Papua New Guinea - Popondetta Smallholder Oil Palm Development Project

Report No. 1160-PNG Papua New Guinea: Appraisal of the Popondetta Smaliholder Oil Palm Development Project R N TOa RETORNTO ~S September 24,' 1976 RPRS0S Projects Department F LE C tOPY ~ WITHIN East Asia and Pacific Region ONE ~WEEI<-- FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1 - K 0.78 K 1 - US$1.27 K 1,000,000 - US$1,270,000 WEIGHTS AND MEASURES 1 hectare (ha) - 2.47 acres 1 kilometer (km) - 0.62 miles 1 metric ton - 2,206 lbs. ABBREVIATIONS ADB - Asian Development Bank ASAG - Australian Staff Assistance Group CDC - Commonwealth Development Corporation DASF - Department of Agriculture, Stock and Fisheries DMD - Deputy Managing Director DPI - Department of Primary Industry (previously DASF) EC - Estate Company FC - Factory Company FFA - Free Fatty Acid FFB - Fresh Fruit Bunch IATI - Highlands Agricultural Training Institute H & C - Harrisons and Crosfield Ltd. IBRD - International Bank for Reconstruction and Development (Bank) IDA - International Development Association M - Million MD - Managing Director NBPOD - New Britain Palm Oil Development Ltd. NEC - National Executive Council OPC - Office of Project Coordination PATI - Popondetta Agricultural Training Institute PC - Project Coordinator PM - Project Manager PMC - Project Management Committee PNG - Papua New Guinea PNGDB - Papua New Guinea Development Bank PRDO - Provincial Rural Development Officer PTA - Plant and Transport Authority PWD - Public Works Department RDA - Rural Development Assistant RDO - Rural Development Officer RDT - Rural Development Technician ROR (E)- Economic Rate of Return ROR (F)- Financial Rate of Return TA - Technical Assistance TC - Transport Company TOR - Terms of Reference  FOR OFFICIAL USE ONLY PAPUA NEW GUINEA POPONDETTA SMALLHOLDER OIL PALM DEVELOPMENT PROJECT Table of Contents Page No. SUMMARY AND CONCLUSIONS ...............................- iii I. INTRODUCTION .......................................... 1 II. BACKGROUND ............................................ 2 A. General ..................................I....... 2 B. Agricultural Sector .............................. 3 III. PROJECT AREA AND FORMULATION .................. 9 A. Area ............................................. 9 B. Formulation ...................................... 10 IV. THE PROJECT ........................................... 11 A. General Description ........ . ... ........... 11 B. Detailed Features ................ ................. 12 C. Environmental Impact .................. 16 D. Cost Estimates ................................... 16 E. Financing .................... .................. 18 F. Procurement ....... ............ .................. 20 G. Disbursements .................. .................. 20 V. ORGANIZATION AND MANAGEMENT ........................... 21 A. General .......................................... 21 B. Department of Primary Industry .............. .... 22 C. Papua New Guinea Development Bank .... ............ 22 D. Staffing ......................................... 24 E. Settler Selection ................................ 24 VI. YIELDS, MARKETING AND SMALLHOLDERS' INCOME .... ........ 24 A. Yields ........................................... 24 B. Markets and Prices ............................... 25 C. Purchase of Smallholders' FFB .................... 26 D. Smallholders Incomes ............................. 26 VII. BENEFITS AND JUSTIFICATION ............................ 27 VIII. RECOMMENDATIONS ....................................... 31 Th document hs a retricted distributn and may be used by recipents only In the performance of their omcial dutis. Its contents may not othetrwis be disclosd without World Bank authorilation.  -2*- ANNEXES 1. Department of Primary Industry Table 1: DPI Staffing Chart 1: DPI Organigram 2. Papua New Guinea Development ]3ank Appendix 1: Organization Chart 2: Staff Numbers 1973-1978 3: Draft Terms of Reference for Agricultural Credit Specialist 4: Terms of Reference for Consultants (Systems and Procedures) 5: List of PNGDB Offfices as at February 1976 Table 1: Balance Sheets 2: Profit and Loss Accounts 3: Analysis of Administrative Expenses 4: Loan Approvals 5: Agricultural Loans to Papua New Guineans - FY75 6: Bank Control-led Companies 3. Oil Palm Development and Research Table 1: Timetable fcir New Settlements 2: Smallholder Labor Requirements 3: Planting Program for Smallholders and the Nucleus Estate 4: FFB, Oil and Kernel Yields in Ton/Ha 5: FFB, Oil and Kernel Production 6: Required Mill Capacity 7: Smallholder Fertilizer Recommendations and Costs 8: Development Costs for New and Existing Settlements and Vilage Holdings 9: Farm Model-Existing Settlements 10: Farm Model-New Settlements 11: Farm Model-Village Holdings 12: Summary Smallholder Oil Palm Development Costs over P'roject Development Period Chart 2: Critical Path for Project Implementation 4. Nucleus Estate and Processing Facility Table 1: Cost for Factory and Estate Companies 2: Financing Plan - Factory and Estate Companies 5. Road Requirements, Infrastructure and Staff Transportation Table 1: Road Construction - Phasing and Costs 2: Social Services - Housing and Building Require- ments and Costs 3: Extension Service - Housing and Building Requirements and Costs 4: Vehicle, Equipment'and Machinery Hire  -3- ANNEXES (Contd/...) 6. Technical Services and Staffing Appendix 1: Terms of Reference Table 1: Social Services - Staff Requirements and Costs 2: Extension Service - Staff Requirements and Costs 3: Technical Assistance - Requirements and Costs 7. Smallholder FFB Marketing Table 1: Transport Company - Construction Program and Costs 2: Transport Company - Staffing Requirements and Costs 3: Transport Company - Vehicles and Equipment Require- ments and Costs 4: FFB Pricing Formula 8. Project Cashflows Table 1: PNGDB Project Cashflow 2: Smallholders Cashflows 9. Disbursement Schedule 10. Project Management Chart 3: Project Management Organization 11. World Market Prospects for Palm Oil Table 1: Palm Oil Production in Major Producing Countries: Five Year Averages and Percentage Shares, 1955-1974 2: Palm Oil World Exports in Major Producing Countries: Five Year Averages and Percentage Shares, 1955-74 3: Palm Oil Imports by Major Importing Countries: Five Year Averages and Percentage Shares, 1955-74 4: World Production of Selected Oil Seeds, Fats and Oils 5: World Exports of Selected Oil Seeds, Fats and Oils 6: Prices and Price Index of Selected Fats and Oils (Current) 7: Prices and Price Index of Selected Fats and Oils (Constant) Graph 1: Palm Oil Production for Selected Countries 2: Palm Oil Exports for Selected Countries 3: Palm Oil Imports for Selected Countries 12. Economic Analysis Table 1: Economic Rate of Return 13. Cost and Benefit Recovery Table 1: Rent and Cost Recovery MAPS   PAPUA NEW GUINEA POPONDETTA SMALLHOLDER OIL PALM DEVELOPMENT PROJECT SUMMARY (i) The proposed eight year project is designed to establish small- holder settlement for oil palm production at Popondetta in the Northern Province of Papua New Guinea. It would be part of an overall area develop- ment program of Popondetta directed to the establishment of 9,600 ha of oil palm comprising 5,600 ha for smallholders, 4,000 ha for a nucleus estate company and the establishment of an oil palm factory company to process both smallholders and nucleus estate production. The nucleus estate/factory companies would be financed jointly by Government and the Commonwealth Development Corporation (CDC). The Project has been based on the highly successful smallholder oil palm development at Hoskins in New Britain which was financed by IDA Credits 137 and 175-PNG. Oil palm is an ideal crop for smallholder settlement in PNG since it has been shown that under local con- ditions the settlers, most of whom have had no previous experience with tree crops, are able to meet the management requirements associated with success- ful oil palm development with intensive guidance from extension staff. Also because of favorable soils and climate, oil palm yields up to 20% more and starts yielding up to 1-1/2 years earlier than in other countries. This gives PNG considerable advantage over other oil palm producing countries. (ii) The Project would focus on the establishment of 4 ha of oil palm and a 1/2 ha of food garden for about 1,400 settlers, 600 of whom would be new settlers from other areas and 800 who would either be existing settlers of a previous unsuccessful cocoa development program or villagers living in the area. The smallholders would be provided long term credit to cover on- farm development costs, settlement/survey costs and a living allowance paid until the commencement of oil palm production. All loans would carry a 11% interest rate with a 4 year grace period. The extension services at Popondetta would be expanded. In addition to providing assistance to settlers on oil palm development the services would also be available to all people in the area to advise on food crop production. The health, education and welfare services in the area would also be upgraded in line with Government's policies to bring the amenities to its standards for rural areas. Technical assistance would provide for recruiting 14 years of tech- nical and financial management expertise and for 2 man years for training field officers of the Papua New Guinea Development Bank (PNGDB) and the Department of Primary Industry (DPI) in smallholder credit operations.  - ii - (iii) Total project costs are estimated at US$18.5 M with about 61% foreign exchange component. The Bank loan would finance foreign exchange costs of US$11.3 M and US$0.7 M local currency for additional extension staff required by the Project. International bidding for purchase of on-farm development items, building construction for extension and social services and vehicles for transportation of smallholders fruit would not be appropriate because of the small nature of individual orders or contracts and also that they would be phased over a minimum of 5 years. For all of these, contracts would be awarded on the basis of competitive bidding advertised locally in accordance with Bank guidelines. Road construction and upgrading would also not be attractive for international competitive bidding because of the small- ness of individual contracts phased over a 4 year period. The Public Works Department (PWD) would tender in accordance with Bank guidelines for bridge and new road works (US$2.56 M) but would carry out upgrading work (US$1.05 M) with its own resources since PWD would be best equipped for this work which is in the nature of maintenance. The recruitment of personnel under technical assistance (US$0.97 M) would follow Bank guidelines for recruiting consultants. (iv) Government recently established a Project Management Committee (PMC) with overall responsibility for project execution. A Technical Director (TD) in the Department of Primary Industry will be responsible for physical imple- mentation of the project. A Project Coordinator (PC) will be the executive officer for the PMC and will be responsible for routine administration. He will be located in the Office of Project Coordination (OPC) which has been established in the Department of Finance to service all National Development Projects. In addition to liaising with the line departments involved in the project and the Project Manager Field (PM), the PC will also be responsible for coordinating project reporting, financial control and preparing disburse- ments claims for the Bank. The TD and the PC will be Government appointed Directors (or Alternate Directors to the Secretaries for Primary Industry and for Finance) to the Boards of the Factory Company, the Nucleus Estate Company and the FFB Transport Company during the peroid of project implementation. (v) The PM would be responsible for supervision and coordination of all field activities of the smallholder development program; as head of the DPI field staff he would be located at Popondetta. He would report to the PC on all matters relating to project financing and to the TD on all extension staff and technical matters. (vi) In addition to it being a crop that is well suited to the Papua New Guinean smallholder, investment in oil palm in PNG is also justified as follows: (a) it is exploiting the proven natural advantages of inherently fertile soils, good climate and freedom from pests and diseases for oil palm production; (b) it is adding to the country'S base of foreign exchange earners; and  - iii - (c) under PNG conditions it is an ideal crop to pioneer area development in many of the underutilized fertile coastal areas by providing a sound commercial base from which further secondary development can expand. (vii) No difficulty is expected in marketing the output of the small- holders and the nucleus estate estimated to peak at 42,400 tons in 1988 when PNG's total production would represent about 2% of estimated world exports and 1% of world production at that time. Smallholders would commence earning incomes in about the 4th year of development and over the period of debt service these would increase to about K 650 (US$825). At full produc- tion, after loans are fully repaid, a settler's cash income is expected to peak at about K1,560 (US$1,981). This income which is roughly three times the estimated subsistence commodity basket affords adequate incentive to ensure smallholder participation. Based on a median farm gate price of K 22.50 per ton FFB the rates of returns to the smallholders is satisfactory at 17.1% for new settlers, 19.8% for existing settlers and 20.5% for villager farmers. The economic rate of return of 14.5% is satisfactory particularly in PNG where opportunities for large scale investment in commercial agricul- ture are limited. In addition to providing increased incomes for smallholders the project would also provide for improved health, education and welfare facilities to all people in the project area. The project would also encourage through its settler selection policy integration of people from many parts of the country with the development of a new social identity amongst them. This aspect is of particular significance as PNG searches for a new post indepen- dence national identity. (viii) This would be the fourth Bank Group project in PNG's agricultural sector. In FY69 a Credit of US$1.5 M was made for a smallholder oil palm project and this was expanded in FY70 with a further credit of US$5.0 M which also financed coconut development and livestock ranching. The third credit of US$5.0 M was made in FY73 for smallholder livestock development. (ix) With the assurances detailed in Chapter VIII, the proposed project is suitable for a US$12 M loan under usual Bank terms. The borrower would be the Government of PNG.   