Peru - Fourth Agricultural Credit Project

RESTRICTED Report No. TO-470a 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 The report may not be published nor may it be quoted as representing their views.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 INTERNATIONAL DEVELOPMENT ASSOCIATION THE FOURTH LOAN OF THE BANCO DE FOMENTO AGROPECUARIO DEL PERU PERU April 30, 1965 Projects Department  CURRENCY EQUIVALENTS 1 US dollar 26.82 soles US $1. 00 = SI 26.82  P E R U THE FOURTH LOAN OF THIE BANCO DE FOMENTO AGROPECUARIO DEL PERU TABLE OF CONTENTS Page No. SUMMARY . . . . .. .i-il I. INTRODUCTION . . . . . . . .1 . . . . . . . . II. DEVELOPMENT POTENTIALS AND PAST LENDING . . . . 1. III. THE BANCO . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 A. Organization and Management . . . . . . . . . . . . . . . . 4 B. Lending Policies and Procedures . . . . . . . . . . . . . . 6 C. Operations. . . . . . . . . . . . . . . . . . . . . . . . . 7 D. Financial Situation . . . . . . . . . . . . . . . . . . . . 7 IV. THE PROJECT . . . . . . . . . . . . . . . . . . . . . . . . . . 10 A. The Lending Program . . . . . . . . . . . . . . . . . . . . 10 B. Lending Policies and Procedures . . . . . . . . . . . . . . 13 C. Financing . . . . . . . . . . . . . . . . . . . . . . . . . 14 V. BENEFITS AND JUSTIFICATION . . . . . . . . . . . . . . . . . . 16 VI. CONCLUSIONS AND RECOMMENDATIONS . . . . . . . . . . . . . . . . 18 ANNEXES 1. Organization Chart 2. Short-Term Credits Approved by the Banco 3. Long-Term Credits Approved by the Banco 4. Comparative Balance Sheets as at 9/30/59-9/30/64 5. Detail of the Short-Term Loan Portfolio 6* Detail of Long-Term Loan Portfolio 7. Delinquent Loan Situation September 30, 1959-September 30, 1964 8. Comparative Statement of Profit and Loss and Income Appropriation 9. Summary of Past and Proposed Lending Program to Farmers  P E R U THE FOURTH LOAN OF THE BANCO DE FOMENTO AGROPECUARIO DEL PERU SUMMARY i. The Banco de Fomento Agropecuario del Peru (Banco) is the major source of agricultural credit in Peru. It has received three loans each of US$5 million from the Bank since 1954. The Banco now requests a fourth loan of US$15 million to assist in financing its program of lending to farmers for the development of agricultural and livestock producticn. The overall program would involve the investment of the equivalent of US$30.4 million. Loans to farmers would cover 70 per cent of the estimated total cost of on-farm development, the balance being provided by participating farmers from their own resources. The Bank and the Banco would share the cost of the loan operations. ii. The Banco's record of repayment is good. The first Bank Loan was repaid by February 1963, and the second by February 1965. The outstanding amount on the third Loan is US$3.4 million. iii. The Banco's technical record of achievement in the agricultural credit field has been good. It has made over 1)4,000 medium- and long-term loans to some 6,000 farmers for defined programs of development since Bank assistance began in 1954. These capital inputs have helped materially to increase production of food crops, export crops and livestock products in Peru. They have involved medium- to large-scale farmers only. iv. The banking record of the institution has not matched its technical performance. Social and political unrest, along with inefficient organiza- tion and administration has resulted in a relatively unsatisfactory financial situation, an important feature of which isapoor debt collection record. The Banco has become directly concerned with numerous commercial activities of variable profitability. It has assumed responsibility for costly nonprofit earning activities on behalf of the Government, including agricultural research, extensizn and other services. These activities have mobilized resources and manpower to an extent that has reacted unfavorably on its financial and operational status. v. Reorganization of the responsibilities, administration, accountancy and operational procedures are currently under review by the management of the Banco. To justify sustained interest by the Bank, considerable improve- ment in all these areas would be necessary. The Bank will make suitable arrangements to ensure that the goal of increased financial efficiency is vigorously pursued. Disbursement of the proposed loan will be geared to better performance of the Banco in areas affecting its efficiency, particu- larly with respect to the punctual repayment of i ts own portfolio loans. vi. The lending program, for which financial assistance is requested, is a continuation of that which the Bank has assisted in financing over the past 10 years. It is technically and economically sound. Its main features  - ii - cover the development of water resources with associated land improvement, farm mechanization, extension and improvement of livestock production, and the establishment of tree and plantation crops. The program would extend over three years from April 1, 1964. vii. Ihe proposed loan would cover about 50 per cent of the total program financed by the Banco amounting to US$30,4 million, of which US$9.1 million would be contributed by the ultimate borrower. This scale of activity is in line with that of the past six years. The proportion' of Bank financing is substantially higher than covered by previous Bank loans which were restricted to financing foreign exchange components. It is proposed that the new loan would again meet the foreign exchange costs estimated at US$6.3 million and in addition, would provide a proportion of the local currency components equivalent to US$8.7 million. Thus, 42 per cent of the proposed fourth Bank loan would be used to finance imports and 58 per cent to finance local pro- curement. This change is necessary to permit the Banco to continue operating on the same scale as in previous years. viii. The short terms of eight to nine years, which characterized pre- vious Bank Loans handicapped the Banco considerably both in relending terms and in financial structure* A longer term is necessary for the proposed loan to permit longer relending terms and to provide a reasonable flow of funds for continued relending. This would strengthen the Banco's financial position and effectiveness. ix. The preject is suitable for a Bank loan of US$15 million for a period of 15 years, including a grace period of four years, subject to satisfactory reorganization of responsibilities, administration and operat- ing procedures of the institution. Disbursement of the proposed loan will be contingent upon the attainment of agreed standards of improved performance by the Banco.  P E R U THE FOURTH LOAN OF THE BANCO DE FOMENTO AGROPECUARIO DEL PERU I. INTRODUCTION 1. The Banco'de Fomento Agropecuario del Peru (Banco) has requested a fourth loan of US$15 million from the IBRD (Bank), to continue its program of agricultural development through medium- and long-term credits to farmers. This loan, along with its own resources, would enable the Banco to carry out a lending program of about US$21 million over a three-year period. 2. Since 1954, the Bank has made three loans, each of US$5 million, to the Banco (105-PE in November 1954, 162-PE in March 1957, and 257-PE in June 1960). All were fully disbursed by September 30, 1963. Loan 15-PE was repaid by February 1963 and Loan 162-PE by February 1, 1965. As of February 1, 1965, the amount outstanding cn Loan 257-PE was US$3,367,000. 