China - Forestry Development Project

Document of The World Bank FOR OMCIAL USE ONLY Rpeft No. P-4069-CHA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED IDA CREDIT OF SDR 47.8 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR A FORESTRY DEVELOPMENT PROJECT May 13, 1985 This document h. a restricted ibtiom sad my be used by reeiplmul emy in the perf.rme of thir oilld duems econtet nay ne odterwise be diose without Wold Bak amthobdzadaI  CURRENCY EQUIVALENTS Calendar 1984 April 85 Currency unit = Renminbi (RMB) US$1.00 = Y 2.32 Y 2.84 Y 1.00 = US$ 0.43 US$ 0.35 (Project cost estimates are based on the January 1985 exchange rate of Y 2.8 per US$1.00.) Fiscal Year . January 1 - December 1 Weights and Measures 1 meter (m) = 3.28 feet 1 kiLometer (km) = 0.62 miles 1 hectare (ha) = 2.47 acres = 15 mu 1 kilogram (kg) = 2.2 pounds 1 ton (t) = 2,205 pounds Principal Abbreviations and Acronyms Used AFS - Academy of Forest Sciences BFM - Bureau of Forest Management CIF - Cost including Insurance and Freight CTB - Commercial Timber Base C3 - Cubic Meter DBH - Diameter of-Tree Trunk at Breast Height ERR - Economic Ra-te of Return FRR - Financial Rate of Return GAF - General Administration of Forestry GVAO - Gross value of Agricultural Output (including animal husbandry, fisheries and forestry) ICB - International Competitive Bidding kw - Kilowatt MAl - Mean Annual Increment MFO - Ministry of Forestry PMO - Project Management Office PFB - Provincial Forestry Bureau (recently renamed Provincial Forestry Department) SFF - State Forest Farm sq m - Square Meter m-m - Man-month mt/a - Metric Tons Per Annum Y - Yuan (Chinese Renminbi)  FOR OMCIAL USE ONLY CHINA FORESTRY DEVELOPMENT PROJECT Credit and Project Summary Borrower: People's Republic of China Amount: IDA Credit: SDR 47.8 million Tei:ms: Standard Project Description: In support of the Government's program to develop forest resources, the project would accelerate afforestation and improve management and exploitation of existing forests on 92 state forest farms in Guangdong, Heilongjiang and Sichuan Provinces. The project would establish about 82,000 ha of forest plantations, introduce forest improvement measures on existing young plantations and natural forests, construct and upgrade about 1,900 km of forest roads and tracks, and expand equipment and vehicle fleets. It would provide for the con- struction of about 157,000 sq m of buildings and 1,100 km of utility lines and the establishment of wood processing facili- ties. The project would strengthen forest research facilities in four provinces and establish extension centers in ten provinces. A technical assistance component would provide overseas training opportunities (533 man-months) in logging, forest road construction and forest production, research and extension; and consulting services (34 man-months) in forestry research and extension, and soil science. At full development the project would produce annually about 546,000 m3 of roundwood, 10,000 m3 of plywood and other miscellaneous wood products to meet strong internal demand. The project faces no significant technical or administrative risks. 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.  Estimated Costs: Local Foreign Total - t$ million) Plantation establishment 11.4 0.6 12.0 Forest improvement 111 0.6 11.7 Chemical fertilizer 0.5 2.7 3.1 Forest road construction 22.7 1.2 23.9 Equipment and vehicles 2.5 10.0 12.5 Buildings and utilities for SFFs 10.1 1.1 11.2 Wood processing facilities 6.3 4.2 10.6 Training and technical assistance (SFFs) 0.2 0.8 1.0 Managements and overhead for SFFs 2.4 - 2.4 Research and extension centers 10.9 8.9 19.7 Base Cost 78.1 30.0 108.1 Physical contingencics 6.9 2.7 9.6 Price contingencies 13.1 5.0 18.1 Total Project Costs /a 98.1 37.7 135.8 Financing Plan: IDA 15.8 31.5 47.3 Government and state forest farms 82.3 6.2 88.5 Total 98.1 37.7 135.8 Estimated Disbursements: IDA FY 1986 1987 1988 1989 1990 Annual 7.1 14.6 14.0 10.2 1.4 Cumulative 7.1 21.7 35.7 45.9 47.3 Rate of Return: >50Z Staff Appraisal Report: No. 5394-CHA, dated Nay 8, 1985. /a No taxes are imposed on major cost items.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF CHINA FOR A FORESTRY DEVELOPMENT PROJECT 1. I submit the foLlowing report and recommendation on a proposed IDA credit to the People's Republic of China to help finance a forestry devel- opment project. The credit, for SDR 47.8 million ($47.3 million equivalent), would be on standard IDA terms. PART I - THE ECONOMY 2. A country economic memorandum, entitled "China: Recent Economic Trends and Policy Developments" (No. 4072-CHA), was distributed to the Executive Directors on March 31, 1983. An economic mission that visited China early in 1984 is currently preparing a report on long-term development issues and options, which is expected to be submitted to the Executive Directors later this month. Basic data on the economy are given in Annex 1. Background 3. To address economic inefficiency and structural imbalances, the Government initiated a program of reform and adjustment in 1979. Reform implementation proceeded most rapidly in agriculture and culminated with the introduction of the "production responsibility system" (in various forms), which gave households and small groups autonomy in production and investment decisions and allowed them to keep most income earned after contracted payments to the state and collective. By the early 1980s, the vast majority of production teams in China had implemented such a system. Reform of the urban economy began much more slowly, but nevertheless significant systemic changes occurred, incLuding bonuses for individual workers; profit retention by state-owned industrial enterprises (at first on an experimental basis); fiscal decentralization measures, which allowed provinces to share in the benefits of increased revenues and gave them more freedom in budgeting; and some decentralization of foreign trade authority. Adjustment policies resulted in an increase in the share of consumption in GDP; a rise in the share of light industry in total industrial output, substantial improvements in living standards, rapid growth of foreign trade (particularly manufactured exports), and relatively modest (in relation to past trends) GDP growth. 4. A number of problems emerged in the process of reform and adjust- ment, including large budget deficits in 1979 and 1980, deterioration of the external position and a significant current account deficit in 1980, infla- tionary pressures and some overt price increases, and excessive investment  -2- demand resulting from decentralization of investment decision making and financing. In response to these difficulties the Government imposed a stabil- ization program in early 1981, which relied mainLy on administrative con- trols. It resulted in a slowdown in growth, a reduction in price inflation (to around 2% p.a.), a sharp cutback in budget-financed investment, a lower budget deficit (1Z of GDP in 1981); and a current account surplus of $1.5 bil- lion in 1981 and $5.6 billion in 1982. Economic Performance, 1981-84 5. Economic growth picked up in 1982 with the resumption of rapid growth of heavy industry and the rebound in investment. Overall performance has remained strong, with real GDP growth averaging over 8% p.a. from 1981 to 1984. Shortages of energy, many producer goods, and construction materials were exacerbated by the rapid growth of demand, yet price increases were limited by further strengthening of administrative price controls (particularly in 1983). Government budget revenue grew very slowly in 1982 (1.3Z) but much more rapidly in 1983 (7.9Z) and 1984 (as much as 10), due to a new tax on enterprise retained funds and extrabudgetary incomes of Gcvern- ment organizations. This permitted an increase in budget expenditures on investment of 17% in 1983 and a further rise in 1984, while maintaining a relativeLy small budget deficit (less than 2% of GDP in 1983). Growth of subsidies was largely stemmed by stopping increases in most of the agricul- tural procurement prices. 6. Gross industrial output value grew at over 10X p.a. between 1981 and 1984, witil heavv industry growing somewhat faster than light industry (12% vs. 9%), a reversal of the 1978-81 pattern. The energy constraint on industrial growth was eased by rising coal output (8% p.a. in 1981-84), consistent annual crude cil output at over 100 million tons, and improvements in the efficiency of energy utilization (primary commercial energy consumption grew only 60% as fast as GDP in 1981-83). Agriculture has continued its very strong perfor- mance, with gross agricultural oucput value rising at 9Z p.a. in 1981-84 and grain output at 7% p.a. (reaching over 400 million tons in 1984). Cash crops and animal husbandry, stimulated by rising *-JZ.ad and attractive prices, have Aso grown very rapidly. 7. There have been impressive increases in personal incomes throughout the period 1978-83. Average per-capita income in rural -?-eas rose by about 12% p.a. in real terms and urban incomes by about 52 p.a. Rural income growth was mainly due to production increases, efficiency improvements, and growth of employment in nonagricultural activities, as well as substantial agricultural procurement price increases (through 1981). Urban income growth, on the other hand, can be attributed primarily to wage and benefit increases, which have exceeded growth of labor productivity. 8. Control of the aggregate level of investment and its composition has continued to be a serious problem. Enterprise and local government investment continued to increase sharply in 1982, far exceeding plan guidelines. In 1983, more stringent measures brought this part of investment under control (though it still exceeded plan targets). But investment outside the rural sector remains rather inefficient, and improvements in efficiency have been  -3- hindered by administrative controls. Construction costs have risen continuousLy (10% p.a. in 1978-83). 