PAPUA NEW GUINEA POPONDETTA SMALLHOLDER OIL PALM DEVELOPMENT PROJECT I. INTRODUCTION 1.01 The Government of Papua New Guinea requested the Bank Group's assistance in the financing of smallholder oil palm development in Bialla (in West New Britain) and Popondetta (in Northern Papua) and submitted its pro- posals for a project in 1973. An IDA/IBRD appraisal mission visited Papua New Guinea (PNG) in March/April 1974 and prepared proposals for the Bialla sub- project subject to agreement between Government and its Japanese co-financiers (in the nucleus estate companies) 1/ on factory design and specifications. Appraisal of the Popondetta sub-project was postponed due to delays by Commonwealth Development Corporation (CDC), Government's joint venture part- ner in that sub-project, in completing its own appraisal. 1.02 An IDA mission visited PNG in February, 1975, but due to continued disagreement between Government and the Japanese co-financiers, there was no progress on the Bialla sub-project. 2/ Processing of the Popondetta sub-project also was further delayed since CDC had still not completed its appraisal. The position improved in 1975 and a Bank mission consisting of Messrs. Milford, Arichandran and Prins (Bank), Bell and Jagger (Consultants) visited PNG in February, 1976 to finalize the Popondetta sub-project. This report is based on the findings of this mission. 1.03 This would be the fourth Bank Group project in PNG's agricultural sector. In FY69 a credit of US$1.5 million (M) was made for a smallholder oil palm project and this was expanded in FY70 with a further credit of US$5.0 M which also financed coconut development, and livestock ranching. The third Credit of US$5.0 M made in FY73 was for smallholder livestock development. 1.04 The proposed project conforms with Government's strategy for development, through diversification, of PNG's agricultural sector and export earnings, 3/ and its aim to achieve national economic growth and social justice, and promote self reliance. 1/ These consisted of a Holding Company and two Subsidiaries for a nucleus estate and a processing factory unit. 2/ During negotiations the Bank was informed that Government had terminated the agreement with its joint venture partner. 3/ The project will help in reducing (at least somewhat) PNG's dependence on copper as a foreign exchange earner.  - 2 - II. BAC]KGROUND A. General 2.01 Formerly, New Guinea, a UN Trust Territory and Papua, an Australian dependency were administered by Australia under an Administrator as one poli- tical and economic unit called Papua New Guinea. It achieved internal self- government on December 1, 1973 and the country became independent on September 16, 1975. 2.02 PNG covering an area of 1.2 mil.lion sq km is in the tropics, some 165 km north of Australia. The country comprises the eastern half of the island of New Guinea (mainland); nine major islands including New Britain in the Bismarck Archipelago; and a large number of smaller islands (Map 1). The total land area is about 475,000 sq km, of which about 85% is mainland. It is an area of unusual diversity with extremely rugged mountains, wide valleys, large river systems, extensive jungles and coastal swamps. Much of the country is mountainous, with ridges on the mainland rising to 4,600 m and on the islands to 2,600 m. Lowland areas are hot and humid, though the ex- tensive highlands have cool temperatures. Most areas have an average annual rainfall of about 2,000 mm, but some exceed 4,400 mm. 2.03 The population at June 1975 was estimated at 2.75 million including about 39,000 non indigenous (mostly Australians). It is estimated to increase at about 3% per annum. About 75% of the population are rural dwellers out- side the cash economy with a strong tribal village tradition based on sub- sistence farming. About 55% of the population is concentrated in the High- lands where in many parts the pressure on the available arable land is high and any significant increases in agricultural output will need to come through the introduction of higher yielding subsistence crops, diversifica- tion of crop production and improvement in the incentives for people to grow more than their subsistence requirements. In most coastal and island rural areas, however, population densities are much lower and as a result there are areas of unused land, some of which is highly fertile. 2.04 The non-indigenous population, although small, has played an important role in PNG's development to date. In addition to being the main source of capital and management in the private business/commercial sector most of the senior middle and to a lesser extent junior management/technical positions in Government were, up to a few years ago, almost exclusively staffed by expatriates. However, since self-government there has been a concerted effort to replace expatriates with Papua New Guineans at all levels. Although Government's policy is to localize its staff as rapidly as possible it has recognized the continuing need for considerable expatriate expertise until existing and planned education/training programs start to meet the needs for trained staff which will not be for a number of years. Many ex- perienced expatriate staff have either left, or are about to leave the permanent service shortly, as a result of the proposed termination of the Australian Staff Assistance Group (ASAG) operation on 30 June 1976.  - 3 - However, a number of these officers plan to remain at their desks and to take up direct contracts with Government. As well, Government has had little trouble recruiting replacement expatriate staff (from Australia, New Zealand, UK, and the Philippines) but most of them are much less experienced than those they are replacing. 2.05 The PNG economy is characterized by a large but slowly growing subsistence agricultural sector and a rapidly expanding monetary sector. Approximately 25% of the population is wholly engaged in activities of the monetary sector which is focused on agriculture and livestock development, mining, Government operations and services. During the 1960's the share of the subsistence agriculture sector fell from 65% to 40% of GDP, and de- clined sharply in 1972 to 20% of GDP when the Bougainville copper mine started producing. The per capita GDP in FY74 was about K 262 (US$335) including the high income expatriate sector. Excluding this sector per capita income was estimated at K 120 (US$153). B. Agricultural Sector 2.06 Agriculture is an important mainstay of PNG's economy. The country has ample land resources. Of its 47.5 million ha of land area, 15 million ha (31%) is topographically, geologically and climatically suited for agriculture. However, only about half of the arable land is put to agricultural use in one form or another. About 90% of the population is directly dependent on agri- culture (including subsistence farming) which up to FY1971/72 accounted for almost all of PNG's export earnings. Since the Bougainville copper mine started operating in early 1972, however, copper has become the country's most important productive activity and export item and the share of agricultural exports fell sharply to about 30% of PNG's total foreign exchange earnings in 1975. The commercial agriculture in PNG consists of (a) a rapidly expanding sub-sector to service the demands of the growing urban population. Fruit and vegetable, beef, pork, chicken and egg production have all increased signi- ficantly and in 1974 were valued at about K 15 M and (b) a sub-sector geared to production of export plantation crops which in 1974 were valued at K 126.2 M. Of these copra and coconut oil accounts for 34%, coffee 27%, cocoa 31%, rubber 2%, tea 3% and oil palm 3%. In spite of the overriding importance of copper as an export commodity it is important for PNG to minimise the risk of dependence on a single commodity as the main source of foreign exchange. At present the only alternative is by increasing output of all or some of the above commodities. Thus by 1984 it is envisaged that the export earnings from this sub-sector would be about K 300 M of which copra/coconut oil would account for 15%, coffee 52%, cocoa 12%, rubber 2%, tea 5% and palm oil 14%. Land Tenure 2.07 About 97% of all lands in PNG are held under traditional tenure systems as "native land." About 1% is held by expatriates and the remainder  by Government (principally settlement schemes) and religious missions. Agricultural development on "native land" has been hampered because of the extreme difficulty in establishing agreed ownership and usage rights over economically sized land parcels. Very little cash cropping is done on these lands and when it is, it is generally on a small scale and as an ad- junct to subsistence farming. Cash cropping on these lands has been the most successful where it has been possible to rationalize land tenure to permit individuals or small groups to use larger parcels of land. However, most significant commercial agricultural development by smallholders to date has taken place on Government lands many of which have been converted to leasehold (99 years) for individual smallholders. Although Government is empowered to acquire "native lands" for development purposes this (for political reasons), is rarely done. Almost all such lands obtained by Government are bought from clan or tribal groups only after complete agree- ment is reached between all parties inzvolved. Government has yet to final- ize many aspects of its land tenure policy, although it has been broadly following the guidelines set by the report of the Commission of Inquiry into Land Matters which was tabled in Parliament in May 1974. Department of Primary Industries (DPI) 1/ 2.08 The DPI is the main agency within the Government responsible for formultation of agricultural development policy. It is also the main anrm for execution of this policy. In addition to its central administra- tive planning and coordinating role DPI is also responsible for country- wide field operations the most important being extension and research. These operations are coordinated by an Assistant Director (Policy Review and Cocrdination'" and four area coordinators who have under them in the field nineteen Provincial Rural Development Officers (PRDO) in charge of extension services in the nineteen provinces. These in turn supervise the activities of Rural Development Officers (RDO), Rural Development Techni- cians (RDT) and Rural Development Assistant (RDA). In addition there are field clerical and other support staff including specialists such as area veterinarians, area economists and special project managers. DPI has been the main executing agency for all of the IDA agricultural projects (oil palm and livestock) financed to date (paras 2.16 - 2.18) with responsibility for providing (a) all extension services and farmer training; (b) sub-loan pre- paration, appraisal and supervision in collaboration with the PNG Develop- ment Bank (PNGDB), and (c) coordinating the activities of other Government departments such as Public Works, Health and Education involved in the projects. Field performance has been excellent but headquarters monitoring particularly of project accounts and aspects of factory design and throughput can be improved. Before independence it was feared that the efficiency of the DASF operations would be greatly affected once independence was declared because oL the loss of large numbers of experienced expatriate staff and the need for it to rely heavily on inadequate numbers of young inexperienced local staff. Although such losses did occur DPI's operational capability has not been seriously impaired because (a) the losses were less than anticipated par- ticularly amongst key middle and senior personnel; (b) Goverment has been 1/ This department was known until March 1976 as the Department of Agriculture, Stock and Fisheries (DASF).  - 5 - successful in its campaign to recruit replacement expatriate staff; and (c) Government has been able to maintain its impetus in recruitment and training of indigenous staff. Details of DPI organization, staffing and services are described in Annex 1. Agriculural Education and Training 2.09 Faced with sizeable local manpower requirements for its agricul- tural development program Government has placed great emphasis on agricultural education and training at all levels. The University of PNG (in association with the University of Technology in Lae) offers degree training at the Bachelor level while DPI itself operates 3 agricultural colleges. These consist of the Vudal Agricultural Training College in New Britain which pro- vides a 3 year Diploma course and the Agricultural Training Institutes at Popondetta (PATI) and Mt. Hagen (HATI) which both offer a 2 year Certificate course. In spite of increased annual output of agricultural technicians the requests by Government (mainly DPI) for new graduates from these institu- tions is expected to exceed the supply for at least five years. 2.10 Vocational training is also given to farmers at 22 training centers around the country for periods of 3-6 weeks. Many of these include special- ist extension refresher courses. IDA has recently negotiated an Education project for board presentation in FY 77, in which provision for rural voca- tional education has been made. Agricultural Inputs and Marketing 2.11 The demand for agricultural inputs from the subsistence sector is small and unpredictable. For this reason local traders in many areas are re- luctant to carry stocks until a regular clientele is established. Thus the DPI extension staff often finds itself involved in arranging for the supply of agricultural inputs particularly for smallholders by assisting them in placing orders and encouraging local traders or cooperatives to maintain stocks. In these cases DPI at times negotiates prices and directly arranges the purchase and transport of the supplies. Internal marketing of agricul- tural consumer products is most inadequate particularly for meat, fish, fruit and fresh vegetables. Government is taking steps to improve this situation and in March 1975 financed a consultant study with funds from Credit 175-PNG. This has provided guidelines on which to commence improvement of marketing both at the small rural and at the larger urban levels. Government is in fact already implementing many of the recommendations of this report. The market- ing of agricultural export commodities is more organized through (a) rural cooperatives which in some cases provide processing facilities; (b) traders and exporters who in most cases are registered under export control boards as with coffee annd cocoa; (c) a commodity board/stabilization fund as for copra and (d) direct negotiations between producers and overseas buyers as with palm oil in which the nucleus estate/factory companies are responsible for market- ing of oil produced from both nucleus estate and smallholder farms. Govern- ment operates an export produce inspection service and through its representa- tion on the various export control boards and joint venture companies exer- cises supervision of export price performance.  -6- Agricultural Credit 2.12 Prior to the establishment of the PNGDB in 1965 access to rural credit by indigenous smallholders was limited. Security requirements of com- mercial banks in general precluded smallholder borrowing while the former Native Loans Board and the Ex-Servicemen's Credit Scheme (both of which were taken over by PNGDB) were restricted in the amount and type of lending pos- sible. Thus the PNGDB was set up to cater primarily to the credit needs of this sector. It commenced business in ]L967 and 1975 it had branches in seven towns/cities, three sub-branches and eight agencies 1/ scattered through the country. 2.13 Extension staff in DPI and Business Development Officers in the Ministry of Labor, Industry and Commerce act as agents for PNGDB. In FY75 PNGDB approved a total of 2,403 loans to the value of K 10.2 M. Of these 1,278 loans valued at K 2.0 M were agricultural loans nearly all of which (1,269, K 1.7 M) were for smallholders. Most of these small loans have been for IDA financed oil palm and livestock development projects, in close col- laboration with field staff of DPI, (para 2.08) for which PNGDB has been the credit channel. At the inception of PNGDB few trained local personnel were available and the bank depended heavily on expatriates. Since 1967 PNGDB has been active in recruitment and training of local staff and today Papua New Guineans comprise 82% of the total bank staff. However, in spite of the success of this program PNGDB is likely to remain dependent upon expatriates particularly at senior and middle management levels for some time. As with DPI the PNGDB did suffer losses of experienced expatriate staff immediately prior to and after independence but fortunately these losses were not large enough to affect seriously the working efficiency of the institution. Further details of Agricultural Credit and PNGDB's operations are given in paras 5.06 and 5.07 and in Annex 2. Government Strategy for Agricultural Development 2.14 Government has not yet drawn up detailed plans for agricultural development in PNG, although it is proposed that a longer-term National Agricultural Plan be finalized during 1976. However, its broad policy is to foster programs which will reduce inequalities in the distribution of incomes and services between urban and rural areas with special emphasis on less- developed rural areas and to reduce imports by increasing domestic produc- tion and marketing of fresh foods. Government recognizes the need for an increased effort to further expansion of village output and living standards through well designed and integrated rural development programs. However, it has still to establish a satisfactory methodology to ensure success of such programs. To date with existing technology and extension techniques it is difficult to generate interest among village farmers either individ- ually or as groups in obtaining yield increases or expanding their areas of arable land because of a lack of sustained economic motivation. This is further hampered by the traditional clan land ownership and usage rights which make it difficult for an individual to expand his holding without 1/ Or representative offices  -7- agreement from his clan members. Government has prepared a modest rural development program for the undeveloped Southern Highlands based on a commu- nal or group development approach which would be a pilot effort on which to base future development strategy. In contrast to the difficulty experienced in establishing satisfactory strategies for in situ rural development Govern- ment has had more success in its efforts at new smallholder/settler develop- ment on lands not held under the traditional "native land" tenure rights (para 2.07). While some of the smaller of these schemes did not achieve stated objectives because of faulty planning or organization and management, well-planned schemes such as the Hoskins Oil Palm Project have been very successful. The programs have been strongly oriented to the establishment of commercial smallholder agriculture and have concentrated mainly on growing export commodities such as coffee, cocoa, rubber, tea, copra and more recent- ly palm oil. With the earnings from copper they constitute the main source of PNG's foreign exchange earnings. There is considerable potential for increasing production of those commodities and Government is anxious to exploit this potential as quickly as possible as an important means of increasing its foreign exchange earnings. 2.15 Amongst these commodities oil palm has perhaps the greatest poten- tial for rapid expansion. There are considerable areas of fertile unused and virtually unpopulated lands in the coastal mainland and the islands which are ideally suited to oil palm cultivation. PNG experience to date has shown that the country has a comparative advantage for oil palm production against almost all other producing countries. Because of the favorable combin- ation of climate and soil type oil palm trees consistently come into produc- tion a year to 1-1/2 years earlier and yield up to 20% more than the same varieties grown in other parts of the world. With IDA assistance Government has developed a highly successful strategy based on a nucleus estace/factory company (owned jointly by Government and an overseas investor) coupled with a large smallholder component (paras 2.16 - 2.18). It proposes that for the time being at least further development along these proven lines will be an important component of its agricultural development strategy. Although some alternative commercial crops such as coconut and cocoa could be gr.own in most of these areas they are less attractive than oil palm which has a lower sus- ceptibility to pests and diseases coupled with an attractive return on investment. Oil Palm Development Program and Bank Group Participation 2.16 In order to diversify its agricultural base the then PNG Admin- istration in 1967 sponsored the development of an oil palm industry. First development occurred in the Hoskins area in New Britain on land purchased by the Government. The basis for development was a "nucleus" estate of some 4,000 ha jointly owned by Government and an overseas company (Harrisons and Crossfield Ltd.) operating a central processing factory company to pro- cess and market both estate production and production from associated settler and village development. This smallholder oil palm development was under- taken by Government with financial assistance from IDA (Credits 137 and 175-PNG) and provided for some 1,560 settlers and villagers planting up to 6,000 ha of oil palm. Generally, field performance and execution of this  - 8 - project have been excellent although heavier and earlier yielding than pro- jected created problems in terms of' the central factory in-capacity to handle the crop. There are now 1,750 smallholders with a total planted area of 6,050 ha. A large percentage (37%) of those have in fact already repaid their farm loans to the lending agency, PNGDB, ahead of schedule. 2.17 The secondary benefits generated by the project are readily visi- ble. Under the traditional "Wantolc" 1/ system the oil palm settlers support at least one other family on their farms and also remit a proportion of their earnings to clan groups in their home Provinces. Although the location of the township of Kimbe is wholly due to the oil palm project, its subse- quent growth has had a notable impact on local employment opportunities and the development of ancilliary enterprises. Largely reflecting the growth of Kimbe, the population of West New Britain has increased by 25% over the past 4 years (from 60,800 to an esitimated 75,800 in 1975). Starting from nothing, a flourishing banking activity has developed in the area and during the course of 1975, about 6,000 new savings accounts were opened - a further measure of the area's development. Cargo passing through the deep water port at Kimbe has increased from 10,157 tons in FY72 to 32,980 tons in FY75. With the ability to accept overseas cargo vessels in addition to the extremely expensive coastal shipping, the Kiinbe district has now the advantage of considerable freight savings. The effect of this has been an increase in smallholder coconut production from 300 to 3,000 tons of copra per annum by providing a ready outlet for direct export. 2.18 While longer-term plans for the future development of the oil palm industry will be detailed in the National Agricultural Plan now in preparation, existing stated Government plans call for substantial oil palm development in recognition of the comparative advantage that PNG has in producing this crop (para 2.15). In addition to the present project development in the Popondetta area, further development has already occurred in the Bialla area of New Britain. A joint-venture "nucleus"' estate of 2,000 ha is being developed by Government in partnership with a Japanese company and preparations are well- advanced for a smallholder scheme involving some 1,000 settlers planting about 4,000 ha of oil palm. About 2,000 ha has been planted on the nucleus estate but further development of the overall project has been delayed pending resolution by Government and the overseas company of satisfactory arrangements for processing and management. In addition Government has under consideration further settlement schemes on the Soi Navo and Kapiura land areas adjacent to the existing Hoskins and Bialla developments. DPI has observation and trial plots in many other areas of PNG and results to date indicate that several of these areas have excellent potential for further oil palm development. Annex 3 gives further details of oil palm development and research. I/ "Wantok" (pidgin for "one talk") is a system of traditional affinity found throughout PNG. The system is characterized by five recurrent features: common language, common kinship group, common geographical area, common social/religious association and a common belief in the principle of mutual reciprocity.  III. PROJECT AREA AND FORMULATION A. Area 3.01 The proposed project would be located in mainland PNG at Popondetta, the administrative center of the Northern Province. Commencing in the mid- fifties, this area was the center of a settlement scheme which focused on the production of cocoa by local villagers and expatriate ex-servicemen. Although many farms thrived initially, the crop has been almost wiped out since 1968 by insect pests for which no satisfactory counter has been found. With few exceptions the settlements became insolvent, there was default in loan repay- ments and the areas were vacated, their titles reverting to the Government. Reflecting this, cocoa production for the Province has fallen from an estimated 3,200 tons in 1967-68 to 350 tons in 1972-75. Accordingly it is envisaged that 800 ha of these ruined cocoa areas would be planted to oil palm under the proposed project. In addition, 2,700 ha of new land would be cleared and 2,400 ha of this planted for new smallholder settlements while 2,400 ha of village lands would be converted to oil palm for existing villagers. 3.02 DPI pilot trials (now 8 years old) have shown that oil palm is well adapted to the Popondetta area and unlike cocoa is free from devastating pests and diseases. Climatically the area is similar to Hoskins but soils at Popondetta, although quite fertile, are generally lighter. It is expected that fertilizer requirements will be above those for the on-going project to sus- tain high-yielding oil palm. 3.03 The population of the Northern Province as of June 30, 1975 was estimated at around 75,000 of which Popondetta and its surrounding villages and hamlets accounted for about 36,000. Population density for the Province of 8.3 per sq. mile places the area amongst the least populated in PNG. Most of the villagers participating in the project would be under the Land Tenure Conversion/settlement scheme whereby individuals surrender communally owned land for division and allocation under individual leasehold title. 3.04 The Popondetta area has a well developed infrastructure. A good two-lane highway of 50 km runs from Popondetta eastwards, passing the Girua airfield and terminating at Oro Bay. West from Popondetta this highway ex- tends for 60 km to Kokoda. There is a network of low class access roads north and west of Popondetta. These roads, which were built to serve the cocoa settlements, are now neglected and overgrown. Being flat, the terrain presents no problems to road construction and gravel and rock are abundantly available. Communications outside the project areas are by sea or by air. To serve the Popondetta area there is a new deep-sea shipping wharf at Oro Bay and there are large wartime bitumen air fields at Embi and Girua. 3.05 In the Popondetta area, schools and aidposts are presently located in many, but not all, settlements. Government services dealing with settlements such as DPI and Department of Natural Resources are concentrated in the township.  - 10 - The Popondetta Agricultural Training Institute (PATI) is located 1 km north of the town (para 2.09) and is administered by DPI. There is a branch office of PNGDB in the town, established in 1974. B. Formulation 3.06 The formulation of the proposed project has been based upon the highly successful smallholder oil palm settlement at Hoskins financed by Credits 137 and 175-PNG. Experience! from this development established the suitability of coastal PNG for oil palm cultivation and the suitability of oil palm as a smallholder crop and that with effective guidance, even settlers without previous experience in tree crop agriculture have been able to easily meet the management requirements associated with successful development. Further, oil palm as a cash crop has been shown to be a significant income earner for smallholders (as well as a significant foreign exchange earner for the country). 