Philippines - National Irrigation Systems Improvement Project

Document of FILE CQP~ 1 The World Bank FOR OFFICIAL USE ONLY Report No.P-2046-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE NATIONAL IRRIGATION SYSTEMS IMPROVEMENT PROJECT April 20, 1977 This document has a restricted distribution and may be used by reciplents only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Pesos (P) 7.50 US$1.00 P 1,000 = US$133.00 P 1 million = US$133,000 ABBREVIATIONS ADB - Asian Development Bank DAR - Department of Agrarian Reform DOH - Department of Health NIA - National Irrigation Administration NISIS - National Irrigation Systems Improvement Study SCC - Schistosomiasis Control Council SPO - Special Projects Organization REPUBLIC OF THE PHILIPPINES FISCAL YEAR 1975: July 1, 1974 - June 30, 1975 1976: July 1, 1975 - December 31, 1976 From 1977: January 1 - December 31  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE NATIONAL IRRIGATION SYSTEKS IMPROVEMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for the equivalent of $50.0 million to help finance the National Irrigation Systems Improvement Project. The loan would have an interest rate of 8.2% per annum and a term of 20 years including 4.5 years of grace. PART I - THE ECONOMY /1 2. An economic mission visited the Philippines in April/May 1975 and its report, "The Philippines: Priorities and Prospects for Development, Basic Economic Report" (No. 1095a-PH of May 5, 1976) was distributed to the Executive Directors on May 18, 1976 (SecM/76/366). Paragraphs 3-16 below are an updated summary of that report. Annex 1 contains country economic data. 3. During the 1960s, the economy grew in real terms at an annual rate of about 5-6%. However, the rate of growth was less than the level that might have been achieved if the considerable natural and human resources of the Philippines had been exploited more effectively. Moreover, the benefits of growth were distributed relatively unevenly. As the population and labor force continued to grow rapidly, unemployment rose. Low levels of taxation accentuated these problems and resulted in inadequate public invest- ment in necessary infrastructure and social services. A relatively weak export performance combined with a failure to reduce the import dependence of domestic industry resulted in a steady deterioration in the balance of payments position. 4. During 1970-72, the authorities adopted policies of monetary and fiscal restraint in order to lay a firm basis for future growth. With assistance from the Consultative Group for the Philippines, they succeeded in improving substantially the maturity structure of the external public debt. Real GNP during that period increased at about 5% a year. In 1972, the Government initiated a series of social and economic reforms including an agrarian reform program, tax reforms, and an administrative reorganization. 5. In 1973, there was a sharp increase in the level of economic activity in the Philippines and the growth in real GNP doubled to 10%. This upsurge was led by the international commodity boom, which resulted in higher export incomes, a strong recovery in agricultural and industrial production for the domestic market, and an expansion in public and private investment. ]j This is the same discussion of the economy as that in the President's Report for the Fourth Rural Credit Project (P-2021-PH) of March 24, 1977. I This document has restricted ditribution and may be used by recipients only in the performance | of their officl duties. Its contents my not otherwise be disclosed without World Bank authorintion.  6. Like most countries, the Philippines was profoundly affected by the events in the world economy that began with the marked increase in the prices for food and petroleum in late 1973. With international trade the equivalent of almost half of its GNP, the Philippines was quite vulnerable to the impact of world inflation, the increase in oil prices, and the prolonged recession in the industrialized countries. While adverse effects of the recession were cushioned somewhat in 1974 by a modest improvement in the external terms of trade, the Philippines was more seriously affected in 1975 by the continued rise in import prices and reduced demand for Philippine exports. While the international economic situation has made it difficult for the Government to realize its objective of accelerating the rate of development, GNP in 1974, 1975, and 1976, nevertheless, grew in real terms at an annual rate of about 6%. 7. Agricultural production has grown at an average rate of 3.2% per year during the 1970s, a period which has been characterized by unusually adverse weather conditions. Rice production increased by 25% in 1973/74, but because of damage by typhoons, grew by only 1% in 1974/75; the Government had to import 200,000 tons in the first half of 1975 to ensure adequate stocks. However, the rice harvest in 1975/76 was very good due to favorable weather conditions and during this period the Philippines was nearly self-sufficient in rice. The Government continues to give the highest priority to further increasing agricultural production and has initiated a number of programs designed to expand the use of fertilizer, irrigation and supervised credit. It has also intensified efforts to expand the social services needed in rural areas, including rural electrification, health and family planning services, and village road and small-scale irrigation projects. 