Honduras - Third Agricultural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 4298-HO STAFF APPRAISAL REPORT HONDURAS THIRD AGRICULTURAL CREDIT PROJECT April 25, 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 EQUIVALENTS US$1.00 2.00 Lempiras (L) WEIGHTS AND MEASURES Iletric System GLOSSARY OF ABBREVIATIONS BANADESA National Bank of Agricultural Development BCH Central Bank of Honduras COHBANA Honduran Banana Corporation COHDEFOR Honduran Corporation for Forestry Development CONADI National Investment Corporation CONSUPLAN'E Superior Council of Economic Planning CU Coordination Unit IHCAFE Honduran Coffee Institute IHMA Honduran Agricultural Marketing Institute IMF International Monetary Fund INA National Agrarian Institute MRN Ministry of Natural Resources PU Project Unit of the Central Bank RUTA UNDP's Regional Unit for Technical Assistance SOE Statement of Expenditure USAID United States Agency for International Development GOVERNMENT OF HONDURAS FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY HONDURAS THIRD AGRICULTURAL CREDIT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. PROJECT BACKGROUND AND OBJECTIVE ........... ............. 1 II. THE AGRICULTURAL SECTOR ...................................... 2 A. Economic Setting... . . 2 B. Importance, Performance and Prospects . .2 C. Main Features and Structure. 3 - Natural Resources... . 3 - Population ............. . . 3 - Land Use .............. 4 - Land Reform . . 4 - Institutions and Supporting Services . . 4 - Public Policy... 5 D. Bank/IDA Involvement in the Sector . . . . 5 Iii. THE FINANCIAL SYSTEM ...................7............. 7 A. Monetary Policy.... 7 B. The Banking System ................... . *....... 9 C. Financing Agriculture .. 9 D. National Bank of Agricultural Development.. 10 IV. THE PROJECT .. ................................... 11 A. Brief Description ................................ . . . . . . . 11 B. Detailed Features ..................................... 11 - Credit Program ..................................... 11 - Project Unit ..................................... 12 - Training ..................................... 12 C. Cost Estimates and Financing . .. . .. 12 D. Procurement . ..................................... 14 E. Disbursement ........ ................... ..... . ........... 14 V. PROJECT IMPLEMENTATION ....... 15 A. Organization and Management .............................. 15 - Executive Committee ................................. 15 - Project Unit .......................................... 15 - Financial Intermediaries (FIs) ..... 16 - National Bank of Agricultural Development . .16 This report is based on the findings of an appraisal mission that visited Honduras during September/October 1982. The mission comprised Messrs. M, Fairless (mission leader), V. Ferrer, 0. Schulz, J. Yaron (Bank) and j. Velez (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.  TABLE OF CONTENTS (CONTINUED) Page No. B. Lending Procedures ......................... 18 - Flow of Funds . . . ............ 18 - Lending Procedures between the Bank and the Government 18 - Leniding Procedures between BCH and FIs ............. ... 19 - Lending Procedures between FIs and Sub-borrowers ....... 20 C. Technical Assistance and Training . ....................... 21 - Technical Assistance ..... ............................. 21 - Training .............................................. 21 D. Management Information System, Evaluation and Reporting .. 23 - Management Information System ..... .................... 23 - Evaluation . . . .................. 23 - Reporting ............................. . .... 23 E. Accounts and Auditing ........................... 24 VI. PROJECT BENEFITS, ANALYSIS AND RISK .25 A. Project Benefits . . .25 B. Economic and Financial Analysis.... 25 C. Project Risk .26 VII. SUMMARY OF AGREEMENTS REACHED AND RECOMMENDATION ............. 27 ANNEXES Terms of Reference ........................................... 29 A. Training Coordinator ...................... .29 B. Extension Specialist ............................... 29 2. Selected Documents and Data Available in the Project File ..... 31 Supporting Tables I - Farm Distribution in Honduras ........... .............. 32 2 - Number and Value of Subloans Granted by Financial Intermediaries under previous Bank Projects ........... 33 3 - Number and Value of Subloans Granted by Activity under previous Bank Projects .................. .............. 34 4 - Summary of General Conditions of Credits and Loans .... 35 5 - Credit Component ....... ............................... 36 6 - Project Unit Component . . .37 7 - Training Component . . 38 8 - Disbursement Schedule ...... ........................... 39 9 - Projected Cash Flow ...... ............................. 40 10 - Milk Collection and Refrigeration Center Investment Model (12,000 liters/day): Investment Analysis and Cash Flow Projection ...... ............................ 41 11 - Tobacco and Maize Investment Model (10 ha): Investment Analysis and Cash Flow Projection ............ ......... 