China - Rural Sector Adjustment Project

Document of The World Bank FOR OFFICIAL USE ONLY ReportNo. 10767 PROGRAM PERFORANCE AUDIT REPORT CHINA RURAL SECTOR ADJUSTMENT PROJECT (LOAN 2967-CHA AND CREDIT 1932-CHA) JUNE 26, 1992 Pr 'AR) ReO' 076 CH pe Author: DUANE'P9I4%Let Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (from PCR, August 1991) Currency Unit = Yuan (Y) US$1 = Y 5.27 Y 1.00 = US$0.19 WEIGHTS AND MEASURES 1.00 jin = 0.50 kg 1.00 kg = 2.00 jin 1.00 mu = 0.067 ha (1/15 ha) 1.00 ha = 15.00 mu ABBREVIATIONS CATIC China Agribusiness Trust & Investment Corporation EZO - Experimental Zone Office ICB - International Competitive Bidding MOA - Ministry of Agriculture MOC - Ministry of Commerce MOF - Ministry of Finance OED - Operations Evaluation Department PBC - People's Bank of China PCR - Project Completion Report PPAR - Program Performance Audit Report PRS - Household Production Responsibility System RCRD - Research Center for Rural Development RCRE - Research Center for Rural Economy RE - Rural Enterprise RRP - Regional Reform Program RSAL - Rural Sector Adjustment Loan SATIC - State Agribusiness Trust & Investment Corporation SECAL - Sector Adjustment Loan SLA - State Land Administration SOE - State-Owned Enterprise TICS - Township Industrial Corporations TVCE - Township and Village Collective Enterprise TVE - Township and Village Enterprise FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. - of Director-Ceneral --ations Evaluatm June 26, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Performance Audit Report on China Rural Sector Adiustment Prolect (Loan 2967-CHA and Credit 1932-CHA) Attached, for information, is a copy of a report entitled "Program Performance Audit Report on China: Rural Sector Adjustment Project (Loan 2967-CHA and Credit 1932-CHA)" prepared by the Operations Evaluation Department. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. FOR OFFICIAL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT CHINA RURAL SECTOR ADJUSTMENT PROJECT (Loan 2967-CHA and Credit 1932-CHA) Table of Contents Paae No. Preface ...................................................... I Basic Data Sheet .................................................. i Evaluation Summary ............................................... v I. BACKGROUND ................................................ 1 II. OBJECTIVES AND CONTENT OF THE SECAL ........................... 2 Preparation ................................................... 2 The Program .................................................. 3 TheeLoan .................................................... 4 Board Discussion ............................................... 4 Ill. IMPLEMENTATION AND OUTCOME .................................. 5 Effectiveness, Procurement and Di3bursements .......................... 5 Rural Policies ................................................. 6 Rural Sector Growth Rates ........................................ 9 IV. FINDINGS, ISSUES, LESSONS ..................................... 10 A. Loan Rationale ............................................. .11 B. Risks from Macroeconomic Environment ........................... 12 C. PolicyExperiments ........................................... 12 D. BroadPositiveList .......................................... 13 E. Effectiveness of ICB ......................................... 13 Attachment 1. Comments from the Ministry of Finance ....................... 15 MAP - IBRD 23926 This document has a restricted distribution ard may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. PROGRAM PERrORMANCE AUDIT REPORT CHINA RURAL SECTOR ADJUSTMENT PROJECT (Loan 2967-CHA and Credi1J932-C-HA1 PREFACE This is a Program Performance Audit Report (PPAR) on Rural Sector Adjustment, involving an IBRD loan in the amount of US$200 milli-i and an IDA credit in the amount of SDR 72.24 million (US$100 million equivalent) to the People's Republic of China, with the objective of supporting both nationwide and regional policy reforms in the rural sector. The loan and credit were approved on June 23, 1988 and became effective on September 19, 1988. The credit was fully disbursed by October 17, 1988, the loan by September 18, 1989. In both cases, disbursement was completed well ahead of the original closing date of July 31, 1990. The PPAR, prepared by the Operations Evaluation Department (OED), is based on the Project Completion Report (PCR) prepared by the former Asia Regional Office, the President's Report, the Loan/Credit documents, the transcript of the Executive Directors' meeting at which the program was considered, on a study of Bank files, and on discussions with Bank staff. An OED mission visited China in February 1992 and discussed the effectiveness of the Bank's assistance with the Ministry of Finance, China Agribusiness Development, Trust and Investment Corporation, China National Chemicals Import and Export Corporation, the Research Centre for Rural Economy, and the Development Research Centre of the State Council, all of which have been involved with implementation of the project. Their kind coopewation and valuable assistance in the preparation of this report are gratefully acknowledged. The PCR provides a good account and assessment of the project experience, and discusses the performance of the Bank and the Borrower executing agencies. The PPAR elaborates on particular aspects such as: the loan's rationale and the Bank's role; the foreknowledge that China's macroeconomic instability posed serious risks of disrupting the program; the novel, experimental nature of the project's policy-making in the provinces; the impact of a broadly-defined positive list of goods on disbursements; and the effectiveness of ICB in procuring fertilizers. The draft PPAR was sent to the Borrower for comments. The comments received from the Ministry of Finance are reproduced as an Attachment to the PPAR. PROGRAM PERFORMANCE AUDIT REPORT CHINA RURAL SECTOR ADJUSTMENT PROJECT (Loan 2967-CHA and Credit 1 932-CHA) BASIC DATA SHEET KEY PROJECT DATA Appraisal Actual or Actual as % of Estimate Estimated Actual Agoraisal Estimate Total Project Costs (US$ m) 300 293.17 98 Loan Amount 200 200.00 100 Credit Amount 100 93.17 93 Economic Rate of Return N/A N/A Institutional Performance CUMULATIVE LOAN AND CREDIT DISBURSEMENTS FY89 FY90 Lgn (US$ m) Credit (SDR) kLnJJ _r11m Credit (OR) Planned 200.0 72.24 200.0 72.24 Actual 195.1 72.24 200.0 72.24 Percent 97.5% 100.0% 100.0% 100.0% PROJECT DATES Oripinal Loan/Credit Dates Actual Loan/Credit Dates Initiating Memorandum 01/25/88 02/09/88 Letter of Development Policy 04/04/88 1& 05/25/88 /& Negotiations 04/27/88 05!09/88 Board Approval 06/28/88 06/23/88 Loan/Credit Signing - 07/15/88 Effectiveness 09/13/88 09/19/88 Loan/Credit Closing 07/31/90 07/31/90 Date of Final Disbursement Loan 09/18/89 Credit 10/17/88 /a First Draft. / State Council approved version. -iv - STAFF INPUTS (Staffweeks) FY88 FY89 EMj FY91 TOTAL Preparation 61.9 61.9 Appraisal 110.0 110.0 Negotiations 23.0 23.0 Other 0.9 0.9 Supervision 0.9 65.5 9.3 7.4 83.1 PCR 17.9 17.9 TOTAL 196.7 65.5 9.6 25.3 297.1 MISSION DATA Date No. of Performance Type of - Persons Rating Prgblem Preparation 11/87 9 Appraisal 02/88 19 Supervision I 09/88 9 1 Pr