China - Seeds Project

Document of The World Bank FOR OMCIAL USE ONLY Report No. P-3997-CWA hi REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED IDA CREDIT OF SDR 41.7 MLLION TO THE PEOPLE' S REPUBLIC OF CHINK FOR A SEEDS PROJECT March 20, 1985 ! This doemeat bh a restricted distributiom md -ay be ued by recipients ely In the pefosmmnce of their olicial duies. I}t conteot may not odtrwise be disclosed without World Bank authoorizoi.  CURRENCY EQUIVALENTS Currency Unit - Yuan (Y) Calendar 1984 January 1985 US$1.00 Y 2.50 Y 2.80 Y 1.00 US$0.40 US$0.36 Fiscal Year January 1 - December 1 Weights and Measures 1 meter (m) = 3.28 feet 1 kilometer (kn) = 0.62 miles 1 hectare (ha) = 2.47 acres -- l5 mu 1 kilogram (kg) = 2.2 pounds 1 ton (t) = 2,205 pounds Abbreviations and Acronyms ABC - Agricultural Bank of China AITC - Agriculture, Industry and Trad' Corporation BSF - Bureau of State Farms CAAS - Chinese Academy of Agricultural Sciences CNTIC - China National Technical Import Corporation GVAO - Cross Value of Agricultural Output MAAF - Ministry of Agriculture, AnimaL Husbandry and Fisheries MOF - Ministry of Finance NSC - National Seed Corporation PBSF - Provincial Bureau of State Farms PCB - People's Construction Bank PMO - Project Management Office PRS - Production Responsibility System tph - tons per hour  FOR OMCIAL USE ONLY CHINA SEEDS PROJECT Credit and Project Summary Borrower: People's Republic of China Amount: SDR 41.7 million (US$40 million equivalent) Terms: Standard Project In support of the Government's seed industry development Description program, the project would modernize facilities at 18 seed production, processing and distribution centers in 12 provinces and two autonomous regions. It would also strengthen operations of the National Seed Corporation (NSC), the central agency under the Ministry of Agricul- ture, Animal Husbandry and Fisheries (MAAF) which is responsible for developing a comprehensive seed quality assurance and control system. The project would contribute to increased production of high quality seed for major food and cash crops and serve as a model for planned construc- tion over the next two decades of over 300 modern seed centers throughout China. Principal features of the pro- posed project would be construction of processing and storage facilities, laboratories, offices, and staff housing for the 18 centers; improvement of farm roads and irrigation works at seed center farm sites; and provision of pre-cleaning, drying, processing, testing, analytical and farm equipment. The project would also include a technical assistance (32 man-months of consultant services) and training component designed to facilitate access by China's seed industry to advanced seed technology, modern quality assurance and control systems, and improved management methods available within the international community. The project faces no major technical risks since it involves proven seed process- ing technology that has been in regular operation in other parts of the world. Any uncertainty regarding overall coordination of project activities would be offset by the fact that the central Project Management Office would include, in addition to NSC staff, representatives from the Bureau of State Farms and the North China Plain Project Office, both of which are responsible for components of the project and have had previous experience in implementing Bank projects. Thlis 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 $ miLlion Buildings 18.0 2.0 20.0 Seed farm deveLopment 12.9 2.3 15.2 Processing and laboratory equipment 2.1 18.8 20.9 Farm equipment and materiaLs 2.4 13.3 15.7 Overseas and local training 0.1 0.8 0.9 Technical assistance - 0.5 0.5 Base cost 35.5 37.7 73.2 Physical contingency 1.9 2.8 4.7 Expected price increase 4.3 4.6 8.9 Total Project Cost 41.7 45.1 86.8 Financing Plan: Total IDA - 40.0 40.0 Seed Centers 30.9 - 30.9 Provinces 10.8 5.1 15.9 Total 41.7 45.1 86.8 Estimated: Disbursements: IDA FY 1986 1987 1988 1989 $ million Annual 6.8 15.2 14.0 4.0 Cumulative 6.8 22.0 36.0 40.0 Rate of Return: 38% Staff Appraisal Report: No. 5348-CHA, dated March 18, 1985.  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 SEEDS 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 seeds project. The credit, for SDR 41.7 million ($40.0 million equivalent), would be on standard IDA terms. PART r - 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 preparing a report on long-term development issues and options, which is expected to be submitted to the Executive Directors by May 1985. Basic data o0 the economy are given in Annex I. 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 CDP; 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) CDP 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 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 2Z p.a.), a sharp cutback in budget-financed investment, a lower budget deficit (1X of GDP in 1981); and a current account surplus of $1.5 bil- lion in 1981 and $5.6 bi'llion 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 8Z 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 Govern- 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 10% p.a. between 1981 and 1984, with heavy indu3try growing somewhat faster than light industry (122 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 oil 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 output value rising at 9% 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 demand and attractive prices, have also grown very rapidly. 7. There have been impressive increases in personal incomes throughout the period 1978-83. Average per-capita income in rural areas rose by about 12% p.a. in real terms and urban incomes by about 5% 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 exreeding 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 hindered by administrative controls. Construction costs have risen continuously (10% p.a. in 1978-83).  -3- 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 25Z. 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 5.5% 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 remartable spread of nonagri- cuLturaL activities like processing, transnort, 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 increasingly 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 procurement 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 interest 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 retention 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 -ose 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 capital 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  - 4 - 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 2OZ 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 progress. 