China - Second Rural Credit Project

Document of The World Bank FOR OFFCIAL USE ONLY Repwt No. 5810-CHA STAFF APPRAISAL REPORT CHINA SECOND RURAL CREDIT PROJECT November 25, 1985 Projects Department East Asia and Pacific Regional Office I ths duueag bas a rMoMi ijutlb.. aM may be mad by rntsleub oly In the perfornance of their oWld doi& lb mknt way so odhrwis be dicbosed witwot World BDank aborlaon  CURRENCY EQUIVALENTS Yuan (Y) 1.00 = US$0.36 Y 2.80 = US$1.00 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 miles 1 hectare (ha) = 2.47 acres (ac) = 15 mu 1 kilogram (kg) = 2.2 pounds (lb) = 2j in I ton (t) = 1,000 kg - 2,205 pounds ABBREVIATIONS AND ACRONYMS ABC - Agricultural Bank of China BOC - Bank of China RCCs - Rural Credit Cooperatives PBC - People's Bank of China MAAF - Ministry of Agriculture, Animal Husbandry and Fisheries PMC - Proiect Management Committee PO - Project Office PU - Project Unit IFAD - International Fund for AgriculturaL Development p.a. - per annum cu m - cubic meter mm - millimeter  FOR OMCIAL USE ONLY CHINA SECOND RURAL CREDIT PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. I. BACKGROUND ............................................... 1 Agricultural Sector ....... ........................... 1 Bank Assistance to Agriculture .................... .... 2 Project Rationale .... 4 II. AGRICULTURAL BANK OF CHINA .. 5 Objectives .. 5 organization ... 5 Staffing .............................................. 6 Training .............................................. 6 Operating Policies and Procedures ..................... 7 Interest Rates .............. ................ .. O... 8 Sources and Uses of Funds . . . 9 Accounting Systems and Auditing .................... . ... 10 III. PROJECT AREA AND BENEFICIARIES .................... ....... 11 Location ............................................... 11 Agricultural Situation .............................. 11 ABC Organization and Operations ..... .................. 12 Other Agricultural Support Services ................... 13 Project Beneficiaries .. 13 IV. THE PROJECT ............................................... 14 Objectives ....................................................... 14 Description ............ ......... 14 Cost Estimates and Financing .. 17 This report is based on the findings of a project preparation mission and an appraisal mission which visited China during November 1984 and April 1985 respectively. Members of the preparation mission were S.J. Khoo, E. Zuckerman, W.P. Ting (IDA), M. Johnson, M. Dendy and J. Cowley (consultants). The appraisal mission comprised S.J. Khoo, R. Deshpande, E. Zuckerman (IDA), R. Koo, T.S. Chang, L.C. Chen and C. Crorberg (consultants). This document has a restricted distribution and may be used by rcpicnts only in the performance of their ofricial duties. IIs contents may not otherwise be disdosed without World Bank autborization.  Page No. Procurement ............................................... 19 Disbursements ............... 20 V. PROJECT IMPLEMENTATION .................................... 21 Organization and Management .. 21 Subloan Terms and Conditions .............................. 23 Accounts, Audit, Monitoring and Evaluation . . 24 Environmental Impact .. 25 VI. MARKETS, PRICES AND FARM INCOMES .......................... 25 Market Prospects . . . 25 Prices .................................................... 26 Farm Incomes and Employment . . . 27 VII. BENEFITS, JUSTIFICATION AND RISKS ......................... 27 Production Benefits . . . 27 Other Benefits . . ........... 28 Financial Analysis . . . 28 Economic Analysis ........ 29 Risks ..................................................... 30 VIII. AGREEMENTS REACHED AND RECOMMENDATIONS ................ .... 31 ANNEXES 1. Table 1: Consolidated Balance Sheet of the Agricultural Bank of China, 1983-1984 Table 2: Consolidated Income Statement of the Agricultural Bank of China, 1983-1984 2. Agriculture in the Project Areas: Fujian and Hunan 3. ABC's Operations in Fujian and Hunan 4. Principal Input and Output Prices and Conversion Factors 5. Table 1: Freshwater Fisheries (New) Table 2: Freshwater Fisheries (Improvement) Table 3: Shrimp Production Table 4: Orange Orchard Table 5: Litchi Orchard Table 6: Poultry Breeding and Egg Production Table 7: Fish Freezing/Cold Storage Table 8: Fish Feed Processing 6. Estimated Disbursement Schedule 7. Related Documents and Data in the Project File MAP IBRD 18971  - lli - CHINA SECOND RURAL CREDIT PROJECT Credit and Project Summary Borrower: People's Republic of China Beneficiary: Agricultural Bank of China (ABC) Credit Amount: SDR 84 million (US$90 million equivalent) Credit Terms: Standard Relending Terms: From Government to ABC: 20 yRars, including five years grace, with interest at 3Z p.a. and commitment fees of 0.5% p.a. Repayment of principal by ABC would be the amount of Renminbi used and the SDR equivalent of the foreign currency used. From ABC to subborrowers: Interest at prevailing rates, currently ranging from 5.76% to 10.08Z p.a. with maturities and grace periods depending on subproject cash flows. Where ABC extends subloans using foreign currency, ABC would pass on the foreign exchange risk to subborrowers. Project Description: The project would expand the Bank Group's support of ABC's medium and long-term lending for the diversification and modernization of agricultural production and processing which was initiated by the ongoing first Rural Credit Project (1462-CHA). Project subloans would be provided by ABC to individual farmers and households, collective units, and enterprises owned by local government entities and collectives in the two provinces of Fujian and Hunan to finance investments for the development of aquaculture, orchards, agro-processing and livestock enterprises. A technical assistance component is included in the project for effective project implementation and to strengthen the operations of ABC. At full development, the value of the incremental output of the project would be about US$140 mil- lion per annum. The project would benefit directly some 16,000 families from increased production and incomes, and generate additional employment equivalent to 61,000 full- time jobs. The project faces no significant technical or administrative risks.  - iv - Estimated Costs: Local Foreign Total - - --- (US$ million) -- Aquaculture 89.1 7.7 96.8 Orchards 79.9 8.8 88.7 Agro-processing 27.9 18.7 46.6 Livestock 15.9 4.1 20.0 Technical assistance 1.5 3.3 4.8 Total Project Cost 214.3 42.6. '56.9 /a Financial Plan: Total (US$ million) IDA 90.0 ABC 90.0 Subborrowers 77.0 Total 257.0 Estimated Disbursement: IDA FY 1987 1988 1989 1990 1991 Annual 5.4 18.0 25.2 26.1 15.3 Cumulative 5.4 23.4 48.6 74.7 90.0 Rate of Return: 28% /a Taxes and duties of about $7 million are included in the cost estimates.  