Supervision II /A 09/89 5 3 F, P Completion 01/91 5 F = Financial, P = Policy Reassessment, Pr = Procurement. OTHER PROJECT DATA Borrower People's Republic of China Executing Agency Research Center for Rural Development Fiscal Year January 1 - December 31 Follow-on Project NONE /p Program Review Mission. -v- PROGRAM PERFORMANCE AUDIT REPORT CHINA RURAL SECTOR ADJUSTMENT PROJECT Loan 2967-CHA and Credit 1932-CHA) EVALUATION SUMMARY 0 Introduction despite worries about the possible disruptive effacts of macroeconomic instability then 1. Early in 1987, the Politburo of the Central evident, principallv inflation, it decided that the Committee of the Chinese Communist Party loan/credit comb.natior - expected to be adopted a statement proposing the deepening of US$200m/US$100m - would not be tranched. rural reforms that hao begun in 1979. The aim The Bank's Board approved the loan/credit on of deepening these reforms was to reinforce June 23, 1988. While several Board members several principles: expanding rural producers' exDressed concern about the macroeconomic decision-making power; developing further a environment, e.g. inflation, most of those who system of markets hat would provide indicative spoke seemed to share the staff's enthusiasm signals to help guide those decisions; allowing about the Borrower's strong commitment to resources to move more freely between agri- deepening its rural reforms and its previous track culture and industry; preserving sta' . ownership record. of primary resources, t it experimenting with a wide range of management forms and marketable Obilcive assets; and to move the state yet further away from exercising direct control over the rural 3. The main objectives of the loan and credit economy. By September 1987, the Government were to foster agricultural development and of China (GOC) had invited the Bank to become specialization; increase economic efficiency; involved in these ambitious rural policy pursuits, encourage r.on-farm rural enterprises--both indus- following a dialogue on what the Bank could offer trial and commercial; expand rural exports; in the ways of experience with other countries' provide productive off-farm employment oppor- reform efforts and of loan assistance. The Bank tunities; reduce agricultural and urban food had not previously supported adjustment lending subsidies; improve agricultural tax buoyancy; and operations in China. improve the range and efficiency of rural financial services. To achieve these complex objectives, 2. The operation took shape relatively quickly. actions taken in 1987 to initiate the second By September 28, 1987, a Bank field mission phase of rural economic reform would be atinounced preliminary agreement on the broad deepened in 1988 and 1989 in the following key format for a loan operation that would provide policy areas: (i) agricultural and food price and direct support for reform experiments and general trade liberalization, while ensuring protection of agricultural imports. A Bank preparation mission low income consumers; (ii) marketing and market visited China in November/ December 19e7. Re- integration, (iii) rural land system reform; (iv) rural gional Management considered a Rural Sector industrialization and commercial activities; (v) Adjustment Loan (RSAL) of around US$300 marketing and service systems in the less com- million ready for appraisal early in February 1988. mercialized areas by establishing special and It regarded the operation as likely to be the first general purpose cooperatives; (vi) state financial of a series of RSALso With this in prospect and support for public agricultural investment; and - vi - (vii) rural financial markets. Typical of China's overall program saw good progress with national approach, many reforms would be introduced reforms of the grain marketing and price syetem, first at the regional level under central govern- and fair progress with the land management, ment supervision, then generalized for nationwide rural industrialization, and financial market implementation. The proceeds of the proposed systems. Regional experimo;ntal offices con- loan and credit would finance three categories of tinued to conduct a wide range of reform imports: commodities and raw materials for the experiments. rural sector; agricultural inputs; and machinery, equipment and spares for the rural sector. Pro- 6. The most sweeping policy changes have curement of about 50% of these imports wouLd occurred In grain marketing and pricing. involve international competitive bidding (ICB). Following nominal increases ir administered producer prices for grain and vegetable oils late Imolementation and Outcome in 1988, GOC began to implement major grain marketing and price reforms In 1990 with the 4. The Loan and Credit were declared effective establishment of wholesale markts. It raised in September 1988. Virtually all the Credit was urban grain ration prices in May 1991 by disbursed within 11 days thereafter. ara 71 % of amounts ranging from 50% to 200%, and decon- the Loan within 37 days. These early disburse- trolled the prices of the higher quality table ments were made against the equivalent of grains. On April 1, 1992, GOC announced advanca contracting, valid under the legal agree- further major price increases for grains, well ments. Loan disbursements then paused until ahead of its expected schedule. It raised quota April 1989, after which the Bank disbursed procurement prices on average by 18%, urban upwards of US$57 million against procurement of ration prices on average by 45%. Implicit taxi- items under ICB contracts, until the Lan was tion of farmers has been reduced, possibly elinat fully disbursed in September 1989, well ahead of ated. Explicit subsidization of consumers has the clusing date. been much reduced. These series of changes followed testing of a range of such policies In a 5. Government attempts to implement the number of regional grain reform experiments. Program's policy components ran into early These provincial and county level experiments trouble resulting from inflation and the counter- provided not only useful lessons for authorities measures taken to cool the economy. Ironically, considering national reforms to mull over, but inflation had accelerated at about the time of loan also some advance warning to the population at approval. Over the next two months, July and large, who learned of such experiments through August 1988, consumers switched in some panic the national media. from financial into real assets. The crisis led government to postpone further price liberaliza- SUstailitv tion at the national level and, in late 1988, it adopted a series of stabilization measures to 7. The continuation of most of the reform dampen inflation. The inflation and the counter program after RSAL was formally closed, and its measures taken impacted directly on some of the recent acceleration in the case of grain pricing, regional reform programs (RRPs) by reducing the indicates that this program will be sustained. real budget resources needed to run them. The Other indications are the favorable annual growth upshot of these events was that national and rates enjoyed by the agricultural sector (2.3% in regional reforms either