Peru - Sixth Agricultural Credit Project

Document of The World Bank tiIL - FOR OFFICIAL USE ONLY Report No. 4325-PE STAFF APPRAISAL REPORT PERU SIXTH AGRICULTURAL CREDIT PROJECT May 16, 1983 Projects Department Latin America and the Caribbean Regional Office 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 EQUIVALENT US$1 = Peruvian Soles S/. 750 S/. 1,000 = US$1.33 WEIGHT AND MEASURES 1 hectare (ha) = 10,000 m2 = 2.47 acres 1 kiloaram (kg) = 2.2046 pounds 1 metric ton (m ton) = 1,000 kg = 0.98 ABBREJIATIONS BEAP Agricultural and Livestock Development Bank BAP Peruvian AgricuLtural Bank DPES Department of P-Lanning and Economic Studies ICB International Competitive Bidding IDB Interamerican Development Bank INIPA National Institute of Agricultural Research and Promotion MA Ministry of Agriculture PPAR Project Performance Audit Report PPF Project Preparat:ion Facility STT Short-Term Commercial Interest Rate  FOR OFFICIAL USE ONLY PERU SIXTH AGRICULTURAI, CREDIT PROJECT TABLE OF CONTENTS Page No I. The Agricultural Sector .. , ......... *..... 1 General .... a.*.o* ............ The Resource Basea. ... .l ... . .0. ....... ..... ... * Rural Population, Employment, Income and Trade 2 Government Policies ... . . . . . . .. . .... 2 Previous Bank Participation......... 3 II. Agricultural Credit...................... 4 Genrl.............r....al0 .. ..... 4 BAP's Past Lending: Volume, Distribution and Sources of Fundus . . . . . . . . *. . . . . . . . . . .. . . . . . . . . 4 Interest Rate Structure...... ............. ......... 5 BAP's Lending Program for 1983-86....................... 7 BAP's Organization and Management............... 7 III. Performance Under Previous Agricultural Credit Projects 8 IV. The Project ..10 Introduction ........................... ..... 10 Project Objectives ............... .... ... .. . . . 10 Brief Descriptions. .......... .s..o. ...... ... ......... 10 Detailed Features Management.. 11 Cos t Estimates ..... . . . ...... ........... . 13 Financing ..................... I.....,....... 15 Procurement and Prgan*n ... ...... . .......... ... 17 Disbursements....................... 17 V. Organization, and Managemaent ............... 18 Maagm nta..................e........ 18 Planning and Programming.*........ .. . ... 18 Lending Terms ............ ...... ................19 Sublending Policies and Proceduroes.ur................... 19 Accounts and Auditingu.... ............. .. i.0.... ...... 21 Monitoring and Evaluation ....... .. .......... 21 This report is based on the findings of an appraisal mission which visited Peru in September 1982. The mission comprised of Messrs. E. Brook, G. Russell and M. Wilson of the Bank and Mr. H. Von Oppenfeld (Consultant). 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 - Table of Contents (continued) Page No VI. Project Benefits and Risks ................................ 22 Illustrative Investment Plans ....................... ....... 22 Project Benefits .... . . 24 Marketing and Storage . .................... 25 Project Risks .................. . .. . . e e * . . a e 25 VII. Summary of Agreeements Reached and Recommendation . . 26 ANNEXES 1. Technical Assistance and Training .. 52 2. BAP Technical Assistance Study - Draft Terms of Reference ....57 3. List of Studies and Working Papers Related to the Project ....................... 59 Supporting Tables Table 1: Credit According to Type and Regions 28 Table 2: Credit According to Type and Beneficiaries 29 Table 3: BAP's Lending in Current, Rea:L Terms and in US Dollars 30 Table 4: Loan Portfolio by Type and Ar r.ears....... 31 Table 5a: Projected Balance Sheets - December 31 ..... ..... 32 Table 5b: Movements in Capital and Reserves 33 Table 6: Projected Summary Profit and Loss Account .............. 34 Table 7: Projected Funds Available for Financing Lending Program 35 Table 8: Reconciliation of -roject Financing with Cash Resources 36 Table 9: Estimated Number of Beneficiaries and Locations Per-- taining to the Farm Models ........................... 37 Table 10: Models of Investment Per Farm .................... 38 Table 11: Total Tnvestment by Type of Farm ................ 39 Table 12: Investments in Each Model in Physical Quantitie- 'Jnits 40 Table 13: Investments Aggregated by Models in Physical Quantit:ies or Units .... ................ ,, ., 41 Table 14: Implementation Schedule - Completion Percentage by Year 42 Table 15: Project Cost ................................. . ..... 43 Table 16: Disbursement Schedule ............................... 44 Table 17: Producer Prices and Farm-gate Level .. 45 Table 18: Volume of Production ..I . ...................... 46 Table 19: Total Gross Value of Production . ................... 47 Table 20: Total Cost of Production ................................. 48 Table 21: Total Project Net Value of Production . . 49 Table 22: Incremental Net Value of Production ..................... 50 Table 23: Labor Mandays and Value Before Project and at Full Development ......... 51  PERU SIXTH AGRICULTURAL (REDIT PROJECT I. THE AGRICULTCURE SECTOR General 1.01 The performance of the agricultural sector in Peru in the 1970s was poor. At a time when the population was increasing at 2.8% per annum (4.1% in urban areas), the value of total agricultural production rose at only 0.7% per annum compared to 2.5% per annum between 1950 and 1970 and in real terms actually declined by 0.6% per annum in the decade of the 1970s. 1.02 The long decline in the value of Peru's per capita agricultural production, which was temporarily halted in the 1980/81 crop year, was caused mainly by the drought that had been affecting a large part of the country during the entire past decade, particularly from 1978 to 1980. However, there were additional reasons for the dismal performance of the agricultural sector, namely the agrarian reform and the manner of its implementation; the dismantling of the extension service; and the official marketing and pricing policies during the 1970s which acted as a disincentive to producers during a period of high running inflation. With the return of a constitutional Government in 1980, high priority has again been given to agricultural diversification and to increasing agricultural production, and policies designed to achieve these goals have already been put into effect. The Resource Base 1.03 Peru's agricultural resource base is limited compared to other Latin American countries. While the total area of the country is 128.5 million ha, only about 3.0 million ha are currently in agricultural use, about 1.2 million ha of which are under irrigation and 1.8 million ha are rainfed. Of the balance, about 22.0 million ha are under natural grass, and the rest is either suitable for forestry or unsuitable for cultivation because it is too dry, too poorly drained, or too steep for any form of food or fiber production. There are three well-defined topographic and climatic zones in Peru - the Costa, the Sierra and the Selva. 1.04 The Costa, which constitutes the Coastal zone in the west of the country, consists mainly of flat desert plains, sand dunes and the dry, heavily eroded Andean foothills. It is a narrow 3,000-km-long belt, covering about 13.1 million ha (10.2% of the total land area), where about 46% of the country's population lives. Coastal agriculture is limited to the river valleys where irrigation is possible; thease valleys produce over 40% of the country's gross value of crop production, including sugar, rice, cotton, maize, potatoes, citrus, olives and grapes. The region enjoys relatively close proximity to the urban markets, a good transportation network, and other infrastructure and is relatively prosperous. 1.05 The Sierra, which constitutes the Andean highland zone, covers over 33.4 million ha (26% of the total land area) and accounts for about 44% of the population. It consists of steep mountains, reaching over 5,000 m and  - 2 - high valleys located between the mountain ranges. Some 2.3 million ha in the Sierra are cropped and about 17.3 million ha are used for grazing, mostly under marginal conditions because of steep slopes and high altitudes. Severe topography, erratic rainfall and extreme changes in temperature make farming difficult and limited to a short season, leading to low agricultural productivity. While there is little scope for bringing new land into production, there is some potential for improving productivity through extension, research and use of production inputs. 1.06 The Selva, which constitutes the tropical forest zone east of the Andes mountains, covers about 82 million ha (63.8% of the total land area) and accounts for 10% of the total population. It comprises two subzones: the eastern slopes of the Andes at medium altitude - the Ceja de Selva; and the Amazon jungle - the Selva Baja (lower Selva). Although most soils in the lower Selva are classified as marginal and suitable only for grazing and forestry, soils in the Ceja de Selva are generally of better quality and are concentrated primarily in four river valleys. With the construction of the Trans-Andean Highway System and oil exploration, the Selva has been gaining in economic importance over the last decade, and the related migration of experienced, commercially motivated farmers from the Sierra to the Ceja de Selva in particular has provided considerable impetus to agricultural development. This dynamic development has led to the conclusion that the Ceja de Selva is likely to be an important new agricultural frontier with potential to help meet the rapidly rising food needs of the large urban population along the coast. Rural Population, Employment, Income and Trade 1.07 Between 1961 and 1981, the percentage share of rural population in Peru had declined from 53% to 33% while the share of urban popu:Lation increased from 47% to 67%. Unemployment in the rural sector is almost nil compared to about 10% among the urban labor force, but underemp:Loyment (as measured by income below the minimum wage rate), is about 61% compared to about 48% in the