42 12 - Melon and Maize Investment Model (4.2 ha): Investment Analysis and Cash Flow Projection ..................... 43  TABLE OF CONTENTS (CONTINUED) Page No. Table 13 - Dual-purpose Cattle Investment Model (200 ha): Investment Analysis and Cash Flow Projection .......... 44 14 - Prices Used in Project Appraisal ................. .. .... 45 15 - Sensitivity Analysis .................................. 46 CHART Project Unit Organization Chart .................... ..... ...... 47 MAP IBRD 16747R - Project Unit Offices   HONDURAS THIRD AGRICULTURAL CREDIT PROJECT I. PROJECT BACKGROUND AND OBJECTIVE 1.01 The Government of Honduras has requested the World Bank Group to continue to finance a rediscount facility for the banking system that provides for investment in agriculture. It would be the Bank's fifth agricultural credit project to be administered by a well qualified Project Unit (PU) established for this purpose in 1970 in the Central Bank of Honduras (BCH). 1.02 Due to the rapid commitment of funds of the ongoing Second Agricul- tural Credit Project (Credit 1005-HO/Loan 18-33-HO), Bank missions identified the proposed project in March 1982, and in June 1982 reviewed the preparation work undertaken by the PU. During July and August, the United Nations Devel- opment Program's Regional Unit for Technical Assistance (RUTA) in Costa Rica assisted the PU in drafting the preparation document. By March 31, 1983, 70% of the US$25.0 million provided by Credit 1005-HO/Loan 1833-HO was committed and 53% was actually disbursed. 1.03 The main objective of the proposed project would be to provide long-term financing for investments and short-term financing for incremental working capital and thereby promote: (i) agricultural exports to improve the country's balance of payments; (ii) rural production, incomes and consumption; and (iii) employment. 1.04 Other objectives of the project would be to: (i) improve subloan collection by the National Bank of Agricultural Development (BANADESA); (ii) upgrade the commercial banks' agricultural loan officers' project appraisal techniques; (iii) improve small-scale farmers' managerial and bookkeeping capacity; and (iv) reduce the present paperwork and time needed for subloan approval.  II. THE AGRICULTURAL SECTOR A. Economic Setting 2.01 Honduras is one of the most underdeveloped countries in the Western Hemisphere; its per capita income was US$590 in 1981. During 1950-75, real GDP grew at 3.7% a year but with a 2.7% rate of population growth, real per capita income grew only about 1% a year. This low growth is partly the result of the economy's dependence on banana production that is often hampered by hurricanes. During 1976-79, GDP recovered and grew at 7.7% a year owing to increased banana and coffee production, high coffee prices and a substantial expansion of both public and private investment. But in 1980, the GDP growth raLte was reduced to 2.9% per annum and in 1981 to only 0.8% per annum, due to reduced production levels and lowered private investment because of political events in neighboring Central American countries. In addition, public finances deteriorated and caused a large increase in the use of domestic credit that resulted in a tightening of credit to the private sector. 2.02 The newly elected Government took office in late January 1982 facing a balance of payments deficit and fiscal problems. The Government took steps to redress these financial difficulties and the adjustment program it designed provided the basis for negotiating a stand-by arrangement with the IMF in November 1982. The program included new tax measures, a reduction of current expenditures of the public sector, higher budget controls over decentralized agencies, elimination of arrears in payments and the phasing out of import restrictions. However, solving the balance of payments deficit in the medium term will depend on export growth originating in the agricultural sector. B. Importance, Performance and Prospects 2.03 Agriculture currently generates three quarters of export earnings and over one quarter of the GDP; the sector also employs over half the economically active population. Agriculture's value added however grew only at an annual compound rate of 1.9% during 1970-80 mostly owing to Hurricanes Francelia and Fifi and to the land tenure insecurity caused by the Agrarian Reform in the first half of the decade. 2.04 The agricultural economy is dominated by two crops, bananas and coffee. During 1977-81, bananas accounted for 31% of the value added by the cropping sector and coffee accounted for 25%. The main basic grain, maize, accounted for 14%;; sorghum, rice and beans for 9%; sugar, 6%; tobacco, 3%;and other crops, the most important being plantains, cotton, oil palm and citrus, for the balance. The whole cropping subsector accounted for about 68% of the value added in thre agricultural sector; livestock, including poultry, accounted for 19%; forestry for 12%; and fisheries, beekeeping and hunting for the rest. 2.05 During 1977-80, coffee exports accounted for about 28% of the nation's exports; bananas for 26%; timber for 8%; and beef for 7%. The main other agricultural exports were sugar, cotton and tobacco. The  main agricultural imports are wheat, averaging about 65,000 tons per year for about US$12.0 million; dairy products, averaging about 6,000 tons per year, for US$9.0 million; and occasionally maize. 