slowed o. were uneven 1988, 3.2% in 1989, and 7.5% in 1990), and for the first nine months after effectiveness. evidence of even stronger growth rates for rural Then came the Tienanmen events of June 1989. industry. There are problems of attribution in Thereafter, implementation stalled or crawled for linking such growth rates for the rural sector to about 12 months until China's leadership reaf- economic policies adopted over the period, but firmed its commitment to the second stage the positive correlation is nevertheless reassuring reforms in June 1990. Within the next 12 to any assessment of RSAL. months, i.e. largely beyond the closing date, the - vil - Findinos and Lessons Learned Strong commitment by a Borrower to Its reforms makes It more justifiable for zhe 8. The audit supports the PCR assessment that Bank to accept greater risks in adjustment the RSAL initiative appears to have been justified lending, In this case those reputedly arising by the progress made until mid-1991. Continued from macroeconomic instability. progress since then, and the recent (April 1992) grain price adjustments reinforce this assess- Other countries that are groping towards ment. In the audit's view, reform achievements radical restructuring of their economies in grain marketing and pricing alone have easily should also consider the merits of under- justified this operation. Some of its lessons have taking poNcy experiments such as those been: IncorporatI into kSAL. Such experiments allow governments a peek at the economic * This operation had a refreshing basis for a and political consequences of policy reforms policy-based loan: the Government's unmis- before they undertake major policy change. takable Interest and initiative In finding more effective economic policies - a clear case of The rapid disbursement of most of RSAL's strong commitment to reform. The Bank funds within five weeks of effectiveness entered into the operation principally and the lack of any ICB as of that time can because of that commitment and not be seen now, in retrospect, to have been btcause of any orima faie need for urgent inevitable, given the list of eligible imports. balance of payments support. In this respect, the Bank's rejection of a negative list of goods In favor of a broadly- * The Bank's declared rationale for lending in defined positive list was inconsequential. such circumstances, which was primarily to Both types of listing encourage fast play a supporting role in the tiesign and disbursement. evaluation of reforms, was most appropriate. Uncertainty as to whether RSAL's ICB con- tracts for fertilizor procurement were more * In contrast to many other Bank policy opera- effective than other procurement methods In tions, where PCRs and aidits typically con- securing favorable prices suggests that the clude that the focus of policy (conditionality) Bank ought to investigate this ssue. was too diffuse, this operation suggests that the involvement of a strongly-motivated Borrower permits the scope of reforms supported to be ambitious. PROGRAM PERFORMANCE AUDIT REP.RT CHINA RURAL SECTOR ADJUSTMENT PROJECT (Loan 2967-CHA find Credit 1932-CHA) . BACKGROUND 1.1 The three earliest items on the 3ank's correspondence files related to this operat1on are- (a) a staff memorandum dated November 25, 1986. expressing interest in an investigation of survey and analysis of land prices in Chir.3, conducted under the auspices of the Development Research Center for Economy, Technology and Society of the State Council, PRC - interpreted 'y staff as one of a number of indications that the Government of China (GOC) was exploring many topics that could be related to market-driven solutions to rural economic problems; (b) a document entitled "Deepening the Rural Reforms," which had been adopted by the Politburo of the Central Committee of the Chinese Comr.unist Party on January 22, 1987 - but was translated at the Bank's Resident Mission in Beijing only on August 22, 1987; and (c) a message dated September 28, 1987 from a Bank mission in China to headquarters announcing preliminary agreement on the broad format for a loan operation that would provide direct support for reform experiments and general agricultural imports, and disburse over a two year period without tranching - with a suggested processing schedule to meet a date for Board presentation of "late June 1988". 1.2 These are rather disjointed indications of how the Bank first became involved in this operation in support of China's second phase of rural reforms. Obviously, there must be other internal memoranda, not on the official file, that would explain that initiation better, but Bank operational staff do not appear to have developed much interest in a RSAL for these reforms before August 1987. The Politburo's document made a deep impression on them. They moved rapidly thereafter. 1.3 GOC's aim i. Jeepening its rural reforms was to reinforce several guiding principles: expanding rural producers' decision-ma king power; developing further a system of markets that would provide indicative signals, yet remain under state plan guidance; liberalizing the rural economy to allow resources to move more freely between agriculture and industry, and among agricultural endeavors; preserving st3te ownership of primary resources, but expernenting with a wide range of management forms and marketable assets based on usufruct rights; and to move the state yet further away from exercising direct control over the rural economy, towards reliance on indirect instruments such as price, taxation, credit and laws and regulations at a "macro" level. -2- 1.4 As seen by Bank staff on September 29, 1987, the Phase II reforms would encompass: significant changes to input and output pricing; changes to the investment system to encourage efficiency and technology transfer; dev3lopment of legal and regulatory frameworks to provide more secura rights (including rights of exchange) to land and other assets; development of a positive business and legal environment for rural commercial activity; liberalization of ti grain procurement and distribution system; and mobilizing rural savings to provide a more flexible and responsive financing system for rural investment. GOC's interest in having the Bank involved in these ambitious rural policy pursuits appears to heve been its understanding that the Bank's funds for such a purpose would have relatively 1few strings attached, aod that the Bank could offer useful advice based on its experience with other countries' reform efforts. The Bank had not previously supported adjustment lending operations in China. II. OBJECTIVES AND CONTENT OF THE SECAL Pregaration 2.1 The operation took shape relatively quickly. Bank staff prepared an Initiating Executive Project Summary Vy November 10, 1987. A Bank preparation mission visited China in November/December 1987. Likely details of the Bank's procurement requirements came under intense scrutiny early during preparation; in anticipation of expected inquiries from GOC, staff posed in December 1987 a US$ 5 million threshold for ICS procurement. IMF staff expressed interest in the proposals' macro implications in January 1988, emphasizing the importance cf taxing the rural economy; they were concerned that, if the agriculture sector escaped the tax net, the economy might run into macro problems. 