3. The request for a fourth loan was submitted to the Bank in June 1963. Appraisal was delayed because the request was modified several times by the Banco after consultation with the Bank. A Bank mission to Peru in June 1964 reviewed the status of previous loans, examined the rather unsat- isfactory financial situation of the Banco, and appraised its proposed pro- gram. Appraisal was completed by two missions in October and December 19644, after the Bance had again remodeled its request on Bank suggestiens. II. DEVELOPMENT POTENTIALS AND PAST LENDING 4. The Banco is the only institution in Peru which provides medium- and long-term agricultural credit in sizeable amounts. Its activities are geared to the national objective of increasing agricultural production through intensification of existing farming activities and by expansion of the area in use. 5. The Banco's role is to provide supervised credit to farmers for irrigation facilities, improved soil preparation and water management, mechanization, increased use of fertilizers and pesticides, and the intro- duction and multiplication of improved plant and animal breeding stock. Planning, appraisal and supervision of loans include comprehensive technical services. 6. The cultivated land in Peru is estimated to be about 2.5 million ha or about 1.9 per cent of the total area of 1,285,215 km2. This proportion could be increased to about 10-15 per cent. Of the three ecological zones, the coastal strip (Costa) and the jungle belt on the eastern slopes of the Andes (Selva), offer the highest potential for development. The high moun- tain regions (Sierra) have restricted potentials.  - 2 - 7. The Costa, including thc western valleys of the Andes, extends over about 22 million ha--about 17 per cent of the total. Aided by the activities of the Bancet, its development has been pursued over recent years so that it now provides about 80 per cent of the total agricultural exports of cotton, sugar and fruit. It also contributes a large proportion of the vegetables, cereals, grains, fruit, poultry, and milk products needed for local consumption. The limiting factor is water. The irrigation potential, including large schemes i/, is estimated at 600,000 ha or more than twice that so handled at present. Of the land currently irrigated, there is scope for considerable improvement on approximately 200,000 ha. 8. The Selva accounts for approximately 50 per cent of the total land area. It is relatively undeveloped and underpopulated. It is still mostly jungle. Some development has occurred in small elevated areas at about 700 to 1,800 meters. Crops include cotton, coffee, cocoa, tea and rubber for export as well as food crops and animal products for regional consumption. The area of useable land is unknown, but very preliminary land-use studies suggest this could be large. Development is slow because of sparse popula- tion, lack of roads and communications, high capital cost of opening land for cultivation, and the meager resources of most settlers. 9. The Sierra accounts for about 33 per cent of the total land area. Its agricultural potential is limited because of most difficult and largely unsuitable physical conditions. In addition, human problems of illiteracy, overpopulation, health and dietary conditions, maximize the technical diffi- culties of agricultural improvement. 10. Up to September 30, 1964, the Banco had made about 190,000 short- term loans to agricultural producers / and 1h,400 medium- and long-term loans since Bank assistance began in 1954. The following table summarizes the extent and character of the medium- and long-term operations only for the six years ending September 30, 1963 when the third Bank Loan was fully disbursed: Gross Annual Value of Increased Type of Loan No. of Loans Amount Production Average Loan ~~.. (i-nmillion soles) .......... ( S/OoO)07 Irrigation 596 81 216 136 Farm machinery 1,258 164 90 130 Land improvement 180 45 98 250 Livestock 3,310 297 552 90 Fencing 129 10 ( 80 Tree crops 3,681 265 208 72 Miscellaneous 488 30 20 61 9,6h2 892 1,184 92.5 (US$33 mil) (US$44 mil) (US$3,300) / Projected private schemes alone total 200,000 ha, half of which would involve new land. g Short-term loans have not been derived from Bank funds.  - 3 - 11. It is not possible to evaluate the benefits derived from the Banco program under the three previous Bank Loans with any precision (paras 80-8B). The individual loan operations involved have been exceedingly variable in size, character and location. It has been impractical to maintain a contin- uous survey of the production performance of the farms concerned with the resources available. From relatively crude projections from sample data the Banco estimates that the gross value of the increased production on farms receiving credit amounted to S/ 1,184 million (US$44 million) in 1963. This amount above pre-investment production should be maintained. This figure for added production cannot be related directly to the investment cost, because it is affected by price rises since the investments were made. Net benefits have not been estimated because of difficulties due to the diverse character and circumstances of the loans involved. With these limi- tations and in such circumstances, the appraisal mission considers that the figure reasonably reflects the benefits of the operations. 12. The Banco also carried out spot checks in 1963 on about 10 per cent of the loans made to representative categories of farmers in the differ- ent agricultural regions. From these it found that overall volume of pro- duction on farms assisted by Banco credit had increased about 42 per cent and livestock numbers about 45 per cent since receiving loans. From field observations, the mission considers these estimates are reasonable. 13. Irrigation loans have provided water for some 24,000 ha of new land and improved the water supplies to a further 5,000 ha. Mechanization has affected the cultivation of about 60,000 ha, including 11,000 ha of new land. Loans for land leveling have improved about 10,000 ha, while drainage loans have been applied to 4,000 ha. Livestock loans have added considerably to the supply of breeding stock of better quality, and made possible the establishment of large numbers of breeding herds under private ownership for the multiplication and distribution of stock of much superior productive capacity. Tree crops have been planted on about 26,000 ha (coffee 8,700 ha, fruit trees 6,200 ha, cocoa 850 ha). Semipermanent crops (sugar cane 5,000 ha, and alfalfa 3,000 ha) have also been financed. Miscellaneous lending activities have led to improved transportation on rivers, improvement of farm buildings and domestic water supplies, the provision of processing plants, related machinery and warehouses and the exploitation of wild rubber 2 14. The impact of the Banco has not been confined merely to the pro- vision of credit. In addition to assistance in planning and appraising loan applications, its large technical staff has given a useful follew-through extension service. Within the limitations provided by its financial resources and the general investment climate, the Banco has done a worthwhile job of development. 15. There is no doubt that there is a widespread continuing need for the type of credit facilities which it has been able to offer. Only about 6,000 farmers g/ of the 560,ooo with holdings between one and 100 ha, and A few trials with cultivated rubber have also been financed. / Many of these have received several loans.  the 11,000 with over 100 ha have received medium- and long-term credit assist- ance over the past 10 years. Thus, in terms of opportunity, the Banco has a wide open field of action, although there are considerable restraining factors in the use and expansion of credit of the type available under Bank loans. These factors include the low educational level of the mass of small farmers, weakness Gf supporting services to farmers operating outside the sphere of Banco influence, and inadequate size of most farm units. 