awarded on the basis of INCORA's local bidding procedure, or that of ICCE (if ICCE is utilized by IhCORA to carry out the school construction program). Local bidding pro- cedures are acceptable to the Bank because foreign firms would not be interested in contracts to erect small buildings in that remote Amazon region, and because the equipment and materials concerned would be in small quantities. However, certain of the items to be procured under local bidding would be of foreign origin. Disbursements 54. The proceeds of the Bank loan would be used to finance 70 percent of the amounts disbursed by INCORA for medium- and long-term credit programs; 70 percent; of expenditures on road construction and buildings; 50 percent of expenditures on water supply and sewerage systems; and 70 percent of expendi- tures on the education, forestation and erosion control, and technical assist- ance programs. The Bank loan would also finance 100 percent of foreign- exchange expenditures on vehicles, equipment, and anti-malaria products or 95 percent of the ex-factory cost of such locally-produced items. About US$3.3 million of the Bank loan would initially be unallocated as a contingency reserve. Disbursement would be made against statements of expenditure  - 16 - submitted by INCORA on behalf of the Government and supported by documenta- tion which would be available for inspection by Bank supervision missions. Disbursement claims for long-term credit would be supported by certified statements from the Banco Ganadero and claims for road construction by statements from the Engineering consultants. Economic Rate of Return and Justification 55. The economic rate of return for Phase II, when costs and benefits are discounted over a 23-year project life, has been calculated at 13.8 per- cent. This compares with a rate of return in Phase I of 15.0 percent. The rate of return for both phases combined is 1.1 percent. 56. Benefits to farm families in the Caqueta region who are not partici- pating in the credit program were included in the rate-of-return ca:Lculation only insofar as such families would benefit from reduced transportation costs for their farm output as a result of project roads. Neither benefits nor costs were included for the education and health programs, in view of the difficulty of quantifying such benefits. Nor were benefits included from the forestry and erosion control element of the second project, or from the reduced cost of transportation of persons. 57. The project would provide direct assistance in the form of super- vised long-term credit and technical assistance to some 2,850 low-income farmers. Though the size of their farms would range upward to 200 hectares, this is not a large holding in an area characterized by poor soils, suitable only for extensive livestock farming. The maximum herd financed for any participant would be 25 head, apart from other animals on loan for fattening. By facilitating the economic progress of these farmers who are highLy moti- vated to improve the income of their families by migrating to an area requiring extremely hard physical work in a difficult environment, the project would be consistent with the objective of more equitable income distribution in Colombia. Similarly, it would be consistent with the objective of reducing the pressure of urban migration. In addition to the 2,850 direct beneficiaries, a large proportion of the 12,000 families living in the region would benefit from the roads, social services, erosion control, and improved availability of technical assistance and training to be provided under the project. 58. Finally, the value of annual meat production in Colombia would be increased by the proposed project at full development by US$8.9 miLlion (1974 dollars), which would create indirect foreign exchange earnings by freeing meat produced closer to ports for export abroad.  - 17 - PART V: LEGAL INSTRUMENTS AND AUTHORITY 59. The draft Loan Agreement between the Republic of Colombia and the Bank, the draft Project Agreement between the Bank and Instituto Colombiano de la Reforma Agraria, the Report of the Committee provided for in Article III, Section h (iii) of the Articles of Agreement, and the text of a draft resolution approving the proposed loan are being distributed to the Executive Directors separately. The draft agreements conform to the normal pattern for loans for rural settlement projects. 60. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI: RECOMMENDATION 61. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments May 2, 1975   COUBNTR DATA - COOWNIA 1,139,000 1,2 23.0 million (mid-1972) .. Pe taf acubic land 1~al1Ainb