Madagascar - Agricultural Credit Project

Document of The World Bank FILE cOpr FOR OFFICIAL USE ONLY Report No. P-2788-MAG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR THE NATIONAL BANK FOR RURAL DEVELOPMENT (BTM) August 20, 1980 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 Calendar 1979 January 1980 Unit n Malagasy Franc (FMG) Malagasy Franc (FMG) US$1.00 = FMG 212.72 FMG 201.91 FMG 1,000 - US$4.70 US$4.95 FMG 1,000,000 = US$4,701 US$4,952 (The cost estimates are based on US$1 - FMG 210) ABBREVIATIONS AND GLOSSARY BFV Commercial Bank (Banky Fampandrosoana Ny) BNM National Development Bank for Madagascar (Banque Nationale Malgache de developpement) BNI Industrial Development Bank (Bankin' Ny Indostria) BTM National Bank for Rural Development (Bankin' Ny Tantsaha Mpamokatra) CFDT Former Malagasy/French Cotton Company FMR Rural Credit Program (Financement du Monde Rural) HASYMA Cotton Company, responsible for production, marketing, and processing MDRRA Ministry of Rural Development and Agrarian Reform (Ministere du Developpement Rural et de la Reforme Agraire) OCP Coffee and Pepper Organization (Operation Cafe Poivre) SINPA Societe d'Interet National des Produits Agricoles SIRAMA Madagascar's largest sugar company Fokonolona Institutions: Fokonolona and Fokantany = village level local government Firaissam-pokantany second tier local government (former canton) Fivondranan-pokonolona = third tier local government (former sub-prefecture) Faritany = fourth tier local government (former province) FISCAL YEAR (Government and BTM) January 1 - December 31  FOR OFFICIAL USE ONLY MADAGASCAR AGRICULTURAL CREDIT PROJECT Credit and Project Summary Borrower: Democratic Republic of Madagascar Beneficiary: National Bank for Rural Development (BTM) Amount: SDR 8.7 million (US$11.5 million equivalent) Terms: Standard Transfer Terms: The Government would make the proceeds of the Credit available to BTM as equity. Project (i) Objective: The project would support the Govern- Description: ment's policy to extend credit for smallholder agricultural develepment, with BTM as the principal itntermediary. It would also strengthen BTM's managerial and financial capability. (ii) Main Project Components: (a) Loans to smallholders for export crops, such as coffee, cocoa, pepper, cloves, and vanilla plantations; for sugar cane plantations; and for foodcrops (rice, maize, and groundnuts); (b) Loans on an experimental basis to farmers and cooperatives for selected agricultural activi- ties, e.g., vineyard establishment, steer stall-fattening, and small-scale pig fattening; (c) Training for BTM staff in financial, managerial, and computer disciplines; (d) Creation and operation ot about seven itinerant banks (consisting of vehicles equipped for the purpose) to extend BTM's activities in rural areas; (e) Feasibility study (3 man-months) for the estab- lishment of a Data Base Management system for BTM. (iii) Benefits: The project would help to increase pro- duction of crops, and would allow an increase in net foreign exchange earnings through increased exports (coffee, cloves, vanilla, pepper, cocoa, sugar) or reduced imports (rice). It would also strengthen BTM as an agricultural development bank. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - (iv) Risks: Critical factors are the provision of ade- quate extension services, the availability of inputs, adequate producer prices and marketing services, as well as BTM's performance as a development bank. The Project has been designed to offset these risks to the maximum extent possible. Estimated Costs: Local Foreign Total -------(US$ million)------- Project Component (a) Seasonal Credit 1.74 1.99 3.73 (b) Medium Term Credit 3.37 1.79 5.16 (c) Long Term Credit 1.40 0.20 1.60 (d) Experimental Credit 0.32 0.19 0.51 (e) Staff Training - 0.45 0.45 (f) Itinerant Banks 0.09 0.09 (g) Consultant Services - 0.04 0.04 Total Base Costs 6.83 4.75 11.58 Price contingencies 1.57 1.05 2.62 TOTAL PROJECT COSTS 5.80 12_ 0 (taxes are insignificant) Financing Plan: Local Foreign Total ----------$ million--------- IDA Credit 5.70 5.80 11.50 BTM 2.70 - 2.70 Total 8.40 5.80 14.20 Estimated Disbursement: IDA FY 1981 1982 1983 1984 -----------$ million----- Annual 0.5 2.2 4.0 4.8 Cumulative 0.5 2.7 6.7 11.5 Rate of Return: 60 percent Staff Appraisal Report: No. 2898-MAG Map: IBRD 14922  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR AN AGRICULTURAL CREDIT PROJECT (BTM) 1. I submit the following report and recommendation on a proposed development credit to the Democratic Republic of Madagascar for the equivalent of US$11.5 million on standard IDA terms to help finance credit operations of the National Bank for Rural Development (BTM) for the period 1980-83. The Government would make the proceeds of the credit available to BTM as a contribution to equity. PART I - THE ECONOMY 2. A zeport entiLled "'Iada,ascar - Recent Economic Developments and Future Prospects" was distributeci to the Executive Directors on October 24, 1979. A summary of recent economic developments is set out below. Country data sheets are provided in Annex 1. An economic updating mission is in Madagascar from August 15 - September 8, 1980. 3. With a population of 8.3 million and a GNP per capita estimated at US$250 in mid-1978, Madagascar is one of the poorest countries in the world. It is predominantly an agricultural country and 85 percent of its population live in rural areas with a per capita income of about US$120 per annum. In many areas the standard of living is at the subsistence level. Although the country is sparsely populated (an average of 14 inhabitants per square kilo- meter), there is great pressure on cultivable land in some regions. Owing mainly to different ecological conditions, the highlands are more advanced than the coastal areas, and the south is particularly poor with a harsh, arid climate and infertile soils. The east coast is rich agriculturally, but crops are frequently devastated by cyclones. Internal migration is common and has accelerated as improved roads have provided access to new areas. However, poor roads remain a major constraint to development; many of the main highways are not passable during the rainy season in a country where production centers may be as far as 800 kilometers from main points of consumption. Many areas are virtually cut off from the rest of the country for several months each year. 4. Over the past few years the growth of the economy has been slow and uneven. Having risen but marginally in 1975, real GDP fell in 1976 by 2.9 percent owing to a slight decline in agricultural production and a steep drop of about 14 percent in manufacturing output. GDP is estimated to have increased by 3.9 percent in 1977; even so, output of goods and services showed only a slight increase over the period since 1974; and, with population increasing by about 3 percent annually, per capita GDP fell by about 5 percent.  - 2 - Bad harvests adversely affected economic growth in 1978; but the reported resurgence of economic activity the following year is likely to have raised the real GDP growth rate above the trend average. Budgetary investment outlays were stepped up considerably after 1975; but the investment rate has generally varied around 14 percent as the sharp rise in Government capital expenditures was largely offset by a substantial decline in private investment. The savings rate also continued to be fairly stable and fluctuated around 10-11 percent. The resource gap as a consequence has been maintained at a low level. 5. Agricultural production has not recorded any marked growth over the last few years. Even over the longer period since 1970 it has increased at an annual rate of only about 1 percent. Despite periodic good crops, paddy production did not keep pace with demand; and production in 1978, estimated at 2.0 million tons, was only about 7 percent higher than in 1970. Groundnut production, after rising significantly in 1976, fell back to 34,000 tons in 1978, while meat production did not register any significant rise. Imports of rice and edible oils which were negligible prior to 1972 have increased to over 150,000 tons and 16,000 tons, respectively in 1978. Sugarcane production continued to stagnate as there has been no addition to the refinery capacity for several years. Among other cash and export crops, coffee production, except for a 6 percent drop in 1976, has been rising steadily, until 1975 reaching some 84,000 tons but has been stagnating since. Raw cotton produc- tion, which had been increasing fairly fast, levelled off after 1977; vanilla output declined, while pepper more than doubled. Hit badly by the drought in 1978, agricultural output is nevertheless expected to have risen significantly last year, although some major export crops, such as vanilla and coffee, encountered production problems. 6. The development of the industrial sector after independence in 1960 was encouraged by promotional measures such as fiscal incentives, protection against competition from imports and provision of institutional term financing. Industrial production now accounts for about 14 percent of GDP. Despite significant diversification of capacity that has taken place, manufacturing is still dominated by food processing, textiles and apparel industries. Together they account for close to 70 percent of the manufacturing output. Among other industries the important ones include tobacco manufactures, chemicals (mainly soap and matches), petroleum refining and production of construction materials. 