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 of macroeconomic management. Adjustments in indirect taxes may be used to affect profitability and supply, in the 'bsence of or as a supplement to price reform. Scope for horizontal flows of investment funds is also widening, as  -5- 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 t 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 of 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 responsibilicies and appropriate incentives at all levels in the economy; and the recognition that thoroughgoing price reform must involve liberalizing the mode of price determination, not just adjustments in administratively set prices. Managers of large state-owned enterprises, however, will still be appointed by Government organizations; a few key products will still be subject to mandatory planning and distribution by the Covernment; state ownership and control over certain institutions like banks and railways will not be relinquished; and establishment, relocation, changing product lines, mergers, and shutdown of enterprises will still be subject to Covernment 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 agriculture between 1980 and 2000 (which means GDP growth of well over 6% 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 agricalture, 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 the 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 investments 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 beneficial impact on growth and efficiency, a new set of issues will come to the fore. Hanagement 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 population 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 resources through the fiscal system, easing restrictions on migration out of the poorest areas, and Lowering nonagricultural wages to make investment in them more attractive are some options for alleviating poverty in these areas.  -7- 23. The Government is in the process of finalizing its Seventh Five Year Plan (covering the period 1986-90). The combination of potentially fundamental reforms and the urgent need for large investments in many parts of the economy to build the foundation for further growth makes this task 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 Group funds, a significant amount of 4 concessionary capital is likely 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 with 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 co finance goods, and later civil works) is being adopted by the Government for most local purchases and many domestic construction projects. 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 equipment imports, provision of foreign consulting assistance, arrangement of training and promotion 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 under 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 experience 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.  -9- 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 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 projects, and future regional industry projects are examples of the links between economic and sector work and the lending program. 32. More fundamental research by the Bank in collaboration with Chi'qt 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 a -: expected to produce the basis for detailed diszussion 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, 22 projects involving lending of $2.274 billion to China have been ap- proved. Annex II contains a summary statement on these loans and credits as of September 30, 1984. For this fiscal year we hope 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, and Changcun (Luan) Coal Mining; the proposed Seeds Project; and projects in rural water supply, roads, railways, forestry, fertilizer industry, gas engineering, and Pi-Shi-Hang Area development.  - 10 - 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 and will take better account of intersectoral linkages. 37. In the energy sector, Lending has included mix projects, which have emphasized increased energy output and technology transfer through financing of equipment, technical studies, training and consultant assiscance. 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 focussed on increasing capacity, upgrading technology for lover cost opera- tions, 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 enter- prises. Intermodal coordination and planning and assessment of alternative investment choices will have increasing prominence in both lending and sector work. 39. In agriculture, seven projects have emphasized support services through improved research and education, production increases through new land development, reclamation, use of improved technologies and management, and strengthening of the agriculture credit system. Projects in seeds develop- ment, forestry and agriculture credit will continue to strengthen support 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 transformction 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 produc- tion-oriented projects such as for fertilizer, machine tools, and cement, to expand output and demonstrate the merits of improved subsector analysis and planning.  - 11 - 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 four 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 policy and curriculum reform has been demonstrated in the first projects. Improved university management is 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 Governnent 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. While there were some initial delays in procurement because of the Government's unfamiliarity with the concept of bidding, it has since estab- lished a specialized central procurement agency to address the problem. 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 AGRICULTURE SECTOR 43. Agriculture in China, including crops, livestock, forestry and fisheries, provides sustenance to over one biLLion peopLe, is the source of income for about 190 million farm families, and accounts for about 35% of the country's GDP. 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 agri- cultural 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 80% of the cropland and account for 55Z of total agricultural output. This intensive system of production allows China to meet the basic food needs of its population (about 22% of the world's total) from less than 8% of the world's arable land. Crop yields are about 50% greater than those in other developing countries and for some crops in some areas yields approach those in developed countries. Agricultural production is carried out largely on household-managed farms within a framework of collective or state ownership of land and major fixed assets. 