China - Heilongjiang Dairy Project

Documentof The World Bank FOROFFICIAL USEONLY Report No: 30314-CN PROJECT APPRAISAL DOCUMENT ONA PROPOSEDLOAN INTHE AMOUNT OFUS$lOO MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FORA HEILONGJIANGDAIRY PROJECT December 14,2005 RuralDevelopmentandNaturalResourcesSector Unit EastAsia andPacific Region This document has a restricteddistributionandmay beusedby recipientsonly inthe performance oftheir official duties. Its contents mav not otherwise be disclosedwithout World Bank authorization. A  CURRENCYEQUIVALENTS (Exchange Rate Effective March 2005) Currency Unit = RenMinBei (RMB) Yuan (Y) Y 1.0 = US$0.12 U S $ 1.0 = Y 8.28 F I S C A L YEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS ABC Agriculture Bank o f China AHB Animal Husbandry Bureau ACWF All China Women's Federation ADAF Asian Development Assistance Fund AI Artificial Insemination BOF Bureaus o f Finance CAS Country Assistance Strategy CCYP China Communist Youth Party CFAA Country Financial Accountability Assessment COMRS Centrally-Operated MR System C M T L Central Milk Testing Laboratory CPMO Country Project Management Offices CQ Consultants Qualifications DHI Dairy Herd Improvement DHIP Dairy Herd Improvement Program (Development recommended) DHIP MU DHIP Management Unit (Formation recommended) DHIP MR T A U DHIP MilkRecording Technical and Administrative Unit DHIP WG DHIP Working Group DP Dairy Park EA Environmental Assessment ECC Environmental Clearance Certificate EIA Environmental Impact Assessment EIL Environmental Impact List EMP Environmental Management Plan EIR Environmental Impact Report EIS Environmental Impact Statement EPB Environmental Protection Bureau EMP Environmental Management Plan EPMR Environmental Protection Management Regulation ERR Economic Rate o f Return ET Embryo Transfer FB Finance Bureaus FRR Financial Rate o f Return FMS Financial Management Specialist FMR Financial Monitoring Report GDP Gross Domestic Product GHG Greenhouse Gas GOC Government o f China HAABT HeilongjiangAssociation o f Artificial Breeding Technicians (Formation recommended) HABC HeilongjiangAnimal Breeding Center HACCP Hazard Analysis and Critical Control Point HADP HeilongjiangAgriculture Development Project HAHB Animal Husbandry Bureau o f HeilongjiangProvince HBOF HeilongjiangBureau o f Finance HDIA HeilongjiangDairy Industry Association HDP HeilongjiangDairy Project  HDRC HeilongjiangDevelopment andReformCommission HEPB HeilongjiangEnvironmentalProtectionBureau HH Household HIDMRS HouseholdInformationandDevelopment MR System HLIC HeilongjiangLivestockInformationCenter HPHB Heilongjiang ProvinceHydrologicalBureau LE Legal Enterprise LW Live weight MDG Millennium Development Goals MOA Ministry ofAgriculture, People's Republic of China MOF Ministry ofFinance MR MilkRecording MS Milking Station M T MilkTesting mu Chineselandarea measurement= 1/15 ha or 666 m2or 116 acre NCB National Competitive Bidding NEAU NortheastAgriculture University NPV Net Present Value PLG ProjectLeadingGroup OM OperationsManual PMR ProcurementManagementRegulation PPMO ProvincialProjectManagementOffice PRC People's RepublicofChina PY ProjectYear QCBS Quality andCost BasedSelection QBS Quality BasedSelection RAP ResettlementAction Plan RCC RuralCreditCooperative RPF ResettlementPolicy Framework SA SpecialAccounts SEPS Socio-economic andProductionStudy SCC Somatic Cell Count SIDD Self-FinancingIrrigation and DrainageDistricts SOE State OwnedEnterprises TAC TechnicalAdvisory Committee TF Trust Fund TOR Terms of Reference UHT UltraHighTemperature VMC Village ManagementCommittees WB World Bank WTO World Trade Organization Vice President: Jemal-ud-din Kassum, EAPVP Country ManagedDirector: David R. Dollar, EACCF Sector Manager: Mark D.Wilson, EASRD Task Team Leader: Mohamed Noureddine BenAli, EASRD  FOROFFICIAL USEONLY  This document has a restricted distribution and may be usedby recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without World Bank authorization.   PEOPLE'S REPUBLIC OF CHINA HEILONGJIANG DAIRY PROJECT CONTENTS A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues 2. Rationale for Bank involvement 3. Higher level objectives to which the project contributes B. PROJECT DESCRIPTION 1. Lending instrument 2. Project development objective and key indicators 4 3. Project components 5 4. Lessons learned and reflected inthe project design 8 5. Alternatives considered and reasons for rejection 9 C. IMPLEMENTATION 10 1. Partnership arrangements 10 2. Institutional and implementation arrangements 19 3. Monitoring and evaluation (M&E) o f outcomeshesults 12 4. Sustainability 13 5. Critical risks and possible controversial aspects 14 6. Loadcredit conditions and covenants 15 D. APPRAISAL SUMMARY 15 1. Economic and financial analyses 15 2. Technical 16 3. Fiduciary 17 4. Social 18 5. Environment 18  6. Safeguard policies 19 7. Policy Exceptions and Readiness 20 Annex 1: Country and Sector Background 21 Annex 2: Major RelatedProjects Financedbythe Bank and/or other Agencies 25 Annex 3: Results Framework and Monitoring 26 Annex 4: Detailed Project Description 30 Annex 5: Project Cost Estimate 37 Annex 6: Implementation Arrangements 38 Annex 7: Financial Management and DisbursementArrangements 43 Annex 8: Procurement Arrangements 52 Annex 9: Economic andFinancial Analysis 59 Annex 10: Safeguard Policy Issues 68 Annex 11: Project Processing 91 Annex 12: Documents inthe Project File 93 Annex 13: Statement of Loans and Credits 94 Annex 14: Country at a Glance 99 Annex 15: Climate Change Activities Detailed Description 100 Annex 16: Line of Credit Arrangements (OP 8 - 30) 111 Map (SI IBRD No. 33741  CHINA CN-HEILONGJIANG DAIRY PROJECTAPPRAISAL DOCUMENT EAST ASIA AND PACIFIC EASRD Date: December 14,2005 Team Leader: MohamedN.Benali Country Director: David R. Dollar Sectors: Animal production(75%);Agricultural Sector ManagedDirector: MarkD.Wilson extensionand research (15%);Crops (10%) Themes: Otherrural development(P);Rural services and infrastructure (P);Technology difksion (S) ProjectID: PO86629 Environmentalscreening category: Partial Assessment LendingInstrument: Specific InvestmentLoan Safeguardscreening category: Limitedimpact [XILoan [ ] Credit [ ] Grant [ ] Guarantee [XI Other:ItalianTF for the Environmentin China For Loans/Credits/Others: Total Bank financing (US$m.): 100.00 Proposedterms: LIBOR-based,singlecurrency (US Dollar denominated), variable spreadloan (VSL), to be repaidin 20 years, including 5 years of grace. RECONSTRUCTION AND DEVELOPMENT ITALY:DEV. COOP. DEPARTMENT 2.20 3.30 5.50 (MOFA) SUB-BORROWER(S) 22.30 5.50 27.80 LOCAL FARMER ORGANIZATIONS 17.00 3.50 20.50 Total: 99.50 1 79.45 I 178.95 Borrower: People'sRepublic of China- Ministry ofFinance San LiH e Lu, Beijing, 100820 Beijing China Tel: 86-10-68551124 Fax: 86-10-68551125 jl.vang;@,mof.Rov.cn ResponsibleAgency: HeilongjiangProvinceAgriculture World BankProjectManagementOffice  No. 202 Zhongshan Rd. Nangang District Harbin Heilongjiang China 150001 Tel: 011-86-451- Fax: 011-86-451-8263-2146 Does the project depart from the CAS incontent or other significant respects? Re$ PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bank policies? Re$ PAD D.7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [XINO I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risksrated"substantial" or "high"? Re$ PAD C.5 [ ]Yes [XINO Does the project meet the Regional criteria for readiness for implementation? Re$ PAD D.7 [XIYes [ ] N o Project development objective Re$ PAD B.2, TechnicalAnnex 3 The proposed project would have two key development objectives. The first objective would be to improve the financial viability o f existing and new dairy operations (about 10,000 HH) in selected areas o f Heilongjiang province. The second objective would be to demonstrate innovative technologies to reduce greenhouse gas (GHG) emissions and increase carbon sequestration. Project description [one-sentence summary of each component] Re$ PAD B.3.a, TechnicalAnnex 4 The proposedproject has four components. The first component i s the dairy production development component, which would aim to increase the scale, efficiency and quality o f milk production in Heilongjiang through household and Dairy Park based productionprograms. The second i s the dairy cattle breed improvement component, which would aim at improving the genetic base o f the Heilongjiang dairy herd. The thirdcomponent is the environmentalprotection and climate change mitigation component. This Italian TF-funded activity would aim to pilot and develop strategies and technologies to mitigate greenhouse gas emissions and increase carbon sequestration. The fourth project component i s the project management support component, whose purpose would be to improve the management, monitoring and evaluation o f project activities. Which safeguard policies are triggered, if any? Re$ PAD 0.6, TechnicalAnnex 10 Safeguard Policies Triggered by the Project: Environmental Assessment (OP/BP/GP 4.0 1): Yes Involuntary Resettlement (OP/BP 4.12): Yes  Significant, non-standard conditions, if any, for: Re$ PAD C.7 Boardpresentation: None. Loadcredit effectiveness: The Grant Agreement for the Italian Trust FundGrant has been executed by the Government, and all Zonditions for its effectiveness have been fulfilled with the exception o f the effectiveness o f the Loan Agreement. Project Implementation: Two SAs would be opened by HBOF at a commercial bank acceptable to the Bank (PAD Section C2, para. 8). PPMOIHBOF would maintain a project account and make sufficient counterpart funds available for the implementation o f the project (PAD Section C2, para. 1). The PPMO with staffwith qualifications acceptable to the Bank would be maintained at all time duringproject implementation. (PAD Section C2, para. 1). The government would maintain the OM untilcompletion o f the project (PAD Section C2, para. 1)- A mid-term review would be undertakenno later than December 2008 (PAD Section C3, para. 2). Disbursement (opening of Letter o f Credit for ICB contracts) for the procurement o f dairy cattle would be contingent on the satisfactory progress, as certified to the Bank by the PPMO, o f all the civil works, other infrastructure and feed necessary to house and care for the procured dairy cattle inthe Dairy Parks and DemonstrationFarms (Annex 6, page 54). Disbursement for each dairy park, dairy demonstration farm and village milkingstation would be contingent on the approval by the relevant local EPA for its respective environmental mitigation action plan (PAD Section D5, and Annex 10, page 90). The agreed criteria (PAD Section C-2, para. 9) would be used for the selection o fproject beneficiaries. Adequate technical assistance would be recruitedfor the implementation o f the DHIcomponent and for the preparation o f tender documents for the procurement o f dairy cows (PAD Section C5, para.4), which represent about 80 percent o f the value o f the Bank's Loan.   A. STRATEGIC CONTEXT AND RATIONALE 1. Countryand sector issues Inrecent years, China's annual growth rate inGross Domestic Product (GDP) has averagedaround 7 to 8 percent, creating substantial domestic savings and international currency reserves. China's access to the World Trade Organization (WTO) in 2001 further strengthened its economic position. This has allowed the country to achieve considerable progress towards an ambitious and broad structural reform agenda and the achievement o f the Millennium Development Goals (MDGs). However, social indicators show that inequality and income gaps appear to be widening between urban and rural populations and between coastal and inland areas, with the poor being mostly located in the rural areas o f the lagging inland provinces. The sustainable development o f rural areas is one o f the most pressing economic and social issues facing China. The agriculture and livestock sectors, the main source o f livelihood for many rural households, will have to undergo substantial structural changes to enhance the livelihood o f rural households. Increasing the value and competitiveness of cash crops and livestock production is seen by the Government o f China (GOC) as critical for improving rural incomes. Heilongjiang i s a major corn and soybean producer and China's dominant milk-producing province, accounting for about 20 percent o f national milk production in 2002. The dairy industryinChina has been rapidly growing over the past 10 years, fueled by a 10 percent annual growth in national dairy the priority development areas of China's loth Five-Year Plan, and the Ministry o f Agriculture has consumption and supported by favorable government policies and programs. The dairy industry i s one o f formulated an "Advantageous Milk Production Area Development Plan, 2003-2007" focusing on improved genetics, feeding management and processing. To increase the income o f farmers and adjust the structure o f agricultural production, the Heilongjiang government has prepared a plan for "Acceleration of Development, Rejuvenation o f Dairy Industry and Facilitation o f Strategic Adjustment o f Agricultural and Rural Economic Structure", including the promotion o f superior breeds o f cattle, silage production, pasture improvement, the development o f dairy production and dairy parks, improved milkingpractices, the development of dairy associations/cooperatives, and investment in research and extension. Milk processing in Heilongjiang has been characterized by increasing consolidation and over-capacity. Marketing studies have shown that there i s a large scope for increasing raw milk production in Heilongjiang without increasing the market risks to farmers. Processors are investing heavily in milking stations to rectify both inadequate milk supplies and milk quality problems. Although Heilongjiang i s the leading milk producing province in China and benefits from a domestic advantage for milk production with relatively lower costs o f production and national resource base, there are several challenges to sustainable sector growth. While on-farm milk production has increased recently, the insufficiency and relatively low quality o f milk supply remain the major impediments to the growth o f milk processing. Existing smallholder dairy operations have low productivity and relatively highrisk interms o f securing highmilk prices and hence financial reward for their operations. With an average production o f 4,300 liters per year per cow, further gains in productivity will require significant investments in both improved herd nutritiodmanagement and genetics. The majority (70-80 percent) o f milk is produced by smallholder households with an average herd size o f 3 to 5 cows. These and other potential dairy households have little or no access to formal financing for investment in dairy production. Farm size and dispersion o f milk production are also considered by the Heilongjiang government as serious constraints to improved productionmanagement, including improved environmental management, herd management and feeding and milking practices. Farmer associations and representation are only beginning to form in Heilongjiang, thus the protection o f farmer interests is an important factor to consider in a sector that has, so far, been driven by milk processors. 1  Finally, research and investments are needed to improve the environmental sustainability o f dairy development, including better management o f the province's pastureland, improved feeding and usage o f crop residues, as well as waste management to mitigate the local and global adverse effects o f the livestock sector on climate change and the environment. 2. Rationale for Bank involvement To maintain the competitiveness of the province's dairy sector and sustain its growth, public and private investments are needed to expand production and productivity, improve milk quality and strengthen the capacity o f important public institutions to serve the dairy sector. Furthermore, as a result o f China's entry into the WTO, Heilongjiang's smallholder farmers may find it more difficult to compete with corn and soybean imports. Given the means to invest in dairy production, these farmers could significantly increase their earning power by shifting from selling commodity corn and soybeans to using them as inputs for higher-value dairy production. The rising demand for fresh milk and the provincial government's commitment to adjust its agriculture from predominantly crop-based sector to an animal production/dairy based sector provide a conducive environment for the development o f Heilongjiang's dairy sector. Through the Heilongjiang Agriculture Development Project (HADP), the Bank has acquired experience with the Heilongjiang livestock sector, including the dairy sector. The Bank's involvement will support the provincial objectives o f fostering development activities with a strong element o f public goods such as capacity building and improving environmental management. This would be very much in line with the Bank's CAS goal o f facilitating an environmentally sustainable process. The Bank's involvement has been instrumental in highlightingthe importance o f improving dairy herd management and feeding along with genetic improvement to achieve and sustain the highdairy production and productivity sought by the Heilongjiang dairy development strategy. Bank involvement would help alleviate the shortage o f funds needed to develop the dairy sector. At present, very few commercial banks are providing medium-to long-term loans to the dairy sector. The RCC has branches in 60 o f 65 counties o f Heilongjiang. However, medium-to long-term credit for dairy production i s only available in 6 o f the 65 Heilongjiang counties. The RCC was able to lend about RMB 200 million in 2004, enough to satisfy 10 percent o f credit demand. Despite its plans to do so, the RCC is unable to expand its dairy portfolio or to satisfy mounting farmers' demand because o f shortage o f funds. The project would alleviate this problem by providing an additional RMB 800 million over a period o f about five years. The Bank's involvement will also contribute to a greater focus on targeting relatively poor dairy farmers. The design o f the proposed project benefited from the Bank's expertise in the assessment o f the environmental and social impacts o f increasing dairy livestock production. The Bank's involvement in the project will ensure that smallholder farmers' interests are fully integrated in the design o f project activities, and will catalyze the emergence o f farmers' associations that would play a key role inthe future management o f the industry support services to be developed under the project. The Bank's involvement has also influenced the project design o f the ownership o f dairy parks by legal entities by giving majority holding to smallholders or smallholders and government in an innovative and inclusive form o f dairy park ownership in Heilongjiang. Bank's involvement also allowed for the leveraging o f additional trust fund resources (Italian Trust fund) for climate change mitigation activities and environmental sustainability. Lessons learned from other Bank projects were incorporated in the design o f the project to ensure that the establishment o f the Dairy HerdImprovement Program (DHIP) would be cost effective, sustainable and a model for the larger China dairy industry, making more efficient use o f the province's natural resource base, and mitigating the environmental impact o f dairy industry development. 2  3. Higher level objectives to which the project contributes CAS document number: 25141-CHA approved on January 22,2003 Date o f latest CAS discussion: December 19,2002 The proposed project i s consistent with the Bank's China Country Assistance Strategy (CAS), and will contribute to the CAS objectives o f (a) improving the business environment and helping accelerate China's transition to a market economy; (b) addressing the needs o f the poorer and disadvantaged people and lagging regions; and (c) facilitating an environmentally sustainable development process. The project i s included in the FY03-05 Operational Lending Program described in the CAS and targeted for commencement in 2005. The project is also consistent with the focus o f the Bank's assistance strategy to China in the rural sector, which i s on facilitating the shift towards commercial agriculture and from quantity to quality inproduction. The project will improve the competitiveness o f the Heilongjiang dairy industry, which i s coming under more pressure from increased market integration, and contribute to the transition o f the province's agriculture sector towards higher-value livestock production. The project will support the establishment o f a strong private and public institutional and technology base for one o f Heilongjiang's most promising growth industries. As a successful outcome o f the project, other provinces could adopt modern dairy herd improvement programs shown to be successful inHeilongjiang. The Heilongjiang government has set rapid growth and improved incomes and employment o f rural dwellers as the backbone of its rural and agriculture development strategy. The project-induced development o f private commercial dairying and the highlevel o f participation o f small-scale farmers in the dairy sector would increase employment and income in line with the government objectives. Income opportunities include buying cows to get into dairying and growing feed to sell to dairy farmers. Employment opportunities include jobs in dairy parks, milking stations, dairy factories and on dairy farms, The project's social assessment confirmed the substantial participation by women in dairying and their clear desire for expanded opportunities in the sector. The development o f a policy framework for farmer associations is one o f several national policies being pursued to improve the living standards o f farmers. The project would also improve understanding o f how farmers can best associate and strengthen the policy framework that i s only now emerging in rural China. Finally, the project would also make a contribution to the mitigation o f climate change, thus helping China to prepare to meet its commitments under the Framework Convention on Climate Change. The agriculture sector accounts for about 9 percent o f China's total greenhouse gas (GHG) emissions, which inturnaccount for 23 percent o f the world's total.' Inlight o f the fact that emissions from agriculture are mainly associated with cattle and maize production, it i s important for the project to take advantage o f the opportunity offered by the availability o f Italian grant funds to pilot test and demonstrate the implementation o f innovative technologies to increase carbon sequestration and reduce GHG emissions associated with dairy development. 