urban sector. As a resu:Lt, agricultural productivity is low, which explains the disproportionately low 12% contribution of the agriculture sector to the country's GDP. .fln As a result cf population increases, the massive migration of the rural population into the cities, and the slow development of agricultural production during the last decade, Peru's agricultural balance of trade has become significantly negative. At the beginning of the 1970s, the trade surplus was typically in the order of abouit US$100 million, but by 1981 there was a trade deficit of about US$230 million. Although this deficit could be decreased to some extent by the recently iincreased production of import- substituting crops and because prices of exportable commodities such as cotton, sugar and coffee, which have been unusually low recently, would probably rise in the near future, it will still require a massive effort to bring back a balance to the agricultural trade of Peru. Government Policies 1.09 The most significant change in Government policy at present as compared to that under the military Government during the 1970s is in the  relative emphasis on private versus public initiative and on incentives versus control measures. This has been especially translated into the ending of agrarian reform actions such as transfer of private farms into cooperatives, and the concomitant freeing of domestic and foreign marketing of farm products by allowing private marketing channels to develop, which were prohibited previously. Furthermore, the present Government decontrolled prices of most commodities, which, until 1980, were highly regulated and eliminated direct subsidies on most food products and inputs. The inte-rest of the new Government was promulgated in the Agricultural and Deve1 ;pm,-,. Law, issued on November 17, 1980. This law guaranteed among other things, the improvement of marketing and distribution channels; the restoratior of a free market for all products except under extreme circumstances which would justify otherwise; and the right of individuals to import and export agricultural products, raw materials and inputs. One of the most sign: ficant institutional changes made by the present civilian Government was the creation of the National Institute of Agricultural Research and Promotion (INIPA). This was done in order to recreate a public sector capability for agricultural research and extension, which, it was universally agreed, had for all practical purposes disappeared under the previous regime. Previous Bank Participation 1.10 The Bank has made 13 agricultural loans to Peru. Five of them, in the period of 1954-73, totaling US$55.0 million, were for agricultural credit and were channeled through the Peruvian Agricultural Bank (BAP) (105-PE, 162-PE, 257-PE, 415-PE and 933-PE). In general, BAP performance has been reasonably good (para 3.01). Disbursements on the last loan (933-PE) were completed in 1979. Two other loans 167-PE of 1952 and 98-PE of 1954), totaling US$3 million, were for farm machinery imports. Loans 114-PE of 1955 and 418-PE of 1965, totaling US$24.5 million, financed irrigation works and land settlement in the San Lorenzo area within the Chira-Piura basins. Owing to managerial problems, inadequate counterpart funding and shortage of water, the second of these loans encountered considerable difficulties and took 11 years to disburse, but it nevertheless achieved its basic goals and produced important benefits (Project Performance Audit Report, SECM-48 of January 1978 and Impact Evaluation Report of October 1981). A third irrigation project (Loan 1403-PE) of US$25 million approved in 1977 financed the rehabilitation of drainage and irrigation systems in six valleys in the southern part of the Coastal zone. Another irrigation rehabilitation project in the Lower Piura area in the northern part of the Coastal zone (Loan 1771-PE) of US$56 million was approved in 1980. Both have experienced early management problems but implementation is progressing satisfactorily although the latter is plagued by a shortage of counterpart funds. The recent loans approved by the Bank were for an integrated rural development project in the Sierra, Puno Rural Development (Loan 1812-PE) of US$15 mnillion; the National Agricultural Research and Extension Project (Loan 2150-PE) of US$40.6 million, which was signed on September 13, 1982; and the Alto Mayo Rural Development Project in the Ceja de Selva (Loan 1812-PE) of US$30.0 million, which is not yet effective. The Bank generally supports the Government's development policy and therefore the Bank's lending strategy is well aligned with the Government's sectoral objectives, which are: (a) rehabilitation of irrigated coastal areas where the potential for improved productivity is great; (b) beginning development of the potentially rich Ceja de Selva;  - 4 - (c) assisting the poorest of the rural poor, particularly in the Altiplano, through rural development projects; and (d) building up agricultural credit, research and extension programs to provide much needed improvements in agricultural support services. II. AGRICULTURAL CREDIT General 2.01 Agricultural credit in Peru has been in recent years practically confined to the Government owned Banco Agrario del Peru (BAP), which has been providing about 93% of the total institutional credit, while commercial banks' loan portfolios captures the remaining 7%, mostly in short-term lending for marketing. Other non-institutional sources, such as suppliers of equipment and inputs, and distributors of farm products, provide credit, but while the exact amount is unknown, this is not believed to account for a significant portion of the total credit. Prior to the 1970s, commercial banks were more active in agricultural credit, capturing about 35% of the total. The reasons for the decline in their share can be attributed mainly to: (a) the overall institutional changes that occurred in the agriculture sector during the 1970s, which affected traditional clients through agrarian reform and created an atmosphere of uncertainty and oriented marketing and lending primarily to the public entities; and (b) the lack of acceptable guarantees for commercial bank lendings, because of the agrarian reform law did not allow land to be mortgaged. Only farm production and imachinery could be used as security against loans, and BAP has a priority as a creditor in securing its loans with the harvest. BAP's Past Lending: Volume, Distribution and Sources of Funds 2.02 Only about 10% of the total number of about 1.8 mill:ion farm families in Peru receive institutional credit, a very low perc(entage compared with other Latin American countries, of whom about half are members of cooperatives. Some 65% of this credit has been lent in recent years to farmers in the Costa, 15% to the Sierra and 20% to the Selva. Approximately 50% of BAP's lendings in 1981 was extended to cooperatives and 50% to private farmers. In previous years the share of cooperatives was larger, but with the changes of Government policy in 1980 (para 1.09), the share of the private sector in agricultural lendings h1as been growing (Tables I and 2). 2.03 Analysis of BAP's credit indicates the following: (a) in current terms its lending increased by more than 11 times between 1976 and 1981; however, accounting for inflation, real 'Lending growth was about 3.4% per annum. Its total lending in 1981 was US'$643 million and its loan portfolio for December 31, 1981 was US$564 million,, 16% of which was overdue (Tables 3 and 4); (b) its lending has been almost exclusively concentrated on short-term credit which provided about 92% of its annual lendings (86% for crops and livestock production credit and 6% for marketing credit) during 1979-81. Crop production credit has been heavily concentrated on about five commodities: cotton, sugarcane, rice, potatoes and coffee; (c) about  - 5 - one-third of BAP's short-term lendings have been financed by the Peruvian Central Bank at preferential interest rates (currently 29% per annum compared to 44% to commercial banks); about one-third by additional equity contributed by the Government; and one-third by its own revolving equity. The need for continuous injections of Government funds to supplement BAP resources for lendings reflect the erosion of BAP's equity resulting from its strongly negative lending rates (para 2.04). Long-term loans have been financed almost exclusively from external funds and, to a small extent, from specially designated Government funds. Since early 1982, BAP has introduced a vigorous and successful campaign to attract savings at competitive market rates; this * accounted for about 20% of BAP's sources of funds in 1982. However, because the lending rates were substantially below the interest paid to savers, the ensuing results contributed to decapitalization of BAP. Interest Rate Structure 2.04 Until recently, it was the policy of the Government to charge low interest rates for agricultural loans. Up to April 1, 1983, BAP lent at nominal interest rates ranging between 32.5% and 49.5%, which until mid-1981 was the highest nominal lending rate allowed in Peru, and was subsequently increased to 57% for medium- and long-term loans and 49.5% for short-term loans. The Government was reimbursing BAP for the difference in interest rates for all loans which were below 49.5%. While the effective and the nominal rates were identical for short-term lending, the effective rates for medium- and long-term lending were actually lower, between 23% and 31%, due to the interest grace periods allowed. These rates compared with an inflation rate in the country of about 70% during 1982 and with commercial bank interest rates, effectively ranging between 65% and 80%. 