Sri Lanka - Tea Rehabilitation and Diversification Project

Document of z rl w, The World Bkank FOR OFFICIAL USE ONLY Report No. 3531a-CE STAFF APPRAISAL REPORT SRI LANKA TEA REHABILITATION AND DIVERSIFICATION PROJECT April 9, 1932 South Asia Projects Department Agriculture Division B This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1 Rupees (Rs) 21 Rs 1 US$0.048 WEIGHTS AND MEASURES 1 kilometer 0.62 miles 1 meter (m) 1.09 yards 1 kilogram (kg) 2.2 pounds 1 hectare (ha) 2 = 2.47 acres 1 square meter (m ) = 10.76 square feet 1 ton (metric) 2,205 pounds ABBREVIATIONS BOC - Bank of Ceylon BOP - Broken Orange Pekoe BOPF - Broken Orange Pekoe Fannings CTC - Cut Tear and Curl DMEC - Department of Minor Export Crops ECP - Endless Chain Pressure FBD - Fluid Bed Drier GOSL - Government of Sri Lanka ICB - International Competitive Bidding JEDB - Janatha Estates Development Board LRC - Land Reform Commission LTP - Laurie Tea Processor MOPF - Ministry of Planning and Finance MPI - Ministry of Plantation Industries MECRS - Minor Exports Crops Research Station NPMI - National Institute of Plantation Management, MPI NSA - Net Sales Average OST - Old Seedling Tea PCC - Project Coordinating Committee SPC - State Plantations Corporation TB - Tea Board, MPI TRI - Tea Research Institute, MPI TSHDA - Tea Smallholders Development Authority, MPI VP - Vegetatively Propagated (Cloned)  FOR OFFICIAL USE ONLY SRI LANKA TEA REHABILITATION AND DIVERSIFICATION PROJECT TABLE OF CONTENTS Page No. I. INTRODUCTION ................................................... 1 II. THE TREE CROP SECTOR .. 1 Land Reform .................................................... 2 The Tea Sub-Sector .. 2 Role in the Economy ............................................ 2 Location and Size ................... 2 Structure ...................................................... 3 Tea Production ................................................. 3 Tea Processing and Manufacture .. 3 Factory Age, Size and Location .. 4 Taxation ....................................................... 4 Subsidies ...................................................... 5 Tea Industry Institutional Structure .. 5 Ministry of Plantation Industries .. 6 Public Sector Corporations ...................................... 7 Tea Margins and Financial Profitability . . 8 Tea Markets ................................................... 9 International Tea Prices and Agreements . . 9 The Minor Crops Sub-Sector ...................................... 10 World Market Prospects .......................................... 10 Domestic Marketing Channels ..................................... 11 Institutions ................................................... 11 IDA Involvement in the Tree Crops Sector . . 11 III. PROJECT AREA ................................................... 13 General ................................................... 13 Elevation, Topography and Soils ................................. 13 Climate ................................................... 14 Socio-Economic Conditions ....................................... 14 Communications .................................................. 15 Fuelwood Availability ........................................... 15 Tea Area ................................................... 16 Yields, Production and Prices ................................... 17 Extension ................................................... 18 Tea Factories ................................................... 18 Power Supply for Tea Factories .................................. 19 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 discicsed without World Bank authorization.  - ii - TABLE OF CONTENTS (Continued) Page No. IV. THE PROJECT ................................................... 19 Objectives and Brief Description ................................. 19 Detailed Features ................................................. 20 Field Program ................................................... 20 Tea-Replanting ................................................... 20 Tea Infilling ................................................... 21 Diversification .................................................. 21 Soil Conservation ................................................ 22 Processing and Storage ........................................... 22 Tea Factory Rehabilitation ....................................... 22 Minor Crop Processing and Storage ................................ 23 Field and Nursery Equipment ...................................... 23 Green Leaf Transports ............................................ 24 Housing ................................................... 24 Medical Services ................................................. 24 Staff Development and Training ................................... 24 Technical Assistance ............................................. 25 Tea Smallholder Assistance ....................................... 25 Administrative Support ........................................... 26 Project Preparation.26 V. PROJECTCOSTS AND FINANCING ...................................... 26 Cost Estimates.26 Financing ......................................... ----------28 Procurement ................................................... ------------ 29 Contract Review.29 Disbursements ................................................... 29 Accounts and Audits.3C VI. ORGANIZATION AND MANAGEMENT.30 Organization and Management-JEDB and SPC ......................... 30 Project Implementation and Coordination .......................... 32 Project Monitoring and Reporting .................................. 32 VII. YIELDS, PRODUCTION AND MARKETS ................................... 32 Yields ..................................................... 32 Production and Markets ........................................... 34 Prices ..................................................... 34 VIII. FINANCIAL ANALYSIS ............................................... 35 Financial Benefits and Operating Cost ............................ 35 Financial Rate of Return ......................................... 36 Sources and Applications of Funds ................................ 37 Financial Profitability .......................................... 38 Financial Structure .............................................. 3E Financial and Fiscal Impact of the Project ....................... 39  - iii - TABLE OF CONTENTS (Continued) Page No. IX. PROJECT JUSTIFICATION AND ECONOMIC ANALYSIS ........................ 39 General ....................... 39 Economic Benefits ....................... 39 Non-Quantified Benefits ....................... 40 Economic Analysis ....................... 40 Sensitivity Analysis ........................,, 43 Project Risks ........................-----. 42 X. RECOMMENDATIONS ............................. 42 ANNEXES Annex 1 Glossary 2 Project Costs and Disbursement 3 Financial Statements and Projecl:ions 4 Organization and Implementation Charts 5 Project Yields, Production and Crop Budgets 6 Economic Analysis 7 Project File Text Tables 2.1 Summary Financial Statements 3.1 Project Tea Area in Hectares 3.2 Tea Area Bush Vacancy in RehabiLitation Areas 3.3 Tea Yields and Production-1980 4.1 Field Program (ha) 4.2 Housing Program 4.3 Diversification Program (ha) 5.1 Project Cost Summary 5.2 Inflation Rate 5.3 Financing Plan 7.1 Tea Yields 7.2 Farmgate Prices (Rs) in Constant 1981 Value 8.1 Financial Benefits and Costs in 1990 (Rs M) 8.2 Financial Rate of Return 8.3 Sources and Applications of Funds 9.1 Economic Benefits/Costs-1990 (Rs M) 9.2 Economic Rate of Return 9.3 Switching Values List of Maps IBRD 15659R IBRD 15660R IBRD 15661R IBRD 15910   SRI LANKA TEA REHABILITATION AND DIVERSIFICATION PROJECT I. INTRODUCTION 1.01 This report appraises a tea industry rehabilitation and diversifica- tion project in Sri Lanka's tree crop sector. The project forms part of the Government's development strategy which emphasizes restoring the productivity of the export-oriented tree crop sector. The proposed project extends the concept of the ongoing IDA assisted Tree Croy Rehabilitation (Tea) I Project (Cr. 818-CE) to other tea areas of high potertial, whilst diversifying poor tea areas into more profitable crops. Increases in tea production resulting from rehabilitation would be offset by diverEification to minimize any effects on world markets. This rationalization of te!a production follows the recom- mendations of Sri Lanka's Tea Master Plan which identified priority areas for investment in the tea sector. The project was prepared in two stages by the implementing agencies with the Ministry of Finance and Planning acting as coordinator. The preparation reports for rehabilitation were completed in January 1981 and appraised during February 1981 by a mission consisting o)f Messrs. T.P.N Sinha, J. A. Hayward, G. Mukami, (Ms.) T. Jones (IDA) and R. Stammers (Consultant). During this appraisal, some of the area proposed for rehabilitation was found to be more suitable for diversification. An agreement was reached to prepare a diversification component. The preparation report for this was presented in June 1981 anid the component was appraised during September 1981 by a mission consisting of Messrs. J. A. Hayward, R. Moreno, C. J. Maguire (IDA) and H. W. Mitchell (Consultant). II. THE TREE CROP SECTOR 2.01 Sri Lanka's tree crop sector consists mainly of tea, rubber and coconut, which together occupy about 48% of crop land and about 95% of land under tree crops. The sector has a dominant role in Sri Lanka's economy. It continues to be the main source of foreign exchange earnings and in 1980 provided about 58% of export revenue. The sector also employed about one- fifth of the labor force and accounted for 21% of the GDP in 1980. In spite of its importance, the sector has suffered from continuing neglect. Produc- tion of the three main crops grew by only abDut 1% per annum during the 1960s and stagnated during the 1970s. The disappointing performance was due to uncertainties associated with GOSL land reforms, declining profitability due to low prices and high export taxes, and inadequate foreign exchange alloca- tion for inputs.  -2- Land Reform 2.02 Sri Lanka's land reform was carried out in two phases. The first phase, initiated in 1972, limited private holdings to no more than 20 ha. At that time, about 225,000 ha of land were vested in the Land Reform Commission (LRC) of which 60% was under tree crops including 23% under tea. The State Plantations Corporation (SPC), then under the Ministry of Plantation Industries (MPI), was given management of about 40 of the larger well-maintained tea and rubber estates. Cooperatives managed most of the remaining land under the con- trol of LRC. In the second stage of land reform, initiated October 1975, all land owned by national and foreign companies, which included the major tea and rubber estates, was also vested in the LRC. The Government assigned manage- ment of about 65,000 ha to SPC and nearly 95,000 ha to the Janatha Estates Development Board (JEDB) which was established for the purpose under the Ministry of Agriculture and later transferred to MPI. 2.03 Though most of the tree crop plantations were nationalized around 1975, the threat of such nationalization existed for about seven years pre- viously. The uncertainties of ownership reduced investments in replanting, infilling and factory modernization, the effects of which are still evident. After nationalization, the Government's experiments with different organi- zational structures added further uncertainty. The experiments with coop- erative run plantations were particularly disastrous and were abandoned. Meanwhile the upkeep of estates further deteriorated. Since 1978, the land tenure and organization structure has been relatively stable and the upkeep of estates has improved. The Tea Sub-Sector 2.04 Role in the Economy. Tea retains a major role in the Sri Lankan economy and in the tree crop sector, although its dominance recently has diminished. Value added, including both growing and processing, accounted for 10% of GDP in 1980, compared to 13.5% in 1977. Tea is still Sri Lanka's main export although its share in total export revenue fell from 50% in 1977 to 36% in 1980. Even then tea accounted for about 60% of the export revenue from the tree crop sector. Taxes on tea, particularly the export levy, provided 17% of the Government-s revenue in 1980. About 18% of Sri Lanka's labor force is employed in the tea sector. 2.05 Location and Size. Tea production in Sri Lanka is situated in the South West wet zone. There are no reliable data on the actual area under tea cultivation. The official estimate of 244,000 ha is probably too high because tea land has in recent years either been abandoned or has been transferred to village development projects. Tea cultivation in Sri Lanka is classified into three elevational categories: high country (1,200-2,000 m), mid-country (600-1,200 m) and low country (0-600 m). Their share of the tea area is about 37%, 38% and 25%, respectively. The high country produces the renowned flavor teas which established Sri Lanka's tea reputation. The low country produces the heaviest yields of strong black teas demanded by Middle East countries. The mid-country produces neither high quality nor  high yields and its lower tea prices are not compensated by greater produc- tion. GOSL strategy is therefore to invest in tea rehabilitation in the high and low country whilst diversifying out of tea in the mid-country. The IDA supported Tree Crops Rehabilitation (Tea) Project (Cr. 818-CE) in the high country and the Tree Crops Diversification (Tea) Project (Cr. 819-CE) in the mid-country are assisting in this process. The proposed project combines both rehabilitation and diversification components and is consistent with GOSL strategy. 2.06 Structure. Since the enactment of land reform, 70% of tea land has been owned by the public sector, primarily by SPC and JEDB. Smallholders with less than 4 ha account for 20%, while the remainder comprises private holdings above 4 ha. Smallholders are predominant in the low grown tea areas in the South West. 2.07 Tea Production. Tea planting commenced in Sri Lanka (then Ceylon) in the 19th century, and after a long period of growth, production reached an annual average of 223 million kg during 1965-69. Since then production has declined to an annual average level of 212 million kg in 1975-79. Production in the mid-country dropped by 20%, from 74 million kg in 1970/71 to 59 million kg in 1978/79, while high-grown production dropped by 11%, from 83 million kg to 74 million kg during the same period. However, output in the low country area increased by 12% in response to market demands, from 58 million kg in 1970/71 to 65 million kg in 1978/79. Total tea production in 1980 dropped to 191 million kg, 7% below the 1979 level, largely as a result of drought during the early part of the year. Sri Lanka's share. in total world production has correspondingly declined from 20% in 1960 to E,bout 10% at present. The poor production performance in the 1970s was due partly to frequent drought, falling world tea prices, and the uncertainties associated with land reform, but most importantly to the Government's tax and foreign exchange policies which discriminated against the tea sector. A,s a result fertilizer use stagnated, stand maintenance was poor and fie'ld investment activities were inadequate. For example, the essential replanting program which had averaged about 2,500 ha a year during the early 1970s J-ell to slightly over 1,000 ha annually in 1976-78. Replanting has increased recently to about 2,000 ha annually, although the level is still below the Government's goal of 3,000 ha per year. In total, only 14% of the country-s tea land has been replanted with heavier yielding clonal (Annex 1) teas, an important reason for the lack of sustained improvement in tea yields. Although yields rose from an average of 1,000 kg per ha in the 1960s to 1,200 kg per ha in 1974-76, the figure was slightly less than 1,000 kg per ha in 1977-79. At least half of the tea bushes in Sri Lanka will be over 70 years old by 1985, well beyond their maximum productive period; most are seedling varieties of uncertain yield and quality and most fields have high vacancy rat-s. The past neglect of stand maintenance and replanting will continue to aEfect production adversely over t'he next decade. The proposed project has a substantial field rehabilitation program to reverse that trend. 2.08 Tea Processing and Manufacture. Almost all the green leaf plucked in the field is processed into black tea before sale and consumption. Pro- cessing involves initial drying (withering), rolling, oxidation (fermentation),  - 4 - final drying, grading and packaging. Most Sri Lankan tea is manufactured by the traditional "orthodox" rolling process which produces high quality loose black tea demanded by Europe, the Middle-East, Asia and Australia. Sri Lanka has been hesitant to adopt newer processing techniques (CTC and LTP) which makes teas more suitable for the tea bags demanded by newer markets in North America. The industry fears that a move away from "orthodox" manufacture, where they have considerable experience and skill, would destroy their com- parative advantage in traditional markets. However, with mid-country tea markets and prices weakening, Sri Lanka is considering switching some mid- country tea to the newer type of processing, while retaining orthodox manu- facture in other areas. The processing and manufacturing is done in about 720 tea factories 2.09 Factory Age, Size and Location. Most tea factories were constructed before World War II and contain machinery which is old and inefficient. The factories are small with average annual made tea production of about 290,000 kg. The small size was appropriate for pre-World War II tea production when yields were low. With higher yields due to increased clonal tea area and increased fertilizer use, larger factory capacities are becoming more econo- mical. 1/ The factories also suffer from a locational problem due to changing market demands and changing geographic pattern of production. With relatively decreased appeal and prices for mid-country tea and higher yields and produc- tion in low country and high country, an imbalance is developing between the location of tea processing capacity and the location of green leaf production. Green leaf is bulky and must be processed shortly after harvesting for good quality tea production. Therefore, more long-range transportation of green leaf is not a feasible solution to the problem, and new tea processing capa- city will have to be added in the low and high-country areas. Already about 20% of the mid-country tea factories which were in operation in the early 1970s have had to close and some new factory capacity is being added in other areas. 2.10 Taxation. In 1979, tea export taxes accounted for 47% of tea export value but were reduced by about a third on July 4, 1979, to account for about 35% in 1980. Still, the Sri Lankan tea industry continues to be the most highly taxed tea industry in the world. The three main taxes on tea in Sri Lanka are: - the specific export tax (Rs 8.00/kg). - the ad valorem tax (35% of the difference between the Net Factory Average for the month and Rs 22/kg). - a Tea Board cess (Rs 0.90/kg). The specific export tax forms about 95% of tea tax revenues. GOSL wishes to emphasize the role of a specific tax as opposed to an advalorem tax. The specific tax maintains full incentive for price improvement through more 1/ The new factories being built in East Africa and elsewhere have annual capacities up to 2M kg.  careful tea picking and manufacture, gives greater incentives for growing tea in the higher priority areas of low and high country, and discourages tea growing in the mid-country. However, in periols when local cost inflation outstrips increases in tea export prices due to sluggish adjustments of the exchange rate, both the specific and the gross revenue based ad valorem taxes erode tea margins. Under these circumstances, incentives are squeezed further which reduces production and exports, as happened in 1978 and 1979. An alternative, whereby the export duty would be abolished and full reliance placed on corporate income tax has been discussed with GOSL. However, GOSL feels that such action must await improvements in financial management and investment decision making, so that the larger margins are not used on less essential investments. The proposed project would provide technical assistance for such improvement. In the meantime, under the ongoing Tea Rehabilitation Project GOSL is committed to maintaining tea margins at about Rs 2.50-2.75 per kg of made tea, through adjustments of tax, cess, or exchange rates (Cr. 818-CE, DCA Covenant 3.07). However, the adjustment process has been slow (see also para 2.17). 