'Theseare 1999 statistics from the International Energy Agency, ref. h tt p ://earthtrends. w r i . org/datatabCEs/index. cfrn?therne=3 3  B. PROJECT DESCRIPTION 1. Lendinginstrument The GOC will borrow the Loan on standard IBRD terms, with a 20 year maturity and a 5 year grace period. In addition, a US$5.5 million grant will be provided by the Italian Trust Fund (TF) for Environmental Protection in China for activities that mitigate climate change and contribute to the environmentally sustainable growth o fthe Heilongjiang livestock sector. 2. Projectdevelopmentobjectiveand key indicators The first objective o f the project would be to improve the financial viability o f existing and new dairy operations in selected areas o f Heilongjiang province. Progress towards the achievement o f this objective would be measured by monitoring increases in the productivity o f the dairy farmers' cattle and adoption o f the Dairy Herd Improvement (DHI) system to improve the genetic potential and management o f the Heilongjiang dairy herd. The second objective would be to demonstrate innovative technologies to reduce GHG emissions and increase carbon sequestration. This would contribute to the global objective o f improving the sustainability and impact o f livestock production on the local and global environments. Progress towards the attainment o f this outcome would be measured by monitoring the manner in which animal manure and crop residues are stored and treated and the area o f improved permanent pastures (carbon sequestration). While this i s not a poverty alleviation project, it will strive to help the neediest o f those who meet the project's beneficiary selection criteria. Key Indicators: Outcome indicators: The outcome and output indicators are detailed in Annex 3. The main project outcomes would be: (a) an increase in the marketed output o f milk and an associated increase in farm households' incomes; and (b) the adoption o f technologies that mitigate climate change (increased carbon sequestration and reduced GHGemissions). The main outcome indicators would be: 0 project dairy operations produce and sell more highquality milk; 0 increase in the income o f farmers participating in project-financed dairy farm households and dairy parks; 0 farmers organize themselves in associations at village and other levels to promote and defend their interests; and 0 technologies to increase carbon sequestration and reduce greenhouse gases are promoted and adopted. Output Indicators: A baseline survey would be conducted soon after loan effectiveness to capture the status o f outcome and output indicators o f the beneficiaries before the project. This would be followed by periodic surveys (once every two years) to measure the outcome and outputs o f the project on its beneficiaries and to contrast these measurements against a sample o f non-project farmers. The main project output indicators would include: 0 The number o f farmers financed and trained by gender and ethnicity; 0 The increase inproductivity (tons o f milk per year) of project beneficiaries' dairy herd; 0 The number o f dairy farmer associations established and operating; 0 The number o f cows under the DHIP; 0 A sustainable system o fbull selection and progeny testing is functioning; 0 The area o f improved pastures; 0 The number o f pilot greenhouse gas emission mitigation activities adopted. 4  3. Project components The proposed project would have four components: (a) dairy production development, (b) dairy breed improvement, (c) climate change mitigation, and (d) project implementation and management. A summary description of these components i s found below and a detailed description i s in Annex 4. The above four project components were selected because they would produce the outputs most likely to achieve the objectives o f the project. Component 1: Dairy ProductionDevelopment(estimatedcost2RMB 1,324.6 million or US$160.2 million). The purpose o f this component i s to increase smallholder dairy production in the project area through investments in improved on-farm dairy production and management, the construction o f milkingstations, dairy parks, and dairy demonstration farms and by building the capacity o f provincial and local institutions to provide training to dairy farmers and to facilitate the development o f dairy farmers associations. The component will target existing small-and medium-size farmers willing and financially able to increase their herd, as well as (generally poorer) new households interested in engaging in dairy production. Under this component, the project would support the following sub-components: (a) Household dairy farms (RMB 791.4 million or US$ 95.7 million) This sub-component would expand smallholder dairy production by providing loans (in kind) to over 10,000 farmers (about 5,500 in individual households and over 4,500 in dairy parks) who would otherwise not be able to obtain medium-to long-term credit from available financial institutions. The project would finance the procurement o f 1 to 6 dairy cows or yearlings per farm, the construction o f a cattle shed, silage and effluent pits, a set o f farm tools, and initial feed and veterinary drug supply for a period o f three months. The actual number o f cows purchased by each beneficiary would be flexible and demand-driven. Beneficiary farmers would also be able to choose between locally purchased or imported cows. The herds o f smallholders would, for the most part, be milked invillage milkingstations. (b) Milking stations (RMB 61.6 million or US$ 7.4 million). This sub-component would allow farmers to significantly improve the quality o f the milk they deliver to processors and hence benefit from higher prices. Through the provision o f loans to investors and farmer groups/associations, the project would help establish about 55 milking stations. The milking stations would be owned jointly by a public sector entity (village government) or by one or several private investors or a farmer group/association. The project would finance civil works, equipment, and initial stocks o f inputs necessary for the establishment and functioning o f the milking stations. Each milking station would also be supplied with an Internet connected computer for the management o f cow performance records. The project would finance civil works and equipment for these centers. (c) Dairy parks (RMB 260.9 millionor US$31.5 million). Dairy parks are defined as an area o f two or more hectares surrounded by a wall enclosing between 5 - 50 sheds and housing 300 to 500 dairy cows, along with a milking station, feed storage and processing facilities and veterinary clinic. Under this sub-component, the project would promote improved milk quality, herd management and environmental management o f dairy production. To achieve this, the project would provide loans to investors and smallholder farmers groups/associations to establish about 50 new dairy parks o f 500 head capacity and the upgrading o f about 20 existing parks. The parks would provide housing and milkingsheds for smallholder farmers to outsource Figuresindicate total costs includingcontingencies (2 percentphysicaland6 percent for prices) 5  part or all milking and feeding management for their cattle. The parks would be jointly owned by a public sector entity with one or several private investors, as well as a number o f smallholders as individuals or as a group. To allow smallholder farmers to own a major share o f the parks, the public sector entity would initially be the majority shareholder and subsequently cede its shares to the smallholders. Smallholder households would receive loans to purchase the dairy cattle to be housed in the parks and an initial feedlveterinary supply stock. The project would finance civil works and the purchase and installation o f equipment for the parks. The parks would have sufficient space to accommodate the dairy cattle o f about 75 households, each owning from 1to 10 cows. As in (a) above, the total number o f cows per household will be flexible and demand-driven. Farmers will be able to purchase local or imported cattle. Experimental waste treatment systems that convert manure into fertilizer would be installed in 13 dairy parks (Italian Grant funding). Contractual arrangements between park owners and park management, and between park management and farmers housing cattle in the parks are described in the Project Operations Manual. Dairy parks will play a public good role by being a part o f the DHInetwork. They will provide outreach services to dairymen outside the parks, which would include technology transfer indairy management, feeding, health care and artificial insemination. (d) Demonstration farms (RMB 189.5 million or US$ 22.9 million). The main purpose o f the demonstration farms would be to accelerate the promotion and adoption o f improved dairy management technologies. Under this component, the project would provide loans to public and private sector enterpriseshvestors to establish up to seven demonstration farms, one in each project district. These farms would provide technical and managerial demonstration, as well as training to technicians (training o f trainers), dairy park managers and park owners. Experimental waste processing systems that convert manure to fertilizer would be installed at each demonstration farm. The demonstration farms would be jointly owned and established by a public sector entity and by one or several private investors. Public sector entities would retain a major share and ensure that the investment continues to provide a public good to the Heilongjiang dairy sector. Under this sub-component, the project would finance civil works, the import o f 600 highquality dairy cows for each farm, the procurement o f an initial feed stock, as well as milking, transport and other equipment for each farm. (e) Farmer associations (RMB 2.9 million or US$ 0.35 million). Under this innovative sub- component, the project would facilitate the emergence and support the development o f village- level, voluntary and independent dairy farmers' associations. The aim o f this sub-component i s to build the institutional capacity o f the associations to make them into key players in the development o f the province's dairy sector and in the promotion and defense o f dairy farmers' interests. To promote associative activities, the project would finance training for farmer association members, leaders and managers, and would provide small grants for registered farmers' associations. The project would also finance: (a) national technical assistance for the training o f municipal, county and township leaders on farmers' association legal framework and social roles and values; (b) provide training and study tours for trainers, government officials and community leaders to selected Chinese provinces where associations have begun to play an active role in rural development; and (c) finance the preparation and distribution o f training materials. (0 Training and technology transfer (RMB 18.4 million or US$ 2.2 million). To support the adoption o f management and technological changes introduced by the project, this sub- component would provide training and demonstrations to staff o f the Animal Husbandry Bureau (AHB), dairy park managers, park and demonstration farm owners and technicians, as well as dairy farmers. The project would finance training o f trainers for participating AHB staff and 6  township and dairy park technicians, as well as farmer training by AHB staff and local technicians. Training o f dairy park managers on financial management, human resources management, and the development o f training and technical manuals for extension workers, milkprocessing staffand farmers would also be financed. Inaddition, the project would finance the procurement o f vehicles and artificial insemination (AI) and extension equipment for participatingtownship AHB offices. The training and technology transfer activities have the double objective o f contributing to increasing the profitability o f dairy operations and reducing risks to farmers. However, in the unlikely event that milk prices should fall during project implementation to a point where project-funded dairy operations would become non-viable in the long run, the Heilongjiang government and the Bank would identify and agree upon other more profitable livestock activities that would be funded under the project. Component2: Breed Improvement(estimated cost RMB 58.0 millionor US$7.0 million). The aim o f this component would be to improve the genetic base o f the Heilongjiang dairy stock, the efficiency o f milk production and milk quality. This would be achieved by establishing a comprehensive (DHIP), including the recording o f milk and livestock management data, bull breeding and progeny testing. While a number o f cattle breeding programs have been implemented in China in the past few decades, this would be the first time that a comprehensive DHIP would be put in place. By the end o f the proposed project, it i s anticipated that this innovative Heilongjiang DHIP would cover about 150,000 dairy cows. Implemented properly, the program would achieve, with low downside risks, substantial and sustained improvements inmilk production, productivity and product quality throughout the Heilongjiang dairy sector and beyond, and would be a key element in improving its competitiveness. The program would be implementedin four steps, which are summarized below and detailed inAnnex 4: Step I:Initial capacity building - The project would finance the establishment o f a DHIP Management Unit (MU), within the Heilongjiang Dairy Industry Association (HDIA), which will provide policy, technical and operational coordination. As a first step, breeding goals will be defined with the participation o f all stakeholders, the capacity o f staff in relevant government agencies would be strengthened, and the milk recording elements o f the program established. Step 2: Broadening and accelerating genetic improvement - The project would finance an initial importation o f 400,000 units o f semen o f proven bulls, increasing by 10 percent annually to a total o f about 840,000 units, civil works and equipment for semen storage facilities, the accreditation o f the Animal Breeding Center inthe international DHIP system and technical assistance. Step 3: Establishing a systemfor local genetic evaluation - The project would support the development o f the milk recording program into a system of genetic evaluation o f promising bulls. The project would establish the systems for the genetic evaluation and selection o f cows and bulls for contract mating, and for local young bull production, progeny testing and lay-off. The project would finance equipment for milk sampling and collection, civil works and equipment for a milktestinglaboratory, software and hardware for data analysis and management, as well as the technical assistance needed to introduce the system. The project would also finance the contract mating o f the top- milking200 cows to the top proven bulls to producethe first batch o f about 80 bull calves for rearing and subsequent progeny testing. The costs o f imported semen and insemination will be fully charged to the farmers, as is currently the practice, and will be used to finance a revolving fund that will finance future semen importation. Options for cost recovery o f those activities will be reviewed at the mid-term review. 7  This Dairy Industry Association will be responsible for the implementation o f this component. Data analysis will be provided by the Heilongjiang Livestock Information Center (HLIC), a public institution with a proven record, and the Heilongjiang Animal Breeding Center (HABC) will be responsible for semen production from the proven bulls resultingfrom the DHIP. Component3: ClimateChangeMitigation(estimated cost RMB86.2 million or US 10.4 million). The aim o f this component would be to demonstrate and pilot innovative technologies to increase carbon sequestration and mitigateheduce GHG emissions resulting from the expansion o f livestock production in Heilongjiang. The project would finance specialized equipment, civil works, technical assistance and training o f staff and project beneficiaries to pilot innovative technologies in: (a) pasture improvement for the purpose o f increasing fodder production, carbon sequestration and combating desertification; (b) treatment o f crop residues to improve their quality and usage in animal feeding, decrease methane emissions and reduce on-field burning o f residues; (c) treatment o f animal manure to reduce methane emissions and convert it into a salable fertilizer; and (d) assessing climate change experimental technologies through the implementation o f research programs. A detailed description of this component i s inAnnex 16. Component 4: Project Implementationand Management (estimated cost RMB 9.3 million or US$ 1.1million). The project would be managed by the existing Bank-supported Provincial Project Management Office (PPMO) within the Heilongjiang Development and Reform Commission (HDRC) and Project Management Offices established at county level. The PPMO would be responsible for all aspects o f project administration, including program management, procurement, financial management, and monitoring and evaluation. The PPMO would receive policy guidance from a Project Leading Group (PLG) and from a Technical Working Group (TWG) as regards technical issues and coordination. Under this component, the project would strengthen the provincial government's capacity to monitor project impacts and would finance the conduct of annual socio-economic and production surveys. The project would help build the capacity o f the PMOs and Finance Bureau at all relevant levels in loan appraisal, monitoring, recovery and the overall management o f the Bank-financed Line o f Credit. The project would also help build the capacity o f the Heilongjiang Environment Protection Bureau (HEPB) to monitor project environmental impacts. The project would finance technical assistance, training and equipment for the PPMO and county PMOs. The structure o f the PPMO and PMOs, including staffing requirements and the composition of the (PLG) and the TWG are described inAnnex 6. 4. Lessons learnedand reflectedin the projectdesign The project design benefited from the Bank's experience in the implementation o f other agriculture and rural development projects in China and other countries, particularly the lessons learnt from the recently- closed Heilongjiang Agricultural Development Project. Key lessons reflected in the project design include: Commitment by government and the active participation o f beneficiaries and other stakeholders.(village, township and country governments, and line agencies) is critical to ensure the smooth implementation, success and sustainability o f the project. The Social Assessment conducted during project preparation allowed for extensive consultations with farmers and other stakeholders to determine site selection for milking stations, parks and demonstration farms. Concerns for gender issues and equity among beneficiaries were also addressed inthe project design. 8  Inrecognition o f China's move towards a market economy, the proposedproject gave a determinant role to private sector enterprises and individuals who would participate in the project. Modeled on the HADP, the proposed project would maintain a focus on helping smallholder dairy farmers at both the farm household and in the proposed dairy parks. Many investment activities under the project will be owned and operated by private entities or individuals. Where local administrations choose to invest in dairy farming infrastructure in support o f local farmers, those assets will be leased to and managed by the beneficiaries or professional managers without government interference. To ensure its success, the project would invest extensively in building the technical and managerial capacity o f farniers, staff o f technical departments and their managers. China has little experience in the development o f farmer's associations outside o f the collective farm model. One emerging example o f successful farmer association in China lies with the Bank financed Self- Financing Irrigation and Drainage Districts (SIDD) supporting farmer participation in local irrigation management. Key lessons learned from the SIDD program to date include: local government must fully support the development of farmer's associations3; farmers must be fully engaged in the setting o f the association goals and charter; associations must directly manage the resources under their control (milking stations, dairy parks, field demonstrations, etc); the ways of management may vary with local circumstances; farmers' associations should be represented in higher level industry organizations (e.g., the HDIA); and farmers' associations will require strong government support (not control) and capacity buildingto succeed. 5. Alternatives considered and reasons for rejection Initially, the project team proposed a concept under which only large dairy parks (500 to 1500 dairy cows) would be set up and operated exclusively by large private sector companies ("dragonhead companies"), and where individual dairy farmers would rent space to raise 20 to 100 dairy cows. This approach was rejected because: (a) it would not have targeted the relatively poorer smallholder farmers who should be the primary beneficiaries o f Bank assistance; and (b) the potential negative environmental impact o f these very large dairy parks would be correspondingly large. The project design allows flexibility, depending on local conditions and beneficiaries' interest, for on-farm or in-park dairy production, and criteria for beneficiary selection have been included to ensure the inclusion o f smaller farmers, as well as gender and ethnic group representation. The initial project concept also proposed the creation o f 15 dairy breeding farms, exclusively owned and operated by private sector companies. This alternative was rejected because: (a) the proposed breeding farms by themselves would have had only a marginal impact on improving the genetic potential o f the Heilongjiang herd; and (b) financing assets for private sector enterprises that do not have a public goods element and do not positively impact the income and livelihood o f significant numbers o f dairy households would not be within the mandate o f the Bank. The project has retained seven demonstration farms with a clear public good element o f training and demonstration purposes. China has an adequate regulatory framework to manage the environmental impact o f smallholder dairy farms, larger dairy parks and the milk processing industry. However, private sector enterprises have shown their reluctance to bear the costs o f environmental protection and tend to circumvent their legal obligations in this regard. Because the provincial regulatory institutions have limited capacity in monitoring and enforcing environmental compliance, project design was amended to include some technical assistance and training support to the HEPB. All seven village leaders interviewedduringthe socio-economic study supported the development oflocal dairy farmer associations. as did most o f the 300 farmers interviewed. 