16. These fzrces, together with conservative appraisal methods with respect to creditworthiness have tended to confine medium- and long-term lending to larger-scale farmers. Although there is a need for credit assist- ance to small producers, and although the Banco also has a legal responsibility under laws controlling its activities to assist these (para 19), the program for which Bank assistance is requested would continue to concentrate on economically viable farm units. For the most part, these would fall in the medium- to large-size range. III. THE BANCO 17. Particular attention has been paid to reappraisal of the Banco, the financial status of which has deteriorated of recent years. A. Organization and Management 18. A Legislative Decree of June 14, 1964 superseded the Law which, with amendments from time to time, governed the operations of the Banco for 20 years. This Decree did not change the functions of the Banco. It remained a government-owned institution primarily responsible for promoting agricul- tural development by providing credit to farmers. Nor did it bring signifi- cant changes in organization and management. In the main, the Decree reflected the desire of legislators to extend credit facilities to small farmers either directly or threugh cooperatives and traditional Indian com- munities, and to enable the Bance to cooperate with the Government in programs of land settlement and agrarian reform. To these ends, it enabled the Banco to continue providing services conventionally the responsibility of Govern- ment and aimed at keeping restrictions on Banco operations to a minimum in the promotion of Peruvian agriculture. In consequence, the Banco can engage in any activity associated directly or indirectly with the agricultural industry. 19. Major new provisions allowed for greater decentralization, an increase in authorized capital from S/ 4oo million to S/ 2,000 million wholly contributed by the State through special taxes, and an obligation to invest not less than 50 per cent of paid-in capital in small farming loans at all times. The Banco was authorized to simplify procedures and to make loans,in special circumstances, on personal guarantees only.  20. Multiple activities, in addition to agricultural credit operations, include commercial operations as shipping services, sale of wool, rubber and jute in respect of which the Banco has a legal or de facto monopoly, supply of farm requisites, and the financing of locally produced and imported rice. Currently too, it ad,ministers loans made to settlers in the San Lorenzo Irrigation Scheme 1/. It has begun to administer loans made by the Institute of Agrarian Reform (IRPA). 21. In addition to these commercial and extra lcan responsibilities, the Banco is involved in agricultural extension work. It operates agricul- tural nurseries for the propagation and multiplication of improved planting material. It runs plantations and livestock farms with research objectives. It carries out artificial insemination and disease prevention schemes. 22. Changes of Government over the past few years have entailed changes in the Board of Directors. The present Board has been in office since October 1963. Its activity was paralyzed up to the beginning of 1964 by continuous strikes. Only since then has it been able tocame to grips with its problems. 23. From its head office in Lima, the Banco controls 11 branch offices which run 36 agencies, 51 subagencies and nine plantations. An organization chart is shown in Annex 1. Some of the subagencies are clearly marginal. Total staff numbered about 1,300 at March 31, 1964, of whom about 860 were in field offices. The staff includes a large proportion of well-qualified personnel, but continuous strikes called by the Union of Commercial Bank Empleyees have reduced their efficiency considerably during recent years. Remuneration conditiens on the basis of salary scales negotiated with the Union are not related to work achieved or the financial status of the insti- tution. These salary increases have almost doubled administration costs. 24. Reorganization of the accounting system of the Banco was commenced in 1958. It was not completed. The present management is aware of the short- comings and has requested the assistance of the Bank in developing the neces- sary remedial measures. It has agreed to the suggestion of the Bank that a credit specialist be hired to make the studies necessary to recommend improve- ments. 25. Recently, it became clear, however, that a critical expert review by outside consultants of all the activities of the Banco was a matter of urgency; such review, including not only administrative and operational procedures, but also the operations themselves if the institution was to be placed on a sound financial footing. Examination of the accounts revealed a deteriorating financial position (paras 36-42) which must be corrected if the Banco is to continue to be a suitable channel for Bank assistance in the agricultural development of Peru. 1/ This is the object of a separate loan (the San Lorenzo Irrigation Project, Stage III).  -6- B. Lending Policies and Procedures 26. The Banco grants short-, medium- and long-term development loans and short-term commercial loans. The basis of these operations is defined under the Decree of 1964 as follows. 27. Short-term loans may be granted for seasonal crops; for land prep- aration, sowing, cultivation and harvesting operations; for the processing and packing of fruit and for operations directed at improving its quality; for the production of rubber and other forestry products; for the purchase of light agricultural equipment, seed, fertilizers and insecticides for all types of livestock and agricultural operations that yield a return within a maximum of two years, Short-term commercial loans may be made to assist in harvesting and marketing agricultural products. In total, shcrt-term opera- tions account for 60-70 per cent of all lending operations. They are financed largely by discounting facilities with the Central Bank. 28. Medium-term loans may be granted for permanent cultivation opera- tions requiring a term of up to six years; for the purchase of farm machinery and pumping equipment; for stock farming operations, the repair of rural dwellings; the opening up and preparation of rubber plantations; and for such other purposes as the Board of Directors may determine. 29. Long-term loans may be granted for irrigation works; for leveling, protection and improvement of land or plantations; for construction of roads and fences, rural dwellings, farm buildings, siloes and other similar works; for processing equipment and its installation; for the execution of agri- cultural or forestry operations, which,by their nature, require a term of up to 20 years; for the purchase of breeding stock; and in general, for all works beneficial to agriculture and stock farming. 30. Security requirements involve crop and commodity liens for most short-term loans, chattel mortgages for medium- and long-term loans for farm machinery, irrigation equipment and livest-:ck, and property mortgages for long-term loans for water supplies, land improvement,processing plants and plantations. In addition to these principal guarantees, additional guarantees may be required. 