2.2 Regional Management considered RSAL ready for appraisal early in February. It regarded the operation as likely to be the first of a series of RSALs. With this in prospect, it decided that the loan/credit - expected to be US$200 m/US$1 00m - would not be tranched. 2.3 A meeting of the Operations Committee on February 17, 1988 felt that the pr,osed reiorm program raised three main issues: (a) how to make the policy matrix more objectively monitorable; (b) was the macroeconomic environment satisfactory (China was experiencing some price inflation); and (c) can steps in the reform program be linked with measures in the macroeconomic program, e.g. grain subsidies? The Regional staff responded that, as long as the current macroeconomic imbalances persisted, the Chinese were unlikely to introduce major price adjustments. In their view, progress on many of the proposed rural reform measures would not be affected by the macroeconomic situation, except with iegard to grain price adjustments. 2.,. A Bank procurement specialist visited Beijing in February 1988 and met with SINOCHEM (China National Chemicals Import and Export Corporation), which had been designated the lead procurement agency under RSAL, and two other import/export -3- agencies. As a result, staff anticipated that an acceptable procurement package would include local procedures only for small contracts (to an aggregate ceiling) for commodities "ncrmally" bought through small contracts or through shopping procedures, e.g. spare parts and non-bulk commodities. Otherwise, disbursements would be made for items to be procured in various ways (including normal ICB), all of which could be characterized as unlimited internaiorial tendering. Amor; che procurement arrangements proposed was use of ICB procedures for purchases over US$5 million and items that could be bulked (including fertilizers, petroleum and related products, agronhe!ials and edible oils), which were likely to constitute in aggregate not less than $125 million of the loan. Another significant proposa was that procurement arrangements would be conditioned by use of a negative list and the need for quick disbursement. 2.5 By March 21, internal Bank discussions placed the negative list idea in controversy. Senior managers outside the Operations Complex recommended a positive list, apparently because China did not appear to have a balance-of-payments problem. In response, the Region pointed out that the proposed program would liberalize the rural sector, i.ot just agriculture, and that over half of all value added in the rural sector was now industrial; therefore, any import surges would likely be multisectoral. 2.6 The Appraisal Mission's BTO report (March 29, 1988) confirmed agreements reached earlier concerning procurement arrangements and procedures to be utilized under the proposed loan, Viz.: (i) a negative procurement list; (ii) ICB (SAL-type procedures) would govern all contracts in excess of $5 million, while the normal procedures of the three eligible importing agencies would govern contracts of lesser amount; (iii) total procurement under ICB would amount to at least $150 million; and (iv) ICB procedures would be required for the procurement of certain goods (e.g. fertilizers, petroleum products, edible oils, and agrochemicals). Senior management subsequently rejected the Mission's recommendation of a negative list, in favor of a broadly defined positive list with three categories: commodities and raw materials for the rural sector; agricultural inputs; and machinery, equipment and spare parts for the rural sector. The Proqram 2.7 As described in the President's Report, the Government's formal letter to the Bank on its Rural Reform Policies had six major foci: (a) Markets and Marketing - to promote the development of well functioning internal and export markets for agricultural commodities. (b) Pricing/Subsidies and Taxation - to reduce reliance on administered pricing; progressively reduce generalized urban consumption subsidies (e.g., for grains), with improved targeting on the poorest groups; remove input subsidies; and replace the output tax implicit in farmer obligations to fulfil state procurement quotas (e.g., for grains) at below-market price quota obligations with a transparent tax based on the value of agricultural land. -4- (c) Land Management System - to improve the security of land use rights by formalizing relationships governing land use under the production responsibility system (PRS); and create agricultural leasehold markets with land as collateral for financial and other transactions, and--where conditions warrant--to reduce land fragmentation. (d) Rural Industry - to provide equal treatment for all industrial enterprises regardless of type of ownership; extend the reform of public enterprises to state operated enterprises (SOEs) operating in the rural sector; support and reinforce the development of town and village enterprises (TVEs); provide internal management and institutional support; and clarify regulations governing their operations. (e) Rural Investment - to improve the organization and management of public investment programs and maintenance of rural infrastructure; and delimit policy frameworks to encourage private investment. (f) Credit and Finance - to promote development of a rural financial system that would efficiently mobilize rural households' savings and intermediate funds for private agricultural and rural nonagricultural investments. 2.8 Some of these features were to be implemented at two levels: regional and national. The more experimental, regional reform programs (RRPs) were to be tested in selected provinces under the overall guidance of the State Council's Research Center for Rural Development (RCRD); implementation of the RRPs began towards the end of 1987. Reforms considered successful or already proven were to be introduced as national policy. The Loan 2.9 Apart from the above outline of policy measures, the Bank required no conditionality in terms of specific policy measures to be taken or of any schedule of actions required. Nor was the Loan to be tranched. The main restrictions were those of the list of goods eligible for reimbursement and the Bank's other procurement requirements already described. The President's Report gives three reasons for Bank involvement in RSAL (PR, para. 67): first, the opportunity - at the request of GOC - to offer its experience and analytical input in the design of reform measures; second, the margin of support which Bank funds would provide to absorb pressure on China's balance of payments, likely to worsen under the reforms; and third, to relieve expected short-term budgetary shortfalls, arising in part also from the reforms. Board Discussion 2.10 At their June 28, 1988 meeting held to consider RSAL, the Bank's Executive Directors generally shared the staff's enthusiasm for the operation. Although not unanimous, they agreed with its "upfront loaded conditionality", i.e., having the major (policy) conditions of lending in place prior to their vote. Some were disappointed, -5- nonetheless, that loan funds release was not tranched in two or more steps against either: different phases of implementation, or improvements in the macroeconomic environment. 