Philippines - Rural Credit Project

p flIJ R E S T R I C T E D FILE te1'r1 ^ Report No P-455 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE CENTRAL BANK OF THE PHILIPPINES FOR A RURAL CREDIT PROJECT October 25, 1965  INTERNATIONAIL BANK FOR RECONSTRUCTION AND DEVELOPIIENT REPORT AID RECOMMENDATION OF THE PR5SIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN T0 TIE CENITRAL BANK OF THE PHILIPPIHTES FOR A RURAL CREDIT PROJECT 1. I submit the following report and recommendation on a proposed loan in various currencies equivalent to $5 million to the Central Bank of the Philippines to assist in the financing of a rural credit project in the Philippines. PART I - HISTORICAL BACKGROUWZ 2. During 1964 the proposal to borrow from the Bank for a rural credit project was investigated by the Government in collaboration with the Resident Advisory Mission. The Mission recommended that the project should be directed towards increasing agricultural output on existing farms through mechanization and by the development of small private irrigation schemes. Late in 1964 a Bank mission visited Manila and found that the project was generally sound and suggested that further studies on farm incomes, farmerst needs and the benefits of mechanization should be uider- taken. These studies were completed in early 1965 and the project was appraised in May. 3. Negotiation of the proposed loan was completed October 15, 1965. The Government and the Central Bark were represented by Hon. Andres V. Castillo, Governor, Mr. Honesto Francisco, Head of the Rural Banks Departrent and Mr. Antiporda; all of the Central Bank of the Philippines, and H-r. A. V. Roxas of the Embassy of the Philippines to the United States. 4. If approved, this would be the Bankts eighth loan in the Philippines and wTould increase the total aniount lent by the Bank to that country to about $111 million net of cancellations. Loans previously made to the Philippines are shown in the table below:  2 - Amount Less Can- Undisbursed Year Borrower Purpose cellations Balance 1/ - - in US$ irllion - - 1957 National Power Corporation Power - Binga 18.4 _ _ 1961 Republic of the Philippines Dredging 8.5 1.1 1961 National Power Corporation Power - Angat 34.0 9.9 1962 National Power Corporation Power - Maria Cristina 3.7 1.8 1963 Philippine National Bank Relending to the Private Development Corp. of the Philippines(HmCP) 15.0 8.9 1964 National Waterworks and Manila Water Supply Sewerage Authority (NWSA) 20,2 19.3 1964 Republic of the Philippines Education (University of the Philippines (College of Agric.) 6.0 6.o Total net of cancellations 105.8 47.0 of which repaid 3.9 Total outstanding 101.9 Amount sold $7.4 of which has been repaid 3.3 4.1 Net Amount held by Bank 97.8 17 As of September 30, 1965. 5. The major disbursement problems in the Philippines have arisen in con- nection with the Angat Power Project of 1961 and the National Waterworks and Sewerage Project of 1964. In thle former, disbursements were initially delayed some 15 months because contracts were not awarded on time, and typhoons caused demage in 1963 and 1964. In June 1965 cave-ins occurred on the construction site and the civil works contract was terminated, causing further dela-ys of about nino months. A new civil works contractor has been engaged and work is now generally proceeding satisfactorily. In the latter, disbursements have been delayed because of slowness in awarding civil works contracts and litigation over the principal pipe contract. All civil works contracts have now been awarded. The Government Corporate Counsel has proposed an alternative bid procedure for the pipe contract which is being followed by N.WSA. The project is now about 10 months behind schedul. PART II - DESCRIPTION OF THE PROPOSM3 LOAN 6. Borrower: Central Bank of the Philippines Guarantor: Republic of the Philippines Amount: $5.5,OCO,OC0 Term and Amortization: 12 years with no amortization during the first three years. Then semi-annual in- stalments to retire the loan on Decembe.r I, 1977. Tnterest Rate: 5- 2% per annum Commitment Charge: 3/8 of 1% per arnum  -3 - Purpose: To assist in financing medium and long- term loans by rural banks for the purchase of farm machinery and the development of small private irrigation systems. PART III - THE PROJECT 7. The project is described in the attached report "Appraisal of a Rural Credit Project - Republic of the Philippines", No. TO-502(a). 8. Out of a total population of 31 million, about two-thirds live in the rural areas. Export agriculture, producing coconut products, sugar, abaca and timber and accounting for two-thirds of export earnings, has on the whole been performing satisfactorily, but dormestic crops have suffered from generally poor yields which are among the lowest in the Far East. food crops are mostly grown on very small farms and 99% of all farms in the Philippines cover less than 50 hectares. Per capita income in the rural areas is one-half the national average and only one-quarter of that in the urban areas. 