Ecuador - Seeds Project

FILE COfPY Document of FoiL " The World Bank FOR OFFICIAL USE ONLY Report No. P-1791-EC REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ECUADOR FOR A SEEDS PROJECT March 18, 1976 This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Sucre (S/.) S/. 1.00 = US$0.04 US$1.00 = S/. 25.00 S/. 1 million = US$40,000 GOVERNMENT OF ECUADOR FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPIENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAIN TO THE REPUBLIC OF ECUADOR FOR A SEEDS PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic cf Ecuador for the equivalent of US$3.0 million to help finance a seeds project. The loan would have a term of 15 years, including four years of grace, with interest at 8-1/2 percent per annum. PART I - THE ECONOMY 2. A report entitled "Ecuador: Economic Memorandum" (No. 1033-EC) was distributed to the: Executive Directors on February 26, 1976. Annex I summarizes the main economic and social indicators. 3. With the first shipments of crude oil from the Oriente Region in 1972, Ecuador became a net exporter of oil. This provided the country with additional resources which at least temporarily removed the savings and foreign exchange constraints that had severely impeded Ecuador's growth in the past. Oil income rose from $38 million in 1972 to over $420 million in 1974. However, during the last year it has become clear that the country's oil wealth is smaller tharn previously estimated. One year ago, it was estimated that the country had total -- proven and probable -- oil reserves equivalent to 5.7 billion barrels. Current estimates are of only 2.5 billion barrels, owing to a substantial decline in the calculation of probable exploitable reserves. Moreover, it is now expected that the production levels projected last year for 1976 will not be achieved until the early 1980s. These revised estimates, together with a better knowledge of the difficulties to be en- countered in the exploitation of Ecuador's untapped oil fields, and with the transitory problems faced by the country's oil exports in 1974-75, indicate that Ecuador is not likely to accumulate substantial amounts of foreign exchange reserves in the foreseeable future. 4. There has beten a sharp decline in petroleum output since mid-1974 because of marketing dlifficulties for Ecuadorian crude in export markets and a protracted disagreement between the Government and the foreign con- cessionaires over the taxation of oil exports. The total offtake of oil dropped from an average of 232,000 b/d during January-June 1974 to 123,000 b/d during the second half of 1974, and became irregular in 1975, owing to two breaks in the trans-An!dean pipeline. For 1975, the average production is estimated at about 165,000 b/d. There has also been a virtual standstill in exploration during the past two years and the level of proven recoverable reserves, estimated at: 1.5 billion barrels, has remained unchanged. 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.  - 2 - 5. The disappointing performance of the petroleum sector had not been expected by the Government. Counting on rising petroleum income, the Govern- ment had adopted policies designed to stimulate further growth. It increased public expenditures -- including subsidies of essential consumption goods; offered more generous credit programs for agricultural and industrial invest- ment; and lifted most quantitative import restrictions. In 1974, import duties were cut by an average of 34 percent. Moreover, imports of agricultural inputs and of essential foodstuffs were fully exempted from duties. 6. The response of the economy to these policies, and to the prevailing very optimistic economic climate was, in general, strong. Gross investment grew by 22 percent in real terms in 1973 and growth of GDP at market prices reached a rate of about 15 percent, far above historical levels (5.5 percent from 1965 to 1970). Continuing rapid growth in industry, construction, trade and Government services made it possible to achieve an overall GDP growth rate of approximately 8 percent in 1974. This was obtained in spite of the significant decline in the oil sector product, and of the virtual stag- nation of agricultural production -- which was hampered, until early that year, by the insufficiency of credit availabilities and by the inadequate price policies followed up to then by the Government. 