9.. China has maintained a strong external position. The dollar value of both exports and imports stagnated in 1981-83, but this masked considerable increases in the volume of foreign trade. Since 1983, imports have grown more rapidly than exports, and in 1984, exports rose by an estimated 10% while imports increased by 25%. Manufactured export growth was slower in 1981-84 than in 1978-81, but it started from a much higher base and occurred in the face of worsening world market conditions. Foreign debt and debt service ratios remained at very low levels ($6.4 billion and 5.5Z respectively in 1983); China's foreign currency reserves (excluding gold) rose to $17 billion (over 7 months' imports) by mid 1984 and have stabilized at that level since then. The value of the Chinese renminbi declined by about 36% against the SDR between the end of 1981 and late 1984 (60% against the US dollar). Recent Reforms 10. Rural reforms have continued to progress more rapidly than reforms elsewhere in the economy. There has been a remarkable spread of nonagri- cultural activities such as processing, transport, and commerce. "Specialized households" (which concentrate on one undertaking - often cash crops, animal husbandry, or nonagricultural activities) and pooling of capital by small groups of households in various types of ventures are becoming more common forms of economic organization in China's rural areas. Wholesale markets for some agricultural products have emerged. To encourage investment in land improvement and development, farming contracts between collectives and peasant households (which typically had been fixed for no more than 3-5 years) can now be extended to as long as 15-20 years. In early 1985, it was announced that planned precurement quotas for agricultural commodities will be aboLished; more methods of financing investment in rural nonagricultural activities will be permitted (including tax exemptions, local government bonds, higher inter- est rates to attract more saving, etc.); and the growth of the agricultural processing industry in coastal areas will be promoted. 11. The momentum of urban reforms has revived, with significant progress on several fronts. Since early 1984, the focus has been on broadening and delineating the decision-making authority of urban enterprises. Profit reten- tion now extends to virtually all state-owned industrial enterprises and to nonindustrial sectors like transport, commerce, construction, and other services. Urban collectives and individual enterprises, as well as a variety of joint ventures between them and state enterprises, have grown rapidly (the number employed in urban individual enterprises rose from 150,000 in 1978 to 2.31 million in 1983). 12. In financial reforms, the most important new development was the implementation of a profit tax system to replace profit remittances by state enterprises to the Government budget. Though most enterprises have switched to this system, the benefits have been limited because of the application of a different effective tax rate for each enterprise, to offset the impact of distorted relative prices and other factors. Similar problems have resulted in the abandonment of an attempt to impose a fee or charge on the fixed capi-  - 4 - taL provided to state enterprises by the Government, and they have hindered the shift from grant to Loan financing of new fixed investment, despite strong Government support. Financial discipline at the enterprise level remains weak, in spite of efforts to strengthen accounting and auditing systems and more strictly enforce existing financial regulations. 13. In the crucial area of price reform, a major price adjustment for textiles and textile raw materials occurred in early 1983; it helped balance supply and demand, to a large extent equalized profit rates for synthetic and cotton textiles (which are close substitutes in production and consumption), and drastically reduced subsidies for cotton procurement, with only a small net effect on the Government budget. Prices of many "minor" consumer goods (which individually do not have a significant impact on living standards) and the majority of agricultural commodity prices have been decontrolled and are now set by negotiations between producers and commercial units. "Floating prices" (up to 20% above or below official prices) are now allowed for many industrial producer goods (either for all output or for output above the mandatory plan target). Price adjustments for key energy products and raw materials (which in many cases are severely underpriced) and for subsidized basic consumer goods like grain and edible oil have proven more difficult to implement, hindered by the potential impact of price changes on urban living standards and on the finances of energy-using enterprises. Nevertheless, some price rises have occurred (e.g. for coal and petroleum), and moreover the share of free market transactions (at largely uncontrolled prices) has increased in recent years. 14. Reforms in the employment and wage system have made limited pro- gress. The bulk of urban labor is still allocated administratively, and transfers of workers or professionals among enterprises are heavily impeded. Numerous attempts are being made to link individual performance more closely with rewards, including piece-rates, "floating wages," and various types of contractual "responsibility systems." These have achieved some success, but problems of egalitarian distribution of bonuses remain, and many enterprises give out bonuses in kind or disguise them as allowances in order to evade regulations. 15. China's foreign exchange rate system has been unified with the abolition of the "internal settlement rate" (Y 2.8 to $1) at the beginning of 1985. Direct foreign investment (which was first allowed in the late 1970s but developed slowly due to the lack of a legal framework) is being actively encouraged and joint venture agreements have increased sharply. In addition to four "special economic zones" open to foreign investment and subject to more flexible policies, 14 coastal cities were recently opened up in the same way. 16. Significant steps have been taken to develop new tools of indirect macroeconomic management. The central banking functions of the People's Bank of China were separated from its commercial banking functions (which were given to the newly estabLished IndustriaL and Commercial Bank of China) at the beginning of 1984. The central bank relies on redeposit requirements and a discount window to influence the operations of specialized banks, and even- tually may use discount rates and interest rates in general as a flexible tool  -5- of macroeconomic management. Adjustments in indirect taxes may be used to affect profitability and supply, in the absence of or as a supplement to price reform. Scope for horizontal flows of investment funds is also widening, as enterprises invest in each other and in joint ventures and as some individuals purchase stocks. Though restrictions on secondary trading remain, Government bonds purchased by individuals can now be sold to banks or used as collateral for loans. Long-term Issues and Prospects 17. The Central Committee of the Chinese Communist Party issued a major document on urban reforms in October 1984, which reaffirms and consolidates recent reforms and provides some general guidelines for the direction of future reform. It emphasizes the need for breakthroughs in: (a) enlivening and better motivating urban enterprises; (b) clearly separating Government and enterprise functions (and limiting direct intervention by Government organizations in enterprises' day-to-day operations); (c) reforming the price system; (d) improving incentives in the wage and bonus system; (e) establish- ing a planning system that is in harmony with greater reliance on the market mechanism and developing indirect macroeconomic management; (f) upgrading managerial personnel to meet the new demands on them in a reformed economy; (g) removing obstacles to a unified national market and promoting cooperation and technology transfer among regions; and (h) expanding utilization of foreign capital and advanced technology. Among the main themes of the document are the role nf competition in promoting a more dynamic, flexible economic system; the recognition that a certain degree of income inequality is necessary to provide better incentives for economic development; the need for clear responsibilities and appropriate incentives at all levels in the econ- omy; and the recognition that thoroughgoing price reform must involve liber- alizing the mode of price determination, not just adjusting administratively set prices. Managers of large state-owned enterprises, however, will still be appointed by the Government; a few key products will still be subject to mandatory planning and distribution by the Government; state ownership and control over certain institutions Like banks and railways will not be relin- quished; and establishment, relozation, changing product lines, mergers, and shutdown of enterprises will still be subject to Government approval. 18. The Central Committee declaration represents a political commitment to economic reform, which will help foster an environment in which fundamental reforms can be gradually implemented in a coordinated way. But specific policy measures will take a considerable length of time to design and then to implement. Many of the reforms required will be very difficult, particularly since reforms in different areas are closely interrelated, and thus appro- priate sequencing and coordination are essential. For example, price reform in the absence of improvements in enterprise financial discipline will have Limited benefits, yet the more profit-oriented behavior that wouLd result from tighter financial discipline would exacerbate the adverse impact of distorted prices. Similarly, reform of the Labor allocation system will be incomplete without eliminating many of the "social responsibilities" of enterprises (which now provide housing, medicaL care, and pensions for their workers and in many cases education and jobs for workers' children) and replacing them with Government-supported social service programs.  -6- 19. China's objective of quadrupling the gross output value of industry and agriculcure between 1980 and 2000 (which means GDP growth of well over 62 p.a.) will require significant improvements in efficiency as well as continued high saving and investment rates. There will be major structural changes in the economy over the next two decades, including a reduction in the share of agriculture, a rise in the share of industry and possibly in that of services (which at present is unusually low), and substantial urbanization (in smaller towns if not in large cities). There will also be a shift within agriculture, away from grain and basic crops and into cash crops and animal husbandry. 