7. Industrial growth since 1972 has been erratic. Following a marked 9.3 percent rise in 1974 the industrial production index declined again in 1975 and 1976; and despite recovering somewhat in 1977 it remained below the level attained in 1974. Within the manufacturing sector itself, however, performance varied between different industry groups. While the output of processed foods and textiles followed a stagnant or a declining trend after 1974, some of the comparatively minor industries, such as chemicals, tobacco manufactures, rubber and paper products maintained a fairly steady growth. However, more recently, the industrial sector has reportedly shown signs of greater dynamism and more rapid expansion.  - 3 - 8. Over the past few years a number of industrial establishments con- sidered to be of national importance were taken over by the State. Some unprofitable enterprises facing closure were also nationalized to prevent layoff of workers. In some other cases the State assumed majority control. The important foreign-owned industrial enterprises that were nationalized include the oil refinery (January 1976), the power and water _1pply company (January 1976) and two sugar firms (December 1976). At present, the State owns, or has acquired majority participation in all major industrial units employing a thousand or more workers. 9. Madagascar's fiscal situation deteriorated considerably after 1975, due to a sudden and sharp rise in current budget expenditure and Government spending on capital investment. Current expenditures rose steeply with the rising wage bill of the Government and increasing outlay on maintenance; and the current budget surplus, which used to be substantial, dwindled as revenues failed to keep pace with the growth of expenditures. Furthermore, as Govern- ment intensified its efforts to raise investment levels and stimulate the economy, public investment expenditure rose from 11.2 billion FMG in 1975 to 20.5 billion FMG in 1977. The outlays on the consumer rice subsidy, although they declined slightly in 1976, rose again to 3.6 billion FMG in the subse- quent year. The overall Treasury deficit, which more than doubled to 20 billion FMG between 1975 and 1977, was financed increasingly through recourse to Central Bank advances. In 1978, the overall deficit was larger than the projected 16.1 billion FMG owing to underestimation of expenditure on per- sonnel and the settlement of payments deferred from 1977 on the one hand, and shortfalls in revenues on the other. The fiscal situation is likely to have worsened considerably in 1979, owing partly to the increasing emphasis on budgetary expenditure for capital development. The Government is exploring ways and means of reducing both recurrent and capital expenditures. 10. Monetary and credit developments since 1975 have been influenced mainly by the Government's deficit financing needs. Outstanding domestic credit went up by more than 50 percent to 126 billion FMG during 1975-77, due, for the most part, to the steep and continued rise in net claims on Government. As a result, money supply, which had been increasing moderately, rose by 15 percent in 1976 and as much as 25 percent in 1977. Despite this monetary expansion and little growth in the output of goods and services, the annual inflation rate has been moderate -- about 9-10 percent during 1976-77, largely because of increasing demand for cash balances and the consequent accumulation of idle funds. Similar monetary trends have persisted subsequently and infla- tionary pressures might even have increased. 11. The balance of payments situation which had been deteriorating showed a substantial improvement in 1976, when a surplus of 2 billion FMG was recorded; but the payments surplus in 1977 was estimated to have been much smaller. The turnaround in the balance of payments situation occurring in 1976 is attributable more to exogenous factors than to any si4nificant im- provement in the structure of the balance of payments. Trade surpluses were recorded in 1976 and 1977 as a result of (a) a sharp rise in prices of exports, particularly coffee, which reversed the continuing deterioration in the terms  - 4 - of trade, and (b) the imposition of more strict quantitative restrictions on imports in 1976. There was a substantial decline in the availability of imports after 1975. On the other hand, the volume of exports dropped sharply in 1976, and continued to fall in 1977, while there was no lasting reduction in the services deficit, nor any sustained rise in capital inflows. More recently the balance of payments position has been increasingly strained by a number of adverse developments: production shortfalls and transportation problems affecting some important export crops, food imports needed to replenish stocks after the drought, international inflation, rising energy prices and the impact on the demand for imports of high levels of public investment. The balance of payments is expected to show a very large overall deficit in 1979. 12. The growth and development of the Malagasy economy have over a fairly long period been affected by constraints resulting from shortage of savings, and low productivity of traditional agriculture. The country, however, is relatively well-endowed with natural resources and has a well- established administrative set-up. With appropriate policies and adequate external capital assistance, medium and long-term prospects for the economy should be favorable. There is considerable scope for the expansion of agri- culture and livestock production. Only about a fifth of the arable land is at present being utilized, and fertilizer consumption, estimated to be some 14,000 tons in 1978, is still rather small. The irrigation potential has as yet been only partially exploited. The outlook for further development of manufacturing based on locally available materials is promising. On the whole, sustained growth at an average annual rate of 4-5 percent appears to be feasible. 13. The Government has been taking far-reaching steps to strengthen national control of the economy. As a part of this process, economic and financial institutions, productive sectors, foreign trade and internal market- ing have undergone extensive reorganization. Inspired by the basic needs approach, the Government has also formulated long-term development objectives which envisage a more egalitarian income distribution and satisfaction of specified minimum consumption requirements of the population by the end of the century. The Government also stresses national self-sufficiency and the eventual establishment of an industrial base large and diversified enough to meet the domestic demand for basic equipment and other essential consumer goods. 14. A Three-Year Plan, which is to be the first of a series of medium- term investment programs designed to attain these long-run development objec- tives, was launched in 1978. The Plan envisages overall expansion of the economy at an average annual rate of 5.5 percent during 1978-80. The rate of investment is projected to rise to 17.1 percent of CDP by 1980 from the Plan estimate of 11.5 percent in 1977. The savings rate is to be stepped up, partly through the mobilization of additional budgetary resources for capital development. But about a quarter of the investment outlays during the Plan period is expected to be financed through external loans and grants. Greater emphasis will be placed on the development of food crops; and household con- sumption is targeted to rise, in real terms, by 3.6 percent per year. The Plan accords high priority to manufacturing, particularly basic industry and processing of agricultural raw materials.  - 5 - 15. Madagascar's external public debt, outstanding and disbursed, amounted to US$258.6 million at the end of 1978. Somewhat over 40 percent of it (US$111.3 million) was owed to the Bank Group, and as much as 23 per- cent to IDA alone. The Bank Group share of debt service in 1978 was 36 percent. Among bilateral donors France and the Federal Republic of Germany are the mos., prominent, each holding about 12 percent of the disbursed debt. Japan and the People's Republic of China rank next in importance (7 and 4 percent respectively) followed by the USA (2 percent). Suppliers' credits and commercial borrowing (9.4 percent of the disbursed debt) have been rela- tively unimportant. The Government had been generally prudent with regard to external debt, and outstanding disbursed debt at the end of 1977 amounted to only 11 percent of GNP as compared to the average of 25 percent for low- income countries. Because of relatively limited reliance on external assist- ance and concessionary terms of most loans and credits, debt service payments have remained small. The estimated debt service ratio of 3.1 percent in 1977 was marginally lower than in 1970. However, since 1978 the debt service ratio has tended to increase rapidly, mainly as a result of increasing foreign borrowing on commercial terms by the public sector. 