CHINA SECOND RURAL CREDIT PROJECT I. BACKGROUND 1.01 The Government of China has requested an IDA credit of US$90 million equivalent to finance a second rural credit project (Rural Credit II Pro- ject). Project funds would be channelled through the Agricultural Bank of China (ABC) to finance investments for the development of aquaculture, orchards, agro-processing and livestock in the two provinces of Fujian and Hunan (attached Map IBRD 18971). The project would be an expansion of the Bank's support of ABC's medium and long-term lending for investments to increase farm and rural output and incomes through che diversification and modernization of agricultural production and processing initiated by the on- going first Rural Credit Project (Credit 1462-CHA) which finances similar type investments in the Guangxi Autonomous Region (para. 1.09). The project would also include a technical assistance component for effective project implemen- tation and to strengthen the operations of ABC. Agricultural Sector 1.02 Agriculture, including livestock, forestry and fisheries, provides sustenance to China's population of over one billion people and is the main source of livelihood for the rural population of some 800 million. Only about 100 million ha of China's land area of 960 million ha are arable. Farming systems are intensive with large inputs of labor and organic fertilizers and, more recently, chemical fertilizers and other agricultural chemicals. Nearly half of the arable land is irrigated and more than half of this area grows at least two crops per year. Foodgrains occupy about 80Z of the cropland and account for 65% of total agricultural output. This intensive system of food production allows China to meet the basic food requirements of its population (about 22% of the world's total) from less than 8% of the world's arable land. Following the introduction of the production responsibility system in 1979 (para. 1.05), collective farming has been largely abandoned and agricultural production is carried out mainly on household-managed farms within a framework of collective or state ownership of land and major fixed assets. 1.03 Agriculture, which accounts for about 35% of the country's CDP, has been accorded high priority since the founding of the People's Republic. Despite a virtually unchanging area of cultivated land due to the limited availability of additional arable land, efforts to develop China's agriculture have been successful. The value of agricultural output has grown at an annual average of about 7% since 1979, or more than twice the rate achieved over the previous two decades. Output of foodgrains increased by about 3.4% annually over the last decade, reaching a record 407 million tons in 1984. Net grain imports, which had risen to about 15 million tons p.a., have begun to de- cline. In nominal terms, per capita incomes of farmers in 1983 were 2.3 times those of 1979. There has also been a substantial diversification of the  - 2 - agricultural sector in recent years with the rapid expansion of cash crops, such as oilseeds, cotton, sugar, fruits, livestock and fisheries. 1.04 The basic long-term objective for the agricultural sector is to increase the production of food and economic (industrial) crops to meet requirements created by population and income growth and export demand. Priority is given to accelerating the expansion of livestock, fisheries, horticultural and other higher value foods to meet their rapidly tising demand resulting from increasing per capita incomes (para. 6.01). Achievement of the basic long term objective will help realize other development goals of expand- ing rural employment, improving the quality (nutrition) of food consumption, raising living standards and minimizing the use of foreign exchange for food and agricultural raw material imports. In land-scarce China, attainment of the production objective requires higher yields from existing cropped areas, efficient development of the few areas of underutilized land, diversification of production into higher value non-foodgrain crops, livestock and fisheries, increased facilities for agricultural processing and marketing, fuller use of the rural labor force, and use of improved technology to increase the effici- ency of agricultural production. 1.05 Improved incentives to producers are also essential and have been at the heart of policy reforms instituted in recent years. These reforms, which together have been a major contributing factor to the exceptionally good performance of the agricultural sector since 1979 (para. 1.03), include: (a) introduction of the production responsibility system, a generic name for various contracting arrangements between the owners of assets (state, collec- tive, or private) on the one hand and managers of these assets (essentially individual or groups of households) on the other, which would permit the latter to retain production in excess of some agreed level; (b) increased producer prices; (c) lengthening the lease periods for use of farm assets, e.g. up to 15 years for land growing annual crops and up to 50 years for land growing tree crops; (d) reducing the number of agricultural commodities sub- ject tc production quotas and/or price controls and allowing market forces to determine the prices of an increasing number of commodities; (e) lifting restrictions on rural "free" markets and widening the range of farm products permitted in local trade; (f) encouragement of private or joint public-private enterprises in rural agro-processing, transport and commerce; and (g) expanding the flow of credit to rural areas, principally through the Agricultural Bank of China. Bank Assistance to Agriculture 1.06 The Bank's lending to China's agricultural sector is designed to support the Government's efforts to raise and diversify agricultural produc- tior. through more efficient use of land, water and labor resources and through improvements in support services such as credit, research and agricultural education. Projects are selected for their demonstration effect in addition to income generation. Suitable opportunities have been found among a wide range of activities and locations. 