2.11 This latter worry about whether the economy was stable enough to support ambitious rural reforms was the meeting's dominant concern. Thece was some alarm over the expansion in credit and the risks due to inflation, and a belief that reforming of pricing systems needed a stable monetary system. Staff acknowledged the risks to the operation coming from the macroeconomic situation, but offered also the view that part of the price inflation then extant was due to the supply situation which RSAL would address. 2.12 Other issues touched on were: whether the Bank's lending program overall to China was appropriate; the way transport constraints would limit improvements to marketing and pricing structures; the deterioration in China's rural infrastructure, and the positive list for procurement. There was one expression of support for a positive list; one expression of preference, in principle, for a negative list. One Director was relieved that so murh of the procurement would be under ICB. Ill. IMPLEMENTATION AND OUTCOME Effectiveness. Procurement and Disbursements 3.1 Both the Loan and Credit were declared effective on September 19, 1988. As reported in the PCR (its para. 4.32), the Credit was fully disbursed by October 17, 1988, i.e. within 28 days of effectiveness tall but a tiny fraction went within 11 days). From an examination of withdrawal applications, IDA disbursed against contracts entered into prior to the date of Credit signature, valid under the legal agreements, which accounts for the fast disbursement. 3.2 The $200 million Loan was fully disbursed by September 18, 1989. IBRD disbursed US$143 million (71%) by October 26, 1988, i.e. within 37 days of effectiveness; as was the case with the Credit disbursements, these early Loan disbursements also represented reimbursements against the equivalent of advance contracting. Loan disbursements then paused until April 1989. Thereafter, the Bank disbursed upwards of US$57 million against items procured under ICB contracts. 3.3 The rapidity of early disbursements both surprised and dismayed Bank staff. Searching for a reason for the rapid drawdowns, the PCR claims it was the Government's urgent need for foreign exchange financing in late 1988 and early 1989 (PCR, para. 4.32), which the audit disputes in Part IV, section D below. Staff dismay that none of the early disbursement was underpinned by ICB led, as early as October 7, 1988, to their seeking promises from the Chinese of a shift in "procurement" to ICB procedures. This explains the above pause in Loan disbursements between October 1988 and April 1989. 3.4 PCR references to Government's urgent need for foreign exchange correctly describes a surge in imports. China's imports in the three years 1985-87 (in 1980 -6- constant prices) were in the range US$38-40 billion. They jumped to US$48.6 billion in 1988 and US$54.5 billion in 1989.1/ These figures certainly vindicate the Bank's second rationale for RSAL: to provide a margin of support to the balance of payments, thought likely to worsen under the reforms. Rural Policies 3.5 The Bank's first, "post-effectiveness" supervision of RSAL, carried out over the period September-November 1988, had to deal with some rapidly emerging problems. For at about this time, Government moved to counter inflation. Both inflation and Government's largely administrative instruments used for fighting it were having dislocative effects on implementation of reforms. 3.6 Ironically, inflation had accelerated at about the time of loan approval. As argued in a 1990 Bank country study, "... demand pressures became pronounced in the first half of 1988, pushing the economy to the limits of its productive capacity. When, under these overheatod conditions, the authorities announced in June 1988, plans for a major price reform to be implemented in 1989, inflation worsened as consumers switched in some panic from financial into real assets. Prices that had been rising at annualized rates of 10-15 percent in early 1988 soared to rates approaching 80 percent, on an annualized basis, by August. Faced with this crisis, the government postponed further price liberalization and, in late 1988, adopted a series of stabilization measures."2/ Inflation impacted directly on some RRPs, e.g. the Grain System RRPs, through its erosion of real budget resources needed to run these programs. The stabilization measures promised even more disruptions during 1989, particularly for national price and other policy reforms. 3.7 Although it expressed misgiving about these developments, nevertheless, the mission made favorable references to the monitoring activities and to implementation of several regional reforms, notably those dealing with the land management system in Meitan (Guizhou Province); the grain system in Xinxiang (Henan) and Yulin (Guangxi); and the rural enterprise system in Fuyang. It rated overall project implementation performance up to that point favorably. 3.8 By the time of the second supervision mission, which visited China briefly in September 1989, the situation had worsened. This second mission believed that implementation of both national reforms and experimental programs during 1989 had stalled due to both a policy reassessment in China, aggravated by the events of Tienanmen 1/ The World Bank, China: Between Plan and Market, September 1990, Table 4-. 2/ The World Bank, China: Between Plan and Market, September 1990, para. v. -7- Square in June 1989, and smaller budget support for reform activities. On top of this, the main implementing agency (RCRD) was scheduled for dissolution latir in the year. The mission believed that project implementation had serious problems. It offered a series of recommendations to turn the project around. 3.9 The Project Completion Report's account of implementation performance is more upbeat. Its Part I, resulting from a Bank mission to China in January 1991 and a drafting process lasting through August 1991, is able to report Government's resumption of reforms by mid-1 990 and the major increase in May 1991 of urban ration sales prices to consumers for the main foodgrains and edible oils. It concludes that the Bank's support of RSAL appears to have been justified. Its Part II reiterates China's commitment to completing the reform program, notwithstanding the various setbacks experienced. 