9. Achievement of higher yields and incomes in domestic agriculture depends on large additional investrnents in irrigation facilities and infra- structure as well as on the adoption of improved farming practices. The Government attaches great importance to accelerated development of domestic agriculture but progress has been slow because of organizational difficulties and inadequate funds. 10. Some 300 private rural banks have been organized over the past twelve years, and have become a substantial source of short-term credit for farmers. However, they are authorized by law to charge a higher rate of interest on short-term than on medium and long-term loans, and since they are short of funds they have not so far provided farmers with loans for the purchase of farm machinery. In order to be able to extend their activities into this field, the rural banks need additional funds on appro- priate terms. The proposed Bank loan would provide such funds. 11. The project is designed to provide medium and long-term credit to farmers for the purchase of farm machinery and for the development of smali private irrigation systems. A Bank loan of $5.0 million would help finance total investments of roughly $8 million, since both the rural banks and the recipients of their loans would contribute towards the total cost of in- vestments. Farmers owning or cultivating 50 hectares or less of arable land, farmers' cooperatives, and persons rendering direct agricultural production services to such farmers or cooperatives would be eligible to obtain loans under the proposed credit scheme. 12. The Central Bank of the Philippines would be the Bank's borrower and would relend the proceeds to the rural banks. Special legislation was enacted to enable the Central Bank to lend to rural banks for this purpose. The Central Bank of the Philippines was chosen as the channel for the loan  because through its Rural Banks Department it has been associated closely with the rural banking system since its irnception. This Department is responsible for the supervision of rural banks? activities, provision of training for the bankst officers and staff and of farm machinery services to the banks and their borrowers. 13. The Central Bank will select from among the 300 rural banks about 80 qualified institutions working in areas of high agricultural potential for participation in the credit scheme. The operating policies and procedures gov3rning the project have been agreed with the Central Bank and will be con- tained in the Rules and Regulations governing rural banks. The Rural Banks Department of the Central Bank will examine applications for loans after they have been appraised by the rural banks. The amount of each project to be self-financed by the ultimate beneficiary will depend on the security offered for the loan but is expected to average about 300. The rural banks will be required to provide from their own resources not less than 10% of the project cost. The balance of the funds required will be made available from the proceeds of the loan up to a maximum of 60%. This participation was determined by the small size of the farms that will benefit from the scheme and the limited resources of the rural banks. The rural banks will carry the commercial risk on all loans made. The Central Bank will lend to the rural banks in pesos and will bear the exchange risk associated with servicing the Bank loan. 14. In order to encourage the participation of rural banks in medium and long-term lending, the maximum interest rate on such loans is to be increased, from the present level of 9% to 12%. At present the rural banks are only allowed to charge the higher rate for short-term advances and this has discouraged longer term lending by the rural banks. The proceeds of the Bank loan would be relent by the Central Bank to rural banks at 62% per annum, i.e. 1% above the rate charged on the Bank loan. 15. The proceeds of the Bank loan would be made available for approved purchases through normal trade channels by the ultimate beneficiaries. Najor international manufacturers of farm machinery are well represented by distributors in the Philippines and service, repair and training facilities are available. Assurances have been obtained that the present competitive situation will be maintained. 16. The Bank loan would be repaid in 12 years with amortization start- ing af'ter the third year. The proceeds of the loans would be relent to rural banks for terms of up to ten years depending upon the use to which the funds are to be put, ranging from three years, for loans for farm implements, to seven years for heavy machinery, and to ten years for small private irriga- tion systems. It is estimated, roughly, that about 70% of disbursements will be to finance imported machinery. 