9  C. IMPLEMENTATION 1. Partnershiparrangements The project would benefit from a U S 5 . 5 million Italian Trust Fundgrant to support measures to increase carbon sequestration and reduce emissions resulting from the expansion o f livestock production. The project would work inpartnership with all agencies involved in the development o f the Heilongjiang dairy industry.The Animal Husbandry Bureau (Heilongjiang Province) (HAHB) would provide technical and animal health support at provincial, municipal, county and township level through its network o f livestock technical extension centers. In this task, the H A B C would be supported by the H L I C and its Internet-based livestock information database, which i s now available through a wireless TV based systems at the farm household. The HABC would provide a comprehensive AI service to project farmers usinghighbreeding value imported semen. The HEPB would provide environmental management advice and monitor environment impacts from dairy park and demonstration farm development. The recently- established HDIA would play a coordinating role in the development o f the dairy industry. The HDIA would also coordinate the development o f the DHIP in collaboration with the HLIC, HABC, HAHB and farmer associations. The implementation o f the climate change activities would require collaboration with the North East University and other institutions involved in pasture improvement and agricultural waste management. The project would also work in close collaboration with the dairy processing industry in Heilongjiang, which plays a major role in milk production and in the establishment o f sanitary milking facilities across the province. While the project would establish a stronger role for private farmers in the production o f high quality milk, the dairy processing enterprises would be a partner in this process. This would occur through cost sharing inthe establishment o f some milking stations, dairy parks, demonstration farms, and with the development and implementation o f milk testing and quality promotion activities across the industry. The project area covers about 120,000 km2with a total population o f 20 million people by 2.67 million ha o f cultivated land. The project would be implemented in approximately 32 counties that extend from the eastern zone city o f Qiqihar, north to Heihe and through to the central zone centered on Harbin city to the western zone areas around the cities o f Jiamusi and Mudanjiang. 2. Institutionaland implementationarrangements ProjectManagement The project would be managed by the existing PPMO within the HDRC. The PPMO has become familiar with Bank procedures through its implementation o f the recently completed HADP. Under the project, the PPMO would be responsible for the day-to-day management, including work programming and financial management, project procurement, progress and financial reporting, staff appointment and management, and project monitoring and evaluation. The PPMO would include eight professional staff and seven administrative and support staff. The composition o f the PPMO i s described in Annex 6. An Operations Manual (OM) would be prepared by the PPMO and FB to standardize project implementation. The OM would include chapters on: (a) detailed on-lending arrangements o f project funds, (b) a financial management system; and (c) procurement procedures. The OM would be maintained as an operations reference manual until the completion o f the project. 10  At county level, County Project Management Offices (CPMOs) will coordinate activities, working in collaboration with county-level Bureaus o f Finance (BOFs) and AHB counterparts. Under the guidance o f the PPMO, CPMOs will be responsible for consultations with farmers and the identification o f participating farmers, coordinating investment planning, monitoring in collaboration with HEPB and HAHB staff the environment impact assessments, organizing supporting services and capacity building programs and monitoring project outcomes at the local level. County BOFs will be responsible for loan disbursement and recovery at county level. As many CPMOs will be new to Bank procedures and project management, extensive training in a range o f technical and management issues, including financial management and procurement, will be provided to CPMO staff. The composition of CPMOs i s described inAnnex 6. At township level, CPMOs will work with township veterinary, animal production and AI technicians who will be provided with training and equipment. At village level, the local village leaders and Village Management Committees (VMCs) will assist the PPMO to advise farmers on project investment options and policies, identify project beneficiaries, and monitor project implementation. The project will also collaborate with the All China Women's Federation (ACWF) and China Communist Youth Party (CCYP) intraining and other village-level project activities. The (DHIP) described under component 2 o f the project would be managed by the (HDIA) whose mandate includes coordination o f public and private stakeholders for the sustainable development o f the dairy industry. A DHIP Working Group, established under the HDIA, would be responsible to the PPMO for planning, monitoring and reviewing the implementation o f the DHIP. The Working Group will include the HDIA, HABC and HLIC. The capacity o f these agencies to implement the DHIP will be strengthened through training, technical assistance and the provision o f equipment. The Climate Change Component would be implementedby the PPMO and relevant CPMOs. The PPMO would implement this activity in close collaboration with the institutions in charge o f pasture renovation and management, and animal waste disposal and with entities that will conduct the special research activities. These research activities would be funded through a competitive grants process on the basis o f recommendations by a research committee to be created within the PPMO. The project would require the project entities involved in the Climate Change Component to monitor and document the environmental impacts and economic performance o f the activities supported by the Italian grant at mid-term review and at project completion. Several o f the proposed activities are still at the applied research stage or have not been field tested under Heilongjiang's harsh winter conditions. The monitoring and evaluation o f their economic and environmental potential, along with that o f more traditional and established techniques, would constitute a major contribution o f the project to the development o f the climate change mitigation strategy for China's agriculture sector. The Terms o f Reference (TORS)for the research committee and for the research evaluation and monitoring framework are detailed inAnnex 15. ProjectLeadingGroup (PLG) Project policy would be set by a PLG, chaired by the Vice Governor o f Heilongjiang Province and include .the Directors o f the Heilongjiang Bureau o f Finance (HBOF), HDRC, HABC, HEPB, the Audit Bureau and the Heilongjiang Agriculture Commission. This would include the approval o f participating municipalities and counties, lending terms and conditions and issues relating to public good investment and the contribution o f private investors under the project. The PLG would meet regularly to review semi- annual and annual progress reports and annual work plans, and to respond to policy issues raised by the PPMO. 11  Technical Advisory Committee (TAC) A TAC would provide guidance to the PPMO on technical issues and ensure the inter-agency coordination required for successful project implementation. The TAC would include representatives o f the HAHB, HLIC, HABC, North-East Agricultural University, HDIA, HEPB and the ACWF. The Director o f the AHB would chair the TAC. The TAC will meet at least quarterly to review project implementation progress, and advise the PPMO on project activities and direction. FundFlows and On-LendingTerms to Beneficiaries Two Special Accounts (SAs) would be opened and managed by the HBOF. One SA would be dedicated to the Bank loan funds and the other to the Italian grant funds. Funds from the Loan and the Grant would flow from the MOF to the SAs and then to the municipal and county Bureaus o f Finance. Loan funds would be on-lent by the M O F to the Heilongiiang Province, which would pass them on to its participating prefectures, cities and counties (Annex 17). The County Bureaus o f Finance would pass on most o f the loan proceeds in kind (about 84percent), in the form o f dairy cattle to beneficiaries. Of the remaining US$16 million, about half would be expended for public good activities such as dairy cattle breeding, training and support to farmers associations. The other half would be on-lent to Legal Enterprises (LEs) made up o f smallholders and private sector enterprises to build dairy parks, demonstration farms and milkingstations. Smallholders and LEs would benefit from project assistance (cows and/or buildings) only once and there are no revolving schemes envisaged. Project beneficiaries are expected to pay for the dairy cattle and buildingsthey receive from the proceeds o f the sale o f their milk through the dairy parks or in cash. The terms for repayment o f their debt to the County Bureau o f Finance would be over a period o f six years with two years o f grace on the payment o f principal for the smallholders purchasing cows and for LEs investing inmilkingstations and demonstration farms. For LEs investing indairy parks, financial models indicate that the repayment period should be o f at least eight years with three years o f grace. The maturity terms and the interest to be charged to project beneficiaries are detailed in Annex 17. Beneficiary Selection Criteria The selection o f smallholder households participating in the project would be conducted transparently, using a weighted point system based on the following criteria: (a) at each project site, and to the extent that demand permits, half o f the project's participants should be households which currently have no dairy cattle; (b) at least one household member should be literate; (c) beneficiaries should be experiencedhkilled with livestock raising, either as owners or workers; (d) beneficiaries should be voluntary participants and households should have sufficient labor; (e) ability to repay loan: factors to consider include credit history, current debt load, current income status, cosignatories/guarantors; and (f) for the individual household sites, space should be available for shed and the household's relative distance to the milkingstation. 3. Monitoring and evaluation (M&E) of outcomes/results Monitoring o f the project's outcomes would be measured through regular progress reports which would include key indicators such as the number o f farmers participating in the project and the increase o f individual household and aggregate milk sales to processors. Through periodic socio-economic and production surveys, the efficiency and social distribution o f dairy production investments under the project would be monitored. Baseline data was collected through a survey o f 300 farmers and 70 milk processors during project preparation. Most farmers interviewed have agreed to be periodically re-interviewed over the life o f the project and beyond. The follow-up data collection and reporting format are detailed in Annex 3 and 12  would be agreed upon during project appraisal. Project progress will be monitored through regular reporting by the PPMO and through project supervision missions. Reporting will be done by the PPMO through semi-annual progress reports, a mid-term review report and a project implementation completion report in a format acceptable to the Bank. Staffing o f the PPMO would include an M&E specialist. The DHIP Working Group will be responsible for monitoring the DHIP. Progress indicators would include the number of farmers using proven semen, the number o f farmers participating in the milk recording system, as well as the number of elite cows identified and the number o f bulls bred and proven. The Working Group would rely on regular progress reports by the participating agencies (AHB, HDIA, HLIC and HABC) to monitor DHIP progress. Under Component 4 (Project Implementation and Management), provision has been made for the PPMO to contract out the conduct of periodic surveys necessary for the monitoring and evaluation o f the impact o f the project. Under this same component, the environmental impacts and economic performance o f the climate change mitigation activities supported by the Italian grant would be monitored and verified. 4. Sustainability The sustainability o f project activities and outcome beyond the implementation period is considered likely, because the project is specifically designed to support and improve the competitiveness and profitability o f an already profitable and rapidly expanding industry. However, given the high income elasticity o f demand for dairy products and the steady growth o f sales, a declining business environment in China would be a negative factor for the long-term development of the dairy industry. The development o f farmers' associations, eventually integrated into dairy sector management through the HDIA, would be central to the sustainability o f smallholder production, both on household farms and in dairy parks. While farmers' associations are a new concept in China and particularly in Heilongjiang, experience with the development o f water users' groups elsewhere in the country, combined with the necessity o f collaborative action to effectively manage project investments and resources (dairy parks, milkingstations, pastureland), mitigates for a sustainable result. Once established, the DHIP could be easily expanded to directly involve the majority o f the dairy sector inHeilongjiang. Significant project benefits would flow not only to producers but also to the processors , and consumers and, in the form o f public goods, to the community as a whole. Because the DHIP provides for both managerial and genetic improvements in milk productivity and hygienic quality, a high return on investment can be anticipated. Within the provincial dairy sector, this return would be spread in a structured way, with participants in the milk recording system of the DHIP benefiting most; hence, the importance o f expanding milk recording at the earliest possible date, once the DHIP i s established. Provision has been made to include the Heilongjiang DHIP within the national dairy herd improvement program to be implemented by the China's National Dairy Association with technical assistance support from a Dutch specialized company. Chinese environmental regulations together with an improved enforcement capacity and the use o f project-managed environmental check lists should ensure a sustainable environmental outcome. The new Chinese Grassland Law (2003), which the project would support, has a strong focus on reducing grassland degradation. Project proposals to transfer effluent to pastureland would reverse the negative fertility balance presently experienced in most pasture management systems. Strict application o f regulations governing dairy farm waste disposal combined with the required Environmental Impact (EIA) would ensure the integrity o f streams and groundwater resources. The Italian Grant would help address the serious problems relating to degraded grasslands and soil salinity. This would require a 13  systems approach and an integrated multi-disciplinary team with researchers covering soils, pasture ecology and agronomy and ruminant nutrition working together. 5. Critical risks and possible controversialaspects Potential risks include commercial risk, financial risk and a capacity risk. The main commercial risk i s related to the operation o f milk processing companies in Heilongjiang. These companies have expanded aggressively in the Province over the last few years, installing milk processing capacity well in excess o f supply. This includes the installation o fmilkingstations to capture supply at the local level. The industry survey indicates an average capacity use by milk factories o f about 60percent, well below good commercial practice. The risk i s that the additional overhead costs are being passed on to farmers through lower milk prices. The difference between farm gate milk price in Heilongjiang and that in the Beijing and Shanghai milk catchment areas, which can be as much as 40 percent, cannot be fully explained by quality differentials, suggesting that company growth strategies may be disadvantaging local suppliers in Heilongjiang. Historically, milk processors in Heilongjiang have negotiated exclusive area rights to milk purchase with county governments encompassing the entire county. The recent expansion o f milk processing in Heilongjiang appears to have set aside these compacts; however, only one company, Yili, has established a province-wide milk procurement strategy and some counties (e.g. Fuyu, Zhaodong) are still dominated by single companies, though not through compacts with County government. The risk o f monopolization of local markets, therefore, remains proximate and should be monitoredby the project. The financial risk relates primarily to the rapidly rising cost o f dairy cattle in the province and fluctuations in raw milk prices. Cow prices have risen approximately 400 percent over the last decade while the farm gate milk price has risen by only 15-20 percent. With dairy cattle now forming between 50-60 percent o f the total investment cost in dairy farming, this i s significantly reducing dairy farm profit. The results o f the February 2005 milk marketing study4were reviewed by the Heilongjiang authorities, MOF and the WB task team, and were found to be realistic. Nonetheless, it was agreed that risks to project farmers should to the extent possible be minimized. To achieve this goal, the design o f the project included funding to support activities aimed at improving dairy yields, animal health, artificial insemination services, farmers' training and milk quality. Furthermore and in order to stabilize milk prices, production contracts would be signed between project dairy farmers and milk processors to guarantee farmers a minimumprice for their milk. The above notwithstanding, it was agreed that, in the unlikely event that milk prices should fall duringproject implementation to a point where project-funded dairy operations would become non-viable in the long run, the Heilongjiang Authorities and the Bank would identify and agree upon other more profitable livestock activities that would be funded under the project. The DHIP could be at risk if the Heilongjiang Government and the PPMO do not fully commit to the program and the Province does not take steps to address its lack o f capacity in the required field-scale organization o f milk recording, genetic evaluation and selection, contract mating, progeny testing, capacity building and awareness programs for service personnel and farmers. Other DHIP risks relate to disease in the AI center, inability to lift bull semen production to international levels and failure to establish common breed improvement goals. Mitigating against these risks, the government has already The milk marketing study found that the expectedincrease inraw milk supply, resultingfromthe proposed " projectwill be absorbedwithoutdifficulty by the milkprocessingenterprises inthe Heilongjiangdairy project area. The liquidmilk products will find growing demand inthe North-Eastprovinces and ingreaterBeijing. The market for Heilongjiangmilkpowder is nationwide. The leadingHeilongjiangmilk powder producerswill continue to increase their saces andmarket share. There is a wide safety margin in the supply/demandprojection for raw milk, Noneofthe identifiedrisk factors is likely to affect decisively the marketabilityofraw milk". 14  endorsed the DHIP strategy, the HDIA provides a suitable forum for agreement on breed policy and the project has allocated funds for the provision o f expatriate technical assistance and training at all levels to support the introduction o f the DHIP. In addition, the China National Dairy Association has recently contracted with a specialized Dutch company to obtain technical assistance in the implementation o f a national DHIP. Heilongjiang would most likely receive long-term technical assistance support under this national program. 