44. Agricultural development has been accorded high priority since the founding of the People's Republic. With public sector investment in agri- culture averaging about 10% of totaL national public sector investment, the sector grew by about 3.2% p.a. from 1955 to 1978. Agricultural productivity per hectare of cultivated land increased considerably. Grain yields nearly doubled between 1952 and 1978; the most rapid increase occurred in the years  - 12 - 1965-78 when Government policy put special emphasis on achieving local self- sufficiency in grain production. These gains, accomplished through combined application of abundant local labor and modern inputs such as improved seeds, chemical fertilizers, and mechanical threshers, allowed China to feed an additional 300 million people. Remarkable as this achievement was - given the arable land constraint - total production in fact did littLe more than keep pace with population growth during the period. Moreover, the Government's policy of promoting increased local self-sufficiency in grains checked possible gains from crop specialization and exchange and, in some extreme cases, led to deterioration of the land base. By the late 1970s, official assessments began focussing attention on the unsatisfactory state of people's incomes and living standards, particularly in the resource-poor areas of the northwest and southwest. 45. Improved producer incentives, a renewed emphasis on specialization, and continuous infusion of new and improved crop varieties are among the principal factors contributing to the high growth performance of the agri- cultural sector since 1979. GVAO has grown at an annual average rate exceed- ing 7%, or more than twice the rate achieved over the previous two decades. The period has seen a steady decline in the share of crop production aud relative gains in livestock. In real terms, rural incomes may have risen by 70%, and consumption gains have been substantial. 46. Beginning in 1979, the Government departed from previous policy by giving greater priority to improved consumption levels while scaling down goals for growth in GNP and investment. The challenge of the coming decades is how to increase the production of food and other agricultural products needed to meet this commitment to improved living standards for China's vast population. Demand for agricultural products is expected to increase steadily over the next two decades in response to increasing per capita income and moderate population growth. China's cultivated area will remain essentially unchanged over the period - land lost to roads, urbanization, and industrial development will be approximately offset by newly reclaimed land. As a result; the production gains required to feed a population growing by at least ten million per year and to supply the raw materials to meet rapid growth in industrial demand will have to come almost entirely from increased yields on existing cultivated areas. Year 2000 growth targets for major food and cash crops include: (a) annual growth in rice production of about 1.8% with the sown area remaining constant and increased yields accounting for output gains; (b) annual growth in corn and wheat production of about 2.62, similarly as a result of yield increases on presently cultivated land; plans also cali for increasing the productivity of other food crops such as tubers and soybeans; (c) increased production and diversity of fruits and vegetables to meet expected expansion of consumer demands accompanying rising incomes; and (d) improved yields and production of cash crops - cotton, sugar crops, oilseeds - the demand for which is projected to grow rapidly. 47. Key elements of the Government's strategy to achieve these growth targets are: (a) improving producer incentives - e.g., making the farm house- hoLd, rather than the collective, the basic unit of management and production in agriculture; providing higher procurement prices for farm produce, and expanding the flow of credit to rural areas; (b) facilitating crop specializa-  - 13 - tion and comercialization through reforms in the farm price structure and relaxation of regional procurement and sown area quotas; (c) expanding agricultural research activities with an emphasis on increased use of modern inputs and technology; (d) strengthening the agricultural extension system to facilitate transfer of relevant technology to farmers and feedback of produc- tion problems to research units; (e) creating improved and well-integrated systems of production, storage, transport, and marketing; (f) strengthening past programs to boost agricultural output - e.g. production of certified seeds, construction of irrigation works, application of fertilizers based on soil and foliar analysis, and development of pest management systems. Organization of the Seed Industry 48. Recognizing that high quality seeds in adequate quantity a e critical inputs to increased crop yields, the Government since 1979 has given attention to strengthening China's seed industry. At the central level there ar's two agencies within MAAF responsible for national seed production, the N.tional Seed Corporation (NSC) and the Bureau of State Farms (BSF). NSC's major responsibilities are to develop national policy guidelines for the seed industry, to establish national seed testing and certification standards, and to provide technical guidance and training to a network of over 2,300 locally- financed and administered seed companies. The local seed companies - provincial, prefectural, and country - are responsible for seed production; they supervise about 2,300 seed farms, the majority of which produce stock seed. They also contract with nearby townships and villages for further multiplication of seed. Each company prepares a production plan for its affiliated farms subject to review by the appropriate local government planning commission and agricultural bureau. Under post-1979 economic poli- cies, seed company revenues from the sale of seeds and various management and technical fees have risen to the point of allowing a small profit margin. As a result, Government subsidies are being gradually reduced. In 1983, 86% of China's 2,300 seed companies reported a small net profit (totalling 63 million RMB) with only 14% recording losses (of 26 million RMB). This compares with figures of 64Z and 36% respectively in 1979. 49. The BSF coordinates a parallel system of seed companies and farms. At the provincial level technical and financial assistance are channeled through the provincial bureau of state farms (PBSF) and its chief marketing and promotion arm, the Agriculture, Industry and Trade Corporation (AITC). A recent (as of the end of 1983) innovation in line with the Government's policy of encouraging commercial development, AITCs are already operational in most provinces. Key AITC responsibilities are interprovincial trade, imports and exports, and construction including contract work outside the state farm system. Under the new AITC structure, seed production, processing, quality control and marketing are handled by AITC-affiliated provincial seed companies and branch seed companies which operate at the state farm level. MultipLica- tion of seed is carried out by specialized subfarms within each state farm. Support Services 50. Breeder seed is supplied to collectives and state farms by national research institutes under the Chinese Academy of Agricultural Sciences (CAAS),  - 14 - by provincial and prefectural research academies, and by research institutes which are part of the state