16. The Bank should continue to be prepared to contribute to local cost financing. In terms of performance, Madagascar appears to have performed about as well as other countries at the same level of development encounter- ing similar constraints. Its domestic savings rate, 13 percent in 1977, compares favorably with the level in most of the countries in the low income group, indicating that Madagascar has made a reasonable effort to mobilize domestic savings. But as savings have fallen far short of the country's requirements, despite resource mobilization efforts and restrictions on imports, the country's balance of payments and reserve position have deteriorated. PART II - BANK GROUP OPERATIONS IN MADAGASCAR 17. Outstanding IDA credits to Madagascar amount to US$252.69 million and Bank loans total US$31.80 million. About 54 percent of Bank Group lending has been for transport, 14 percent for electric power, 24 percent for agricul- ture and 8 percent for education. IFC's first investment was made in March 1977 with an equity investment of US$290,000 and a loan of US$11.0 million for the expansion of a textile mill, and a loan of US$1.25 million for shoe manufacturing; other projects are under consideration. Annex II contains a summary statement of Bank loans, IDA credits, and IFC investments as of July 31, 1980, as well as notes on the execution of ongoing projects. 18. The priority given to transport investment recognizes that improve- ment in communications is a precondition for Madagascar's development. Four projects have been for the construction of all-weather highway links between the island's different regions; a fifth highway project for road maintenance was signed on July 30, 1979. There have been projects for improving Madagascar's main port of Toamasina (Tamatave) and one for modernizing the railway line between Toamasina and the capital, Antananarivo; a second project  supporting the railways modernization efforts was signed on June 25, 1979. Bank Group lending for agriculture consists of two livestock development projects, two irrigation projects and a forestry project. A credit for an agricultural development project in the Mangoky delta was signed on May 17, 1979. Bank Group involvement in the utility sector includes the financing by IDA of part of the cost of the large Andekaleka hydroelectric project for which substantial external assistance was secured by the Government; addi- tional financing of US$10 million to help cover a doubling in cost of civil works under the project was approved by the Executive Directors on January 29, 1980. A first credit of US$5.0 million for an industrial development bank project (BNI) was approved by the Executive Directors on January 29, 1980, while a US$20.5 credit for a water supply and sanitation project for the city of Antananarivo was approved on April 1, 1980. A US$12.5 million credit for a petroleum exploration promotion project was approved on May 6, 1980. 19. In future lending to Madagascar, we expect agriculture to absorb a larger share of Bank Group lending, in line with Government strategy to expand agricultural production as a prerequisite to the development of the country. In addition to the proposed project, IDA is assisting the Govern- ment in preparing these rural development projects, an irrigation system management and rehabilitation project, a third livestock project and a second forestry project. We will also continue to support Government investment in such areas as education, urban development, roads, railways and ports. An audit/accounting project is also being prepared. We expect the Government to seek cofinancing from external lenders for some of the projects, and we intend to assist the Government in its efforts to mobilize new external sources of financing. 20. In the past, problems have arisen in the course of execution of several projects. There were delays in execution, cost overruns and deficien- cies in institution building, especially in agriculture. The Morondava Project had to be substantially reduced, and the Government has prepared a plan of action to deal with the remaining problems. The main aspects of this plan include a redefinition of the implementing agency's (SODEMO) responsibilities and financial structure, completion and audit of overdue accounts, and prep- aration of an investment program and budget for development of the Morondava area. Implementation of the plan of action has started and is being closely monitored by the Government and the Association. Implementation of the Village Livestock Project has improved substantially. The Mangoro Forestry Project is ahead of schedule, and cost estimates are in line with forecasts. The first three highway projects have been completed, while the fourth project is still being implemented; the road construction component is nearly completed and the maintenance studies have been completed. However, under the fifth highway project there has been a delay in the start of the highway maintenance training program for personnel in the Ministry of Public Works. Since training of local staff is essential, Government has agreed that training consultants will be employed and that construction of training facilities would begin in the first half of 1980.  21. Since the start of our program in Madagascar four projects all of which included technical assistance have been completed and audited by the Operations Evaluation Department. The audit report of December 17, 1976 on the Lac Alaotra project concluded that the project was generally quite success- ful. However, the performance of Somalac, the project implementation agency, has deteriorated considerably since the completion of the project. The audit report of April 11, 1977 on the Beef Cattle Development Project concluded that the Project objectives of demonstrating the feasibility of modern commercial ranching techniques in Madagascar had not been achieved. The report also concluded that the Project had nevertheless had some positive aspects, namely with respect to pasture development. The audit report No. 2143 of July 27, 1978 concluded that the Madagascar Third Highway Project was well justified and had a good rate of return despite the substantial cost overrun experienced by the project. The audit confirmed that training of local staff and adequate provisions of Government funds were essential factors for a successful road maintenance program. Report No. 2299 of December 22, 1978 concluded that the physical objectives of the Tamatave Port Project were satisfactorily achieved, but pointed out that the institutional objective was not accomplished during project implementation because of inadequacies in the staffing of the port authority and the failure of the technical assistance component. PART III - THE AGRICULTURAL SECTOR Background 22. About 85 percent of Madagascar's roughly 8.3 million inhabitants live in the rural areas. Agriculture dominates the economy, contributing about 40 percent of total GDP, accounting for more than 80 percent of export earnings, and directly supporting over 80 percent of the population. Mada- gascar's agricultural sector is striking in its diversity. The rural economy varies among several sharply different geographic regions, producing a very wide range of crops and agricultural produce. A variety of production systems is employed, ranging from large-scale mechanized agriculture to the simplest, small-scale traditional farming. This diversity has, to some extent, protected Madagascar against the fluctuations of international commodity prices and adverse climate (drought and cyclones are ever-present hazards). It also contributes to wide disparities in wealth and level of development among geographic regions. In many areas, the standard of living is close to subsistence level, while in others, the population is relatively prosperous. Owing mainly to different ecological conditions and social factors, the central highlands and particularly the area around Antananarivo are generally more developed and prosperous than the coastal areas, while the south is particularly poor. 23. The growth of Madagascar s agricultural production over the past 13 years has been disappointing, with the average rate of increase somewhat less than the population growth rate of 3 percent a year; from 1970 to 1975, the annual rate of increase of agricultural production was about 2 percent. This performance largely reflects the low growth rate of rice production and the stagnation or even decline of livestock production. The potential for  - 8 - agricultural development in Madagascar is considerable. Many commodities now being produced offer excellent scope for expansion, while intensification of production in virtually all parts of Madagascar could significantly increase output. Large areas of undeveloped yet fertile land which can be brought into production are still available In many cases, as a result of research and trials, the technical base for expansion or intensification exists already. In other areas, notably rice production, promising high- yielding new varieties could be introduced based on an effort in applied research. Government Objectives 24. Madagascar's broad objectives for rural development are articulated in a Three-Year Plan (ref. para 14). Long-term goals for agriculture are: (a) attainment of self-sufficiency in food and development of basic industries, largely supplied by the agricultural sector; and (b) decentralization of all economic activities, through the fokonolona system. Agriculture is to represent the basis of all developments, and is to receive a major share of in'O'estments. The Government is expected to assume control of as part of cultivated land, particularly large farms which have been lying idle for some time, or newly- developed land for which socialist cooperatives would become responsible. 