8. Although progress has been slower than initially planned, the Government has made some progress with its agrarian reform for the nation's one million tenant farmers who grow rice and corn. By September 30, 1976, the Government had issued Certificates of Land Transfer to 224,000 of the 424,000 tenants on holdings of over 7 ha; thus, title to 390,000 ha of the total 825,000 ha of farms occupied by such tenants has been transferred. The Government has raised the cash portion of the compensation package to landlords to reduce their resistance to land reform, but strong administrative efforts will be necessary to ensure continued progress in the implementation of the program. 9. Industry accounts for almost 30% of net domestic product, one third of total fixed investment and 15% of total employment. Industrial production, which grew by 12% in 1973, was adversely affected in 1974 and 1975 by the worldwide economic slowdown and the depressed demand for Philippine exports. As a result, industrial production increased by only 4% in 1974 and 5% in 1975. Stepped-up public sector spending for infrastructure development and other priority projects has contributed significantly to sustaining the higher level of domestic activity in 1976, especially in the construction industry. The longer term prospects for industrial growth are favorable because of the natural and human resource endowment of the Philippines and a very active private sector.  10. The Government has made significant progress in increasing public investment. The ratio of public investment to GNP is currently over 4%, having risen from 1.8% in FY72./1 The Government has also implemented a series of long needed tax reforms and improvements in tax administration. These reforms, aided by the increased economic activity, the boom in export incomes, and domestic inflation, resulted in a 36% increase in national government tax revenues in FY73, and an estimated 47% in FY74. The ratio of national government tax revenues to GNP has increased from an average of 9% in the early 1970s to about 12% during the period FY74-76. 11. Significant financial reforms have also been introduced. At the beginning of 1976, the Central Bank issued circulars designed to help ration- alize the level and structure of deposit and lending rates; deposit rates were r4ised for the second time in 18 months; long-standing statutory ceilings on the long-term lending rates of banking institutions were increased from 12-14% to 19% per annum; and the ceilings on short-term lending rates were raised. Efforts were also made to control short-term money market operations and to strengthen the organized banking institutions. These actions should help to improve the mobilization and allocation of domestic resources in the Philippines. 12. In the latter part of 1973, inflation emerged as a major problem in the Philippines. The increase in prices was caused by the large increase in liquidity that came with the export boom in 1973/74, and by a number of cost-push factors, including the higher rate of world inflation. To deal with this problem, the Government adopted contractionary monetary and fiscal policies, and attempted to reduce the impact of inflation on consumers by subsidizing such essential goods as wheat, imported rice, and cooking oil. The annual inflation rate fell from 35% in 1974 to 8% in 1975 and 6% in 1976. 13. On the external side, the Philippines' balance of payments benefited considerably from the international commodity price boom during 1973. High prices for the country's chief exports, including coconut products, sugar, copper and wood products, resulted in a 70% increase in export earnings and a current account surplus of about $550 million. Since mid-1974, the external trade position has deteriorated, due to the sharp increases in the prices of oil and other imports, less favorable prices for Philippine exports, and reduced volume of some exports resulting from the downturn in the econo- mies of the Philippines' main trading partners. As a result, current account deficits of about $900 million in 1975 and about $1,000 million in 1976 were incurred. The current account deficits have been offset by direct foreign investment, inflows of medium- and long-term loan capital, the use of IMF facilities and some short-term borrowing by the Central Bank. External reserves were about $1.2 billion at the end of 1976, equivalent to four months' imports. Assuming continued sound debt management and the mainten- ance of a reasonable maturity structure of foreign borrowings, the overall level of external debt of the Philippines is expected to remain within reasonable limits, as the ratio of debt service payments to exports and /1 Fiscal year July 1 to June 30.  - 4 - nonfactor services would average about 16-17% during the rest of this decade. At present, the Bank/IDA share in total debt outstanding is about 17% and its share in debt service is about 4%. These shares are expected to increase somewhat in the years ahead. 