1.07 The North China Plain Agriculture Project (Cr. 1261-CHA), the first Bank Group operation in the agricultural sector, will provide irrigation and  - 3 - drainage for 200,000 ha covering parts of nine counties in three provinces; it is the first large-scale attack on soiL salinity and waterlogging in China. The AgricuLtural Education and Research Project (Cr. 129i-C!fA) supports the Government's program to strengthen higher- education and research in the agri- cultural sector by providing technicaL assistance and equipment to selected agricultural colleges and research institutes. The Heilongjiang Land Reclama- tion Project (Ln./Cr. 2261/1347-CHA) is developing some 200,000 ha of new Land through land reclamation and introduction of modern farming equipment in the Northeast. The Rubber Development Project (Cr. 1417-CHA) in Guangdong Province involves new pLanting of about 25,000 ha and replanting of some 15,000 ha of rubber with high yielding cLones. The first Rural Credit Project (Cr. 1462-CHA) finances investments in the development of orchards and other economic tree crops, agro-processing, livestock and aquaculture through the Agricultural Bank of China in Guangxi (para. 1.09). The Second Agricultural Research Project (Cr. 1516-CHA) will expand and improve 15 agricultural research centers and include a pilot project for 10 agro-technical extension centers. The Seeds Project (Cr. 1577-CHA) will modernize facilities at 18 seed production, processing and distribution centers in 12 provinces and two autonomous regions to increase the supply and improve the quality of certified seeds. The Forestry Development Project (Cr. 1605-CHA) would esta- blish about 82,000 ha of forest plantations and improve the management and exploitation of 122,000 ha of existing forests in Guangdong, Heilongjiang and Sichuan, and strengthen forest research facilities and extension services. The Pishihang-Chaohu Area Development Project (Ln./Cr. 2579/1606-CHA) would improve irrigation and flood control drainage on about 710,000 ha in the Pishihang and Chaohu areas in Anhui Province. 1.08 Other projects at various stages of processing are an aquaculture project and a red soils area development project. Future project possibil- ities include livestock, agro-industries, and land development in the Northwest. 1.09 The First Rural Credit Project (Credit 1462-CHA). The project pro- vides funds to the Agricultural Bank of China (ABC) for medium and long-term loans to individual farmers and households, cqllective units and state-owned enterprises in the Guangxi Autonomous Regionl for investments in orchards and other tree crops, aquaculture, livestock and agro-processing; and technical assistance to ABC. The major objectives of the project were to (a) support a three-year lending program of the ABC which would be part of a high priority government development effort to increase agricultural and rural production and incomes through the diversification and modernization of agricultural production and processing, and (b) assist ABC in developing and implementing procedures and methodologies for appraising agriculture and rural development projects. Other objectives were aimed at expanding rural employment and making fuller use of the ample rural labor force, alleviating rural poverty, raising the value added of agricultural production, improving production 1! At the time of appraisal ot this project, the Bank also appraised on behalf of IFAD a similar type project which supports ABC's medium- and long-term Lending for agricultural diversification in Hubei Province. The proposed Rural Credit IT Project would in effect be the third such project for ABC.  - 4 - efficiency, and increasing the supply and quality of agricultural produce, including processed foods, to consumers. 1.10 Total project costs were estimated at about $142 miLlion of which IDA financed $50 million (35%), ABC $30 million (21Z), the Government $20 mil- lion (14%) and subborrowers $42 million (30%). The project, which is sche- duled to be completed by the end of June 1988, became effective on November 1, 1984. Implementation of the project has been proceeding well and project lending is ahead of schedule. ABC had as of the end of April 1985 already appraised 449 sublaans for Y 221 million of which 210 subloans for Y 86 mil- lion (31Z of tocaL project funds) were approved as of the end of 1984 (para. 1.13). 1.11 To facilitate preparation of the project, a team of ABC senior staff visited development banks in Pakistan and Mexico prior to project appraisal to learn about their experiences in preparing and managing Bank-financed credit projects. The project is also inancing three overseas study tours to a tocal of six countries to allow project staff to observe rural credit project impLe- mentation in countries with experienced development credit institutions and Bank-financed projects. The first such tour to India and the Philippines was completed in June 1985. In addition, five local training courses have been conducted since November 1983 mainly for ABC Guangxi staff. To facilitate preparation and implementation of the Rural Credit II Project, over 30 ABC staff from Fujian and Hunan also attended the Guangxi courses. Of the five training courses, two were on agricultural investment analysis, two on agricultural finance and accounting and one on project appraisal mechods. The ABC Project Appraisal Manual was the primary training material in these courses. The training was conducted by ABC Guangxi staff who had earlier attended the EDI training courses in Shanghai (para. 2.08). Project Rationale 1.12 As part of China's effort to diversify, modernize and enhance the efficiency of its agricultural sector, the Government is increasing the role and autonomy of the banking system and making more use of credit instead of grant finance of development projects. ABC has a large staff and a wide network of offices which serve households, collectives and state enterprises throughout the rural areas of China. ABC's capacity to lend for projects aimed at agricultural diversification is constrained, however, by the limited availability of medium and long-term funds and by its lack of experience with sound technical, financial and economic analysis of developmenc projects. The major rationale for the Bank's expanded involvement with ABC is therefore to assist ABC both in expanding the availability of medium and long-term funds for agricultural diversification and in developing and implenienting improved project appraisal techniques. 