2.06 The near term prospects of the agricultural sector are not promising. The world economic recession has depressed the prices of Honduras' main agricultural exports and caused recent international trading restrictions: the coffee export quota for 1982/83 to markets covered by the International Coffee Organization is 180,000 bags less than the previous year's quota, representing a revenue loss of about US$40 million; furthermore, US preferential treatment for Honduras' sugar exports has been cut back, representing an annual loss of about US$25 million. In conclusion agriculture is a key sector within the Honduran economy and under the present difficult world trade outlook agriculture must diversify rapidly to meet the impact of market fluctuations. To that end agricultural farm investment must be increased and the proposed project would help achieve this. C. Main Features and Structure Natural Resources 2.07 Honduras has a land area of 11.2 million ha, 80% of which is rugged mountains and 20% is flat to undulating land. About 6.6 million ha are forests (mostly hardwood and coniferous) and some 1.8 million ha are covered by eroded soils, swamps or urban areas. In 1981 the estimated potential farmland was about 2.8 million ha, about 1.0 million of which was used as grasslands or fallow. Use of the remaining 1.8 million ha varies each year, but currently 1.1 million ha is under pastures, 0.2 million under permanent crops, and about 0.5 million under seasonal crops. 2.08 Honduras has five geographic regions: western Honduras is mountain- ous terrain used mainly for lumber, cattle and coffee; the northeastern coastal plain has a humid tropical climate, poor soils and is used for cattle raising; the southern coastal plain has a long dry season and is used mostly for cattle raising, sugarcane, cotton and rice under irrigation; and the central valleys have relatively fertile soils that are used for similar crops. The northwestern valleys and plains hold the most productive soils and there the major banana plantations are located; it is, however, an area subject to flooding. Population 2.09 Of the country's 3.8 million inhabitants in 1982, increasing at a rate of 3.4% per annum, 64% is rural. The country has a low demographic density (32 persons per square kilometer) but an uneven distribution as most of the population is concentrated in the northwestern part of the country. Malnutrition is severe and health standards are poor with one-half of the nation's population not having access to potable water and three-quarters of the households being without sanitary waste disposal and electricity. Under- employment is pronounced although labor shortages are seasonal, almost 80% of the agricultural labor force is engaged in subsistence agriculture.  -4- Land Use 2.10 The agricultural sector shows a dichotomy in its productive and social structure. The low average yields of subsistence crops (such as basic grains) are a result of the low level of technology used by small-scale farmers. These crops are often grown on hillsides under shifting cultivation, causing erosion. These farmers have great difficulty in both obtaining production credit and in marketing their product. Export-oriented or industrial crops, such as bananas and tobacco, are usually grown under a high level of technology and in close coordination with organizations that support production and marketing. Coffee is an exception, being produced under both low and high levels of technology. Livestock production including dairy production is undertaken by both small and large farmers under a wide array of technology. Land Reform 2.11 Actual land distribution is highly skewed. According to the 1974 National Census, there were 195,341 farms, 64% of which were less than 5 ha, accounting for only 9% of the 2.6 million ha available for agricultural development (Table 1). 2.12 The first land reform legislation was decreed in December 1972 in order to create more stable political conditions as the downfall of the previous Government had been caused by land invasions by peasant groups. A more comprehensive agrarian reform law, still in force, was decreed in January 1975 and aimed at improving land utilization by transferring poorly used land held by large landowners to landless rural families. The National Agrarian Institute (INA) is responsible for land acquisition and distribution as well as for the organization, training, management and technical support including extension of the peasant settler groups. By mid-1981, INA had settled about 48,000 peasant families; about 36,000 remained organized in nearly 1,400 farmer groups, after initial desertion due to lack of adequate infrastructure. Beneficiaries were forced to form these groups to qualify for credit from the National Development Bank that later