7. The rapid economic expansion was accompanied by inflationary press- ures. The cost of living index for low and medium-income families in Quito, which had risen by about 8 percent per annum during 1971 and 1972, increased by 13 percent during 1973 and by over 23 percent during 1974. While the inflationary pressure was largely generated by the rapid rise of public expenditure, the strong expansion of credit to the private sector also contri- buted to the increasing money supply. Domestic supply could not respond in full to the growth in demand, which led to higher imports of wheat, oils and fats, and other products. In construction materials, domestic production did not keep pace with increases in demand. In manufacturing, the process of import substitution of finished goods accelerated, leading to rapidly rising imports of equipment, raw materials and semi-finished products. As a result, total imports of goods and non-factor services rose from about $440 million in 1972 to $515 million in 1973 and over $1.0 billion in 1974. This import growth in part also reflects a rise in import prices of 17 percent in 1973 and 28 percent in 1974. Exports -- also including non-factor services -- expanded from $365 million in 1972 to about $1.1 billion in 1974. Of the inc ease, about 75 percent was accounted for by petroleum. 8. Despite the growth of imports, Ecuador's balance of payments showed, until mid-1974, a marked improvement. In 1973, Ecuador achieved the first surplus in its resource balance since the early 1950s, and net foreign ex- change reserves rose from $128 million at the end of 1972 to $371 million by the end of June 1974. However, these favorable trends could not be maintained after mid-1974. As oil exports declined and total imports continued to rise substantially, Ecuador's reserve position began to deteriorate rapidly. By August 15, 1975, the country's net foreign exchange reserves had fallen to $181 million, equivalent to less than two months' imports.  - 3 - 9. Until 1974, increasing oil revenues brougnt about a substantial improvement of the Government's financial position. For the Central Govern- ment 1/ -- which received about 54 percent and 57 percent of total oil rev- enues in 1973 and 1974 respectively -- these revenues led to a strong in- crease in current savings and to an expansion of capital expenditure substan- tially above the growt:h of current expenditure. With current savings rising to about $68 million in 1973 and $298 million in 1974, the overall cash position of the Central Government turned from a small deficit in 1973 to a $62 million surplus in 1974, despite a more than threefold increase in capital expenditure in 1974. FONADE, established in late 1973 in an effort to earmark part of the additiona:L oil revenues for the financing of public investment projects over and above budgetary allocations, disbursed about $93 million in 1974. Most of these disbursements helped finance the construction of the Esmeraldas refinecy, and the credit programs of the National Development Bank and other financial institutions. As a result of the decline of oil revenues, current savings decreased by an estimated 20 percent in 1975 despite an improved performance of non-oil taxes. These developments led to a tem- porary financing gap in the Central Government operations and to the decision to contain the growth of Government expenditure in 1976. 10. A number of recent measures have contained the deterioration of the balance of payments, and foreign exchange reserves are estimated to have totalled about $245 million at the end of 1975. The measures included a reduction of the tax-paid cost of petroleum exports by the equivalent of about US$0.43 per barrel; the concession of higher allowances to oil companies for their production cost; and the introduction of import restrictions in August and September 1975. Oil production has recovered, mainly as a result of the cutback in the income tax rate on oil exports, and is estimated to have reached over 210,000 b/d towards the end of 1975. 11. On October 2, the Government announced new financial objectives for 1976: to achieve additional increases in foreign exchange reserves and a more balanced budgetary position, which would make it unnecessary for the Government to borrow further from the domestic banking system or from foreign commercial banks during 1976. The Government hopes to reduce the annual rate of inflation from some 15 percent in 1975 to about 10 percent in 1976. Further negotiations with the oil companies are expected to open the way to increased exploration and development efforts. 12. Ecuador's cil production is now expected to increase gradually and to reach about 270,OC00 b/d by 1979-80. An expansion beyond this level appears feasible, provided that a vigorous exploration and development program can be brought underway in the near future. Increasing export earnings from petro- leum, coffee, sugar and manufactured goods, combined with a net inflow of foreign capital in the order of $265 million a year during 1976-80 -- needed 1/ Including the National Development Fund (FONADE) and the National Parti- cipation Fund.  - 4 - largely to finance new gas and oil-related ventures -- should make a sub- stantial improvement of the overall balance of payments situation possible after 1976, and permit a moderate increase in foreign exchange reserves. The extent to which Ecuador's balance of payments situation will actually improve depends largely on the success of immediate stabilization policies, the development of oil production, the behavior of oil prices, and the mobilization of foreign capital. 