2.05 Because of the burden this has represented to the Government budget in the face of increasing budget constraints, and after extensive discussions with the Bank, the Government decided in August 1982, to change its interest rate policy. The new policy became effective on April 1, 1983 and has the following main characteristics: (a) BAP's borrowers are charged commercial interest rates; (b) farmers who are borrowing less than S./ 20 million are entitled to subsidized lending rates, which have remained as they were before April 1, 1983 for short-term lendings but are substantially higher for medium- and long-term lendings; (c) BAP is charging interest during grace period; and (d) BAP is charging interest for part of the period in advance, in line with commercial bank practices. BAP's past and present interest rates are shown in the following table:  -6- Interest Charges by Peruvian Agricultural Bank (P,ercentage) System Prevailing Until April 1, 1983 Short-term Loans Medium- and Long-term Loans Purpose Nominal Effective Nominal Effective 1/ Selva 32.5 32.5 32.5 20 - 30 Food 46.5 46.5 46.5 36 - 42 Non-Food 49.5 49.5 49.5 36 - 42 Marketing 2/ 18.0 90.0 - - New Policy System, Effective Since April 1, 1983 Short-term Loans Medium- and Long-term Loans Purpose Nominal Effective Nominal Effective Loans up to S./ 20 million for food 3/ (except rice and maize for livestock) 46.5 46.5 50.5 60.9 Loans up to S./ 20 million for non-food 49.5 49.5 50.5 60.9 Loans up to 12 months larger than S./ 20 million 49.5 69.5 - Loans up to 24 months larger than S./ 20 million 54.5 79.7 - Loans larger than S./ 20 million for livestock, infra- structure and perennial 41 - - 54.5 66.7 Loans larger than S.! 20 million for machinery, equipment and others 5/ - - 57.0 70.4 Marketing 18.0 90.0 - - 1/ The lower rates compared to the nominal rates are due to not charging interest during grace periods. 2/ Lending for marketing is denominated and repaid in dollars. It applies mainly to lendings for coffee exports. 3/ The reason that the effective rate is higher than the nominal rate is because interest is charged in advance for part of the period. 4/ Include investments in fruit orchards, alfalfa, coffee, cocoa, purchasing of livestock, fences, installations,.forages, irrigation canals, irrigation equipment, pumps, roads, dikes, drainage and land leveling. 5/ Tractors, machinery, equipment, vehicles, wood, storage, refrigeration, mills, classifying equipment and other agroindustry.  - 7- BAP's Lending Program for 1983-86 2.06 BAP is experiencing strong demand for agricultural credit, more than it can satisfy for short-term lending and considerably more so for medium and long term. In order to determine the amount of additional funding needed to satisfy its requirements, BA]' has drawn up a lending program, approved by the Government, for the 1983-86 period in which it expects to increase, in 1982 constant prices, its short-term lending by 17.6% (4tA 7er annum) and in its medium-/long-term leniding by 93% (about 18% per an-uMn which, in the light of present demand, is considered realistic. According to a study commissioned by the Ministry of Agriculture (MA), the expected change of the interest rate structure is not likely to significantly affect the demand for agricultural credit because the incremental cost of financing would comprise only a small percentage of the cost of production. The thrust of the BAP program would be to augment food production in order to reduce the current high level of imports. In addiLtion, it would complement the Government's National Plan for Development to support rural and regional projects. BAP's investment plan would be coordinated each year with the Ministries of Agriculture and Finance and be approved by the Board of Directors. Projections show that, over the four-year period, some 60% of BAP's increased lending would have to be financed from external assistance, even if taxes on BAP's profits would be ploughed back into BAP as Government's contribution to meet its :Lending requirements. About a third of the external assistance required would come from other sources such as the Interamerican Development Bank (IDB) and others; the remainder would be covered by the proposed Bank loan (Tables 5 to 8). BAP's Organization and Management 2.07 BAP's Board of Directors comprises seven members, four of whom represent the Ministry of Finance, one being, by statute, the president, and three representing the Ministry of Agriculture. The Board is responsible for (a) setting BAP's economic and financial policies; (b) making organizational and procedural changes; (c) maintaining control of accounts and budgetary policy; and (d) approving medium- and 'Long-term loans over S/. 1,500 million (US$2.1 million) to cooperatives and ovier S/. 240 million (US$336,000) to individuals. Generally, BAP is a sound organization, although, as it has been entirely dependent on Government intervention for a long time, its management has been somewhat lax and not quick to take decisions. As a result, good control over cash management and the loan portfolio have been lacking. To remedy this situation the proposed project would include several components that would enhance the management control of BAP (paras 4.06 and 4.07). 2.08 BAP's General Manager is appointed by the Board and is in charge of day to day operations and administration. He has, under his direct super- vision, the sub-departments for accounting, administration, legal affairs, public relations, and inspection and auditing. He also supervises the directors of BAP's three main operational departments: (a) Credit, which is responsible for lending activities, monitoring and supervision of loans; (b) Finance, responsible for budgeting and administration of financial resources; and (c) Planning and Economic Studies, responsible for preparation of feasi- bility studies, training and programming of BAP's budget and activities.  - 8 - Altogether, there are 19 branches, 65 agencies and 25 inspectorates of BAP located throughout Peru. Of the total of about 3,400 employees, 2,800 are located in branches and other field offices, with about 600 professionals, mainly agronomists. 2.09 Internal auditing is done by the Inspection and Auditing Department, which refers directly to the President of the Board and carries out auditing of accounts and operations according to regulations established for all state banks by the state Controller General. The internal auditors are quite active and showed evidence of pursuing identified weaknesses and recommendations. BAP carries out annually an expost evaluation of about 15% of its sublendings from external resources. This economic evaLluation is carried out by staff from the Office of Planning and Economic Studies and does not involve the relevant field offices and technicians. Inspection of accounts financed from BAP's resources is undertaken yearly at headquarters and in a representative number of branch offices and agencies under its jurisdiction. III. PERFORMANCE UNDER PREVIOUS AGRICULTURAL CREDIT PROJECTS 3.01 The Bank has to date financed five credit projects, totaling US$55 million, to support lending for crop and livestock development. The benefits derived from the first four loans to BAEP are difficult to evaluate because of the changes induced by the land reform after 1968 and because the impact of the projects on production was not recorded. However, from sample data, BAP estimates that the gross value of increased production on farms receiving credit from the first three projects amounted to about US$44 million in 1963 (about US$170 million in 1982 dollars). Spot checks carried out by BAP in 1963 on about 10% of the loans made to representative categories of farmers in the different regions indicated a significant degree of success in the sense that the overall value of crop production increased by about 42% and livestock numbers increased by about 45%, which was compatible with or even better than the estimates at appraisal. 3.02 The Fifth Agricultural Credit Project with a Bank loan of US$25 million became effective in 1973 and its closing date was the end of 1978. The project commenced slowly because of competing funds, but after those were exhausted, about a year after effectiveness, the project gathered momentum. Total project cost at appraisal were estimated to be US$41.7 million but the final project cost was in fact about US$51 million equivalent, as BAP continued sublending even after full commitment of the Bank loan in 1978, in anticipation of a rapid repeater. This, however, did not materialize, so that BAP's share of project cost was actually 31% rather than the originally expected 20%. Also, the total number of subloans was 4,620 rather than the 2,500 anticipated at appraisal. 3.03 Before commencement of the Fifth Agricultural Credit Project subloan arrears were above 30%. The Bank loan agreement called for BAP to make plans to improve its loan recovery. Progress was slow but steady. By 1976 the arrears had fallen to 18.6% and by 1978 dropped further to 11.8%; however, this level remained unchanged through 1981. In view of the  - 9 -- difficulties which Peruvian agriculture encountered during the agrarian reform years, BAP's performance on collections can be regarded as quite remarkable. Further improvement of thLe collection rate would be possible, but at a relatively slow pace. 3.04 The main issues attributed to the Fifth Agricultural Credit Project, as defined by the Project Performance Audit Report (PPAR) were: (a) deficiency in the capacity of BAP to evaluate properly and promptly subloan applications, which resulted mainly from shortage of qualified staff; the proposed project, therefore, would include a component of training to remedy any shortage of technical staff envisaged (para 4.06), and specific outline of planning and programming of the lending program each year (para 5.03); (b) the absence of extension services to provide technical assistance to borrowers under the project; this situation has been remedied since, to a great extent, with the establishment of INIPA which carries out the extension program for the country and in which the Bank has been involved under a separate project loan (para 1.10); and (c) the substantial losses to BAP due to negative real interest rates that the Government of Peru insisted that BAP should charge. Even though interest rates had been raised during the course of the project, they were still maintained at about half the inflation rate level. Consequently, BAP's capital base had declined in real terms between December 31, 1973 and December 31, 1979, despite massive injections of funds by the Government. In addition to the above issues, the project completion report identified, among other things, a deficiency in the monitoring by BAP of project results. Sub-borrowers' performance, even on a sample basis, was not tracked and assessed. To remedy this situation in the proposed project, requirements for monitoring and evaluation of the project results would be spelled out from the outset in a manner satisfactory to the Bank (para 5.12). Despite the criticism leveled above of the project, its economic rate of return, estimated by the Bank audit mission, was about 30%, compared to about 26% estimated at appraisal. 