25. To this end the Government has undertaken a major reorganization of local administration and government levels. The so-called "fokonolona" system reflects an effort to associate traditional institutions and practices with a more representative and responsive local government, and to provide a vehicle for decentralization of power as part of Madagascar's socialist revolution. The reform has been implemented gradually, and many details of the new system, notably regarding local finance, the role of cooperatives within the fokonolona system, and the role of fokonolona institutions in the control of industry and parastatals, are still being considered by the Government. However, the new entities are assuming important responsibilities, notably for agricultural credit, for marketing of rice and other agricultural products, and planning and implementation of small-scale development projects. The hierarchy of fokonolona institutions comprises the Fokontany, which coincide roughly with traditional village units (about 11,400 in all), the Firaissam-pokantany, at the former canton level (about 1,250), the Fivondronan-pokonolona, at the former sub-prefecture level (about 110), and six Faritany, at the former province level. 26. The Ministry of Rural Development and Agrarian Reform (MDRRA) is the central institution for rural development programs. It is concerned with extension, plant protection, veterinary services, irrigation systems, fisheries and forestry. It also deals with planning, with overseeing semi-autonomous regional authorities and parastatals agencies, and with land tenure. In 1979, a far-reaching reorganization of MDRA was introduced with the principal objective of providing better support to the fokonolona institutions through decentralization. The Director of the Provincial Service of the MDRA now has full authority over the operating services of the MDRA in a given faritany (province). In addition to the Ministry's basic services and departments, several regional and parastatal agencies provide extension services to farmers  - 9 - in parts of Madagascar. These are formally part of the Ministry but tend to function autonomously. Their integration in the reorganization of the MDRA services has not yet been fully worked out. About 30 parastatal agencies operate under the aegis of the Ministry. Agricultural Credit 27. Traditionally, formal credit for agricultural development has been largely restricted to the modern agricultural sector; the well-developed commercial banking system has provided appropriate credit for large farms and commercial enterprises. Credit for small farmers, however, has been generally limited. Farmers have traditionally relied upon private money lenders to satisfy their credit needs, and while these systems have been quite widely available, interest rates are generally very high. Government efforts to provide agricultural credit for smallholder agricultural date from the early 1950's, and from 1963 most programs were focused through the BNM, which lent both to regional development agencies and to farmer associations. However, the Government has since 1977 embarked on a major program to increase the availability of credit to small farmers and local government institutions which represent them, symbolized by the creation of the National Bank for Rural Development (BTM) and the rapid expansion of its recent lending for smallholder agriculture. 28. BTM was established on December 27, 1976 as a result of the reorgan- ization of Madagascar's banking system, which lead to the creation of three specialized, wholly government-owned banks for the principal economic sectors: the National Bank for Rural Development (BTM), for agriculture, the Industrial Development Bank (BNI) for industry, and the Commercial Bank. A general Orientation Council for the Banking and Financial Sector is to be established to provide general policy guidance for all banking operations. The reorganiza- tion of the banks is still underway, and the three banks still operate to some extent in all three sectors; the general institutions called for in the law, establishing the banks, notably the Orientation Council for the Banking and Financial Sector, and regional credit committees, are not yet operational. National credit policies are in principle established by the Central Bank but it is expected that the Orientation Council for the Banking and Financial Sector, when it is established, will play an important role in the definition and monitoring of credit policies. 29. BTM-s mandate is to promote rural development and to favor the mobilization of national savings. By law, the share-capital of BTM can be subscribed by the Government, fokonolona institutions, socialist institutions, Government institutions and enterprises. BTM's share capital of 2 billion FMG (US$9.5 million) is owned by the Government (90 percent) and the Central Bank (10 percent). BTM is managed by a Management Committee nominated by Cabinet decree and chaired by the Minister for Finance and Planning. 30. BTM is largely decentralized, reflecting its rural vocation and its recent expansion into new areas; it is the bank most widely represented in Madagascar. Apart from its headquarters in Antananarivo and six regional offices (one in each faritany), BTM has 38 branches, two sub-branches, and 26  - 10 - field offices. The headquarters and the regional offices assume administra- tive and control responsibilities, while the branches, sub-branches and field offices perform operational activities. As of September 15, 1979, BTM's staff amounted to about 1,230 officers, including senior managers. About 150 officers were at headquarters, 40 in the group offices, and about 1,030 in the branches and field offices. Staff increased by 2 percent a year in 1979 and is expected to continue at that rate in the coming years. In general, the professional competence of BTM staff has been satisfactory for the level and type of activities it has maintained since it was established. 31. Field offices are generally well located and equipped and BTM's management appears to have a sound and pragmatic approach to expansion, having resisted some recommendations for more rapid growth of physical infrastructure. Rural branches are modest and accessible to the rural clientele. Transport means are generally available for field staff, although they are not always sufficient, in particular in the newer areas of activity where distances are great, and security is at times a problem. For such cases, the mobile banks included in the project proposal appear to be a judicious solution. BTM's present data processing equipment is limited. The computer, which is used to process all accounts and financial statements has proved too small to handle the volume of work and BTM has now ordered a new computer to be installed at headquarters by the end of 1980. 32. Lending Policies. Pending the introduction of new Credit Regulations called for in BTM's statutes, BTM continues to apply many operating procedures of its predecessors which are in general satisfactory. Agriculture, including livestock and fisheries, is to be BTM's main area of lending, and BTM can finance: (a) all seasonal inputs (seeds, fertilizer, insecticides, labor, small equipment, etc.); (b) all investments leading to an increase in agricul- tural production (plantations, land improvement, irrigation works, etc.); and (c) marketing, processing, and conditioning and export of agricultural products. BTM's borrowers can include Government enterprises or institutions, parastatal companies, fokonolona institutions, cooperatives, private enterprises or individuals. There is no minimum income requirement. All credit applications for general clientele operations are individually analyzed and managed in accordance with adequate banking standards. Loan applications for private enterprises and individuals are analyzed by the branches, and BTM branch or group management carry out random field cross-checks of borrowers. Loan applications for government enterprises or parastatal companies are processed at headquarters. 33. Average maturities on short-term loans are twelve months, but small seasonal loans can extend to eighteen months. Medium-term loans range from two to five years, and long-term loans from six to ten years. Repayments for agricultural loans are generally timed with crop harvests. There is no ceiling for general clientele loans. However, total loans to a single bor- rower cannot exceed 10 percent of BTM's outstanding portfolio. In addition, BTM's total outstanding portfolio is controlled through the ceiling on its rediscounting facility with the Central Bank (currently 4,600 million FMG). For agricultural loans, 10 percent borrower's contribution is required for seasonal and marketing loans and 33 percent for investment loans and bridge  - 11 - financing. Smallholder loans, which are presently limited to 200,000 FMG (US$950) for an individual farmer, are appraised in accordance with specific criteria for sub-groups of loans by the branches. Tangible guarantees include mortgages on the borrowers assets (land, buildings, stocks, and equipment). 