20. Certain physical/technical constraints will hinder the attempt to achieve China's targets for t.Le year 2000 and its longer-term goal of catching up with developed countries. Despite rapid growth and substantial improve- ments in efficiency in recent years, agriculture may again become a constraint on overall growth, since land in China is severely limited. In energy, shortages of fuel (primarily coal) and electricity may continue to constrain growth in transport and commercial infrastructure. Without large new invest- ments and improved efficiency, economic growth will lag. In mobilizing resources in all these areas, China could profitably make use of foreign borrowing. Finally, the rising share of the elderly in China's population (related to the slowdown in population growth) means that more resources will have to be devoted to maintaining their consumption Levels, especially in the decades after 2000. 21. Poor motivation and inefficient utilization of labor in the state sector of the economy are major problems which can be solved only by coor- dinated reforms in labor allocation, the wage system, enterprise management, and social services, among other things. Reforms in the system of education and training to develop China's "human capital" potential also are crucial. Backward technology and inefficient use of existing technology must be addressed by a combination of reforms, appropriately directed investment, and transfer of advanced foreign technology. IrrationaL location of factories, suboptimal scale of many plants, and poor utilization of physical capital in general are related problems. 22. If reforms successfully transform the economic system, with a bene- ficial impact on growth and efficiency, a new set of issues will con.m to the fore. Management of a reformed economy with indirect fiscal, monetary, and other instruments is a major issue. In this context, maintaining an adequate saving rate (if the Government no longer accounts for the bulk of aggregate saving) and avoiding inflation (as well as deep cyclical downturns) will be major goals. Assuring an adequate minimum standard of living for the popula- tion and an appropriate level of social services will become a major chaLlenge as enterprise and rural communal responsibilities in these areas are reduced. The problem of poor, backward rural areas in various parts of the country will continue to require attention. Redistributing financial resour- ces through the fiscal system, easing restrictions on migration out of the poorest areas, and lowering nonagricultural wages to make investment in them more attractive ar me options for alleviating poverty in these areas. 23. The Government is in the process of finalizing its Seventh Five Year Plan (covering the period 1986-90). The combination of potentially  -7- fundamental reforms and the urgent need for large investments in many parts of the economy to build the foundction for further growth makes this talk difficult. In order to mobilize the investment resources needed for rapid, sustained economic growth and development, China will need to rely in part on foreign borrowing. Recognizing this need, the Government plans to gradually draw down its substantial foreign exchange reserves and hopes to attract foreign capital through a variety of channels. China also has a claim to concessionary lending because it is still one of the poorer countries of the world. But China's access to concessionary capital to finance development and modernization is limited; apart from Bank Croup funds, a significant amount of concessionary capital is likelv to come only from Japan and a few other bilateral donors and will probably average no more than $500-600 million p.a. during the rest of the 1980s. PART II: BANK GROUP OPERATIONS 24. To sustain rapid growth over the coming decades, to increase efficiency and innovation, and to maintain equity in distribution, China will need continuing and fundamental reforms. These challenges are compounded by China's large investment requirements and difficulty in efforts to open up to the rest of the world. In light of this, there are several broad objectives for the Bank to pursue in its relationship wich China. First, the Bank can offer China development experience and institutional knowledge as well as opportunities for interaction with the Bank's other member countries. Second, the Bank can assist China in removing major constraints on development and in improving investment planning and policy coordination in the priority sectors - namely energy, transport, other infrastructure, human development and industry. Third, the Bank can assist the Government in efforts to remove the remaining pockets of poverty. 25. The Bank Group's strategy to meet these objectives is formulated in line with China's broad development priorities and related issues outlined in Part I of this report. However, Bank Group lending can provide only a small portion of overall resource needs. As a key element of the strategy, there- fore, the Bank's lending operations will aim to create a substantial demon- stration effect applicable to China's overall development efforts. For example, projects involving new techniques for land development or for provi- sion of social services have been designed so they can be repeated by local authorities with their existing resources. Some of the agriculture projects and rural health projects are examples of this approach. The introduction of international competitive bidding through Bank projects (first to finance goods, and later civil works) is being adopted by the Government for most local purchases and many domestic construction projects.  -8- 26. Bank assistance can help improve the efficiency of investment, through introduction and dissemination of improved analytical techniques for investment and project planning and through institution building. Preparation of the project appraisal manuals for the China Investment Bank and the Agricultural Bank of China, consultant assistance and the EDI-sponsored pro- grams, as well as specific sector work in transport, industry, health, educa- tion and other sectors have improved the quality and content of project pro- posals. Assistance to Chinese enterprises and agencies through staff train- ing, consultant assistance, creation or reorganization of institutions, and improvement of costing and financial management has been included in a number of projects ranging from the ports and railway projects to the several educa- tion and petroleum projects. Sector work in enterprise management, urban development, health and industry has also provided assistance for improvement of investment efficiency. 27. Human resource constraints are a particularly serious problem for China's development. There are severe scarcities of higher level trained manpower. Substantial economic and sector work and technical assistance and training components in most of the Bank projects are providing support. In terms of poverty alleviation, the rural health project, proposed urban and water supply projects and sector work on labor mobility and regional develop- ment options address poverty, health and equity issues. 28. Transfer of technology in the broad sense is of fundamental impor- tance in China's efforts to improve efficiency of the economy. Outmoded, inefficient and costly industrial technologies are serious impediments to development and are wasting valuable energy resources. Here, the Bank can play the role of an intermediary. In transportation, energy, industry, agri- culture and even education, the Bank can finance transfer of technology through equ;nmenc imports, provision of foreign consulting assistance, arrangement of training and prommotion of licensing and other agreements such as are now being discussed in the railways and other projects. Long-term investment for new technology will require increased foreign borrowing in the future and the Bank can assist China through cofinancing. Progress is being made in introducing co-financing tunder the first and second power projects, coal, urban, water, and some agriculture projects, and the Bank will continue these efforts. 29. For most of these elements of country strategy, however, progress will be gradual and will require sustained Bank involvement over a series of projects in various sectors. Economic and Sector Work 30. Economic and sector work in China was initially designed in part as a learning experi nce to provide the Bank with a basis of knowledge on the development and functioning of the Chinese economy. It also introduced the Government to alternative ways of economic analysis and views about its achievements. 31. In the last four years, the above approach has been well received and has fostered economic and sector work that is responsive to the problems  -9 - of adjustment and reform. FolLow-up to the first economic report emphasized technical assistance and sector work for investment analysis and selection techniques and enhanced sector planning. The content of the lending program has been directly influenced as a result. The rural credit project, the China Investment Bank proj.Jcts, and future regional industry projects are examples of the lnks between economic and sector work and the lending program. 32. More fundamental research by the Bank in collaboration with Chinese economic research institutions into the problems of enterprise management is nearing completion. The research has yielded insights into the attitudes of enterprise managers toward system reform and has led to better understanding of how policy changes can improve planning, performance and management of enterprises. In addition, there is a variety of project-related sector work underway through studies included in the projects. These are expected to produce the basis for detailed discussion of development options and policies in the various sectors. 33. Current economic work focuses on future options and issues to the year 2000. A comprehensive report will be ready later this fiscal year. In light of the experience of other countries in making the transition from low to middle income levels, the report will pay special attention to inter- sectoral linkages and cross-sectoral and economy-wide issues. 