31. The size of loans under the different categories is governed by legal provisions relating to the cost of the project and the value of the security. Loans may not normally exceed 75 per cent of the collateral and must be lower for some categories. By law, no one loan may exceed S/ 2 million (US$759000) and no aggregate of loans to an individual or group can be more than S/ h million. In practice, loan amounts have beern substantially below these limits (para 10). 32. Amortization periods are varied according to the pl Miu of the loan. Interest rates rm ge from 7 to 10 per cent, small loans carrying the smaller rates. The Banco does not charge commissions.  33. The Banco employs a large loan appraisal staff of credit personnel, engineers, agriculturists, lawyers and other specialists. Its appraisal methods for all types of development loans are comprehensive and soundly based. They involve not merely appraisal of creditworthiness, but take into account the technical feasibility and benefit potentials of the project to be financed. The standard of appraisals of medium- and long-term operations are good and compare very favorably with those of many similar institutions in other countries. In fact, they are often overelaborate and in the case of subsequent loans to the same borrower, may be too repetitive. They tend to be costly, particularly in the case of small loans in a country where the farming community is so widely dispersed over areas with poor communica- tions. The poor repayment record (paras 37-39) is attributable to factors other than appraisal. 34. Disbursement of loans to farmers is in installments against docu- mentation or after inspection of work done. Supervision is generally good. The standard of appraisal used and the degree of supervision results in loans which are generally well secured. This point has some validity in relation to the poor repayment record (paras 37-39). C. Operations 35. Annexes 2 and 3 give details on loans to farmers approved for the seven years ended September 30, 1964. Short-term credit operations steadily increased in number and amount up to 1963/64 when the granting of new loans to small farmers slowed down due to social unrest and bad collections. The pace of lending on long-term reached a maximum in 1960/61, decreasing mark- edly thereafter. Besides some decline in the demand for medium- and long- term loans, the Banco had to restrict and slow down these operations because of administrative and organizational problems of increasing arrears and insuf- ficient resources. This was particularly accentuated in 1963/64 credits when the third Bank Loan was fully disbursed. D. Financial Situation 36. Condensed balance sheets as at September 30, 1959 through 1964 are given in Annex 4. As at September 30, 1964, total resources were twice as high as at September 30, 1959. Paid-in capital increased from about S/ 292 million to about S/ 421 million when the proceeds of new taxes were allocated to capital. The annual rate of increase of capital from such taxes is expected to reach about S/ 58 million annually from 1964/65 on, instead of S/ 20 to 25 million of former years. Reserves have risen from about S/ 98 million to S/ 177 million. The rate of growth of paid-in capital, reserves and long-term funds, however, has been slower than that of resources on short term, such as deposits and rediscounts and part of these latter resources has been used in long-term operatio,ns. Recently, the ratio of current assets to liabilities has deteriorated - 1/ Current assets (cash in hand or in banks and assets held for conversion within a reasonably short period); current liabilities (short-term debts, including sight and short-term deposits).  - 8 - 37. The growth in volume of the Banco's short- and long-term portfolios can be seen from Annexes 5 and 6e The increase originates less from a real lift in volume of operations than from an increase of loans in default. The development of loan delinquency during recent years is shown in Annex 7. The figures relate only to current operations for which the Banco assumes full responsibility. The amount in arrears on short-term loans has risen from about 30 per cent of the short-term loan portfolio as at September 30, 1959 to about 45 per cent as at September 30, 1964. At this date, 24 per cent was in arrears for periods over 90 days. The percentage of total arrears on medium- and long-term loans remained almost at the same level of about 13/14 per cent of the medium- and long-term loan portfolio, but the proportion of arrears over 90 days increased markedly (10.2 per cent as against 2.3 per cent over the six years). The percentage of arrears on these medium- and long-term loans, while not good, is reasonably satisfac- tory; it is excessive for short-term loans. 38. Additional information on the delinquent loan situation is shown in Annex 8. In the case of short-term loans in arrears more than 90 days, about one third have been overdue for more than two and a half years, about one third for between one and a half and two and a half years, and the same proportion for less than this period. Of the medium- and long-term loans in arrears more than 90 days, one half has been overdue for longer than two and a half years and the balance for under this period. 39. When the third Bank Loan was made, a gradual improvement of the delinquent debt situation was expected. Instead it deteriorated, chiefly in areas of the country subject to political unrest. Due to the political situation, the Banco was compelled to be lenient with respect to enforce- ment and foreclosures. Enforcement measures involved less than one per cent of all loans in 1962/63. This was too few. Although all loans are generally well secured (para 34), scme losses must be expected. With reasonable application of enforcement measures it is expected that losses on short-term loans will amount to about S/ 100 million, and on medium- and long-term loans to about S/ 25 million or about 24 per cent of total arrears. Adding to this, estimates of other losses on various accounts receivable and other debts of private and public institutions of about S/ 20 million and crediting related reserves of about S/ 109 million, the net loss at September 30, 1964 is estimated at less than S/ 36 million (about US$1.3 million). This estimate excludes about S/ 16 million losses for the fiscal year 1963/64 (about US$0.6 million). For farm loans only, losses amount to about S/ 24 million j(about US$0.9 million). 40. On these figures, it is clear that the reserves for bad debts are inadequate. As at September 30, 1964, the percentages of reserves to total arrears and arrears over 90 days were about 20 and 35 per cent, respectively. The situation would have got out of control if greater political stability had not occurred which permitted the Banco to initiate energetic steps to improve the situation. Continuation of such measures is clearly necessary. In part at least, the poor loan collection record is a consequence of the short repayment period imposed for Bank loans. These were eight years for two and eight and a half years for the third.- These short periods forced 1/ Estimated uncollectible loans: S/ 125 million less related reserves as of September 30, 1964: about S/ 101 million.  the Banco to impose still shorter loan terms on farmers. The loans made, required on average, a longer period than allowed to return adequate benefits. Difficulties of farmer repayment were thus accentuated. 