2.11 Subsidies. Part of the revenue obtained from tea taxes is returned to the tea industry through subsidies on fertilizer, and through tea produc- tion and manufacturing investment subsidies. However, the subsidies are low and, in 1979, were valued at about 6% of revenue from tea taxes. Their structure is complex (Annex 2) with about eight different types of subsidies. They are administered by MPI through the Tea small Holder Development Autho- rity (TSHDA) and the Tea Board (para 2.16). While GOSL recognizes the com- plexity of administering a system of taxes and compensatory subsidies, they feel that without such a system, profits from tea would be spent on less essential investments. While there may be such tendencies in the two public corporations, which control 70% of production, a better way to ensure proper investments is through better management, incentives, financial controls and decision making. Accordingly, the project provides for technical assistance to strengthen management, especially financial management, of the public corporations. 2.12 Tea Industry Institutional Structures. With the nationalization of tea estates, the Government has become predominant in the tea industry and controls the tea industry through five miaistries: the Ministry of Planning and Finance (MOPF), the Ministry of "land, the Ministry of Plantation Industries (MPI), the Ministry of State Plantation (SPC), and the Ministry of Janatha Estates Development (JEDB). MOPF controls the profit margin of the tea industry through export taxes, coordinates project preparation through the tree crop sector division of the Planning Department, and approves the investment program of public sector corporations. The Ministry of Lands owns the nationalized tea estates through the Land Reform Commission. The tea estates are operated by the two public sector corporations--SPC and JEDB-- which individually constitute separate ministries. Tea research, extension, promotion and subsidy administration is handled by MPI. With the involvement of the five ministries the institutional structure is complex. However, the structure will be simplified during the project period, as Government intends to transfer ownership of project estates from LRC to the two public sector corporations.  - 6 - 2.13 Ministry of Plantation Industries. The MPI was established in 1970 and given overall responsibility for the major crops in the tree crop sector. However, the Government felt that the Ministry was too large for effective management and in February 1980 separated SPC and JEDB from MPI. The Ministry was left with primary responsibility for tea smallholders and subsidy administration through TSHDA, tea research, promotion policy and control through the Tea Board, and training through the National Institute of Plantation Management (NIPM). 2.14 The TSHDA was established in 1975 but began most of its operations in early 1978. The Authority was given responsibility for the promotion and development of the smallholder tea sector, which totals 129,000 small- holders, each with less than 4 ha, covering approximately 50,000 ha, and for assisting those tea plantations up to 20 ha without their own factories. Presently the main activities of the organization are the operation of five tea factories, the administration of the smallholder price support scheme, the sale of fertilizer and planting material, the provision of extension services and the payment of subsidies for field operations. The TShDA has also organized green leaf collection centers, and transports some small- holder leaf to TSHDA factories. The Authority has faced many problems which have impaired its effectiveness; overall management is weak, particularly in the areas of finance and planning, there are insufficient staff, and training is inadequate. As a result extension suffers. The Authority views itself primarily as a service organization even though it must operate as a commer- cial organization in running its tea factories. Consequently TSHDA has given insufficient attention to profitability of its tea factories and has tended to rely on Government grants. For instance, it has operated Derangala fac- tory using oil fired furnaces even though, by using firewood which is plenti- ful, TSHDA could have reduced firing costs by about 90% and total manufac- turing costs by about 16%. The conversion cost would have been recouped in less than a year. The Government wishes to strengthen TSHDA and has started implementing an Asian Development Bank assisted Third Tea Development Project which would provide staff, training, and tea processing facilities for TSHDA in the low country. Consequently, the proposed project would limit itself to strengthening TSHDA extension services in a small area, bearing in mind the limited implementation capacity of TSHDA. 2.15 The Tea Board, funded by an industry cess, presently 90 cents/kg, was established in 1976 for tea promotion and research, collection of statis- tics and market information and the administration of subsidies in which it is assisted by TSHDA. The Tea Board also gives advice on tea policy. These functions are performed through three agencies under the Tea Board--the Tea Promotion Board, the Tea Commissioner and the Tea Research Institute. The Tea Promotion Board carries out some marketing activities such as funding tea centers abroad, but in general most information and advice on market trends comes to the estates through either the tea brokerage houses or the head offices of the corporations. The Tea Commissioner's Department administers subsidies and collects statistics. In 1977 the registration of tea land and the administration of development subsidies for the tea smallholder sector were delegated by the Tea Commissioner to the TSHDA. The Tea Research Insti- tute (TRI) carries out research into all aspects of tea production. The  -7 - Institute, established in Talawakelle in 1925, has produced detailed recom- mendations covering all aspects of tea production. These recommendations can produce tea of the highest standard. Fertilizer application is based on comprehensive TRI recommendations which relate to crop growth, yield levels and fertilizer materials. New high yielding clones, suitable for a wide range of environments and for replanting and infillirg, are continually being tested and released by TRI. Similarly, methods for ccntrolling pests and diseases, both with chemicals and through integrated pest management, are being widely applied. TRI recommendations have been critizEd for lacking economic focus and evaluation. Accepting this, TRI has embarked on production research to overcome the shortcoming which may result in minor modification to the recom- mendations. In the meantime, estate superinterLdents, in consultation with their Visiting Agents, adapt the recommendations to individual field needs. The current poor condition of most tea fields reflects recent neglect, not a lack of good tea technology. In addition to research TRI also has an active Advisory and Extension Service responsible for training at all levels. Provision for training in the Tree Crop Sector is the responsibility of the National Institute of Plantation Management (NLPM). The Institute works closely with the Advisory and Extension Service of TRI and during 1980, organized seminars, courses and field days for all levels of estate staff. However, the program has been almost exclusively of a technical nature with ad hoc courses designed solely to improve tea production methods. No atten- tion has been given to the need for systematic staff development. 2.16 Public Sector Corporations. The two public sector corporations, SPC and JEDB, control 60% of tea lands and 70% of tea production. Because of their size, each with net sales of over Rs one billion, each of the cor- porations have been given the status of a Minis;try with the President as the Minister-in-charge. In 1980, the Corporations, which had previously been highly centralized, were given a regional structure with four boards each, to improve manageability (Chapter 6). However, decision making is still cen- tralized which has on occasion caused uncertainty and confusion at regional level. Reporting procedures are cumbersome and financial management is weak. High levels of current assets, amounting to 51% and 62% of sales, are main- tained by the corporations (Table 2.1). Furthermore, performance incentives for both staff and management are non-existent,. The proposed project addresses these problems (Chapter 6).  - 8 - Table 2.1: Summary Financial Statements 1980 (millions of dollars) JEDB SPC Income Statement Income 89 97 Less Expenditure 90 98 Net Income (1) (1) Balance Sheet Current Assets 55 49 Other Assets 11 17 Total Assets 66 66 Current Liabilities 54 44 Long Term Debt 3 14 Equity and Surplus 9 8 Total 66 66 Ratios Income/Sales (%) -1 -1 Current Ratio 1.02 1.11 Total Debt:Equity 86:14 88:12 Current Assets/Sales (%) 62 51 2.17 Tea Margins and Financial Profitability. The two corporations, JEDB and SPC, incurred losses on their operations (Table 2.1) because of high export taxes, weak tea markets and high local inflation. Recognizing the in- adequacy of tea margins, and in response to an agreement with IDA under CR 818-CE, which requires tea margins to be maintained around Rs 2.50-2.75 per kg, GOSL reduced the specific export duty in 1979 by about a third to Rs 10.50 per kg. Since then, margins have again suffered due to falling world tea prices and to doubling of fertilizer prices which has added about one rupee per kg to the cost of production. GOSL had been informed that restoring the margin to at least Rs 2.50 per kg through adjustment of export tax, cess or exchange rate, was a condition of Board presentation. In response, GOSL has recently reduced export duty by Rs 2.50 per kg to Rs 8.00 per kg, thereby meeting the condition. Ad-valorem tax has also been revised, but this will have minor impact on overall margin. Recognizing the importance of tea taxes as a source of revenue for the Budget, in the longer term, more reliance will have to be put on reducing tea production costs and increasing productivity of tea lands. The proposed project aims to reduce production costs through rehabilitation of tea lands and factories and diversification of poorer tea areas into other crops. Periodic reviews of margins would, however, be required to ensure that their level does not deteriorate, and that a reason- able return on investments is obtained.  - 9 - 2.18 Tea Markets. World trade in tea is estimated at about 940 M kg and is expected to grow at about 2.7% per annum, slightly above the historic trend of about 2.2% during 1961-80. However, Sri Lankan tea exports of about 187 M kg in 1980 have declined from a peak of 224 M kg reached in 1965 for an average growth rate during 1961-80 of about -0.3% per annum. Consequently, Sri Lanka's market share has declined from about 35% in the 1960s to about 23% in 1980. The decline in exports is due to declines in production which also averaged about -0.3% per annum during 1961-80. The proposed project would help retard the declining trends in production and exports by rehabilitating tea lands and factories. The major markets for Sri Lankan tea in 1979 were the United Kingdom (11%, including production sold at the London auction), Pakistan (8%) and the United States, Iraq, Egypt and Saudia Arabia (each ac- counting for about 7%). The major growth market for Sri Lankan tea comprises Middle East and Persian Gulf countries which ncw account for 50% of Sri Lankan exports, compared with only 25% in 1975. These markets favour leafy black tea grown in Sri Lanka-s low country. Consequently, the average price of low country teas is now higher than that for other regions, whereas it was the lowest in Sri Lanka before 1970. Most of the proposed project investments are directed towards rehabilitating low country tea areas and factories. Over 90% of Sri Lankan tea is marketed through intermediaries who buy at the Colombo tea auction, now the world's largest. Only about 10% is locally consumed. The auction is operated largely by six Colombo brokerage houses. The market is competitive and functions well, although in some market seg- ments a few major international tea packaging and merchandizing firms dom- inate. The amount of Sri Lankan tea sold at tihe London auction declined throughout the 1970s and presently accounts for only about 7% of total tea exports. The price of Sri Lankan teas at London auction relative to world averages has declined from a 6% premium in 1969/70 to a 4% disadvantage in 1980. Both buyers and brokers complain about a general deterioration in tea quality. The proposed project would help ^aise quality through factory rehabilitation and through improvements in green leaf transport and handling. 2.19 International Tea Prices and Agreements. Except for a short period in 1976/77, tea prices (the average of all teas sold at the London auction measured in 1977 constant dollars) have droppe,l steadily since the 1950s, and in 1979 the price in real terms was only 45% oE the 1959 price. The price decline resulted from weak demand and a rapid increase in tea production in Africa (about 8% per annum). Reflecting concern over prices, the FAO Inter- Governmental group on tea met in November 1979 and agreed to promote an international agreement comprising export quotas and buffer stocks. To date, no agreements have been reached and further meetings are scheduled. Reflect- ing concern about commodity prices, the existing Bank Group policy, as stated in the President-s August 17, 1973 memorandum to the Executive Directors (Document No. R73-206), states that no financing of projects involving tea production is to be undertaken, except: "(i) financing for increases in output in countries with no investment alternatives yielding an acceptable rate of return; and (ii) financing for rehabilitation involving no increase in output (this implies reduction in acreage and encouragement to diversifi- cation)." The proposed project qualifies under the second exception.  - 10 - The Minor Crops Sub Sector 2.20 Sri Lanka's minor export crops, which consist of cocoa, coffee, cardamom, pepper, cloves, nutmeg, mace, cashew, ginger, citronella, papain and sesame, are important to the economy. The share of these crops in official agricultural exports fluctuates considerably from year to year (from 8.9% in 1974, 5.3% in 1975 and 8% in 1979) due primarily to a lack of integrated marketing arrangements, speculative behaviour of exporters and unofficial exports. However, the export of minor crops has proved to be a significant foreign exchange earner and above all offers the opportunity of broadening the export base. Sri Lanka is the world's largest exporter of cinnamon (33% of the market) and exports a significant proportion of cloves (6.7%), sesame seed (5.9%), cardamom (3.2%) and nutmeg and mace (2.8%). Exports of the other minor crops constitute less than 1% of the world market. In contrast to tea, rubber and coconuts the minor crops are mostly grown by smallholders on homestead plots and have received little formal attention from Government extension, research and marketing programs. Field data on areas, yields and production are scarce. Recently, however, in response to worsening world prices for the major export crops and the country's rapidly deteriorating foreign reserve position, Sri Lanka has made export crops a high priority agricultural activity, has established institutions devoted to the minor crops, and has developed promotional and incentive schemes to imiprove production and quality. The area under minor export crops 1/ is currently estimated at 50,000 hectares and Government policy is to increase this to 80,000 hectares by 1990. 2.21 World Market Prospects. A recent Bank analysis 2/ of market prospects and rate of returns for the minor export crops recommended that Sri Lanka should promote increased production of coffee, pepper, cardamom, and cloves in the mid-country. This analysis confirmed views held in the country and reinforced Government policies. Recent developments in market prospects for coffee have resulted in the establishment of an International Coffee Agreement which defined export quotas for most producers including Sri Lanka. In recognition of this Agreement the Bank will not finance projects which would lead to coffee production in excess of established exports limits. The proposed project therefore is confined to assisting increased production of pepper, cardamom and cloves on areas presently under tea in the mid-country. Sri Lanka pepper is admired for its high quality and commands a premium price on world markets. The share of the market is small (0.6%) so that even large proportional expansion in pepper exports would have no repercussions on market prices. Cardamom is a high-value spice and the quality of Sri Lanka's export is considered good; it could, however, be easily improved further by expanding better processing facilities. With annual exports of about 175 mt, the market share is small (about 3%). Sri Lanka's small share of the world's clove 1/ Including cocoa, coffee, cardamom, pepper, cloves, nutmeg, mace, ginger, citronella and papain. 2/ Sri Lanka: Minor Export Crops - Sector Review, August 1981.  - 11 - production is of high quality and occupies a salective position in the market. Therefore, although the general market outlook for cloves is soimewhat uncertain, Sri Lanka's position within the market appears secure. 2.22 Domestic Marketing Channels. The existing domestic marketing system for minor export crops is adequate. The produce from small farmers passes through several middlemen who then auction it away to exporters. Larger producers such as JEDB and SPC go directly to brokers for auctioning their produce to exporters. There are a considerable number of exporters, both large and small, which ensures adequate competition. These exporters are generally well informed about daily fluctuations in world markets, and have adequate communication with potential markets. 2.23 Institutions. The Department of Minor Export Crops (DMEC) within the Ministry of Agricultural Development and P.esearch has prime responsibility for the promotion of minor export crops. It is stationed in Kandy and advises on all aspects of minor crop production through its extension division, pro- vides planting material from its nurseries, and administers replanting and new planting subsidy schemes. A Minor Export Crops Research Station was established in Matale in 1972. This is maintained by DME( and supported by a UNDP/FAO program which has provided two minor crop research specialists since 1978. The research program is in its early stages but is directed towards varietal selection for disease and pest resistance, uncdercropping of coconuts with minor crops and maximizing land production through mixed crop models suitable for small holders and plantations. Work has begun on a substation at Delpitiya in Kandy district, which was established to support the IDA-assisted Tree Crops Diversification (Tea) Project (Cr. 819-CE). Impressive crop growth and early yields are in evidence on trials establiLshed in 1979 on old tea land typical of the proposed project area. Extension of new technology to small holders is weak because of staff shortages and lack of extension transport to ensure good coverage of the widely dispersed :smallholdings. Responsibility for export promotion of minor crops is held by the Export Development Board, established in 1979 as the executive arm of the Export Development Council of Ministries. The Board offers incentives to producers to gear production to export demand through attention to type and quality standards. It also operates special export credit schemes and export expansion grants. Recently the Board has promoted the establishment of producer associations and is attempting the improve export crop processing and marketing facilities. IDA Involvement in the Tree Crops Sector 2.24 IDA credits are supporting five projects in Sri Lanka's tree crops sector. A Tree Crop Rehabilitation (Tea) I Project (CR. 818-CE) is promoting rehabilitation of high country tea areas whilst a Tree Crops Diversification (Tea) I Project (Cr. 819-CE) supports the replacement of unprofitable mid- country tea with a diversity of crops including pepper, cardamom, cloves, fuelwood and a range of local fruit trees. Two further projects, Kurunegala Rural Development Project (Cr. 891-CE) and the Second Rural Development Project (Cr. 1079-CE) in the Matale and Puttalam areas involve extension to smallholders for minor crop production as part of rural infrastructure devel- opment. The fifth project, Smallholder Rubber Rehabilitation (Cr. 1017-CE)  - 12 - supports a rubber rehabilitation program in the low country. Management of all these projects is good and physical achievements on field programs are close to target. However, Government budgetary restrictions have seriously constrained the flow of funds