farm system. Research programs in genetics and plant breeding at China's 66 agricultural colleges and universities are also contributing to the development of new plant varieties. Extension institu- tions continue to be of pivotal importance in encouraging farmers to adopt improved varieLies. The Government is in the process of consolidating previously separate extension services, including seed offices, into a single, county-level agrotechnical extension station; about 300 of a projected 2,300 stations are already in operation. Training in seed production -- including upgrading courses for the estimated 400,000 employees in NSC and state farms seed operations nationwide -- has been organized in recent years by the seed companies and provincial bureaus of state farms. While the numbers enrolled are impressive, the course content in such areas as seed processing techno- logy, quality assurance and control, and enterprise management needs revision to fit the requirements of a modern, efficient seed industry. Seed Production and Processing 51. Under the NSC system, multiplication of stock and certified seed is carried out by seed farms either managed by or under special contract to the local seed companies. Currently about two million ha are planted with stock seed for an annual yield of about six million tons of seed to be used for crop production. All of this seed - representing about 35Z of the nation's total annual seed requirement of 17 million tons - is grown under seed company technical supervision and is thus labelled "certified." However, only about two million tons which is purchased from the farms by the seed companies for processing and resale has undergone rigorous field inspection and testing. Under the state farm system, AITC-affiliated seed companies manage production and distribution of about 650,000 tons of seed - or about 4% of the total national requirement - for crop production. Though historically the state farms have focussed on supplying only their own seed needs, current trends encouraged by economic policies since 1979 show state farms increasing the amount of seed marketed both outside the province and outside the state farm system (the latter presently 14%). Over the next two decades, about 25X of state farm seed (and other planting material) output is expected to be sold to the collectives. Of the nearly 7 million tons of seed supplied by NSC-and GBSF-affiliated enterprises, about 90% has been processed using traditional methods - e.g., sun drying and hand or machine winnowing. The remaindrr is mechanically processed, for the most part using small-sized equipment which is worn, outmoded and inefficient. Less than 1%, or about 50,000 tons, has been properly processed - in the only six modern high-capacity seed processing plants now operating in China - and certified in accordance with modern procedures. Current base retail prices for industry-supplied seed reflect full production costs for bulk, untreated seeds plus a small premium amounting to 15X or more (see also para. 61). Bank Group Lending for Agriculture 52. The Bank's strategy for lending in China's agriculture sector is to support the Government's efforts to raise agricultural production thrcugh the more efficient use of land and water resources and improvements in support services such as credit, research and agricultural education. Projects are  - 15 - also being selected for their aemonstration and catalytic impact in addition to immediate income generation. The first Bank Group operation in the agriculture sector, the North China Plain Project (Credit 1261-CHA) is pro- viding irrigation and 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 (Credit 1297- CHA), and Agricultural Education II (Loan 2444/Credit 1500-CH) and Agricultural Research II (Credit 1516-CHA) projects are supporting the Government's program to strengthen higher education and research in the agriculture sector by providing technical assistance and equipment to selected agricultural colleges and research institutes. The Heilongjiang Land Reclamation Project (Loan/Credit 2261/1347-CHA), che Bank Group's third agricultural project in China, has as its main objective developing new land on state farms in the Northeast for wheat, corn and soybean production. As its fourth investment in the sector, the Bank is financing a Rubber Develop- ment Project (Credit 1917-CHA) in Guangdong Province; the project assists in the new planting and repLanting of about 40,000 ha of rubber. The Rural Credit Project (Loan 1462-CHA) which became effective on November 1, 1984, finances investments in Guangxi Province for the development of orchard and other tree crops, agro-processing, livestock and aquaculture through the Agricultural Bank of China. Other projects at various stages of processing include: the proposed seeds project; a forestry project covering commercial timber production and forestry research and extension; and the Pi-shi-hang area development project. Future project possibilities include a second credit project, aquaculture, irrigation and drainage, red soils development in the southern uplands and land development in the Northwest. Project Formulation and Rationale 53. As part of its overall program to boost agricultural production the Government is placing high priority on strengthening the seed industry. Long range plans call for establishing throughout China over 300 integrated seed production, processin- and distribution centers, each comprising several seed companies and affiliated stock and certified seed farms. By the year 2000, production of fully-processed, high quality seed by these centers is expected to reach 2.5 million tons p.a. The major rationale for Bank involvement in the proposed project is to support the Government in this seed industry deve- lopment program. In particular, participation of the Bank would enable staff of the NSC and BSF to gain access to improved seed technology and technical advice available within the international community. This would incLude advanced equipment for seed drying, processing, packaging and laboratory analyses; techniques of preparing facility layouts and developing uniform quality assurance/control procedures; and approaches to technical and business management of seed enterprises. Over the long term, this transfer of techno- logy and expertise would facilitate rapid modernization of seed processing facilities as well as strengthening the capacity of the NSC to administer a modern national system for seed marketing and control. Based on project crop production requirements and considerations of regional comparative advantage, the Government, in consultation with Bank staff, selected 18 seed centers for inclusion in the project. The centers are located in 14 provinces/autonomous regions representing principal producing areas for major food and cash crops including rice, wheat, corn, soybean, potatoes, fruit, vegetabLes, sugar crops, and cotton.  - 16 - PART IV - THE PROJECT 54. An exchange of views between the Government and Bank staff and con- sultants on the original project proposal prepared by MAAF led to refinement and elaboration of the project design. Negotiations were held in Washington from March 5 to March 7, 1985 with a delegation led by Mr. Ge Fucun of the Ministry of Finance. A Staff Appraisal Report No. 5348-CHA, dated March 18, 1985, is being distributed separately. Supplementary data are provided in Annex III. Project Scope and Design 55. The principal objective of the proposed project is to support the Government in its seed industry development program. The project would moder- nize facilities at 18 seed production, processing and distribution centers in 12 provinces and two autonomous regions. It would also strengthen operations of China's central seed agency, the NSC, in particular its seed testing and certification services. The project would contribute to increased production of high quality seed for major food and cash crops and serve as a model for planned construction over the next two decades of over 300 modern seed centers. Principal Project Features 56. The project would include: (a) construction of about 350,000 sq m of buildings for processing plants, warehouses, testing laboratories and staff housing; Cb) improvements to about 28,000 ha of seed farms including land level- ing and construction or upgrading of 480 km of rural roads, 1,500 km of irrigation canaLs and drains, about 165 wells, and five pumping stations; (c) provision of seed processing and laboratory equipment; (d) provision of farm machinery, vehicles and materials; (e) local and overseas training in seed technology, quality assurancelcontrol, and management for staff of the centers and implementing agencies; (f) technical assistance to conduct seminars and workshops in seed tech- nology, quality assurance/control, and management and to help develop a model seed technology and science curriculum at four agri- cultural colleges; and (g) studies of seed supply and demand, marketing and prices, and quality assurance/control procedures.  - 17 - Detailed Features 57. Buildings. The project would provide for construction and renova- Lion of seed drying units, processing plants, storage warehouses, seed testing laboratories/offices, staff housing and other specialized facilities at the 18 seed centers. A typical processing plant would consist of a receiving area, drying/bulk storage area, processing hall (including equipment and main- tenance areas), and warehouses for storage of processed seed. Storage facili- ties for the most part would be of the ventilated warehouse type, but conditioned storerooms would be provided in some case*, e.g., vegetable opera- tions. The project would provide for expansion and new construction of labor- atories at all seed centers. Housing would be built at most centers to accom- modate a planned expansion of center staff by about 30Z. 58. Seed Farm Development. The project would improve infrastructure on about 28,000 ha of a total of 117,000 ha of NSC and BSF seed farms to bring the land to the level required for reliable, economic seed production. Con- struction and rehabilitation of drains and irrigation canals and some land leveling would be undertaken on most seed farms. Five pumping stations would be constructed and transformers, high-voltage lines, and distribution lines supplied. The project would provide for well drilling mostly in the arid regions of Xinjiang. About 480 km of farm roads would be constructed linking production areas to processing and treatment plants. 59. Processing and Laboratory Equipment. Equipment installed at the plant sites of 10 centers for rice, corn, wheat, soybean and/or sugar beet seed would consist of receiving and precleaning equipment, continuous flow or bin-type drying systems, bulk storage facilities, processing (cleaning and g-ading) equipment including a main cleaner, sizing equipment, gravity separa- tor, treater, and semi-automatic weighing and packaging system with conveyors, holding and surge bins, dust and trash disposal systems, and other accessory equipment. Equipment would be standardized to the extent possible to facilitate maintenance and repairs and training of equipment operators. Two centers - one for hybrid rice, the other for grain and cotton - would be provided primarily with individual processing machines for use at small farm sites. Three cotton centers would be provided with a total of seven modern 2-3 tph combination acid-delinting processing plants for cottonseed. Ancillary equipment including refrigerators, dehumidifiers and electrical equipment would be installed at the Nei Monggol Seed Potato and Qiansuo Fruit Tree Nursery Centers. The project would provide all centers with laboratory and office equipment including seed testing instruments and scientific equipment; the latter would apply especially to the fruit tree, cotton and potato centers. 60. Farm Machinery, Vehicles and Materials. The project would streng- then the capacity of the seed centers to carry out land improvements, land preparation, and cultivation and harvesting operations by providing, inter alia, tractors, plows, harrows, seeders, laser levelers, harvesters and threshers. In addition, the project would expand and replace equipment fleets for project centers through procurement of 153 heavy trucks, 104 pickup trucks, and 83 vans and microbuses to be used primarily (a) to distribute stock seed to contract farms, (b) to transport crops from seed farms to  - 18 - processing plants, (c) to carry processed seed to seed company sales units, and (d) to transport materials, production crews, and seed inspectors. Materials supplied by the project include about 15,700 tons of fertilizers and pesticides, limited quantities of breeder and basic seed, and about 5,500 tons of steel for use in construction of project facilities. 61. Traning. The project would provide 600 man-months of local short- term (1-2 month) courses for seed center and seed company/AITC personnel pri- marily in project and seed enterprise management; seed processing, testing and certification; and operation of research instruments. Overzeas study suppor- ted by the project would consist of about eight one-month study tours and 326 man-months of specialized (10-12 months) training for senior center staff and staff of project implementing agencies in seed processing, testing, quality assurance and enterprise management. During negotiations assurance was obtained that training of staff of project centers and implementing agen- cies would be carried out in accordance with a program agreed between the Government and IDA (Section 3.03 of the draft Development Credit Agreement). 