41. Condensed profit and loss accounts for the six years ended Septem- ber 30, 1964 are given in Annex 8. Gross income increased by almost 80 per cent during this period (from S/ 111 million to S/ 197 million) with a higher proportion of income originating from loans to farmers during recent years (83 per cent in 1963/64 as against 71 per cent in 1958/59). Income from other operations dropped considerably. Salaries and general adminis- trative expenses more than doubled. In order to avoid declaring losses for the year 1962/63, the Banco had to reduce allocations to depreciation and reserve for bad debts, but losses of about S/ 16 million were declared for the year 1963/64. 42. Reference to the commercial activities of the Banco is necessary. While the existing system of accounting makes it impossible to isolate the profit and loss situation accurately with respect to individual operations, close examination suggests most activities are unprofitable. Thus, in 1962/63-1963/64 losses were made on merchandizing, river transportation, workshop operation, nurseries and miscellaneous operations. Profits on rubber sales appear to have carried all other operations in the past, but they were insufficient in 1962/63 and 1963/64. A careful appraisal of this area of activity of the Banco is essential. Should it be found that con- tinued participation is necessary in the national interest, the Government should reimburse any deficits incurred by the Banco. 43. The mission holds the view that little can be done to improve the gross income of the Banco at this stage and that some administrative expenses are likely to continue to rise. Unprofitable activities, extraneous to credit operations should be abandoned. These would include not only unprof- itable commercial enterprises, but the provision of services more properly a function of the Government. In addition savings on various expenses can be achieved. The whole institution is in need of an overhaul if it is to assume a condition of continuing viability. 44. As suggested by the Bank the Banco has decided to recruit outside consultants to review not only its accountancy and procedural methods, but its whole sphere of activities. It has elaborated in agreement with the Bank the terms of reference of the consultants and will discuss with the Bank their recommendations and will, in agreement with the Bank, reorganize along lines which will lead to greater financial viability and more expedi- tious accounting and administration. The Banco has also entered into nego- tiations with the Government to be relieved of nonprofit earning functions carried out in the national interest or receive adequate compensation for the cost of the services provided. The Government of Peru has undertaken that if the Banco should be unable to obtain from its normal sources of capital sufficient funds to meet the demand for short-term credit in con- nection with medium- and long-term credit operations under the project, it would provide the Banco with the funds necessary.  - 10 - IV. THE PROJLCT 45. The project is an agricultural credit operation of the Banco. It is designed to finance a lending program to farmers to increase the produc- tion of agricultural crops and livestock. It proposes an investment of S/ 570.5 million (US$21.3 million) in medium- and long-term credit over a three-year period, commencing April 1, 196h4 It would provide loans to farmers for defined development purposes as farm water supplies, land improve- ment, agricultural machinery, livestock, fencing, tree and plantation crops, and miscellaneous items. The project would be financed from the Banco's own resources of S/ 168.5 million (US$6.3 million) and a Bark loan of S/ 402 mil- lion (US$15 million). The loans made would cover about 70 per cent of the total estimated cost of projected on-farm developments, the balance of about S/ 245 million (US$9 million) being provided by participating farmers from their own resources. The total development program involves an investment of S/ 815 million (US$30.4 million). A. The Lending Program 46. The lending program of the Banco is essentially a continuation of that which the Bank has helped finance over the past ten years. This can be seen from the comparison of lending operations financed under the first three Bank Loans over the two, three-year periods 1957-1960 and 1960-1963 with those proposed in the current loan request for 1964-1967 (Annex 9). The volume of new lending would be substantially the same as during the three-year program 1960-1963, the small increase of about 12 per cent being due to anticipated price rises. The elements of the lending program would also be the same with some modifications in relative importance considered necessary to take care of anticipated changes in demand. This cautious approach of the Banco reflects its restricted capacity to handle a larger volume of business together with some uncertainties in demand. 47. The administrative problems of the Banco necessitate long-range corrective measures which preclude too rapid a growth. The Banco is also confronted with the responsibility of executing special lending programs under recently enacted agrarian reform schemes of the Government which would add to its workload. It is expected to play a significant role in the bank- ing aspects of these schemes. 48. Although there is no doubt as to the need for much more extensive medium- and long-term credit to farmers in Peru than that proposed under the project, the realities of the demand side also suggest the wisdom of moderate estimates. A marked slowdown in demand occurred during the disbursement of the second Bank Loan. This was due to political uncertainties, social unrest in some areas, and to increases in interest rates 21 Although conditions Rates were increased to compensate the Banco for abandoning commissions in loans.  - 11 - have much improved, fluctuations in actual demand are still possible for these and related reasons. 49. The investment proposed in each major lending category is shown in Annex 9. Each category has important features and functions. Farm Water Supplies 50. These cover the development of small new irrigation schemes from streams or wells, and the improvement of existing water facilities of this type. Loans may apply to individual farms or to several properties. Expen- ditures would be for drilling and casing costs of tubewells, pumps and motive power, equipment housing and canal construction. 51. Lending for this category is estimated to cater to the full irri- gation of about 20,000 ha and would be about 60 per cent greater than during the 1960-1963 period (Annex 9 ), due to the growing interest of farmers in water development and to Government-supported technical assistance in the more efficient use of water resources. 52. The technical staff 2 and loan officers of the Banco have had long experience in this type of development. From past performance, they can be expected to maintain a high standard of appraisal, construction, supervision and operation. In respect to larger projects involving loans in excess of US$75,000, equivalent, the Banco would satisfy the Bark that an adequate study of technical, financial and economic aspects had been made and that construction, operation and maintenance would be efficiently supervised. Land Improvement 53. Loans for this element would be related normally to new or exist- ing irrigated land. They would cover the cost of land leveling (about 60 per cent of the average loan), drainage (about 30 per cent), and on-farm roads (about 10 per cent). Land leveling and drainage loans would cover machinery, its operation and maintenance, and hired labor, or alternatively, the fees of contractor service. 