3.05 The Fifth Agricultural Credit Project was implemented during a period in which the Government was preoccupied with land reform, and it did not deem it prudent to introduce policy changes in agricultural credit practices that could have ensured a self-sustaining operation by BAP. According to the PPAR, the Bank, in responding to the challenge to work with the "reformist" Government had largely to forego its attempt to impose sound credit policies. Nevertheless, eventually more realistic policies were adopted by the Government. The November 1980 agricultural promotion law, emphasizes the role of the private sector and relies more on incentives than on direct controls. Hence, the Government is now more amenable to proposed changes in the institutional structure of BAP, such as creating a rediscount facility in BAP to allow other banks to participate in agricultural lendings, as well as to the changes proposed under the new agricultural credit policy which eliminated most of the subsidies inherent in the previous interest rate structure (para 2.05).  - 10 - IV. THE PROJECT Introduction 4.01 The Government has requested Bank assistance for BAP to help finance, through an Agricultural Credit Project, its four-year lending program (1983 through 1986). The project preparation report was prepared by BAP in coordination with the Ministry of Agriculture, approved by the Ministry of Economy and Finance, and submitted to the Bank in April 1982. A list of studies and working papers related to the project is given in Annex 3. Project Objectives 4.02 The main policy objectives of the Government are to increase agricultural production, increase farmers' income, improve marketing channels, and strengthen agricultural institutions, including the credit system. Provision of agricultural credit, both for medium-/long-term and for short-term, is one of the most essential elements in this policy. The objectives of the proposed project, which are compatible with those of the Government, are basically threefold. First, it would help satisfy a strong demand for agricultural investment credit in the country, which BAP's own resources are in no position to fulfill, as well as for short-term working capital, in order to accelerate agricultural export growth, reduce dependence on imported foodstuffs and alleviate poverty and underemployment in the sector. Second, through elimination of most of BAP's subsidized lending, it would arrest the strong erosion of BAP's capital, progressively improve its position to finance lending requirements out of its own resources and expand its presently very limited credit coverage of the farming population. Elimination of subsidized interest rates except for small and underprivileged farmers (para 5.04) would also enable private banks to participate to a greater extent in agricultural sector letnding. To achieve this, the proposed project would provide funds to design a rediscounting facility in BAP, which would further expand credit coverage. T'hird, the project would help reinforce BAP as a more efficient lending institution by improving its management control through setting up a new information system and providing training for its technical staff. Brief Description 4.03 The proposed project would be BAP's lending program for agricultural activities over a four-year period (1983-86). Investment loans to individual farmers, farmer groups and cooperatives, comprising about 50% of tne lending program, would be based on sound development plans for a wide array of activities related to crop and livestock production and agroindustries. Investments for institutional improvement of BAP and studies would comprise about 2% of the project cost. Incremental short-term loans, comprising the remaining 48% of the lending program, would be made to cover the additional working capital requirements of borrowers having made investments in their enterprises and to fe-rmers and farmer groups borrowing for short-term production requirements f-or the first time. Type and size of  - 11 - medium- and long-term as well as short-term loans Auld vary considerably given the wide range of borrowers and variations in regional conditions. Detailed Features 4.04 Medium- and Long-Term Financing. Components of the project under this category would comprise about US$120 million, including contingencies. In line with the present structure of BAP's lending portfolio, it is expected that about two-thirds of the total value of loans under the project wcvld benefit irrigation farmers in the Costa. The remainder would benefit rainfed crop and livestock farming in the Sierra and Selva. The most important improvements expected in the Costa would include: (a) improvements in the on-farm irrigation infrastructure: canal and drainage construction, canal. lining, irrigation control structures and land levelling; (b) changes of cultural practices of cropping: higher crop intensities, improved yields and establishment of perennial crops such as bananas and fruit orchards; and (c) expansion of mixed crop/livestock farming by the introduction of alfalfa under irrigation and expansion of the dairy herd. In the Sierra, livestock production would be expanded by: (a) the expansion of improved pastures (mainly by rye-grass seeding) as well as forage crops (such as oats); (b) the purchase of cattle (bulls and heifers) and sheep (rams and ewes); (c) the purchase of machinery and equipment, and the construction of fences and livestock building facilities; and (d) an expansion of the area under subsistence food production: potatoes and quinua. In the Selva, major improvements would include: (a) an expansion of the rice cultivated area and improvements in rice yields; and (b) an increase of livestock production by improving pastures (brachiaria) and purchase of cattle and equipment. The investment component in BAP's lending program is estimated on the basis of 10 illustrative farm models representing typical farming enterprises in Peru that are expected to participate in borrowing under the project. Accordingly, four models represent farmi'ng activities in the northern Costa region, two in the central Costa region, one in the south central Costa and Sierra regions (Tacna and Arequipa), one in the Sierra, one in the northern and central Selva regions, and one in the Costa and Selva regions (Tables 9 to 13). 4.05 Short-Term Financing. This component would comprise about US$114 million and cover the financing needs for increased production that would be generated from the project and from esti'mated expansion of production in the agriculture sector by and large (para 2.06). In 1981 BAP's short-term loan portfolio was about S/. 188 billion (about US$445 million) compared to projected needs of about S/. 462 billion in 1986 (about US$616 million). Due to mounting fiscal pressures, the Government would be unable to provide BAP with all the additional financial resources necessary to carry out the short-term lending program. If not provided by external sources such as the Bank, this would cause a stagnation of agricultural production or would force BAP to borrow in external commercial markets at extremely unfavorable terms. 4.06 Training and Consultant Servic:es. The cost of this component would be about US$1 million. BAP presently hats an impressive contingent of technical agricultural staff, but is short of financial analysts and economists who can properly evaluate subloan applications. Out of about 650 technical staff, only 47 are accountants and six are economists.  - 12 - On the basis of the experience&ained from the previous Bank project (para 3.04) and in order to successfkly carry out the proposed project, more staff would need to be trained. BAP has already started a training program, carried out by the Department of Planning and Economic Studies (DPES), but it is short of funds and qualified training personnel. This prompted BAP to request funding for a technical assistance program, including consultant services, through the project. BAP has already prepared a detailed training program for 1983 and outlines for a prograin over the following three years, including designation of resource persons, participants, location, budgets, and a program for about 30 man-month consultant services, valued at about US$10,000 per man-month. The consultants would: carry out inventory and assess the qualifications of existing staff; review and evaluate ongoing training programs; and assist in defining responsibilities and dlevelop a system for effective mutual support between technical and credit staff of INIPA and BAP. In addition, the program would finance the training program for lending policies, accounting, banking techniques, training fellowships and equipment and material. Details on the proposed program and objectives for the training program, with terms of reference for the consultants, are in Annex 1. Technical staff of the Ministry of Agriculture, especially INIPA, managers of cooperatives, and farmers, would participate. Courses at headquarters and branch offices would concentrate on: (a) investment project formulation and evaluation; (b) accounting and banking techniques; and (c) operation and management of agricultural credit. The project would provide 30 man-months of training fellowships abroad. Assurances were obtained that consultants with qualifications and terms of reference acceptable to the Bank would be engaged for the above purposes by March 31, 1984. 