34. Future economic and sector work will be based on the conclusions of the economic report and will look in more detail at some of the issues raised. It will continue to improve our knowledge of the economy - its struc- ture, the issues and constraints in key sectors, and the functioning of the economic management system. Collaboration with Chinese research institutions on issues of institutional and policy change will continue. Review of the investment program in key sectors when the Seventh Five Year Plan (1986-90) is finalized will help develop the next generation of projects for the lending program. Lending Operations 35. Since China's change of representation in the Bank Group in May of 1980, 24 projects involving lending of $2,391 million to China have been ap- proved. Annex II contains a summary statement on these loans and credits as of March 31, 1985. For this fiscal year we expect to present a total of twelve projects to the Board. These include the already approved projects for Second Agricultural Research, Second Power, Second University Development, Changcun (Luan) Coal Mining, Seeds Development, Rural Water Supply; the proposed Forestry Development Project as well as projects for highway, railway, fertiLizer rehabilitation, Pishihang-Chaohu area development, and gas engineering. 36. For FY86 and beyond, the China lending program should continue to grow from current levels. Areas of emphasis would incLude development of energy resources, transport infrastructure, skilled manpower and improved technology. We will also investigate the feasibility of a regional approach in a number of sectors to take better account of intersectoral linkages.  - 10 - 37. In the energy sector, lending has included six projects, which have emphasized increased energy output and technology transfer through financing of equipment, technical studies, training and consultant assistance. The Lubuge Hydropower Project has resulted in the Government's extensive use of competitive bidding for power projects. The Second Power Project places particular emphasis on better system planning. Fuel alternatives for electric power, generating plant location and interconnection of power grids will be the subject of future work. For development of China's petroleum and coal resources, Bank Group assistance will emphasize acquisition of appropriate technologies, least cost planning of investment and related transport investment programs. 38. In the transport sector, raiLway, port and road capacity must be substantially increased. So far, one project each in ports and railways has concentrated on increasing capacity, upgrading technology for lower cost operations, and establishing better costing systems. Expanding domestic capacity to manufacture improved transport equipment will continue to be a theme in the sector and this should provide scope for substantial foreign private sector involvement. Improved management and information systems and analytical techniques for better cost control will be encouraged under the projects, which, once proven, will be suitable for wider use throughout transport enterprises. Intermodal coordination and planning and assessment of alternative investment choices will have increasing prominence in both lending and sector work. 39. In agriculture, six projects have emphasized support services through improved research and education, production increases through new land development, reclamAtion, use of improved technologies and management, strengthening of the agriculture credit system and seeds development. Projects in forestry and agriculture credit will continue to strengthen sup- port services and rural institutions. Land and area development projects will endeavor to provide models of integrated regional development. Specialized activity projects such as fisheries, livestock and agro-processing may also be developed to support ongoing structural transformation in agriculture. 40. In the industrial sector, two projects have focused on establishing and strengthening the China Investment Bank. Improved investment selection criteria, incentives for more efficient management, technology transfer, and energy conservation are priorities for future projects. Lending will have a two-pronged approach - further strengthening of the China Investment Bank (and perhaps other financial intermediaries) and financing large regional produL- tion-oriented projects such as the proposed project for fertilizer as well as other projects for machine tools and cement, to expand output and demonstrate the merits of improved subsector analysis and planning. 41. Further expansion of higher education and improvement of teaching, curricula and graduate quality will be needed to the end of the century. The human resource constraints have already been addressed by five education projects and a component of the Rural Health/Medical Education Project. The value of international competitive bidding for equipment purchases and of international advisory panels for educational poiicy and curriculum reform has been demonstrated in the first projects. Improved university management is  - 11 - being encouraged through establishment of quantitative targets for growth, student-teacher ratios, classroom utilization, laboratory experiments per- formed, and other reforms (including development of evaluation and monitoring procedures and greater decentraLization). Projects in heaLth, urban development and water suppLy wiLl assist the Covernment in addressing diffi- cult poverty-linked questions of affordability, cost recovery, and minimum standards with focus on particularly impoverished regions. 42. implementation. Project implementation is generally proceeding well. There have been some delays in procurement because of the Government's unfamiliarity with the concept of bidding, but these are now being addressed through a central procurement agency. Most project agencies, as well as the Ministry of Finance and the State Planning Commission, have established and staffed offices to handle Bank Group projects. To support further expansion of the lending program, accelerate project preparation, improve project implementation, and facilitate further economic and sector work, the Bank Group is planning to open a resident office in China early in FY86. PART III - THE FORESTRY SECTOR Resources and Production 43. With about 120 million ha (13% of the total land area) under forest cover, China ranks first in Asia and sixth in the world in terms of forest reserves. On a per capita basis, this translates into 0.13 ha of forested area per person, compared to a world average of i.25 ha. Since 1949 some 86 million ha have been afforested, but plantings on only about one third of that area are resorted to have survived. Total growing stock is estimated to be 9.5 billion m , of which 55% is in coniferous species and 45% is in broad- leaved types. About 21% of the forested area is in Heilongjiang Province alone and five provinces (Heilongjiang, Yunnan, Jilin, Guangdong, Sichuan) account for 48Z of the total. A significant feature of China's forest resource is the high proportion of the forested area and of the standing volume accounted for by mature forests (more than 30Z and 60Z, respectively). 44. Forestry's share in the GVAO has increased steadily from about 1% in the early 1950s to just over 4Z at present. Employment in forestry and forest industries totals 2.2 million (less than 1% of the rural work force), with 60X in wood processing, 30% in land preparation and planting and 10% in nursery operations, logging, et . Industrial roundwood production in recent years has been about 50 million m . Substantial additional quantities, including logs and poles, but excluding fuelwood, are produced largely for self-use by collectives and rural households. Estimates of timber used annually for fuel- wood range as high as 70 million m3. Production of timber products includes sawn timber (2 sillion m3 in 1981), plywood (3.35 million m3), fiberboard (0.57 million m ) and particleboard (76,700 m ). Paper and paperboard output was about 5.7 million tons in 1982. Annual per 3apita consumption of industrial forestrX products is less tban 0.10 m (excluding fuelwood) compared to 0.08 mo in India and 1.5 mo in the United States. Since 1975, the rising demand for timber has led to a sharp increase in imports of wood and wood products.  - 12 - L.-ganization of the Sector 45. The Ministry of Forestry (MF0) provides technical guidance to provincial and county forestry bureaus which are administratively responsible to their respective levels of local government. In areas where forestry is of minor importance, forestry and agriculture frequently are combined into a single bureau. State forest farms (SFFs) are responsible to county forest bureaus. In Heilongjiang there exist both a Ceneral Administration of Forestry (GAP) and a Provincial Bureau of Forest Management (BFM). The GAF oversees some 64 Local forest enterprise bureaus which are commercial ventures involved in logging, afforestation and timber processing in areas with the richest forest resources. The BFM, operating through county and municipal forest bureaus, oversees 354 SFFs, some of which are less well-developed than the GAE enterprises and receive state budgetary subventions for capital construction. 