5h. A 30-per-cent increase over the previous three-year lending period is proposed to cater for an estimated 10,000 ha (Annex 9 ). This figure is only half of the proposed activities in water supplies, since many farmers would be able to carry out the on-farm development work of leveling and draining with existing equipment and labor force. Agricultural Machinery 55. The demand for farm machinery is expected to be about the same as during the 1961-1963 period. Accordingly, about the same credit allocation has been provided for (Annex 9 ). Tractors would account for about 70 per cent of machinery loans, associated equipment and implements about 20 per cent, and farm transportation equipment about 10 per cent. j Professional engineers and agriculturists.  - 12 - 56, The Banco estimates that the existing farm tractor force in Peru is sufficient to cultivate about 500,000 ha annually, and that it is feasible and desirable to double this coverage in the current decade. The allocation provided for under the program would meet about 25 per cent of the overall national demand for farm mechanization during the three years. It would improve cultivation practices and extend the cultivated area on about 40,000 ha. Fencing 57. The allocation for farm fencing is double that used during the 1961-1963 period (Annex 9). Demand for fencing loans fell during recent years consequent upon discontinuation of imports in favor of more costly locally manufactured wire. Recently, an upward trend in demand has been noticeable. This is expected to accelerate as livestock prices render the industry more profitable. 58. The project continues to lay considerable emphasis upon animal production, in respect of which more fencing is an essential improvement element. Additional fencing is needed to increase the stocking rate of existing grazing lands and to permit the use of livestock on new irrigated farms. Fencing of natural grasslands used mainly for sheep grazing would increase stocking rate about 20-30 per cent. The amount of loans provided for is expected to meet the fencing needs of an additional 18,000-20,000 ha. Livestock 59. The importance of the livestock element is clear from the fact that along with fencing, livestock loans would account for about one third of the total lending program. This proportion is substantially the same as in pre- vious projects (Annex 9). It is important to note, however, that the pro- posals involve a significant change in the type of livestock operation to be financed. 60o Hitherto, livestock loans have been designed to facilitate the importation of pedigree or high grade stock. Native stock are generally of poor productivity, and provide an unsatisfactory base from which to lift national livestock productive levels through selective breeding. Superior animals were needed to provide the nucleus breeding material from which a national lift in productive capacity could be derived. The Bank finance under the first three loans make possible the importation of large numbers of high quality pedigree dairy cattle, dual-purpose cattle and sheep, and the widespread establishment of privately-owned and operated breeding herds and flocks. These have been very successful and may now be regarded as national foundation herds, multiplication within which is now able to supply increasing numbers of superior progeny to commercial producers at economic rather than at imported prices The high cost of imported animals is jus- tified mainly because of their breeding value. Importation merely to produce milk is generally uneconomic. I/ Imported cattle cost about double local prices.  - 13 - 61. Thus, the stage is set for local procurement livestock loans. These would be made for financing the purchase of locally bred pedigree and grade animals by commercial rather than pedigree farmers. This stock would replace poor yielding native cattle or sheep on existing livestock farms and initiate livestock farming on newly established farms. Both proposals are essentially developmental in character and a logical follow-through from the original Bank-supported import policy. They do not involve financing of recurrent expenses. Some importation of pedigree livestock is still envisaged. This would be restricted to highly selected sires, semen for artificial breeding, and to small numbers of females sufficient to ensure the maintenance of high standards in pedigree nucleus herds. There would be no importation of live- stock solely for milk or meat production. 62. The amount of loan money proposed would be sufficient to finance approximately 25,000 head of dairy or dual-purpose cattle and about 4O,000 breeding ewes. The precise ratio of cattle to sheep would depend upon demand. Tree and Plantation Crops 63. A reduction in this category of lending is envisaged (Annex 9) due to the current restriction on coffee production under the International Coffee Agreement to which Peru is a signatory. Coffee can now be financed only on farms smaller than 15 ha in size in areas where transport difficulties preclude the cultivation of other high value cash crops. 64. The major activity in this field would be in the cultivation of fruit trees. Some 3,600 ha of orchards are planned. These would absorb about 45 per cent of the total allocation; coffee, cocoa, rubber, sugar cane and alfalfa would account for the balance. Only in the case of alfalfa, for which the planting of an additional 3,000 ha is provided, would the area of each of these exceed more than a few hundred hectares. Miscellaneous 65. An increase of some 80 per cent over previous miscellaneous lend- ing activities is estimated (Annex 9 ) due to increased demand for processing and storage facilities, and farm buildings. 66. There is an established need for processing plants and fruit packing installations in areas where plantations previously financed by the Banco are coming into production. Small rice mills, crop storage facilities and farm buildings are needed in areas recently opened up to cultivation. B. Lending Policies and Procedures 67. The policies and procedures described in paragraphs 26 - 3h, would be used. These are substantially the same as applied to lending to farmers under the previous three Bank Loans.  - 14 - 68. The only major change would be in respect to the relerding terms. Attention has been drawn to the problem encountered in previous Bank loans of unduly short repayment schedules by farmers,to the cause of this and to its effects on repayment records (para 40). Under the proposed loan, the Banco wishes to adopt longer periods of amortization. Loans for farm machin- ery and mechanical equipment would be for five years; loans for livestock, up to 10 years; and loans for irrigation, land improvement and plantations, up to 15 years. These terms are more directly related to the purpose of the loans and the feasibility of repayment by farmers from incremental production resulting froe the investments. In addition, farmers would no longer be required to carry the exchange risk. 69. To make this approach possible, the Banco requests a comparable extension of the amortization period of the proposed Bank loan relative to previous loans. This request for a 15-year loan is reasonable, but close supervision by the Bank would be necessary to ensure that the more generous terms do not result in even worse repayment records from farmers than that currently-existing. In this connection it is clear that the new loan will not be used for refinancing farm loans in arrears and that its proceeds will be relent for new development operations only. C. Financing 70. The estimated program cost and the proposed source of finance is summarized as follows: Total Program US$ (Million) Source of Finance SI Million Equivalent Percentage From farmers 244.5 9.1 30 From Banco 168.5 6.3 20 Frem Bank 402.0 15,0 50 Total 815.0 30.4 100 The lending program for the various categories is set out in Annex 9. 