1.13 Under the first Rural Credit Project (para. 1.09), considerable progress has been made in upgrading the technical and financiaL expertise of ABC in Guangxi. A project appraisal manual has been prepared with the assi- stance of the Bank and distributed to offices throughout Guangxi as well as other provinces and regions and a series of training courses in the use of the manual have been held. The technical capabilities of ABC have also been  - 5 - enhanced by secondmenc to ABC of experts from various technical bureaus. The quality of project preparation and appraisal is improving and project imple- mentation is proceeding well. 1.14 Under the Rural Credit II Project, it is proposed to extend the experience gained in the appraisal and supervision of subprojects in the first project to two other provinces, Fujian and Hunan. In addition, more emphasis will be placed on training of ABC staff in appraisal of agricultural and agro- processing investments and the dialogue with ABC headquarters on its overall financial situation and future role in a reformed financial system. This will complement the study on investment finance in China that the Bank will shortly be initiating. II. AGRICULTURAL BANK OF CHINA Objectives 2.01 The Agricultural Bank of China (ABC) is the dominant institution in the mobilization of rural savings and the financing of agriculture and rural development. ABC's general objective is to contribute to the effective execu- tion of Government economi': policy throughout the rural areas of China. Its activities extend beyond agricultural lending to include financing rural com- mercial and industrial activities which support agricuLture and -Tural develop- ment. In addition to its main tasks of mobilizing rural financial resources and excending credit and a wide range of banking services to the rural areas, ABC provides leadership to the large network of rural credit cooperatives (para. 2.33) and financial guidance to collectives (communes, production brigades and production teams) and other rural organizations. The communes and production brigades have recently been renamed townships (xiang) and villages (cun) respectively. Organization 2.02 ABC is headed by a President who is assisted by four vice presi- dents. It has 12 departments (planning, personnel, staff supervision, agri- cultural credit, rural industrial and commercial credit, external affairs, accounting, rural credit cooperatives, investigation and studies, technology and education, research, and general affairs). The planning department plays a major coordinating role in ABC's operations and is also responsible for the collection of statistics. The agricultural credit and rural industrial and commercial credit departments are responsible for appraising and recommending agricultural loans and rural industrial and commercial loans respectively. The rural credit cooperatives department oversees the management and opera- cions of the rural credit cooperatives (para. 2.04). A basically similar organizational structure exists in ABC's provincial and regional branch offices (para. 2.03). 2.03 At the end of April 1985, ABC had 28 branch offices in the capital cities of the provinces and autonomous regions and the two municipalities of Shanghai and Tianjin, 304 central subbrqnches at the prefecture or district level, 174 business offices in major urtL.n centers, 2,260 subbranches at the  - 6 - county level, 25,350 offices at the township (commune) level, 1,090 offices on state farms and 405 savings offices in urban areas. The bank is therefore represented at all administrative levels with close to 30,000 offices spread throughout China. In addition to the above network, there are about 56,000 rural credit cooperatives (RCCs) which, although collectively owned and managed, operate effectively as part of the ABC network (para. 2.04). This means that virtually all of China's 53,000 townships and 2,000 state farms have at least one ABC office or RCC in their area. This extensive national coverage is a major strength in ABC's operations and reflects ABC's role as a banker to the rural community as well as its responsibility as the financial agent of the central and local governments for the rural areas of China. 2.04 RCCs play a major role in the mobilization of savings and provision of credit at the township (commune) and lower levels. Between 1979 and 1983, RCC deposits more than doubled from Y 21.5 billion to Y 48.7 billion while subloans disbursed increased fourfold from Y 4.8 billion to Y 16.4 billion. Lending by the RCCs is generally focussed on short-term loans to individual farmers, households and collectives, whereas the larger and longer-term loans are usually provided by ABC. RCCs are required to deposit at least 30% of their funds with ABC (para. 2.15). ABC supervises the management and opera- tions of the RCCs, including carrying out periodic inspection of the accounts and training staff. Staffing 2.05 ABC has a total staff of some 328,000. Of this total, nearly one- fourth are women. The staff at the head office in Beijing is small (about 400 persons) reflecting the decentralized character of the bank. In addition to the ABC employees, the RCCs employ some 250,000 staff on a full or part-time basis. A small proportion of the ABC staff (less than 5%) are university graduates. Local office managers and department heads are usually middle school graduates with professional training at the banking schools (para. 2.06). Training 2.06 Most ABC and RCC staff at the local level have had many years of experience in rural finance. For training of its staff, ABC generally relies on the two year courses offered by the banking schools of the People's Bank of China (PBC) or in-house training and part-time courses at local colleges or universities. The PBC banking schools, of which there is one in each province/autonomous region, provide training for the staff of PBC, ABC, China Investm-nt Bank and the Bank of China. With the increasing importance accorded to training of its staff, ABC has in recent years established 163 in- house training centers of which 134 are for staff at the county level and below, 27 for staff in the capital cities of the provinces and autonomous regions, and 2 for senior management staff. Although the major emphasis of both formal and in-house training continues to be on accounting and banking, project appraisal methodologies are being introduced to the curricula beginning with the training of ABC staff in Guangxi, Hubei, Hunan and Fujian which have or are expected to have credit projects financed by the Bank and IFAD (para. 2.08).  