14. Substantial foreign assistance will be essential to help finance the large investment expenditures which will be necessary for the country's develop- ment. In order to ensure that disbursement of external assistance reaches levels commensurate with the level of development expenditures which will be required during the latter part of the decade and that debt service obligations remain within reasonable limits, total commitments of official assistance will need to be maintained in real terms at least at the annual level of about $500 million which was achieved in 1974. The Consultative Group for the Philippines at its meeting in Paris on June 15 and 16, 1976, agreed that it would be reasonable for the Philippine Government to seek official aid commitments of about $600 million in 1976 and $700 million in 1977. Total new commitments of public and private medium- and long-term capital are estimated to have reached $2 billion in 1976 and need to be maintained at approximately this level through 1980. 15. Despite the slowdown in the growth of the economy, which is pri- marily a result of worldwide economic conditions, the Government remains committed to regaining the growth momentum, which began in 1973, to provide for a continued increase in incomes and employment. Both the Philippine Government and the Bank's Basic Economic Report estimate that it should be possible in the longer term for the Philippine economy to grow in real terms at a rate of about 7% per annum provided that good economic management continues and international economic conditions improve. High priority must be accorded to expanding employment opportunities, because unemployment and underemployment are still high and the labor force continues to grow at 3% a year. Continued attention must also be given to expanding the Government's effective family planning program to reduce the rate of growth of the population and the labor force. 16. The Government is pursuing a development strategy which focuses on rural development with emphasis on food production, accelerated industriali- zation, both in capital-intensive resource based industries and labor-intensive export industries, and a substantial expansion in public sector investment in infrastructure to support the growth of the productive sectors. In support of these objectives, the Government plans to continue its efforts to increase public revenues, to strengthen the capacity of public sector agencies and to foster the growth of exports. The Government recognizes that the increased cost of petroleum and other imports cannot be financed indefinitely by borrow- ing abroad, and it is actively encouraging both local and foreign investors to expand productive investments. It will, however, take time for Government programs to have an impact on the balance of payments, and the Government is, therefore, seeking increased support from the international financial community to assist in the financing of its development effort.  - 5 - PART II - BANK GROUP OPERATIONS 17. By April 15, 1977, the Philippines had received 43 Bank loans (of which two were on Third Window terms) and three IDA credits for a total of $1,113.7 million, net of cancellations. About 40% of Bank lending ($401 mil- lion) has been for infrastructure projects in power, transportation, and water supply and one-third ($355 million) has been for agriculture. Of the remainder, about $250 million has been for industry and about $108 million has been for social sector projects in education, population and urban development. There has been a marked improvement in the execution of Bank- financed projects in the last four years compared with experience in the 1960s, when there were serious problems caused by a shortage of peso counter- part funds and poor administration. All ongoing projects are now being implemented reasonably well. Annex II contains a summary statement of Bank loans and IDA credits as of February 28, 1977, and IFC investments as of March 31, 1977 and notes on the execution of ongoing projects. 18. The Bank's lending program has been designed to continue to support the Philippine development effort with its emphasis on agriculture and infra- structure and its growing attention to the needs of lower income groups. About one third of Bank lending planned for the next few years would be for agriculture and rural development projects and another third would be for needed basic infrastructure projects, mainly in the fields of transportation and power. The amount of lending for social sector projects, including education, population and urban development, is expected to continue to grow rapidly and account for nearly 20% of future lending. The balance of future lending would be for industrial development, where growing attention is being given to the needs of small and medium industries with high employment potential. The rapid growth in public revenues during the past five years has allowed for a significant expansion in public investment and both the ambitious Philippine development program and the Bank's growing lending program have been designed to make good past neglect and to meet future needs. Bank lending totalled $165.1 million in FY74, $208 million in FY75 and $268 million in FY76 compared to about $30 million a year in the preceding five years. 19. This loan and the one for the Provincial Cities Water Supply Project are the fifth and sixth loans to be presented to the Executive Directors in FY77. Other loans which may be ready for presentation within two months are for a land settlement and a power project; a smallholder tree farming/forestry project and a rural infrastructure project are also under consideration and are well advanced in the appraisal cycle. A primary objective of most of these projects is to help the Government meet its objective of increasing the productivity and incomes of the poorer segments of the population. 