Zambia - Second Coffee Project

DoCumAnt Of The World Bank FOR OFFICIAL USE ONLY Report No. 6236-ZA STAFF APPRAISAL REPORT ZAMBIA SECOND COFFEE PROJECT October, 1986 Eastern & Southern Africa Projects Southern Agriculture Division 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 dsclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit Kwacha (K) US$ 1.00 - K 7.2 K 1.00 8 US$ 0.139 M1 million The US Dollar/Zambian Kwacha exchange rate is determined by weekly auction. The exchange rate shown above Is the result of the auction held on May 24, 1986. WEIGHTS AND MEASURES 1 kilogram (kg) 2.2 pounds 1 metric ton (ton) = 0.98 long tons 1 millimeter (mm) 0.39 inches 1 meter (m) = 3.28 feet 1 square meter (m2) - 10.76 square feet 1 cubic meter (m3) = 1.31 cubic yards 1 kilometer (km) = 0.62 miles I square kilometer (km2) 0.386 square miles I hectare (ha) - 2.47 acres 1 litre (It) - 1.76 pints ABBREVIATIONS AFC = Agricultural Finance Company CARO - Chief Agricultural Research Officer CBD Coffee Berry Disease CDC - Commonwealth Development Corporation CFTC = Commonwealth Fund for Technical Cooperation DBZ - Development Bank of Zambia EEC = European Economic Community GDP = Gross Domestic Product GRZ = Government of the Republic of Zambia ICA = International Coffee Agreement ICO International Coffee Organization IDA = International Development Association IFC = International Finance Corporation INDECO = Industrlal Development Corporation LINTCO - Llnt Company of Zambia MAWD = Ministry of Agriculture and Water Development NCDP = Natlonal Commission for Development Planning PMCC = Project Management and Coordination Committee RUCOM = (Rural Commercial Companies) Rucom Industries Ltd. UNDP United Nations Development Program ZADB = Zambia Agricultural Development Bank ZCCL Zambia Coffee Company Ltd. ZCGA = Zambia Coffee Growers Association ZIMCO - Zambia Industrial and Mining Corporation FISCAL YEAR Government of Zambia : January 1 - December 31 ZCCL and LINTCO April 1 - March 31  olt omc- IL uR ONLY ZAMBIA SECOND COFFEE PRWOECT Staff Appraisal Report Table of Contents Page No. Credit and Project Summary ........ ....................... 1 I. PROJECT BACKGROUND AND THE AGRICULTURAL SECTOR 1 A. Project Background ... .......................... 1 B. Agriculture in the Economy ..................... 1 C. Agricultural Institutions and Services ......... 2 D. Production Potential, Constraints and Development Policies .......................... 6 E. Bank Lending Strategy in Agriculture .......... 7 F. Previous Bank Group Involvement In Agriculture . 7 II. THE COFFEE SUB-SECTOR 10 A. General ................. 10 B. Coffee Marketing ....13 C. Government Coffee Policy ..................... 16 III. PROJECT AREA AND BENEFICIARIES 16 IV. THE PROJECT 18 A. Rationale for Bank Support 18 B. Project Objectives and General Description so... 18 C. Detailed Features .............................. 19 D. Project Costs 23 E# Financing 23 F. Procurement 25 G. Disbursement ......27 H. Accounts and Audits 28 Is Environmental Impact 29 V. PROJECT IMPLEMENTATION 30 A. Organization and Management o................... 30 B. Executing Agencies ............................. 30 C. Status of Project Preparationparation.... 33 D. Implementation of Specific Components 34 VI. PRODUCTION AND FINANCIAL ANALYSIS 41 A. Coffee Yields ...... 00*00*00*066600............ 41 B. Financial Analysis 42 This report is based on the findings of an appraisal mission to Zambia in March 1986, comprising Messrs. C. Warnaars, W. Schwermer, Y. Doka, T. Turtiainen; D. Dawit (IDA) and A. Finney and R. Lacroix (consultants). The mission was joined by Mr. D. Brown as a CDC observer. This document has a restricted distribution and may be wed by recipients only in the performance of their officil duties. Its contents may not otherwise be disclosed without World Dank authoriation.  VI. PRODUCTION AND FINANCIAL ANALYSIS (continued....) Page No. C. Distributional Impact ...................... 42 D. Cash Flow Projections and Flnacial Rates of Return .....................,...... 43 E. Financial Analysls - ZCCL ...................... 44 F. Project Budgetary Implications 47 VII. BeNEFITS AND JUSTIFICATION AND RISKS 47 At Justification ................................ 47 B. Benefits ...................................... 47 C. Economic Rates of Return (ERR) ................. 48 D. Sensitivity Analysis .......................... 48 S. Economic Rate of Return - ZCCL Component .a..... 49 F. Uncertainties and Risks ...................... 49 VIII. ASSURANCES AND RECOMNENDATIONS 50 ANNEX I Draft Coffee Policy ANEX It Charts 1. Implementation Schedule 2 Program of Field Operatiao- for Establishment and Maintenance of Coffee ANNEX III Tables 1 Projected Coffee Plantings and Farmer Participation in Project Sumary 2 Investment Cost Estimates - Agricultural Machinery and Tools 3 Investment Cost Estimates for Credit Component Summary 4 Improvement in Coffee Extension Services - Detailed Cost Table 5 Research - Detalled Cost Table 6 Coffee Marketing - Detailed Cost Table 7 Credit Component - Detailed Cost Table 8 Assistance to Zambia Coffee Company - Detailed Cost Table 9 Estiated Yields for Project Coffee 10 Price Projections for Zambia Coffee 11 Fnancial Analysis - Smallholder/Small Emergent Farmer Growing 0.5 ha of Coffee and Using Stationary Hand Pulper for Processing  - liii- (AS=131 III contlaued...) Tables 12 Financil Analysis - Smallholder/Small Emergent yarmer Growing 0.5 ha of Coffee (Central Processing Facility) 13 Finanlcl Analysli - Large Emergent Farmer - 15 ba Coffee Plantatlon 14 nancial Analysis - Commercial Farmer - 40 ha Coffee Plantation 15 Financial Analysis - Commercial Farmer - 80 ha Coffee