34. Interest Rates. Interest rates and fees are establtshed by the Central Bank. For general clientele operations, BTM's interest rates on short-term loans range from 8 to 10 percent a year; in addition a fee of 1 percent a year is charged on current account overdrafts. For small loans, interest rates calculated pro rata temporis are replaced by a fixed fee. This fee is applied on the loan principal for the total duration of the loan; as a result, the actual interest rate to the borrower is higher than the nominal rate. For small loans for equipment, this fee is set at 1 percent a month. For the first two years of BTM's operations, the interest rate structure appears to have been adequate. Madagascar's rate of inflation was main- tained at 7-8 percent a year, and the cost of BTM's resources has remained low, about 3 percent of its working assets. However, these interest rates are low in relation to projected inflation rates of about 12 percent a year on average for the next three to four years; the entire question of interest rates is being reviewed and senior officials are aware of the need to raise interest rates in this inflationary period (see para 60). Pricing and Marketing 35. With minor exceptions, the Government fixes official prices for all agricultural produce. In general these prices do not correspond to the costs of production and, as a result, substantial quantities are marketed through unofficial channels (particularly in the case of paddy) and in the absence of financial incentives, production of major crops such as paddy, coffee or cotton has been stagnating and declining. The price of rice at the consumer level is held at an artificially low level and includes an important element of direct Government subsidy to the consumer. Official export prices for cash crops are generally well under real export prices and provide substantial profit margins to the stabilization funds which manage them. Historically marketing channels were in private hands, operating an intricate network involving small collectors and foreign-owned trading companies. The latter have been nationalized. It is Government policy to increase the share of parastatals in marketing agricultural produce but the present situation is still characterized by the existence of a complex of local arrangements between private and parastatal operators. Lack of transport infrastructure, especially roads, and the generally weak management of the parastatals are serious constraints on the development of the sector. Principal Crops 36. Rice, grown throughout Madagascar on about 50 percent of permanently cultivated land, is the staple food; per capita rice consumption (over 150 kg per year) is among the highest in the world. Since 1960, production has increased on average by less than 3 percent a year; total production appears to have stagnated since 1976 at around 2 million tons of paddy a year; yields average 1.8 tons per hectare. Due to a growing deficit in domestic production  - 12 - and severe marketing problems, imports have increased from a negligible tonnage in 1970 to over 160,000 tons a year in 1978 and 1979; this represented about US$56 million or 15 percent of the total value of exports, and more than 40 percent of export earnings from coffee. Rice cultivation is mostly con- centrated on the central plateau and in the north west. Family rice fields are generally terraced, located on valley floors, and range in size from a few acres to 5 ha, the average being about 1 ha and often less in heavily popu- lated zones. Most farmers produce a single crop per year, relying almost exclusively on traditional production techniques and water control systems. 37. From 1973-77, the Societe d'Interet National des Produits Agricoles (SINPA), a parastatal company, had a monopoly on marketing, collection, imports, processing and distribution of all agricultural products including rice. SINPA's marketing operations encountered serious problems, however, and in 1977 the Government assumed direct overall responsibility for rice marketing. While SINPA still retains responsibility for the largest area, recently-nationalized trading firms and other parastatal agencies have been assigned marketing responsibilities. 38. The rice marketing system is far from satisfactory; weak manage- ment, 1/ lack of trucks, bad roads, and poor operation of the port and railway facilities have made the supply of rice to deficit areas unreliable and Government and the Army are increasingly involved in basic food marketing and distribution. The total quantity of paddy marketed through official channels ranged between 217,000 and 309,000 tons in the years 1970-1978, representing an estimated 11 percent to 16 percent of total production. The Ministry of Economy and Commerce officially estimates that about 40 percent of all marketed paddy now goes through unofficial channels; prices vary widely but are well above official levels. Numerous paddy mills are scattered throughout Madagascar, many of which have been nationalized and are operated by SINPA or other parastatals, while others are still operated by private traders, with charges fixed by the Government. There is excess capacity in existing mills for the current volume of marketed production. 39. The Government fixes paddy and rice prices at the producer and retail levels as well as margins for marketing, processing and wholesale transactions. The producer price of paddy is currently FMG 38/kg and the retail price is FMG 55/kg; these prices apply throughout Madagascar, and involve a direct subsidy to customers of about FMG 25 to 30/kg on locally produced rice. Only FMG 15/kg is reimbursed to marketing agencies from an equalization fund (Fonds de Perequation) managed by the Ministry of Finance and Planning, which pools resources from crop specific stabilization funds. The Government is consider- ing an increase in producer and consumer prices in the near future. 40. Groundnuts. Groundnuts are grown throughout Madagascar, generally on comparatively poor soils. Cultivation methods, on individual plots averag- ing 0.3 ha, remain mostly traditional and yields are around 1.0 tons/ha. 1/ The value of physical losses of paddy by SINPA at the collection stage was estimated for 1977 at 1 billion FMG corresponding to 26,000 tons of paddy.  - 13 - Production is expected to increase to about 40,000 tons in 1979 after a sharp decline from an average 45,000 tons from 1972-1977 to 34,000 tons in 1978. Traditional private marketing circuits have been replaced in recent years by government-owned marketing companies which face coordination problems. Oil mills face serious supply problems, and Madagascar is heavily dependent on imports of f-..s and oils, valued at 2.2 billion FMG in 1978 and 2.3 billion FMG (US$11 million) in the first six months of 1979. Producer prices for groundnuts and ex-factory prices for oil are fixed by the Government, cur- rently at FMG45/kg and FMG 278/kg respectively. With present low yields, producer prices do not provide an adequate incentive and Government plans for a sizeable increase in planted areas from 40,000 ha to 64,000 ha and for self-sufficiency in oil by 1990, will be difficult to achieve. 41. The cultivated area under roots and tubers, particularly cassava, has been expanding in response to population growth. Yields, however, con- tinue to be low, stagnating around 5 tons/ha. Production of cassava reached 1.6 million tons in 1978; with only limited amounts marketed for industrial uses. Other subsistence crops are sweet potatoes, potatoes, saonjo, maize and beans. It is estimated that 30 percent of maize production is used for animal feed. About 6,000 tons of butter beans were exported in 1978 for a total FOB value of 970 million FMG (US$4.4 million). 42. Coffee is Madagascar-s foremost export commodity, accounting for about 36 percent of total export earnings in 1978. There are an estimated 350,000 coffee growers (10 percent of the rural labor force) cultivating 230,000 ha of coffee, and 30 percent of the rural active population is directly or indirectly involved in coffee production; coffee production has been stagnating since coffee plots are generally small averaging about 0.5 ha most plantations are overaged (at least 60 percent of the trees over 20 years old), and techniques remain largely traditional. Coffee-is mostly grown in association with pepper, vanilla or cocoa. Use of inputs such as fertilizers is limited. Average yields now stand around 0.35 tons/ha, and are likely to decrease on existing plantations unless a strong regeneration effort is made. 43. With a 20 percent contribution to total export earnings, cloves are Madagascar-s second most important export crop. Plantations are mostly small (under 1 ha); total planted area was 45,000 ha in 1978. Production varies widely from year to year but has shown a general upward trend; in 1978 it reached 15,000 tons, of which 13,000 tons were exported; 1,000 tons of leaf distillate were also exported. Prospects for export markets are good in the short term, due in particular to the steady expansion of the Indonesian market. However, since the production of existing plantations will probably reach 20,000 tons by 1985 further expansion of the planted area should be considered cautiously. Vanilla is grown on the northeast coast, particularly in Antalaha, by an estimated 70 percent of farmers of that area. Average growers have about 1,000 plants on 0.50 ha, producing 150 kg of green vanilla a year. Total production has been following a general downward trend since 1972 and was estimated at about 5,000 tons green vanilla in 1978. World market prospects are generally viewed as good. Provided long-term credit is made available for new planting, promising possibilities therefore exist for redeveloping vanilla production. Although pepper planted areas have been  - 14 - decreasing in recent years, average yields have increased to over 700 kg/ha. Total production has also increased, reaching 5,200 tons in 1978, for a planted area of 7,200 ha. About 5,000 ha are under cocoa and an annual production is around 2,000 tons; smallholder plantings account for about one fourth of the total. 