71. The foreign exchange component is estimated at about US$6.3 million or 42 per cent of the Bank contribution. Thus, US$8.7 million or 58 per cent of the Bank loan would be disbursed for local procurement. Most of this (about US$7 million) would be absorbed by livestock, justification for which has already been given (para 61). 72. Although the proposed Bank contribution is only 50 per cent of the total program cost, it would cover about 70 per cent of the Banco's lending program. This proportion is substantially higher than in previous Bank loans which have been confined to the foreign exchange cost. It is also three times the size of each previous loan.  73. Justification for both increasing the arnount and prQportion of the Bank's ccntribution as well as for extending the amortization term rests on two main grounds. 74. The first is the precarious financial position of the Banco. This has been described (paras 35-1h). The mission has carefully examined the financial requirements of the Banco to continue its development program at the same pace as in recent years. It has also assessed existing and poten- tial resources. There is a shortfall between its amount of long-term obli- gations (about S/ 1,i00 mil) and the amount of its long-term resources (about S/' 830 mil) of about S/ 270 million. This shortfall is due partly to the temporary payment of long-term loans from shurt-term sources during the period since the third Bank Loan (257-PE) was disbursed and to accumula- tion of defaults. Capital increases from taxes already provided for would make good most of this shortfall. A further S/ 300 million should be derived from loan repayments, assuming a repayment rate only 30 per cent higher than in 1962/63 which was a poor farming year in Peru. The proposed Bank loan of S/ 402 million would permit the total lending program to be executed in these circumstances with a surplus of capital resources over capital needs in the three years of only S/ 27.0 million. This small surplus is highly desirable to give the Banco much needed flexibility in its financial struc- ture. It could be argued that the Government might make a special contribu- tion. However, it is doubtful whether it would deem it appropriate to do so in light of other high priority commitments. In any event, consideration will be given by Government to financing those aspects of the Banco's responsibilities not concerned with agricultural credit (para 43). 75. The second reason lies in the hand-to-mouth nature of the Bank's assistance to the Banco so far. Each Bank loan, geared as it has been to the actual foreign exchange cost of a three-year lending program, and tied to a relatively short repayment schedule of eight years, has strictly limited the Banco to but one "turnover" of the loan monies involved. It has further tied it to overshort repayment schedules for farmers, considering the nature of farming as a business. Such short terms are not realistic in a financial sense. A larger Bank loan, for a longer term, capable of slightly being turned over meets the needs of an agricultural credit institution much better. A loan of the proposed magnitude, tied to better performance of the Banco in respect to its operational efficiency, its loan collection perform- ance, and its direct responsibility only for profit earning activities could make it eventually independent of external borrowing for projects of similar magnitude, and help prepare it for expanding future credit operations to keep pace with Peru's growing agricultural economy. 76. For many reasons apparent from this review, the Bank should not give the Banco a blank check for its program. The basic proposed measures of paragraph 44 must be effectively carried out. This would be achieved by making disbursements contingent upon attainment of specified standards of performance. These standards will relate particularly to the reduction of the delinquent debt, the abandonment of profitable commercial transactions, the introduction of improved administrative and accounting procedures, the abandonment of or payment by Government for national service activities and such other matters affecting efficiency as were agreed upon during negotiations.  - 16 - Measures taken by the Banco to improve collections iriclude the requirement of additional collateral, enforcement of penalty rates and legal remedies available against defaulting borrowers. The targets as fixed during nego- tiations are a progressive reduction of arrears over 90 days by about 35 per cent to about S/ 190 million as of December 31, 1967, against S/ 288 million as of September 30, 1964. The Banco will have also to continue to build up reserves against bad loans at an accelerated pace. 77. Supervision of the project will be on a regular quarterly basis, and the Banco has recognized unequivocally that disbursements will depend upon progressive improvement in the areas listed in the preceding paragraph. Initially, the main criteria would be in respect to the reduction of delin- quent debt. 78. The loan would be disbursed for expenditures incurred for approved loans under the project between April 1, 1964 and March 31, 1967. This backdating would not be unreasonable in view of the timing of the loan request (June 1963) and the delays involved in resubmissions and appraisals during which the Banco has had to continue its lending program. The Bank would disburse an agreed percentage (averaging 70 per cent) against state- ments of expenditures presented by the Banco showing loans paid out to farmers for eligible items under the Bank loan. Procurement 79. The Banco would continue its past practice of making credit avail- able for approved purchases by farmers through normal trade channels. Inter- national firms handling farm machinery and equipment are well represented in Peru. Their spare parts and servicing facilities are satisfactory. The procurement arrangements have worked well with past loans. The Banco would no longer import livestock direct, but would eventually provide a line of credit to the Livestock Producers Association which would be turned into loans to farmers purchasing the imported stock. V. BENEFITS AND JUSTIFICATION 80. The procedures normaLly used by the Bank in the economic appraisal of agricultural projects cannot be applied to an agricultural credit opera- tion of the type under consideration (para 11). 81. Development projects as irrigation, livestock, pasture improvement, land settlement, or tree crop development, can usually be sufficiently well- defined ta permit an accurate measurement of the various inputs and a reas- onable assessment of potential benefits. Such projects usually involve the development of specific areas of land, the previous productivity of which is known with reasonable accuracy. They are usually characterized by the introduction of new and definable farming patterns which are generally applicable throughout the whole or measurable parts of the project area. Even although many such projects do involve extensive sublending to farmers,  - 17 - and as such can be described as agricultural credit operations, the character and purpose of most subloans tend to be similar, or at least to follow definite patterns. 82. This is not usually the case in agricultural credit operations where a loan is made to an institution for multi-relending purposes. The Banco has to lend to a wide variety of farmers ranging from specialist "one- crop" producers to truly "mixed" farmers producing a wide range of products. Farms may vary in size from smallholdings of a few hectares to thousands of hectares of extensive mountain grazing lands. They may be located on irri- gated lands capable of being cropped intensively with several different crops each year. They may be dry-land farms with output and potentials widely varying with irregular rainfall. 