Plantation 16 Zambia Coffee Company Ltd. (2CCL) - Capital Expenditures, Operating Expendltures and Revenues 17 Zambia Coffee Company Ltd. (ZCCL) - Income and Cash Flow Analysis IS Zambla Coffee Company Ltd. (2CCL) - Projected Balance Sheet 19 Incremental Capital Expenditures, Operating Expenditures and Revenues 20 Zambi Coffee Comapny Ltd. (ZCCL) - Incremental Income and Cash Flow 21 Incremntal Economic Benefits and Costs 22 Sonsitlvlty Tests 23 ZCCL Economle Analysis - Incremental Economic Costs and Benefits 24 Estimated Schedule of Disbursements AM-tV Schedule 1 Draft LandIng Terms and Conditions 2 Coffee Subproject Yeasibillty Study 3 Criteria for Appraisal of Subprojects &s (IDE) No.19165 Selected Documnts avallable in Project file. 1. Proposed Second Coffqes Preparation Report, January 1986, IDA. 2. Coffee Productlon and Processing of Mild Arabica Coffee. Working Paper, June 1986. A. Finnay, Consultant. 3. Coffee Marketing. Working Paper, July 1986. R. Lacroix, Consultant. 4. Detailed Tradinig Program. Working Paper, June 1986, IDA. S. Mbnitoring and Evaluation check list. Working Paper, June 1986, IDA. 6. Consultants Terms of Reference. June 1986, IDA. 7. Detailed Cost Tables and Niscellaneous Information on ZCCL. 8. Worklng Paper on irrigation of coffee, October 1985. D.A. Brown, Consultant. 9. Review summary of participating banks, April 1986. IDA.  - i - ZANBIA SECOND COFFEE PROJECT CREDIT AND PROJECT SUMMARY Borrower: Government of the Republic of Zambia Amount: SDR 16.9 million (about US$20.4 million equivalent) Terms: Standard IDA Beneficiaries: Coffee Farmers, the Zambia Coffee Company Ltd. (ZCCL) and the Ministry of Agriculture and Water Development Re Lending The Government would channel US$15.4M of the credit proceeds Terms: to participating banks for on-lending to farmers. Farmers would be able to choose the curren,,y denomination of their borrowings. Interest rates on foreign currency loans would be in accordance with IDA's policy on lending to commercial entities with farmers carrying the foreign exchange risk. Interest on local currency loans would be in line with rates charged by participating banks for similar loans outside the Project; they would be expected to be positive in real terms and cover the foreign exchange risk. Loan repayments would be over a period of up to 12 years with a grace period of up to 5 years. On-lending of IDA funds to ZOCL (US$2.0M) would be in foreign currency at an interest rate similar to that charged to Project farmers. Repayment would be 15 years with a five year grace period on principal repayments. Project At full development, the Project would increase the national Description: annual production of high quality arabica coffee by about 4,700 tons primarily for export. It would create a suitable institutional framework for the establishment of a coffee industry and build up national expertise in all aspects of coffee production and marketing. Unlike the first project which was oriented towards the parastatal sector, the Project would concentrate on coffee development in the private sector. It would be implemented over a seven-year period and comprise: (e) provision of credit to eligible farmers through the commercial banking system for establish- ment of itrigated coffee and installation of processing facilitites; (b) strengthening of the Lint Company of Zambia (LINTCO) and training of its staff in order to improve coffee extension support; (c) assistance and training to coffee research to complement the proposed National Research and Extension Project; (d) technical assistance. and training in coffee marketing; and (e) assistance to ZGCL to improve its viability and management capabilities. The Project activities would be concentrated mainly in the Northern provinces of Zambia. Total number of participating farmers is expected to be 1,200 of which 1,100 are samllholders. The total area to be planted in coffee is expected to be about 3,250 ha.  - li - ftnefits The principal benefit of the Project would he the stiaul- ad Risks: tion of private sector coffee production. The financial rates of return for participating frmers rage between 262 and 322 depending upon size of operation. The Project would also provide the country with an additional source of foreign exchange, raise rural incomes and provide employment opportunities. The Project risks mainly revolve around the Government's commitment to economic reforms , and timly implementation of the coffee policy. An outbreak of coffee berry disese could reduce yields, but this risk could be overcome by Increased crop spraying. A long-term col'apee of the Inter- national Coffee Agreement would depress coffee prices, but even under this scenario the Project would remain viable. Remining problems of the first coffee project have been fully addressed and lessons learned have been incorporated. estimated Costs: Local Forl d Total -(USfffilfion)-- Credit 7.7 11.6 19.3 Extension 0.9 1.7 2.6 Research 0.2 0.4 0.6 marketing 0.1 0.3 0.4 Assistance to ZCCL 1.2 3.0 4.2 Base Cost 10.1 T7W i7:T Physical Contingencies 0.1 0.2 0.3 Price Contingencies 2.9 4.6 7.5 Total Project Costs 13.1 21.8 34.9 Financing Plan LocalN aI -12.3 - 12.3 ZCCL equity partner(s) 0.7 1.5 2.2 IDA 0.2 20.2 20.4 Totalt 3E TM 73 / XIncludes contributions from Government (US41.2); participating banks (US$3.9); farmers (US$6.4); and ZCCL's own resources (US$0.8). stimated IDA Disbursements: IDA Fiscal Year 87 88 89 90 91 92 93 94 95 Annual: 1.0 1.4 2.2 32 3.8 2.8 2.4 2.4 1.2 Cuftative: 1.0 2.4 4.6 7.8 11.6 14.4 16.8 19.2 20.4 Rate of Return: 242 !bzs IBRD 19765  ZAMBIA SECOND COFFEE PROJECT Staff Appraisal RepRrt I. PROJECT BACKGROUND AND THE AGRICULTURAL SECTOR