4.07 Improvement of Information System. This component would cost about US$3 million. The project would provide technical assistance in computer hardware and for the upgrading of information procedures, which would be determined by a study carried out under the project that would precede the investments. While BAP's information system was upgraded in 1981, there is still room for much improvement to cope with the wide geographic spread of branches and the extended lending program. There is currently a considerable delay in receiving information from the branches and agencies, and information that is provided is usually lacking in sufficient details to allow comprehensive analysis. The objectives of improving the information system are to provide BAP's management with current information on which to base decisions on lending; improve coordination and communications between the headquarters and branches, thereby making supervision and monitoring by management more effective; and enhance BAP's organizational structure by standardizing the information flow and allowing management to reach more prompt decisions (see Annex 2 for proposed outlines of terms of reference to implement the improvement of the information system). 4.08 Organization of Rediscount Facility. The cost of this component would be about US$0.6 million. The project would provide technical assistance to BAP in establishing a second-tier rediscount facility, which would enable other commercial banks to participate in medium- and long-term lendings for agriculture using the financial resources available under this project. Other commercial banks have not lent regularly for agriculture for many years. Hence, this mechanism would allow an increase of the resources available for financing investment in the sector. However, participation of  - 13 - other commercial banks in agricultural lendings through the rediscount facility would depend on: (a) BAP's increasing its lending rates to average market rate; (b) the extent of the operating margins allowed; (c) the required share of the participating bzLnk in the lendings; and (d) the security to be provided for subloans. The technical assistance provided by the project to organize the rediscount facility in BAP would, therefore, need to: (a) set out a program in which other banks' opinions on the above issues should be taken into account in structuring the facility; (b) prepare all the procedures related to rediscounting between BAP and the participating banks and operation manuals of the rediscounting facility; and (c) train and prepare staff to carry out the operations of the facility. If a program for the operation of a rediscount facility, which is satisfactory to the Bank, is developed, then Bank funds could be used for lending through the facility. 4.09 Studies (Sugar Rehabilitation). The project would provide supple- mental funds, amounting to about US$0.3 million, for completion of a feasibility study on rehabilitation of the Peruvian sugar industry. About half of these funds would be required to cover local costs. The Bank has already provided some funds under a Project Preparation Facility (PPF) for the aforementioned project, and the sugar cooperatives have provided the counterpart funds from a loan which they received from BAP. The study is presently being carried out by foreign consultants, and is expected to be completed by the end of 1983. However, because of substantial cost increases since the PPF approval, and the inability of the sugar cooperatives to provide additional funding due to their severe economic and financial difficulties, it is proposed that all the necessary supplemental funds, both for the local and foreign components, would be provided through the project. Since the feasibility study is managed by a joint commission which represents the beneficiaries, the Ministry of Agriculture, and the Ministry of Labor, BAP would sign a subsidiary agreement with Government by November 1983 to ensure the repayment of the feasibility study cost. This component would constitute a bridge loan until a Bank loan could be approved for sugar rehabilitation, and if this loan were not forthcoming, the Government would guarantee its repayment. Assurances on the above procedure were obtained in negotiations. Cost Estimates 4.10 The total cost of the project is estimated at about US$239 million, about 44% of which represents foreign exchange requirements. Costs have been estimated at September 1982 prices and include allowances for domestic and international inflation amounting to about 25% of the base cost. Domestic price escalation has been estimated at the same rate as the foreign price escalation, assuming that any changes in domestic inflation would be fully compensated in the exchange rate by corresponding devaluations of the local currency (as has been the policy in thea recent past). The contingency for international inflation is estimated at 8%, 8%, 7.5%, 7% and 6% per annum for 1982, 1983, 1984, 1985 and 1986, respectively. Project costs are summarized below and details are presented in TabLes 14 and 15.  - 14 Summary of ProJect Cost-l (US$ million) x % of Foreign Base Item Local Foreign Total Exchange Cost I. Irrigation Infrastructure, Land Improvement and Construction 1.1 Irrigation Infrastructure (Canals) 6.4 6.4 12.8 50 6.7 1.2 Land Improvement (Land Leveling and Subsoiling) 0.8 0.8 1.6 0.8 1.3 Construction 7.0 7.0 14.0 50 7.3 Subtotal 14.2 14.2 28.4 50 14.8 II. Perennial Crops 2.1 Pastures 4.0 1.7 5.7 30 3.0 2.2 Fruit Orchards 7.2 3.1 10.3 30 5.3 Subtotal 11.2 4.8 16.0 30 8.3 III. Machinery Equipment and Vehicles 3.1 Machinery (Tractors, Rice Mill, Motors etc.) 2.5 10.0 12.5 80 6.6 3.2 Equipment (Pumps, Work Shop, Tools, etc.) 2.4 9.5 11.9 80 6.2 3.3 Accessories (Sprinklers, Cultivating Tools, etc.) 1.7 6.7 8.4 80 4.4 3.4 Vehicles 1.4 5.4 6.8 80 3.5 Subtotal 7.9 31.7 39.6 80 20.7 IV. Livestock 8,2 3.6 11.8 30 6.2 V. Other 5.1 Training 0.2 0.7 0.9 78 0.5 5.2 Improvement of Information System 0.2 2.1 2.3 90 1.2 5.3 Organization *f Rediscount Facility 0.1 0.4 0.5 88 0.3 5.4 Studies (Sugar Rel,abilitati:-n) 0.1 0.2 0.3 100 0.1 Subtotal 0.6 3.4 4.0 86 2.1 VI. Incremental Short-Term Financing 64.3 27.5 91.8 30 47.9 Total Base Cost 106.4 85.2 191.6 44 100.0 Price Contingencie 2/ 26.4 20.7 47.1 44 24.6 Front End Fee - 0.3 0.3 100 0.2 Total Project Cost 132.8 106.2 239.0 45 124.8 1/ Assuming a foreign exchange rate of 750:1. 2/ Assuming the project would commence in 1983, the expected inflation rate would be 8%, 8%, 7.5% 7%, 6% for 1982, 1983, 1984, 1985 and 1986, respectively.  - 15 - Financing 4.11 The proposed Bank loan of US$130 million equivalent would finance about 54% of the total project cost. This would cover the full foreign exchange cost and 17% of local currency expenditures as well as the capitalized front-end fee. Beneficiaries would provide the equivalent of US$13.7 million, or 5.7% of total project cost; this is an estimated weighted average based on the assumption that farmers would contribute 5% of their investment cost when possessing less than 5 ha in the Costa, 10 ha in the Sierra and 50 ha in the Selva; 10% with 5 to 50 ha in the Costa, 10-100 ha in the Sierra and 50-100 ha in the Selva; and 20% with more than 50 ha in the Costa, 100 ha in the Sierra and 150 ha in the Selva. Cooperative shares in investment financing would be determined on the basis of cultivated area per member, after which the same percentages, which are applicable to private farmers, would apply. BAP would provide counterpart funds equivalent to about US$38 million, or about 16% of tolal project cost. The Government would provide the remaining counterpart funds, about US$57.3 million, or 24% of total cost, which would be necessary to finance the proposed expansion of BAP's lending program. Assurances were obtained during negotiations that Government would agree to provide to BA' on a timely basis any funds required to carry out the project. Moreover, the Government would guarantee the value of BAP's equity in constant soles from the time that the loan will be signed, while BAP would assume the responsibility to limit the size of its debt in relation to its equity by a ratio of 5 to 1. The proposed financing plan is presented in the following table:  - 16 - Financing Plan (US$ million) World Bank Beneficiaries BAP Government- Amount % Amount Z Amount Z Amount % Total I. Irrigation Infrastructure Land Improvement and Construction 1.1 Irrigation Infrastructure (Canals) 6,4 50 1.5 11.5 4.$' 38.5 - - 13 8 1.2 Land Improvement (Land Leveling) 0.BR 50 0.2 11.5 0.6 38.5 - - 1.6. 