to the rural development projects and the diversification project and all have suffered as a result. In contrast, the tea rehabilitation project, which is funded directly by JEDB, SPC and Bank of Ceylon (BOC) has had less problems in this respect. All projects have suffered from high local cost inflation, and limited construction industry capacity has necessitated modification of the civil works programs. Proce- dural problems have slowed disbursement of credit to smallholders but pro- cedures are being modified to accelerate disbursement. Compliance with the loan conditions is generally good. The following relevant lessons learned from previous projects have been incorporated into the proposed project: a. Housing: Even though larger and better ventilated houses were provided for tea workers in the high country, the workers complained that precisely these features made their homes very cold and they preferred their old homes with some minor improvements. They expressed most interest in improvements to water supply, roof and ventilation only for kitchen. Therefore these aspects are stressed in the current project. b. Training: The training programs have been narrowly focussed on teaching new technology to junior staff and extension workers, and motivating estate superintendents through overseas visits to other tea producing countries. Both programs have worked well and the overseas tours have stimulated new ideas. The proposed project would add to current procedures by introducing a graduated staff development program to include management and financial procedures as well as technical training. c. Smallholder credit moved slowly because the commercial banks did not wish to deal directly with very small borrowers. The proposed project will use TSHDA as an intermediary. TSHDA will guarantee credit to smallholders. d. Factory power source: In view of oil price increase and general shortage of power in Sri Lanka, the proposed project places more reliance on wood-fired furnaces, micro-hydro units and fuelwood plantations. e. Accounts: Delays in preparing accounts were experienced. Partly as a result, technical assistance for financial management has been provided.  - 13 - III. PROJECT AREA General 3.01 The project area (Map 15659R) consists of three geographically distinct tea growing regions, one in the Nuwara Eliya administrative district of the high country (Map 15660R), the second in the Kandy, Nawalapitiya and Matale districts of the mid-country (Map 15910), and the third in the Galle and Matara districts of the low country (Map 15661R). These regions differ in elevation, climate, topography, pest and disease incidence, tea manufac- turing process and social factors, all of which affect agricultural potential, tea management practices and production. The high and low country areas were selected for rehabilitation because of their high potential for tea produc- tion; the Nuwara Eliya district produces good yields of high quality, good flavor teas, while Galle and Matara districts produce heavy yields of strong black teas now in great demand in world markets. Teas from both areas fetch some of the highest prices in Sri Lanka. The mid-country areas were selected for diversification because they produce poorer low-priced teas with lower yields and are agriculturally better suited to the production of a range of minor export crops. 3.02 The high country project area, located about 120 km east of Colombo, consists of two adjacent plantation groups managed by JEDB. The first, JEDB Board I (JEDB I), in the Hatton district, consists of 12 estates totalling 4,200 ha; the second, JEDB Board II (JEDB II) in the Agrapatana Valley and Lindula sub-district, consists of 22 estates t:otalling 7,640 ha. Virtually all tea in the area is grown on estates; indivridual smallholdings make little contribution to total production. The low country project area, located in the southernmost tea area in Sri Lanka, consists of 40 estates managed by SPC Board IV (SPC IV) with a total tea area of about 6,000 ha and a pilot area of about 2,500 ha of smallholder tea. The mid-country project area covers three estate groups; to the north SPC Board I (SPC I) manages 41 estates in Matale with a total tea area of 10,700 ha, in the central portion JEDB Board II (JEDB II) manages 19 estates in Kandy with an area of 5700 ha, and in the southern portion JEDB Board IV (JEDB IV) managnes 14 estates in Nawalapitiya district with a total tea area of 8538 ha. Thle mid-country diversification program therefore involves 75 estates with a total area of over 19,000 hectares. Elevation, Topography and Soils 3.03 The high country estates are located at elevations ranging from 1,200 m to 2,000 m in undulating to deeply dissected terrain where many slopes exceed 70%. Soil erosion on the upper slopes has exposed bare rock which is widely scattered throughout the area. Soils are mostly uniform red-yellow podsols and wet mountains regosols (recently classified as ultisols and oxisols) which vary greatly in depth depending upon their position in the catena. They are all acid to very acid with pH around 5. Neither soils nor topography are well suited to land uses other than tea, forestry or pasture. 3.04 The mid-country estates are located at elevations ranging between 600 m and 1200 m on terrain similar to that of the high country. Most of  - 14 - the tea is planted on slopes which vary from 20% to 70%. Soil depth varies greatly depending on the degree of erosion, and rocky outcrops occur in many areas. The soils are mostly red yellow podsols and redish brown latosols which are free draining, highly leached, of low base exchange capacity and with pH between 5 and 6. Topsoils are sandy loams whilst the subsoil contains a higher clay content. The soils are inherently stable, nevertheless expo- sure to wind and rain has gradually caused serious erosion in many areas. The soils are suitable for a wide range of crops provided erosion control measures are taken and fertilizer and organic matter applied to ensure good early crop growth. In most areas slopes are too steep for the cultivation of annual crops but many indigenous perennial crops thrive in the humid conditions, moderate temperatures and elevations of the mid country. 3.05 Low country estates are situated below about 600 m with most between 60 m and 150 m. The land is mostly gently undulating with rolling hills, slowly moving streams and paddy fields in valley bottoms. To the north east of the area the land rises steeply to over 600 m where topography and tea estates resemble the mid country. Soils are generally deep and free draining but exposed rock is abundant on hill crests. The soils are mostly red-yellow podsols, of pH about 5, and are ideal for tea; though other crops can also be grown. Climate 3.06 Mean annual temperatures throughout the project area depend upon altitude, and range from 21 C in the high country to 27 C in the low coun- try. Diurnal temperature variation is about 4 - 8 C. Low temperatures are not limiting and frost, where it occurs on high land, is not severe enough to damage the tea bushes. The project areas are served by the south-west monsoon rains from May to August (Yala season) and the high country also receives the north-east monsoon rains from September to December (Maha season). Rainfall is less from January to April but prolonged droughts during this period are uncommon. Total rainfall and seasonal distribution vary consider- ably over short distances depending upon altitude and aspect. Annual totals range from under 2000 mm in the mid-country through about 3000 mm in the low country up to about 5500 mm in the high country. Local storms, driven by high winds can be severe and cause erosion and damage to exposed crops. Climate and soils are very suitable for tea production and in the mid-country for the production of diversification crops proposed under the project. Socio-Economic Conditions 3.07 The economy of the high country is almost entirely dependent upon tea. The population is made up largely of Tamils of Indian origin, who live and work on the tea estates. There are a few traditional villages sandwiched between the estates but the only substantial urban settlement in the area is Hatton. The Tamil population is gradually declining because of the Government's repatriation program and Sinhalese from the mid country are being encouraged to move to the area. Estate facilities for workers are, however, poor and immigration is slow. This results in labor shortage at peak demand periods on some estates. In the low country the economy is not  - 15 - dominated by tea; rubber, coconuts, paddy and a variety of traditional food crops are also grown. Numerous small villages are located close to all estates and village labor supplements estate labor when required, but resident labor still provides most of the estate work force. The mid-country presents a transition between these extremes; remote areas resemble the high country but clusters of villages and some large urban areas around Kandy and Matale also exist. With the gradual deterioration of mid-country tea estates labor demand is reduced and many Tamils have moved to labor-short estates in the high country; a migration actively encouraged by SPC, JEDB and other Govern- ment agencies. 3.08 The estates have traditionally provided the basic needs of their labor force, including barrack-style housing for resident labor and simple medical facilities for all labor. Housing areas are congested and most houses are old and in poor repair despite the obvious attempts of the occupants to keep them clean and tidy. Poor housing, particularly in the cold and wet climate of the high country estates, is a major factor in the sub standard health of estate labor. Over 700 new twin cottages have been built by Gov- ernment in the project area to house about 6,ODO people. However, rapid cost escalation and limited capacity in the construction industry have constrained the Government housing program and necessitated a revision of estate housing strategy from new construction to renovation of existing line units. Medical facilities on most estates are below national standards, and infant mortality is about 50% above the national average. IDA's first Tea Rehabilitation project has addressed these problems and UNICEF is assisting in reducing the mortality rate. Communications 3.09 A good network of public all-weather roads serves most of the project area. This is supplemented by an extEnsive network of gravelled roads on every estate. Villages are well supplied with public transport and Hatton, Nuwara Eliya, Kandy, Matale, Galle and Matara are served by rail. Telephone links throughout the estate network are reasonably reliable and regional offices maintain good inter-communication links. Fuelwood Availability 3.10 The low-country project area contains rubber plantations which produce fuelwood at replanting. SPC IV has about 6,200 ha of rubber trees of which about 200 ha are uprooted every year. In the mid-country, estates obtain fuelwood for factories, and to supply 'Labor, from rubber estates to the north and west and from local jungle clea:rings. Fuelwood planting was seldom undertaken on mid and high country estates in the past but with the ever increasing scarcity of fuelwood, particuLarly in the high country, a program of planting Eucalyptus is being vigorously pursued. Fuelwood is transported from low and mid-country to high country estates but transport- ation costs are high. Where fuelwood is abundant prices are about Rs 50 per stacked yard but in the high country prices around Rs 118 per yard are common.  - 16 - Tea Area 3.11 Project tea area is about 35,000 ha of which 27% is in the high country, 55 percent in the mid-country and 18 percent in the low country (Table 3.1). Tea bushes in low country have higher mortality rate due to termite attack and disease problems, hence average bush life is about 20-25 years compared with at least 50 years in the high country. This has, how- ever, resulted in the low country being forced to replant more frequently and clonal tea constitutes a greater proportion of the tea area. Table 3.1 - Project Tea Area in Hectares Seedling Mature VP Immature VP Total High Country JEDB I 1,988 (65%) 676 (22%) 397 (13%) 3,061 JEDB II 5,177 (82%) 1,003 (16%) 132 (2%) 6,312 Total 7,165 (76%) 1,679 (18%) 529 (6%) 9,373 Mid Country JEDB II 4,344 (77%) 1,215 (21%) 109 ( 2%) 5,668 JEDB IV 2,019 (735) 700 (25%) 35 ( 2%) 2,754 SPC I 9,096 (85%) 1,305 (12%) 301 ( 3%) 10,702 Total 15,459 3,220 445 19,124 Low Country SPC IV 3,048 (49%) 2,156 (35%) 980 (16%) 6,184 Smallholders /a 1,221 (50%) 1,068 (44%) 137 (6%) 2,426 Total 4,269 (50%) 3,224 (37%) 1,117 (13%) 8,610 /a Pilot project in 3 electorates, Hakmana, Akuressa and Weligama. 3.12 The condition of the old seedling tea is mostly poor. During the last decade, uncertainty of tenure and low profitability reduced investment in tea maintenance. The continual replenishment of field stocks through replanting and infilling programs, an integral part of good tea management, was depressed and most fields have a high proportion of vacancies (Table 3.2). This gradual attrition of seedling tea bushes is proceeding more rapidly in the low country where termite attack is prevalent.  - 17 - Table 3.2 - Tea Area Bush Vacancy in Rehabilitation Areas (Percent) Proposed Proposed Board Replant Area Infil Area Average JEDB I 40 16 18 JEDB II 25 9 13 SPC IV 40 12 18 In mid-country estates vacancies vary greatly between estates and between fields depending upon the maintenance program which itself depends upon previous yields. On poor estates many fields have been virtually abandoned and vacancies can be over 80%. Yields, Production and Prices 3.13 Existing tea yields in the high country and low country project estates are above the national average of about 1000 kg/ha (Table 3.3). Table 3.3 - Tea Yields and Production-1980 Yield Production (kg/ha) (M kg) High-Country JEDB I (Hatton) 1,160 3.1 JEDB II (Nuwara Eliya) 1,360 8.4 Mid-Country JEDB II (Kandy) 1,006 5.6 JEDB IV (Nawalapitiya) 581 1.6 SPC I (Matale ) 685 7.1 Low-Country SPC IV (Galle/Matara) 1,250 6.5 Smallholders (Galle/Matara) 1,390 3.2 Total Project Area 1,013 35.5 Poor weeding techniques and inadequate soil conservation result in exposure of tea bush roots to sunlight which slowly kills the plant. Many OST bushes now contribute little to production and yielcls are in decline. Average tea yields on mid-country estates are poor but show a wide variation between estates. Tea quality throughout the mid country, whether from OST or VP teas, is poor. Net sales prices in 1980 averaged ERs 18.5 in high country, Rs 19.5 iin low country but only Rs 14.5 in mid-country. However, net sales averages from project high country and low country esl:ates ranged between Rs 19 and Rs 22 per kg, illustrating that tea quality on project estates in these areas was good.  - 18 - 3.14 Data on yields and production of minor crops are scarce. Pepper yields range between 0.8 kg per vine and 2 kg per vine in the third year. Clove trees of mixed age between 8 and 12 years at Hunasgiria currently yield about 0.7 kg per tree but DMEC estimates that with good management yields of at least 2.5 kg per tree could readily be attained and that mature trees have a yield potential of about 10 kg per tree. Mature cardamom plantations on mid- country estates presently give low yields of 10-50 kg/ha of dried capsules. However, most of these cardamom plantations are over 30 years old, have never received fertilizer and are poorly maintained. Young cardamom in the mid- country should produce about 300 kg per ha of dried capsules. Extension 3.16 Recommendations on all aspects of tea production are passed directly to tea estate superintendents through TRI seminars held at Talawakelle and by publications. TSHDA is responsible for smallholder extension but has been constrained by lack of funds, staff and transport. TSHDA operates 6 fertilizer distribution centers and 46 leaf collecting societies in Galle and Matara. Twenty-two Extension Officers are responsible for over 33,000 smallholdings spread throughout Galle and Matara but are mainly involved in administering rehabilitation subsidies. TRI organizes field days for farmers and refresher courses for TSHDA officials but most smallholders have little or no contact with extension and have learned their tea growing techniques from working as laborers on estates. Extension on minor export crops is conducted by the extension division of DMEC but because of lack of staff and transport the service to smallholders is weak. Those estates superintendents who grow minor export crops deal directly with the FAO/UNDP research specialists at the Matale research station and rapidly adapt research findings to the needs of their own estates. Tea Factories 3.17 All 32 factories in the high-country project area manufacture tea by the orthodox process. Some factories supplement the process with one cut through rotorvanes. In the low country, 52 factories (30 SPC and 22 private) also manufacture tea by the orthodox process but do not use rotorvanes. Most factory machinery is well over 20 years old and has become inefficient, so that tea quality has suffered and operating costs have increased. Leaf with- ering takes place on tats (hessian or nylon racks) which adversely affects tea quality through poor control over the withering process. Fermentation is conducted on cement floors or on multi-tier cement tables, often cracked and dirty causing poor aeration, bacterial contamination and loss of quality. In the high country, 50% of the factories use imported fuel oil for their driers. Operating cost for these driers is high (Rs 1.42 per kg) compared with solid fuel driers (Rs 0.55 per kg). Most drying rooms were constructed to allow discharged hot air to be used for withering tea. This produces poor working conditions which would be improved by hot air ducting. Factory sorting machinery is old and inefficient and tends to break tea into small grains (powder) which reduces the proportion of top tea grades. In the mid-country, as production has decreased, so many factories have become non-viable and processing has been discontinued. Equipment from these silent factories  - 19 - and in some cases the building itself, has been transported to other more productive areas within SPC or JEDB. Some factories are being used as stores and others for drying and processing minor crops. 3.18 Power Supply for Tea Factories. Most tea factories are on the Government grid system. Uncoordinated power interruptions adversely affected factory operations and tea quality but unavoidable load shedding operations are now being announced in advance and coordinated so that factory operations can be scheduled accordingly. IV. THE PROJECT Objectives and Brief Description 4.01 The main objective of the proposed project is to reduce tea pro- duction costs whilst improving tea quality. This would be achieved by increasing productivity of existing tea lands in high potential areas of the low country and high country, by rehabilitatiag factories and improving leaf transport and by diversifying out of tea into minor export crops and fuelwood in unprofitable low-yielding tea lands in the mid-country. In addition, the project aims to strengthen management and financial control of the major tea producing corporations, to stabilize tea prodacing lands through soil conser- vation and to improve the welfare of estate workers. 