A. Project Background 1.01 The Project, for wh;ch an IDA Credit of SDR 16.9 million (about US$20.4M) is proposed, forms the second phase of IDA's assistance to coffee development In Zambia. It forms part of the couni.ry's long-term development plan and the Bank Group's lending strategy to diversify agricultural production and foreign exchange earnings. The Project was identified by an IDA mission in mid-1984 in the course of discussions with Government on the IDA-assisted Coffee Production Project (Credit 863-ZA). Subsequently, the Ministry of Agriculture and Water Development (MAWD), with assistance from IDA staff, comenced the preparation of a second phase coffee development project. Following a final preparation mission in November 1985, a preparation document was prepared, which formed the basis of an appraisal carried out in March 1986. B. Agriculture in the Economy 1.02 Background. Zambia, a land-locked country covering some 750 ,000 km2, has, as of 1986, a population of about 6.4 million with an annual growth rate of 3.42. Since 1975 the country has been gripped by a steadily worsening economic crisis, precipitated by a decline in external trade, falling copper production, and recurring droughts. Accumwlating balance of payments and budgetary deficits over the past ten years have led to increasing delays in completion of investment projects, under-utilization of productive capacity, and deterioration of basic infrastructure throughout the country. There has been limited structural change and diversification of production in the economy since Independence in 1964. An economic restructuring program including liberalixation of prices, marketing and credit and the introduction of a foreign exchange auctlon system, underway since October 1985, and supported by the Bank Group, shows promise of eventually reversing the long-term economic decline. 1.03 Agriculture, providing a living to about 60X of the total population and employing 67X of the labor force, contributes 17X of GDP, indicating the low levels of rural productivity and incomes. Agricultural output grew at about 2.8Z per annum during 1965-85, which was less than the population growth rate; self-sufficiency In major food crops consequently declined. In the early 1980s, food imports (aainly whest, dairy products and vegetable oils) accounted for 1OX of the total value of Zamblats imports, while agricultural exports (mainly tobacco, cotton and groundnut.) accounted for less than 22 of the country's total export earnings. Zambia's 600,000 farm households comprise some 700 modern, capitalized farms, about 450 ,000 traditional farming families on smallholdl gs that average two hectares each, and a growlng category (140,000) of small and mediur scale 'emergent' farmers producing for the market on farms of up to  - 2 - 40 .1. While the commercial (including the "emergent" farmer) sector more than doubled its contribution to GDI in the period between 1965 and 1982, the growth rate of the traditional sector has been stagnant and its relative importance has declined significantly. C. Agricultutal Institutions and Services 1.04 The agricultural sector is serviced almost entirely by Government or parastatal organizations, and to a lesser extent by Provincial Cooperative Unions (PCUs), whose functions range from direct participation in crop and livestock production to distribution and processing of agricultural products. In addition to MAWD, the major parastatals include the National Agricultural Marketing Board (NAMBOARD), the Cold Storage Board, the Dairy Product Board, Zambia Coffee Company Ltd. (ZCCL), and the cotton (LINTCO) and seed companies (ZAMSEED). There are nine PCUs, all of which are involved in input delivery and produce marketing. The PCUs, together with NAMBOARD, are the official and exclusive purchasers of maize, and the buyers of last resort for all other major crops including groundnuts, sunflower, wheat and rice. They also distribute and sell fertilizer and other agricultural inputs to farmers at Government-controlled prices. Private enterprise plays a major role in the marketing of cassava, millet, sorghum, rice, sunflower, soyabeans, livestock products, and fruits and vegetables; it also handles most of the distribution of agro-chemicals, farm machinery and implements. 1.05 Extension services to the farm community are provided mainly by MAiWD through its Department of Agriculture (DOA). The Extension Branch is headed by an Assistant Director at Lusaka headquarters, assisted by national Subject Matter Specialists (SMS) in crop and animal husbandry, horticulture, tobacco, training, youth and home economics, and by administrative personnel. In each of the nine provinces, extension services are organized through a Provincial Agricultural Officer (PAO), who is assisted by provincial SMS and administrative personnel. At the district level in each province, extension is carried out through the District Agricultural Officer (DAO), assisted by staff at district headquarters and field extension staff based in agricultural camps (the lowest field level) and blocks (each consisting of 6 - 8 camps). Tn addition to the extension services provided directly by the Department of Agriculture, cotton, coffee and soybean extension is carried out by DOA staff seconded to LINTCO (Lint Company of Zambia) (para 2.07). While these staff members receive their salaries from the Extension Branch, LINTCO provides incentive allowances and transport. 