13. Although the oil sector will continue to be the major source of foreign exchange in the medium term, there are considerable uncertainties with respect to the possible production profile of this sector in the longer run. Most of the oil likely to be produced until the early 1980s has already been found. Unless exploration efforts are substantially stepped up and new oil fields are discovered, production could decline soon afterwards. To make the most efficient use of oil revenues, the Government therefore intends to begin to diversify the production base of the economy by developing agricul- tural and industrial activities in which the country has a potential compara- tive advantage. Exports other than oil need to be developed -- for example, natural gas, and agricultural and forest resources. An appropriate use of the financial resources provided by oil will make it possible to alleviate the country's most pressing social needs. However, Ecuador continues to be one of the poorest countries in Latin America, with an estimated per capita income of $450 in 1974, and a large proportion of the population living at subsistence levels. Oil has only shifted Ecuador from the upper strata of the poorest countries to the lower brackets of the middle income developing countries. 14. The Government several years ago designed an ambitious development strategy. It is reflected in the 1973-77 Plan Integral de Transformacion y Desarrollo and focuses on (a) promoting the diversification of the economy by fostering agricultural and industrial development; (b) alleviating poverty in the countryside through rural development programs; (c) upgrading social services; (d) expanding infrastructure; and (e) improving the absorptive capacity by overcoming major bottlenecks to development, notably the shortage of qualified manpower and the administrative weakness of the public sector. 15. To pursue these broad objectives, efforts have been made to improve the investment capacity of the public sector. In 1973, a preinvestment fund (FON --RE) was set up to finance prefeasibility and feasibility studies. Inventories of projects and project ideas were compiled in the entire public sector. Also the Government has been able to increase public investment rapidly. However, progress has been slow in sectoral planning -- particularly in setting investment priorities in some major sectors -- and in the coor- dination of investments by region. 16. Ecuador's development needs, as well as persistent structural and institutional weaknesses, call for continued external assistance. Although the country's creditworthiness has improved greatly, it would not be sound policy for Ecuador to rely on the private capital market as the sole source  of external finance. Neither the amouncs nor the terms available to Ecuador in the market would make this advisable. Rather, a mixture of commercial and official financing will best suit Ecuador-s needs during the next few years. 17. Ecuador is creditworthy for further lending at Bank terms. The ex- ternal public debt outstanding on December 31, 1974 was estimated at US$530 million, of which US$297 million was disbursed. Service on outstanding pub- lic debt is relatively moderate -- about $85 million in 1975, equivalent to about 8.0 percent of the exports of goods and non-factor services. The debt service ratio is projected to fall to approximately 4 percent in 1979-80. The Bank/IDA share in outstanding and disbursed public debt as of December 31, 1974 was about 19.7 percent, it is exnected to rise. PART II - BANK GROUP OPERATIONS IN ECUADOR 18. Starting with the first loan in 1954, the Bank and IDA have made twelve loans and six credits to Ecuador totalling US$150.0 million, net of cancellations. At the end of January, 1976 the Bank and IDA held about US$115 million, including about US$45.2 million not yet disbursed. The IFC has made five loan and investment commitments in Ecuador, two in a large textile companv and three in a development finance company, amounting to USS4.3 million of which, as of January 31, 1976 US$2.7 million had been sold, terminated or cancelled. In addition, IFC is considering a loan to help finance the expansion of sugar production in the Guayaquil area and a plywood mill near Esmeraldas. Execution of Bank Group financed projects has, on the whole, been satisfactory, even though it has not been free of difficulties often caused by the insufficiency of the country's managerial and technical resources -- a constraint that still is a major obstacle for Ecuador's econo- mic and social development. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of January 31, 1976, and notes on the execution of ongoing projects. 