1.3 Construction 7.0 50 1.6 11.5 5.4 38.5 - - 14.0 II. Perennial Crops 2.1 Pastures 1.7 30 0.7 11.5 3.3 58.5 - - 5.7 2.2 Fruit Plantations 3.1 30 1.2 11.5 6.0 58.5 - - 10.3 III. Machin-y Equipment and Vehicles 3.1 Machinery (Tractors, Rice Mill, Motors, etc.) 10.0 80 1.4 11.5 1.1 8.5 - - 12.5 3.2 Equipment (Pumps, Work- shops, tools, etc.) 9.5 80 1.4 11.5 1.0 8.5 - - 11.9 3.3 Accessories (Sprinklers, Cultivating Tools, etc.) 6.7 80 1.0 11.5 0.7 8.5 - - 8.4 3.4 Vehicles 5.4 80 0.9 11.5 0.5 8.5 - - 6.8 IV. Livestock 3.5 30 1.4 11.5 6.9 58.5 - - 11.8 V. Other 5.1 Training 0.7 78 - - 0.2 22.0 - - 0.9 5.2 Improvement of Infra- structure System 2s1- 90 - - 0.2 10.0 - - 2.3' 5.3 Organization of Rediscount Facility 0.4 88 - - 0.1 12.0 - - 0.5 5.4 Studies 0.3 100 - - - - - - 0.3 VI. Incremental Short-Term Financing 45.9 50 - - - - 45.9 50 91.8 Total Base Cost 103,3 54.p -11.3 5.95 30.9 16.1 45.9 24.0 191-s6- Prica Contingencies 26.2 53.8 2.5 5.9 7.0 16.3 11.4 24.1 47.1 Front-End Fee 0.3 100.0 - - - - - - 0.3 Total Project Cost 130.0 54.4 13.7 5.7 38.0 15.9 57.3 24.0 239.0- 1/ Government would also reimburse BAP for the difference between commerical and subsidized lendings. April 6, 1983  - 17 - 4.12 The proposed loan would be made to BAP at the Bank's standard terms. The Government would guarantee the loan. It would also assume the foreign exchange risk, and BAP and the Government would, by December 31, 1983, make arrangements, satisfactory to the Bank, for this purpose. Assurances to this effect were obtained at negotiations. Procurement 4.13 Procurement of investment works, material and equipment by sub-borrowers would be through normal commercial channels and directly from suppliers, as it would not be practicable to arrange for bulk procurement and international competitive bidding (ICB), considering the number of sub-borrowers and the wide range of items to be financed under the project. An adequate selection of farm machinery and other agricultural equipment is available through local and international suppliers, and servicing and supply of spare parts is satisfactory. For farm machinery and equipment, BAP would require its borrowers, wherever feasible, to obtain quotations from at least three sources of supply. BAP would make available to sub-borrowers a catalog of suppliers of agro-industrial machinery, including those from Bank member countries as well as their agents or their representatives in Peru. 4.14 Procurement of equipment for carrying out the improvement of the information system, which would be determined by a feasiblity study, would be implemented under ICB in accordance with Bank Guidelines for procurement. Procurement of consultants to carry out assignments established; in the training component, improvement of the information system, and organization of the rediscount facility, would be implemented in accordance with principles and procedures satisfactory to the Bank on the basis of the "Guidelines for the use of Consultants by World Bank Borrowers and by the World Bank as Executing Agency", published by the Bank in 1981. Assurances on the points mentioned in this and the preceding paragraph were obtained during negotiations. Disbursements 4.15 The investment period would extend over four years and Bank disbursements are expected to run about four years. The disbursement profile for the project was determined mainly onI the basis of BAP's experience with recent credit projects financed by IDB, as well as by evaluation of BAP's credit demand and its management capacity to carry out the scheduled investment program. Similar projects in Latin America indicate a range of between three and seven years for their disbursement. Since BAP's management capacity is known, the proposed disbursement profile is considered to be realistic. Disbursements from the loan would be made against: (a) 45% of amounts disbursed to individual farmers and cooperatives for irrigation infrastructure, land improvement, construction, perennial crops and livestock; (b) 50% of amounts disbursed for short-term capital subject to a predetermined limit that would be set each year; (c) 90% of foreign expenditures for machinery, equipment and vehicles procured under the project subloans;  - 18 - (d) 100% of foreign expenditures for directly imported machinery and equipment, and 80% of local expenditures for imports procured locally for improvement of the information system in BAP; and (e) 100% of total expenditures of the studies program agreed with the Bank. Disbursements would be made against certified statements of expenditures for (a) and (b). Relevant documentation would not be submitted to the Bank, but would be retained by the borrower and be made available for review by Bank project supervision missions. All other disbursements would be fully documented. A schedule of estimated Bankc disbursements is given in Table 16. V. ORGANIZATION AkND MANAGEMENT Management 5.01 BAP would implement the project using its normal procedures. BAP would appoint a project coordinator who would serve as the liaison between BAP and the Bank and would be responsible for the collection and analysis of results of subprojects; for supervision of the application of the specific technical guidelines agreed with the Bank in regard to implementation of the project; and for submitting quarterly reports to BAP's management and the Bank, prepared according to guidelines mutually agreed with the Bank. The project coordinator's position would be maintained throughout project implementation, and persons appointed to the position should have experience and qualifications acceptable to the Bank. Assurances on this were obtained at negotiations. 5.02 BAP's branch offices, agencies and field offices have adequate office staff for operations being carried out at present. But with implementation of the proposed project which would expand the volume of operations in BAP, there is a need to ensure that field staff are used more efficiently in project formulation and subloan appraisal. The main need is to expedite processing of medium- and long-term loans which presently takes several months to prepare. BAP is aware of the need to simplify its procedures in order to speed up loan processing time. A monitoring program (para 5.12) would be carried out in BAP by DPES. Investments for exploitation or groundwater resources through drilling new wells or equipping existing wells, investments in irrigation and drainage works, and financing of water users' associations wouid require the Ministry of Agriculture's approval. Planning and Programming 5.03 Planning for short-, medium- and long-term development credit is done in BAP by DPES in accordance with national priorities and determined on the basis of: (a) response to questionnaires from DPES to branch offices; and (b) coordination with the MA regardi'ng investment funds needed for new  - 19 - projects. In regard to short-term financing, DPES also takes into consideration: (a) the area of specified annual crops financed in previous years (cotton, rice, wheat, potatoes, maize/sorghum); (b) availability of funds for short-term lending; and (c) analysis of variable costs per hectare of crops and livestock, which determines the short-term credit needs per crop or per unit of livestock. Based on physical lending targets assembled by DPES, the Office of Finance elaborates the financial consequences for BAP's annual plan. BAP's overall planning andl programming capacity, strengthened by training and improvements of the management information system, would b considered adequate to implement the proposed lending program. For the proposed project, BAP would prepare each year during project execution: (a) an annual investment program and mediuim-term plan, including funds needed for BAP's updated annual lending, with follow-up reports for comparisons; and (b) an estimate of short- and long-term crelit requirements by agricultural activities throughout the country. BAP's updated annual lending, including its funding program and medium-term plan, would be reviewed by MA and Finance each year, and the proposed program wit]h comments of the ministries would be submitted to the Bank for review by September 30 of each year. The final program, approved by the Ministry of Finance, would be submitted to the Bank no later than December 31 of each year. Assurances on the above were obtained at negotiations. Lending Terms 5.04 The recent changes in the Goviernment's interest rate policy for the agricultural sector already decided upon (para 2.05) will have a profound effect on BAP and its borrowers mainly because most of BAP's lendings would be closer to market rates. BAP's lending rates would be reviewed by BAP's management at biannual intervals and adjustment of the rates would be carried out within three month from the date of the last review to reflect changes in market rates. For the purpose of reviewing its lending rates BAP will use a reference rate which would represent an average of short- and medium-/long- term effective lending rates of the largest commercial banks of Peru, weighted by the proportion of short- and medium-/long term lending balances in BAP. BAP would adjust its weighted interest rates whenever the reference rate would change by more than three percentage points or five percent, whichever is larger. A decline in BAP's average lending rate, excluding the subsidized rates, by more than 10% from the rate of inflation in Peru which was not remedied in three months would give the Bank the right to suspend or cancel the loan. Assurances on the above were obtained at negotiations. Sublending Policies and Procedures 5.05 The lending period of subloans that would range between three and 15 years and the grace period of up to four years would be determined on the basis of cash flow projections of beneficiaries. When a subloan to an individual sub-borrower resulted in the beneficiary holding an outstanding credit balance exceeding US$200,000 equivalent, or to a cooperative holding outstanding credit exceeding US$1 million, Bank approval prior to the new  - 20 - lending would be required. Complementary short-term credit for working capital would be provided within the project on a medium- and long-term basis, if analysis of the beneficiary cash flow indicated such need, or on the basis of a representative model, if the subloans were relatively small. Assurances for the above were obtained alt negotiations. 5.06 Criteria for Incremental Short--Term Lending. To determine incrementality, short-term loans eligible for financing under the Bank loan would be those made to farmers who: (a) are receiving short-term credit for the first time; (b) would make capital investments financed by medium- and long-term lendings; or (c) would increase their demand for short-term capital due to changes of cropping pattern or production technology. Ilowever, complying with the above criteria would be possible only after carrying out the improvement of the information systetm in BAP. From the initiation of the loan, however, incrementality would also be determined by the planned increase in real terms of short-term lending on the basis of the annual lending program as compared with last yeiars' short-term lending. Bank funds would be disbursed up to an annual ceiling agreed upon between the Bank and BAP by December 31 of each year. In the event that, upon review of the results of BAP's actual short-term lending during the previous year, the Bank determines that the projected targets were not achieved, the ceiling for the disbursement for short-term operations would be reduced until the shortfall is made up. Assurances to this effect were obtained at negotiations. 