became BANADESA, but they did not always blend well into a working group and often ended with low production, splintered groups and credit mismanagement. Seventy percent of the land settled has still not been properly titled, but titling is a priority of the present Government, and external financial resources are being provided by the United States Agency for International Development (USAID). Institutions and Supporting Services 2.13 The Ministry of Natural Resources (MRN), BANADESA (paras 3.10 to 3.15), and INA (para 2.12) are the most important institutions in the agricultural sector. Other organizations in specific fields are the Honduran Banana Corporation (COHBANA), the Honduran Corporation for Forestry Development (COHDEFOR), the Honduran Coffee Institute (IHCAFE) and the Honduran Agricultural Marketing Institute (IHMA). 2.14 MRN is responsible for animal health, plant quarantine, research and extension, and some services such as machinery rental and the execution of specific projects such as the Bank-financed Guayape Rural Development  - 5 - Project. MRN received technical support financed under the First Agricul- tural Credit Project, Credit 628-HO (para 2.20), but its performance has deteriorated in the last few years owing to frequent personnel changes. USAID is presently providing funds to help improve MIRN and consolidate the extension service and research. 2.15 The marketing of major export commodities is well handled by the private sector. IHMA has begun to have a positive effect on the marketing of the four basic grains. Inefficiencies occur at the processing stage usually because of overdesigned facilities, as in the case of milk, meat, feed concentrates, cotton and sugar. Price controls through market intervention is exercised for selected products but the recent freeing of price controls at the consumer level for milk and meat is expected to act as a needed stimulant to production. Public Policy 2.16 The Government is attempting to improve the financial performance of the public sector by controlling expenditures and increasing tariffs of public enterprises. The public investment program is designed to encourage export production, particularly forestry and palm oil from the areas of Olancho and the Aguan Valley where the agricultural frontier can still be expanded. Private investment is expected to recover some of its previous dynamics on the basis of increased access to credit with the support of external credits from international banks. As mentioned above (para 2.12), the present Government is promoting effective land titling in addition to policies to strengthen the agricultural sector, such as the development of sound land use and watershed management practices; preparation of a new water law; implementation of a new seed law; training of public agricultural staff, and improvement of management personnel policies. D. Bank/IDA Involvement in the Sector 2.17 The Bank has helped develop Honduran agriculture with the Guayape Rural Development Project that is proceeding well and four agricultural credit projects, implemented by BCH. In addition to its lending, the Bank has recently undertaken two studies I/ on the sector. 2.18 The First Livestock Credit Development Project had a total project cost of US$5.2 million, of which US$2.6 million was provided by IDA Credit 179-HO; the project became effective in October 1970 and was fully disbursed by January 1975, a year before the original closing date. The objective of the project was to help diversify Honduran agriculture by increasing livestock production and exports in addition to raising beef consumption. Funds were lent to medium- and large-scale farmers to cover long-term needs for beef and dairy development and working capital for fattening operations. A PU headquartered in Tegucigalpa with three regional offices was set up in 1/ "Review of Selected Key Problems of the Agricultural Sector" (Green Cover, October 28, 1981) and "An Inquiry into Rural Population, Small Farmers and Agrarian Reform" (Gray Cover, January 14, 1982).  - 6 - BCH to promote the project and control procedures. Seven private banks participated as financial intermediaries and made sizeable financial contributions to the project (Table 2 shows both the number of subloans and amounts financed while Table 3 snows the types of activity that were financed). The Project Perforaance Audit Report (No. 1920) of February 21, 1978 showed that, compared to appraisal expectations, fewer farmers were involved for larger amounts, less pasture improvement took place but a greater number of cattle were involved; the project had increased production but mostly by extensive means of production. 