46. Nationwide there are over 100 forest enterprise bureaus and 3,900 SFFs, of which - in addition to the 354 in Heilongjiang -- 296 are in Sichuan and 222 in Guangdong. About 60% of the industrial roundwood is produced by state forest enterprises while about 30Z is produced by colLec- tives and 10Z by SFFs. The major objective of the SFF system is to expand China's forestry base through accelerated afforestation and improved manage- ment of forest lands. In total the SFFs manage more than 46 million ha of land, of which 26 million ha are under forest. Most of the total managed area not currently under forest is suitable for forestry development. The SFFs employ about 500,000 people and account for 1OX of the standing volume of timber in China, 21% of the total forested area, and 25% of the area under forest plantations. Since 1979, as part of the production responsibility system (PRS) special contracting arrangements with individual families or groups of hot!eholds have been introduced as a means to encourage afforesta- tion programs on more than 50 million ha of barren or sparsely covered areas. Support Services 47. The MFO's Academy of Forest Science (AFS), China's leading agency for forestry research, operates seven institutes located in the Beijing area and three institutes in the provinces. Most provinces and some prefectures operate research institutes and several forestry and agricultural colleges also carry out research. Research priorities at the national level are determined through interaction between the AFS, the State Council, State- Planning Commission and the State Scientific and Technological Commission. The 1982 budget for forestry research by the Ministry of Forestry was Y 6 mil- lion (less than 0.1% of the annual gross value of forest production in recent year ) and was channelled largely through the ten AFS-affiliated research institutes. Research expenditures by provincial fcrestry institutes are funded largely by provincial governments. 48. Forestry extension services are being strengthened to meet demands created by contracting-out arrangements and other new programs to encourage afforestation. A Division of Technical Exchange and Extension was established within the MFO's Department of Science and Technology in 1980. In 1983, the Government announced plans to set up a national network of forestry extension  - 13 - units at the provincial and county levels. Eight provincial stations had been established by mid-1984. Construction of about 50 county forestry technical extension centers is to be completed by 1987. Extension work at present is handicapped by shortages of buildings, equipment and trained staff. Collection of seeds and production of seedlings are functions of seed centers run by Provincial Forestry Bureau (PFBs) and SFF-operated nurseries. Forestry Policy 49. In view of rapid growth in demand and concern over deteriorating forest resources in many parts of China, the Government has accorded high priority to forestry development in recent years. Future de-elopment will focus on accelerated afforestation, increased exploitation of mature and over- mature areas, expansion of forest industries and strengthening of forest research, education and extension. Government plans call for the land area under forest to be increased to about 20Z by 2000, an increment of some 60 million ha. Annual harvesting of industrial roundwood is to increase to about 100 million m by 2000 and the production of wood-based panels is projected to aLmost triple from present levels. Constraints to Development 50. Achieving planned targets in forestry development depends on overcoming certain critical constraints: (a) Lack of adequate access roads to facilitate exploitation of large areas of virgin forest, particularly in Heilongjiang, Nei Mongol, Sichuar and Yunnan. China is reported to :.ave only about 2.3 m ' forest roads per ha of trees, as compared -with the 9-10 m/ha whic. would be desirable in the types of forestry and terrain found in China. The use of outdated equipment in logging operations also impedes efficient exploitation of existing forest reserves. (b) Inadequate land use planning and poor plantation management. Planting on degraded sites appears to have been hampered by inadequate research on suitable species and the appropriate use of chemical fertilizers. Many of the existing plantations have been planted too densely for optimum growth and are in need of thinning. (c) Lack of processing plants close to the main forest areas, including the shortage of wood based panel plants which can make use of log- ging wastes, sawmill residues and secondary species. Within exist- ing manufacturing plants, particularly small-scale industries operated by SFFs, there is considerable scope for the introduction of more modern equipment to minimize losses in log conversion, to improve the quality and value of the end product, and to enhance plant safety. (d) The shortage of trained technical and managerial manpower resulting from the rapid expansion of forestry activities in China and the hiatus in technical training during the Cultural Revolution.  - 14 - Bank Group Lending for Forestry 51. Lending in China's forestry sector is part of the Bank's broader efforts to assist in expanding the production of commodities expected to be in continued short supply. While the proposed Forestry Development Project is the Bank's first full-scale involvement in the sector, forestry components have figured importantly in other IDA-financed projects in agriculture. The North China Plain Project and the proposed Pishihang Chaohu Area Development Project include establishment of tree nurseries, plantations, and protective border plantings on a total of more than 50,000 ha. The Rubber Development Project in Guangdong Province is assisting in the new planting and replanting of about 40,000 ha of rubber trees and 12,000 ha of windbreaks. The Agricultural Education and Research Project and the Second Agricultural Research Project are providing scientific equipment, computers, technical assistance and training to expand and upgrade forestry colleges and research iastitutes. The Rural Credit Project is financing investments in Guangxi Province to develop, inter alia, orchard and other tree crops. Project Rationale 52. The major rationale for Bank involvement in this project is to help expand China's forest resource base through afforestation, forest road con- struction and improved management of planted areas. Assistance to the SFFs is an appropriate mechanism in this regard because of their central role in afforestation, the extensive forested areas under their control and the sizeable areas available to them for future plantings. Technology transfer in the project is expected to be considerable. Notwithstanding some impressive efforts at afforestation, forestry in China is less advanced than crop development. The project,would increase supplies of high quality seed and introduce improved technologies related to soil and plant analysis, plant spacing, weeding, thinning and fire protection, use of chemical fertilizers in nurseries and new plantings, road construction, logging, log handling and forest products utilization. Proposed study tours would update technical knowlege of SFF staff who have been relatively isolated from international developments over the past 30 years. Project assistance to forestry research and extension would come at a time when these activities are being reformulated and given increased emphasis by the Government. In view of the need to expand production of wood and wood products and upgrade technology, this project could be viewed as the first of several Bank Group operations in the sector. PART IV - THE PROJECT 53. In early 1983 the Ministry of Forestry requested Bank assistance for a forestry development project; the proposed project was prepared by the Government and Bank staff, with the assistance of FAO/CP; it was appraised in September 1984. A Staff Appraisal Report No. 5394-CRA, dated May 8, 1985, is being distributed separately. Supplementary data are provided in Annex III. Negotiations were held in Washington' from April 22 to April 26, 1985. The Chinese Delegation was led by Mr. Wang Liansheng, Deputy Director, External Finance Department of the Ministry of Finance.  - 15 - Objectives and Scope 54. The project would accelerate afforestation and improve management and exploitation of existing forests on 92 SFFs in Cuangdong, Heilongjiang and Sichuan. It would strengthen forest research facilities in four provinces and establish extension centers in ten provinces. The 92 SFFs in the project have been grouped into 12 "commercial timber bases" and encompass about 1.2 million ha of which 729,000 ha are under forest. Plantation forestry accounts for 729,000 ha out of this total. The permanent labor force resident on project SFFs numbered about 20,800 in 1982; seasonal workers from nearby collectives are employed for plantation establishment, forest tending and logging, and road construction and maintenance. Principal Project Features 55. The project would include: (a) the establishment of about 82,000 ha of forest plantations of which some 24,000 would be fast-growing plantations; (b) forestry improvement, including tending of some 73,000 ha of young plantations and thinning in about 49,000 ha of young plantations and natural forest; Cc) construction or upgrading of about 1,430 km of forest roads to Class III standards and construction of about 500 km of forest tracks; .d) prc' sion of logging trur*s. wheeled and crawler tractors, logging and log handling equipmen. and passenger vehicles; Ce) construction of about 157,000 sq m of buildings, 1,100 km of utility lines, and other infrastructure related to forest fire protection and log handling; (f) construction of wood processing facilities, including a plywood mill, a tannin extract factory, a wood shuttle factory and small wood working shops; (g) strengthening of forest research and extension programs by providing equipment for four provincial forestry research institutes and constructing and equipping ten forestry extension centers; and (h) provision of training and technical assistance, including domestic and overseas training and consulting services for participating SFFs and overseas training and consulting services in support of forestry extension and research activities. 56. Plantation Establishment. About 82,300 ha, of which some 23,900 would be in fast-growing plantations, would be planted during the project implementation period, 1985-88. To reduce costs and encourage early tree growth, the project would recommend planting at densities moderately below  .:~ ~ ~ ~~~~~~~~~~L - t6 - current practice. The project would supply some 10,80 tons of chemical fertilizer for use particularly in the fast growing plantations. The increased use of fertilizer would provide an important impetus to growth in the early years of the plantings, thereby enabling trees to overcome weed competition more readily and substantially reducing weeding costs. Rapid early growth would accelerate cash flow from the plantations by producing saleable log volumes at time of first thinning. The major product would be roundwood, with intermediate yield during thinning of pulpwood, mining timbers and construction poles. The project would establish 60 ha of seed orchard in Sichuan where seed from superior planting materials is in short suppiy. About 25Z of the seedlings produced on the project SFFs would be made available for purchase by nearby collectives. 