4.02 The main components of the proposed project are: a. field program: continuing replanting and expanding in- filling programs in high country and low country areas; renovation of soil conservation works; diversifying non- viable tea and abandoned tea areas into minor export crops and fuelwood plantations. Quantities are (ha): Table 4.1: Field Program (ha) JEDBI JEDBII JEDBIV SPCI SPCIV Other Total Replanting tea 120 152 - - 1,390 100 1,762 Infilling tea 854 1,242 - - 1,800 - 3,896 Soil Conservation 975 1,950 - - 2,420 - 5,345 Spices and fuelwood 424 1,587 2,565 3,633 - - 8,209 Total 2,373 4,931 2,565 3,633 5,610 100 19,212 b. processing and storage facilities: expanding and rehabili- tating 84 factories (JEDB I 12; JEDB II 20; SPC IV 30; private 22), and providing 18 cardamom drying barns;  - 20 - c. providing field and nursery equipment; d. providing additional vehicles for green leaf transport; e. constructing new labor housing, rehabilitating line houses and improving water supplies for estate labor. Numbers are: Table 4.2: Housing Program JEDB I JEDB II SPC IV Total New houses 90 150 150 390 Rehabilitation 909 2,235 600 3,744 f. improving project area medical facilities; g. providing local and overseas training and improving local training facilities; h. providing technical assistance for the housing, medical, and factory components and for improving financial manage- ment and performance incentives; i. providing extension support for smallholders in a pilot area; j. providing staff, equipment and vehicles to improve administration, and k. providing funds for project preparation. Detailed Features Field Program 4.03 Tea-Replanting. The project would assist with the replanting of 272 ha of tea in the high country and 1,490 ha in the low country. Replant- ing costs in high country areas are far greater than those in the low country (Rs 77,000 to Rs 90,000 compared with Rs 49,000) because of the associated need for intensive soil conservation works and control of the root disease (Poria hypolateritia) in high country areas. The high costs, combined with the slow return to full tea production, make replanting high country areas justified only on land with high potential. Replanting would be restricted to those areas where infilling is not feasible because of high vacancies, extensive Poria problems or the presence of a high proportion of non- productive tea bushes, and decisions to replant would be based on historical yields, soil analysis and topography. Replanting in the low country is more readily economically viable. Replanting would follow soil fumigation treatment  - 21 - for root disease where necessary and about 18 months of land rehabilitation under Guatamala grass (Tripsacum laxum). Replanting techniques are good. Replanting would replace the smaller-leafed old seedling tea with clonal material which would be planted on the contour at a spacing of 120 cm x 60 cm, which is at least 50% above the old seedling tea density. An extensive range of clones is approved for project areas; most commonly used are the 2,020 series developed by TRI (notably 2,025 and 2,023) but individual estate selections are also used (DTI, N and K 145). Quality clones, tolerant of nematodes and Blister Blight are available for the high country, and heavy yielding, drought tolerant clones (2,026 and 2,045) are recommended for elevations below 600 m. A promising new generaLtion of clones in the 3,000 series is being released by TRI. The replanting program would cost about Rs 45 M (US$2.1 M). 4.04 Tea Infilling. The vacancies in high country and low country tea fields, which reduce yields, encourage weed growth, and increase erosion would gradually be filled, firstly by infillinlg larger vacant patches and later by infilling small spaces as a part of routine field maintenance. Average vacancies for areas to be infilled are about 16% in JEDB I, 9% in JEDB II and 12% in SPC IV areas. The infillinl programs of the high and low country would be 2,096 ha and 1,800 ha, respectively. Infilling would be carried out in the year of pruning to minimize interplant competition. Patch infilling would be on the contour at plant spacing of 120 cm x 60 cm and soil fumigation for Poria control would be conducted where necessary. Infilled areas would be managed in the same way as the 3urrounding tea and plucking and husbandry differences would be minimized by using clones such as DN, CY9 and N2 recommended by TRI for infilling. Sufficient planting material for the replanting and infilling programs would be available from the estate nurseries. The infilling program would cost about Rs 19 M (US$0.9 M). 4.05 Diversification. The establishment of pepper, cardamom, cloves and fuelwood to replace non-viable mid-country tea would be phased over the four year period 1982-84. In addition, on abandoned tea lands and land prone to erosion Leucaena leucocephala (Ipil Ipil) and Eucalyptus grandis (above 700 m) would be planted to supply fuelwood for factories, to provide shelter belts and to aid soil conservation. Total areas are (ha): Table 4.3: Diversification Program (ha) JEDB II JEDB IV SPC I Total Pepper 234 309 528 1,071 Cardamom 224 321 560 1,105 Cloves - 10 180 350 Fuelwood 568 673 1,240 2,481 Total diversified 1,026 1,473 2,508 5,007 Fuelwood on abandoned tea areas 368 1,092 1,125 2,585  - 22 - Land selection for diversification would follow the results of a survey undertaken by FA0/UNDP in 1978 on SPC I estates and of a field-by-field survey by the JEDB Diversification Manager for JEDB II estates in the Kandy area. These surveys formed the basis for preparation documents. The area to be diversified is 26% of the total tea area on the 74 mid country estates, a figure which coincides with the area of Class C fields (the lowest yielding third). SPC Class C fields in Matale yield 400-500 kg/ha of made tea and JEDB Class C fields yield 600-700 kg/ha. Diversification crops would be planted into existing tea which would continue to be plucked until the new crop is established (see para 4.06). Cloves are the most demanding of the diversification crops requiring shade during the early years and shelter from strong winds. Clove cultivation would be confined to the lower and warmer areas between 600 m and 800 m on sheltered sites of moderately sloping land. Pepper is less demanding than cloves, is shallow-rooted and could be grown over a wider range of conditions. It would be grown on strong support trees (Gliricidia or Erythrina) planted one year before the pepper vines, at eleva- tions from 600-1,000 m on moderate slopes of 20-50%. Cardamom would be grown in the higher areas above 1,000 m on steeper and wetter areas. The crop is adversely affected by excess light and wind and would be planted under shade trees established 3 years earlier. Leaf fall from the shade trees would build up surface mulch. Eucalyptus grows vigorously under the high rainfall conditions of the high country and mid-country and would be planted on old tea land too steep for cloves and pepper, and, at higher elevations, on soils which would not support cardamom. The cost of planting diversification crops and fuelwood would be about Rs 65 M (US$3.0 M). 4.06 Soil Conservation. With the general neglect of the tea estates during the past decade, soil conservation structures, stone terraces, grass bunds, stone-lined channels and drains have fallen into disrepair and gully erosion has occurred in many areas. The project would promote the renovation of terraces using local stone for walling on steep slopes and live terraces (grassbunding using Eragrostis curvula) on gentler slopes. Many drains are blocked, are incorrectly aligned and have been used as paths by plucking labor. Drains would be cleared and realigned (to about 1:120 gradient) to achieve good water control. In the high country, soil conservation works would be renovated on 2,900 ha (about 30% of the total cropped area). In the low country, terraces would be repaired on 2,420 ha (39%) and drains renovated on 3,600 ha (58%). In the mid country soil conservation would accompany the diversification program on 2,500 ha. A minimum number of tea bushes would be uprooted to make space for planting holes; the remaining tea bushes would provide ground cover until the new crop was fully established at which time the old remaining tea bushes would be cut back just below ground level to kill the bush but leave the roots and soil undisturbed. Further protection of new minor crop plantations would be provided by surrounding fuelwood belts in the mid country (para 4.05). The cost of the soil conser- vation program including fuelwood planting in rehabilitation areas would be about Rs 21 M (US$1.0 M). Processing and Storage 4.07 Tea Factory Rehabilitation. Factory rationalization proposed in the project would rearrange machinery and equipment to ensure efficient flow  - 23 - of leaf through the manufacturing process. Sonte 62 factories (12 JEDB I, 20 JEDB II and 30 SPC) would be expanded and rehabilitated to improve the quality of manufacture. Tats would be replacec by withering troughs which would increase withering capacity by 261,360 kg green leaf per day. Old driers with an annual capacity of 11.4 M kg made tea would be replaced with new driers. Additional drying capacity of 10.3 M kg would be provided to cater for increased production. (Total cost for driers would be Rs 29.7 M (US$1.4M)). The project would also convert oi]. fired driers to solid fuel (US$0.2M) to reduce firing cost (from Rs ].42 to Rs 0.55/kg) and to reduce the demand for oil imports. Initially fIuelwood would be transported from low and mid-country where it is more plent:iful. Later, fuelwood from on-estate plantations would supplement outside supplies and further reduce firing costs. To improve the throughput and quality of top grade teas, worn-out double-action rollers would be replaced by single-action rollers. Rotorvanes would be introduced in the rolling process in high-country fac- tories to increase capacity and enable grade composition to be changed in response to market conditions. In particular, it would be possible to increase the proportions of BOPF and Dust I grades required for the tea bag trade. Handling, sorting, and packing capacity would be improved. A provi- sion of Rs 3.0 M is made for structural alterat:ions and replacements of wornout roofing material. A provision of Rs 1.1 M is made to rehabili- tate small hydropower units in the high country. In addition to factory investments in JEDB and SPC, the project would replace worn-out machinery ancl equipment in 22 private factories out of 65 existing in the low country (Galle and Matara Districts) and at the same time increase the annual capacity of these factories from 10.8 M kg to 17.8 M kg of made tea. These private factories process their own leaf plus bought leaf from smallholders. The requirements of machinery and equipment are similar to those of corporations. The estimated cost for private factory rehabilitation is Rs 16.7 M (US$0.8 M). The total cost of factory rehabilitation prograim would be about Rs 159 M (US$7.6 M). 4.08 Minor Crop Processing and Storage. High quality green cardamom can only be obtained by artificial curing under controlled conditions; sun drying bleaches the capsules which lose value. The project would provide 18 curing barns to ensure that Sri Lanka.s reputation for good quality cardamom is maintained as production increases. Processing of pepper and cloves consists simply of sun-drying. Nevertheless cleanliness is important and the project would provide 30 concrete slabs for drying thes~e crops. Minor crops would be stored in excess space available in mid-counitry tea factories before on- ward transmission direct to Colombo auctions. (The cost of providing minor crop processing facilities would be about Rs 1.9 M (US$0.09 M).) 