2.19 The Second Livestock Development Project had a total project cost of US$11.0 milliorn, of which US$6.6 million was provided by IDA Credit 434-HO. It became effective in January 1974 and was fully disbursed by the end of 1979, a year after its original closing date. The objectives of the first lending operation were expanded to encompass lending to smaller scale livestock producers, including pig breeders. and to raunicipalities to construct abattoirs. The project also provided for the hiring of four livestock advisors; and for the training of PU staff. Nine private banks participated as well as the National lDevelopment Bank. Changes were made to the lending terms (Table 4), the main innovation being a 3% spread allowed to BCH to help cover the PU costs. The Project Completion Report (dated May 3, 1982) showed that project implementation slowed down due to the environment created by the Agrarian Reform Law as well as by a decline in the international demand for beef. As in the previous project, only about half the number of subloans expected at appraisal were financed, with a higher percentage of the funds being used for buildings and pasture development than expected. Despite. the slow disbursement, the broad objectives of the project were achieved. 2.20 The First Agricultural Credit Project has an estimated total project cost of US$20.0 million, of which US$14.0 million was provided by IDA Credit 628-HO; the Credit became effective in December 1976 and by March 31, 1983, all funds were fully committed and US$13.0 million was actually disbursed. The objectives of this project are broader than those of previouis projects, with subloans for on-farm investments being made available to the cropping subsector for agro-iiadustries and for the purchase of heavy agricultural machinery as well as to the livestock subsector. The project also included funds for technical assistance to maintain the momentum of agrarian reform by strengthening institutions such as MRN, INA, COHBANA and the Pan-American Agricultural School and to provide full time technical staff and credit to finance the rehabilitation of the Isletas banana plantation. Funds were on-lent by 10 participating barks, including the National Development Bank; the interest rate charged to sub-borrowers was increased from 9 to 11% per annum. Tne original funds for general credit activities were disbursed in only three years. BCOH provided additional counterpart funds amounting to about US$2.6 million. Despite the quick disbursement of the credit component, the slow implementation and disbursement of the technical assistance components has resulted in t1hree extensions of the project's closing date, the latest being to June 39, 1983, 2.21 The Second Agricultural Credit Project has an estimated project cost of US$38.5 million, of which US$5.0 rmillion is provided by IDA Credit 1005-HO and US$20.0 million by IBRD Loan 1833-THO the project became effec- tive in September 1980 and is still under implementation (para 1.02). The objective of the project is to provide long-term credit for farm development,  - 7 - the purchase of agricultural machinery, and the construction of municipal abattoirs. Funds were also provided for flood control and drainage works on the Ulua River to allow for more banana plantations, the implementation of a pilot forestry project, and various studies. The rediscounting percentage for financial intermediaries was changed to encourage them to lend to small-scale farmers, and a separate loan category for these farmers was established to facilitate the monitoring of funds channeled to them. Interest rates have been increased from 11% to 16% during implementation because of the higher international rates that predominated during the last two years. The disbursement of project funds is proceeding well, with 12 financial intermediaries participating but lending to small-scale farmers is proving difficult, mainly because they lack collateral. Of the 861 subloans made by December 31, 1982, 380 went to small-scale farmers, accounting for about 26% of the total investment funds on-lent. Lending has taken place for the production of a wide array of commodities, including tobacco, maize, sugarcane, cotton, citrus, oilpalm, bees, rabbits, shrimp, poultry, pigs and goats, in addition to cattle. The level of arrears in BANADESA has risen considerably and by October 30, 1982 39% of the principal and interest due was still outstanding. Implementation of the non-credit components is proceeding at a slower pace but is still satisfactory. 2.22 Over the past 12 years, there has been a gradual change in the Bank's agricultural credit projects with regard to sub-borrowers, financial intermediaries, lending terms, and activities. These changes are worth noting, as they have been taken into account in the design of the proposed project. First, sub-borrowers have changed, both in number and in economic status, from 78 cattle ranchers to about 1,800 sub-borrowers, including agrarian reform settlers. Second, the number of financial intermediaries has grown from seven to 12, and the type of institutions participating has also widened as BANADESA now is the most important institution because of both the volume of funds on-lent and because of the emphasis on lending to small-scale farmers. Third, there has been a great improvement in financial reporting by FIs, thanks to guidance from BCH's Office of the Superintendency of Banks. Fourth, the activities that are financed have