5.07 Subloan Appraisal and Supervision. Overall quality of subloan appraisal in BAP is reasonable, and BAP is taking steps through its training program to further improve the work. BAP field officers, would assist sub-borrowers, when necessary, to preparie farm development plans which would become part of subloan applications. Each subloan, considered by BAP, would be appraised in accordance with guidelines satisfactory to the Bank that is based on: (a) detailed development plans, including farm budget, an income and operating expense statement, and a financial cash flow; or (b) a financial cash flow and representative models whenever the size of such subloan or similarity to other subloan investment projects so justifies. Assurances for the above were obtained at negotiations. 5.08 Financial and Economic Criteria. In appraising subprojects, BAP would ensure that: (a) the detailed development plans and the representative models, are technically feasible, financially viable and economically justified for their incremental production; and (b) enterprises should have a satisfactory management and credit standing. Creditworthiness would be contingent on their not having any arrears on outstanding loans. For cooperatives, an analysis of their financial statement would also be required to determine creditworthiness. The financial rate of return of approved subloans based on development plan or the representative model, should be equal to at least the opportunity cost of capital. Assurances for the above were obtained at negotiations.  - 21 - 5.09 Reporting Requirements. Quarterly progress reports summarizing project performance, and subloan disbursements by categories (beneficiaries, principal activities, and subloan size) would be submitted to the Bank no later than 60 days after the end of each quarter. Detailed reports, which would include subproject costs, subloan commitments and disbursements by categories, lending by activities and regions, type and number of beneficiaries, and sub-borrowers' contributions, would be prepared annually and submitted to the Bank no later than four months after the end of each year. BAP would also send to the Bank annually: (a) a summary of its loan portfolio showing loans to be collected and those collected and uncollected; (b) total loans rescheduled; (c) a sumtary statement of changes in its own staffing on an overall and regional basis; (d) a statement on the progress of its training programs; and (e) a summary statement of project impact prepared by DPES. Within 12 months of the closing date of the Bank loan, BAP would submit a Project Completion Report prepared in accordance with Bank guidelines. Suitable assurances were obtained at negotiations on the above. Accounts and Auditing 5.10 BAP would maintain adequate records to reflect, in accordance with generally accepted principles of accounting, its operations and financial condition, its credit operations, the cost of consulting services and the training program under the project. Auditing arrangements, which are satisfactory for the ongoing project, would be that: (a) the annual accounts of BAP would be audited by independent auditors acceptable to the Bank, whose reports would be of such scope and in such detail as to include in their comments: (i) the accuracy of statements of expenditures submitted to the Bark for reimbursement; (ii) the compliance with the criteria set for incremental short-term sublending (para 5.06); and (iii) such other information as the Bank may reasonably request; and (b) copies of BAP's audited accounts and the auditors' reports (including the long form report or a management letter) would be submitted to the Bank within six months of each financial year end. Assurances that accounting and auditing would be carried out as outlined above were obtained during negotiations. Monitoring and Evaluation 5.11 The results of the agricultural lending would be monitored by BAP, through the DPES. Presently the monitoring system is inadequate as stated in the Bank Completion Report of the previous credit project to BAP (para 3.04). DPES, however, for the purpose of this project, would design a recording system which would show: (a) the value of assets and liabilities of sub-borrowers as well as farm operations (physical and financial) before development; (b) a comparison between expected and actual achievements using a system of main indicators such as yields, calving rates, production and income; (c) the number, nature, and size of loans made and their phasing or timing; (d) the source of the sub-borrowers' investment funds; (e) changes (on designated reporting dates) in the number of physical assets; (f) level and sources of beneficiaries income; and (g) expenses and production costs, showing details of important items. A careful stratified sample of subprojects would be selected for monitoring. This information would be made available for inspection by Bank supervision missions, and summaries and analysis of the information would be included in the annual progress reports. Assurances for the above were obtained at negotiations.  - 22 - VI. PROJECT BENEFITS AND RISKS Illustrative Investment Plans 6.01 Subloans to individual farmers, farmer groups and cooperatives would be made for a wide range of activit.ies for crops and livestock under varied ecological conditions throughout the country. Consequently, subloan amounts would vary considerably by benefiLciary categories and principal activities. Based on BAP's past experience, 10 investment plans (farm models) have been selected to demonstrate the development effects of investment programs, each showing the investment mix, development concept, technical change, and financial and economic results. The following table summarizes the financial and economic results of each investment plan.  INVESTMENT PLANS - SUMMARY OF RESULTS Number Investment Cost Net Cash FloF_/ Pinancial Economic of Subloan Borrower's Without with Rate Rate Investment Pl-n Families Amounts Contribution Total Investment Loan Investment Loa l of Return of Return - - - - - - - - - - - - - - US$ 000 1. N. Costa Family Crop Farm (7 ha)3/ 430 6.7 0.8 7.5 0 4.3 37 49 2. C. Costa Family Mixed Farm (7 ha)3/ 330 26.6 3.0 29.6 0 4.4 21 21 3.- S. Costa Family Crop Farm (7 ha) 600 9.5 0.5 10.5 1.7 3.2 16 25 4. N. Costa Coop. Crop Farm (700 ha) 4,375 318.0 80.0 398.0 105.0 150.0 33 41 5. N.C. Costa Coop. Crop Farm (500 ha) 3,750 202.2 70.0 352.0 101.0 157.0 26 25 6. C. Costa Coop. Crop Farm (585 ha) 5,800 269.0 67.0 336.0 252.0 343.0 26 47 7. S. Costa/Sierra Family Livestock Parm(8ha) 800 11.7 1.3 13.0 1.1 2.0 20 23 8. Sierra Coop. Livestock Farm (4,000 ha) 1,250 119.0 30.0 149.0 7.1 23.9 18 17 9. Selva Family Livestock Farm (100 ha) 600 19.1 0.9 20.0 0.9 6.0 22 22 10. Selva/Costa Fruit/Veg. Market (450 ha) 2,275 257.0 65.0 322.0 180.0 285.0 17 29 1/ Incremental net value of production. 2/ At full development year. _/ Farm model. 1 and 2 would be established wi-th the project.  - 24 - 6.02 The underlined assumptions in estimating the economic results from the project are as follows: (a) agricultural production figures are derived from investment of the medium- and long-term loans over four years; (b) production costs are priced at local 1982 constant market prices; (c) economic prices for cotton, rice, grain feeds and oranges are derived from estimates of border prices and Bank projections, adjusted to farmgate level, while prevailing farmgate prices were used for other products (non-tradables) (Table 17); all project works, equipment, and physical contingencies are included in investment costs; (d) social expenses (such as social security) of 46.2% were assumed only for hired labor; and (e) the life of the project is assumed to be 30 years. Project Benefits 6.03 Based on the illustrative farm model analysis, the incremental volume of production resulted from the project at full development is expected to be quite substantial (Table 18). The estimated increases by key crops are summarized in the table below: Comparison of Benefits With and Without Project Without With Volume of Production (tons) Project Project Rice 73,000 108,000 Potatoes 71,000 86,000 Beans and Soybeans 800 3,200 Sorghum 29,000 46,000 Fruit and Vegetables 142,000 238,000 Milk (million of liters) 22 78 Beef (liveweight) 3,200 14,000 Mutton (liveweight) 180 380 Wool 80 150 Consequently, the gross value of production is expected to rise from about S/. 79 billion per year (about US$106 million) to about S/. 131 billion per year at full development in the tenth year (about US$175 million) (Table 19); costs of production are expected to rise from about S/. 57 billion (about US$76 million) to about S!. 83 billion (about US$111 million) per annum at full development (Table 20); and consequently, the net value of production is expected to increase from about S/. 22.8 billion (about US$30 million), to about SI. 48 billion in the tenth year (about US$64 million) (Table 21). The incremental value of production is expected to reach about S/. 25.1 billion per annum (about US$33 million) in the e:Leventh year (Table 22). 6.04 About 21,000 families would benefit directly from the project medium- and long-term lending program. 'Income per family, which ranged between S/. 255 thousand and 3,825 thousand (US$340-US$5,100) per family before project, is expected to increase to a range between S/. 