62. Technical Assistance. The project would strengthen the technical and managerial capacities of China's seed industry by providing about 32 man- months of foreign consultant services. Assistance would cover three broad areas: seed processing technology and operations; quality assurance and control including testing, certification, and legislation; and management as related to both purely business activities and technical operations. In addi- tion, seed specialists would work with NSC staff and staff of four agricul- cural colleges offering seed science and technology to develop a model program. The project would also provide foreign consultants to review designs of drainage and irrigation systems at selected project sites and to assist in preparing studies of China's seed industry. 63. Studies. The NSC and BSF would supervise studies of (a) seed supply and demand, (b) seed marketing and prices, and (c) quality assurance and control (legislation and regulatory) procedures. Assurance was obtained at negotiations that a report presenting the main findings of the studies would be prepared by the MAAF Project Management Office (PHO) and submitted to IDA for review not later than December 31, 1987 (Section 3.04 of the draft Development Credit Agreement). Implementation Schedule 64. The project would be implemented over a four-year period beginning in July 1985. Detailed designs for civil works are well under way. Working drawings and contracting arrangements with local construction companies would be finalized during 1985 so that construction might begin by December. Bid documents for the first package of equipment would be issued by the end of March 1985. Bids would be opened in June 1985 and contracts awarded in August. Equipment deliveries would begin in early 1986 and be completed during the first quarter of 1987. Training activities and consultant services would be expected to start by mid-1985.  - 19 - Cost Estimates 65. The total cost of the proposed project is estimated at US$86.6 mil- lion including contingencies with a foreign exchange component of US$45.1 mil- lion or 521. Costs for buildings include a small eLement of local taxes on materials, probably less than 1OZ. Imported equipment is exempt from taxes or duties. Cost estimates for civil works, goods and services are based on June 1984 prices adjusted for expected price increases. Civil works were estimated on the basis of preliminary designs using unit prices based on similar type of work. Equipment costs were based on suppliers' current price quotations applied to detailed equipment lists. Training costs were estimated at $15,000 per man-year for overseas specialized training, $6,000 per man-month for over- seas study tours and about $170 per man-month for local training. The contin- gency allowance is about US$13.6 million or about 191 of the project base cost. Physical contingencies (US$4.7 million) equal 5% of base costs for civil works, equipment and materials (10% for seed processing 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. Expected price increases (US$8.9 mil- lion) amount to 11% of the base cost plus physical contingencies and are based on the rates of price escalation of 3% annually for domestic inflation and for international inflation 3.5% in 1984, 8% in 1985, 9Z annually from 1986 to 1988, 7.5% in 1989, and 6% annually from 1990 to 1995. Financing 66. Total financing required is US$86.8 million. The proposed IDA credit would amount to $40 million (46% of total project costs) and would be used primarily for purchase of equipment, virtually all of which would be imported. The balance of US$46.8 million would be met from funds from the budgets of provincial, prefectural and county governments (US$15.9 million equivalent) and contributions from the project seed centers (US$30.9 million). Procurement 67. Procurement arrangements are summarized in the table below. Seed processing and laboratory equipment with an estimated cost of US$20.9 million and farm equipment and materials estimated at $15.6 million would be procured on the basis of ICB in accordance with Bank Group guidelines. Items of equip- ment costing not more than $100,000 per contract and $2.5 million in total would be procured on the basis of quotations received from at least three eligible suppliers under procedures acceptable to IDA. For equipment procured through ICB, local manufacturers would be extended a preference margin of 15% or the prevailing customs duties, whichever is lower, in bid evaluation. Prior IDA review of contract awards would exclude small contracts ($200,000 or less) estimated to cover less than 15% of the value of all contracts. Goods with a value of $4.4 million, mainly small equipment items fabricated locally, and civil works (US$23.6 million) would be financed by the Government and ptrcured locally through local procedures which are acceptable to IDA. Consultants would be selected under terms of reference agreed with IDA and in accordance with Bank Group Guidelines on the use of consultants.  - 20 - PROCUREMENT PROFILE Procurement method ICB LP /a Other /b Total Buildings - 23.6 - 23.6 (0) (0) Seed farm development - 17.8 - 17.8 (0) (0) Processing and laboratory equipment 20.9 2.5 2.0 25.4 (20.9) (0) (2.0) (22.9) Farm equipment and materials 15.6 1.9 0.9 18.4 (15.6) (0) (0) (15.6) Overseas and local training - - 1.0 1.0 (0.9) (0.9) Technical assistance - - 0.6 0.6 (0.6) (0.6) Total 36.5 45.8 4.5 86.8 (36.5) T(T (3.5) (40.0) Note: Figures in parentheses are the respective amounts financed by IDA. /a LP stands for "local procedures" which involve the assignment of one or more civil works contracts to a preselected contractor. For goods, contractors may be factories or suppliers. /b "Other" includes (i) procurement of equipment on the basis of evaluation of bids from at least three suppliers, and (ii) procurement of technical assistance and training. Disbursements 69. Disbursements for equipment, materials and vehicles would be made at 100% of the CIF cost for direct imports and 100% of the ex-factory cost for locally manufactured items. Disbursements for overseas training and consul- tant services would be made at 100X of total expenditures. All withdrawal applications would be fully documented except: (a) for expenditures under equipment, materials and vehicles contracts whose value is less than $50,000 equivalent; (b) for expenditures for overseas fellowships and study tours; and (c) for expenditures under consultants' services contracts whose value is less than $50,000 equivalent. Withdrawal applications for these expenditures would be supported by a statement of expenditure certified by the central PHO's Pro- ject Coordinator. In order to provide for efficient disbursement of credit proceeds, a special account wouLd be opened in US dollars in the Bank of China with an authorized allocation of SDR 4.2 million which represents the estimated expenditures for the most active four-month period. Applications  - 21 - for replenishment of the special account would be submitted quarterly, or whenever the special account is drawn down to 50% of its initial deposit, whichever comes first. Bid documents for equipment are expected to be com- pleted by March 1985, making it possible to procure most items in the first three years of the project. The closing date of the credit wculd be December 31, 1989. Accounts and Audits 69. Records of