20. As of March 31, 1977, IFC had made commitments in the Philippines totalling $79 million for investment in 14 projects in the fields of devel- opment banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibres and edible oils. Of these investments, $27.4 million had been sold, cancelled or repaid, leaving a net portfolio of $51.6 million, including $0.6 million undisbursed. A Regional Mission for East Asia was established in Manila by IFC on April 1, 1977.  - 6 - PART III - THE AGRICULTURAL SECTOR 21. Agriculture is the predominant sector in the Philippine economy, accounting for about one-third of net domestic product, over one-half of total employment, and nearly three-quarters of export earnings. Over 70% of the 9 million ha of land under cultivation is used for the production of cereals, of which rice and corn are the most important. The remaining land is taken up by the major export crops: sugar, coconuts, abaca, pineapples, and tobacco. 22. The performance of the agricultural sector will be crucial in deter- mining whether the Philippines can increase incomes both rapidly and equitably. At present, the domestic market for industrial products is limited by relatively low rural incomes. Although in recent years there has been a substantial change in the terms of trade in favor of agriculture, the problems of poverty and income distribution continue to be particularly acute in rural areas; of the 15 million people in the lowest 40% of the income scale, 12 million live in rural areas. The Government is aware of these problems and, as noted in paras. 7 and 8, has initiated a number of programs designed to assist the rural poor. 23. A major Government objective is to increase rice and corn produc- tion as a means of raising the incomes of small farmers and of attaining national self-sufficiency in food grains. The deficit in rice, the main staple crop, has been a persistent problem in the Philippines, and annual rice imports have averaged about 200,000 tons in recent years. The ability to assure sus- tained self-sufficiency in rice will depend largely on improving yields through increased cropping intensity, the expanded use of fertilizer and agro-chemicals, and the provision of adequate credit and other supporting services. In order to achieve their full potential, high-yielding varieties, which helped to increase production in the late 1960s, require a much greater degree of water control than is possible under rainfed conditions or with the typical unimproved irriga- tion systems in the Philippines. At present, out of 3.2 million ha planted with rice, only 1.3 million ha, or 40%, is irrigated. A program to upgrade and expand irrigation facilities is therefore of high priority. 24. About one-half of the expected Bank lending for agriculture in the Philippines in the next five years is expected to be for irrigation. The Bank has already financed seven irrigation projects designed to increase rice production in the Philippines. These projects - three in Central Luzon, two in the Cagayan Valley of Northern Luzon, one on Mindoro Island, and one in the Visayas /1 - have set the pattern for the type of irrigation rehabilitation, /1 The Upper Pampanga River Irrigation Project (Loan 637-PH), Aurora-Pena- randa Irrigation Project (Loan 984-PH, Credit 472-PH), Tarlac Irrigation Systems Improvement Project (Loan 1080-PH), Mindoro Rural Development Project (Loan 1102-PH), Magat River Multipurpose Project Stage I (Loan 1154-PH), Chico River Irrigation Project Stage I (Loan 1227-PH), and Jalaur Irrigation Project (Loan 1367-PH).  - 7 - new construction, and operations needed for increasing rice production. The projects are providing improved irrigation and drainage facilities, better road systems for efficiency of operations and maintenance and for the marketing of farm products, stronger supporting services to assist farmers in adopting the new techniques needed to increase production, and technical assistance and training to help the National Irrigation Administration (NIA) expand and improve its irrigation program. These projects, together with the project now proposed, would bring about substantial increases in rice production on about 284,000 ha and would benefit nearly 137,000 farmers, most of whom are smallholders. The existing projects are being well executed although initially there were some difficulties in attracting bids for civil works contracts and there have been cost increases under two of the projects as a result of the unexpectedly high rates of inflation during 1974 and 1975. These problems are being overcome and progress under the projects is satisfactory; all of the projects are expected to have high economic benefits. 