3.07 On-Farm Development: The proposed farm plan and the credit package provided to each settler family for farm establishment was guided by the fol- lowing major considerations: (a) the farm unit should afford the settler family the opportunity for self-sustained growth of per capita income roughly in line with the projected growth of PNG's commercial agricultural sector; (b) to be in line with the Government's decision that there should be cost recovery with no subsidy for on-farm inputs or any grant aid; (c) the settlement project as a whole should be economically viable and, so that with appropriate shadow pricing for wages and the cost of extension/social services and roads costed fully, the rate of return on the investment should be not less than 10% while with appropriate allocation of these lat- ter costs it should be not less than 12% (para 7.07); (d) need to provide for a reserve area for subsequent planting (with the settlers own resources) to establish a replanting cycle needed to stabilize farm income after year 10 when FFB yields are expected to decline; (e) the farm unit should be viable even if the expectation that under the traditional "wantok" system it should provide sub- sistence for at least one other family of the settler's clan group; and (f) that there is a need to provide some buffer against price and yield fluctuations to ensure sufficient incentive to keep settlers working their blocks at all times.  - 11 - Project formulation recognizes that financial viability for individual units is possible with about 4 ha planted to oil palm with a 2 ha reserve area. Holdings of this dimension, supplemented by small subsistence gardens, have been shown to provide sufficient levels of incentive to attract the required inputs of family labor. In this regard it is expected that family incomes as a result of the proposed project would be raised from an estimated subsistence level of K 516 per annum to about K 1,500 per annum at year 13. Project reve- nues would enable the full recovery of all farm development costs. IV. THE PROJECT A. General Description 4.01 The proposed project would comprise one part of an overall area development program for Popondetta which would be directed primarily towards the establishment of 9,600 ha of oil palm. The program would comprise (a) a 4,000 ha nucleus estate; (b) 5,600 ha for smallholders; and (c) the estab- lishment of a palm oil factory to process the fresh fruit bunches (FFB) from both the estate and the smallholders. The nucleus estate/factory complex will be financed jointly by Government and the Commonwealth Development Corporation (CDC). The CDC board has approved this project in principle and their legal advisers have drawn up documents for signing (see paras 4.27 and 8.02 regard- ing conditions of loan effectiveness). In anticipation of this CDC has already started field work at Popondetta. Annex 4 gives details of the nucleus estate/ factory complex. 4.02 The proposed project would focus on the development of the small- holder component of the program as follows: (a) establishment of 600 farms each of 6 ha with 4 ha of oil palm for new settlers selected from all parts of PNG, and assistance for establishment of 4 ha of oil palm to 800 existing settlers and/or villagers (Base cost US$3.8 M); (b) provision for the above of long-term credit facilities to smallholders through PNGDB; (c) provision of agricultural extension and visiting inspection services (Base cost US$2.4 M); (d) establishment of a Government owned company for transportation of smallholder FFB (Base cost US$1.0 M); (e) provision of a suitable road network to service the project area and improvement of other infrastucture - health, education and welfare services (Base Cost US$3.8 M); and (f) provision of technical assistance for Project Management and for training field officers of PNGDB and DPI in smallholder credit operations (Base Cost US$0.8 M).  - 12 - B. Detailed Features 4.03 Land Clearing: Saleable timber would be removed from the forests in the settlement areas. Clearing of the remaining timber is relatively inex- pensive and Government would arrange for prefelling at a cost of about K 31 per ha. On each new settler's block of 6 ha, 4.5 ha would be felled prior to the settler's occupancy. The settler himself would then brush, stack, burn and complete the clearing of the land. Four hectares of the cleared land on each block would be planted in oil palm and the other 0.5 ha used for subsis- tence gardening and housing. Subsequently, the settler would have to clear the 1.5 ha remaining on his block for supplementary cash crops or for further oil palm planting. Prefelling would be carried out by contract labor brought from outside the settlement areas. Some of these laborers would eventually receive land allocations. Prefelling would not be necessary in land blocks held by existing settlers or on village holdings as these lands have already been under cultivation. For new settlers the land clearing would be com- pleted in the year prior to planting. The land clearing program for the smallholder development would commence in FY77 and be completed in FY81. 4.04 Planting Program: Each new settler would plant 4 ha of oil palm under supervision of the DPI extension staff during his first year of occu- pancy with planting material grown by the nuclues estate company. Existing settlers 1/ would plant up to 4 ha of their holding in the same year. Villagers would establish their plantings in two annual installments of 2 ha as they would not, on account of existing commitments, be in a position to devote adequate family labor to complete a 4 ha oil palm planting in one year. The nucleus estate and smallholders' plantings would be completed in FY82. Details of the planting program for both smallholders and the nucleus estate are given in Annex 3, Table 3. 4.05 Roads and Infrastructure: A good road network to serve the pro- ject area is essc-tial for the successful development of the project. Al- though Popondetta already has some road infrastructure built to service the old cocoa settlements the access roads are neglected and over-grown. Thus about 98 km of those serving the proposed oil palm settlements would be up- graded. In addition about 122 km of new roads would be constructed to serve those growers outside the cocoa area, About 88 km of the roads have been designed as access roads providing for about 50 vehicles a day while 132 km have been designed to a lower standard classified as subdivision roads to service the individual blocks. Details of the proposed roads program are in Annex 5. 4.06 Housing would be provided under the project for all settlers. Each house, complete with water tank, would cost about K 700 excluding labor which would be contributed by the settler. Houses would be constructed according to a standard low-cost design and would be built from sawn hard wood, available locally. Until house construction is completed, new settlers would be accommodated in temporary faLcilities provided under the project. 1/ Mostly farmers with cocoa crops affected by pests and diseases.  - 13 - 4.07 An integral part of the development program involves the provi- sion of social amenities for settlers. It is proposed therefore that funds would be made available under the project to up-grade and expand to usual Ct,vernment rural standards, local community centers, schools, markets, trade stores, police posts and health facilities. Details of social infrastructure requirements are shown in Annex 5, Table 2 and for staffing in Annex 6, Table 1. Benefits from these project expenditures would have a community impact extending far beyond the settlers alone. It is estimated that 70% of these investments would benefit villagers outside the confines of the oil palm project. 4.08 Oil Palm Establishment: The nucleus estate would, under contract with Government, supply the smallholders with their oil palm seedling require- ments. The seed would be of high quality Dura x Pisifera cross (Tenera), and obtained from DAMI Research Station at Kimbe. Seedlings raised on the nucleus estate would be sold to the smallholders at an estimated price of K 1.20 each. A leguminous cover crop would be sown before planting the oil palm seedlings. An assurance has been obtained from Government that the nucleus estate company would provide smallholders with suitable planting material. 4.09 Fertilizers: The specific fertilizer requirements of oil palm in the project area are still unknown. However, from experience with oil palm elsewhere and with coconuts in the project area, indications are that despite the high initial fertility of the soil, some fertilizer applications might well improve yields (Annex 3, para 10). Thus provision has been made for fertilizer use by the farmers. In order to minimize any risk of reducing FFB yields through nutritional problems during the critical period of the first years of growth, an initial "shotgun" fertilizer application of 42 kg per ha (value K 22) is proposed. Application after year three would be to meet the needs of a growing and producing palm determined from foliar analysis. 4.10 Pests and Diseases: Contingency plans have been prepared to counter possible outbreaks of oil palm pests and diseases. In such an event chemicals and spraying equipment would be supplied to the field project management who would be responsible for application. The smallholders utilizing these serv- ices would be expected to pay for them on the basis of cost of chemicals plus labor. If necessary credit would be provided through PNGDB (Para 4.19) to cover these costs as part of the on-farm development credit package. Terms and conditions of this credit package are given in Para 4.25. 4.11 Pollination: Assisted pollination needed to obtain maximum yields in the first four to ten years of production is required. Suitable supplies of pollen would be obtained locally and would be provided free of charge by the extension service to the smallholders. 4.12 Extension and Research: In addition to providing extension ser- vices and visiting inspection services specifically to assist smallholders in developing their oil palm as at Hoskins, it is also proposed to provide additional extension staff to assist the smallholders to develop their food  - 14 - gardens. This service would be available to all villagers within the project area. Details of Extension Services Staffing and Costs are shown in Annex 6, Table 2. Infrastructure requirements are given in Annex 5, Table 3. Assuran- ces have been obtained that Government would review annually the requirements for the extension staff to service the increased demand for food cropping expected to be generated by the oil palm development program and appoint additional staff as and when required. 4.13 Although it is not proposed to finance oil palm research under the project a small research program specific to the problems of oil palm culti- vation in Popondetta particularly fertilizer requirements and tree spacing (for both smallholders and nucleus estate) would be necessary. Government has agreed that this work will be financed from its own budget. The logical site for the program would be the nuc:Leus estate and assurances have been obtained that the nucleus estate would provide for oil palm research and the results of such research would be reaclily available to all smallholders in the area. 4.14 FFB Processing, Transportat:ion and Pricing: Although the project would not provide funds for financing the palm oil factory it is important to the project that the factory be constructed in time to process fruit from the first plantings of nucleus estate and smallholders (mid 1980) and that the milling efficiency be such to ensure maximum yields of oil and kernel. This in turn will enable maximum returns per ton of FFB to project smallhol- ders. The FFB price paid by the factory for smallholders fruit, would be based on a formula agreed upon between Government and the factory management. The formula would be based on that currently in use at Hoskins (Annex 7, Table 4) which accounts for milling charges of FFB and storage, tax, distribution, freight, insurance, brokerage commissions, and shipping losses for oil and kernel. The FFB price is reviewed monthly by the Marketing Division of DPI and adjusted for any changes in the formula input. During negotiations the general criteria to be used for the pricing of project smallholder FFB have been agreed upon and an assurance given that any changes in these criteria will be discussed with the Bank. Under its agreement with Government, CDC would be responsible for mill design, construction and management. CDC is well expe- rienced in this field and their engineers have benefitted from their knowledge of the problems encountered by the Hoskins mill. CDC have discussed their plans for the Popondetta factory with the Bank and it is evident that they propose to use the best equipment available. The construction schedule has been phased taking into account proposed smallholder and estate FFB production with the result that there is every indication that factory operation will commence on time and will run at optimum levels (Annex 3, Chart 2). 4.15 Transport Company: Efficient transportation of the smallholder's FFB to the factory is an essential requirement if there is to be high quality oil production and optimum returns to smallholders. Taking regard of the administrative and financial inputs associated with this activity, it is proposed to establish a separate Government owned transport company under the project. In addition to organizing pick up and delivery of FFB, this  - 15 - company would also be responsible for maintaining records of individual FFB output and for disbursing FFB payments after deduction of transport costs and PNGDB loan dues. A standard transport charge would be made to all producers irrespective of distance from the factory. It is intended that the amount charged 1/ would be sufficient to allow the company to make a profit of not less than 12% and not more than 15% on capital employed, which would be about 2 to 5% above the anticipated borrowing rate by the company (Annex 7). It is Government's intention that smallholders be given the opportunity to buy out its interest in the company. Until this is possible, Government proposes that excess profits would be paid as bonuses to the smallholders on the basis of the amounts of FFB produced. Assurances have been received during negotia- tions that prior to the first production of FFB by smallholders Government will establish a Transport Company whose capital structure and operating policies shall be satisfactory to the Bank. It is intended that equity sub- scriptions by the Government would be equal to at least 50% of the total capital requirements of the company. 