6. Loadcredit conditions and covenants EffectivenessConditions (a) The Grant Agreement for the Italian TF Grant has been executed by the Government. (Standard condition) and all conditions for its effectiveness (with the exception o f the effectiveness o f the Loan Agreement) have been fulfilled. At negotiations assuranceswere obtained from the government as follows: Two SAs would be opened by HBOF at a commercial bank acceptable to the Bank (PAD Section C2, para. 8). PPMO/HBOF would maintain a project account and make sufficient counterpart funds available for the implementation o fthe project (PAD Section C2, para. 1). The PPMO with staff with qualifications acceptable to the Bank would be maintained at all time duringproject implementation. (PAD Section C2, para. 1). The government would maintain the OM until completion o fthe project (PAD Section C2, para. 1). A mid-term review would be undertaken no later than December 2008 (PAD Section C3, para. 2). Disbursement (opening o f Letter o f Credit for ICB contracts) for the procurement o f dairy cattle would be contingent on the satisfactory progress, as certified to the Bank by the PPMO, o f all the civil works, other infrastructure and feed necessary to house and care for the procured dairy cattle inthe Dairy Parks and DemonstrationFarms (Annex 6, page 54). Disbursement for each dairy park, dairy demonstration farm and village milking station would be contingent on the approval by the relevant local EPA for its respective environmental mitigation action plan (PAD Section D5, and Annex 10, page 90). The agreed criteria (PAD Section C-2, para. 9) would be used for the selection o f project beneficiaries. Adequate technical assistance would be recruited for the implementation o f the DHI component and for the preparation o f tender documents for the procurement o f dairy cows (PAD Section C5, para.4), which represent about 80 percent o f the value o f the Bank's Loan. D. APPRAISAL SUMMARY 1. Economic and financial analyses Economic analysis. The project's economic rate o f return (ERR) is estimated at 23 percent, with an economic net present value (NPV) o f RMB 1,064.1 million (at 12 percent). Activities with high ERRS include household investments in dairy production (19 percent), rehabilitation o f existing dairy parks (21 percent) and dairy breed improvement (63 percent). The sensitivity analysis shows that total project economic returns are robust in the case o f a decrease o f project benefits, an increase in investment costs, or a delay in project benefits. However, the economic viability o f investments in new dairy parks, for which the ERR is 14 percent, i s compromised by moderate (20 percent) decreases in project benefits or increases o f investments costs. Duringproject implementation, specific attention will have to be given to 15  the design and construction o f the dairy parks and to their management to mitigate those risks. Similarly, the economic viability o f demonstration farms i s sensitive to investment costs and decreases in project benefits. Financial analysis. The project's financial rate o f return (FRR) is 26 percent with a financial NPV o f RMB 1,387.8 million. At household level, the FRR of project activities are inthe range o f 25-27 percent for smallholder on-farm investments, and 25-26 percent when households keep their cows in dairy parks. Additional benefits o f dairy parks for households, not quantified inthe analysis, include time available for other remunerative activities and space provided in the dairy park (when farm size does not allow the development o f dairy activities). For milking stations, the FRR i s 30 percent, assuming that the station i s working at its full capacity o f 450 cows per day. Inthe case o f new dairy parks, the FRR for the investor i s 11.5 percent, assuming that rental rates are kept at a minimumto allow acceptable financial returns for the investor. Increases in rental rates result in better financial returns for park owners, but conversely involve higher costs for farmers. For demonstration farms, the FRR i s 17 percent. The financial viability of project activities has been tested against a decrease in milk prices, an increase in investment costs, and an increase in feeding costs. The sensitivity analysis shows that the returns for smallholder farmers are comparatively more sensitive to a decrease in milk prices. Trends in milk prices in Heilongjiang and the continued unmet demand for dairy products in the short and medium-term indicate that a decrease in milk prices i s unlikely. Prices paid to producers will be affected if (a) insufficient attention i s given to milk quality, and (b) unfavorable contractual arrangements allow milking statioddairy park owners to reduce prices to farmers in order to maximize their own profit. Special attention was given to those two aspects during project design and they will be monitored during implementation. The sensitivity analysis also indicates that investments in dairy parks are generally riskier than other project activities. Inparticular, the financial viability o f investments in new dairy parks i s very sensitive to investments costs. Design and construction o f the parks will require close attention to avoid extra costs. In the case o f milking stations, the sensitivity analysis indicates that investment costs and milk prices (which are based on milk quality) will be critical factors to ensure the financial viability o f the investment. The financial analysis indicates that revenues from dairy productionwould allow farmers and investors to cover their debt repayment needs under the loan conditions considered for the project. It i s expected that some households would seek loans from other sources (including informal loans) to raise some o f their contribution. This represents an additional risk for the household, and will have to be considered as part o f the assessment o f individual households' debt repayment capacity. Similarly, the financial situation o f investors in dairy parks, milkingstations and demonstration farms would need to be assessed on a case by case basis. 2. Technical Heilongjiang has a sufficient technical base for the development o f its dairy industry; however, further investment in institutions and staff capacity i s required to lift the industry beyond its present level o f productivity and resource utilization. The project will invest extensively in the key livestock institutions and staff through the development o f the DHIP which will underpin future industry efficiency and productivity. The Italian Trust Fund will also finance a broad-based program o f field trials and demonstration investments to strengthen pasture development and sustainable management and to improve dairy farm waste management. The project would also invest extensively in national and international technical assistance and technician and farmer training including a training o f trainers program. 16  3. Fiduciary Procurement. The procurement under this project covers goods, livestock, civil works and consultants' services which will follow the Bank Guidelines and Standard Bidding Documents. Procurement o f livestock would account for a large portion o f total procurement. It was agreed that both international and national consultants would be hired during project implementation to review technical specifications for the purchase o f livestock and to provide advice to implementing agencies inhandling the large amount o f livestock purchase, including bidding, bid evaluation, transport and inspection o f livestock and other technical matters. A procurement capacity assessment was undertaken in August 2004. The assessment reviewed the implementing agencies' organizational structures and functions, past experience, staff skills, quality and adequacy o f support and control systems, and the legal and regulatory frameworks. The overall project risk for procurement is rated as average. The agreed procurement responsibilities o f Provincial PMO are: (a) to prepare procurement management regulation (PMR); (b) to preparehpdate the procurement plan; (c) to organize and manage ICB procurement, (d) invite and sign consultants services contracts; (e) to coordinate internal clearance by central government agencies, such as the Ministry o f Commerce for procurement o f mechanical and electronic equipment and the Ministry o f Agriculture for import o f livestock; (f)to review and supervise the procurement activities handled by the citylcounty PMOs; (g) to provide technical guidance to PMOs at lower level; (h) to organize and provide procurement training to city PMOs and county PMOs; and (i) prepare the procurement progress report. At city and county levels, the PMO was also established in each city and county to implement the project activities for their own part. The organization structure, allocation o f responsibility and decision-making authority are almost as same as provincial level. The main responsibilities o f PMOs are: (a) prepare procurement plans for their own city or county; (b) to manage (NCB) and shopping procurement; (c) to monitor and supervise procurement activities at lower level; and (d) to organize final inspection and acceptance o f completed works and delivered equipment and other procurement activities. At township level, the project will be supervised through township animal husbandry stations. Village households will build their own animal sheds, silage pits and other very small works in accordance with the construction standards issuedby the Provincial PMO. The agreed actions to address weaknesses include: (a) roles and functions o f PMOS at each level as above mentioned should be defined and documented in the (PMR which would form part o f the OM)) to be prepared by Provincial Development and Reform Commission; (b) qualified procurement officers at each level should be employed no later than loan negotiations;. qualifications and job descriptions should be prepared and submitted to the Bank for comments; (c) procurement training plan should be included in the overall project training program; (d) the procurement plan for the initial 18 months has been prepared and reviewed and approved by the Bank before loan negotiations. The procurement plan should be updated annually or as required to reflect the needs o f the project implementation and capacity o f the implementing agencies; (e) procurement filing system should be in place after the loan i s negotiated. It i s also recommended to carry out prior review o f procurement documents and to use a six-month cycle for procurement field supervision missions in the first two years o f the project, and once a year thereafter for carrying out procurement expost review. Financial management. A financial management assessment, conducted in August 2004 (in line with the guidelines issued by the Financial Management Sector Board on October 15, 2003), concluded that the project meets the minimum Bank financial management requirements, as stipulated in BP/OP 10.02. The project would have an adequate project financial management system in place that would provide, with reasonable assurance, accurate and timely information on the status o f the project in the reporting format agreed with the project and required by the Bank. N o outstanding audits or audit issues exist with the Heilongjiang PPMO. The task team, however, will continue to be attentive to financial management matters and audit covenants duringproject supervision. 17  Fundingsources for the project include the Bank's loan, the Italian TF Grant and counterpart funds. The Bank loan and grant proceeds would flow from the Bank into two project SAs to be opened and managed by the (HBOF). HBOF funds would move to the relevant Municipal/Prefecture and county Bureaus o f Finance and then on to the beneficiaries, contractors and suppliers. The Bank Loan and Italian TF Grant Agreements would be signed between the Bank and the People's Republic o f China represented by its Ministry o f Finance (MOF). The Bank loan would be fully repaid by MOF and there would be an on- lending agreement between MOF and the government o f Heilongjiang Province. In accordance with the prevailing agreement between the Bank and MOF, the project would disburse on the basis o f traditional disbursement techniques and would not use the PMR-based disbursement system. The contribution o f counterpart funds would be about 14 percent from prQvincial/city/county government budgets, about 16 percent from private sector companies and individual investors, and about 11 percent from beneficiary households. 4. Social The results o f the socio-economic and production survey conducted in May 2004 have been used as a basis for social assessment in this project. The findings o f this study have generally been used in designing the project. The study was done in consultation with stakeholders, the government and local village administrations. A social assessment summary i s contained inAnnex 10 (C). Aside from Social Safeguard concerns (see below and Annex lo), the main social issue was ensuring the participation o f poorer villages and villagers to enhance the poverty alleviating potential o f the project. This aim was achieved partially through the project management's placement o f half the project sub- components in villages and townships whose annual per capita income was lower than the annual per capita rural income o f the counties in which they are situated in (see Appendix 1). Selection criteria for households were adjusted to enable those poor households which could repay the loans to participate in the project, Both o f these measures should boost the project's contribution to socially balanced economic growth, In addition, the project includes activities to support the creation and growth o f Farmers' Associations (Annex 4: l(f)). 5. Environment The project i s classified as an Environmental Category B and a safeguards policy S2 project, in accordance with Bank environmental assessment procedures. A draft Environmental Impact Assessment has been prepared. The document includes a description o f the project, a description o f possible activities that the project might finance, potential environmental issues for each type o f activity the project could finance, a description o f the guidelines the PPMO and HEPB would follow in evaluating the impacts o f each sub-project, a description o f the Bank and PRC safeguards and EIA systems, and sample forms to be used in environmental monitoring. The document has been reviewed and cleared by the project environment specialist. The EIA report has been translated into Chinese and made available locally. The report has also been discussed with the staff o f the HEPB, whose recommendations were incorporated in the OM. The EIA report has been sent to the Bank's info-shop for disclosure to the public. The project would not finance any major infrastructure, and sub-projects are unlikely to involve the acquisition o f land through eminent domain. Environmental regulations prohibit the construction o f dairy parks close to water courses and drainage systems, and proposals to spread effluent on under-fertilized pastureland or compost it to produce bio-fertilizers would significantly reduce any environmental threat. The project would not finance activities that would significantly convert or degrade any protected areas, known natural habitats, or established or proposed critical natural habitats as defined under the policy. The project area includes over 50 different minority groups. None would be specifically disadvantaged by the project which would pro-actively encourage minority household participation in dairy development. Since sites o f the dairy parks have not been identified, at this time it i s not known whether project activities would adversely affect sites having archeological, historical, religious or unique natural values. 18  An appropriate clause would be included in all construction contracts regarding the procedures to be followed in the event o f chance finds o f culturally significant sites. The project would not directly finance purchases o f fertilizer, agro-chemicals, medicines or vaccines, although farmers are able, of course, to purchase them in the market or through farmer groups. The use and storage o f antibiotics in the project area is managed by the veterinary service, and dairy factories test systematically for the presence o f antibiotics in milk. The risk o f animal disease i s offset by an extensive local disease management program and movement control on all farm animals, which have a unique animal health identity number. Training would be provided for farmers under the project in appropriate application techniques and timing for fertilizers, pesticides and medicaments, as well as handling o f residues. This would be expected to contribute to reducingthe negative impact o f increased inputuse. Safeguard policies SafeguardPoliciesTriggered by the Project Yes N o Environmental Assessment (OP/BP/GP 4.01) [X 1 [X 1 11 Natural Habitats (OP/BP 4.04) [I Pest Management (OP 4.09) [I [X 1 Cultural Property (OPN 11.03, being revised as OP 4.1 1) [X 1 [I [X 1 Involuntary Resettlement (OP/BP 4.12) [X 1 11 Indigenous PeopCEs (OD 4.20, being revisedas OP 4.10) [I Forests (OP/BP 4.36) [I [X 1 Safety o f Dams (OP/BP 4.37) [I [ XI Projects inDisputedAreas (OP/BP/GP 7.60)' [I [XI Projects on InternationalWaterways (OP/BP/GP 7.50) [I [XI Involuntary Resettlement (OP 4.12). The PPMO hired a resettlement specialist to investigate land acquisition issues for the project. His report confirmed the PPMO's affirmation that the project will not involve any significant involuntary land or productive assets acquisition. However, in the event that small land parcels are affected by project acquisition or rental, a Resettlement Policy Framework (WF) for the various project sub-components (see Annex 10 [C]) will be implemented and the following guiding principles regarding land acquisition or rental by project components has been agreed upon: All efforts will be made to avoid or minimize the taking o f farmland for project use. Iflandisrentedfor projectuse, all effortswillbe madeto avoidrentingoffarmland. Iftheuseorrentoffarmlandorproductiveassetsisunavoidable,thenthePPMOwillproceed to compensate for losses according to the guidance o f both the World Bank's OP 4.12 on Involuntary Resettlement and relevant Chinese laws and regulations, including the PRC's Land Management Law and applicable provincial regulations. Property (OP 4.11). Although unlikely, some civil construction works could affect cultural property sites. The PPMO, incollaboration with the Provincial Cultural Relics Bureau, thus: (a) Confirmed that there are no sites in the project area (milking stations, dairy parks or demonstration farms) that are under the protection o f cultural relics protection units above the county level nor does any project sub-component site affect any historical and cultural sites recognized by any local relics bureaus. * By supporting theproposedproject, theBank does not intend toprejudice thefinal determination of theparties' claims on the disputed areas 19  (b) Explicitly pledged that if any culturally or historically significant finds are encountered during project implementation China's laws on protection o f cultural relics and the World Bank's OP 4.11will be invoked, leadingto the immediate cessation o f work, followed by an initial survey o f the site, its later excavation, and comprehensive protection o f the site. (c) Agreed that all project civil works construction contracts will include a provision stating that if cultural relics are found work will immediately cease and a report to the local cultural relics bureau will be made for the purpose o f relics preservation. Indigenous People's (OD 4.20). Indigenous people (Koreans, Manchus, Mongols, and Daur, among others) live in the project areas, overall comprising about 5 percent o f the project's potentially affected people, A minority nationalities expert was engaged by the PPMO to explore the likely indigenous dimensions o f the project. This report indicated that: (a) no special cultural tailoring o f the project was necessary to ensure that minority nationalities participate fully and appropriately in the project; (b) no negative effects were foreseen affecting any minority nationality, and (c) the province's most numerous minorities were adequately included in the project with the sole exception o f the Daur nationality. To rectify this omission, the project added two Daur villages to host project sub-components. With this inclusion, no Indigenous Peoples Development Planwas deemed necessary or useful. 6. Policy Exceptions and Readiness The project i s fully consistent with Bank policies and does not require any exceptions. Project staff at the various implementation units i s being mobilized and trained, including in the Bank's procurement arrangements. 20  Annex 1: Country and Sector Background HEILONGJIANGDAIRY PROJECT-PRC 1. Further progress on poverty reduction in China will to a large extent depend on the sustainable development o f China's rural areas. In recent years, China's annual GDP growth rate has averaged 7-8 percent, creating substantial domestic savings and international currency reserves. China's access to the World Trade Organization (WTO) in 2001 further strengthened its economic position. This has allowed the country to achieve considerable progress towards an ambitious and broad structural reform agenda, and the achievement o f the Millennium Development Goals (MDGs). Notwithstanding these achievements, almost 40 million people still live below China's poverty level. Living standards for rural areas have been on the rise and only 3 percent o f the population now faces food insecurity, but rural areas are still poor in absolute terms and the wide divide in income and living standards between rural and urban areas remain entrenched. Social indicators show that inequality and income gaps appear to be increasing between urban and rural populations and between coastal and inland areas, with the poor now mostly located in the rural areas o f the lagging inland provinces. The sustainable development o f rural areas i s one o f the most pressing economic and social issues facing China. With WTO membership and increasing integration with the global economy, the agriculture and livestock sector, the main source o f livelihood for many rural households, will have to undergo substantial structural changes. Increasingthe value and competitiveness o f cash crops and livestock production i s seen by the government o f China as critical for improvingrural incomes. 2. Rural areas in Heilongjiang have faced continually lower income levels than urban areas. In 2002, the average rural households' per capita income was RMB 2,405, only 39 percent the level o f urban areas. Of the 38 million people living in Heilongjiang, 61 percent live in rural areas. Approximately 80 percent o f the cultivated land i s farmed by smallholders, whose households are characterized by little arable land and unpredictable output. 