2.07 In recent years ABC has also been attempting to improve the quality of its project appraisal work. Emphasis continues to be placed on ensuring that projects conform to the state plan and overall government policy, chat the necessary supplies and materials are available and that there are markets for the project output. However, most of the project proposals are still not reviewed in much detail; there is little examination of issues of scale, tech- nology, location and timing of proposed projects, and formal financial or economic anaLysis using discounting techniques is usually Lacking, althougn pay-back periods are calculated and used as supplementary criteria for invest- ment decisions. This deficiency is because the Large majority of ABC staff are generally not trained in project appraisal methodology and therefore have little experience with technical, financial and economic analysis of develop- ment projects. 2.08 To help address this issue and to ensure that ABC staff can under- take proper appraisal of subloans under the first Rural Credit Project (para. 1.09) and the proposed Rural Credit II Project, the Economic Develop- ment Institute (EDI) conducted in Shanghai three training courses on agricul- tural investment analysis and financing for about 100 ABC staff in 1983, 1984 and 1985. Twelve staff from the Ministry of Agriculture and cher Government agencies also participated in the training courses. However, Lne staff trained by EDI can meet only a small proportion of ABC's needs. ABC itself will carry out similar training courses to fully meet its requirement of trained project appraisal staff. A start on this was made by ABC in the five training courses it has conducted since November 1983 mainly for ABC staff involved in implementing the first Rtural Credit Project and preparation of the Rural Credit II Project (para. 1.11). 2.09 To improve its project appraisal, ABC with the help of Bank staff recently prepared a Project Appraisal Manual (para. 1.13). The Manual provides guidelines for project appraisal and is also being used in ABC's training of project appraisal officers. The appraisal of subloans under the Rural Credit II Project would be based on the Manual as in the case of sub- loans under the first Rural Credit Project. Some 150,000 copies of the Manual were printed and distributed in December 1984 to all ABC offices involved in project appraisal work throughout China. Operating Policies and Procedures 2.10 ABC now has considerably more authority regarding individual invest- ment decisions at the local level than it did several years ago and is playing an increasingly important role in rural investment financing with the switch in emphasis from grant to loan financing of rural development projects. With increasing autonomy granted to ABC on investment decisions, sound project appraisal by ABC has therefore become more important. Large projects requir- ing funds from ABC, especially those in industry and commerce, still require approval by local government planning committees and relevant line agencies as well as by ABC. For smaller projects and almost all agricultural projects, however, the planning committee decides only on the total amount of loans to be made (taking into account available materials and supplies and other sources of finance). ABC then approves the allocation of those resources among different types of projects and different areas and townships.  - 8 - 2.11 Procedures for loan approval by ABC offices at different levels have been established by ABC Beijing and are uniform throughout the country. At present ABC and RCC offices at the township level and on state farms have authority to approve agricultural loans of up to Y 10,000 to individuals/ households and up to Y 30,000 to collective units and other borrowers. Loans in excess of these limits but less than Y 500,000 require the approval of ABC's county offices. Loans of Y 500,000 to Y 800,000 would need to be approved by ABC's prefectural offices. Loans larger than this amount and up to Y 2 million require approval by ABC's provincial offices, while loans exceeding Y 2 million require approval by ABC Beijing. 2.12 ABC is placing increased emphasis on project supervision and monitoring. It enters into a formal contractual arrangement with the borrower which stipulates the loan amount and disbursement schedule, specifies the type, quality, quantity and delivery time for the equipment, indicates the repayment schedule for the borrower and requires the timely repayment of the loan. The contract also provides for remedies in the event of default, such as suspension of loan disbursements, acceleration of loan maturity and penalty interest. The State Council recently promulgated Loan Contract Regulations which stipulate and confirm these provisions. On completion of a project, ABC compares the actual use of funds with the stated intent and measures produc- tion achievements against targets. ABC plans to assess the lending experience gained under the first Rural Credit Project as a guide to further loan opera- tions and monitoring. Interest Rates 2.13 Recent economic reforms, including banking system reforms, have increased the role of interest rates in the Chinese economy and lending and deposit rates have been raised significantly. During 1985 ABC increased its lending rates twice, in April and August. ABC's present lending rates range from 5.76Z to 10.08% p.a. The average rates for loans of three to five years and more than five years are 8.28Z and 9X respectively. These rates are about four times the rate (2.16Z) charged in 1981 and are positive in real terms. ABC expects its lending rates to remain positive. 2.14 During the last three years there have been a series of increases in the interest rates payable by ABC on individual deposits with the latest increase in August 1985 when interest rates on time deposits were raised by 0.72-1.44Z p.a. Demand deposits of individuals now earn interest at a rate of 2.88% p.a. and rates on time deposits range from 6.12% p.a. for a six-month deposit to 10.44% p.a. for an eight-year deposit. Interest rates payable by ABC on deposits of organizations range from 2.7% p.a. for dpmAnd deposits to 5.8% p.a. for a three-year time deposit. China has had a history of generally positive real interest rates on deposits and recent increases are expected to contribute to greater savings mobilization in rural areas.  -9- Sources and Uses of Funds 2.15 ABC's sources of funds mainly comprise deposits and capital contri- butions from the central government. Major deposits (both demand and time) as of December 31, 1984 were those of the RCCs (Y 37.2 billion), rural commer- cial, industrial and state-owned enterprises (Y 16.3 bilLion), individuals (Y 9.7 billion), local governments (Y 3.5 bilLion), and other deposits (Y 3.4 billion). The capital contribution from the central government (net of write offs) totalled Y 21.1 bilLion at the end of 1984 as against Y 20 billion at the end of i980. Sources of RCC financing incLude deposits from indivi- duals and coLlectives (township and village enterprises), operating profits, member subscriptions and Loans from ABC (para. 2.16). In general, RCC deposits with ABC exceed ABC loans co the RCCs i.e., they are nec suppliers of funds to ABC. Deposit policy of both the ABC and the RCCs emphasizes volun- tarism in deposits and withdrawals, confidentiaLity, and payment of interest on all deposits by individuals and collective units. 