1.06 Crop research responsibilities are vested in the Research Branch of DOA. The Branch is headed by an Assistant Director, supported by a Chief Agricultural Research Officer (CARO) based at the Central Research Station at Mt. Makulu. A National Coordinator of the Adaptive Research Planning Tewms (ARPTs), presently stationed at Lusaka headquarters, also reports to the CARO. The latter is in charge of staff and programs of all the national Commodity and Specialist Research Teams (CSRTs) as well as the provincial ARPTs. The Research Branch also administers three advisory services: Biometries, Soil and Crop Advisory, and Library. Coffee research is concentrated at the Misamfu Research Station in the North Province with sub-stations in Lucheche and Malashi (para 2.08).  - 3 - 1.07 Institutional credit to the agricultural sector, about K188M in 1984, is provided largely by six commercial banks (of which Barclays, Standard Chartered, and National Commercial are predominant) and several parastatal organizations, including the Agricultural Finance Company (AFC), the Zambia Agricultural Development Bank (ZADB), the Development Bank of Zambia (DBZ), the Zambia State Insurance Corporation (ZSIC), and Zambia Cooperative Federation Finance Services Ltd. (ZCF). Commercial banks, (paras 1.08-1.12) with a total of more than IUO branches all over Zambia (IBRD Map 19765), lend primarily to commercial farmers, mainly for seasonal purposes under lines of credit or through overdrafts. They also provide Government guaranteed financing to the agricultural marketing parastatals and cooperative unions. DBZ and ZSIC provide a limited amount of medium and long-term funds for agricultural production as a relatively minor element of their overall activities. AFC, a subsidiary of ZIMCO, remains the only significant source of seasonal and medium-term credit to some 20,000 small-scale and emergent farmers, although about half of Its total lending also goes to large-scale borrowers. But its procedures are time-consuming and cumbersome, and it has suffered from mismanagement, poor recoveries, and inadequate financial performance. ZADB, established in 1982, was intended to become the principal agricultural credit institution in Zambia, eventually replacing AFC. However, its operations so far have been very limited (only 47 loan accounts with 28 clients as of October 31, 1985) and it has experienced considerable financial difficulties since its start-up. A recent Bank-funded consultancy study recommended the merger of APC with ZADB. This will be pursued further by a proposed Bank-funded agricultural credit project. Coopera-ive credit institutions, although small, have shown promising results and good recovery rates during the past two years. 1*08 Barclay's Bank of Zambia Ltd, which had assets of K822M in 1984, is the largest commercial bank In the country.l/ Although Barclay's is a local bank, all its shareholdings are with a foreign holding company, Barclay's PCL, with headquarters in the United Kingdom. The bank has 31 branch offices (Man IBRD 19765) and a total staff of about 1,500. Three of the branches are in Luapula and North Western Provinces, which form part of the proposed Project area. There are no agricultural lending departments in the branch offices, but the head office in Lusaka has an agricultural section of two persons. More than 70% of Barclay's loans are short-term; 30% are medium-term and there is no long-term lending. The bank has reserved 45% of its lending volume for agricultural purposes. Nearly all of these funds are used for seasonal credit and agricultural marketing. Barclay's participates in lending to small-scale farmers through a special RCC-assisted program which has 18 credit supervisors. In 1985, about 2,700 families borrowed K1OM through this program. The bank has shown sub- stantial growth during the last few years, but this growth has not kept pace with inflation. Its total assets Increased from K681 M in 1983 to K822 M in 1984 (15.3%). The Bank's own capital (shares and reserves) amounted to at K57.8 M in 1984, which represented 7% of its assets. Liquidity remained good until 1985, when as a result of the new 'foreign currency auction system", devaluation increased the amount of lending. In 1983-1984, cash and short-term funds amounted to about half of its assets. 1.09 Zambia National Commercial Bank Ltd. (ZNCB) is the second largest Zambian bank in terms of savings and deposits as well as total assets (K 716 M and K776 M in FY 1984 and 1985 respectively). It is a subsidiary 1/ 1985 values were not available at appraisal. I/ 1985 values were not available at appraisal.  company of the government-owned Zambia Industrial and Mining Corporation Limited (ZIMCO), wbich holds 99.82 of the bank's issued capital. ZNCB has a staff of about 15200, divided among its 30 offices, four of which are in the main project areas (IBRD Map 19765). ZNCB has three persons dealing with agricultural lending at its head office in Lusaka. Two agriculturists help the branch offices in their agricultural lending operations. Bank management is planning to increase the field staff to 12 to improve its agricultural coverage in the provinces. The bank provides all the usual banking ser-ices except long-term loans. About 90% of the outstanding agricultural loans (K35M) are short-term. The bank has no policy limitation on agricultural lending. It operates a small-farmer program, under which K1.OM has been reserved for farmers who have less than 2 ha of cultivated land and who have applied for a loan of not more than K2,q00. In 1986, the allocation for this purpose was increascd to K2M. ZNCB's total assets grew from about K305M in FY 1980 to K776M in FY 1985; in 1985, its savings and deposits reached K717M and loans K379M. Profits- bility also increased; the pre-tax profit grew from K8.5M in 1980 to K23.8M in 1985 (average increase: 24% per annum), when the profit-to-equity ratio reached 49.5% and the profit-to-assets ratio 3.1%. ZNCB's capital, however, is smaller than that of the other banks-K48M In 1985 (6.2% of assets). Its liquidity had been at a level of 40% to 502 of assets until 1985-86 when the "foreign currency auction system" was Introduced. 