4.16 Staff Transportation: Funds would be provided to permit vehicle hire from the Plant and Transport Authority (PTA) to cover the movement of extension and social services personnel employed under the project. The PTA is a statutory authority established by Government to meet the transportation requirements of all operating departments countrywide. Since it was esta- blished in 1973 no Government Departments are permitted to own and main- tain their own vehicles, plant or equipment (Annex 5, Para 25, Table 4). 2/ 4.17 Technical Assistance: Technical assistance funds totaling US$675,000 (base cost) would be provided for employment of key expatriate personnel, consisting of a Project Manager Field (6 years at US$38,000/year), a Project Accountant (6 years at US$32,000/year) for the smallholder manage- ment/coordination unit (paras 5.02, 5.03) and a Transport Manager at US$25,000/year, a Financial Controller at US$23,000/year and a Superintendent Field at US$19,000/year for the last four years of the disbursement period for the smallholder transport company. 4.18 In order to help DPI and PNGDB improve their performance in small- holder credit operations, US$89,000 would be provided for a consultant for 2 years to establish training programs for field staff (Terms of Reference for this consultant is given in Annex 2). Also US$76,000 would be allocated to enable key DPI and PNGDB field staff to make short -term visits to small- holder credit operations in other countries. Terms of Reference for the Project Accountant, Transport Manager and.Financial Controller and technical assistance costs are shown in Annex 6. The estimates for technical assist- ance include salaries only and are based on actual salaries currently being 1/ Based on Hoskins experience FFB transport charges for Popondetta have been estimated (January 1976) at about K 5.50/ton FFB. 2/ During negotiations the Bank was informed that Government is in the process of reorganizing PTA. The result of this reorganization may be that certain departments will be allowed to own vehicles.  - 16 - paid to expatriates in PNG with similar qualifications and experience. The other non-salary costs - allowances, housing, transport, etc. have been included in the overall budget of the institution responsible for employ- ing the consultants. 4.19 Long-Term Credit to Smallholders: Cash savings of most partici- pants are insignificant so financial assistance provided to smallholders would therefore cover 100% of the costs of settlement, land clearing, housing and oil palm development up to the first harvesting year. These costs would range from-K 1,667 for village holdings, K 1,761 for existing settlements, to K 2,892 for new settlements (Annex 8, Table 2). As new settlers would in- variably not have other sources of income they would be given an additional K 500 total towards living expenses during the development period. PNGDB would manage the smallholder credit operations as in the Hoskins project (para 5.06). C. Environmental Impact 4.20 Forests in the project area and unproductive cocoa would be re- placed by properly cared for oil palm plantings. Wildlife is not abundant and none of the project area forests are designated as game or nature re- serves. Road specifications have been designed to minimize soil erosion and disturbance to river flows. The palm oil mill would be situated in the nucleus estate far removed from the villages and settlements. At the mill adequate care will be taken to incinerate empty bunches and to deal with mill effluent by means of sludge trenches or other adequate technology. D. Cost Estimates 4.21 The estimated total cost over the 7 year development period of the project is US$18.52 M (K 14.58 M), of which US$ 11.34 M (K 8.93 M) is foreign exchange. Total project cost components are shown below and in Annex 8. Costs were estimated on the basis of prices determined at the time of ap- praisal in February 1976. Physical contingencies have been provided for by adding 5% 1/ to the base costs of all items except roads, for which 20% has been added. Price increases that are expected for equipment items are 9% for 1976, 8% for 1977-79 and 7% thereafter. Expected price increases for civil works are 13% for 1976, 12% for 1977-79 and 10% thereafter. Local expenses are expected to increase at 9% per annum. 1/ By comparison with similar projects in other countries the 5% physical contingency is low. However, because it has been derived from sound data obtained from the Hoskins project, the 5% figure is considered adequate.  - 17 - SUMMARY OF PROJECT COSTS Local Foreign Total Local Foreign Total Foreign ------- K'OOO -------- ------ US$'OOO ------- Exchango 1. Smallholder Development A. On-Farm Housing 245 735 980 311 934 1245 75 Land Preparation 72 72 144 91 92 183 50 Planting Material 202 619 821 257 786 1043 75 Tools & Equipment - 259 259 - 329 329 100 Fertilizer - 31 31 39 39 100 Pest Control - 84 84 107 107 100 B. Other Renoval Expenses 23 67 90 29 85 114 75 Subsist./Living Allowance 207 138 345 263 175 438 40 Survey, Legal Fees 80 45 125 102 57 159 36 Rent 72 - 72 91 - 91 - Sub-total 901 2050 2951 1144 2604 3748 69 2. Transport Company Houses & Buildings 44 131 175 56 166 222 75 Trucks & Equipment - 300 300 - 381 381 100 Staff Salaries 148 212 360 188 269 457 59 Sub-total 192 643 835 244 816 1060 77 3. Extension Service Houses & Buildings 80 238 318 102 302 404 75 Staff Salaries 781 - 781 992 - 992 - Sub-total 861 238 1099 1094 302 1396 22 4. Social Services Houses & Buildings 100 301 1048 949 382 509 75 Staff Salaries 647 - 647 822 - 822 - Sub-total 861 238 1099 1094 302 1396 29 5. Vehicle. EQuinment & Machinery Hire 257 774 1031 326 983 1309 76 6. Technical Assistance 60 540 600 76 686 762 90 7. Roads 578 1228 1806 734 1560 2294 68 Base Cost Estimates 3596 5774 9370 4567 7333 11900 62 =sfl ..= -.=.. =.. flW1 =.mm. as Physical Contingencies 266 474 740 338 602 940 64 Expected Price Increases 1792 2677 4469 2276 3400 5676 60 TOTAL PROJECT COSTS 5654 8925 14579 7181 11335 18516 61 =--- =555 ==I:a= 5=5= 555=== =55-=5 Farmers' Labor (including contingencies) 2732 - 2732 3470 - 3470 Total 8386 8925 17311 10651 11335 21986  - 18 - E. Financing 4.22 Financing of the project would be in about the following amounts and proportions: Financing - (US$M) PNGDB Gov't. Bank Total Components Amt. % Amt. % Amt. % Amt. %_ _ Smallholder Development 1.76 30 - - 4.02 70 5.78 100 Smallholder Transport Comp. - - 0.44 24 1.42 76 1.86 100 Extension & Social Services - - 3.05 49 3.14 51 6.19 100 Technical Assistance - - 0.11 10 0.97 90 1.08 100 Roads - - 1.16 32 2.45 68 3.61 100 TOTAL (US$M) 1.76 9 4.76 26 12.00 65 18.52 100 4.23 The proposed Bank loan would be for $12.0 M of which $11.3 M would be for foreign exchange requirements and the balance for local currency financing of the additional agriculturaLl extension staff required by the project. 4.24 The loan would be issued to the Government on the current Bank terms, with Government assuming the foreign exchange risk. In the past, the Govern- ment charged PNGDB a nominal interest rate of 1-1/4% on all IDA funds onlent to it for smallholder development. This was reasonable at a time when PNGDB was in its infancy, but Government has now indicated that PNGDB should not receive such subsidies. Therefore the Bank's financing of smallholder devel- opment (70%) would be onlent to PNGDB aLt 9%. Since smallholders would be charged an interest rate of 11%, the estimated spread 1/ would be adequate to cover PNGDB's incremental expenses in administering the project (Annex 8, table 1). 2/ PNGDB would repay the Government loan over a period of 16 years (including a grace period of 7 years) under a Subsidiary Loan Agreement. The conclusion of an agreement satisfactory to Bank would be a condition of effec- tiveness. PNGDB's contribution to project financing would represent the local cost component of smallholder development. PNGDB's resources would be adequate to meet these requirements but an assurance has been obtained from Government that it would provide PNGDB with additional funds as may be neces- sary for on-farm development. The smallholders' contribution to the project 1/ Since PNGDB would use its own funds to finance 30% of smallholder devel- opment cost and such funds have been costed at 8% in the PNGDB cashflow in Annex 8, Table 1, the blend cost to PNGDB on the total funds would be 8.7%, thus giving it a spread of 2.3%. 2/ Although PNGDB would earn any significant surplus from this project, Government considers that this would be adequate since PNGDB enjoys a very good spread on its present operations (average spread now is about 9%).  - 19 - would consist of their labor, priced at the ruling wage rate, valued at US$3.4 M over the project development period. This has not been included in the cost estimates. 4.25 The Government's policy has been to charge lower rates of interest to Papua New Guineans in order to make loans attractive to them and to help the transition from subsistence agriculture to a monetized economy. The pre- vailing annual rates of interest in PNG for lending at the time of appraisal were: normal commercial loans - 11.5%; larger commercial loans - 12% and over; loans to Papua New Guineans (including oil palm loans) - 8%, while treasury bill and deposit rates varied around 8% per annum. The present rate of inflation in PNG is estimated at 9% per annum. The PNGDB Board reviews interest rates annually and increases are automatically passed to ongoing loans. 1/ Under the present project onlending rates for smallholders would be increased from 8% to 11% per annum. The loan periods for the new settlers would be 13 years, while the period for the existing settlers and villagers would be 9 years. All loans would have a grace period of 4 years (Annex 8, Table 2 for smallholder cash flows). Terms and conditions for PNGDB lending under the project were agreed during negotiations and an assur- ance was obtained that these would not be amended without prior consultation with the Bank. 4.26 Government's contribution to the project would represent the local currency costs of financing the smallholder transport company, social and extension services, hire of vehicles for social and extension services, roads and technical assistance with the exception of those local extension staff salaries which would be financed by the Bank loan. 4.27 The balance of the oil palm development program, which includes the construction of the processing unit and establishment of the nucleus estate (para 4.01 and Annex 4), would be financed jointly by Government and CDC. Total cost of this component is estimated at US$27.6 M of which CDC would finance about US$11 M and the Government would finance the balance. Proportions of debt and equity have not yet been determined. As a condition of loan effectiveness of the project, it is proposed that agreements between Government and CDC covering the establishment and financing of the factory and nucleus estate companies will have been concluded to the satisfaction of the Bank. Before making a final commitment for its part of the program CDC will require Bank approval of the smallholder project. 1/ The initial lending rate for smallholders under IDA Credits 137-PNG and 175-PNG was 6%. This was gradually increased to 8% by 1975 and subsequent to appraisal, interest rates have been raised as follows for term loans: Papua New Guineans - range of 8% to 11%; Others - 5% below equivalent commercial bank rate which is currently about 12%.  - 20 - F. Procurement 4.28 The procurement of all items for smallholders' on-farm development, involving fertilizers, pesticides, tools, equipment and housing materials (US$1.72 M) would be in small lots. Total expenditures of these items would average US$215,000 per annum over the full development period and would in no one year total more than about US$467,000. Under these circumstances in- ternational bidding would not be appropriate. Building construction for ex- tension staff, social workers and the transport company (US$1.14 M) would be phased over 8 years, averaging about US$142,900 per annum with a maximum of US$318,000, and would also be unsuitable for international bidding. For all the above items contracts would be awarded on the basis of competitive bid- ding advertised locally in accordance with local government procurement pro- cedures which are satisfactory to the Bank. Except for some housing materials, all the above items will have to be imported. International suppliers are well represented in PNG, competition between them is keen, and provision of spare parts is adequate. The twelve vehicles proposed for the smallholder transport company (valued at US$305,000) to be supplied over a five year period would be acquired from local truck agencies which operate competitive- ly in PNG. The road construction and upgrading (US$2.29 M) is planned over a four year period with an annual expenditure of approximately US$573,000 split into a small number of contracts. This rate of expenditure would not attract overseas contractors to tender. However, there are two local con- tractors with foreign backing who are qlaite capable of undertaking the work. The bridge works (about US$260,000) would be designed by the PWD and offered to tender. The new road-works (US$1.37 M) would be designed by the PWD and surveyed by the Lands Department. The upgrading work (about US$665,000) is more in the nature of maintenance work iand would be performed by the PWD who are best equipped to carry out this type of work. The supply of gravel for road upgrading would be undertaken by local contractors. Recruitment of personnel under technical assistance and consultants for visiting inspection services would follow Bank Group guidelines for hiring consultants. G. Disbursements 4.29 It is proposed that the Bank loan would be disbursed over an eight year period (Annex 9). This time lapse recognizes the usual constraints associated with tree crop agriculture which, for the proposed project, would specifically involve (a) a maximum planting rate of 2,500 ha per annum, given the local supply of planting materials; (b) a total planting requirement of 9,600 ha including the nucleus estate; and (c) a plant immaturity period of 2-1/2 to 3 years. Collectively, these factors dictate that the minimum development period of the project would be about 7 years and an additional one year provision in the disbursement period would accommodate organization and management limits which are expected to occur in relation to new settlement. 