2.16 ABC's tgtal loans outstanding as of the end of 1984 amounted to Y 112.4 billion.2 The majority of the portfolio are short-term loans. Loans to rural commercial and industrial enterprises (mostly short-term loans to supply and marketing cooperatives) accounted for 63% of the portfolio, loans to collective units 21%, loans to state-owned agricultural enterprises 6%, loans to individuals 4%, loans to the RCCs 3%, and other loans 3%. Until recently, ABC also acted as an agent for PBC in a number of fields, of which the most important were loans to the commercial departments of the Ministry of Food and Commerce for the purchase of agricultural commodities from producing units. The amounts on-lent by ABC on a commission basis, have been substan- tial (Y 48.0 billion at the end of 1984). As the former agency activities are expected to be increasingly funded by ABC with its own funds, the relative importance of its major sources and uses of funds, and items of revenue and expenditure would undergo significant changes in the future. Recent interest rate reforms would enable ABC to supplement its resources by greater deposit mobilization and to safeguard its profitability through improved interest spreads (paras. 2.14 and 2.19). 2.17 The RCC loan portfolio has grown rapidly - more than doubling (103%) between 1979 and 1983 - largely reflecting 34arp increases in loans to commune and brigade enterprises and to individuals.- By the end of 1983, loans to individuals were 71Z as large in total volume as all agricultural loans to communes and brigades. It was 48% at the end of 1979. As production on pri- vate plots increases and as the production responsibility system expands, RCCs are likely to become increasingly important in generating deposits and making loans. Loans to individuals are among the fastest growing elements in the RCC loan portfolio. The continuing rapid growth in RCC lending is reflected in its year-end total loans outstanding of Y 16.4 billion in 1983 compared with Y 12.15 billion in 1982, a substantial increase of 35%. 2/ This does not include loans by the RCCs. 31 Data for 1984 are not yet available.  - 10 - 2.18 ABC reported a profit of Y 1,755 milLion in 1984. Revenues were de- rived mainly from interest earnings, agency fees and interest from deposits (Y 8,084 million). Expenditures were mainly for interest paid (Y 5,856 mil- lion), and administration, including salaries (Y 1,239 miLlion). Administra- tion costs of about 22 of total resources employed are reLatively low by international standards and reflect generally Low salaries. 2.19 ABC estimates that bad debts currently are less than 2% of Loans outstanding. ABC has recently issued a set of guidelines to its branch offices on treatment of bad debts in its agricultural loan portfolio and pro- cedures for their write-off. Under the guidelines, subloans for failed enter- prises and activities which cannot be collected from the guarantors or by sale of mortgaged properties must be written off annually. ABC's county, prefec- tural and provincial leveL offices are aLLowed to write off individual bad debts of up to Y 1,000, up to Y 10,000 and up to Y 100,000 respectively. A reporting procedure has aLso been introduced for monitoring the assessment and write-off of bad debts. During 1984, ABC wrote off bad debts amounting to about Y 880 million by utiLizing a part of its equity provided by the Govern- ment. The majority of the bad debts were due to loans made during the Cul- tural Revolution (1966-1976) when appraisal and supervision of loans were lacking and which are now therefore uncollectable. It is expected that ABC may have to write off from the outstanding loan portfolio a further sum of Y 1.0 billion over the next few rears. However, in view of its sizeable equity (Y 21.1 billion), ABC's overall financial condition after the write off would remain satisfactory. Also, to help maintain and improve its loan recovery performance ABC now places more emphasis on subproject appraisal and full and timely repayment of its loans. ABC's overall liquidity and profit- ability are closely monitored by PBC and the Ministry of Finance. Accounting Systems and Auditing 2.20 In most provinces ABC has an adequate number of accounting and statistical staff at all levels. Few of these are experienced in comprehen- sive financial analysis, but they prepare timely, consistent and detailed records. ABC requires the financial accounts to be balanced daily at each office. Summary details are reported by township-level offices every two weeks by telephone to the county office and township-level accountants come to the county once per month to reconcile accounts. County offices report monthly to provincial offices which in turn send detailed accounts to head- quarters every six months. Statistics on loan operations, which vary from province to province but which always compare actual operations with loan targets in the credit plan, are forwarded to provincial levels on a similar schedule. These statistics are quite detailed with reference to types of investments financed, geographic location of subprojects, expected incremental production, etc. 2.21 The accounts of ABC headquarters are audited by the Ministry of Finance, although the auditing appears to be only a fairly cursory check. Recent moves to restore auditing in China, especially the establishment in September 1983 of the State Audit Agency (SAA), and emphasis on financial accountability are expected to lead in the future to a satisfactory external auditing of ABC accounts and improvement of its internal auditing. Directly  - 11 - accountable to the State Council, the SAA has indicated that it has started auditing all projects financed by the Bank and other multilateral agencies but that its capabilities will only be built up gradually and over an extended period because of its lack of experienced auditing staff. In this regard, the Bank conducted a seminar on auditing for the SAA staff and is planning to further assist the SAA in the training of suitably qualified auditing staff. III. PROJECT AREA AND BENEFICIARIES Location 3.01 The geographical scope of the proposed project would comprise the provinces of Fujian and Hunan (attached Map IBRD 18971). These two provinces were selected because: (a) Both are relatively poor provinces in which alleviation of rural poverty is a priority objective of the Government. (b) The provincial governments and local leadership have expressed strong support for the project and the proposed subprojects are to be included in the provincial development plans. This would also ensure the adequate and timely provision of local funds and other inputs required by the project. Cc) The ABC offices and government technical bureaus (agriculture, aqua- culture, livestock, etc.) in the provinces are keenly interested in and have initiated steps to participate in the project, including determining the proposed subprojects and training staff. (d) The agro-climatic conditions in both provinces are suitable for growing a wide range of crops and for fish culture. 