1.10 Standard Chartered Bank of Zambia Ltd. ranks third among the commercial banks in assets and lending. It has, however, the largest network of branches and agencies (36). Ten of these are in the Northern Province, which is an essential part of the Project area, and where Barclays has no branches. No Standard Bank branches are located in the other two Project provinces which are served by Barclays. The bank is registered under Zambian Law, but 90% of its share capital is owned by a British-based holding company, Standard Chartered PLC. The staff totals slightly more than 1,000. The bank has no specific agricultural lending unit but handles agricultural loans through the Advances Department at the head office in Lusaka. The bank has three agricultural specialists, one at the head office and two assisting the oranchei. Standard Bank provides all the usual banking services except long-term loans. In 1985, about 38% of all lending including loans to cooperative unions and parastatal marketing boards, went to agriculture, making 'C'is the largest sector in the bank's credit portfolio. Standard Chartered Bank had participated earlier in small-farmer schemes but none of these were active at the time of appraisal. Both its assets and capital have Increased, but at a rate below inflation. Its total assets grew from K642M in 1983 to K697M in 1984 (8.6%). Profits before taxes were K21.5M in 1984, a marked increase over the K14.6M in 1983. The 'ratio' of capital to assets improved from 7.0% in 1983 to 8.3% in 1984 (K45 M and K57.5 M, respectively). Liquidity has been good; the total amount in loasa and advances in 1984 (K269 M) amounted to less than 40% of ite assets. 1.11 Development Bank of Zamba (DBZ), established as a statutory corporation by an Act of Parliemzent in 1972, started operations in 1974. Its main objectives are to provide medium- and long-term loans and equity financing for projects in industry, agro-industry, constrvetion, transport, power, tourism, mining and agriculture. DBZ is also authorized to provide technical assistance and advisory services and to administer Special Funds  on behalf of the Government. The World Bank Group assisted the Government in establishing DBZ by participating In the feasibillty study that led to Its creation through an IFC equity investment of US$350,000 and by granting a US$1S million loan to DBZ in 1975 and an additional US$15 million loan in 1980. Since inception, DBZ has malntained its autonomy In making invest-ment decisions, has become the major source of term flnanclng for productive Investments in Zambia and, despite the country's economiz difficulties, has remained a basically sound financial institutlon. DBZ has a total staff of 182 consisting of 64 professionals and 118 support staff. The Supervision Division has a staff of 19 professionals who visit projects once a year. 1.12 DBZ'e present loan portfolio is almost evenly divided between foreign and local currency denominated loans. On foreign currency loans, DIZ has been charging a fixed annual interest rate of 15X and a commitment fee of 32 due on the date of signing the contract and on the undisbursed amounts on esch subsequent anniversary of contract signing. Local currency loans bear a semi-annual floating interest rate. As of March 31, 1986, the Interest rate for loans for Industrial projects was 282 p.a. and for agri-cultural projects 262. Following the adoption of the foreign exchange auction in October 1985 and the recent decline In world interest rates, DBZ is considering the establishment of a lower interest rate for new foreign currency loans based on IBRD rates plus an adequate spread. As of December 31, 1985, DBZ had mobilized long-term local currency resource- amountlng to K107.9 million consisting of paid-in share capital of K18.95 million, reserves and retained earnings of K8.98 million and medium- and long-term borrowings totall.ing K79.97 milllon. DBZ has also been successful in mobiliing resources from foreign institutions. As of December 31, 1985, it had obtained foreign currency resources amounting to K145.3 million. 1.13 Overdues. The credits are granted by the banks for a specified puriod, but because almost all lending is short term (except for DBZ) and, In practice, is renewed to reliable customers, the overdues have come to resemble bank overdrafts, or 'ong-term lending. The banks do not monitor the overdues as a matter of .oncern, but rather as "carryovers" that affect liquidity. These "carryover" amounts vary from a relatively low 10% in Standard Chartered to an estimated 502 in ZNCB. Overdues in medium-term lending are Insignificant. The collaterals are checked during annual audits. 1.14 Interest Rates have been decontrolled since September 1985. However, for lending to agriculture the Bank of Zambia issues a guideline for the interest rate whick. should generally not be exceeded. During the last five years, the interest rates for the agricultural sector have increased along with the cost of funds for the banks, e.g., in the AFC from 101 in 1980 to 17% in 1985-86. The interest rates under the Cooperative Credit System are also at 17%, except those for small-scale farm input loans, for which the cooperatives charge only 62. Zavbia Development Bank and comercial banks charge rates for agriculture which are slightly less than those for other sectors. There are no significant differences In rates for short-term and medium-term loans. The Bank of Zambia discount rate was 23.51 at the time of appraisal.  - 6 - D. Production Potential, Constraints and Develoment Policies 1.15 The major challenge now facing Zambian policy-makers is to diversify the economy away from its dependence on mining (mainly copper),by implementing long-term structural adjustments and policy changes in which agriculture is accorded much higher priority than in the past. Analyses of its resource base suggest that Zambia has good potential for expansion of its agricultural sector. Out of 43 million ha available for agriculture, only some 12 million ha (28%) have been cleared; of the latter, 5 million ha are regularly cultivated while 7 million ha are under shifting cultivation. Only about 40% of the regularly cultivated areas and less than 15% of the areas under shifting cultivation are harvested each year, the rest being under fallow. The climate is generally favorable for the cultivation of a wide range of crops. Only 4% of the large potential in stable river run-off and groundwater is currently utilized for irrigation. The vast majority of traditional farmers have still to be reached by research, extension, credit and other services which could help raise their productivity. 1;16 Despite its potential, several constraints have limited agricultural sector development. Inadequate planning and lack of a clear agricultural development strategy have led to the creation of many Ill-conceived new programs and organizations. The Government-controlled monopoly parastatals and cooperatives have not been allowed margins adequate to cover marketing costs and thus have caused a persistent drain on budgetary resources. Late input deliveries, inefficient marketing arrangements and frequent delays in crop payments, together with cumbersome credit procedures, have often discouraged subsistence farmers from starting cash cropping. Agricultural production, which is low per unit of labor and land, has been discouraged by: the taxation of farmers (and consumer subsidies) implicit in price controls; the weaknesses of credit institu- tions which have failed to assist emergent farmers to expand production; and, until recently, the Kvacha's over-valuation which has favored imports over domestic production. A further constraint is the low population density in many areas where there is good land and water. Production has also been constrained by the inadequate provision of infrastructure necessary for agricultural development such as rural roads, water supply and transportation, rural storage and processing industries. In addition, the sector had been consistently accorded low priority in the allocation of financial resources. 1.17 Government's stated long-term objectives in agriculture include the achievement of a more equitable distribution of income and employment, self-sufficiency in major foodstuffs (particularly maize), an increase in the production of import-replacing commodities, and diversification to widen the export base of the economy. Since Zambia is a land locked country, it would give priority to products with a high value per unit weight such as coffee. Recoguizing that economic growth will depend to a large extent on the performance of the agricultural sector, GRZ strategy is to make increasing use of the sector's potential and overcome existing constraints through: (a) improved institutional and allocative efficiency in the sector; (b) more active participation by siallholder, emergent and commercial farmers; and (c) increased emphasis on agricultural research, extension and trainiag. Government is encouraging private sector  -7- investments in agricultural production and in agro- processing, and is reforming the sector through: (a) progressively decontrolling consumer prices and, since September 1985, interest rates; and (b) revising the price structure of production inputs in order to phase out producer subsidies. GRZ is also contemplating reforms and improvements in agricultural marketing and input distribution to stimulate producer incentives. Sustained real increases in budgetary resource allocation to agriculture and the introduction of a foreign exchange auction system are important additional Government measures taken recently to benefit the development of the agricultural sector. E. Bank Lending Strategy in Agriculture 1.18 The Bank Group's strategy in Zambia is to act as a catalyst in assisting Government in its moves toward better economic management and structural change for diversification of the economy. In agriculture, this strategy has three broad objectives: (a) strengthening Government's capacity for agricultural planning and policy analysis, to develop and maintain a policy environment conducive to agricultural growth; (b) strengthening MAWD's implementation capacity through improved resource allocation, long-term institutional reform, technical and human resource development, and identification of and support for viable diversification options; and (c) making further improvements in the agricultural pricing, credit and marketing systems. To attain these strategy objectives, the Bank Group intends to act principally through its sector work and lending programs, and through supervision of outstanding Loans and Credits. The lending strategy in Zambian agriculture within the next five years consists of: (a) financial support for importation of key agricultural inputs to mitigate the negative effects of the foreign exchange crisis, and (b) financial and technical support to public and private enterprises involved in agricul- tural credit, marketing, processing, agricultural services, and discrete area-based or commodity-specific production-oriented projects (coffee, fisheries, forestry, etc.). F. Previous Bank Group Involvement in Agriculture 1.19 Bank Group financial assistance to the agricultural sector so far has involved 12 projects: three for industrial forestry, two for livestock/ dairy development, two for tobacco production, one for coffee production, two area-based projects for overall agricultural development, one for fisheries development and one for agricultural rehabilitation. Until 1981, Bank involvement was largely limited to the development of commercial crops and forestry projects. Following the change in Government's priorities toward increastng smallholder productivity, two area development projects (in Eastern and Southern Provinces) were started in 1981/82. Generally, implementation of projects has been problematic because of the weak institutional and policy framework in the agricultural sector, the poor management performance of parastatals, the complexity of rural development projects, lengthy procurement delays, and chronic shortage of recurrent financing. The first livestock loan was cancelled in 1973 at GRZ's request because of pricing problems and poor manaLement. The Smallholder Dairy Project, which was approved in 1982, encountered implementation problems and was scaled down to a pilot design. The forestry projects, after some initial start-up problems, are being relatively well-executed. The two  - 8 - tobacco projects were unsuccessful In meeting their objectives of training farmers and raising tobacco production because of managerial and pricing problems. The coffee project baa also been hmpered by a shortage of funds and management deficiencies* The two area-based agricultural development projects, which both became effective in 1982, have faced some initlal problems with Inadequate funding and lengthy procurement procedures; these problems are gradually being resolved. The fisheries and agricultural rehabilitation projects recently became effective. A nationwide Agricultural Research and Extension Project, appraised In 1986, has the objective of increasing agricultural production, improving agricultural services and strengthening existing institutions. 1.20 The Zambia Coffee Production Project (Credit 863-ZA) was appraised in April 1978. An IDA Credit of US$6.0 million was approved later that year and became effective in July 1979. The broad objectives of the project were to achieve self-sufficiency in coffee, and to diversify the agricultural base and produce exportable surplases. Mbre specifically, the project aimed at increasing the annual production of clean coffee by about 800 tons through the establishment of a 400 ha estate at Kateshi (north of Kasama) and the rehabilitation of an existing 50 ha estate at Ngoll. Processing, packing and storage facilities were to be established at Kateshi. The project Included a pilot smallholder coffee production component, developing 90 ha and involving about 600 subsistence farmers. Coffee research was also to be strengthened. The coffee produced by the project was primarily meant for domestic consumption. Implementation of the estate and factory components was to be carried out by RUCON Industries Ltd., and the smallholder and research components by MAWD. Total project costs were estimated at US$8.3M at appraisal. 1.21 From the beginning, the execution of this project was beset with problems, many of which can be traced to poor appraisal estimates, a shortage of funds, and a worsening economic situation in Zambla resulting in increasing budgetary restrictions. These led to shortages in materials and supplies, late deliveries of fertilizer and other chemicals, and general delays in project Implementation. In addition to the delays,operations like land preparation were not always carried out in accordance with appropriate norms. A aid-term review mission (March 1981) re-estimated total project costs at US$18.1M. This mission further concluded that the most viable option was for the plantation component to be implemented as designed, but that the largest part of the crop (80X) to be oriented toward the export market and only the remainder toward the domestic market. Although project costs were estimated to be much higher than originally estimated, project benefits under the export/domestic marketing scenario were also projected to increase, resulting In an estimated ERR of about 17X. The funding problem was partly resolved by eliminating and reallocating funds from the smallholder and research components. Local funding for factory civil works and plantation completion was to be provided through equity and loan funds by ZINCO and INDECO. After IDA funds were no longer available for research and smallholder coffee development, these two project components received only scant further attention. The situation improved when coffee extension and research support was included in a UNDP/FAO financed project which provided mainly technical assistance. During the Initial years of the UNDP/FAD project from 1981 to 1983, about 400 smallholders took up coffee  production, cultivating coffee primarily under rainfed conditions. When LINTCO, with Government financial support, took over the responsibility for smallholder coffee development at the end of 1983, the increase in coffee farmers and expansion of coffee area gained additional momentum. However, development efforts have not been fully successful (see para 2.07) and assistance provided by UNDP/FAO and the Government for coffee research all but terminated In 1984. 