19. Bank and IDS lending were originally concentrated in transportation and power, where therE: were substantial deficiencies to be overcome. These two sectors still account, respectively, for about 25 percent and 10 percent of total past lending. Most of the lending for transportation was to improve the road network of the country, although one loan was made to help finance a new port in Guayaquil (FY59). Lending for power has been concentrated in improvin- generation and distribution facilities in Quito. The first live- stock development loan (FY67) marked the beginning of a diversification of lending; since then the Bank and IDA have made four more loans and credits for agriculture and fisheries, two loans to support industrial development through two development finance companies, two loans for education and one loan for water supply. Bank/IDA assistance for the commodity producing and social sectors account now for about 55 percent of total lending. 2o. External development financing has also beci provided by IDB and AID and, to a lesser extent, by other bilateral sources. External financ- ing by sector and by source thlrough 1n74 is summarized below:  - 6 - (US$ million, Figures Net of Cancellations) IBRD IDA IDB AID Lending 1954-64 54.0 8.0 35.3 67.7 Lending 1965-74 59.5 28.9 232.6 42.0 Transport 18.0 Power 6.8 67.7 3.6 Education 5.1 4.1 5.3 Health & Sanitation 23.2 49.3 2.8 Agriculture & Fisheries 8.3 17.0 53.7 10.8 Industry 28.0 21.2 8.0 Urban Development 14.4 Other 4.2 11.5 113.5 36.9 267.9 109.7 TDB is the largest single lender, having extended most of its loans to Ecuador from the Fund for Special Operations, which has normally carried a 2 percent interest rate, a ten-year grace period, and repayment terms of up to forty years. It is likely that IDB will remain the major development lender in the immediate future, although the terms will be less concessionary than in the past. AID loans generally have had amortization and grace periods similar to those of IDB, with interest at 2-3 percent. Education, health and other socially oriented activities, as well as agricultural development, have been receiving increasing attention from the external lending agencies in recent years. IDB, AID and the Bank Group have coordinated their efforts in these fields to assure the most effective use of all available resources. 21. Bank lending is aimed at supporting the Government priorities outlined in Part I above. This objective will be met by emphasizing pro- jects that will help strengthen the institutional framework for development policy -- particularly concerning project planning, preparation and imple- mentation -- in agriculture and rural development, transportation and other high priority activities. The highway project and the Second Port of Guayaquil project, which are being processed for your consideration later this year, will complete an important stage of the Bank's involvement in Ecuador's transport sector. These two projects are designed to help the Government establish the administrative mechanisms and technical procedures required for designing and implementing appropriate policies and investment projects in the sector during future years, while assisting also in the overcoming of some major transportation bottlenecks. 22. Beyond those two transportation projects, the current Bank program is heavily concentrated on agricultural and rural development. The Bank can undertake a major institution-building effort in these fields, which should yield tangible benefits for Ecuador. Agriculture is, at the same time, the most important and the most neglected sector of the Ecuadorian economy. Its potential is far from being adequately realized and its low productivity is  - 7 - a main cause of the extreme poverty in which most of the Ecuadorian popula- tion still lives. The current Bank program includes a substantial support of integrated rural development projects and important assistance for the development of the country's agricultural potential. All projects pro- grammed for this sector include sizable technical assistance components, as a major part of the overall institution-building effort referred to above. This is reflected particularly in the project that will be presented for your consideration to aid Ecuador in the preparation of agricultural and rural development projects, as well as this proposed seeds project. Other projects in this sector which are planned over the next two years include one agri- cultural credit, one irrigation and two rural development projects. Moreover, most of the other prDjects currently under consideration -- for instance, rural roads, rural electrification and agroindustries -- are also related to the major objectives referred to above for agriculture and rural development. / .;~~ART III - THE AGRICULTURE SECIOR v~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 23. Agriculture is the mos impo ant secFor of the Ecuado/rian economy in terms of output and employmen , and scnd oply to oil as a source of foreign xchange earnings. It as a rge gro th potential, but it is also the sec or with the most seriotusLin-st tu jonal!and social problems, and the oneLI - the poorest performance . The Government's 1968 Agricultural Census showed that one-third of farm holdings were less than 1 ha, and that i:hree of every four fart$s were smaller than 5 ha. The same 75 percent of a:Ll farm holdings compri/sed only 10 percent of total agricultural acreage. The r'esults of the y1974 census, currently being analyzed, are not expected/to show any ma or change. Partly as a consequence of this situation, and of the relatively/low agricultural productivity, an estimated 1.5 million persons (the poorei half of the rural population) had per capita incomes in 1974 of less than the amount estimated to be needed for basic nutritional requir/ements. Three-/fourths of the rural population earned less than one-third of the national average annual per capita income. By contrast, the 1968 census indicated th&at the wealthiest 1;O percent of the econ(omically active r1ural population received about 60 percent of agricultural income. This situatij n has been aggri avated by the virtual stagnation that has prevailed in agricult-kre during recept years. Food production per capita showed barely any increase in the eakrly 1970s and then slipped in 1973. The overall rate of agri!cultural growth/was only 0.7 percent per year from 1972 to 1974. Real per capita GDP in agriculture diminished from 1969 to 1973 at an average yearly rat 1,cf 2.4 percent Since growth in other sectors was quite strong at the sameTjtime, this tren4 has increased the difference between rural and urban income ]evels, and has also widened the gap between the demand and supply of agr.fcultural and livestock products. This resulted in serious food shortages, significant inflationary pressures and a soaring food import bill. 24. Ecuador's agricultural potential is larg(- conugh to permit a pro- nounced reversal of tlie disappointing treonds rofei rcJi LO 1bove. The country  - 8 - ( has a favorable endowment of the resources needed/for a varied and far greater output. There are sizable amounts of uncultivate land, some in almost completely unexploited zones, that could be devel ped for agriculture and livestock. Some events of the past decade -- the remarkably fast transfer of _-~~ banana production from the Gros Michel to the Cav ndish variety; the return of rice to the array of traditional exports; and the rq.^d cocoaawe sugar r4& yields4+n 1974 -- all suggest a promising capability for achieving greater agricultural output. This potential, however, will not be easily realized. Over 40 percent of the unexploited arable land and grassland of Ecuador is in the eastern Amazon area of the Oriente which is largely isolated and un- inhabited. Another one-third of potential additional agricultural land is in the Andean highlands where erosion and population pressures have constrained growth possibilities. The remainder is in the coastal zone whose areas with the best soils suffer from flooding and insufficient drainage. Further- more, agricultural production in Ecuador has risen in the past by the exten- sion of cultivated area rather than by the adoption of improved techniques. U;tD /fn3,the agricultural sector has operated largely without the support of extension services; of credit, storage and marketing facilities; and of improved seeds and other inputs. Technological progess in Ecuador's agriculture -- parti- cularly in small farms -- has, therefore, been very slow. As a consequence, average national yields are lower than those in adjoining countries. 25. The present Government has reacted positively to these problems in its recent actions, reflecting its appreciation of the importance of the future of agriculture. Since the beginning of 1974, the Government has raised producer prices, increased the flow of credit, reduced import duties on agricultural inputs, and reduced sales taxes on those intermediate and capital goods used in farming to offset their rising costs. Producer support prices were raised for rice, meat, milk, sugar, wheat and oil seeds to counter the deterioration of farmers' terms of trade. The National Develop- ment Bank -- which is receiving a large share of the country's oil revenues -- increased credit to the agriculture sector from $23 million in 1972 to $45 million in 1973 and $105 million in 1974. Moreover, a Seeds Corporation was formed in 1973 to promote the production of certified seed. Agricultural policy continued to improve during 1975. In January of that year, the Minister of Agriculture announced an ambitious mechanization program and plans to expand storage facilities while the Monetary Board made loans to agricul- ture more profitable for the commercial banks than those to industry and to the commercial sector. The Government also announced during the year its intention to allocate to agriculture and rural development a higher share of total public expenditure. At the same time, it has requested Bank technical and financial support for several projects in these fields. 