3.02 Fujian is located along the southeast coast of China, facing the Straits of Taiwan to the east, and bordering on the provinces of Zhejiang to the north, Jiangxi to th2e west and Guangdong to the south. The province has a total area of 120,000 km and a population of 27 million as of the end of 1984. Hunan, with a total area of 210,000 km2, is in south-central China bordering on the south side of the Yangtze River and Dongting Lake (China's second largest lake). It had a population of 56 million at the end of 1984. In terms of per capita rural income, Fujian's was below and Hunan's about the same as the national average. The agricultural situation and the operations of the ABC in the two provinces are described below and further details are given in Annexes 2 and 3. Agricultural Situation 3.03 Fujian province has a subtropical climate with average temperatures ranging from 120C in January to 280C in July. Annual rainfall exceeds 1,630 mm and typhoons occur frequently along the coastal areas. Two important rivers, the Min to the north and the Jinlong to the south, cut across the  - 12 - province and flow into the Straits ot Taiwan. Most of the province is hilly or mountainous and 75X is covered by forest. About 10Z of the totaL land area is cultivated and almost two-thirds the cultivated area is irrigated. The cropping intensity is 180Z. Crop production, livestock, forestry and aquacul- ture accounted for 46%, 122, 9% and 6% of the gross value of agricuLtural out- put in 1984 with the remaining 27% accounted for by househoLd sideline activi- ties. Rice is the major grain produced. Important cash crops include sugar- cane, fruits (mostly citrus). vegetables, tea, tobacco and spices. Fujian's large marine fisheries output includes fish. prawns and shellfish. rhe provincial development plan emphasizes the fucure production of forestry, livestock, aquaculture and cash crops. 3.04 Hunan province also has a subtropical climate, with average temperatures ranging from 50C in January to 290C in July and with annual rain- fall exceeding 1,400 mm. Hunan contains the drainage basin of the Xiang River which empties into Dongting Lake to the north. The Dongting Lake area has excellent rice-growing conditions and is also one of China's most important freshwater aquaculture areas. However, Hunan's terrain is predominantly (88Z) hilly with only 7% covered by flat land and 5% by water areas. Over 80% of the cultivated land is irrigated and the cropping intensity is 230%. Crop production, livestock, forestry and aquaculture accounted for 592, 20Z, 5% and 3Z of the gross value of agricultural output in 1984 with the remaining 13% accounted for by household sideline activities. Rice is the main grain crop and ramie, cotton, tea, rapeseed, fruits (mostly citrus), jute and tobacco are important cash crops. Hunan is China's chief producer of ramie. Aquatic output consists mainly of freshwater fish and plant products such as lotus roots and seeds. ABC Organization and Operations 3.05 The ABC organization in Fujian includes one branch office in Fuzhou, two municipal offices under provincial jurisdiction in Fuzhou and Xiamen, seven prefectural offices, 72 county and municipal offices, and 785 township and state farm offices. In addition, there are 902 RCCs with 767 branch offices and 8,068 credit stations which provide services at the township and village levels. ABC has a staff of about 8,600, 56% of whom work at the town- ship and state farm levels. RCC staff total about 5,900. The majority of ABC and RCC staff have been involved in banking for more than 20 years and 27% of ABC staff have university qualifications. In 1983 ABC Fujian established two Banking Schools in Fuzhou and Xiamen to provide courses in rural finance for staff. ABC staff are also trained in rural finance at the Fujian Agriculture Institute and at the Fujian Banking School of the People's Bank of China (PBC). ABC Fujian's sources of financing comprise mainly deposits (Y 2,285 million at the end of 1984), including RCC funds (Y 849 miLlion). Loans outstanding at the end of 1984 amounted to Y 2,794 miilion. About 95% are short-term loans. ABC Fujian reported a profit of Y 28 million for 1984. 3.06 The organization and operations of ABC in Hunan follow a similar pattern to that in Fujian although the network coverage and staffing situation is more extensive reflecting a much larger provincial popuLation. Under the provincial office there are 14 municipal and prefectural offices, 103 county and municipality offices, and 947 township and state farm offices. In  - 13 - addition, there are 3,531 RCCs with 548 branch offices and 38,465 credit sta- tions. ABC Hunan has a scaff of about 14,800, 58Z of whom work at the town- ship or state farm level. The total RCC staff is about 15,000. En 1983 ABC Hunan established a Banking Scluol to provide courses in rural finance for staff. ABC Hunan also has four secondary technicaL banking schools in Changde, Hengyang, Loudi and Xiangtan to train staff at the grass-roots level. The provincial Banking School run by PBC also provides training in rural finance to ABC staff and assists the ABC Banking SchooL with short-term and in-service training. At the end of 1984, ABC Hunan's sources of funds comprised mainly deposits (Y 2,390 million), including RCC funds (Y 1,234 mil- lion). Loans outstanding were Y 3,867 million of which about 95Z are short- term. ABC Hunan reported a profit of Y 75 million for 1984. Other Agricultural Support Services 3.07 Research and Extension. En both provinces ABC relies heavily on the agricultural, livestock, fisheries and light industry bureaus for technical guidance and assistance. These bureaus are supervised by appropriate minis- tries in Beijing and have offices at provincial, prefectural and county levels. These offices are responsible for supervising local research, experi- ment and agro-technical extension stations and providing technical guidance at the township and village levels. The technical bureaus and offices at appro- priate levels will play a critical role in project appraisal and supervision (see para. 5.06). 