1.22 Current Status. Of the 450 ha of coffee to be established or rehabilitated by RUCOM under the project, 407 ha have so far been planted, although some of the new plantings require considerable infilling. Civil works construction for the factory and equipment installation are completed, and the factory has been commissioned in June 1986. The Credit Closing Date was extended by one year to September 30, 1985. A project completion report is under preparation. 1.23 Operating and management performance of RUCOM has not been satisfactory: the Lusaka based management has not always given adequate attention to the plantation; forward planning, coordination and monitoring have been lacking; past shortages of inputs and other materials have affected the plantation and field practices and husbandry, maintenance and general operations have frequently been out of line with acceptable standards. To overcome these problems, GRZ decided to transfer the responsibility for project completion to a newly established parastatal, the Zambia Coffee Company Ltd. (ZCCL) in. early 1984. The company's main responsibility was to (a) manage the two coffee estates, (b) dry, hull and grade all coffee produced in Zambia through their dry processing plant; and (c) market all clean coffee for export. ZCCL is taking steps to bring the problems under control but its coffee experience and know-how is still Inadequate and progress is slow: crop husbandry practices, although Improved, do not yet meet acceptable standards and coffee yields are still low; problems associated with the existing furrow irrigation system, its maintenance and operations are yet to be addressed. However, ZCCL has the potential of becoming viable through improvements in management; invest- ments in machinery, equipment and housing; and major corrections in the irrigation system. Total cost estimates, including contingencies for these improvements would be US$5.OM (para 4.18). 1.24 The problems experienced in project implementation have high- lighted the need for preparation of reliable cost estimates and careful evaluation of technical details. They have also shown that, given the current Zambian lack of experience in coffee production, processing and marketing, reliance on the public sector for a project of this size and complexity has been inappropriate. To ensure ZCCL's future viability, the most effective course to follow would be to provide coffee management expertise, additional equity funds and the cost-consciousness required through private sector participation in the Company. Such participation would also be expected to help in the removal of existing constraints on effective personnel management and the management of the Company in general. INDECO has initiated discussions with the Commonwealth Develop- ment Corporation (CDC) for the provision of financial assistance. There is also possible interest by some private firms in assisting ZCCL with management and equity input. To avoid further delays in addressing urgent operational and management problems INDECO/ZCCL, in consultation with IDA,  - 10 - have recently entered 'nto an agreement with Tate and Lyle Technical Services, under which management and irrigation expertise are being provided. Also, with the assistance of the Commonwealth Fund for Technical Cooperation (CFTC) a Corporate Plan is being prepared which is to establish the basis of suitable organization, management and equity participation arrangements. (See also paras 4.12 and 5.14). 1.25 The lessons learned from the first project have been incorporated in the proposed second phase by concentrating on the private sector in the project's main component. Care has also been taken to arrive at realistic cost and production assumptions, and to ensure that irrigation works and processing facilities, financed under the Project, would be efficient and of appropriate design. II. THE COFFEE SUB-SECTOR A. General 2.01 The history of coffee cultivation in Zambia goes back to the 1920s. Being largely confined to the Northern Province, coffee growing remained isolated and the lack of support facilities and an export marketing outlet caused production to remain low. Most of the coffee consumed in the country is still imported. During 1970/76, local coffee production, although slowly increasing, averaged about 15 tons of clean coffee per annum while annual imports averaged about 450 tons. Since then, with the restrictions on foreign exchange, imports have declined considerably while local production has been increasing. This increase is due mostly to the implementation of the IDA-assisted Coffee Production Project. Total production at plantation maturity has been estimated to reach about 800 tons per annum. A similar output is forecast for a 400 ha coffee estate which is being developed by the Mpongwe Development Corpora- tion - a company owned 51i by GRZ and financed in part by IFC. This potential production, combined with that currently grown by smallholders and commercial farmers (about 140 tons), should satisfy local requirements of about 600 tons (para 2.14) and leave about 1,000 - 1,200 tons surplus for export. Recently, interest in coffee production has been growing rapidly among all groups of farmers. Efforts to expand production have, however, been constrained by lack of experience in coffee growing and processing technology, inadequate and unfocussed extension support, insufficient credit availability and uncertainty with respect to Government coffee policy. 2.02 Growing Conditions. The northern areas of Zambia are the most suitable for the production of high quality arabica coffee. The region's altitude, ranging from 1,300 to 1,700 meters, is well suited to arabica coffee. This type of coffee can be grown in lower altitudes but its intrinsic quality would be lower. Temperatures are also within the range required, with the mean monthly range between 8