57. Forest Improvement. Under the project, 73,000 ha of young plantations would be weeded more intensively in their formative years to enhance growth and reduce the risk of fire. Commercial thinning and other improvement operations (improvement felling, seLection felling) would take place on about 48,000 ha of young plantations and natural forest. More intensive thinning regimes would increase tree diameter growth rates, provide greater intermediate returns before clear felling, and produce a higher quaLity end product. The project would increase the effectiveness of fire detection and suppression by providing nine look-out towers and modern communication and fire suppression equipment. 58. Forest Road Construction. The project would construct some 930 km of forest roads to Class III standards, upgrade about 500 km of forest roads to Class III standards and construct about 500 km of forest tracks. Nearly 60% of the Class III road building program would be in Sichuan where the existing density of forest roads is particularly deficient. As a result of the project, the density of forest roads and tracks in the three provinces would increase by at least 75%. 59. Equipment and Vehicles. Equipment and vehicles would be provided to improve logging, log handling and timber transport. Logging operations would be made more efficient by the introduction of improved cable logging systems, articulated skidders and improved chain saws. The introduction of improved cable logging systems would be particularly important in Sichuan where 70Z of logging must be done by cable systems because of difficult terrain. Aboar 400 trucks would be introduced and the average load capacity would increase from the present five tons per truck to seven tons. Four truck-mounted hydraulic cranes would facilitate loading of trucks at roadside and five articulated front-end loaders equipped with log forks would be provided to replace cable cranes and winches at log yards. Five of the log yards would be expanded to accommodate the larger volume of logs expected from project activities. Other vehicles, consisting of 4-wheel drive utility vehicles, pickups and microbuses, would assist in passenger transport and fire control activities. 60. Buildings and Utilities on SFFs. The relatively autonomous nature and isolated location of most participating SFFs requires that each has a comprehensive set of buildings and supporting infrastructure. About 85% of the construction program would take place in Heilongjiang and the balance in Sichuan. Housing construction would alleviate crowded =onditions on SFFs f  - 17 - where present average housing per capita is about a third of the national average, and provide some additional facilities for field crews engaged in logging and plantation establishment and management. The project wouLd construct about 100,000 sq m of housing and school buildings, 33,060 sq m of storage and garage area, 13,150 sq m of office space and 10,350 sq m of mechanical workshops. It would provide about 739 km of telephone lines and 345 km of power lines, construct and equip nine fire watch towers and con- struct other misceLlaneous transport and log handling facilities. 61. Wood Processing Facilities. The project would c nstruct a plywood mill in Shaoguan, Guangdong, capable of producing 10,000 mg of plywood per year. The mill would introduce to the area the technology co utilize small diameter logs in the production of wood-based panels. A factory to extract tannin from eucalypcus leaves would be established in Leizhou, Guangdong. This plant would utilize each year some 5,000 tons of leaves and twigs to produce 1,000 tons of tannin extract for use as a drying agent in the local cement industry. In Bin County, Heilongjiang, the project would establish a factory capable of producing annually about one million wo3d shuttles for the textiLe industry. The factory would utilize about 4,000 m of Logs annually from nearby SFFs. On participating SFFs in Sichuan, the project would construct and equip 12 small workshops to process locally available bamboo and small-dimension timber into packing boxes, shuttles and bobbins, and simple furniture. 62. Research and Extension Centers. The project would strengthen for- estry research capabilities in the provinces of Guangdong, Shaanxi and Sichuan and in Guangxi Autonomous Region. The research efforts would focus on Ci) site classification and soil management; (ii) tree improvement and tree breeding; (iii) afforestation, forest management and logging; and (iv) extrac- tion and utilization of forest products, including non-wood materials such as gums and resins. During the first year of the project, forestry research scientists and administrators would visit overseas institutions which are working on similar problems and would assess research technologies and equip- ment considered most appropriate to conditions in their respective provinces. Assurances were obtained that research plans and equipment lists would be com- pleted by June 30, 1986 and would be submitted to IDA for review and approval (Section 3.06(a)(i) of the draft Development Credit Agreement). In addition to supporting major provincial and county level research and extension activities, the project would construct, equip and provide technical assis- tance for two small (100 sq m each) soil laboratories at Harbin, Heilongjiang and Chengdu, Sichuan and would establish a research unit in Leizhou, Guangdong which would examine the technical and economic aspects of mechanized land preparation for large-scale development of eucalyptus plantations. 63. Forestry Extension. The project would support current plans to strengthen China's forestry extension services by constructing and equipping ten pilot extension centers in Fujian, Gansu, Hebei, Henan, Hubei, Hunan, Liaoning, Shandong, Sichuan and Zhejiang Provinces. These centers would include simple laboratories, classrooms and offices for extension personnel and would be furnished with audio-visual aids and basic laboratory equip- ment. Overseas study tours would be arranged for key extension staff. Assur- ances were obtained that the detailed extension plans and equipment lists  - 18 - would be completed by June 30, 1986 and would be submitted to IDA for review and approval (Section 3.06(a)(ii) of the draft Development Credit Agreement). 64. Training and Technical Assistance. For the SFFs, the project would finance about 84 man-months of overseas study tours (two to four weeks per participant) and 110 man-months of overseas training (more than four weeks per trainee). Study tours would reLate largely to forest management, logging and forest road construction. The overseas training would include work in soil analysis and plant nutrition, and operation and maintenance of wood processing equipment. Four man-months of consulting services would be provided to SFFs through provincial forestry bureaus to assist in the establishment of the soil laboratories in Heilongjiang and Sichuan. The domestic training program for the SFFs p-ovides for 1,460 man-months of practical training to forestry technicians and workers of the SFFs and nearby collectives. In support of research and extension activities, the project would provide about 250 man- months of overseas training to university graduate level or above in subjects directly reLated to forestry development; and 30 man-months of consulting services, of which about 15 would be to assist in forestry research and another 15 to help formulate and implement fcrestry extension programs, which would include assistance in extension planning and organization, monitoring and evaluation, and the production of training materials. Assurance was obtained at negotiations that overseas training and study tours wouLd be carried out in accordance with a program acceptable to IDA (Section 3.07 of the draft Development Credit Agreement). Implementation Schedule 65. The project would be implemented over a four-year period beginning about July 1, 1985. The construction programs for Class III roads (about 50% of the totaL road construction in the project) and project buildings would be substantially compLeted by 1987; this is considered feasible in view of the ready availability of labor and managerial skills in the project area. Detailed work plans for the first year of the project have been prepared by the SFFs and provincial forestry bureaus. The Government's plans for streng- thening forestry research and extension activities would be developed on the basis of the report prepared by the FAO/CP team in August 1984 and with the help of consultants provided by the project. Assurance was obtained from the Government that by September 30 of each year a detailed work and financing plan for the following year would be prepared for IDA review (Section 3.08 of the draft Development Credit Agreement). Procurement actions for goods and services would begin during the second half of 1985, with first deliveries expected before mid-1986. The project is expected to be completed by June 30, 1989. Cost Estimates 66. Total project cost in mid-1985 prices is US$135.8 million, with a foreign exchange component of $37.7 million, or 28Z of the total. No taxes are imposed on major cost items. Unit costs for plantation establishment, forest improvement, roads and building construction are based on expenditures by the SFFs for carrying out similar activities in the project areas. Prices for locally available equipment are based on data provided to MFO by local  - 19 - suppliers. Prices for vehicles, chemical fertilizers, large log handli5ag equipment and related items are based on list prices obtained from manufacturers. Physical contingencies (8.9X of project base costs) equal 1O0 of base costs of construction (including plantation establishment and forest improvement) and equipment. For the calculation of price contingencies, it is assumed that exchange rate adjustments will, on average, be made to maintain the parity