83. Within this complex, the actual loans made to farmers become most variable in both size and character. They may range from large complete coverage loans to'develop new farms to small simple loans for but one input as a tractor, a farm implement, or a few cows. The precise pattern of lend- ing cannot be determined until after the event. Even then, their systematic classification into meaningful groups in an economic sense is most difficult. 84. As an agricultural credit institution, the Banco has a good tech- nical record in implementing a relending program. Its performance in previous credit operations financed in part by the Bank has been summarized in para- graphs 10-14. Its proposed program is soundly based both in its general and its detailed objectives. It is capable of implementing this program. Its appraisal procedures, made by competent technical staff would result in individual subloans, each of which would be likely to increase agricultural and livestock production significantly and profitably. 85. The Bancols continuing lending program is a major aspect in the implementation of the Government's agricultural policies to meet the economic needs of the country. The population of Peru is variously estimated to be increasing at 2.2-2.5 per cent annually. Per capita food consumption is rising with more and better food supplies and improved wage levels. Exports of agricultural products comprise a substantial part (34 per cent) of the total export trade. On the oth r hand, Peru is still importing substantial quantities of some foodstuffs 1/. In 1963, the import of dairy products amounted to S/ 194 mi)lion, cereals S/ 590 million, meat S/ 110 million, and fruit S/ 78 million ?X All these could be produced locally in much greater quantities. Their increased production is a specific objective of the proj- ect. In addition, expansion and intensification of agricultural production is needed to provide productive employment opportunities for an expanding population. Intensification and the opening up of new areas to meet all these needs call for capita investments which exceed considerably the farmers' own financial resources. They cannot be carried out without agri- cultural credit of the type under review. / Total import of foodstuffs in 1962 amounted to S/ 1,988 million and total export S/ 2,478 million giving a net export of S/ 539 million. Food exports were largely fish, coffee and sugar. 1962 Figure.  - 18 - 86. Finally, the proposed credit program would supply capital only to econcnically viable commercial farmers whose resources and financial position are appraised when individual loans are made. Farmers on marginal land, or with uneconomic holdings, would not be financed. In these circumstances, there should be a substantial economic benefit to the country, even although this benefit cannot be satisfactorily quantified. VI. CONCLUSIONS AND RECOMMENDATIONS 87. The project, which the Banco has asked the Bank to assist in financ- ing, is a continuation of a lending program which the Bank has been assisting for about 10 years. This program has been successful in developing agri- cultural and livestock production in Peru. The Banco is the only institution in the country providing medium- and long-term credit of the type required to farmers on suitable terms. 88. The project is suitable for a Bank loan of US$15 million for a period of 15 years, including a grace period of four years, subject to sat- isfactory reorganization of the responsibilities, administration, and operating procedures of the Banco. 89. D_sbursement of the loan would be subject to quarterly supervision of performance (para 77). The Banco would seek approval of the Bank before making subloans under the project in excess of the equivalent in soles of US$75,oOO. 90. Standards of expected improved perfomnance were agreed upon during negotiations. Particular attention was paid to improvements in performance likely to lead to increased financial viability of the Banco. These included: a) a reasonable systematic reduction in the amount in arrears of both the long- and short-term loan portfolios (para 76); b) adoption of improved accountancy and procedural methods, based upon recommendation of outside consultants and mutually agreed upon by the Banco and the Bank (paras 24,h44); c) revision of its operations other than credit with a view to increasing their profitability as recommended by outside con- sultants and as and when agreed upon by the Banco and the Bank (paras 44,76); d) arrangements will be made by the Government for the financing of certain services provided by the Banco in the national interest (paras 44,76). April 30, 1965  aANCO DE FXOMENrO AGROPECUARIO DEL PERU Organization Chart Board of Di recotrs [ ~~~~~~~~~~~~~~~~~~~~Committee er| Operat Oprtons Organizaton Aan ub Manager ~ ~ ~ ~ Sb-anger Sub-Nana er Sb. e spe IBM ICurrent | Wol Cit osa Ser Sla Lvao pcial Las Catr Bace rn B urn Engineer Ma ters gz. B R A N C H E S (1 I I I b e r J a E s t a t e)  ANNEX 2 BANCO AGROPECUARIO DEL PERU Short-TeIn Credits Approved by the Banco (in million soles) ---1957/58---- ---1958/159--- ---1959/60---- ---i960/61---- ----1961/62---- ----1962/63---- ----1963/64---- Number Amount Numnber Amount Mumber Amnount Number Amount Number Amount Number Amount Number Amount Loans to Small Farmers Agriculture 9,998 92.3 13,444 138.2 16,078 178.3 17,806 189.4 20,910 243.0 21,446 273.4 19,392 305.0 Livestock 3,282 12,3 3,748 14.2 10,711 4o.6 4,922 34.1 .6,228 53.1 3,082 3908 2,529 27.7 Subtotal 13,280 lo4.6 17,192 152.h 26,789 218.9 22,728 223.5 27,138 296.1 24,528 313.2 21,921 332.7 Loans to Large- Scale Farmers Agriculture 995 377.8 1,091 439.9 1,134 523.8 1,153 637.1 1,268 715.5 1,270 784.3 1,676 971.5 Livestock 106 15.6 108 16.2 121i 19.9 160 30.8 151 26.5 119 24.7 109 27.5 Subtotal 1,101 393.4 1,199 456.1 1,258 543.7 1,313 66709 1,419 742.0 1,389 809.0 1,785 999.0 Others 353 18.1 413 19.7 372 25.4 385 23.4 266 20.3 334 22.2 3U6 24.8 Grand Total 14,734 516.1 18,804 628.2 28,419 788.0 24,1)226 914.8 28,823 1,05804 26,251 1,144.4 24,052 1,356.5  ANNEX 3 BANCO AGROPECUARIO DEL PERU Long-Term Credits Approved by the Banco (in million soles) __________ l8' 1958/59 1959/60 1960/61 1961/62 1962/63 1963/64 Aint., No. Amt. No. Amt. No. No. A mt. No. Jbnt. No. Amt. Irrigation 106 10.6 137 14.5 50 7.0 93 13.2 99 16.9 111 19.0 30 9.7 Mechanization 222 23.3 157 14.8 181 27.6 246 33.1 236 34.9 216 30.0 7 o.5 Betterment of land 32 6.9 33 5.5 40 18.4 31 603 21 4.0 23 4.0 33 7.2 Livestock 355 31.9 474 32.1 516 45.7 640 60.8 627 61.8 698 64.4 744 61.5 Permanent crops & plantation 410 33.1 417 43.1 704 4706 875 58.8 603 42.8 672` 39.8 848 48.9 Fencing material 33 -2.0 36 3.2 21 1.1 5 o.9 11 0.9 23, 1.6 1 __ Miscellaneous 11 1.2 77 8.4 64 3.3 100 4.9 129 6.6 lOi 6,0 187 5.7 1,169 109.0 1,331 121.6 1,576 15007 1,990 178.0 1,726 167.9 1,850 164.8 1,850 133.5 Related resources Banco's resources 774 59.8 1,015 88.7 1,344 1144. 1,643 124.1 1,405 115.1 1,467 111.9 1,850 133.5 IBRD Loan 395 49.2 316 32.9 232 36.3 347 53.9 321 52.8 383 52.9 _ -_ 1,169 109.0 1,331 121.6 1,576 150.7 1,990 178.0 1,726 167.9 1,850 164.8 1,850 133.5  ANNEX 4 B!kNCO AGROPECUARIO DEL PERU Comparative Balance Sheets as at September 30, 1959-September 30, 1964 (in S/'000) ----------------------S e p t e m b e r 3 O,----------------------