3.10 National policies. Recapping the PCR's main observations regarding implementation, the following summarizes the outcome for national policy reforms: (a) Following its nominal increases in administered producer prices for grain and vegetable oils late in 1988, GOC began to implement grain marketing and price reforms in 1990 by establishing wholesale markets. It raised urban ration sales prices in May 1991 by amounts ranging from 50% to 200% for individual grains and grades. It decontrolled the prices of the higher quality grains. Prior to this, ration prices, which had been around 20% of equivalent international price levels, were considerably below producer prices. (b) Reforms of the rural land management system proceeded less dramatically. National laws to establish markets in rural land use rights were drafted in 1989, but their enactment remains pending. The State Land Authority enforced new land conversion procedures in 1989 and 1990, slowing considerably the annual decline in cultivated area. (c) Regarding rural industrialization, Government made progress in clarifying the legal status of private firms and in promoting separation of management from ownership in rural collective firms through contractual arrangements. However, it did not introduce formal bankruptcy regulations for non-state firms, nor did it accomplish a variety of intended measures relating to rural industrial and commercial policy for all forms of nongovernmental enterprises. (d) There were two main components to developing rural financial markets: the establishment of China Agribusiness Trust and Investment Corporation (CATIC); and a Review of Rural Financial Market Policies. CATIC (also called SATIC) grew rapidly from its inception in 1987 and became the channel for disbursement of RSAL counterpart funds to experimental program areas. The financ!il market policy review did not take place; though still viewed as urgently needed, the PCR now thinks it was too ambitious an objective for RSAL. -8- 3.11 Hence, the national policy accomplishments were mixed and, in some cases, delayed. However, on April 1, 1992, GOC announced further major price increases for grains, well ahead of its expected schedule. It raised quota procurement prices on average by 18%. The procurement prices would be applicable to about 50 million tons of grain (the balance of state procurement is already purchased at negotiated prices that fluctuate with the market). It raised urban ration prices on average by 45%. These adjustments bring official producer and consumer grain prices to the same level. Implicit taxation of farmers (through low official prices) has been reduced, possibly eliminated. Explicit subsidization of consumers has been much reduced, but not eliminated. 3.12 Regional Experiments. Implementation of the regional reform experiments was also mixed, reflecting some of the same financial and policy review problems encountered by the national reforms. Resumption of reform momentum in mid-1 990 carried these experiments forward also, as detailed in the PCR, which covers the eleven RRPs endorsed by State Council at the time of RSAL appraisal and one RRP added Shortly thereafter (ten other RRPs were added subsequently). The audit will limit its account of these RRPs to three experimental office activities that it reviewed first hand. 3.13 Experiments with the land system in Jiangsu and Shandong Provinces succeeded in establishing the feasibility of separating a household's rights to land for subsistence needs (referred to as food ration land), from rights to land for commercial production that might also fulfil state procurement quotas (referred to as responsibility land). The aim of drawing such distinctions was to identify land that might be leased out to contract farmers were they to show interest.3/ The following anecdote emerging from this work illustrates the kind of information obtained on how households preferred to allocate their land and labor if given wider choices. One village having 600 potential farmers (households) arranged for all their land - about 70 ha - to be cultivated by just ten "contract" farmers, thus "releasing" the other 590 to take (unfettered) employment in industry and other pursuits. The land so reallocated on a contract basis included in this case not only the village's "responsibility" land, but all its "food ration" land as well. This is an extreme example perhaps, for a village/locality having both little land and a strong demand for labor from industry. Yet it resuited from creating only a limited market in land rights. The market-guided solution so obtained suggests how villages in comparable circumstances might lower their costs of agricultural production and increase their household's earnings from industrial or off-farm employment. 3.14 Experiments with a shareholding system in a rural industry RRP in Shandong Province sought to clarify property rights, distribute earnings, separate party and government functions from enterprise functions, explore procedures for bankruptcy, and establish operational rules for enterprises - in particular, TVEs. Local officials reported that all these purposes had been achieved satisfactorily, with good results. Improved work incentives for employees probably account for part of the reported favorable results. One 21 China's earlier land reforms had ordained a relatively equal distribution of land use rights among households in a village, but the households had virtually no opportunities for trading these rights. This restricted their opportunities for taking advantage of management economies of scale to collective or state-owned forms of enterprise. -9- purpose of the experiment not achieved, however was to set up a local stock exchange. The absence still of any means of trading ownership rights restricts the potential value of some of these innovations. Accordingly, this experiment has considerable room yet for further development. 3.15 Experiments in grain markets and pricing in Xinxiang, Henan Province involved localized reforms in two stages. In the first stage, the Experimental Office raised prices for local grain procurement in May 1988 by about 22%, replaced the former indirect tax represented by low procurement prices with a direct tax, and raised input (e.g. diesel and urea) prices. Implementation slowed during 1989, because the stabilization program affected the availability of funds. When the stabilization program eased during 1990, the Office moved to implement the second stage, which was to cover local consumers. In July 1990, the authorities deregulated the prices of grains for breweries and bakeries across the whole province. In September 1990, they restricted the volume of sales at ration shop prices for the catering and food industries. The purpose of this and similar experimental RRPs in other provinces was to test policy measures in advance of nationwide application. The lessons learnt from them played an important role in defining national grain policies that have been adopted. Rural Sector Growth Rates 3.16 Agricultural sector growth rates (agriculture GDP at factor cost, constant 1980 prices) in the three years 1985-87 were in the range of 2.7% to 4.5%. The growth rates subsequently were 2.3% in 1988, 3.2% in 1989, and 7.5% in 1990. While it is difficult to attribute any part of these outcomes to the reform initiatives per se, such steady growth of the agricultural sector makes it even more difficult to dismiss their impact in the face of the Government's stabilization measures. 