3.08 Marketing. In both provinces there is a network of supply and marketing cooperatives reaching down to the township, village and state farm levels which supply fertilizers, pesticides, feed and equipment to households, collectives and state enterprises and purchase agricultural outputs. There are also specialized companies supplying seeds, various types of machinery, etc., and purchasing certain specialized products such as citrus. Rural free markets play an increasingly important role ant individual and joint state- collective enterprises are beginning to engage in suppLy and marketing functions. Project Beneficiaries 3.09 Project beneficiaries would be mainly individual farmers/households and collective units or enterprises (para. 2.01). Collectives in agriculture have been undergoing major changes in organization and management in recent years and the production responsibility system is now in operation in most of the enterprises owned by the collectives and local government entities. The right to use collectively-owned land and water areas for crop and animal production and aquaculture is also increasingly being granted by the collec- tives to individual farmers and households through appropriate term leases (para. 1.05) often with fixed annual fees. This would provide the farmers and households with even greater incentive to raise the output and officiency of agricultural production. In support of these reforms, ABC will, under the project, provide medium and long-term loans directly to individuals, special- ized households, collectives and local government enterprises. In both provinces, there is also an increasing number of agricultural enterprises under joint ownership of local government entities and collectives some of  - 14 - which include specialized househoLds. These are particuLarly important in the agro-processing sector as well as in fisheries and livestock. They are usually large-scale operations which fulfill a demonstration as well as a pro- duction function. Some of the project funds will be used to assist these enterprises. IV. THE PROJECT Objectives 4.01 The proposed project wouLd be an expansion of the Bank's support of the Agricultural Bank of China's (ABC) lending for investments to increase farm and rural output and incomes through the diversification and moderniza- tion of agricultural production and processing. It would provide funds to ABC for medium- and long-term loans to individual farmers and households, collec- tive units, and enterprises owned by collectives and local government entities in the two provinces of Fujian and Hunan to finance investments for the deve- lopment of aquaculture, orchards, agro-processing and livestock enterprises. ABC expects that of the total project loan funds, some 80 would be utilized by farmers (as members of households and collectives) and the remaining 20% by local government entities, including enterprises jointly owned by these entities and the collectives (para. 3.09). The project would also finance a technical assistarce component to ensure effective and efficient project implementation and to strengthen the operations of ABC. Description 4.02 Aguaculture. This component would finance investments to expand the production of freshwater fish, mainly grass, common, silver and bighead carp and tilapia, and marine fisheries, such as shrimp, mullet, oysters, clams and other shellfish. It would comprise construction of new fish ponds and improvements to existing fish ponds, including supporting infrastructure and equipment such as dykes, drains, canals, sluice gates, pipes, hydraulic struc- tures, roads, pumping stations, manure holding pits, fishing gear, aerators, boats, hatcheries, and floating platforms or rafts for culture of oysters and clams. The areas to be converted into fish ponds are swamp, marsh and other low-lying poorly-drained land unsuitable for crop production and their conver- sion would represent the most productive use of such land which otherwise would remain idle. Fish and shrimp ponds would also be constructed on lands formerly under shallow waters located along the edges of large water bodies, such as sea inlets or bays, lakes and reservoirs. 4.03 The improvements to existing fish ponds would include partitioning the ponds for more efficient operation, raising the dykes and excavating ditches, deepening and leveling pond bottoms and canals, and constructing additional sluice gates. The investments to be financed would also incLude production of green manure and the purchase of fry, organic manure, fertil- izers, lime, pesticides and feed required to produce the first harvest from the ponds.  - 15 - 4.04 A total of some 12,300 ha of ponds would be developed of which about three-fourths would be new ponds and the remaining one-fourth existing ponds. Fresh water ponds would account for about three-fourths of the total area of ponds to be developed. The greater part of fresh water fish pond development would be in Hunan Province and would be centered on Dongting Lake and the surrounding area. The development of salt water (incLuding brackish water) fish and shrimp ponds would be located along the coastal region of Fujian Province. These ponds would account for about one half of the pond development in the province. In addition to these ponds, about 2,500 ha of coastal water surface would be utilized for oyster, clam and other shellfish culture. All the project ponds and facilities would be owned and in many cases also managed by collectives and enterprises belonging to the counties and municipalities who would be the main subborrowers. However, operation of the ponds (fisheries production) would be carried out by individuals and specialized households involving a total of some 18,000 persons (about 10- 15 mu per person) under contractual arrangements with the collectives and enterprises based on the production responsibility system. 4.05 Orchards. This component wouLd provide for the establishment of new plantings and improvements to existing plantings amounting to some 14,000 ha of orchards of which about three-fourths would be orange (mainly mandarin orange). The other fruits would include litchi, longan, banana, plum, peach, persimmon, loquat, bayberry and pomegranate. Most of the new plantings would be on slope lands of up to 20