changed, from exclusively cattle ranching to investment in almost any productive enterprise (para 2.21), thus encouraging diversification. The PU has also changed: in staff numbers, rising from two technicians to 34; in regional offices, going from two to five; and in expertise ranging from strict agriculturalists to economists, financial analysts and cooperative experts. This staff expertise is due to training (in part undertaken at the Bank's Economic Development Institute) and to the experience gained over time as there has been very little turnover in personnel. These improvements in the PU's capacity have enabled it to draft the Completion Report for the Second Livestock Credit Project and to be primarily responsible for the preparation of the proposed project. III. THE FINANCIAL SYSTEM A. Monetary Policy 3.01 BCH was established in 1950 with the responsibility for formulating and implementing monetary policy and supervising the banking system; it also takes an active role in economic development, policy formulation, planning  - 8 - and financing. 'BCH exercises the function of being the regulatory body for the banking system through the Office of the Superintendency of Banks that also undertakes external audits of projects financed by international banks, including past and ongoing Bank agricultural credit projects. BCH is regarded, both inside and outside Honduras, as professionally managed and adequately staffied. 3.02 As the monetary authority, BCH determines credit policy and regu- lates the flow of credit to the economy by: (a) fixing minimum legal reserve requirements on deposits; (b) determining rediscount facilities (mostly for agricultural activities and export financing); (c) setting maximum interest rates for lending and deposits; (d) fixing sector portfolio limits; (e) determining limits for external debts; (f) conducting open market opera- tions; and (g) setting exchange rates. Monetary policy in Honduras has traditionally focused on: (a) maintaining the stability of the Lempira within a system of free currency convertibility; (b) maintaining equilibrium in the balance of payments; and (c) maintaining domestic inflation at a rate not exceeding the US' level of inflation as the US is Honduras' main trading partner. 3.03 As a result of a conservative monetary policy, the historical rate of inflation in Honduras, as measured by the consumer price index, has been low compared to that in many other Latin American countries. The US dollar- Lempira exchange rate has been maintained at a 2:1 ratio for the last four decades, and, despite the recent pressure on the exchange rate, the Government plans to maintain the existing exchange rate with the support of an IMF standby arrangement. The increase of the consumer price index averaged 3.3% per annum between 1970 and 1973, but it rose to 13.9% per annum between 1979 and 1981. In 1980 inflation rose to 19% because of substan- tially higher prices of imported goods and low basic grain production; however, in 1981 and 1982 inflation abated to about 9%, as the production of basic grains improved and international inflation slowed down. 3.04 BCH's policy requires that banks in Honduras presently have to maintain a 30% reserve requirement (either in cash or Government bonds) against both their domestic and foreign liabilities. To help channel funds for productive activities, BCH has set a limit of 25% as the maximum share of domestic trade and consumption in the loan funds of commercial and develop- ment banks. However, most of the production credit is only for short-term credit; almost all long-ternm credit for agriculture in Honduras stems from Bank-financed agricultural credit projects. 3.05 Interest rates were modified infrequently in the 1960s, but since the 1970s they have played an important role in monetary policy. Following the trend in the international capital markets, in December 1982, BCH reduced the interest rate to 17% per annum on short-term loans for production credit that are financed through local resources; loans for basic grains production have a special incentive rate of 14%. There is no limit on interest rates for loans financed with foreign funds. The deposit rate has been left free to fluctuate in accordance with market forces. Both loan and deposit interest rates are reviewed quarterly in the light of domestic and foreign financial market conditions in order to ensure a positive return in real terms to domestic savers as well as to maintain the competitiveness of domestic interest rates vis-a-vis comparable rates in foreign markets.  - 9 - B. The Banking System 3.06 The banking system in Honduras consists of BCH, 15 commercial banks, three development banks namely, BANADESA, the National Investment Corporation (CONADI) and the Municipal Bank, as well as nine specialized credit institutions that are mostly savings banks and loan institutions. 