4.30 The Bank would reimburse against statements of expenditure for 70% of loans granted to oil palm smallholders by PNGDB and 75% for funds expended  - 21 - by Government on the transport company and for payments for building housing, and vehicle/machinery hire for extension and social services while 50% of the salaries paid to local extension staff would be reimbursable. In addition tie foreign exchange cost associated with technical assistance would be fully reimbursed as well as 70% of road contracts and force accounts expenditures. V. ORGANIZATION AND MANAGEMENT A. General 5.01 Government has proposed an organizational structure which will enable maximum flexibility in the management of the project by ensuring (a) full coordination between the line departments involved in the project; (b) ready access to funds through a central budget allocation, and (c) an effective channel of communication between head office and field officers. These proposals are based on the experience with the organization set up to manage the small-holder development under Credits 137 and 175-PNG. However, under the proposed new organization those aspects relating to cost control, accounting, reporting and project monitoring would be given more attention than under the Hoskins arrangement. Details of the proposed Government organization are shown in Annex 10, Chart 3. 5.02 A recently established Project Management Committee (PMC) under the Minister of Primary Industry, would have overall responsibility for the carrying out of the project and the formulation of policy. The Secretary for Primary Industry would be its Chairman. PMC would comprise the Secretary for Finance, the Secretary for National Resources, the Director of the National Works Authority, the Managing Director of PNGDB, the Technical Director for the project and the Provincial Commissioner of Northern Province. A Project Coordinator (PC) who would act as the executive officer of the PMC, would be responsible to the PMC for for day to day headquarters project administra- tion. He would be the Assistant Secretary for Finance in charge of the Office of Project Coordination (OPC) which has been established to service all National Development Projects. Funds for the project other than salaries for line department officers would be annually appropriated in the National Development Projects Division of the Appropriation Act. The PC would adminis- ter these funds (with the exception of farm development loans) in accordance with budgets and work programs as approved by the PMC. 5.03 A Technical Director (TD) oil palm projects, a senior specialist officer in DPI, would be responsible for the physical aspects of project implementation. He would have direct authority over the Project Manager Field (PM) and he would liaise between and cooperate with the line depart- ments involved in the project at headquarters level. He would also cooperate with specialists and consultants in fields such as extension, training, plan- tation management, oil mill technology, marketing and transport management. Overall supervison of field activities would be the responsibility of the PM. He would be a DPI staff member and head of the DPI field team in  - 22 - Popondetta. The PM would report to the PC on all matters relating to project financing and to the TD on extension staff and technical matters. 5.04 The PMC would meet at least four times a year to review and update project development plans, phasing and work programs. Once a work program has been established and agreed to the TD and the PC would work directly with the PM to carry out the program. The PC's main duties would be to liaise with the various departments involved in the project to ensure approval of the project expenditures incurred by these departments in line with the work pro- gram. (A project implementation schedule is presented in Annex 3, Chart 2.) Any major changes in the work program would require agreement of the TD and the PMC chairman. The PC would also be responsible for coordinating project reporting, monitoring and cost control. In addition to these duties related to smallholder development the TD and the PC would be ideally qualified to represent Government on the boards of the nucleus estate, the factory and the FFB transport companies. Assurances have been obtained that the TD and the PC would be Government appointed Directors (or Alternate Directors to the Secretaries of Primary Industry and Finance) to the boards of these companies during during the period of project implementation. The PC would be assisted in his duties by a Project Accountant appointed specifically to the OPC under the project (para 4.17). Assurancies have been obtained that a project Manager Field and a Project Accountant with qualifications and experience acceptable to the Bank be appointed within 6 and 9 months of project signing. B. DPI 5.05 In addition to supplying the PMC chairman, the TD and the PM, the DPI would be responsible for extension services. The composition, duties and deployment of these services have been based on the successful Hoskins experience (Annex 3). In addition to their technical and advisory functions the extension officers will, as at Hoskins, act as field agents for the PNGDB in appraising and supervising loans to smallholders (Annex 1, para 12). C. PNGDB 5.06 PNGDB would be the channel for the smallholder on-farm development credit (paras 4.19, 4.24, 4.25). In this activity it would liaise closely with the DPI officers acting as its fie:Ld agents and with the proposed Smallholder FFB Transport Company (para 4.15) responsible for smallholder accounting services. 5.07 Although PNGDB's performance under the previous IDA smallholder loans (para 1.03) has been satisfactory some improvements are necessary to strengthen its operations. These are discussed briefly below and in more detail in Annex 2.  - 23 - (a) PNGDB's financial position requires strengthening. Although the Board Policy Statement refers to the maintenance of re- serves consistent with prudent financial management, it had a cumulative debit balance on Profit and Loss Account amounting to K 0.9 M (US$1.1 M) at the end of FY75 and this is expected to increase to K 1 M (US$1.3 M) at the end of FY76. One reason for this position is PNGDB's failure to do long term planning. PNGDB enjoys very favorable interest spreads on its operations 1/, but its administrative expenses are heavy and this is being looked into closely by the Managing Director (MD). In the past, PNGDB has received annual grants from the Government; funds have also been onlent to it on easy terms. Future grants at previous levels are unlikely and new loans will carry higher rates of interest. It is therefore essential that PNGDB should become more viable financially. An assurance has been obtained during negotiations that an effective system of budgetary control and management reporting system together with longer term planning would be instituted by June 30, 1977. (b) PNGDB's equity investments include subsidiary companies set up and managed by its Technical Department. These companies are faring satisfactorily. The accounts of these companies should be audited by external auditors. It is PNGDB's intention to sell these companies to nationals in due course and when this is done, the buyers should be charged a fair price, based on a valuation. Assurance have been obtained on these matters during negotiations (Annex 2, para 27); and (c) PNGDB's lending policy was recorded in a Board Policy Statement in 1971. Subsequent developments such as the setting up of and management of subsidiary companies, and the extensive financing of hire purchase and equipment loans require incorporation in the Policy Statement (Annex 2, para 5) and assurances have been received on this matter during negotiations. PNGDB's MD, though an experienced banker, joined the organization in March 1975 as the DMD and was made MD in August 1975. The present DMD, a young PNG national was also appointed to his post on the same date. The policy of the NEC in appointing these two key officers for only one year is unsatisfactory as it does not ensure continuity. 2/ The Bank's view is that these appoint- ments should be made for a period of at least three years and it was agreed during negotiations that this would be conveyed to the NEC. Assurances have been received during negotiations that Bank would be consulted on the terms and conditions of future appointments to the posts of MD and DMD of PNGDB (Annex 2, paras 6 and 32). 1/ About 9%; see Annex 2, para 21. 2/ The present DMD was appoined MD in August 1976 for a period of two years.  - 24 - 5.08 Accounts and Audit: Accounts of the Transport Company would be audited by independent auditors acceptable to the Bank. PNGDB's accounts are audited annually by the Auditor General of PNG, but the accounts are presented in a condensed form in accordance with the PNGDB Act. These are not satisfactory for Bank purposes. Arrangements have therefore been made with PNGDB and the Auditor General that the preparation of accounts for the Bank and the audit reporting would be done in accordance with World Bank Group guidelines on the audit of Development Finance Companies. Assur- ances were received on this matter (luring negotiations (Annex 2, para 35). D. Staffing 5.09 The organizational structure outlined in paras 5.01 to 5.04 would ensure that the required infrastructure and materials for the extension, edu- cation, health and community development services are available as and when required. Staffing of these services would be the responsibility of the respective line departments involved. Staffing problems are expected to be minimal since in selecting Popondetta as a site for a major area development program Government places highest priority in ensuring that all the services involved in the project are adequately staffed with people of the right qua- lifications. Most departments have already allocated the key staff for this purpose. E. Settler Selection 5.10 Settler selection would be the responsibility of the Land Board and would be on a nationwide basis with some preference to residence from the Northern Province. The criteria of selection (Annex 3, paras 21 and 22) have been drawn up in light of experience from previous settlements to minimize selection of unsuitable applicants. Successful applicants would be given one month from the time they have been advised of their selection to take up their blocks. If a successful applicant declines to move to the project area, another settler will be selected. Settlers will be given long term (99 years) leasehold title to their blocks on occupancy. A settler would not be permitted to sell his lease without permission from the Department of Natural Resources. VI. YIELD, MARKETING AND SMALLHOLDERS' INCOME A. Yields 6.01 Conditions for growing oil palm in the project area are excel- lent, and perhaps better than they are in the Hoskins area. Experience has  - 2 5 - shown that PNG yields are higher than those achieved in Malaysia and Indonesia although it is still too early to draw definite conclusions as to future trends. Certainly, with comparable inputs, the estate company would be apable of achieving higher average yields than are recorded in Malaysia or Indonesia, however, yields from smallholders' plantings are estimated to be about 80% of the CDC/Government nucleus estate performance of about 25 tons FFB/ha. This assumption is well supported by the Hoskins' experience. FFB production is expected to be 6 tons per ha in year four, steadily rising to a peak of 20 tons in year eight to ten. Oil and kernel extraction rates are assumed to increase from 18% and 3% in year four to 21% and 3.6% respectively in year eight (Annex 3, Table 4). Annual production figures for oil and kernel are shown in Annex 3, Table 5. On the basis of these projections pro- dui.tion generated by smallholders and the nucleus estate would reach a peak of 42,400 tons in 1988 when PNG's production, including about 70,000 tons from the Hoskins and the Bialla projects, would represent about 2% of esti- mated world exports at that time. B. Markets and Prices 6.02 The most significant change in the world fats and oil consumption over the past decade has been the significant shift from animal fats to vegetable oils in which vegetable oil consumption increased from 60% of an annual production of 34 M metric tons in 1967 to 65% of an annual production of 44 M metric tons in 1975. This coincided with a sharp rise in palm oil output from 1.4 M metric tons to 2.9 M metric tons over the same period re- flecting the large increase in oil palm plantings in the mid 1960's particu- larly in Malaysia. Under these changed market conditions palm oil enjoys a competitive edge over other fats and oils because of its low production costs, in spite of a consumer preference for soft oils such as soybean, cottonseed and sunflower oils, over hard oils such as palm oil. Thus although the price elasticity of demand for palm oil is high, ranging from 3.0 to 10.0, the figure for all fats and oils is low at about 0.125. 6.03 The Bank's staff projects world production of fats and oils to increase by 88% between 1976 and 1985. During this period, palm oil will ex- pand its share from 6.8 to 10.1%. Most of this expansion will come from oil palms planted during the late sixties which will reach their peak yields dur- ing this period. Oil palm projects financed by the Bank Group will contribute about 10.1% to the world production of palm oil by 1985. 6.04 Palm oil consumption in producing countries is projected to grow rapidly during the next decade and exports (mainly to developed countries) are projected to grow even faster. Thus share of palm oil in the world trade of fats and oils will rise from 11.8% in 1976 to 22.9% in 1985. Malaysia will continue to dominate exports followed by Indonesia; the Ivory Coast and Zaire will be the main exporters in West Africa (Annex 11, Graph 2).  - 26 - 6.05 Developed countries import about 90% of palm oil traded in interna- tional markets. Germany, Netherlands and the United Kingdom account for almost 60% of world palm oil imports (Graph 3). While the shares of three European countries declined slightly during the past two decades (1955-1975), the share of US palm oil imports increased by 300% during the last decade (1965-1975). The growing demand for palm oil in the United States reflects the trend towards greater use of vegetable oiLs in consumer products and the decline in the price of palm oil relative to that of other vegetable oils. 6.06 Palm oil development in PNG started in 1967. By 1985 about 23,000 ha of oil palm (smallholder and nucLeus estates) is expected to be in produc- tion. Production of palm oil would amount to 51,000 tons in 1980 and then increase to 103,000 tons in 1985. This would amount to about 1% of total estimated world market exports of palm oil in 1980 and 2.4% in 1985. Con- sidering these small percentages and the overall favorable world market prospects for palm oil products in the eighties, the marketing of PNG's palm oil should not encounter any difficulties. The Secretariat of the Inter- governmental Group of Oil Seed, Oils and Fats has been informed of the Project and raised no objections. 6.07 For the purposes of financial and economic rates of return calcula- tions, prices of US$400 for oil and US$250 for kernel per metric ton cif Europe (at 1976 constant prices) are used. These are the median prices of the range given in Bank commodity price projections and correspond to ex- pected world market prices in 1988 when the project will be in full production. C. Purchase of Smallholders' FFB 6.08 The Factory Company would undertake the marketing of palm oil and kernel processed from the FFB production of the Estate Company and the small- holders. The company would purchase the smallholders' FFB crop in accordance with an agreed price formula (Para 4.14 and Annex 7). Based on the prices assumed in para 6.07, the farm-gate price paid to smallholders would be about K 22.50 per ton FFB (Annex 7, Table 4). D. Smallholders Incomes 6.09 Cash flow statements for the different classes of smallholder plant- ings are shown in Annex 8, Table 2. During the planting and establishment period of 3 years when no fruit is being produced, the cash income would be maintained at K 120 per year by a living allowance payment included in the loan. Over the following years while PNGDB loans are being repaid, the annual cash income would rise from about K 280 in year 4 (US$360) to about K 650 (US$825) 1/ in year 7. At full production and after loans are fully 1/ After Debt Service.  - 27 - repaid, cash income from a 4 ha oil palm holding is expected to peak at about K 1,500 (US$1,900) in year 13 after which it would decline gradually. In addition, all settlers would be able to continue growing some food crops. 6.10 The project provides for extension services to improve subsistence cropping. Moreover, once the 4 ha of oil palm reaches full development, many of the settlers would be able to plant the remaining 1.5 ha of their blocks in oil palm or other cash crops, using their own family labor and surplus revenue from the 4 ha plantings. Such extra benefits have not been quanti- fied and, therefore, are not included in the income figures stated above. Financial Return 6.11 On the basis of farm models in Annex 3, Tables 9 to 11, the financial rates of return on farm investments would be as follows: Smallholders ROR (F) % New Settler 17.1 Existing Settler 19.8 Village Farmer 20.5 In calculating these returns family labor has been included in the capital and operating costs at K 1.62 per man day which is the present official wage rate for non-skilled farm labor. VII. BENEFITS AND JUSTIFICATION Benefits 7.01 The development of oil palm has been an important feature of the Government's program to implement its rural development objectives: to foster the geographic spread of development, to increase the opportunities for earn- ing cash incomes by Papua New Guineans, to diversify agriculture and to increase export earnings. The proposed project, together with the nucleus estate development would bring into production more than 7,500 ha of fertile land not presently used. By providing resettlement opportunities the project would contribute to reducing population pressure in other parts of the country (mainly the Highlands). 7.02 The project would bring about 1,400 smallholders into the cash economy. Additionally, the project would create employment opportunities as a result of the processing operation required to convert FFB into palm oil and kernel. Also the multiplier effects on the regional economy of the pro- posed investment would create substantial project-induced job opportunities. Since manpower is lacking in the project area, expected emigration of labor- ers would further help to reduce population pressure in some rural Provinces of the country and also alleviate growing unemployment among unskilled workers  - 28 - in PNG's major cities. The smallholder development and associated activities would support a total population of about 25,000. 7.03 Further benefits would result from improved access and communica- tions for villages not directly participating in the project and from the establishment of community development centers. Also, the project would lead to the direct shipment of goods into Oro Bay which would considerably reduce freight costs. Presently, all freight into Popondetta is shipped down the coast from Lae at high cost. Undoubtedly increased import and export acti- vity would-lead to further use being made of the modern but underutilized Oro Bay wharf facilities. Thus, the project is expected to act as a catalyst inducing further development in the Popondetta area. 7.04 At maturity (1988) the oil palm project (smallholders and nucleus estate) would produce about 42,400 tons of palm oil and about 7,400 tons of palm kernel. All project oil and kernel would be exported and, at full production, foreign exchange earnings from these products would be about K 10.75 M (US$13.65 M). Project Evaluation 7.05 Settlement Costs per family have been computed as follows: Project Costs US$ Buildings for Extension/Social Services 650 Road Costs /a 1,150 Sub-total 1,800 Smallholder Development Costs On-Farm Costs 2,105 Other Costs 705 Sub-total 2,810 Smallholder Transport Company 430 TOTAL 5,040 /a Based on the assumption that 30% of direct benefits of roads would be to nonparticipants of the project. When- the costs of the extension and social services over the development period are included, and assuming that the proportional cost of these serv- ices between project participants and non participants in the area would be 75:25 for extension services and 30:70 for social/respectively, the cost per services  - 29 - smallholder is about US$6,000 and if no adjustments are made for these ser- vices or road usage the cost per smallholder is about US$7,925. 7.06 The number of jobs created by the project has been estimated as follows: Smallholder Development 2,100 Government Services & Transport Company 300 Secondary Urban Development 200 Secondary Rural Development 500 TOTAL 3,100 The cost per job for the project would be about US$4,000. 7.07 In estimating the economic rate of return, adjustments to the costs of extension/social services and roads were made to take into account use by non-project participants living in the area. Thus these costs were pro- portioned to the project beneficiaries as follows: Extension Services 75%, Social Services 30%, Roads 70%.1/ A shadow wage rate of K 0.80 per day instead of the full rural wage rate was also used. This reflects the employment and wage situation in the areas of settler origin. With these assumptions the economic rate of return for the Project is estimated at 14.5%. If the exten- sion/social services and roads were costed fully in the Project the return would be 11%. 7.08 Sensitivity of the economic rate of return (Annex 12) to changes in various cost elements and export prices for palm oil and kernel has been tested with the following results: Type of Change ROR(E) (a) 10% cost increase 11.5% (b) 10% benefit increase 16.5% (c) 10% benefit reduction 11.5% (d) 10% cost increase and 10% benefit reduction 9.0% No attempt has been made to quantify other benefits such as increased employ- ment opportunities in trade and marketing based on the increased production and incomes for the project area, and the secondary benefits of facilities such as roads under the project. Indeed, construction and improvement of main roads in the project areas will not only serve the oil palm development schemes but also improve traffic conditions for other road users. Finally, the benefits smallholders would derive from subsistence crops and from development of the balance of each settler's holding for expansion of oil palm production, or other cash crops, have not been taken into consideration in the ROR calculations. 1/ These percentages are based on discussions with PNG authorities in the light of their experience.  - 30o - 7.09 Risks to the smallholder have been minimized by taking into ac- count the experience gained from the organization and management of the very successful IDA financed smallholder oil palm development at Hoskins. Also trial plantings made in 1967 have shown the areas selected for growing oilpalm in the Popondetta Province are most suitable. The soils are level, well drained and fertile, the rainfall plentiful and well distributed, and there is ample sunlight. In addition no problems are foreseen in selling the palm oil pro- duced under the project in the same European markets as that from the Hoskins area. Further the average price projections (constant 1976) of US$400 for oil and US$250 for kernel per metric ton c.i.f. (para 6.07) are adequate to ensure a satisfactory income to the farmer plus loan repayment from 5 to 13 years and thereafter provide sufficient incentive for the farmers to clear and plant the remaining 1-1/2 ha of uncleared land on their farms. Cost and Benefit Recovery 7.10 All costs incurred on farm development 1/ are charged to the small- holders' loan accounts and recovered in full together with interest. As in the Hoskins project, where recoveries have been done efficiently, 50% of farmgate income 2/ will be recovered at source and set off against the loan accounts until they are repaid in full (Annex 8, Table 2 for smallholders' cash flows). PNG has an effective income tax system and taxes will be re- covered, as is being done on the Hoskins project, from smallholders when they become payable. 7.11 Annex 13 examines the implications for public revenues and project beneficiary incomes of the Government's proposed recovery policies for vari- ous project components. The analysis presents two indices which are defined as follows: (a) Cost Recovery Index: the ratio of incremental direct payments for the project by all project beneficiaries to incremental project development operation and maintenance costs; and (b) Rent Recovery Index: the ratio of incremental direct payments for the project by a typical farm family to incremental "proj- ect rent" where project rent is defined as incremental net income less the value of labor, returns to management, returns to incremental investment funds of the farmer and an allowance for risk and uncertainty. 7.12 All project charges, costs and benefits are measured at present values discounted at 10% annual rate of interest over the life of the project in constant 1976 prices and summed. The results are summarized as follows: 1/ Including housing and subsistence and living allowances paid during the development period. 2/ Subject to a minimum payment, based on present requirements, of K 7.50 per ton FFB, to the smallholders.  - 31 - Cost Recovery Rent Recovery Rent Recovery (Total Project) (Existing Settlers & Villagers) (New Settlers) 63% 57% 74% Without project income: K 516/family K 516/family With project income: K 1,500/family K 1,500/family The incremental net farm incomes would provide sufficient incentives for settlers to participate in the project. The allowances for the rent recovery indices are shown in Annex 13, Table I while for cost recovery the items shown in the same table are from the various component annexes. All farm development costs are charged but only 75% of extension services, 70% of road up-grading and construction and 30% of social services are charged to the project since much of the benefits of these components are captured by non-participants in this project. Social Impact 7.13 Except for the benefits which accrue directly to the Government and the nucleus estate company, most of the project benefits would accrue to PNG settlers, villagers and laborers, who are expected to come from the least developed and overpopulated areas of PNG. The distributional impact of the project would therefore be favorable. In addition to a considerable increase in incomes, smallholders and factory workers will be provided with improved health, education and other infrastructure facilities to improve their living standards. Finally, in the design of settlements there has been an attempt to encourage integration of people from many parts of the country. Ideally, six to ten families from a particular ethnic group are settled on adjoining pro- perties. In the overall choice of settlers, allocations will be made with a view to a balanced selection from the different geographic areas of PNG. This aspect is of significance as PNG searches for a new, post-independence, na- tional identity. VIII. RECOMMENDATIONS 8.01 The project is considered to be financially viable, economically sound and socially desirable. It is suitable for Bank financing of US$12 M. During negotiations agreement on the following major points was reached with the Government: (a) nucleus estate company would provide smallholders with suit- able planting material (4.08); (b) Government would review annual requirements of extension staff to service increased demand for food cropping and appoint additional staff when required (4.12); (c) nucleus estate company would provide for oil palm research and the results of such research would be readily available to all smallholders in the area (4.13);  - 32 - (d) any changes in the criteria for determining FFB price will