44. Cotton is produced almost exclusively on the west coast, on flood plains as water recedes, under rainfed conditions, and with full irrigation. Cotton production increased rapidly during the past decade, from about 9,000 tons in 1967 to 37,000 tons in 1977, but dropped to 33,000 tons in 1978 and 30,000 tons in 1979. Total planted area is presently about 18,000 ha; yields range from 1.0 ton/ha on dry land to 2.5 ton/ha on irrigated or on regularly flooded area. Private companies, operating principally in the northwest, still contribute nearly 50 percent of total cotton production, but their share is declining. The share of state farms has also diminished to about 12 percent; smallholders produced 42 percent of cotton in 1977, com- pared to about 28 percent in 1971. Smallholder cotton has predominated in the southwest, around Tulear and Ihosy, mainly under rainfed conditions. The analysis of farm budgets suggests that producer prices are currently too low to generate reasonable cash incomes under dryland smallholder farming condi- tions. Indeed, a shift towards more profitable crops (such as tobacco) is taking place in some regions; moreover, political uncertainties have restrained investments on large private plantations. The Government objective of substan- tial increases in cotton planting (7,200 ha in six years) to support the expansion of the textile industry will be very difficult to achieve unless additional incentives are provided to farmers. PART IV - THE PROJECT Background 45. The proposed project was prepared by BTM with assistance from RMEA. The project was appraised in September 1980. A Staff Appraisal Report, No. 2898-MAG, dated July 7, 1980 is being circulated separately. A map IBRD 14922, is attached showing the distribution of BTM activities. Negotiations were held in Washington, D.C. from June 9-17, 1980. The Malagasy Delegation was headed by Mr. Leon Rajaobelina, Governor of the Central Bank of Madagascar, and BTM was represented inter alia by its Director General, Mr. Henri Jean Marie. A credit and project summary appears at the beginning of this Report, and a supplementary project data sheet is given in Annex III. Project Objectives 46. The project would be the first IDA-financed agricultural credit project in Madagascar, and would support the Government s policy of extending credit for development in the rural areas, with BTM as the principal inter- mediary. It would be the continuation of an on-going smallholder Rural Credit Program which BTM initiated in 1977; potential beneficiaries are the present 1.5 million smallholder families of Madagascar. It would increase  - 15 - production of export and industrial crops and foodstuffs. The proposed project would also strengthen the managerial and financial capability of BTM. Project Components 47. The Project includes incremental investments fores ..-i by BTM under the Rural Credit Program for the three-year period starting with the 1980-81 planting season which have been evaluated as financially and economically viable and which are consistent with Government rural development goals. The credit categories are present estimates, but depending on demand, prices and other factors, such as the availability of inputs, the relative distribution of credit operations may change during project implementation and additional crops may be included. Therefore, appropriate provisions have been included in the project description of the draft Development Credit Agreement, Schedule 2, Part A of the Project, to allow for such flexibility. Specifically, the project components are: 48. Loans to Smallholders: (a) Seasonal credit would be made available for the maintenance of existing coffee, vanilla, clove and sugar cane planta- tions, as well as for the cultivation of foodcrops, like paddy, maize, and groundnuts; (b) medium-term credit for the regeneration of coffee plantations, the establishment of new sugar plantations, and the purchase of draft animals; and (c) long-term credit for the establishment of new plantations of coffee, vanilla, pepper and cocoa. Farmers would use the credit to pay for fertilizer, pesticides, planting material and tools, land preparation and tree trimming and hired labor. Since the majority of farmers cultivate several crops, usually subsistence crops with coffee and another export crop, each farmer would receive short- and medium-term credit, or short- and long-term credit, depending on his needs. 49. It is assumed that credit would be used to finance all the farm expenditures for export crops, and that the farmers own contribution would be family labor. It is estimated that during the project period, BTM would extend credit for export crop development totalling about 680 million FMG (US$3.2 million) to about 25,000 farmers. These loans would be used for the maintenance, regeneration, and establishment of 9,400 ha of coffee plantations, the maintenance of 5,000 ha of cloves, the maintenance and establishment of 2,400 ha of vanilla, 300 ha of cocoa, and the establishment of 300 ha of pepper plantations. 50. BTM would limit smallholder credit for industrial crops to sugar cane. Short-term credit would be provided for the maintenance of existing plantations, and medium-term credit for the establisment of new ones. Farmers would use the credit to pay for fertilizer, planting materials, and tools, mechanical ploughing and transport, and for hired labor. It is estimated that during the project period BTM would extend credit to some 1,200 farmers for sugarcane cultivation, for a total amount of about 250 million FMG (US$ 1.4 million), of which about 40 percent for existing plantations and 60 percent to establish new ones. 51. For subsistence crops, BTM would extend c edit for irrigated or rainfed rice in the lowlands, and maize and groundnu'ts on the hills (tanety)  - 16 - as follows: (a) short-term credit would be provided for seasonal inputs, principally seeds and fertilizer; and (b) medium-term credit for the purchase of draft oxen, ploughs and carts. It is estimated that during the project period BTM would extend credit to some 6,000 farmers for subsistence crop cultivation, in a total amount of about 1,300 million FMG (US$6.2 million). 52. Credit for Experimental Projects: This component is designed to generate experience with new types of activities to be used by BTM in the design of its future lending activities in rural areas. Activities already identified include vineyard establishment in Fianarantsoa Faritany, steer stall-feeding in the central plateau, and possibly smallholder dairying and pig fattening. It is anticipated that the majority of borrowers for these activities would be smallholder farmers. BTM could also extend some credit to some village producer cooperatives which are being established in several parts of the country. BTM would extend credit for such experimental projects on a case-by-case basis after a careful review of the technical justification of the proposed activities, and of managerial and financial viability in the case of village cooperatives. An amount of FMG 107 million (US$500,000) has been included in project costs for this component. 53. Staff Training: BTM would carry out a training program for its managerial and financial services department staff, with the objective of establishing an in-house training program, and offering refresher and profes- sional training possibilities for all staff levels from headquarters and field offices. Emphasis would be put on accounting, simple financial analysis, and banking administration and management. Sixty-three million FMG (US$300,000) have been earmarked for these training activities, including 24 months of consultants' services, didactic material, and scholarships for practical training abroad. For the computer staff, the objective would be to complete the training of the existing staff with the new computer, and to expand BTM's staff capacity for various services; analysts, programmers, 14 operators, and one operations manager would be trained. The program would be contracted to IBM; part of the training would be given in Europe, part in Madagascar. The principal investments would include the cost of courses, travel, living allowances, and didactic materials. Consultants to help design and establish the programs would be employed on terms and conditions satisfactory to the Association (Section 2.02, draft Project Agreement). The monthly costs of consultants- services have been estimated at about US$10,000 including fees, allowances and travel. 54. Itinerant Banks: BTM would establish seven itinerant banks to extend its activities in rural areas where the volume of business is not yet sufficient to justify the establishment of a permanent field office. These banks would consist of four-wheel drive vehicles especially equipped for such operations. 55. Study: BTM would hire consultants, satisfactory to the Associa- tion, to prepare a feasibility study on establishing a Data Base Management System. The Study would investigate BTM's existing programs and the activities  - 17 - of other foreign banks with similar operations. The consultants would propose a detailed implementation schedule for the introduction of a Data Base Manage- ment System with a detailed staff training program. The feasibility study would require three man-months of consultants' services, at a total cost of US$40,000 equivalent; the man-month cost of consultants' services has been estimated a, about US$13,000 including fees, documentation, transport and allowances. Project Implementation 56. The Project would be carried out by BTM. BTM is a sound, well managed financial institution but it is still at a relatively early stage of development. Certain aspects of the laws under which BTM was established have yet to be fully elaborated and applied. Therefore, BTM would exchange views with the Association on any proposal to modify its Statutes or its organization which could threaten BTM's ability to carry out its obligations (draft Project Agreement, Section 3.07). BTM's organizational structure was reviewed during negotiations. 