14 out o f the province's 47 counties are classified as national poverty counties, while 21 counties are assessed by the provincial government as poor. 3. Agriculture and livestock sector development are key elements o f Heilongjiang province's growth and poverty alleviation strategy. The Heilongjiang Government has identified the agriculture and livestock industries as key elements o f its future growth and poverty alleviation strategies. Heilongjiang i s a major corn and soybean producer and one o f China's dominant milk-producing provinces, accounting for about 20 percent o f national milk production in 2002. China's Dairy Industry 4. China's dairy industryhas been rapidly growing over the past decade. It i s characterized by both rapidly growing demand and supply, with domestic production consistently lagging behind demand. Dairy consumption has grown at 10 percent per year for the past ten years, although it remains well below the world average o f 98 kg/capita, with 11 kg/capita consumption in 2002. This trend is largely driven by rapidly increasing incomes, and consumption is much higher in urban areas. The Ministryo f Agriculture i s projecting an 8 percent per annum rise in production over the next three years. Milk production i s dominated by smallholder farmers: 70-80 percent o f raw milk production comes from farms that typically have 3 cows each. 5. Government policies towards the dairy sector in China have been highly favorable. Since the 1980s, the government o f China has been promoting dairy production, which has stimulated large increases in production. Increases in milk consumption are valued as they improve nutrition and stimulate demand for milk, increasing economic development opportunities in rural areas. During the 21  mid-1980s, donor-supported programs began to provide funding and technical assistance for dairy production. More recently, the government o f China has declared the dairy industry as one o f the priority development areas for the 1Oth Five-Year-Plan (2001-2005). To increase milk production and reduce the gap between raw milk supply and demand, the Ministry o f Agriculture has formulated an Advantageous Cow Milk Production Area Development Plan, 2003-2007 to make better use o f milk resources and increase production through improved genetics, feeding management and processing in key milk production areas. A School Milk Project which reaches 1.5 million children i s part o f efforts to further stimulate long-termdemand for dairy products. 6. Accession to the WTO has increased pressure on the Chinese dairy industry to improve competitiveness. The tariffs on dairy products have been decreasing since WTO accession. The tariff on milk powder has decreased from 25 percent in 2001 to 10 percent in 2004. Currently, domestically produced milk and dairy products are cheaper than imported products. Imports o f milk powder are expected to increase, but markets for fresh and Ultra High Temperature (UHT) milk will largely continue to be supplied by domestic producers. Imports o f whey and powdered milk products increased dramatically from 60,000 tons in 2001 to 111,000 tons in 2002 and to 16,000 tons in the first half o f 2003. The increased competitiveness o f these imported dairy products will have a downward pressure on domestic dairy product prices, forcing processors to improve efficiency and competitiveness and drive further consolidationinthe processing sector. HEILONGJIANG PROVINCE'S DAIRYSECTOR 7. Heilongjiangis one of the leadingmilk producing provinces in China, supplying 20 percent o f China's total raw milk production in 2003. Production has been increasing by 20-25 percent per year since 2001. Milk prices are up to 35 percent lower than around Beijing and Shanghai, indicating a domestic comparative advantage, stemming from favorable natural conditions and availability o f labor. Dairy inputs are readily available in Heilongjiang, which i s one o f the grain production bases o f China, with an annual grain production o f 15 million tons. Inaddition, 65 million mu (4.3 millionha) o fpasture are available. Input capacity i s still underutilized as pastures have low value forage and corn stalk i s often burned instead o f being used for feed. Productivity levels are lower than both domestic and international levels. With an average o f 4.3 tons o f milk per cow per year, it i s 30-40 percent lower than productivity around Beijing and Shanghai and 50 percent lower than averages o f developed countries. 8. The Heilongjianggovernment has taken several steps to increase the growth of the dairy industry.A plan has been formulated for "Acceleration of Development, Rejuvenation of Dairy Industry and Facilitation of Strategic Adjustment of Agricultural and Rural Economic Structure", based on "The Tenth Five-Planfor National Economic Growth and Social Development of Heilongjiang Province". To increase the income o f farmers and adjust the structure o f agricultural production, the dairy rejuvenation plan i s focusing on industrial and scientific dairy production and provision o f social services/public goods. This includes promotion o f superior breeds o f dairy cattle, silage production, pasture improvement, new dairy farms, formation o f dairy parks, usage o f parlors for milking (target o f 80 percent by 2005), increasing household level production, dairy associations/cooperatives, and investment inresearch and extension. 9. The sustainable growth of the smallholder part of Heilongjiang's dairy sector is facing several challenges. The total size o f Heilongjiang's dairy herd i s 1.2 million cows. Although the structure o f dairy productionhas over the past few years seen significant changes, the majority o f milk i s still produced by smallholder households with herd sizes o f 3-5 cows. These households have little or no access to formal sources o f finance for investment in dairy production that would allow them to increase the quantity and improve the quality o f milk production. Milk prices have been increasing in Heilongjiang (4 percent in 2003), followed by increasing heifer prices, which more than doubled since 22  1999, reaching as high as RMB 17,000 for quality heiferdcows. These increases in prices have made it even more difficult for poorer individual households to access significant savings and credit to invest in dairy heifers, yet demand for milk has been buoyant enough to support demand for heifers at these prices. Heifer and yearling imports from New Zealand and Australia have been significant, but are not sufficient to lower pressure on domestic prices, leaving import prices, currently at approximately RMB16-20,000 post-domestic quarantine, only marginallyhigher. 10. Financingthe development of dairy production. Bank involvement would help alleviate the shortage o f funds needed to develop the dairy sector. At present, few commercial banks are providing medium-to long-term loans to the dairy sector. Most o f the commercial banks are pulling out o f the rural areas and leaving the burden to the Rural Credit Cooperative (RCC). The RCC has branches in 60 o f 65 counties o f Heilongjiang. However, medium-to long-term credit for dairy production i s only available in 6 o f the 65 Heilongjiang counties. The RCC was able to lend about RMB 200 million in 2004, enough to satisfy only 10 percent o f credit demand. Despite its plans to do so, the RCC is unable to expand its dairy portfolio or to satisfy mounting farmers' demand because o f shortage o f funds. The Project would alleviate this problem by providing an additional RMB 800 million over a period o f about five years. 11. The government of Heilongjiangconsiders a serious constraint to the growth of the dairy industry to be farm size in rural areas. Household-level dairy production faces production limits in village areas, as total space is limited. Duringthe long winter months, dairy animals must be housed in sheds because o f the extreme cold. Further expansion at the household level potentially poses a human health hazard from increased numbers o f animals sharing living space with humans. In the poorest households, cows are often even kept in the house. Environmental damage from increased animal waste managed at a dispersed level invillages i s also a concern o f local authorities. 12. The structure of milk processing in Heilongjiang is characterized by over-capacity and increasingconsolidation.All major nationalmilk processors have operations inHeilongjiang as well as a few foreign processors; there are also many provincial-level processors. 190 processing companies had operations in Heilongjiang in 1995, decreasing to 70 in 2003. Processing has been shifting from milkpowder to fresh and UHT milk,with a current UHTcapacity exceeding 1million tons and growing. Major national processing companies have gradually been buying smaller provincial level companies and many provincial companies now undertake contract processing for these national-level companies. Although there are still a large number of processors present, there i s a definite decreasing trend in the number o fpurchasers o fraw milk. 13. Low quantity and quality of milk supply are major problems for milk processors in Heilongjiang. Currently many processors are operating at 20-60 percent o f capacity, because o f a deficit in raw milk supply, indicating a large scope for increasing provincial production. The quality o f raw milk i s another major problem for milk processors, including high bacterial levels, adulteration o f milk, and high leukocyte (white blood cell) count due to sub-clinical mastitis. Milk not provided from milking stations is often adulterated with water or vegetable oil (to increase the fat content that brings a premium);the highbacteria and leukocyte levels are due to unsanitary living and milkingconditions for cows. Given these problems, processors have begun to invest in milking stations in milk production areas o f Heilongjiang. Typically, the milk processors provide milking equipment and some staff to oversee milkingwhile buildings and other infrastructure are provided by local government or investors. Some processors also have plans to invest in dairy parks, with ownership o f cows and/or infrastructure. Although companies would prefer not to invest in production or milking stations, these strategies are considered critical for capturing milk supply that has both adequate quality and quantity and maintaining long-term competitiveness given current provincial conditions. Some investors and companies, especially near urban areas, have also invested in larger-scale dairy farms. Currently, an estimated 10- 23  15 percent o f the cow herd i s in dairy parks that have 300 cows on average, a development that has occurred over the past three years. There are 28 large-scale farms with herds o f approximately 1000 cows. 14. Market risk to farmers is currently low. Risks related to raw milk demand, raw milk prices, market demand, and provincial competitiveness for Heilongjiang are low. A survey o f processors in the proposed project area has indicated that the expected increase in raw milk supply resulting from the proposed project will be absorbed without difficulty, with a wide safety margin, by the milk processing enterprises in the project area. Liquid milk products from Heilongjiang will find a growing demand in the north-east provinces and in greater Beijing. The market for Heilongjiang milk powder i s nationwide and the leading Heilongjiang milk powder producers will continue to increase their sales and market share. 15. Further improvements in dairy cow feeding management and genetics are needed for additionalproductivitygains.At the productionlevel, great progress has been made inimproving milk productivity through improved genetics and nutrition. Cows in Heilongjiang now have an average production o f 4,300 liters per year, well above average developing countries levels o f 2000 liters per year per cow. To further increase milk productivity, additional investments will have to be made inboth genetics and improved nutrition. Many producers still feed poor quality maize stalk instead o f maize silage as roughage. Silage maize i s already grown widely in Heilongjiang, but many farms do not have adequate sources o f silage or knowledge o f silage-making and its nutritional and cost advantages. Overall efficiency o f dairy feeding would be improved by investments in promoting maize silage use and training farmers to make silage. Ammoniating maize stalks will also improve feed quality. 16. Farmer representation and association is only beginning to form and be addressed in Heilongjiang. Inthe development o fprovincial dairy policy, no farmer associations are represented. At the local levels, counties and townships sometimes sign sourcing contracts with milk processing companies on behalf o f farmers. It will take time before farmer interests in the dairy industry can be adequately represented and associations formed. There are still national-level legal barriers to formation o f farmer associations and the facilitation o f cooperation amongst farmers, which i s only beginning, i s a gradual, iterative process. Inthe meantime, the protection o f farmer interests i s an important factor to be considered in dairy sector policy and development. This i s especially critical given the monopsonic nature o f local milk markets. In addition, better organization o f farmers through dairy associations would facilitate the dissemination and adoption o f improved milking, feeding, and animal husbandry practices. 17. Finally, research and investments are needed to improve the environmental sustainability of dairy development. This includes the renovation and better management o f the province's pastureland, improved feeding and usage o f crop residues, and improved waste management to mitigate the local and global adverse effects o f the livestock sector on climate change and the environment. 24  Annex 2: Major RelatedProjectsFinancedby the Bankand/or other Agencies HEILONGJIANGDAIRY PROJECT - PRC Sector Issue Project Latest Supervision(PSR) Ratings (Bank-financedprojectsonly) Bank-financedin China: Implementation Development ~ ~~ Progress(IP) 3bjective (DO) Agricultural commercialization, Songliao Plain Ag. Dev. relevance o f gender Project S S Fosteringresearcldfarmers and Agricultural Technology - - private sector partnerships Project (Recently approved) NA NA Heilongjiang Ag. Dev. S S Improve smallholder income Project Bank-Financed(other Countries) Improve the competitiveness o f Romania: Modernizing farmers and agro-processors in the Knowledge and NA NA EUaccession environment Information Systems: Appraised India - Several sub- S HS Small dairy production and project forming processing "operation flood" - Completed Other DevelopmentAgencies There are currently no other donor programs relevant to the agricultural sector effective inHeilongjiang IPiDO Ratings: HS (Highly Satisfactory), (Satisfactory), U(Unsatisfactory), HU(HighlyUnsatisfactory) 25  Annex 3: ResultsFrameworkand Monitoring HEILONGJIANG: DAIRY DEVELOPMENT PROJECT - PRC ResultsFramework' PDO OutcomeIndicators of OutcomeInformation Targeted dairy operations 0 Targeted dairy operations sell *Use1-5. P Y Gauge the quality o f achieve greater financial more highquality milk. project implementation and impact. viability through improved 0 Sustainable system o f bull * PY-3 Evaluate the development productivity and higher milk selection and progeny testing o f the milk recording program and quality. is functioning. breeding policy framework. 0 Increasedcarbon Local and global sequestration from improved * P Y1-3. Gauge the effectiveness environmental impact o f pastures and reduction in o f the manure treatment unitsand project dairy activities GHGemissions from better other GHGreduction treatments. reduced. manure treatment and disposal, IntermediateResults ResultsIndicatorsfor Each Use ofResultsMonitoring One Der ComDonent ComDonent Component One: Component One: ComponentOne: Dairy Production Development 0 Targeted number o f PY2-3. Evaluate the management About 10,000 targeted smallholder dairy farms, o f milkingstations, dairy parks and smallholders are efficiently dairy parks and demonstration farms to ensure the producing greater quantities o f demonstration farms participation o f smallholders and quality o f milk on their farms established. the adoptiono fprofitable and Anticipated increase in dairy sustainable management practices. productivity at household and P Y1-3 Monitor project training parks dairy levels achieved. schedules and ensure they are 0 Number o f dairy farmer relevant and competency based. associations established. P Y1-5 Monitor the emergence o f 0 Number o f technicians and Dairy Farmers' Associations to farmers trained. ensure their integrity. 0 Credit monitoring and loan collections. Component Two: Component Two : Component Two: Breed Improvement 0 Number o f cows under milk PY1.Ensurethat training o f staff is A sustainable dairy herd recording (MR). adequate for DHIP development. improvement program 0 Level o f semen production PY3. Review role o f HDIA inthe established and producing and inter-bull ranking o f development o f the DHIP and proven bulls through contract HABCbulls. evaluate the DHIP's organization mating programs. and sustainabilityhhding. Component Three: Component Three: Component Three: Climate Change Mitigation 0 Area o fpastures renovated. P Y1. Ensure that climate change Environmentally and Number o f manure/waste development (pastures, residue and commercially sustainable treatment units established manure treatments, etc.), research systems for pasture and number o f environmental and technology development are The results framework andattachedarrangements for results monitoringtable will bepart ofthe Project Agreement. 26  PDO Outcome Indicators Use of Outcome Information development and dairy manure research topics investigated. effective. treatment are established. 0 Number ofcrop treatment for PY1-5. Ensure that the HEPB feed (silage) facilities provides effective monitoring o f investigated. project environment impacts. Other wise implement corrective actions. Component Four: Component Four: ComponentFour: Project Management 0 Project progress, financial P Y1. PPMO i s fulfilling PPMO and PMOS and procurement reports are procurement, financial implementing project initiated and submitted in a management and M&E (including activities, monitoring outputs timely manner. household and production surveys) and impact, and providing 0 Project impact/outcome responsibilities. timely progress and financial monitoring indicators PY5. Ensuretimely transfer o f reports, annual plans and regularly updated. responsibilities to various project- budgets. supported institutionsbefore moiect closure. 27  00 N && " 4 m w  0 0 82 Y v1 -- , ' *  Annex 4: DetailedProjectDescription HEILONGJIANGDAIRY PROJECT - PRC 1. The proposedproject has four components: Dairy Production Development (Component l), Dairy Breed Improvement (Component 2), Climate Change Mitigation (Component 3), and Project Implementation and Management (Component 4). 2. The first component would focus on increasing dairy production and productivity. The second component would strive to improve the genetic potential o f the dairy herd in Heilongjiang. The third component aims at developing and extending the use o f dairy feeding and waste management technologies with a view to reducing GHG emissions from dairy activities and increasing carbon sequestration in improved pastures and the fourth component would support the implementation, management, monitoring and evaluation o fproject activities. 3. The project will be implemented in eight prefectwedcities and 32 districts/counties o f Heilongjiang Province which have been identified by the PPMO. Criteria for the selection o f townships and project beneficiaries are detailed in Annex 10. While the project is not specifically a poverty alleviation operation, in the sense that it does not a program o f targeted interventions focused on the poorest of the poor, it will strive to help the neediest o f those who meet the project's beneficiary selection criteria. Component 1:Dairy ProductionDevelopment(EstimatedCost US$160.2 million) 4. The objective of this component is to strengthen the base for smallholder dairy production through investments in smallholder milk production, milking stations, and dairy parks, and to build the capacity o f provincial and local institutions to provide training to dairy farmers and to support the development o f dairy farmers associations. The project will support: (a) about 5,500 individual households to engage in dairy production, or expand the size and productivity o f their herd, with an investment per household o f 1 to 6 cows/yearlings, and a total o f about 17,000 cows; (b) the establishment o f about 55 milking stations, each with a capacity to milk about 300 cows daily; (c) the establishment o f about 50 dairy parks for about 75 households each, with an investment o f 1 to 6 cow/yearlings per household, and a total stocking of about 300 cows and their offspring per park, and a total o f about 25,000 cows; (d) the upgrading and supplementary stocking o f about 20 existing parks, for an estimated 5,000 cows owned by individual households, and an investment o f 1 to 6 cows/yearlings per household; (e) the establishment o f seven demonstration farms for about 4,200 cows/yearlings and their followers; (f) the provision o f training o f trainers and farmers training; and (8) the development o f dairy farmers associations. 5. The actual number of households, the number o f cows per household, the number o f milking stations, the number o f new and upgraded dairy parks, and the origin (domestic purchase or import) o f the stock for the different farms will be demand-driven and flexible; these parameters would be defined by the PPMO on the basis o f annual work plans, which will be submitted to the Bank at least three months before the beginning o f each year. Overall, about 10,000 households are expected to benefit from the project. 30  6. The component will have the following sub-components: (a) Household Dairy Farms (US$95.78 million). This sub-component would at expand the smallholder dairy farmers' production base o f Heilongjiang province by providing cows/yearlings to smallholder farmers to engage in dairy production or to increase the size o f their dairy herds. Under this sub- component, the project would finance on-farm investments for over 10,000 households (about 5,500 in individual households and over 4,500 indairy parks), including the purchase o f 1to 6 dairy cow/yearlings per household and a set o f farm tools. Farmers will finance the construction o f cattle sheds, silage and effluent pits. They will be provided with detailed designs for civil works based on the experience from HADP. Particular care would be given to the design o f sheds with a view to providing humane conditions for cattle tethering and to minimizing feed wastage. Farmers will participate in an initial project awareness, civil works design and environment awareness training session prior to the commencement o f on-farm development. Further training on livestock management will be provided upon arrival o f the purchased livestock. These herds would be mostly milked through milkingstations equipped with suitable mechanical milkingand milk cooling and storage equipment. 