17. Ale size of the proposed Bank loan is much less than the estimated requirements of the agricultural sector for investments in farm machinery and private irrigation systems. In deciding how to expand agricultural credit operations of the kind which would be supported by the proposed  Loan, the Central Bank will be guided by the experience gained in operating the proposed scheme. lhe Government is also endeavoring to prepare for the Bank's consideration a credit scheme for the benefit of farmers cultivating more than 50 hectares. PART 1V - THE ECONOMY 18. The last economic report, entitled "Current Economic Position and Prospects of the Philippires", was distributed to Excecutive Directors on June 2, 1965 (R65-81). It pointed out that output grew by 5-62o in 1963-196!1, 'argely as the result of fast growth in export earnings from agricultural commodities where remarkable increases in output were achieved in response to the higher exchange rate, favorable weather and strong demand abroad. During 1964, inflationary pressures apparent in 1963 in rising prices and declining exchange reserves were brought under control through tight re- strictions on credit expansion. In 1965, the policy of monetary restraint continued in force, the money supply continued to decline. 3.9. Restrictive credit policies have undoubtedly been very successful in producing financial stability. Prices remained virtually constant. Imports receded from the high level of 1964. This reduction, together with exports continuing at the high level of the previous year and some increase in foreign borrowing, shifted the Philippinest payments position from a large deficit in the first half of 1964 to a surp'lus in 1965. There was a further increase in reserves in July, when the Supreme Court upheld the right of the Central Bank to continue its exchan7e surrender scheme. Altogether, exchange reserves are now about $55 million above their low point of $100 million in April last year when exchange speculation was at its height. 20. However, it is also becoming increasingly evident that continuation of present credit restrictions will not be conducive to rapid economic growth. It is equally evident that no significant relaxation of these credit re- strictions would be compatible with maintaining financial stability, unless it were accompanied by a thorough-going reform of some important narts of the financial framework within which the economy is operating. Externally, under-declaration of imports will have to be dealt with effectively; inter- nally, public revenues will have to be raised considerably so that public investment can be increased without involving excessive deficits. In addition, the ability of the public sector to prepare and execute infra- structure projects will have to be stepped up significantly. Action along these lines will not be possible until the next Adninistration takes office in January 1966. The Philippines possess the material and human resources for rapidly increasing output and raising export earnings. Delays in tackling effectively the problems indicated above would tend to hold actual growth below the potential. As long as this situation persists, the Philippines' net capital inflow requirements will be correspondingly small. To the extent that these have to be met by borrowing, they can be accommodated on conventional terms as service on external public debt -- less than 5% of export earnings -- is small.  W 6 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 21 The draft Loan Agreement between the Bank and the Central Bank of the Philippines, and the draft Guarantee Agreement between the Republic of the Philippines and the Bank, have been circulated separately. The Guarantee Agreement in general follows the usual form. The Loan Agraement is designed to provide some flexibility as to the operating policies and procedures for carrying out the Project which must, however, be established by agreement with the Bank (Section 5.02(b)). The policies and procedures aill in the main be set out in Rules and Regulations which can be changed only with the Bank's consent. In other respects the Loan Agreement is in the usual form used by the Bank for projects of this type. 22. Also being circulated separately is the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank. PART VI - COMFLIANCIE 'WITH ARTICL!,,S OF AGREIEMET 23. I am satisfied that the proposed Loan complies with the Articles of Agreement of the Bank. PART VII - RECOMW4BNDATION 24. I recommend that the Executive Directors adopt the following resolution: RESOLVED: THAT the Bank grant a loan to the Central Bank of the Philippines to be guaranteed by the Renublic of the Philippines in an amount in various currencies equivalent to five million United States dollars (US$5,0oo,0oo), to mature on and prior to December 1, 1977, to bear interest at the rate of five and one-half percent (52) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Rural Credit Project) between the Bank and the Central Bank of the Philippines, and the form of Guarantee Agreement (Rural Credit Project) between the Republic of the Philippines and the Bark which have been presented to this meeting. George D. Woods President Attachments Washington, D. C. October 25, 1965