of purchasing power during project implementation. Price escala- tion for both foreign and local costs when expressed in US dollars, is based on expected international annual price increases of 5Z in 1985, 7.5Z in 1986 and 8% in 1987-89 and when expressed in yuan, is based on expected domestic inflation of 32 p.a. in 1985-89. Financing 67. Bank Group assistance would be US$47.3 million (351 of the total project cost), consisting of an IDA credit of SDR 47.8 million. The balance of US$88.5 million equivalent would be provided from the central government budget (about US$46.3 million equivaLent) and provincial forest bureaus and participating state farms (about US$42.2 million equivalent). Provincial governments would contribute about US$16.4 million equivalent in support of project research and extension activities. Procurement 68. International competitive bidding (ICB) in accordance with Bank Group Guidelines would be followed in procurement of equipment and vehicles (US$23.1 million) and chemical fertilizers (US$3.1 million). Domestic manu- facturers would receive a preference of 15% or the applicable customs duty, whichever is less, in bid evaluation. Prior IDA review of contract awards would exclude small contracts ($200,000 or Less) estimated to cover less than 15Z of the value of all contracts. Small items of equipment costing not more than US$50,000 each or US$5 million in total wouLd be procured on the basis of three price quotations under procedures acceptable to the Association. Estab- lishment of plantations (US$15.2 million), forest improvement (US$11.7 mil- lion), construction of buildings and utilities on SFFs (US$11.2 million) and construction of facilities for extension and research (US$7.8 million) wouLd be carried out by force account employing the workers on participating SFFs and nearby collectives. Because these works are in widely separated provinces and distributed among 92 SFFs, they could not be readily packaged into con- tracts large enough for ICB. Construction of forest roads and tracks would be done under contracts between the SFFs and construction companies from the county or nearby townahips. Competitive bidding among local construction teams, which has been rarely used by the SFFs, would be encouraged by SFF man- agement in road construction.  - 20 - PROCUREMENT PROFILE (US$ million) /a Procurement methods Limited international Other pro- T.A. Total Item ICB bidding /b cedures guidelines cost Plantation establishment 15.2 15.2 (7.5) (7.5) Forest road construction/ grade 3 23.6 23.6 (6.1) (6.1) Chemical fertilizer 3.1 0.5 3.7 (3.1) (3.1) Equipment and vehicles 23.1 5.0 28.1 (including the plymill) (23.1) (5.0) (28.1) Technical assistance 2.5 2.1 (2.5) (2.5) Construction and operation/ research and extension 12.0 12.0 Forest improvement 11.7 11.7 Buildings and utilities/SFFs 11.2 11.2 Wood processing (buildings, equipment except plymill) 7.2 7.2 Forest track construction 5.3 5.3 Other, incLuding management and overheads and associated contingencies 15.3 15.3 Total 26.2 5.0 102.1 2.5 135.8 (26.2) (5.0) (13.6) (2.5) 47.3) /a Figures in parentheses indicate amounts which would be financed by IDA. All figures include price and physical contingencies. /b Includes the financing of small items of equipment costing not more than US$50,000 each or US$5 million in total which would be procured on the basis of three price quotations under procedures acceptable to IDA.  - 21 - Disbursements 69. Disbursements against expenditures for equipment, vehicles and materials for SFFs would be at a rate of 100X of the foreign exchange costs of imported items or 100Z of the ex-factory price of locally manufactured items. Disbursements for overseas training and consulting services would be 100X of total costs. Disbursement for the establishment of plantations on SFFs, excluding chemical fertilizers, would be 49X of total expenditure and disbursement for construction of roads to Class III standard would be 25% of total expenditure. Such disbursements would be against statements of expen- diture supported by progress reports showing physical quantities and unit prices. Agreement was reached with the Government at negotiations on these unit prices. Unit prices would be updated annually by the provincial forestry bureaus (PFBs) in the participating provinces and approved by IDA. Disbursements against expenditures for equipment and vehicles for the provincial research institutes and county level extension centers would be made at 100l of the foreign exchange costs of imported items or 100% of the ex-factory price of locally manufactured items. For overseas training and contracts valued at less than $50,000 each, disbursements would be made on the basis of statements of expenditure to be certified by th4e MFO. Documentation supporting the SOEs would be retained at the Project Management Office (PMO) in Beijing for review by IDA. To provide for efficient disbursement of the credit proceeds, a special account would be opened in US dollars in the Bank of China with an authorized allocation of the US dollar equivalent of SDR 4.5 million which represents the estimated expenditure for an average four-month period. Applications for replenishment of the special account would be submitted quarterly, or whenever the special account is drawn down to 50Z of its initial deposit, whichever comes first. No disbursements would be made against other project expenditures. The credit closing date is December 31 1989. Accounts and Audits 70. Accounting systems maintained by the PFBs and based on regular sub- missions by accounting units in SFFs are adequate to control project finance and disbursements. Assurances were obtained that the PFBs would maintain detailed project accounts for major expenditure categories and that these would be audited annually by independent auditors acceptable to the Association and submitted within six months of the close of each financial year (Section 4.01 of the draft Development Credit Agreement; Section 3.01 of the draft Project Agreement). It is expected that the state audit agency of the Central Government would audit project accounts of the PFBs. Environmental Effects 71. The project would improve environmental conditions and no detri- mental effects are anticipated. The afforestation of presently underutilized and unproductive land would lead to better water conservation and water quality and would reduce soil erosion. Amenity values would be enhanced, wildlife habitats improved and fire losses reduced. Soil fertilizer levels would be raised through the use of increased quantities of chemical fertili- zers. All areas scheduled for logging would be surveyed to ensure the protec-  - 22 - tion of rare or endangered species. Areas of natural forest with slopes of more than abcit 80% would be designated as areas of protection forest from which all forestry activities would be excluded. The increased availability of fuelwood from new plantations is expected to reduce random cutting in existing natural forests thereby improving the quality of those stands. Industrial wastes produced by the plywood mill would be recycled as fuel to be used within the plant. Project Management and Execution 72. The forestry development activities in the project would be carried out by the SFFs under the supervision of the PFBs of Guangdong, Heilongjiang and Sichuan Provinces. The plywood mill, the tannin extract factory and the wood shuttle factory would be the responsibility of county forestry bureaus operating under PFB supervision. The PFBs would operate under the general guidance of a PMO established within MFO and headed by a representative from the Silviculture and Management Department. Provincial project management offices would be responsible for coordinating the activities of participating SFFs and providing technical and logistical support. Similar groups responsible for day-to-day activities would be established within participating SFFs. An assurance was obtained at negotiations that t'e PMOs at ministry, provincial, and local levels would be maintained during project implementation and adequately staffed with qualified personnel. (Section 3.04 of the draft Development Credit Agreement and Section 2.04 of the draft Project Agreement). The research and extension activities in the project would be carried out by the PFBs of the participating provinces under the general supervision of the MFO's Department of Science and Technology. A simple intra-governmental project implementation agreement between HFO and the participating PFBs outlines their respective responsibilities and has been approved by all units concerned. 73. In the project, funds made available for forestry development from IDA and -he Central Government would be passed to the SFFs through the PFBs for repayment over 15 years, after 5 years' grace period at 3Z p.a. interest. The terms at which funds from provincial sources for forestry development would be made availabLe to SFFs would vary among SFFs, depending on their financial strength and repayment ability. In keeping with national policy, increased emphasis would be placed on loan assistance in lieu of grants. Domestic funding of the research and extension activities would be financed entirely from the government budgets of the fourteen participating provinces. The proceeds of the IDA credit would meet costs for equipment, overseas training and consulting services in the research and extension activities and would be repaid by the fourteen provincial governments on terms similar to those applicable to Central Government funds channelled to the SFFs. Markets 74. Strong internal markets exist for all of the project output. Log production in China meets only about 85% of current consui.ption and imports of logs, sawn timber and other wood products are increasing rapidly. Rapid income growth and the surge in construction of rural housing will lead to  - 23 - continued strong demand for wood and wood products. The plywood mill is sited in a rapidly developing p ovince (Guangdong) which had a plywood production capacity of only 10,000 m in 1983 and purchased large quantities from other provinces. The demand for tannin extract by the local cement industry is estimated at 4-5,000 tons per annum while current production is reported to be about 100 tons. Annual replacement demand for wood shuttles is estimated at about 10 million units, as compared with yearly output from the project facility of one million units. Financial and Economic Prices 75. It is estimated that about two-thirds of log production in the project would be commercial timber allocated within the state plan and sold at the state fixed price co the central or provincial governments. The remaining output in excess of the quota would be sold at higher-than-state prices. On average, financial prices are about 55% of current estimated world prices for timber of comparable quality. World prices in real terms for the same type and mix of timber are projected by the Bank to increase by about 1Z per annum over the medium term. The Government recognizes the need to further increase state prices of timber to provide additional incentives for production. A policy directive effective January 1985 permits all timber from individually- controlled plots and che collectives to be sold on the free market at prices which have been substantially higher than state prices. The Government aims to increase average domestic timber prices to world Levels over the next few years as part of the ongoing price reforms. 