26. On the whole, these policies seem to be in the right direction and are already achieving some success, although they still need substantial reinforcement. Overall agricultural production in 1974 was impaired by massive increases in the import prices of machinery, fertilizer, and other agricultural inputs. The prevailing poor weather, and some uncertainty among landowners following the approval of the October 1973 agrarian reform law, also made it difficult to achieve substantial progress toward solving the  - 9 - main problems of the sector. Despite these negative factors, however, the previous inadequate production trends have been partly reversed. During 1974, thiere was an increase in wheat production for the first time since 1969 (up 13 percent). At the same time, production of rice rose by 17 percent, of cocoa by 50%, and of cotton by 65 percent. The preliminary data available for 1975 indicate that agricultural output for domestic consumption has increased significantly with some crops such as cotton, corn, and rice providing sur- pluses for export. Moreover, the new emphasis placed by the Government on rural development has already made possible some progress toward an appro- priate coordination of policies affecting the rural population. At the same time, the Government has already started the preparation of several integrated rural development projects. During the last year, the Bank staff has been assisting the Government in these fields through several missions which have visited Ecuador for that purpose. Further missions and the pro- jected Bank operations cited in para. 22 are expected to contribute to greater efficiency of the Government's investments in the high priority agricultural and rural development fields. The Bank's involvement also would help to underscore the need fDr, and to bring about additional constructive policy changes at the sectoral and project levels. PART IV - THE PROJECT Background 27. The proposed project was prepared with the assistance of the FAO/ IRRD Cooperative Program. It was appraised in August 1975 by a Bank/FAO team. Negotiations were held from February 2 to Febru.-; 3, 1976, at which time the Republic of Ecuador was represented by a delegation led by Mr. M. Calisto, Executive Manager of the National Pre-Investment Fund and included representatives of the Ministries of Finance and Agriculture and Livestock, as well as of the Seeds Corporation and the National Development Bank. An appraisal report entitled "Appraisal of a Seeds Project - Ecuador" (964-EC) is being circulated separately. A summary statement on the proposed project and loan is contained-in Annex III to this Report. General Description 28. The proposed project is directed tc widening the scope of Government activities in the production and distribution of improved seeds. Basic seed production for several important crops began in Ecuador in the mid- 1960s, under the auspices of the National Agricultural Research Institute. The multiplication and distribution of improved seeds by the Ministry of Agriculture and Livestock started shortly afterwards. This effort has already yielded significant results. The existing seeds industry distributed about 3,400 tons of improved seeds of rice, hard corn, wheat and barley in 1974. Although this already represents a promising beginning, that level was only sufficient to plant about 14 percent of the national area for these food grain staples of Ecuador. At the same time, more intensified research is needed for the development of suitable varieties of soft corn, pastures and beans.  - 10 - Moreover, a number of existing wheat varieties need to be replaced. As a consequence, Ecuadorian farmers still mainly use their own seed, which is generally of very low physical and genetic purity. This, combined with limitations on other inputs, results in the very low yields which figure significantly in the agricultural production deficiencies cited in Part III above. Two years ago, the Government established the Seeds Corporation to satisfy the need for a more concerted and better organized national seed system. It subsequently requested Bank assistance for further improving that system -- a request which led to the present project. 29. The proposed project would help develop a modern seeds industry, capable of producing and delivering substantial quantities of high-quality seeds for most of Ecuador's basic food crops and pastures. It would provide the means for strengthening seed research and development; field production of certified seed; seed processing, storage and distribution; quality control and regulation; and seed promotion. The emphasis of the project is on obtain- ing better coordination among the present Ecuadorian institutions handling portions of those activities, and in upgrading them. The crops included in the project are important to improve food supply, reduce imports, and provide exportable surpluses. At full development, the project would result in pro- duction and distribution of some 8,800 tons of certified seed,