3.07 The commercial private banks (11 of which participate in the ongoing agricultural credit project) operate 222 branches throughout the country; in addition, BANADESA has 28 branches. The three largest commercial banks -- Banco Atlantida, Bancahsa and Banco El Ahorro Hondureno -- accounted for 44% of the total assets of the commercial banking sector, 50% of all deposits mobilized, and 50% of the total time deposits and savings accounts of the sector as of October 31, 1981. All commercial bank assets accounted for 79% of the total assets of the banking sector at the end of 1981 and for 95% of total deposits. C. Financing Agriculture 3.08 Private commercial banks usually account for about 70% of the funds lent annually to agriculture; BANADESA accounts for the remainder. Both commercial banks and BANADESA depend heavily on BCH's rediscounting facility that is used almost exclusively for the financing of short-term credit. Although the new loans financed through the Bank's agricultural credit projects do not even amount to 10% of the total amount lent to agriculture each year, they are almost the only available source of investment financing. 3.09 The present economic crisis that Honduras is facing (paras 2.01 and 2.02) has produced a shortage of funds that has resulted in a reduction of the credit made available to agriculture. The main cropping and livestock activities financed during 1976-81 were: 1976 1977 1978 1979 1980 1981 --------------(US$ million)------------ Total new credit granted for crops and livestock 126 189 168 190 140 137 Coffee 64 108 86 74 42 24 Sugarcane 8 21 10 19 14 19 Basic grains 9 8 11 12 16 20 Livestock 17 17 20 31 26 24 Other 28 35 41 54 42 50 Despite the crop diversification that has begun to take place in Honduras, the increase in the financing of activities other than coffee, has not been sufficient to compensate for the decline in the financing of coffee that occurred because coffee prices dropped after 1977. However, the Bank's previous agricultural credit projects (Table 3) and particularly the ongoing Second Agricultural Credit Project (para. 2.21) have been specially important in promoting the diversification of agricultural production. The proposed project would continue with this objective.  - 10 - D. National Bank of Agricultural Development 3.10 The National Bank of Agricultural Development (BANADESA) was created from the National Development Bank in March 1980, as an autonomous Government institution with an authorized capital of L 75 million. BANADESA's Board of Directors is made up of the Ministers of MRN (Chairman), Economy, Finance and Public Credit; the Executive Secretaries of the Superior Council of Economic Planning and INA; the President of BCH; representatives of the associations of farmers, cattlemen and the peasant organizations; and BANADESA's Executive President. The Board decides credit policies and annual budgets and approves the naming of senior staff. A smaller Executive Committee, made up of selected Board members, has the power to approve major loans, interest rates and the opening and closing of branches. The three main managers of the bank are in charge of Operations, Administration and Finance; legal counsel and the head of Special Studies also report directly to the Executive! President. In October 1982, the bank had a total staff of nearly 1,000 employees, 40% of whom were based in the Tegucigalpa headquarters. 3.11 The Government did not immediately arm the new i-nstitution with adequate financing because of the lack of resources. Finally in July 1982, the National CorLgress authorized BANADESA's gradual capitalization program (1982-96) with L. 114.9 million to cover: the previously authorized capitalization of L 75.0 million, an inherited deficit from the National Development Bank of L 27.8 million and various portfolio losses of L 12.1 million. At theu same time Congress authorized the Government to become the guarantor of a loan given by BCH to BANADESA for L 107 million under favorable terms to help reschedule the loans BANADESA had with BCH itself, 3.12 BANADESA's income statements show that it has suffered losses since it was founded; its losses for the last nine months in 1980 amounted to L 7.1 million and in 1.981 losses rose to L 16.3 even though no allowance was made for unpaid sublcans that fell due that year. The negative equity BANADESA shows on its balance sheet results from operating losses that in turn are mostly because of high administrative costs and a very poor rate of recovery of its loan portfolio. 3.13 BANADESA's loan portfolio as of December 31, 1981 totalled L 143,9 million. Current loan portfolio, without arrears, amounted to 47% of the portfolio, arreaLrs exceeding 12 months amounted to 23%, arrears of less than 12 months amounted to 15%, rescheduled loans to 9% and loans with partial arrears to 6% of the portfolio. Partial unaudited data for the first six months of 1982 indicates that loan collection has not improved. Several factors contribuLte to BANADESA's extremely low rate of loan recuperation: inadequate drafting and supervision of farm developmeLnt plans, lengthy subloan processing, poor field supervision of the use of the funds provided to sub-borrowers and insufficient collection efforts. 