3.17 Rural industrial output grew even more strongly than agriculture over 1988- 90. The following figures show the relative shares of agriculture and industry in total rural output over 1985-90. Again, there are problems of attribution in linking such rapid growth of rural industry to economic policies adopted over the period, but these figures, read in combination with the agricultural sector growth rates of the previous paragraph, are nevertheless reassuring to any assessment of RSAL. - 10- COMPOSITION OF CHINA'S RURAL OUTPUT AT CURRENT PRICES (Rural Total Output = 100) Gross Output Gross Output Gross Output Year Total Value of Value of Value Aqriculture Industry ofQther -----------------% -------------- ------------- 1985 100 57 28 15 1986 100 53 32 15 1987 100 50 35 15 1988 100 47 38 15 1989 100 45 41 14 1990 100 46 40 14 Source: China Statistical Yearbook 1991. IV. FINDINGS. ISSUES. LESSONS 4.1 The audit supports the PCR assessment that the RSAL initiative appears to have been justified by the progress made until mid-1 991. Continued progress since then, the strong reaffirmation of the reform program made by China's political leaders in March 1992, and the more recent grain price adjustments reinforce this assessment. In the audit's view, reform achievements in grain marketing and pricing alone have easily justified this Bank operation. 4.2 It should be interesting, therefore, to reexamine the Bank's rationale for this project and the lessons to be drawn. A second issue worth examining is the risks to a SECAL from the macroeconomic environment, sorely tested in this case, and whether design changes could have improved matters. Third, experiments in policy making, which were a novel feature of this SECAL, could prove useful to other Borrowers also. The fourth and fifth issues concern procurement: whether the Bank's switch from a negative to a (broadly-defined) positive list made any difference - apparently not; and whether ICB was worth the bother - possibly not. - 11 - A. Loan Rationale 4.3 This operation had a refreshing basis for a policy-based loan, one that the audit finds superior to the usual reasons for Bank involvement in this type of operation: the Government's unmistakable interest and initiative in finding more effective economic policies for guiding the country's rural industries. The Bank entered into the operation principa;ly because of Borrower commitment and not because of any prima facie country need of urgent balance of payments support (para 2.5). The need for such urgent support is probably the most common factor underlying other Bank policy loans. This initial balance of RSAL characteristics forced the Bank to state its rationale for lending (para. 2.9) which, in .etrospect, still looks good. Its primary purpose, to provide technical assistance in the design and evaluation of reforms, was pursued satisfactorily. Staff sector work, especially in the area of grain marketing and pricing, offered useful analyses and perspectives. Chinese participants in that dialogue expressed their appreciation to the audit mission for this part of Bank assistance, mentioning in particular the role played by the Bank's task manager, Mr. Richard Burc.off II. The Bank's secondary purpose, to provide a margin of balance-of-payme.its support, was probably underestimated. The RSAL experience has demonstrated the important tole of imports in taking the strain of market liberalization. 4.4 The paucity of early information found in the Bank's file on RSAL suggests that the Bank discovered the opportunity for policy-based lending in China rather late. This impression may be exaggerated - discussions with Bank staff indicate that many relevant memoranda are missing, a product perhaps of internal disruptions caused by the 1987 Reorganization. Nevertheless, the existence of well-organized and highly motivated groups of policy reformers within the Chinese Government seems to have dawned upon Bank staff only as late as 1987. This is surprising, considering that rural reforms had been the agent of spectacular economic growth over the previous seven years. But also, perhaps, serendipitous. 4.5 By 1987, the Chinese reform movement had become well established and confident of what it was about. It could benefit from independent analysis and criticism without risk of losing its identity and with less political risks related to the identity of its interlocutors. To its credit, the Bank recognized the back seat, supportive role it should play. Hence, the audit commends in this case the key element of project design: zero conditionality. Furthermore, although the idea of tranching disbursements to, say, a mid- phase of implementation can be argued, its rejection in favor of the prospects of an RSAL II was clearly appropriate in the audit's view. 4.6 Finally, RSAL demonstrates that where the success of an operation depends more on borrower commitment and much less on the Bank's role, that operation can afford to be ambitious. GOC's second stage reforms are indeed ambitious and the wide spread of RSAL policy interests made it a difficult project for the Bank to supervise. However, this is not a potential weakness when the Borrower has decided independently that such a wide range of (interlocking) policy issues needs to be addressed. If such circumstances pose larger cost implications for Bank supervision, the extra costs are worth bearing. These conclusions are in contrast to what has been learned from most other Bank policy - 12 - operations, where PCRs and audits typically conclude that the focus of policy (conditionality) was too diffuse. B. Risks from Macroeconomic Environment 4.7 Adverse impact on the second stage reforms of GOC's economic stabilization measures illustrates how prescient was the Board's discussion of macroeconomic instability in 1988 and the PR's presentation of this as a risk (PR, para. 84). The audit enquired into whether this (timing) problem could have been handled better and concluded that it could not. 4.8 The issue is whether this risk wou'd have justified either delaying presentation of RSAL for Board approval or conditioning its release of funds on macroeconomic performance. In both cases: the audit feels such justification to be weak. The reforms were so fundamental, and Government commitment to them (just reviewed) so strong, as to make these other concerns subordinate. 4.9 Delaying a policy loan on the grounds of macroeconomic instability would be an absurd argument with which to confront a typical SAL operation, the rationale/timing of which is virtually driven by such instability. It had relevance for this SECAL to the extent that its policy content did not address such instability directly and, conceivably, might even worser it. Staff had considered the latter prospect as early as February 1988 (para. 2.3) and had concluded that Government would exercise appropriate discretion when introducing major price adjustments. 4.10 These risks were good ones to flag in the President's Report and to lay on the Boardroom table, where they could inform the audibnce and Borrower. Given the judgment reached already that GOC deserved wide latitude for initiating a promising line of policy thinking on the rural sector, the audit believes such latitude covers these risks to RSAL. Conditioning release of funds - for example, on macroeconomic performance - would have had no influence on that performance; nor would it have leveraged RSAL reforms. From the Bank's perspective at least, the risks from macroeconomic instability had to be taken. 