be made in consultation with the Bank (4.14); (e) Government would establish a Transport Company (TC) prior to the first production of FFB by smallholders with capital structure and operating policies satisfactory to the Bank (4.15); (f) Government would enter into a subsidiary loan agreement with PNGDB on terms and conditions satisfactory to the Bank (4.24); (g) Government would make available to PNGDB additional funds as may be necessary for on-farm development (4.24); (h) PNGDB loans to smallholders would bear interest at 11% per annum and lending terms to the smallholders would not be amended without prior consultation with the Bank (4.25); (i) the Technical Director and the Project Coordinator would be appointed as Government's representatives to the boards of the nucleus estate and factory companies and the TC (5.04); (j) a Project Manager Field with qualifications acceptable to the Bank would be appointed by March 31, 1977 (5.04); (k) a Project Accountant with qualifications acceptable to the Bank would be appointed to the OPC by June 30, 1977 (5.04); (1) an effective system of budgetary control and longer term planning would be instituted by PNGDB by June 30, 1977; (5.07(a)); (m) the Bank would be consulted on the terms and conditions of future appointments to the posts of MD and DMD of PNGDB (5.07 (c)); (n) PNGDB's subsidiary companies would be audited externally and when these companies are sold, the buyers would be charged a fair price based on a valuation (5.07(b)); (o) PNGDB's policy on financing of hire-purchase and equipment loans and setting up and management of subsidiary companies would be incorporated in its Lending Policy Statement (5.07(c)); and (p) accounts of PNGDB, and the Transport Company would be audited by independent auditors acceptable to the Bank: PNGDB's accounts would be audited in accordance with World Bank Group Guide- lines on the audit of DeveLopment Finance Companies. (5.08)  - 33 - 8.02 Conditions of loan effectiveness would be (a) the conclusion of a Subsidiary Loan Agreement between Government and PNGDB which is satis- factory to the Bank (4.24); and (b) the agreement between Government and CDC covering the establishment and financing of the factory/nucleus estate companies would have been concluded to the satisfaction of the Bank (4.27).   ANNEX 1 Page 1 PAPUA NEW GUINEA POPONDETTA SMALLHOLDER OIL PALM DEVELOPMENT PROJECT Department of Primary Industry Organization 1. The Department of Primary Industry (DPI), previously the Department of Agriculture, Stock and Fisheries (DASF), is the Government Department responsible for policy formulation, planning and implementation of agricutural, livestock, fisheries and wildlife management and conservation programs. During 1975 and in early 1976 substantial changes took place in the organiza- tion of the Department and in ministerial responsibility. A January 1976 reshuffle of ministerial responsibilities has placed responsibility for DPI together with the Department of Forests under a new Ministry of Primary Industry. This new arrangement which reduced the size of the Ministry re- placed the cumbersome arrangement which existed through much of 1975 where the Director of DASF was reporting to 3 ministers (Agriculture for agriculture and stock; Natural Resources (forests) for fishing; and Conservation and Environ- ment for wildlife). While at the time of the Mission's visit the Minister had been appointed, no final details were available on the proposed relationship of the existing departmental heads (DASF and Forests) to a new permanent min- istry head. However, DPI responsibilities and organization remain unchanged from that approved in 1975. 2. The present organization of DPI is shown in Chart 1. This repre- sents some significant changes on the previous departmental organization in- cluding: (a) the disbandonment of the previous regional organization where four regional controllers had financial responsi- bility for all departmental activity in the wide regions they administered; (b) the devolution of responsibility for planning, implementa- tion and financial control of departmental activity in the nineteen Provinces (previously Districts) to nineteen Pro- vincial Rural Development Officers (PRDO) (except for national agricultural projects and some specific functions); (c) the organization of headquarters on a commodity basis with the establishment of separate Agriculture, Livestock, and Wildlife and Fisheries Branches; (d) the creation of a headquarters branch (Policy Review and Coordination) for coordination of departmental activity at Provincial level;  ANNEX 1 Page 2 (e) the integration of planning into the Planning Economics and Marketing Branch; and (f) the appointment of a Deputy Director. 3. Part of the rationale for this re-organization was the Government's desire to meet the growing demands by provincial or area groupings for greater participation in the planning of development in their own areas. While these demands have not, with the exception of Bougainville, as yet led to any form- alized Provincial level of Government there are indications that some general arrangements at this level could evolve with such groups at least having greater say in the development for the area concerned. The new organization does in fact cater for this while at the same time placing greater control of func- tions such as national policy development, pest and disease control, produce quality control, research, conservation of fauna, organized marketing and national project development in headc[uarters. Another factor influencing the reorganization was the fact that Government administration is generally organized on a provincial basis with the Provincial Commissioner being the senior public servant in a Province. Probably the most important factor, however, was the growing recognition that rural, fishery, and wildlife planning, and implemen- tation needed to be organized on a commodity by commodity approach at the same time as a (small) area by area approach. 4. The headquarters functional branches (Agriculture, Livestock, Wild- life, Fisheries) are responsible for the development of policies, and plans for each commodity within the framework of priorities developed within the Planning Economics and Marketing Brarnch. They are responsible for providing the technical and support services (pest and disease control, research, etc.) to ensure that programs are implemented at the Provincial level. They are also responsible for the implementation of projects of national importance e.g., the Popondetta Smallholder Oil Palm Development Project would be under the control of the Assistant Director, Agriculture, as far as Departmental responsibility is concerned. 5. The Agricultural Education and Training Branch has responsibility for training at colleges, in-service training and career planning, farmer training program coordination, speciaLlist training, rural broadcasting, library and other support services, and research into extension methods. The Planning Economics and Marketing Branch has broad responsibilities for the development of national area and specific project policies and plans and coordination of departmental planning and implementation with budget prepara- tion and review as well as with international credit and aid and agro-related development in forestry, transport etc. As well they provide Government repre- sentation on statutory marketing boards, administer policy on organized market- ing, and provide marketing and produce inspection services. The Branch is also responsible for the collection and publication of smallholder statistics and provision of economic and planning services to field staff and farmers.  ANNEX 1 Page 3 6. The PRDO is responsible for planning and implementing programs within national policy guidelines at Provincial level. His staff includes Rural Development Officers (RDO), Rural Development Technicians (RDT), Rural Development Assistants (RDA), clerical support staff, and some specialists. Other specialist staff such as Veterinary Officers, agricultural economists, produce inspectors who may in fact be resident within a Province, are directly supervised by the RDO but have clear lines of communication to section heads at headquarters. Staff within a Province are usually posted on a sub-province or extension center basis with some specialist extension staff at provincial headquarters. Where a national project such as an oil palm project is located within a Province this is under the control of a project manager with direct links to the relevant headquarters branch, but with regular contact with the RDO. 7. The RDO's are in constant contact with the Policy Review and Co- ordination Branch at headquarters and work through four area coordinators. These four people together with their Assistant Director apart from general servicing of RDO's are also represented on the Departmental Standing Committee. The Committee including all Assistant Directors meet with the Director and Deputy Director on a regular basis for at least one hour each week. This enables the RDO's field problems to be immediately represented at top depart- mental level. More formal meetings of Standing Committee where policy matters are discussed are held on a regular 6 to 8 weekly basis. 8. DPI staff increased about sixfold from 403 in 1960 to 2,542 in 1975. Apart from the magnitude of this increase of equal significance has been the change in the proportion of local personnel. In 1961, the department was staffed almost exclusively by expatriates while in December 1975 there were 2,191 local staff and 351 expatriate staff (Table 1). Although Government policy is to eventually localize all its staff, it also recognizes that this should be done gradually and that for some time to come the maintenance of a core of expatriate staff is essential to the efficient running of the Depart- ment. At present, DPI is heavily dependent upon expatriates to provide upper and middle level administrative and middle level expertise. Its local staff is young and inexperienced and many lack the qualifications to fill these positions. 9. Before independence it was feared that once independence was declared the outflow of expatriate staff would be such that it would seriously impair DPI's ability to function efficiently. While it is true that the DPI did lose (and still is losing) valuable experienced expatriate staff financed and employed by the Australian Government, the impact of this loss has not been as serious as anticipated. Also, Government has been successful in its campaign to recruit expatriate staff directly. Most of these have been con- tracted for 2 years and after June 30, 1976, when the direct payment of ex- patriate staff by the Australian Government ceases, all expatriates will be recruited in this manner. However, under these conditions turnover is likely to be high and working conditions less stable than before.  ANNEX 1 Page 4 10. Government has placed great emphasis on education and training of PNG nationals in the rural field. I]n particular, it is encouraging more people to take agricultural degrees at the University of PNG, is stepping up its diploma programs at Vudal Agriculture College, and also has expanded facilities at the HATI and PATI agricultural training institutes to increase output of Agricultural Certificate graduates. Already DASF is benefitting from these programs and in January 1976 employed 104 graduates out of a total of 140 from Vudal, HATI and PATI. However, in spite of Government's excel- lent efforts in education and training, it will be sometime before there are sufficient experienced local officers to replace expatriate staff at the upper/middle management and technicaLl levels. Extension Services 11. The main staff members who have direct contact with the farmers include the RDO, who normally has a Diploma in Agriculture, and his team of Rural Development Technicians (two-year Certificate in Agriculture) and Rural Development Assistants (without formal training). The keenness and enthusiasm of the staff are apparent, but there are problems associated with short-term contracts given to expatriates and the inevitable inexperience of newly trained local personnel. There are 461 trained staff and 808 without formal training, classed as Field Staff, serving an estimated 370,000 farmers - a ratio of one trained field man to about 3,000 farmers. The service has func- tioned satisfactorily so far, but there is the danger that rapid turnover and transfer of local staff 1/ as well as the departure of expatriates could affect its efficiency in the short run. A summary of DPI field staff is given below: DPI Field Staff 1975 Rural Development Officer /a 194 /b Rural Development Technician (Certificate) 183 Rural Development Assistant 808 Other Ic 203 1,388 /a Mostly diploma holders. Tb Includes 88 ASAG officers. /c Includes 31 project managers, 120 clerical support staff, and 53 others in such groups as produce inspectors etc. 1/ With the rapidly expanding service promotion opportunities are good for local staff willing to accept transfer.  ANNEX I Page 5 Agricultural Credit Activities 12. In addition to the purely technical aspects of the work DPI ex- tension officers are officially designated to act as field agents for PNGDB's farm credit service. In this the RDO's and their staff are responsible for: (a) the technical side of the loan; (b) preparing the farm plan and budget; (c) helping an applicant prepare the loan application; (d) evaluating the managerial ability of the applicant and his creditworthiness; (e) helping the applicant procure stock and materials; (f) ensuring that the farmer keeps to the development program; and (g) preparing progress reports for PNGDB. However, apart from specifically defined projects (and or commodities), the involvement of DPI extension staff in agricultural credit operations has been disappointing. In many centers there is virtually no contact between the DPI and PNGDB officers. An important reason for this lack of cooperation is that most extension staff have had little or no training in agricultural credit operations. Similarly, many PNGDB field officers are inexperienced and inade- quately trained. Under the proposed Project provision has been made to finance the training of DPI extension officers and PNGDB field staff in smallholder rural credit operations.  PAPUA NEW GUINEA POPONDETTA SMALLHOLDER OIL PALM DEVELOPMENT PROJECT Department of Agriculture Stock and Fisheries Staffing