4.09 Field and Nursery Equipment. Most estates operate tea and fuelwood nurseries and all mid-country estates produce Epice plants; nursery standards are high and plant quality is good. To ensure that nursery field operations and the recommended program of pest and disease control would not be con- strained by lack of implements and machinery, cultivation tools and sprayers would be provided. To allow expansion of spice plant production, mid-country nurseries with an adequate water supply would be proivded with simple sprinkler II  - 24 - systems. To increase green leaf weighing stations to make plucking labor more efficient, 600 field weighing scales would be provided. Power and hand winches would be made available for uprooting operations. These items would cost an estimated Rs 13 M (US$0.6 M). 4.10 Green Leaf Transport. To improve plucking efficiency and to ensure that green leaf arrives at factories regularly and in good condition 105 tractors (45 HP) and 210 trailers would be provided to high country and low country estates. For longer hauls to the edges of larger estates 73, 3-ton trucks would be provided (larger capacity trucks are not practicable on estate side roads). The trucks would also be used for fertilizer, machinery and labor distribution. Trucks and trailers would be fitted with racks to separate leaf sacks and permit maximum ventilation during transport. Six 18,000 liter fuel bowsers would be provided to transport fuel from railheads to estates. (Estimated cost of providing transport for green leaf is Rs 33 M (US$1.6 M).) 4.11 Housing. About 250,000 people are housed on the project tea estates, mostly in barrack type lines. Most blocks are in poor condition with leaking roofs, blocked drains and inadequate water supplies. GOSL is aware of the extremely poor housing facilities provided for estate labor but is equally aware that for financial and logistic reason the problem cannot be rapidly solved. Therefore the project would improve housing conditions for 37,500 people (15%). The project would renovate 7,900 line rooms by providing re-roofing, drain construction and individual water supplies. These line rooms would be enlarged where feasible by making two units into one in a program phased with the construction of new twin cottages. The project would construct 390 twin cottages (63 sq. m floor area), each to house 2 families with separate kitchen, latrine and bathing facilities. Satisfactory designs have been produced under the IDA supported Tea Rehabili- tation I Project and these would be used for the proposed project. (The cost of the housing program is estimated at Rs 44 M (US$2.1 M).) 4.12 Medical Services. Estate labor productivity is greatly reduced by poor health (mostly respiratory disease, anaemia and parasite problems). Health of the estate population is much below national standards largely because of poor housing conditions which would be improved under the project (para 4.12). In addition medical facilities on individual estates would be improved by: renovating and upgrading 84 project dispensaries; providing 7 new dispensaries in SPC IV estates; providing 30 ambulances to carry labor to the nearest hospital; providing motorcycles for estate dispensary staff to visit the lines to treat bedridden patients, attend childbirth and provide maternity aftercare. The project would also provide a stock of basic drugs and supplies to dispensaries. The estimated cost of the medical component is Rs 11.6 M (US$0.6M). Technical assistance consultants would assist with the development of detailed specifications for the health component (para 4.15). 4.13 Staff Development and Training. The project would establish a staff development and training coordinating capability within NIPM to address the keenly felt need on the part of SPC and JEDB Boards and estate managers for improved skills in management and technical fields related to the  - 25 - industry. The NIPM, presently operating from temporary quarters in the Ministry of Plantation Industries, Colombo, would be relocated to renovated premises close to Kandy. It would engage two Sri Lankan training specialists and would retain the services of an internationally recruited Staff Develop- ment Consultant to assist with the establishment and initial operation of the program which would draw upon the expertise of resource persons from the TRI, Minor Crops Research Institute, Sri Lanka Industrial Development Association, the Ministry of Agricultural Development and Research and the University at Peradeniya in planning and presenting its training sessions. The staff development and training program would assist SPC, JEDB and the TSHDA to organize and conduct a regular series of in-country training activities for estate staff and would coordinate a limited number of carefully planned study tours for selected Board and estate management-level personnel. The project would also provide funds to enable TRI to purchase audio-visual equipment for its program of training for SPC and JEDB. The NIPM training specialists would assist SPC and JEDB to establish their own in-service training units and would introduce a systematic rather than an ad hoc program of training, flexible enough to react to changes in the industry and wide enough eventually to provide assistance to the plantation sector on a nationwide basis. The cost of the staff development and training program would be about Rs 16 M (US$0.8 M). 4.14 Technical Assistance. The two corporations, JEDB and SPC, are relatively new, and management and financial procedures are still being established. Precise data collection and records are maintained at all estates but data assimilation and analysis for management purposes is not undertaken. The project would provide 34 man nmonths of local expertise and 16 man months of international assistance to inmprove market promotion by the Tea Board and management procedures within the Corporations. The con- sultants would review incentive schemes and establish data retrieval and analysis procedures. The project housing program (para 4.12) is complex, involves the phased renovation of occupied old buildings and the efficient use of local materials in a new building program. Technical assistance to coordinate and supervise the housing and water supply programs and to design and supervise the building program would be provided by the project. Detailed proposals for the health component of the project have still to be worked out. The project would appoint local qualified medical consultants to review existing facilities and to integrate a project program with Ministry of Health and other welfare programs in project areas. "he distribution of private estates and factories between Corporations has resulted in an imbalance in the supply of green leaf to factories and factory capacity. The rearrangement of capacity and the rationalization of leaf supply would require assistance from a factory consultant. The project would provide eight man months for a factory rationalization study. The Technical Assistance program would involve a total of 87 man months of locally recruited consultants (Rs 10,000/mm) and 16 man months of internationally recruited consultants (Rs 200,000/mm). The total cost of technical assistance would be about Rs 4.6 M (US$0.22 M). 4.15 Tea Smallholder Assistance. Extensioa support for smallholders throughout the project area is weak (para 3.16). The project would mount a pilot smallholder support component in 3 eleztorates of the low country (Weligama, Hakmana and Akuressa) where 2,300 ha of tea are grown by 3,197  - 26 - registered smallholders. Clonal planting material would be provided on credit, recovery being made by TSHDA from the Government replanting subsidy. The project would recruit 21 additional extension officers to operate from villages in the low country. They would be administered by three Senior Extension Officers and one Regional Extension Officer based at the Galle office of TSHDA. Extension officers would be trained through the NIPM staff development and training program (para 4.14). The program would cost about Rs 1.5 M (US$0.07 M). 4.16 Administrative Support. The project would provide basic office equipment for all estate offices and for the Regional Board offices. A mini computer facility would be sited at Regional Offices in Hatton, Kandy and Galle for data summary and analysis. Much of the estate personnel transport is old and inefficient and junior field staff have little transportation for supervision of labor. The project would provide 31, 4-wheel drive vehicles for work in high country and mid-country estates and 146 motor cycles for use by junior assistants. To ensure efficient supervision throughout the scat- tered estates of the mid-country and low country a total of 50 small cars would be provided. A mini bus would be provided to ease transportation problems in the Galle office of SPC IV. Two 3-ton trucks would be provided for SPC I in Matale to facilitate collection of spice produce from estates to the central storage facility. As the Tea Smallholder Development Authority is weak and is currently being reorganized, the project would provide the additional extension and financial staff to enable TSHDA to fulfill its important smallholder support role. The TSHDA Head Office in Colombo would be strengthened with a financial manager and two accountants and the Regional Office in Galle would be strengthened with senior extension staff and ac- countants to supervise the district extension staff and the subsidy and credit programs. A 4-wheel drive vehicle, 3 motor cycles and 22 bicycles would be provided for project extension staff. The total base cost of administrative support for the Boards and TSHDA would be about Rs 17.6 M (US$0.84 M). Sup- port vehicles for the Diversification Program would cost a further Rs 6.7 M (US$0.3 M). 4.17 Project Preparation. SPC and JEDB are to establish a task force to undertake a field-by-field classification of estates which would enable a rationalized medium-term investment program to be drawn up for future project preparation. This project would provide Rs 1 M (US$0.05 M) to fund local travel and incidental expenses for the task force operations. V. PROJECT COSTS AND FINANCING A. Cost Estimates 5.01 The estimated total cost of the 4-year project, including contin- gencies, is Rs 695 M (US$33.1 M equivalent), of which about US$10.9 M (33%) would be foreign exchange. Taxes and duties would amount to approximately Rs 40 M (5.8%). Details of project costs, summarized below, are in Annex 2.  - 27 - Table 5.1 - Project Cost Summary Local Foreign TotaL Local Foreign Total F.E.