4.11 One part of this issue that has not been clarified is whether SECAL operations that attempt to reform pricing mechanisms for significant segments of an economy pose credible risks to macroeconomic stability. The experience of RSAL leads this audit to believe that manaL rs of important microeconomic reforms should not defer to such risks. They should obviously consult with monetary and macro authorities, but leave the problems of imbalances for those authorities to manage, as they arise. C. Policy Experiments 4.12 The policy experiments conducted via the RRPs have played a vital role in influencing the course of rural policy-making in China. One has only to consider, for example, the sequence of grain reform experiments and the (later) decisions taken on national grain policy. -13- 4.13 Other countries that are groping towards radical restructuring of their economies should also consider the merits of undertaking policy experiments such as those incorporated into RSAL. Such experiments allow governments a peek at the economic pnd political consequences of policy reforms before they commit their prestige to major policy change. While these advantages seem obvious, we need to know more about the staying power of experimental policy zones. Governments would need to be sensitive to the fatigue - for some zones/experiments - of being part of a social experiment. While this is a field of investigation that China needs to address for its own benefit, the results would be of wide interest also to policy makers elsewhere. D. Broad Positive List 4.14 While two-thirds of the Loan and Credit were allocated to finance agricultural inputs, one-third was allocated to finance commodities, raw materials, machinery, equipment and spare parts for the broader, rural sector. Hence, the positive procurement list eventually adopted was responsive to RSAL being a rural as distinct from ACricultural operation. 4.15 More important, though, the list of eligible goods was expansive in another sense that has typically permitted borrowers of policy-based loans to seek reimbursement from the Bank for eligible imports that had already been completed at the eligibility date. As observed in a recent OED report on this subject: "This practice, which has essentially the same effect as unrestricted advance contracting, is not disallowed by the loan agreements, and generally results in very fast loan disbursement; it is the principal reason why international competitive bidding (ICB) has been very little used for procurement under these loans."A/ The loans referred to in the context of this quotation were a group of policy loans that financed either general imports or goods defined through the use of negative lists or broadly-defined positive lists. Hence, both the rapid RSAL disbursement up to October 1988 and the lack of any ICB as of that time (para. 3.3) can be seen now, in retrospect, to have been fore-ordained. In this respect, the Bank's move from a negative to a broadly-defined positive list was inconsequential. 4.16 Consistent with the detailed PR expectations of US$125-150 million of ICB procurement, the Region's Part I of the PCR regards the limited amount of ICB as an anomaly. Yet it is the fact that China finally procured up to US$57 million of RSAL goods under ICB that is probably unusual for this type of loan. E. Effectiveness of ICB 4.17 The audit invited both SINOCHEM and Bank staff to present any evidence bearing on the issue of ICB effectiveness. Namely, did ICB help China secure its goods at lower prices than could be obtained through customary procedures of price negotiation? SINOCHEM officials believe that ICB added $6 - 8 per ton to the costs of procuring fertilizers, but did not supply supporting data. Bank staff could not supply such evidence A/ OED Report No. 8341, A Review of Procurement in Policy-Based Lending, January 19, 1990, para. 6. - 14 - either. One staff member, however, produced a memorandum dated November 1988, in which he related an evaluation of SINOCHEM's fertilizer procurement practices by the marketing manager of a major fertilizer manufacturer. This evaluation, obtained through a chance meeting on an aircraft, supports SINOCHEM's contention. In fact, the price advantage obtained over ICB by shopping and negotiation was thought to be, at that time, $10-15 per ton. Another staff member believes strongly that ICB for bulk commodities can be effective, citing the Region's special study of procurement in China carried out in 1988. 4.18 At this stage, it is difficult to come to a clear judgment abeut the effectiveness of ICB in RSAL. There is either not enough objective evidence to evaluate independently, or such evaluation is beyond the resources of this audit. Hence, this issue is transformed somewhat into whether it is important for the Bank to know the answer to this question. 4.19 OED's audit of the Bank's first loan operation in Hungary, an investment project, gave an extremely favorable evaluation of ICB's effectiveness in procuring equipment.l/ Compared with direct negotiations for tractor procurement, loan-mandated ICB procedures earned savings of 20%. This impressed local skeptics so much that, for many foreign purchases unrelated to Bank operations in Hungary, ICB became the rule ... and a sustainable legacy of the project in that country. 4.20 The present doubts surrounding ICB's merits in RSAL, for the procurement of fertilizer, should not be left uninvestigated. If ICB and serial tendering for bulk commodities has merit in China, its record should be clarified. If they have weaknesses, these also should be clarified, before the Bank repeats such demands in its negotiations of loan agreements. / OED Report No. 7924, Project Perfomance Audit Report, Hungary* Grain Storage and Agricultural Mechanization Project (Loans 231 6-HU. 8-2-HU. B-3-HU). June 30. 1989, para. 58. - 15 - ATTACHMENT 1 BEIJING, CHINA M.,Y 30, 1992 FOR: MR. GRAHAM DONALDSON CHIEF AGRICULTURE AND HUMAN DEVELOPMENT DIVISION OPERATIONS EVALUATION DEPARTMENT THE WORLD BANK, WASHINGTON, D.C. USA COPIED TO: MR. JOSEPH GOLDELERG, CHIEF, ACRICULTURE DIVISION, CHINA AND MONGOLIA DEPARTMENT, THE WORLD BANK RE COMMENTS ON PROJECT PERFORMANCE AUDIT REPORT OF CHINA RURAL SECTOR ADJUSTMENT PROJECT (LOAN 2967-CHA AND CREDIT 1932-CHA) WE ARE PLEASED TO INFORM YOU THAT AFTER CONSULTATION WITH DEPARTMENTS CONCERNED WE FIND WITH SATISFACTION THE AUDIT REPORT ATTACHED TO YOUR LETTER OF APRIL 24, 1992 COMPREHENSIVE AND OBJECTIVE, WHICH IS GREATLY APPRECIATED. BEST REGARDS, LUO OING DIRECTOR, WORLD BANK DEPARTMENT MINISTRY OF FINANCE P.R. CHINA 22486 MFPRC CH 248423 WORLDBANK MIEILONGÅIANG e" " MONGOLIA NLA AON GtRR LomsmN ANJING OF "'°P KOREA an ~ ~~~ i nte e shc h b bnny . Y. R OE The BLI.zd~frfj , 5N ORE ,'.t«o al . oZ f TbW,d B-ok C -ooThl. éd-i~ .~o .d th.*. td. t*; idq- ?O th.lobod tfatnn,yt.,otÄn.,- A!ZANG 4ANr NE o.51CHunN CHINA ®-h 0 Z.GÅ RURAL SECTOR ADJUSTMENT LOAN G REGIONAL REFORM PROGRAM(RRP) SITES C-T-n LAND MANAGEMENT SYM: RURAL COOPERATIVES o LABOR SWUS AREA ( EUNGSPPORT SERVICES): LABOR DEFCaT ARA & MULTIPURPOS Kn0GANG ' GRAN SYSTEM AGICULTJRAL 1AXATON: & SPECA PURPOSE A GRANN SURPLUS AREA RURAL NANAL N1 : YUNNANGUG v GRAMN DERTAA INFORMAL SECR RURALINDUTRIE(TVE •FORMAL SECTOR> o PRIVATE OWNERSHIP .NG KONG, UK. col~0~e PROVINCE CAPMfLS VIET N' . NAlb -LRVAOONDRE PEOPLE'S Oih.PHIUIPPINES T PINE T ESIONAL BOUÅNDARIES T. HRN