'hile the exact timing of these prire increases cannot be predicted, it is expected that the next price adjustments will take place before the end of 1986 and that parity with international prices will be achieved within the Seventh Plan period (i.e., by 1990). An understanding was reached that the MFO would prepare a report for discussion with the Association before the end of 1986 which describes more fully the entire forestry price and marketing system. 76. Most of the labor used in the project is provided by nearby collec- tives. iages range from Y 2.50 per man-day in Sichuan to Y 5.00 in Heilong- jiang. The base case economic analysis assumes that the economic wage is one- half of the financial wage. Substantially higher economic costs for labor would not jeopardize the economic viability of the project. Financial prices for fertilizer of the type requirel by this project have been assumed equal to economic prices over the life of the project. Production 77. The major output from the project would include logs, poles, ply- wood, tannin extract, shuttles and miscellaneous wood products such as furni- ture and packing crates. Through road building and provision of equipment, the project would improve access to existing mature forests and permit accel- erated logging of natural stands. Annual total production in the natu ral stands on the SFFs would increase from the current level of 507,000 m to 660,000 m3 in 1988. Without the project it is assumed that production from natural forests would decline by 20% annually in 1986-88 and remain at that level over the next several years. Production from plantations, virtually all of which would be established on cut-over land now of low or zero producti-  - 24 - vity, would begin with commercial thinnings after 1988. All output from the plantations and the wood processing facilities is considered as incremental. Incremental production of logs for the project wouid average about 204,000 m annually in 1985-88 and would total 11.2 million m over the 23-year period assumed in the economic analysis. A3nual incremental production at full development would be about 546,000 m , or 18% greater than total log production from these farms in 1982. Although difficult to quantify precise- ly, additional production benefits would be expected from the tending activi- ties in the project (mainly weeding, pruning and fire protection). The ply- wood mill is projected to reach full production of 10,000 m annually in 1989 while the shuttle and tannin extract factories would be producing at an annual capacity of a million units and a thousand tons, respectively, in 1988. Financial and Economic Analysis 78. The FRR is estimated to be 28% in timber production, 16% in the case of wood processing and 27% overall. In timber production, FRRs are 17%, 29% and 46% for Sichuan, Heilongjiang and Guangdong, respectively. In wood pro- cessing, FRRs are 12%, 14% and 24% for the plywood mill, the tannin extract factory and the wood shuttle factory, respectively. The relatively high FRRs in timber production are consistent with returns to similar activities in other countries and reflect in part the near-term benefits realized from the accelerated logging permitted in mature forests as a result of investment in road construction and equipment upgrading. Following Bank Group practice in similar earlier projects, returns have been calculated for timber exploitation and plantation establishment combined, as these two activities are normally considered an integral part of weLl-managed forest production systems. The relatively low FRR for the plywood mill reflects in part the low conversion rates obtained in producing plywood from small diameter logs. 79. The overall ERR for the project exceeds 50% (67% in timber produc- tion; 14% in wood processing). The ERR exceeds 50% for both Guangdong and Heilongjiang and is estimated at i4% for the plywood mill. At a discount rate of 12Z, the prcject has a net present value of Y 562 million, of which about 80% is contributed by timber production in Guangdong and Heilongjiang. As in the case of the financial analysis, the high ERRs in timber production are due in part to the early returns made possible by project activities which accele- rate logging of mature forests. Sensitivity testing indicates that no plausi- ble changes in prices, costs or timing of benefits would jeopardize the econo- mic soundness of the project. Similarly, the project would remain economi- cally viable with an assumed doubling of economic labor costs to equal the financial wage. On the other hand, a 10Z decline in prices of wood products, a similar increase in costs, or a one-year delay in benefits would push the ERR for wood processing to the 8-9% range. Project Risks 80. The timber production activities in the project face no significant financial, technical or organizational risks. The SFFs are in general well managed. They have experience with the tree species to be planted and silvi- cultural practices to be introduced have been proven elsewhere. Administra- tive and financial risks associated with wood processing are larger, but  - 25 - considered manageable. The SFFs operate wood processing facilities in the project provinces, including wood-based paneL plants, although the technology using small diameter timber would be new to the SFF system. It is expected that the supplier of this equipment would provide necessary support in training the operational and maintenance staff. Efficient operations would be required to ensure satisfactory economic and financial results. Little administrative risk is attached to the research activities in the project, as these are geared largely to a strengthening of on-going programs. More administrative risk is associated with the extension component which is viewed as a pilot operation in a key support service currently being reformulated in China. It is believed that these risks can be kept within acceptable bounds by the consulting services provided in the project. PART V - LEGAL INSTRUMENTS AND AUTHORITY 81. The draft Development Credit Agreement between the People's Republic of China and the Association, the draft Project Agreement between the Association and the Provinces of Guangdong, Heilongjiang and Sichuan, and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement of the Association are being distributed to the Executive Directors separately. 82. Special conditions of the project are listed in Section III of Annex III. An additional condition of effectiveness would be that China's State Council shall have approved the Development Credit Agreement and the Project Agreement (Section 6.01 of the draft Developmenc Credit Agreement). 83. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 84. I recommend that the Executive Directors approve the proposed credit. A. W. Clausen President May 13, 1985 Washington, D.C.  -26- ANNEX I Page I of 6 cmA. mrCDs uP. or - sOCIL INOcCTO.s .As s er CUM, oML-WLS UP. OF r M131Uc cOUPS (ZICHI ATD A*IAGES) /a VW3 (lSw mm=u 33?DI&2) A -R 7 IU 133l3 301 a9seoLd L30k ru:uExc& ASA6FWISA4 rxcIE -U, Siu .l u) TVIAL 9561.0 3561.0 9361.0 AUIlC0lMAL 3257.6 IU2.0 3865.9 - ECam= (36s$) 40.0 Ie M0. 310.0 278.6 1092.2 NM ci momwrzw PM cairn (LoAGAs Or OIL 741VA.LZII) 191.0 230.0 461.0 272.0 567.3 PeUamm ammi VxTAL srAUSzC I PVOVLAZXOK.KLD-21 (TIOoSAMS) 87800.0 845700.0 10817.0 . - OREM POPUL*hO CZ O1 TOM) 18.4 /4 .. 20.6 21.7 34.7 POPULATIONI USOZICTIO POPLATE IN Wm 20KlL) 1196.3 _ _ SAIORA POPuIAm (MILL)1.. OULATIM Renew= 1.7 POPULMTON pzsusm PER SQ. S1. 71.3 88.5 103.8 186.6 26L.9 PM SQ. . AC!. LAND 211.1 217.9 256.8 345.5 1735.1 POPULATION ASE STMCZU CZ) 0-14 US 38.9 37.7 30.9 35.8 39.0 15-4 URS 56.3 57.2 63.3 59.8 57.S 65 AND AU3 4.8 5.1 5.5 4.3 3.3 POrmSoATI cOllIE 3! CZ) 70rAL 1.3 2.1 1.5 1.9 2.3 URN" - .. 4.1 4.3 zM MUE 3I82 (PE11 25) 39.2 le 3X60 16.5 27.7 30.1 liE OWN tAU (PER T30S) 23.5 7 10.1 6.6 10.1 9.5 cOss 3E0OcU0 7= 2. a 2.3 1.2 L1S 2.0 -MS. AlC C S) uns CZ O0 MAru3D WD). 69.4 If . _ 52.7 (1969-71-100) 1001.0 124.0 11L2. 1230 PIE CAPITA 5011'!.? 0r CALCUES CZ O UIQUXREIENTS) 93.0 83.0 107.0 97.7 114. P-*7E C (GRUB MM DAY) 56.0 53.0 66.0 56.8 57.0 0F wzCR AuXuL AND PlSE 16.0 16.0 17.0 14.9 14.1 -D (CAZS 1-4) DZA A 26.0 14.0 7.0 9.3 7.2 _~~~~~~~~ LIM EPICI Ar BR (TEARS) S 41.0 lb 52.3 66.5 60.0 60A ISUA 1R1. RATE (In eM) 165. 0 109.0 67.0 83.8 66.3 *c~ TO 5a wJar (2307 TOT'L -' 41-0 3329 37.0 11M! ,, .s-a 70.9 54.8 RURAL~~~3 20 1 26.1. ACS TO Vw4A 015D10612 CZ Or POPULATION) TOTAL .- .. __ 18.1 41.3 8834A . .. .- 72.8 47.4 RAL _ _. _ 6 33.3 POPULATION PM PUSICIN B390-0 If 3830.0 /t l110 0t 3484.2 7749.4 POP. PM 3M P.7 * 050 _ 4030.0 2870.0 1790.0 4793.1 240.A POP. PM WSFIXAL BED TOTAL 1040.0 760.0 490.0 1066.5 1044.2 05343 210.0 -. 160.0 298.0 651.A 33312 10140.0 .. 1020.0 93.4 2594.6 AUSS PE OSPL E .. .. .. .. 27.0 AVERACE SUE OP HOOSEBMD TOL .. .. 5.2 ca11 _ .. 4.2 USRAL .. .. 5.5 *USaS N0_ or 2URSNIZOa TOTAL -' '- 03.6 .. .. .. RE.aL .. . .. . ACCS TO EXECT. (Z OF .ELLIC_S) TOTAL _ .. .. _. _, ., ~~~~ _a  -27- . ANNEX I Page 2 of 6 Mu29. M091 ur. er - uLC1SDICA?(So DA 1 GR,M no0u1 EU. oP * WhIn 0c0 (MEGUD