civil works expenditures would be maintained by the People's Construction Bank (PCB) which would be responsible for disbursements to county/state farm construction companies/teams engaged under the project. These records would be consolidated into a single account by the PCB in Beijing and forwarded annually to the PMO. The PMO would keep records of equipment expenditures and would prepare an annual account of equipment and civil works expenditures. Assurance was obtained from the Government that the accounts wouLd be audited annually by independent auditors acceptable to IDA and that the audited accounts would be submitted to IDA within six months of the close of each financial year (Secrion 4.01 of the draft Development Credit Agreement). The project accounts would be audited by the State Audit Agency. Project Management and Execution 70. The MAAF would have overall responsibility for project implementa- tion. Within the MAAF, a PMO, made up of staff from the NSC, the BSF, and the North China Plain (NCP) Project Office has been established to coordinate project execution in the 14 provinces/autonomous regions involved in the project. A Project C-iordinator and three Deputy Coordinators, one each from NSC, NCP, and BSF, have been designated to head the PMO staff. The PMO would be responsible for coordinating project work with all central agencies involved; acting as chief liaison with IDA; maintaining project accounts and submitting disbursement applications to IDA; monitoring civil works design and construction; administering local and overseas training programs; and super- vising all aspects of the equipment procurement process. The PHO would also be responsible for preparing a project completion report for IDA review. An advisory group composed of six to eight Chinese seed experts has been estab- lished to assist the PMO. In equipment procurement, the PMO would be primarily responsible for equipment review and preparation of technical specifications and the China National Technical Import Corporation (CNTIC) for bid invitation, evaluation, and award of contracts. 71. At the provincial level, project management offices have been esta- blished as separate units within provincial seed companies, provincial state farms bureaus or AITCs to coordinate and supervise project implementation in the participating counties, subbureaus and state farms. An advisory group has been appointed to assist each provincial PMO. At the seed center level, a designated representative of the participating units - county seed companies, provincial and county stock seed farms, state farms - has established a management office to handle the day-to-day activities of project execution. Each would be responsible for preparing work schedules and supervising local units involved in the project such as county construction companies and state farms construction bureaus. During negotiations assurance was obtained that  - 22 - the MAAF PM0 and provincial PMOs, with their attached advisory groups, and other local PMOs would be maintained and adequately staffed with qualified personnel during the life of the proposed project (Section 3.01(b) of, and para. B (d) and (g) of Schedule 5 to, the draft Development Credit Agreement). 72. The proceeds of the proposed IDA credit would be used almost entirely for procurement of equipment and materials for the 18 project seed centers. The costs of these items as well as of the proposed overseas train- ing and consulting services would be debited to the 18 centers. Under current Government procedures, the centers would repay these costs at an annual inter- est rate of 3% over 20 years with a five year grace period. The foreign exchange risk would be borne by the Government. Local contributions to the project would be channeled through appropriate local branches of the Agricul- tural Bank of China (ABC) in the case of locally-procured equipment, and through branches of the People's Construction Bank (PCB) for civil works. Arrangements regarding implementation of the project, including budget and staffing, by the 14 provinces included in the project would be described in project implementation agreements between MAAF and the aforementioned provinces (Section 3.05 of the draft Development Credit Agreement). The execution of such an agreement would be a condition of effectiveness (Section 6.01 (b) of the draft Development Credit Agreement). Market Prospects and Prices 73. Annual production of stock and certified seed from the 18 seed centers would reach about 200,000 tons by 1990, a near doubling of present output. In addition, annual production of scions and budded seedlings would be increased by about three million. It is expected that the domestic market would easily absorb project output. First, as the sole local seed suppliers, the project centers would have an assured market for their hybrid seeds (hybrid rice, corn, sugar beet and vegetables). Second, project improved nonhybrid variety seeds would be in demand because of their superior quality which would decrease production costs and increase output and returns. Third, many of the seed centers already do business with regular customers on the basis of advance purchase contracts; these assured markets would be expected to be maintained and to expand with the current trend toward increasing inter- provincial trade. 74. Base retail seed prices - which refer to bulk, untreated seed only - range between 15 and 25% above the commodity price in the case of conventional varieties and may exceed the commodity price by up to 50% or more in the case of hybrid seeds, thus allowing the seed companies to sell their output at a reasonable margin (10-20Z) over their costs. Modern seed processing would increase the cost per kg of clean seed because of higher operating costs and the screening out of poor quality seed during processing. The Government has assured the seed centers that retail prices for their fully processed seed would be set at least 20 to 30% above full production costs. Given the scar- city of high quality seed in China, such a moderate increase in retail prices would not be expected to encounter market resistance. This is especially true since the increases in price would be more than compensated for by reduced production costs and increased yields.  - 23 - Benefits 75. The increased seed production achieved under the project would be sufficient to plant about 2.8 million ha (instead of 1.5 million now): 900,000 ha of rice, 1,075,000 ha of wheat, corn, and soybean, over 80n,000 ha of cotton and other cash crops, and over 20,000 ha of vegetables. The project would also produce an additional three million fruit tree scions and budded seedlings and enough seed potatoes and sugar cane sets to plant about 77,000 ha. The major benefits to the farmer from using the higher quality ,:roject seed are decreased costs of production by about 5%; value enhancement of the product associated with a change in variety - e.g., better and more uniform cotton fiber; and increased production arising from improved yields (output/unit area) primarily attributable to improvements in the genetic, physical and physiological qualities of the seed planted. Expected yield increases from use of improved seed alone are in the range of 10 to 15% for cotton and sugar beet; 6 to 8% for corn; 5 to 8% for soybeans; 4 to 6% for wheat; and 2 to 3% for rice. The resulting annual incremental crop production from project seed would include about 110,000 tons of rice, 160,000 tons of corn and wheat, and over 60,000 tons of cotton. The principal long-term benefit resulting from the transfer of seed technology and expertise under the project would be rapid modernization of China's seed industry. The 18 project centers would serve as trial and evaluation units in designing plans for con- struction over the next two decades of over 300 additional seed production, processing and distribution centers throughout the country, and as catalysts and suppliers to new project seed centers. By including a broad range of major food and cash crops, the project would promote diversification of the seed industry at the same time as encouraging expanded production of certain crops - e.g., vegetables and fruits - expected to be in increased demand as incomes rise. The major benefit to the seed industry from strengthening NSC operations would be establishment of uniform national standards for seed quality assurance and control, an essential first step in the planned expan- sion of interprovincial seed marketing and distribution. The model seed curriculum would contribute to raising the level of training in seed science and technology. Social benefits from the project include increased production and incomes for some 3.7 million farm families. Financial Analysis 76. The financial rate of return (FRR) for the project as a whole would be about 12Z, with FRRs ranging between 8 to 17% for individual seed cen- ters. Seed centers supplying hybrid seed would have somewhat higher FRRs than seed centers supplying conventionaL seed. A cash flow analysis for several of the seed centers was performed using the assumption that retail prices would exceed total costs of production by 10%. The seed centers would have no difficulty repaying project funds within 20 years, including a five-year grace period.  - 24 - Economic Analysis 77. In the economic analysis, incremental costs of seed production have been estimated as 15Z of labor costs and 51 of nonlabor costs. The economic cost of unskilled labor is considered to be Y 2/workday for unskilled and Y 4/workday for skilled. The Y 2/workday for unskilled labor probably overstates the opportunity cost of labor in China. However, the economic analysis is not sensitive to use of a lower shadow price for labor. Estimated seed processing costs cover electricity and other utilities, coal, bags, permanent and seasonal labor, treatment chemicals and miscellaneous expenses. Marketing costs have been estimated as the transport expense of delivering project seed. Major uutputs, traded inputs, and labor have been valued at projected economic prices (an average of 1983 and 1995 economic prices in 1983 constant yuan). Discou-,ting costs and benefits over 30 years, the economic rate of return (ERR) for the project as a whole would be about 38%. At a discount rate of 12%, which is considered to approximate the opportunity cost of capital in China, the net present value (NPV) of the project would be Y 686 million. The ERRs vary considerably among seed components (from 19% for rice to 49% for zotton), but are satisfactory in each case. The highest ERRs are for the production of seeds with relatively large expected incremental yield, viz., food grains (except rice) and cotton. Sensitivity of the ERR was tested to a 20% investment cost overrun, 20% and 50% increases in operating costs, and a 50Z decrease in expected benefits. Ho single variant proved critical to the economic viability of the project or any of the project's components. A 50% reduction of benefits would reduce the project's overall ERR to 17Z. Risks 78. The proposed project faces no significant technical risks since it involves proven seed processing technology that has been in regular operation in other parts of the world. To ensure effective transfer of this technology to China, the project would provide a program of technical assistance in plant design and equipment procurement as well as training for equipment operators to supplement that customarily provided by equipment suppliers. Given the fact that a sound organizational structure for seed operations is already in place, no significant problems are expected during project implementation. The seed companies are functioning effectively in terms of seed multiplication and are becoming increasingly profitable commercial operations. The project centers are adequately staffed w-ith technicians and managers recruited from affiliated companies and seed farms. Personnel have also been appointed to the PMOs. A possible project uncertainty relates to the capability of the NSC, as a relatively new agency, to handle the task of coordinating project activities. This uncertainty would be minimized by the fact that the PMO includes not only NSC staff but also representatives from the NCP Project Office and the BSF, both of which have had previous experience in implementing Bank Group projects. Environmental Effects 79. Project activities would be environmentally neutral. Mechanized seed drying and processing produce dust but not more than traditional  - 25 - winnowing, and dust control systems would be provided. Seed treatment materials used would be relatively nontoxic, used in small quantities, and colored with intense dyes to ensure that the treated seed are not used for purposes other than planting. Use of the seed as a delivery system for systemic insecticides and fungicides would reduce the quantity of pesticides by ten fold or greater as compared to application to the growing crop. The acid delinting technology provided would be the type specially developed in the U.S. to reduce the environmental hazard to acceptable levels. PART V - LEGAL INSTRUMENTS AND AUTHORITY 80. The draft Development Credit Agreement between the People's Republic of China and the Association, 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. 81. The conditions of effectiveness of the proposed credit would be the following: (a) China's State Council shall have-approved the Development Credit Agreement (Section 6.01(a) of the draft Development Credit Agreement); and (b) The project implementation agreements between MAAF and the provinces shall have been executed under terms and conditions acceptable to IDA (Section 6.01(b) of the draft Develcpment Credit Agreement). 82. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 83. I recommend that the Executive Directors approve the proposed credit. t A. W. Clausen President March 20, 1985 Washington, D.C.  -26 ANNEX I Page 1 of 6 .IU PUoP.3 U.0?F- 5ocw TOsS^ DsA u czas fup:ss or c xWm tolO, *X A 1I . 1370 hS! L as