3.14 BANADESA's past loan recuperation performances under Bank-financed projects has not. been much better than that of the overall institution; 55% of the principal and 29% of the interest payments; 39% of the amounts due on Bank-financed suLbprojects was outstandinng as of October 30, 1982 (para 5.O8).  - 11 - 3.15 BANADESA's problems are not new; the previous National Development Bank, despite costly studies financed by international donors was an equally weak institution that was dismembered with the hope of creating a new, strong institution. This did not occur; BANADESA is inadequately run and in serious financial disarray. However, BANADESA is the main source of funds for on-lending to small-scale farmers and in that light its participation under the project, within conditions that were agreed upon at negotiations, is possible and desirable. The proposed strategy and suggested conditionality for dealing with BANADESA is outlined in paragraphs 5.07 to 5.10. IV. THE PROJECT A. Brief Description 4.01 The project would consist of: (a) a nationwide credit program to finance, through rediscounting facilities, investments in rural areas for both on- and off-farm activities; (b) the incremental short-term credit needed to complement long-term investments; (c) incremental PU administration costs; and (d) training for PU staff, the financial intermediaries'(FIs) staffs,including BANADESA, and farmers. B. Detailed Features Credit Program 4.02 The credit funds are expected to be committed by the banking system in three years and disbursed in four. Most of the funds would be used to finance farm development, but funds could be used to finance any rural activities, including non-farm activities such as milk collection centers or cottage brick-making. Participating FIs would bear the credit risk and would provide part of the funds. About 40% of the total credit funds are expected to be lent to small-scale farmers (para 5.19), most of whom would be settlers in agrarian reform groups. Cost details of the credit components are shown in Table 5. 4.03 Specific investments would consist of items such as pasture devel- opment, fencing, water supply, farm buildings, machinery and breeding animals. Complementary short-term capital would be provided under the project to finance the seasonal production costs such as seed, fertilizer and labor that are related to the investment plan. Most of the lending is expected to follow the pattern established under the ongoing projects with  - 12 - different average subloan sizes according to the type of sub-borrower. For example in 1982 small-scale independent farmers spent about US$15,000 on investments and about US$5,000 for their first-year short-term credit requirements, however, small-scale farmers who borrowed as a collective group usually required about US$60,000 for investments and nearly US$30,000 for their short-tern capital needs. Larger scale farmers, on average, spent about US$50,000 on investments and required some US$15,000 for short-term capital. Project Unit 4.04 The PU in BCH would administer the program. Three new staff posts would be created at headquarters: a Deputy Director, an Extension Specialist, and a Training Coordinator. All PU staff would receive a better benefits package and one that would be comparable to that received by other BCH staff. A new office would be started in Juticalpa, Department of Olancho. A computer would be installed at PU headquarters to assist with financial analysis, monitoring and evaluation, administration, accounting, and the control of subloan repayments. Ten vehicles would be purchased for use by the PU staff. Consultant services would be used by the PU, as described in paragraph 5.04. Cost details of the PU component are shown in Table 6. Training 4.05 PU staff, who are usually agriculturalists, are expected to require training mostly in finance and banking. FIs' agricultural loan officers would be trained in credit analysis and project appraisal; BANADESA's agricultural loan officers would, in addition, be trained in loan collection while branch managers would be provided with general banking courses. Training for farmers would be geared toward small-scale settlers and would cover bookkeeping, credit management, administration, accounting and cooperative management. Cost details of the training component are shown in Table 7. C. Cost Estimates and Financing 4.06 The total project cost is estimated at US$73.9 million, of which about 33% represents foreign exchange. As most of the goods and services expected to be f-inanced under the project are exempt from taxes, there are no significant taxes included in the project cost. Costs are based on September 1982 prices; price contingencies have been allowed for the PU and training components and are based on international inflation figures of 8% in 1983, 7.5% in 1984 and 7% in 1985; the domestic inflation figures used differ only in 1983, when 9% was used. The summary of the project cost is shown on the following page:  - 13 - Project Cost Foreign Baseline Project Components Local Foreign Total Local Foreign Total Exchange Cost