57. The Government would inform IDA of the establishment of an Orienta- tion Council for the Banking and Financial Sector (ref. para 28) for BTM or for the establishment of a new, separate Management Committee for BTM, instead of the present joint Management Committee (Section 4.01, draft Development Credit Agreement). In general, BTM has adequate staff to handle its current volume of operations and to accommodate a modest expansion. Staff development plans call for the recruitment of about 110 additional technical staff over the next four years, or 2 percent staff expansion annually, a rate which has been achieved over the past few years. Before June 30, 1981, BTM would recruit a qualified and experienced financial analyst to serve at its head- quarters and additional data processing staff to ensure efficient management of its financial and computing services (Section 3.06, draft Project Agreement). 58. Rural Credit Program. The basic objectives, procedures, lending terms and conditions for BTM smallholder loans, the role of the fokonolona institutions and credit committees in credit administration, and the role of MDRRA extension services, have been defined in an agreement (Protocole d'Accord) on administration of the Rural Credit Program between the Borrower and BTM (Section 3.01 (c) draft Development Credit Agreement). The signing of this agreement would be a condition of credit effectiveness (Section 6.01 (b), draft Development Credit Agreement). The Government would consult with IDA prior to modifying the Protocole d'Accord between BTM and MDRRA on the Rural Credit Program. BTM would carry out an appraisal of the creditworthiness of all its borrowers and the viability of all its investments (Section 3.05(a), draft Project Agreement). 59. The quality of extension services for farmers varies widely among the different regions of Madagascar and, given the diversity of geographic conditions, production systems and the state of the road network, a careful evaluation of the viability of different crops and farming systems for each region is essential. BTM has agreed that it would carefully assess the financial and economic viability of proposed farm investments for food crops  - 18 - as well as the availability of adequate extension services and technical inputs and would only extend loans where such viability could be demonstrated (Schedule para B, draft Project Agreement). BTM would prepare detailed proposals for the design and administration of activities under the experi- mental credit component in consultation with IDA, and the same criteria would apply for these activities as for other BTM lending operations in terms of the viability of investments. It would be a condition of disbursement for experimental credit activities that in any year BTM would have furnished a detailed program of credit for the Association's approval (Schedule 1, para 4, draft Development Credit Agreement). 60. Lending Terms: In the past, BTM's interest rate structure which is established by the Central Bank (ref. para 34), has been appropriate to assure the institution's financial viability. However, rates of inflation in Madagascar have increased in recent years and are projected to continue at an average rate of about 12 percent a year during the Project implementation period. Therefore, some revision of interest rates applicable for proposed Project lending activities was appropriate. In determining the levels of proposed interest rates, the effective rate charged to farmers, including all fees and commissions has been taken into account with the objective of ensur- ing that the weighted average return for BTM's rural credit portfolio would not be less than 12 percent per annum (ref. Schedule, paragraph A2, draft Project Agreement). This level of interest rates would be appropriate to assure BTM-s continued financial viability, and assure a positive interest rate. 61. The Government's rural credit policies and the adequacy of BTM's lending terms and policies for activities under the Project would be reviewed at least annually between the Government, BTM and IDA (Section 3.02 (a), draft Development Credit Agreement and Section 2.01(d), draft Project Agreement). In general, BTM has adopted a sound policy toward loan recovery, barring further lending in fokontanys where repayments have been unsatisfactory. Agreement was also reached on a detailed schedule for repayment of Government arrears to BTM (Section 4.03, draft Development Credit Agreement). 62. Extension Services: Subject to certain reservations (para 26), the current MDRRA organization of services for activities under the Project is generally adequate to support the proposed developments. However, at present there is no effective extension organization for vanilla and responsibility for extension to smallholders producing sugarcane is divided between the MDRRA and the Sugar Stabilization Fund. Under the Protocole d'Accord the Government has made arrangements to ensure that the Coffee and Pepper Operation (OCP) would provide appropriate extension services for vanilla growers, and that services for sugarcane growers would be provided by SIRAMA in the Ambilobe area and by the Sugar Stabilization Fund in the Brickaville area. 63. Marketing and Prices: Incremental production of export crops would be marketed through the existing channels, mainly parastatal trading companies. The quantities involved are not expected to place substantial additional burdens on existing structures. Incremental production of foodcrops would also be marketed through existing fokonolona and parastatal institutions.  - 19 - Should the present price structure for paddy be maintained, a substantial part of incremental paddy production is likely to be marketed through unofficial channels. The Government and IDA would exchange views anually on the pricing of the crops to be financed under the Project (Section 4.02, draft Development Credit Agreement). Project Costs and Financing 64. Total project costs are estimated at about US$14.2 million, of which about US$5.8 million or 40 percent represent foreign exchange costs. Project costs are estimated at prices as of April 1980. Price contingencies were calculated on a cumulative basis, at a weighted average rate for domestic and international inflation of 12 percent for 1980 and 1981, and 10 percent thereafter. Taxes are not significant. The proposed IDA Credit of SDR 8.7 million (US$11.5 million equivalent) would be made to the Government of Madagascar on standard IDA terms and would finance about 80 percent of total project costs (100 percent of the foreign exchange costs and US$5.7 million equivalent in local cost). Local cost financing is recommended in view of the low foreign exchange component of the project and Madagascar's efforts to stimulate rural development. 65. The Government would make the proceeds of the Credit available to BTM under a Subsidiary Financing Agreement (Section 3.01 (b), draft Development Credit Agreement). The Government would assume the foreign exchange risk (Schedule 3, para 4, draft Development Credit Agreement). The funds disbursed under the Credit account would be capitalized every year and added to BTM's equity. Amounts equivalent to repayment of subloans, including principal and interest, would be earmarked every year by BTM for lending to smallholders under the Rural Credit Program. Assurances were obtained from Government on the above terms and conditions for relending the proceeds of the IDA Credit to BTM, and for BTM's use of funds obtained from sub-borrowers loan repay- ments. Ratification of the Subsidiary Financing Agreement would be a condition of credit effectiveness (Sections 6.02 (b), draft Development Credit Agreement). Procurement 66. The items to be financed under the Project are varied and would not be suitable for bulk procurement through international competitive bidding, except for the vehicles that BTM will purchase as itinerant banks. However, there is adequate competition, both international and national, in the normal supply channels which buyers would use. Fertilizer is the largest single item to be procured under the Project. For export crops and sugar, the extension organizations and the companies procure their fertilizer through international bidding; for foodcrops, the fertilizer made available to the MDRRA extension services is normally obtained by the Government from bilateral donors, and some of the parastatal companies also operating in the fertilizer trade obtain it through international bidding, following Government procedures which are satisfactory to the Association. Procurement of most other items would be through normal commercial channels. Draft animals, implements, and tools would be obtained from local sources. Seeds and planting material would be obtained from OCP for export crops, from sugar companies for sugar cane, and from MDRRA extension services for foodcrops.  - 20 - Disbursements 67. The Project commitment period is for three years (October 1, 1980 - September 30, 1983) and BTM's estimated disbursements to sub-borrowers would be in accordance with the estimated credit demand for the various activities financed. The proceeds of the Credit would be disbursed on the following basis: (a) 80 percent of incremental amounts disbursed by BTM under short, medium, and long-term sub-loans for coffee, vanilla, cloves, pepper, cocoa, sugar, and foodcrops (including draft animals); (b) 80 percent of the amounts disbursed under the experimental credit scheme; and (c) 100 percent of foreign expenditures and 95 percent of local expenditures, for technical assistance, training, consulting services and vehicles. Disbursement against (a) and (b) would be made against statements of expenditure certified by BTM. The documentation for the statements of expenditure would be retained by BTM for review by supervision missions. Disbursements against (c) would be fully documented. It would be a condition of credit disbursement for each year's program for experimental credit that a detailed program of activities had been approved by IDA in any given year (Schedule 1, para 4, draft Development Credit Agreement). Accounts and Audit 68. BTM's accounts are fully computerized, and with the expansion of its computer capacity, BTM is expected to be in a position to obtain monthly position statements for all its field offices and consolidated quarterly balance sheets and financial statements for all its operations. To date, BTM's accounts have been verified by a "Commissaire aux comptes", but the Government has agreed that BTM accounts will, in future, be audited by independent auditors acceptable to IDA. It has been agreed with BTM that (a) the accounting plan for financial institutions would be redesigned to allow for an adequate analysis of the agricultural loan portfolio and finan- cial ratios; (b) that BTM would maintain separate accounts adequate to show utilization of Project funds, and (c) that BTM's accounts would be audited by independent auditors acceptable to IDA, and submitted to IDA within six months of the close of each fiscal year (Section 3.03 (a) and 3.04 (a), draft Project Agreement). The 1978 and 1979 accounts have been audited and the auditors report found acceptable by IDA. 69. Evaluation. BTM would establish a simple monitoring and evaluation system for the rural credit program under the project. This would be one of the responsibilities of its Studies and Planning Department. The system would be designed to provide clear information on lending operations by region and by crop, to assist BTM in planning future lending activities. The borrowers sampled would represent a range of regions, types of cropping pattern, farm sizes, and types of loan. The proposed monitoring system would be furnished to IDA for its comments not later than June 30, 1981 (Section 3.08, draft Project Agreement).  - 21 - Benefits 70. The principal benefits expected to result directly from the pro- posed project would be increased production of export and industrial crops and reduced imports of rice. Additional benefits, which have not been quantified, ..-uld be felt beyond the immediate beneficiaries of the project investment as the result of better organized extension services and the availability of oxen for hire as draft animals. In all, about 31,400 low income families would benefit from the Project: about 25,000 from the export crop component; their incomes could be expected to double to between US$330 and US$250 per year on the average; about 1,200 families would be expected to benefit from the industrial crop component, their incomes could also be expected to more than double, reaching the equivalent of US$850 a year; and some 6,000 families would be expected to increase their cash revenues from practically nil to US$185 a year as a result of activities under the foodcrop component. In addition, about 1,800,000 man-days of hired labor would be created annually, the equivalent of roughly 7,000 permanent jobs. This employment creation, moreover, would benefit mostly migrant workers from the southern, poorest part of Madagascar where the setting up of development projects is constrained by lack of natural resources. 71. The economic rate of return for all directly productive components of the project (equivalent to about 91 percent of total project cost) has been estimated at 60 percent. Economic rates of return for individual Project components range from 13 percent (for improved rice and animal traction) to over 100 percent (for improvement of existing coffee and vanilla plantations). The sensitivity analysis demonstrated satisfactory rates of return for the project as a whole as well as for individual components. Risks 72. The success of the project would depend on three major factors. The first would be the provision of adequate extension services and the availability of inputs. It would not be possible or advisable to address these critical sector issues in the context of the proposed project but steps have been taken to offset this risk: (a) OCP, which is an experienced extension agency, would be made responsible for extension and provision of inputs for all export crops including vanilla and cocoa; (b) SIRAMA would be put in charge of organizing and providing extension services to sugarcane outgrowers supported by the Project; and (c) in all cases, and particularly for foodcrops, loans would be granted only to fokontany where BTM is satisfied that extetsion services and inputs are available to farmers. 73. The second critical factor is related to producer prices and market- ing. The project is viable under the present structure but increases in producer prices of coffee, pepper and paddy would undoubtedly improve its results. Difficult and complex problems are involved and slow progress must be expected through a continuing dialogue with the Government. Marketing risks would be reduced to a minimum by selecting project areas in zones where easy road transportation is available. The third risk concerns the performance of BTM and its relations with fokonolona institutions (ref. para. 25). This risk is offset by the sound management of BTM in the past years and the agreed  - 22 - Protocole d'Accord, but it will be essential that a continuing dialogue on BTM's management and procedures be maintained throughout the project imple- mentation period. PART V - LEGAL INSTRUMENTS AND AUTHORITY 74. The draft Development Credit Agreement between the Democratic Republic of Madagascar and the Association, the draft Project Agreement between the Association and BTM, and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement of the Association are being distributed separately to the Executive Directors. 75. Special conditions of the project are listed in Section III of Annex III of this report. 76. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 77. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President by Ernest Stern Attachments August 20, 1980  ANNEX 1 Pase 1 MADAGASCAR - SOCIAL INDICATORS DATA SHEET MADAGASCAR REFERENCE GROUPS (WEIGHTED AVESGES LAND AREA (THOUSAND SO. KK.) - MOST RECENT ESTIMATE) TOTAL 587.0 AGRICULTURAL 369.3 MOST RECENT WOW INCOME MIDDLE INCOME 1960 /b 1970 /b ESTIMATE /b AFRICA SOUTH OF SAHARA AFRICA SOUTH OP SAHARA GNP PER CAPITA (US$) 120.0 180.0 250.0 228.9 726.2 ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) 38.0 71.0 78.0 80.0 699.4 POPULATION AND VITAL STATISTICS POPULATION, MID-YEAR (MILLIONS) 5.5 6.8 8.3 URBAN POPULATION (PERCENT OF TOTAL) 10.6 14.1 17.5 17.3 28.9 POPULATION PROJECTIONS POPULATION IN YEAR 2000 (MILLIONS) 14.0 STATIONARY POPULATION (MILLIONS) 38.0 YEAR STATIONARY POPULATION IS REACHED 2160 POPULATION DENSITY PER SQ. KM. 9.0 12.0 14.0 27.4 61.7 PER SQ. KM. AGRICULTURAL LAND 15.0 18.0 22.0 82.6 126.0 POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS. 41.6 42.8 43.4 44.9 45.5 15-64 YRS. 55.2 53.9 53.3 52.2 51.6 65 YRS. AND ABOVE 3.2 3.3 3.3 2.8 2.8 POPULATION GROWTH RATE (PERCENT) TOTAL 1.8 2.2 2.5 2.7 2.7 URBAN 5.0 5.1 5.3 6.8 4.9 CRUDE BIRTH RATE (PER THOUSAND) 47.0 45.0 45.0 47.4 46.8 CRUDE DEATH RATE (PER THOUSAND) 27.0 22.0 19.0 19.6 16.4 GROSS REPRODUCTION RATE 2.9 3.2 3.0 3.2 3.2 FAMILY PLANNING ACCEPTORS, ANNUAL (THOUSANDS) USERS (PERCENT OF MARRIED WOMEN) .. .. FOOD AND NUTRITION INDEX OF FOOD PRODUCTION PER CAPITA (1969-71-100) 89.0 102.0 92.0 91.8 94.0 PER CAPITA SUPPLY OF CALORIES (PERCENT OF REOUIREMENTS) 106.0 108.0 115.0 90.2 92.7 PROTEINP (GRAMS PER DAY) 60.0 60.0 60.0 53.0 53.0 OF WHICH ANIMAL AND PULSE 18.0 17.0 15.0 18.4 15.6 CHILD (AGES 1-4) MORTALITY RATE 41.0 32.0 27.0 27.7 21.3 HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) 37.0 42.0 46.0 45.3 50.1 INFANT MORTALITY RATE (PER THOUSAND) .. 177.0 .. ACCESS TO SAFE WATER (PERCENT OF POPULATION) TOTAL .. 11.0 26.0 23.2 31.0 URBAN .. 67.0 76.0 58.0 66.8 RURAL .. 1.0 16.0 16.8 ACCESS TO EXCRETA DISPOSAL (PERCENT OP POPULATION) TOTAL .. .. .. 28.9 URBAN .. 88.0 .. 67.0 RURAL .. .. 9.0 POPULATION PER PHYSICIAN 9619.0 10194.0 10301.0 30910.4 14508.2 POPULATION PER NURSING PERSON 3105.0 3361.0 3536.0 5793.2 3279.5 POPULATION PER HOSPITAL BED TOTAL 469.0 355.0 405.0 1198.9 1141.5 URBAN 115.0 147.0 RURAL 761.0 472.0 ADMISSIONS PER HOSPITAL BED .. .. HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL .. 5.8 4.7 URBAN .. 5.3 5.0 RURAL .. 5.9 4.7 AVERAGE NUMBER OP PERSONS PER ROOM TOTAL .. .. URBAN .. .. RURAL .. .. ACCESS TO ELECTRIC ITY (PERCENT OF DWELLINGS) TOTAL .. 5.0 URBAN .. .. RURAL .. ..  ANNEX 1 Page 2 MtADAGASCAR - SOCIAL INDICATORS DATA SHEET MADAGASCAR REFERENCE GROUPS (WEIGHTED AVEBAGES - M1ST RECENT ESTIMATE)TA. MOST RECENT LOW INCOME MIDDLE INCOME 1960 /b 1970 /b ESTIDATE /b AFRICA SOUTH OF SAHARA AFRICA SOUTH OF SAHARA EDUCATION ALJUSILD LEKNLLMENT RATIOS PK11,ARY: TOTAL 52.0 83.0 92.0 57.7 61.7 yNA3,E 5b.0 90.0 98.0 74.2 69.2 FPDALE 45.0 77.C 66.0 54.1 51.4 51CONDARY: TOTAL 4.0 11.0 12.0 10.0 20.6 tvALE 5.0 13.0 14.0 13.7 29.2 F,S1ALE 3.0 8.0 10.0 7.1 14.7 VuJCA1IOSAL LEROL. (0 OF S