7. The actual number o f animals to be purchased per household will vary from 1to 6, depending on the capacity o f the household to pay back the project loan. Households will be able to choose between cows purchased locally or imported cows/yearlings. The selection o f smallholder households to participate in the project would be conducted transparently, using a weighted point system based on the following criteria: (a) at each project site, and to the extent that demand permits, half o f the project participants should be households which currently have no dairy cattle; (b) education: at least one household member should be literate; (c) at least one household member should be experiencedhkilled with livestock raising either as an owner or a worker; (d) participation should be voluntary and the household should have sufficient labor; (e) ability to repay loan: factors to consider include credit history, current debt load, current income status, cosignatories/guarantors; and (f) for the individual household sites, space available for shed and the household's relative distance to the milkingstation. The terms for on-lending loan proceeds to project beneficiaries would be agreed to during prior to loan negotiations (Ref. Annex 17). (b) Milking stations (US$7.4 million). This sub-component would aim at improving milk quality through the provision o f loans for the establishment o f about 55 centralized milking facilities (milking stations), staffed with professional milkers, and allow farmers to benefit from a quality premium o f about RMB 0.15 per liter. Under this sub-component, the project would finance a central milkingfacility where smallholder households investing in dairy cattle and other smallholder dairy farmers in the vicinity would bring their cows for milking. The project would finance civil works, and milking and milk storage equipment. The milking stations would include a milking parlor for a bucket or line milking system, a cleaning room, an office, a holding yard, a small cattle shed for veterinary and AI activities, and an effluent pit. Equipment will include water pumpingand distribution, a boiler, a transformer and electrical distribution and a tanker and trailer for effluent disposal. Each milking station will be supplied with an Internet-connected computer for the management o f cow performance records associated with the DHIP. The project will finance civil works, including a milk reception area, equipment for milk quality control, and milk cooling tanks. (c) Dairy Parks (US$31.5 million). This sub-component would aim at improving, inter alia, milk quality, herd management and environmental management o f dairy production, through the establishment o f about 50 dairy parks and the upgrading o f about 20 existing dairy parks. The parks will provide housing and milking sheds for dairy farmers to outsource part o f or all dairy cows' milking and feeding management. Under this sub-component, the project would finance the construction o f civil works Totals including contingencies (physical 2 percent and prices 6 percent) 31  including access roads, the purchase and installation o f equipment for about 70 dairy parks (including the establishment o f 50 new parks and the upgrade o f 20 existing parks), each with a group o f about 75 households and, at household level, the purchase o f 1 to 6 dairy cows/yearlings and complementary on- farm investments including a cattle shed, silage and effluent pits, and a set o f farm tools. For the dairy parks, the civil works would include dairy sheds to house 500 cows, a milking parlor, a veterinary/AI shed, an exercise yard, a silage pit and hay shed, and an effluent pit. Equipment would include a water pumpand water distribution system, a transformer andpower distribution system, a milkingmachine, two boilers, a milk storage vat and milk plant cleaning system, a tractor and sludge trailer, a silage cutter, a feed mill and mixer, a light truck, a weigh bridge, a weigh scale, and office equipment, including a computer. As in (a) above, the total number o f cows purchased per household would be flexible and demand-driven, and farmers would be able to choose between locally purchased cows or imported cows. Sample forms o f ownership and contractual arrangements: (i)for the establishment o f the parks; (ii) between park owners and the manager; and (iii) between the park and the farmers have been drafted by the PPMO (Annex 6). 8. In addition to applying hightechnology dairying principles to benefit smallholders lodging their cows in the dairy parks, the parks, will also play a public good role. Dairy parks will allow the monitoring and adapt collection for the DHI activities, which will have a positive impact on the genetics o f the Heilongjiang dairy herd. The parks would introduce cutting-edge dairy management techniques which will improve the management, feeding, health care and AI not only inproject dairy parks but also in those established by private investors outside the project area. The DPs will also provide outreach services to dairymen outside the parks that would include technology transfer in dairy management, sales o f feed and ration formulation advice, preventive and clinical health services as well as AI. 9. Dairy parks would be built on land adjoining the village(s) o f the participating farmers. The criteria for site selection would be determined by (a) farmers' interest injoining a dairy park, (b) close vicinity to source o f feed for the dairy cows; (c) compliance with HEPB and project environment and safeguards policies; and, (d) the ability o f the municipality to provide the land. Additional safeguard criteria are provided in Annex 10. All dairy park sites will require an EIA, including a waste management plan, approved by the HEPB, which would monitor the project's dairy parks development and operation. (d) Demonstration Farms (US$22.9 million). The objective of this sub-component is to accelerate the diffusion and adoption o f new technologies in the Heilongjiang dairy sector through the establishment o f up to seven demonstration farms, one ineach o fthe project's districts, initially stocked with 600 imported cows each. These farms will provide demonstration and training in manure management, improved feed production and conservation practices, animal nutrition and improved reproductive techniques. The farms would also be used for activities financed under Component 3 (Climate Change Mitigation). Activities would include livestock waste management to reduce NO2emission, the production o f improved feed to reduce methane emission from livestock and, where applicable, improved fodder and pasture management techniques. The main target audience will be technicians (training o f trainers) and dairy parks managers and owners. The project would finance the construction o f civil works, imported dairy cattle o f high quality, and the purchase and installation o f equipment for 7 breeding farms. The civil works would include dairy sheds to house up to 1000 cattle (including replacement stock), a milking parlor, a veterinary/AI shed, an exercise yard, a silage pit and hay shed, and an effluent pit or composting operation. Equipment would include a water pump and water distribution system, a transformer and power distribution system, a milking machine, two boilers, a milk storage vat and milk plant cleaning system, a tractor and sludge trailer, a silage cutter, a feed mill and mixer, a light truck, a weigh bridge, a weigh scale and office equipment including a computer. Ownership arrangements for the dairy parks, milkingstations and demonstration farms are described inAnnex 6. 32  (e) Farmer Associations (US$0.35 million). The objective o f this sub-component is to support the emergence and development o f village-level dairy farmers associations. As experience from other countries shows, these associations could play an essential role in improving the efficiency o f dairy production and processing. Emphasis will be on activities which will, over the life o f the project, build farmers' trust and capacity to engage in this kind o f organization. Strong rural leadership is essential for successful farmer association. The project would identify and train community motivators/association organizers, who would be freely elected by the community groups but would most likely be people who have a demonstrated desire to assist their communities and have a long-term vision for their community. Women would be encouraged to act as association organizers. It would be desirable to have at least 40 percent women trained as group organizers. Gender training would be provided to ensure that farmers and local officials see the importance o f selecting women as well as men. The farmer association program would be coordinated by the communication and training specialist in the PPMO who would receive refresher training in farmer association establishment and management including a study tour to relevant models in China. Training would also be provided to government officials, trainers and community leaders to buildtheir understanding o f community development processes and farmer associations. 10. Under this sub-component, the project would finance a bi-annual one-week training program for the managers o f start-up farmer associations together with training and support to association members with regard to member rights and association charter development. Registered farmer's associations (or, insome cases, farmer joint stock companies or cooperatives) would be eligible for a one-time small grant (of up to Y16,OOO through the Borrower's counterpart funds) to be used to help consolidate association development. This could include, inter alia, the constructionhehabilitation of an association office, the purchase o f a computer or a local technology testing and demonstration program. The project would also finance domestically recruited technical assistance to prepare and deliver a competency-based training program in farmer association development for municipal, county and township trainers. This i s likely to include training in participatory development and rural leadership, laws and regulations pertinent to agriculture and civic associations, agricultural business management, strategic planning, monitoring and evaluation, etc. The project would assess what training materials already exist in China, identify suitable overseas materials, and finance high quality translation and distribution o f these materials. The project would also finance a series o f in-country study tours for trainers, government officials and community leaders to selected provinces, to build their understanding o f community development processes and farmer association. ( f ) Training and Technology Transfer (US$2.2 million). This sub-component would provide training and demonstrations to AHB staff, dairy park owners, managers and technicians, township technicians and dairy farmers. With a significant number o f new entrants in dairy farming and a general increase in the level o f technology brought by the project, a well-focused and practical training program will be critical to ensure that the project's objectives are met. Under this sub-component, the project would finance training o f trainers for participating AHB staff (about 12 person days/year each) and township and dairy park technicians (about 10 person days/year each), focusing on animal husbandry and breeding, animal nutrition including least cost feed rationing and animal condition scoring, pasture and natural resource management, milk hygiene and environmental protection. The project would also finance farmers' training by AHB staff and local technicians (3 person days per household per year), training o f dairy park managers on financial management, resource and human resources management (2 person days per year each), and training o f farmers' association managers. The project would finance the development o f training and technical manuals for extension workers, milk processing staff and farmers, a four-wheel drive station wagon vehicle for each participating AHB county office, and 1 or 2 motorbikes, animal health, AI and extension equipment for each participating township AHB office. Farmers and township and county technical staff would receive regular training over the life o f the project. Detailed annual training programs would be prepared by the PPMO as part o f the annual work plans. 33  11. The training and technology transfer activities have the double objective o f contributing to increasing the profitability o f dairy operations and reducing risks to farmers. However, in the unlikely event that milk prices should fall during project implementation to a point where project-funded dairy operations would become non-viable in the long run, the Heilongjiang Authorities and the Bank would identifyand agree uponother more profitable livestock activities that would be fundedunder the project. Component 2. Dairy BreedImprovement(EstimatedCost US$7.0 million) The objective of this component i s to improve, in Heilongjiang province and eventually beyond the province, the genetic base o f the dairy stock, the efficiency o f production and milk quality by establishing a comprehensive Dairy Herd Improvement Program (DHIP), including milk recording, bull breeding and progeny testing. This Program, already used in about forty countries, i s still not applied in China. It will replace the current, provincially-focused and inefficient breeding system, based on the use o f semen o f untested bulls, and a very limited coverage under the Milk Recording System. The introduction o f the DHIP would be a key element in improving the international competitiveness o f Heilongjiang in milk production and in lifting the Heilongjiang dairy sector to a higher productivity level, now that the first productivity leap from simple crossbreeding is leveling off. The 100 percent coverage o f the provincial dairy herd with AI, the development o f dairy parks uniquely suited to carry out progeny testing, and the already high productivity level (on average 4,300 liters per cow per year) justify the introduction o f an ambitious breed improvement program. The program would follow a "step-wise'' approach as described below: Step 1: Buildingcapacity and establishing the overall framework, to be carried out in the first year, including: e Establishment of the DHIP Management and Coordination Unit. The project will support the establishment o f a DHIP Management Unit, within the HDIA and supported by the AHB, which will be guided by a larger DHIP Working Group. This unit will provide overarching policy and technical and operational coordination across the involved services and help those services to work more closely together, which i s a necessary condition for a successful DHIP. Of critical importance in the first year will be the establishment o f the key breeding goals for dairy cattle; this would be carried out with the participation o f all stakeholders, taking into account current and expected price incentives regardingthe composition o f milk, longevity and feed efficiency targets, and user characteristics such as use o f milking. e Capacity Building. The project would finance the training o f trainers and o f key service staff o f all services, including milk recorders, laboratory technicians, inseminators, farmers participating inthe bull testing program, and field technicians. Key training topics will be on how to support farmers to use their cow and herd milk record reports and how to develop more efficient reproductive management to shorten the average calving interval as a first step in improving productivity. e Establishment of the Milk Recording System (MRS). The project will seek to register, over the implementation period, a total o f 150,000 animals under the MRS, of which about 50 percent would be on the demonstration farms and dairy parks, which will form the basis for the selection program for elite animals, described in Step 3, and the rest at individual farms. The MRS will cover breeding, feeding, milk production and hygiene, and the HLIC will be responsible for the preparation o f monthly analysis and herd reports. Feedback will be provided every two months to the farmers. Under this sub-component, the project would finance the civil works for a milk testing laboratory, the milk recording administration and DHIP offices at the DIA, and equipment 34  for milk sampling, and operating costs. Computers with Internet connection are already included inthe dairy parks and milkingstations (Component 1). Step 2: Broadening and accelerating genetic improvement through funding an initial import o f 400,000 units o f semen o f proven bulls. The Animal Breeding Centre would sell this semen with a fair profit margin, with income from the sale of the initial semen import used to finance a revolving fund that would finance future semen importation. The revolving fund would receive additional funding from the 10percent incremental semen importation and sale financed by the Loan. This imported semen would substitute for about 50 percent o f the currently used semen o f local sires, which are inadequately tested, at very similar costs to the farmer as the local semen. The semen would be sold through the existing widespread network of private inseminators. In addition to the 840,000 doses o f semen imported over the project duration, the project would finance civil works for an on-station semen storage and a separately located long-term secure semen storage facility, equipment for liquid nitrogen storage, the accreditation o f the Breeding Center in the International DHIP system, and technical assistance to: (a) introduce the system and increase productivity in semen production; and (b) prepare internationally acceptable standards for the accreditation o f the inseminators. Step 3: Establishing a system for local genetic evaluation, by developing the MRS into a system o f genetic evaluation of promising bulls. About 200 top producing cows, identified through the MRS established under step 1, would be mated (under a contract with the farmer) with the semen o f the top proven bulls imported under Step 2, for the production o f about 80 young bulls. These young bulls would be used inthe insemination o f a limited number (about 500 each) o f cows at the level o f the dairy park or the demonstration farm. Once about 160 daughters inthese parks or demonstration farms have completed their first lactation year records, the best 10 bulls from the original batch o f 80 young bulls would be selected for widespread use. This would be a continuous process, with bull mothers and elite bulls continuously identified for the production o f young, improved bulls, and the offspring o f these young bulls continuously tested. 12. Under this sub-component, the project would finance the software and hardware for data analysis and management, a secure duplicate data facility, technical assistance including six months o f overseas expertise in DHIP management, the adaptation of the software used for this evaluation, and contract mating to produce the young bulls. The project would also finance overseas training in genetic evaluation analytical systems and insire analysis techniques, and the local training o f technical staff and farmers. 13. The costs o f imported semen and insemination would be fully charged to the farmers, as i s currently the practice. The income would be put into a revolving fund at the H B A C and used for semen import in subsequent years. The costs o f milk recording, progeny testing and the genetic evaluation elements o f the DHIP be financed by the project. At mid-term review, cost recovery for those activities would be reviewed, and it i s expected that the farmers, the HBAC (from the profits from the sale o f superior semen) and the province would share the costs. 14. This component would be implemented under the auspices o f the DIA, which will manage the overall framework (setting o f breeding objectives, incentives), and the M R S and bull testing program. Data analysis would be the provided by the HLIC, a public institution with a proven record. The HBAC would be responsible for semen production and sale o f the proven bullsresulting from the DHIP. 35  Component3: ClimateChangeMitigation(EstimatedCostUS$10.4 million) Italian Trust FundProgram 15. The aim o f this component would be to demonstrate and pilot innovative technologies to increase carbon sequestration and mitigatelreduce GHG emissions resulting from the expansion o f livestock production in Heilongjiang. The project would finance specialized equipment, civil works, technical assistance and training o f staff and project beneficiaries to pilot innovative technologies in (a) pasture improvement for the purpose o f increasing fodder production, carbon sequestration and combating desertification; (b) treatment o f crop residues to improve their quality and usage in animal feeding, decrease methane emissions and reduce on-field burning o f residues; (c) treatment o f animal manure to reduce methane emissions and convert it into a salable fertilizer; and (d) assessing climate change experimental technologies through the implementation o f research programs. A detailed description o f this component is inAnnex 16. 16. Considerable additional research i s required for Heilongjiang to establish a sustainable pasture development and management program. This would require multidisciplinary research into species introduction, optimal establishment techniques, soil amelioration and fertility management, and forage harvesting strategies. Animal manure, which currently plays an important role in field crop fertilization, could also play a significant role in pasture fertility, reversing the present practice o f "mining" grassland fertility and avoiding the need to resort to expensive treatment processes. Ammoniated or bio-degraded straw has a low energy density and is unlikely to be useful for high production dairy cattle, even for younger stock, where higher growth rates and earlier first calving could result in large gains in productivity. Maize silage production i s now established in the province (26,000 ha in 2003) and a more relevant technology for profitable dairy farming. Its expansion would also reduce the availability o f stover, which, incidentally, still plays an important role in home heating in winter. Stover treatment i s more likely to be of value to Heilongjiang's nascent beef industry. Component4: ProjectImplementationand Management (Estimated Cost US$ 1.1million) The proposed project would be managed by the existing Bank-supported Provincial within the HDRC. The PPMO would be responsible for all aspects o f project administration, including program management, technical assistance, goods and materials procurement, financial control, and monitoring and evaluation. A TWG including representatives from the AHB, the HLIC, the HABC, the Northeast Agricultural University and the HDIA would provide guidance to the PPMO on technical issues and ensure the inter-agency coordination required for successful project implementation. The TWG would operate under the aegis o f the HDIA and play a key role inthe coordination o f the DHIP. The structure o f the PPMO and its staffing are described in Annex 6. The project would also strengthen Government's capacity to monitor project impacts. The project would finance an annual socio-economic and production survey and capacity building o f the HEPB to monitor environmental impacts. The project would also finance technical assistance, training, and office equipment for the PPMO to manage and monitor the project, as well as to the finance bureaus to monitor, report on and recover project loans. 