517 thousand and 4,687 thousand (US$490-US$6,250) at full development. In addition, many more farmers would benefit from expanding short-term lending, which would  - 25 - allow new farmers to participate. The direct economic benefits from the project realized by the beneficiary farmers would come from: (a) increased income compared to without project situation; (b) increased employment and job security as work on the farm would absorb about 10.7 million mandays per annum at full development compared to about 5.4 million mandays per annum without the project (Table 23). 6.05 The project would have a substantial impact on institution building by: (a) strengthening BAP's information system, and planning and programming capabilities; (b) increasing agricultural lending capabilities by involving other commercial banks through a rediscount facility; and (c) by training BAP personnel to improve their lending efficiency. 6.06 From a national point of view, the project would yield the following benefits: (a) it would support the Government's rural development policies because it would raise the income of the rural poor; (b) it would contribute toward improvement of the balance of payment by about US$30 million per annum, as a result of increasing production of import substitution crops, such as rice and feied grains, as well as increasing foreign exchange revenues from export of cotton; (c) it would help decrease income disparities between rural and urban areas, thereby reducing rural urban migration; (d) it would increase activities of commerce and banking as more produce and crops would be marketed; and (e) it would create a more efficient allocation of resources in the agricultural sector that would stem from adoption of an interest rate policy that is adjusted to market rates rather than heavily subsidized rates. Marketing and Storage 6.07 Given that agricultural production in Peru tends to lag behind domestic demand, the incremental production generated by the project should have no difficulty in finding internal markets. There is a risk that some production surpluses would be created, but it is limited to good years and involves only few crops such as potatoes, of which some can be exported. Cotton and wool, which are traditional iexport crops, should find satisfactory markets abroad and expanding demands domestically. 6.08 In the Sierra and Selva, marketing channels are poorly developed, except near major cities. The more prosperous coastal areas, on the other hand, have sufficient collection centers and storage facilities. These factors were taken into consideration in the project design and the calculations of project benefits. Project Risks 6.09 The project is subject to a certain degree of risk because it depends on the farmers' reaction to the new Government agricultural credit policy, which could result in their borrowing much less than expected. The success of the project also depends on Government policies both in regard to input and output prices. However, farm models of this project show that farmers could bear the cost of the interest rate and prevailing market prices quite adequately. Though prices have been largely liberalized from regulation, any reversal of the Government policy is likely to affect the  - 26 - project adversely. An equally important risk is the political climate which is reflected mainly in the ability of the Government of Peru to abide by its decision to carry out the new agricultural credit policy. 6.10 Though BAP is a reasonably efficient and mature institution, the success of the project also depends on training of BAP's staff which presently lacks sufficient financial and economic expertise. Analysis and evaluation of subprojects at the branch and agency levels would need to be improved to meet Bank requirements. Despite the risks mentioned above, the project has a high probability to succeed because the Government and BAP are presently fully committed to carry out the new credit policy. VII. SUMMARY OF AGREEMENTS REACHED AND RECOMMENDATION 7.01 Assurances were obtained during negotiations that: (a) by March 31, 1984 BAP would initiate its training program and hire consultants with qualifications and terms of reference acceptable to the Bank (para 4.06); (b) by November 1983 BAP would sign a subsidiary agreement with the Government to transfer US$300,000 to a Government commission which manages a study of rehabilitation of the sugar industry, and the Government would guarantee repayment of the above sum, including interest, to BAP (para 4.09); (c) Government would agree to provide to BAP on a timely basis any funds required to carry out the project. The Government would also guarantee the value of BAP's equity in real term and BAP would limit its debt in relation to equity by a ratio of 5 to I (para 4.11); (d) by December 31, 1983, BAP and the Government would enter into agreement satisfactory to the Bank under which the Government would assume the foreign exchange risk (para 4.12). (e) procurement procedures would be followed as outlined in paragraphs 4.13 and 4.14; (f) the project coordinator position in BAP would be maintained throughout project implementation and persons appointed by BAP to the position of project coordinator should have experience and qualifications acceptable to the Bank (para 5.01); (g) BAP would submit to the Bank by September 30 each year its proposed lending program, including its funding, and comments of the Ministries of Agriculture and Finance for review. Final lending program would be submitted to the Bank by December 31 of each year (para 5.03);  - 27 - (h) BAP's lending terms and. their adjustment under the project would be as set out in paragraphs 5.04 and 5.05; (i) incremental short-term capital lending entitled to disbursement under the project would be in accordance with the criteria set out in paragraph 5.06; (j) BAP's procedures in appraisal of subloan applications and its financial and economic criteria would be as outlined in paragraphs 5.07 and 5.08; (k) BAP's reporting requirements to the Bank would be as outlined in paragraph 5.09; (1) BAP's accounting and auditing arrangements would be as outlined in paragraph 5.10; and (m) BAP's monitoring and evaluation procedures would be as set out in paragraph 5.11. 7.02 With the above assurances and conditions, the project would be suitable for a Bank loan of US$130 million, of which about US$324,000 is a capitalized front-end fee. May 1983  PERU SIXTH AGRICULTURAL CREDIT PROJECT Credit According to Type and Regions 1976 - 1981 (million of soles) 1976 1977 1978 1979 1980 1981 No. Amount No. Amount No. Amount No. Amount No. Amount No. Amount Costa Short-Term Credit 29,529 13,329 29,408 17,397 26,389 25,174 34,976 52,463 34,540 89,898 46,706 163,090 Medium- & Long-Term Credit 827 751 1,244 764 1,219 1,966 1,212 4,679 2,544 9,792 1,050 8,660 Comercialization 58 216 20 349 32 396 25 1,004 26 1,243 27 1,770 Subtotal 30,414 14,296 30,672 18,510 27,640 27,536 36,213 58,146 37,110 100,933 47,783 173,520 Sierra Short-Term Credit 27,107 1,993 32,098 3,515 31,534 4,665 30,185 8,760 36,296 19,316 43,524 40,355 Medium- & Long-Term Credit 314 303 446 277 546 761 617 1,054 903 2,753 377 2,452 Comercialization 36 1,062 24 593 22 704 25 756 26 2,158 21 940 Subtotal 27,457 3,358 32,568 4,385 32,102 6,130 30,827 10,570 37,225 24,227 43,922 43,747 Selva Short-Term Credit 20,484 1,864 22,577 2,717 26,287 5,038 27,608 9,369 31,726 19,444 34,998 32,456 Medium- & Long-Term Credit 227 97 241 106 311 223 392 406 1,247 2,737 617 4,193 Comercialization 84 2,395 87 5,194 102 4,671 184 12,609 99 21,083 96 17,504 Subtotal 20,795 4,356 22,905 8,017 26,700 9,932 28,184 22,384 33,072 43,264 35,711 54,153 Total Short-Term Credit 77,120 17,187 84,083 23,629 84,210 34,877 92,769 70,592 102,562 128,658 125,228 235,901 Medium- & Long-Term Credit 1,368 1,151 1,931 1,147 2,076 2,950 2,221 6,139 4,694 15,282 2,044 15,305 Comercialization 178 3,672 131 6,136 156 5,771 234 14,369 151 24,484 144 20,214 Grand Total 78,666 22,010 86,145 30,912 86,442 43,598 95,224 91,100 107,407 168,424 127,416 271,420 November 19, 1982  PERU SIXTH AGRICULTURAL CREDIT PROJECT Credit According to Type and Beneficiaries 1976 - 1981 (million of soles) 1976 1977 1978 1979 1980 1981 No. Amount No. Amount No. Amount No. Amount No. Amount No. Amount Short-Term Credit Cooperatives 1.500 9,806,773 1,249 12,866,038 1,289 19,319.495 1,349 38,824 1,389 65,594 1,946 106,454 Individuals 75,620 7,380,110 82,834 10,763,178 82,921 15,557,884 91,420 31,768 101,173 63,064 123,282 129,447 Subtotal 77,120 17,186,883 84,083 23,629,216 84,210 34,877,335 92,769 70,592 102,562 128,658 125,228 235,901 Commercialization Cooperatives 122 3,657,270 116 6,083,823 852 1,527,116 224 14,327 128 24,241 113 19,863 Individuals 56 14,782 15 52,228 1,824 1,442,394 10 42 23 244 31 351 Subtotal 178 3,672,052 131 6,136,051 2,076 2,949,510 234 14.369 151 24,485 144 20,214 Medium- & Long-Term Credit ' Cooperatives 276 873,297 213 595,832 136 5,722,951 205 3,963 230 5,419 108 4,251 Individuals 1,092 277,867 1,718 551,283 20 47,755 2,016 2,176 4,464 9,862 1,936 11.054 Subtotal 1,368 1,151,164 1,931 1,147,115 156 5,770,706 2,221 6,136 4,694 15,281 2,044 15,305 Total Cooperatives 1,898 14,337,340 1,578 19,545,693 1,677 26,569,562 1,778 57,114 1,747 95,254 2,167 130,568 Individuals 76.768 7,672.759 84,567 11,366,689 84,765 17,027,989 93,446 33,966 105,660 73,170 125,249 140,852 Grand Total 78,666 22,010,099 86,145 30.912,382 86,442 43,597,551 95,224 91,100 107,407 168,424 127,416 271,420 November 22, 1982  PERU SIXTH AGRICULTURAL CREDIT PROJECT BAP's Lending in Current,Real Terms and in US Dollars --Total Lendings Per Annum----------- Current In 1981 Current In 1981 Inflation Exchange Rate Year Terms Prices Terms Prices Rate (Soles/US$) (S./ millions) (US$ millions) % % 1976 22,010 221,443 393 525 100.0 56 1977 30,912 225,366 368 534 138.0 84 1978 43,598 201,303 279 477 217.9 156 1979 91,100 250,837 405 594 365.4 225 1980 168,424 291,354 583 690 581.6 289 1 1981 271,420 271,420 643 643 1,006.1 422