25. The major focus of irrigation projects in the past has been on the large-scale gravity systems. Since the late 1960s the NIA, with the assis- tance of the Bank and the Asian Development Bank (ADB), has been engaged in upgrading and extending large national systems, mainly in Luzon and to a lesser extent in Mindanao. Particular attention has been given to the reha- bilitation and new construction of canals and structures, the provision of better drainage and access, and the introduction of water management and rotational irrigation practices. Additional water supply is being provided in some areas through the construction of storage dams or by transbasin diver- sion. In order to provide a basis for improving the badly deteriorated but essential smaller systems scattered throughout the Philippines, a National Irrigation Systems Improvement Study (NISIS) was financed under Loan 1080-PH to inventory the smaller irrigation systems and to select a total of about 150,000 ha with the highest priority for improvement. The inventory of the national systems has been completed and priority projects have been identified on the basis of the need and potential of the system for improvement, the degree of human poverty in the area served by the system and the capacity of NIA's regional office to implement needed improvements. The proposed project is the first to be prepared under NISIS. PART' IV - THE PROJECT Background 26. The proposed project would support the Government's objectives of achieving self-sufficiency in rice, increasing ir.comes of poor farmers and providing for a better regional balance in the Philippines' development effort. The project would improve and expand irrigation facilities on 22 existing irrigation systems in three of the poorest regions of the country: the Ilocos and Cagayan regions of Northern Luzon and Leyte in the Eastern Visayas. In Leyte it would also provide for a schistosomiasis control program in one of the most severely affected regions in the country. The proposed project would be the first Bank-assisted irrigation project dealing with the relatively small widely scattered systems operated by NIA's regional offices and the first on the west coast of Luzon and in the Eastern Visayas. (See attached map.)  - 8 - 27. The feasibility report for the project was prepared by NIA with the assistance of consultants. The project was appraised in October-November 1976 and negotiations were held in April 1977. The leaders of the Government negotiating team were His Excellency, Eduardo Z. Romualdez, the Philippines' Ambassador to the United States, and the Honorable Alfredo Juinio, Administrator of the National Irrigation Administration. The Appraisal Report (No. 1488a-PH) on the project is being circulated separately to the Executive Directors. Annex III of this report contains a loan and project summary and Annex IV contains supplementary project data. The Project Area 28. Transplanted rice, both irrigated and rainfed, is the predominant crop in all three subproject areas, although there is a small area (1,300 ha) of dry-season irrigated tobacco in the Ilocos subproject area and some dry- season rainfed corn (2,000 ha) in the Leyte subproject area. The Ilocos region and the Eastern Visayas are rice deficit areas, while the Cagayan region is one of the major rice surplus areas in Luzon. The majority of farmers in the irrigated areas use improved rice varieties. In rainfed areas, farmers rely almost entirely on the lower yielding but hardier local varieties. In the irrigated areas, the mean paddy yields for both the wet and dry seasons are 2.5 tons/ha in Ilocos, 2.0 tons/ha in Cagayan, and 1.7 tons/ha in Leyte. In the rainfed areas the average paddy yields are 1.6 tons/ha in Ilocos, 1.5 tons/ha in Cagayan, and 1.4 tons/ha in Leyte. 29. Inadequate irrigation has been a major factor contributing to rela- tively low yields in subproject areas. The 22 existing NIA systems in these areas, which cover about 27,600 ha, have seriously deteriorated due to poor initial design and inadequate maintenance resulting from the lack of sufficient funds and equipment. The existing systems also have poor distribution networks which make it impossible for most farmers to obtain water at the right time and in the right amount. There are also few access roads, which makes it difficult for farmers to transport farm inputs and to market production. 30. Seven of the ten irrigation systems in the Leyte subproject are located on the island's northeastern plain, an area of natural and man-made swamps, which causes it to be one of the worst schistosomiasis-endemic regions in the Philippines. About 87,000, or 18% of the people living in northeastern Leyte, have been infected with schistosomiasis. The climate and topography of the coastal plain are particularly conducive to the disease, while the way of life of the rural population, with its constant exposure to water, and the low levels of public hygiene all work together to produce high infection rates. In many areas, the high incidence of schistosomiasis seriously inhibits agri- cultural production. 31. Approximately 37,000 farm families, or a total of about 200,000 people, live in the project area. About 60% of the farmers are in the Ilocos subproject area and the balance are evenly split between the Cagayan and Leyte subprojects. The mean farm size is about 1.3 ha, although there are substantial differences among the subproject areas; the mean farm size is 0.8 ha in Ilocos, 1.5 in Leyte and 2.5 in Cagayan. Survey and census data indicate that, in addition to farm operating households, there are approximately 6,000 landless agricultural households in the project area.  - 9 - 32. Estimated present total net incomes vary considerably between sub- project areas and within areas, depending on whether the farm is irrigated or rainfed. Present per capita annual incomes in the