36  Annex 5: ProjectCost Estimate HEILONGJIANGDAIRY PROJECT - PRC ProjectCost Estimate* Local Foreign Total Component US$ Million US$Million US$ Million Dairy Development 83.5 64.7 148.2 Household Dairy Farms 47.7 41.2 88.9 Milking and Collection Stations 5.6 1.1 6.7 Dairv Parks 20.3 8.6 28.9 ~ Demonstration Farms 8.1 13.2 21.3 Training and Technology Transfer 1.5 0.6 2.1 Dairy Farmer Associations 0.3 0.0 0.3 BreedImprovement 2.5 4.0 6.5 Climate ChangeMitigation 4.6 4.9 9.5 ProjectManagement, Monitoringand Evaluation 0.8 0.3 1.1 TotalBaselineCost 91.4 73.9 165.3 Physical Contingencies 2.8 1 .o 3.8 Price Contingencies 5.3 4.3 9.6 Total Project Costs 99.5 79.2 178.7 Front-end Fee 0.0 0.25 0.25 Total FinancingReauired 99.5 79.45 178.95 *Identifiable taxes and duties are US$13.5 million and the total project cost, net o ftaxes, is US$165.2 million, Therefore, the share o fproject cost net of taxes is 92.5 percent. `Total' column may not exactly equal `local' colunm plus `foreign' column due to rounding error. 37  Annex 6: ImplementationArrangements HEILONGJIANGDAIRY PROJECT - PRC ProjectManagement 1. The project would be managed by the existing Bank PPMO within the HDRC. The PPMO has become familiar with Bank procedures through the implementation o f the recently closed Heilongjiang Agricultural Development Project. The PPMO would provide financial control for the project and would be responsible for the project's day-to-day management, including work programming, financial management, project procurement, progress and financial reporting, staff appointment and management, and monitoring and evaluation. The PPMO would include 8 professional staff and 7 administrative and support staff. Professional staff positions would include a project manager, a deputy project manager, a financial controller, a senior dairy specialist, an animal breeding specialist, a training specialist, a farmer communication and association specialist, and a monitoring and evaluation officer. The PPMO would be supported administratively by an assistant to the Project Manager, a procurement officer, two interpreters/translators and three drivers. The project would finance technical assistance, training and equipment for the PPMO. 2. At the county level, CPMOs would coordinate activities, working in collaboration with county- level FB and AHB counterparts. Although CPMOs would be under the direct authority o f the PPMO, they would also report to the county administration. Under the guidance o f the PPMO, CPMOs would be responsible for consultations with farmers and the identification o f participating farmers, coordinating investment planning, monitoring the environmental impact assessments in collaboration with HEPB and HAHB staff, organizing support services and capacity-building programs, and monitoring project outcomes at the local level. CPMOs would include a local Program Coordinator, a dairy production specialist, an administrative assistant and a driver. CPMOs would be supported technically by the county AHB. County BOFwould be responsible for loan disbursement and recovery at county level, under terms and conditions set by the PLG and agreed by the Bank. As many CPMOs would be new to Bank procedures and project management, county-level staff would receive extensive training in a range o f management issues including financial management, procurement and technical training to establish them as effective trainers o f township technical staff. County AHB staff would be provided with a 4 W D vehicle and training equipment to facilitate their training, supervision and monitoring roles. 3. At the township level, CPMOs would work closely with township veterinary, animal production and AI technicians. The township livestock office would be provided with 1-2 motorcycles, dependent on the scale o f their program, to improve the effectiveness o f their farmer outreach activities. Township level staff would also be provided with training, animal husbandry and AI equipment required for project activities. The project would provide up to 5 person-days o f training per township technician per year. At the village level, the local village leaders and VMC would assist the PPMO and CPMOs to advise farmers - including credit-worthy poor and ethnic minority families interested in entering the dairy sector or in expanding their existing herd - on project investment options and policies, identify project beneficiaries, and monitor project implementation. The project would also collaborate with the ACWF and the CCYP intraining and other village-level project activities. 4. Ownership of dairy parks, demonstration farms and milking stations: It was agreed during project pre-appraisal that the PPMO and CPMOs would facilitate the creation and registration o f Legal Entities (LEs) that would own the dairy parks, demonstration farms and milking stations to be established under the project. The shareholding in the LEs that would own the dairy parks and milking stations would be as follows: smallholder groups would own at least 51 percent o f the total shares in each LE, 38  whereas, other investors together would own up to a maximum o f 49 percent o f total shares in each LE. To facilitate access of smallholder groups to the ownership o f the parks and milking stations LEs, the government or its entities would (ifthe smallholder groups are not able to contribute the full 51percent o f the registeredhominal capital) contribute up to 35 percent o f the initial registered capital o f the LEs on behalf o f the smallholder groups. The smallholder groups would have the exclusive right to purchase the government's shares at their convenience. A clause to this effect would be included in the by-laws o f each LEbefore its registration with the Commercial and IndustrialAdministration Office. 5. Because the establishment o f the demonstration farms has a dual objective - creating cutting-edge management technologies) - the shareholding in the LEs that would own the demonstration-farms would commercial enterprises and delivering a public good (demonstration o f innovative production and be as follows: governments would own 51 percent o f total shares o f each LE, and other investors would own up to a maximum o f 49 percent. 6. Inorder to ensure that the dairy cattle to be procuredunder the project are promptly housed and cared for upon delivery to the dairy parks and demonstration-farms o f the project, disbursement for the procurement o f dairy cattle (opening o f Letter o f Credit for ICB contracts) would be contingent on the completion, certified to the Bank by the PPMO, o f all the civil works, other infrastructure and feed necessary to house and care for the dairy cattle. 7. Implementation of the DHIP. While the overall implementation responsibility for the Dairy Breed Improvement component rests with the PPMO, significant portions o f the DHIP would be managed and coordinated by the HDIA which has been recently established with a mandate including the coordination o f public and private stakeholders for the sustainable development o f Heilongjiang's dairy industry.A DHIP Working Group, established under the HDIA, would be responsible to the PPMO for planning, monitoring and reviewing the development and implementation o f all elements o f the DHIP. The DHIP Working Group would include the HDIA, H L I C and HABC. In addition, the HDIA would establish: (a) a DHIP management unit, staffed by two senior dairy industry specialists; (b) a DHIP milk recording technical and administrative unit, staffed by two specialists and four technicians, who would be responsible for animal data verification and monthly analysis and reporting to farmers and other support services; and (c) a central milk testing laboratory (CMTL) which would coordinate milk sampling and rapid testing o f samples for protein, butterfat and cell count. The CMTL would be staffed with a milk quality specialist, two technical assistants, and supporting administrative staff, including a six-person milksamplingteam responsible for on-farm milk sample collection andtransport to the laboratory. 8. The HABC has already employed the staff required for the management o f the planned bull breeding and progeny testing program. The project would provide training, technical assistance, equipment and software to make this team an effective genetic improvement unit. Under the project, the H L I C would be staffed with two specialist staff dedicated to the DHIP and the project would provide computing equipment, software, training and international technical assistance to develop and manage the DHIP information system. 9. Implementation of the Climate Change Mitigation Component. The Climate Change Mitigation Component (Component 3) would be implemented by the PPMO and relevant CPMOs. The PPMQ would implement this component in close collaboration with the institutions in charge o f pasture renovation and management, animal waste treatment and disposal, and institutions that would conduct the special research activities. Research activities would be funded through a competitive grant process on the basis o f the recommendations o f a research committee to be created under the PPMO. The project would require the establishment o f an Monitoring and evaluation protocol for documenting and verifying the environmental impact and economic performance o f the climate change mitigation activities. Several o f the proposed activities are still at the applied research stage or have not been field tested under 39  Heilongjiang's harsh winter conditions. The monitoring and evaluation o f their economic and environmental potential, along with that o f more traditional techniques, would constitute a major contribution o f the project to the development o f the climate change mitigation strategy for China's agricultural sector. The TORSfor the research committee and for the research monitoring and evaluation framework are detailed inAnnex 16. 10. Training management and implementation.Project training programs would be coordinated by the PPMO training officer and implemented through the CPMOs and provincial and county AHBs. The project's training program would start with a skill gap assessment o f farmers and staff inthe project area, leading to the development o f a competency-based training program encompassing training-of-trainer and farmer training activities. 11. ProjectLeadingGroup. Project policy would be set by a PLG, chaired by the Vice Governor o f Heilongjiang Province and including the Directors o f the HBOF, the HDRC, the HABC, HAHB, the HEPB, the Audit Bureau and the Heilongjiang Agriculture Commission. This would include the approval o f participating municipalities and counties, lending terms and conditions, and matters relating to public good investment and the contribution o f private investors under the project. The P L G would meet regularly to review annual work plans, semi-annual and annual project progress reports, and respond to policy issues raised by the PPMO. 12. Technical Advisory Group. A TAG would be established in order to provide guidance to the PPMO on technical issues and ensure the inter-agency coordination required for successful project implementation. The TAG would include representatives from the HAHB, HLIC, HABC, HEPB, NEAU, the HDIA, and the ACWF. The Director o f the HAHB would chair the TAG. The TAG would meet at least quarterly to review project implementation progress, and advise the PPMO on project activities and direction. 13. Fund Flows. The HBOF would receive project funds from MOF under terms and conditions identical to those extended by the Bank to the government o f China. These terms and conditions would be defined in the loan agreement. Two SAs would be opened and managed by the Heilongjiang BOF. One o f the SAs would be dedicated to the Bank Loan Funds and the second would be dedicated to the Italian Grant Funds. Funds from the Loan and the Grant would flow from the MOF to the SAs managed by the HFB and then down to the municipal and county Finance Bureaus. Loan fhds would be on-lent by the MOF to the Heilongjiang Province, which would pass them on to its participating prefectures, cities and counties. The County Bureaus o f Finance would pass on most o f the Bank loan proceeds in kind (about 84 percent), inthe form o f dairy cattle to beneficiaries. Ofthe remaining US$16 million, about half would be expended for public good activities such as dairy cattle breeding, training and support to farmers associations. The other half would be on-lent to LEs made up o f smallholders and private sector enterprises to buildthe dairy parks, demonstration farms and milkingstations. 14. Smallholders and LEs would benefit from project assistance (cows and/or buildings) only once and there are no revolving schemes envisaged. Project beneficiaries are expected to pay for the dairy cattle and buildings they receive from the proceeds o f the sale o f their milk through the dairy parks or in cash. 15. Line of Credit On-lending Terms and Arrangements, Interest rates in China are controlled administratively by the Central Bank. They have recently moved from a fixed interest rate regime to operating within specified interest rate bands. These interest rate bands vary by industry. There are two potential interest rate anchors for on-lending to final sub-borrowers under this project. Both RCCs and the Agricultural Bank o f China (ABC) make medium-term loans for the financing o f dairy production. Inthe recent past, RCC branches in 6 o f the 68 counties in Heilongjiang Province, o f which two were in the 40  project area, have provided a limited number o f loans to farm households to raise dairy cows. These loans had a 3 to 5 year maturity and an annual interest rate in the range o f 10 percent 11.7 percent. After - the appraisal mission, the Heilongjiang government carried out a more comprehensive survey and determined that the A B C had lent about RMB Y351 million in the dairy sector during the period from 2000 to 2005 in at least four counties, o f which three were in the project area. These are medium-term loans with an interest rate o f about 8 percent per year. Among the sub-borrowers, there are 2,870 household borrowers and the loan size ranges from RMB 3,000 to 50,000. 16. Based on the above analysis o f the prevailing interest rates for similar loans, the government has proposed that the interest rate anchor for on-lending to final sub-borrowers under this loan be the lower o f the ABC or RCC rate for similar term loans. This rate would be set on an annual basis based on a survey o f the interest rates prevailing on January 1 each year (starting in 2007) for RCCs and ABCs making loans for dairy production in the project area. At the current time the ABC rate i s the lower rate and i s o f about 8 percent. This rate is positive inreal terms, because the inflation rate in China i s currently about 4 percent and i s expected to remain at that level or lower in the medium term. Further details are available inAnnex 16. 17. Beneficiary Selection Criteria. The selection o f smallholder households participating in the project would be conducted transparently, using a weighted point system based on the following criteria: (a) at each project site, and to the extent that demand permits, half o f the project participants should be households which currently have no dairy cattle; (b) education: at least one household member should be literate; (c) at least one household member should be experiencedhkilled with livestock raising either as an owner or as a worker; (d) enthusiasm: participant should tie voluntary and the household should have sufficient labor power; (e) ability to repay loan: factors to consider include credit history, current debt load, current income status, cosignatories/guarantors; and (0 for the individual household sites, space available for shed and the household's relative distance to the milkingstation. 18. Selection Criteria for Project Enterprises. To benefit from loan funds, project enterprises would be selected on the basis o f the following criteria as defined in the Operational Manual, including: (a) it i s an legal entity registered according to the laws o f the Borrower with authority to borrow and carry out the sub-project; (b) it i s creditworthy and has a sound financial structure; (c) it has the organization, management, staff and other resources required for the efficient carrying out o f its operations, including its respective sub-project; (d) it has the technical skills and experience required for the carrying out o f its respective Sub-project; and (e) its majority ownership is held by smallholders. 19. Operations Manual (OM). Arrangements for the updating o f the OM were discussed during appraisal. A draft OM was prepared by Lincoln Consulting and was updated by both the PPMO and the HFB to reflect the final project design and latest agreements. The final OM dated July 5, 2005 was submitted to the Bank on August 17, 2005 and includes, inter alia, chapters discussing: (a) detailed on- lendingarrangements; (b) a financial management system, including disbursement procedures and special and project accounts management; and (c) procurement procedures. 20. Monitoring and Evaluation. The PPMO would be responsible for project process and impact monitoring and evaluation, which would be coordinated by the PPMO monitoring and evaluation officer. Process monitoring would be used to monitor and evaluate the performance o f agencies and individuals involved in implementing the project against a performance schedule. The process monitoring would include: (a) recording regular work and activities o f agencies and individuals involved; evaluating their overall performance; and (c) preparing periodic assessment reports for submission to the P L G and the Bank. 41  21, The PPMO would conduct or contract out the undertaking o f project surveys needed for project impact monitoring and evaluation. A technical baseline survey would be conducted soon after loan effectiveness to capture the status o f output and outcome indicators o f the beneficiaries before the project. Periodic surveys to measure the outcome and impact o f the project on beneficiaries would also be conducted every two years. 42  Annex 7: FinancialManagement and DisbursementArrangements HEILONGJIANG DAIRY PROJECT-PRC Executive Summary and Conclusion 1. The Financial Management Specialist (FMS) has conducted an assessment o f the adequacy o f the project financial management system o f the Heilongjiang Dairy Project. The assessment, based on guidelines issued by the Financial Management Sector Board on October 15, 2003, concluded that the project meets minimumBank financial management requirements, as stipulated in BP/OP 10.02. In the FMS's opinion, the project would have in place an adequate project financial management system that can provide, with reasonable assurance, accurate and timely information on the status o f the project in the reporting format agreed with the project and as requiredby the Bank. 2. Funding sources for the project include Bank loan, an Italian Trust Fund grant and counterpart funds. The Bank loan proceeds would flow from the Bank into the project special account to be set up at and managed by the HPFB, to the relevant municipal finance bureaus, to the relevant county finance bureaus, and finally to contractors or beneficiaries. The Bank loan would be signed between the Bank and the People's Republic o f China through its MOF, and an on-lending agreement for the Bank loan would be signed between PRC, through its MOF, and the Provincial Government o f Heilongjiang through its HPFB and then between HPFB and municipal government through municipal finance bureaus and then between municipal finance bureaus and county government through county finance bureaus, and finally between county finance bureaus and beneficiaries. Interms o f disbursement technique, the loan would be disbursed based on the traditional disbursement techniques and would not be using PMR-based disbursements, in accordance with the agreement between the Bank and MOF. The constitution o f counterpart funds would be contributions from government entities at different levels, investment from enterprises and farmers. 3. No outstanding audits or audit issues exist with any o f the implementing agencies involved inthe proposed project. The task team however would continue to be attentive to financial management matters and audit covenants duringproject supervisions. Summary Project Description 4. The objectives o f the project would be to increase the income and number o f households engaged in dairy production in selected areas o f Heilongjiang province. This objective would be achieved by increasing the productivity o f the beneficiaries' dairy cattle and improving the genetic potential and management o f the Heilongjiang dairy herds. 5. The main components o f this project are: Dairy Production Development: The project would assist about 10,000 household dairy farms, 70 five hundred-cow dairy parks, 55 village milking stations and 5 collection centers, and seven one thousand- cow demonstrationbreedingfarms. Breed Improvement: The project would establish a DHIP with a view to realizing, at low risk, substantial improvement in household milk production, productivity and product quality through the Heilongjiang dairy sector. Climate Change Mitigation: The project would develop strategies and pilot innovative technologies to reduce GHG emissions resultingfrom the expansion o f dairy farming in Heilongjiang. 43  Project Implementation and Management: The project would provide technical assistance, training and equipment to the provincial P M O and FBs. 6. The overall investment o f this project is estimated at US$ 178.95 million, and contributions from various sources are as follows: US$lOO.O million by IBRD; US$5.5 million trust fund from Italian government; and US$73.45 million contributedby households, investors and the government. Country Issues 7. To date, no Country Financial Accountability Assessment (CFAA) has been performed for China, though dialogue with the government in respect o f the CFAA exercise has been initiated. The Bank has relied on a similar exercise carried out by the Asian Development Bank in 2000 for reference. 8. However, based on observations o f developments in the areas o f public expenditures, accounting and auditing, and Bank experience with projects in China during the past few years, we noted that substantial achievements have been made and further improvement i s expected. As the economic reform program further unfolds, the government has come to realize the importance o f establishing and maintaining an efficient and effective market mechanism to ensure transparency and accountability, and minimize potential fraud or corruption. 9. Due to unique arrangement by the Government o f China, funding (in particular the Bank loan) of Bank supported projects is controlled and monitored by the MOF and its extension, (FBs at provincial, municipal/prefecture and county level). However, project activities are usually carried out by implementing agencies o f a specific industry or sector because o f the level and complexity o f expertise involved. The above arrangement then usually requires more coordination on the project, as the multi- level management o f the funding and implementation mechanism sometimes works to the detriment o f smooth project implementation. Risk Analysis 10. The following risks with corresponding mitigating measures have been identified during assessment: Risk Risk MitigatingMeasures Rating I. ProjectRisk Inherent Moderate Some implementing agencies involved in the project have no prior Bank experience; Close monitoring by the task team i s extremely important, particularly at the initial stage. 11.Control Risk a. ImplementingEntity Moderate Close monitoring by task team i s needed to ensure all the implementing entities are familiar with Bank procedures and requirements. 44  b. FundsFlow Moderate The task team would ensure that mechanisms would be in place to assure that Bank and counterpart funds would be released to the ultimate beneficiaries on a timely basis. c. Staffing Moderate Periodic checking on accounting work by project management offices at various levels would be performed d. Accounting Policies Low I Accounting policies and procedures are already inplace. and Procedures eTInternal Audit Moderate No internal audit arrangement for the project. However, disbursement documents would be reviewed by the FBs at the various levels. f.ExternalAudit L o w The external auditors, the Heilongjiang Provincial Audit Office, have extensive audit experience with previous Bank- supported projects. g. Reportingand Low Format o f financial statements and frequency o f submission Monitoring have been clearly defined by the Bank and MOF. h.Information Systems Moderate Checking by the task team at the initial implementation stage to ensure correct setup, which should be followed up by regular supervision missions. Strengths andWeaknesses 11. Strengths The PMO has been established under the HDRC, which is also the PMO o f the Heilongjiang Agriculture Development project that was closed at the end o f June 2004. Furthermore, since HDRC i s considered one o f the more influential departments within the Heilongjiang provincial government, this arrangement would ease the coordination of the project given the involvement o f several government agencies in this project. The Heilongjiang provincial FB has extensive prior experience on several Bank-financedprojects, which would benefit the implementation o f this project. 45  12. Weaknesses The following significant weaknesses with resolutionhave been identified: Significant weaknesses Resolution 1. Nearly halfo f the project counties are new Strong assistance and training program should be to Bank projects and are short o f relevant provided by the PPMO. experiences, 2. The PMOsbelow the provincial level have All the PMOs should receive training infinancial recently been established. management and implementation prior to loan effectiveness. 3. Because o f the lack o f start-up funds by the Only those farmers able to provide the start-up hnds farmers, some project activities may be would be eligible to participate inthe project. difficult to implement. ImplementingEntity 13. A PLG (see Annex 6) has been established and would oversee project policy. The proposed project would be managed under the umbrella o f the existing Bank-supported PPMO within the HDRC. The PMOs at municipal and county levels would also be established within the This would be decided prior to loan effectiveness. The county PMOs would be the lowest project management level and would be responsible for overseeing the various implementing entities at their respective counties. The organization chart i s as follows: [--1 Project Leading Group Provincial MO Municipal Municipal Municipal i I 46  Funds Flow 14. Funds flow for the Bank loan would follow Bank and MOF requirements. One SA would be established and managed by HPFB. The funds flow is as follows: The World - - SA Municipal County Suppliers Bank managed by finance bureaus -+ finance -b Beneficiaries HPFB bureaus Staffing 15, Adequate project accounting staff with educational background and work experience commensurate with the work they are expected to perform i s one o f the factors critical to successful implementation o f project financial management. Based on discussions, observation and review o f educational background and work experience o f the staff identified for financial and accounting positions in implementing entities, the task team note that the staff are qualified and appropriate to the work they are expected to assume. 16. To strengthen financial management capacity and achieve consistent quality o f accounting work, a Project Financial Management Manual (the Manual) will be prepared. The Manual would provide detailed guidelines on financial management, internal controls, accounting procedures, fund and asset management, and withdrawal application procedures. Although some regulations were set up for the Heilongjiang Agriculture Development project, most items cannot meet the requirements o f the new project. The first draft o f the Financial Management Guidelines has been prepared by the provincial FB and submitted to the Bank for review. The Bank's comments have been provided to the project for their update o f the Guidelines. A final versioin o f the Guidelines would be included in the project OM and distributed to all the financial staffbefore project effectiveness. 17. Inorder to ensure the smooth implementationo fthe project, including the maintenance o fproject accounts and the monitoring and evaluation o fproject activities, PMOSwith trained accountants would be established at both city and county levels before project effectiveness. Staff turn-over at project implementing units should be avoided to ensure the efficient and timely implementation o f project activities As most implementing entities are new to the Bank's projects, a well-designed and focused training program in project financial management should be provided prior to loan effectiveness by provincial P M O to all financial and accounting staff to ensure a good understanding and knowledge o f the following: 0 Bank's financial management policy and disbursement procedures 0 Fund/asset/contract management 0 Format and content o f project financial statements 0 Audit requirement Accounting Policies and Procedures 18. The administration, accounting and reporting o f the project would be set up in accordance with the Circular #13: "Accounting Regulations for World Bank FinancedProjects" issuedinJanuary 2000 by 47  MOF. The circular provides in-depth instructions o f accounting treatment o f project activities and covers the following: 0 Chart o f accounts 0 Detailed accounting instructions for each project account 0 Standard set o f project financial statements 0 Instructions on the preparation o fproject financial statements The standard set o f project financial statements has been agreed between the Bank and MOF. It applies to all Bank projects appraised after July 1, 1998 and includes the following: 0 Balance sheet 0 Statement o f source and use o f fund 0 Statement o f implementation o f credithoan agreement 0 Statement o f Special Account 19. In order to streamline financial management o f trust funds, MOF issued in July 2001 a set o f financial and accounting regulations, providing detailed instructions for accounting setup and treatments, format and content o f financial statements, internal control procedures, and audit requirements. Therefore, the financial management and accounting treatment o f the activities supported by the Italian Trust Fundwould follow these regulations specifically established for the grant. 20. The PMOSat each level would manage, monitor and maintain project accounting records. One set o f complete supporting documentation, provided by the various implementing entities for project activities, would be retained by each county PMO. In addition, each county PMO would prepare financial statements, which would then be consolidated by their respective municipal P M O and then submitted to the Provincial PMO. The Provincial P M O would then review and approve these financial statements. Subsequently, the Provincial P M O would then prepare a consolidated project financial statements for submission to the Bank for review and comment on a regular basis. Internal Audit 21. There i s no formal independent Internal Audit department for the project. However, this would not have an impact on the project's financial management as PMO management and monitoring and yearly external audits would serve as the mechanism to ensure that financial management controls are functioning appropriately. ExternalAudit 22. The Bank requires that project financial statements be audited in accordance with standards acceptable to the Bank. In line with other Bank-financed projects in China, the project would be audited inaccordance with ISA and the Government Auditing Standards o f the People's Republic o f China (1997 edition). The Heilongjiang Provincial Audit Office has been identified as auditors for the project. Annual audit reports would be issued inthe name o f Heilongjiang Provincial Audit Office. 48  23. The annual audit report o f project consolidated financial statements would be sent to the Bank within six months of the end o f each calendar year. These requirements are stipulated in the loan and grant agreements. The responsible entity and due dates are stated below: Component Submitted by Due date Consolidated project financial statements Provincial PMO June 30 (lending) Grant financial statements Provincial P M O June 30 Reportingand Monitoring and Formatof FinancialStatements 24. Each county P M O would prepare its own project financial statements, which would then be consolidated by municipal and provincial PMO. The project consolidated financial statements would be sent by provincial PMO to the Bank for review and comment on a regular basis. 25. The format and content o f the following project financial statements represents the standard project financial reporting package agreed to between the Bank and MOF, and have been discussed and agreed with all parties concerned. In line with the newly issued Financial Monitoring Report (FMR) guidelines, the un-audited project consolidated financial statements would be submitted as part o f FMRto the Bank on a semi-annual basis (prior to August 30 and February 28 o f the following year), and would include the following statements: Lending 0 Balance Sheet 0 Summary o f Sources and Uses o f Fundsby Project Component 0 Statement o f Implementation o f Loan Agreement 0 Statement of Special Account Trustfunds 0 Balance Sheet 0 Statement o f Implementation o f Grant Agreement 0 Statement o f Special Account InformationSystems 26. The accounting books o f the previously implemented Heilongjiang Agriculture Development Project were done manually. However, the P M O i s considering the utilization o f an accounting software for the new project. The decision has not yet been made. The FMS would review the adequacy o f their financial accounting and reporting systemprior to loan effectiveness. 49  Impact of Procurement Arrangements 27. Threshold set for procurement post-review would be consistent with that set for Statements o f Expenditure (SOEs) for disbursement purpose. To have maximum effectiveness and efficiency, the financial management specialist and procurement staff should jointly participate in supervision missions to ensure the following: 0 Contracts awarded are inline with the Bank's procurement guidelines 0 Contract payments made are in accordance with the terms o f the contract and well supported Disbursement Arrangements 28. The loan would be disbursed usingtraditional disbursement techniques and would not use project management report (PMR)-based disbursements, in accordance with the agreement between the Bank and MOF. 29. Bank loan proceeds would be disbursed against eligible expenditures as follows: (a) civil works - 25 percent o f expenditures; (b) equipment - 100 percent o f foreign expenditures, 100 percent o f local expenditures (ex-factory) and 75 percent o f other items procured locally, (c) livestock - 100 percent; (d) consulting service - 100 percent o f expenditures, and (e) foreign training-100percent and local training 0 percent o f expenditures. 30. The Italian trust fimd grant would be disbursed against eligible expenditures as follows: (a) civil works - 50 percent o f expenditures, (b) equipment - 100 percent o f foreign expenditures, 100 percent o f local expenditures (ex-factory) and 75 percent o f local expenditures for items procured locally, (c) Consulting service - 100 percent o f expenditures, (d) training-100 percent o f expenditures; and (e) competitive research grants - 55 percent. 31. Two SAs would be established in HPFB, one for the Bank's loan and one for the Italian Trust Fund Grant. The authorized allocation o f SA is proposed to not exceed: US$7.0 million and: US$D0.4 million for the grant. The Bank funds would be disbursed to the SA set up at HPFB, and then to municipal FBs and county FBs, and finally to supplier or beneficiaries. 32. Heilongiiang Provincial Finance Bureau would be directly responsible for the management, monitoring, maintenance and reconciliation o f the SA activities o f the project. Supporting documents required for Bank disbursements would be prepared and submitted by project implementing agencies through county PMOs and FBs and municipal PMOs and FBs and provincial PMO to HPFB for final verification and consolidation before sending to the Bank for further disbursement processing. The flow o f the Withdrawal Application would be as follows: Implementing Approve by Approve by Approve Approve World agencies county municipal by by Bank __I PMOsand +PMOsand+PPMO +HPFB + I finance finance bureaus I I bureaus I 33. Considering the complexity o f disbursement procedures and the number o f entities involved in the approval process, clear disbursement procudures and review time requirements for each level should be stipulated in the project FM Manual. The FMS would check the disbursement status during supervision missions. 50  Action Responsibleperson CompletionDate 1, Financial management training to all relevant HPFB and Provincial P M O June 30, 2006 project staff 2. Financial management guidelines finalized HPFB and Provincial P M O Before negotiations and issued as part o f the OM to related financial staff. 3. The FMS would review the adequacy of Provincial PMO and The On-going project financial accounting and reporting World Bank system. FinancialCovenants 35. In addition to the standard financial covenants (e.g. maintaining project accounts in accordance with sound accounting practices, audit requirement and SOE), as described inthe loan agreement, further specific financial covenants (ifany) applicable to project "entities" would be provided by the task team. For the financial covenants on the "entity" portion, please refer to section G of PAD. SupervisionPlan 36. A detailed supervision plan for this project would be includedas part o fthe China Audit Strategy document which i s currently inprocess. This document would take into consideration the size o f project and the risk identified. 51  Annex 8: ProcurementArrangements CHINA: HEILONGJIANGDAIRY PROJECT General 1. Procurement for the project would be carried out in accordance with the World Bank "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004; and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" dated M a y 2004, and the provisions stipulated in the Legal and Grant Agreements. The description o f various items under different expenditure categories i s presented below. For each contract to be financed by the Bank LoadItalian Grant, the different procurement methods or consultant selection methods, the need for pre-qualification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The first procurement plan would cover the initial 18 months o f the project and would be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Procurement of Works 2. IBRD Loan: A total of US$27.4 million o f works would be procured. These works would include buildings and access roads, such as milk production facilities, milking sheds, breed improvement infrastructure, cattle barns, silage pits, fodder sheds, storage and office construction, required under Dairy Production Development Component and Breed Improvement Component. The procurement would be done using the Bank's Standard Bidding Documents (SBDs) for all I C B and Model BiddingDocuments (MBDs)for NCB agreed with the Bank. International CompetitiveBidding (ICB) Although not anticipated, any contract for works estimated to cost US$15 million equivalent or more would be procuredunder ICB procedures specified inthe Procurement Guidelines. National CompetitiveBidding (NCB) Contracts for works estimated to cost less than US$15 million equivalent may be awarded under NCB procedures acceptable to the Bank. Works contracts with estimated values of less than US$2 million may be advertised only in provincial newspaper. NCB procurement would be managed by provincial PMOS. Small Civil Works Procurement (Shopping) Contracts for works estimated to cost less than US$lOO,OOO equivalent per contract would be awarded through shopping procedures. These works would be suitable for lump-sum and fixed-price contracts awarded on the basis o f quotations obtained from at least three qualified domestic contractors in response to a written invitation. Small civil works procurement would be managed by each county PMO under the supervision o f the PPMO. 3. Italian Trust Fund Grant: Community Participation in Procurement Pasture improvement and silage pits required under the Climate Change Mitigation Component would be implemented through community participation by communities and beneficiary households by utilizing local labor, materials, equipment, and technology. These works are scattered in about 25 counties with a total value o f about US$4.6 million. The nature o f these works requires more flexibility procurement procedures and arrangements. To ensure those activities are effectively carried out, the following arrangements have been agreed: 52  Selection of Communities/Beneficiary Households: Communities and beneficiary households would be selected based on the criteria developed by the PPMOs as detailed in the Operational Manual. Community workshops/consultation would be organized to discuss and inform communities o f the objective o f the Component, eligible activities to be supported and technical standards to be followed. Project Support Agreement: County-level PMOs would sign the Project Support Agreement with each selected community. The agreement would specify the scope o f the works, financing amount, implementation schedule, payment terms and conditions, monitoring and supervision, inspection and acceptance procedures. Implementationand Payment: Communities would carry out the works in accordance with the signed Project Support Agreement and agreed technical standards. Payment would be made against completion o f the works and agreed unit rates for each type o f works in the Agreement. Auditing and Reporting:A special audit would be arranged by county PMOs together local FBs to verify the use o f the grant on a six month basis by external consultants. The six month audit report would be provided to the Bank supervision mission within one month after its audit. In addition, each community would disclose the financial data among its community periodically. Procurement of Goods and Livestock 4. IBRD Loan: A total o f US$14.5 million worth o f goods and 1US$86.96 milliono flivestock would be procured for the project. These would include: dairy equipment, feeding equipment, animal manure disposal facilities, milk testing equipment, animal breeding equipment, office equipment, vehicles, and livestock. The procurement would be done usingthe Bank's SBDs for all ICB and MBDs for N C B agreed with the Bank. (a) International Competitive Bidding (ICB) All contracts for goods including livestock and vehicle, costing US$500,000 equivalent or more, would be awarded through ICB procedures. (b) National Competitive Bidding (NCB) NCB procedures would be used for procurement o f goods costing less than US$500,000 equivalent per contract. Contracts with estimated values o f less than US$300,000 may be advertised only in provincial newspapers. Both ICB and N C B procurement would be managed by the provincial PMOs. (c) Shopping. Other goods, such as equipment for animal health protection, artificial insemination, testing equipment and training equipment in smaller quantities and available o f the shelf, would be procured by city/county PMOs using shopping procedures with contracts under US$lOO,OOO equivalent per contract. (d) Purchasing of Livestock by Individual Households. Livestock required by individual households would be procured by each individual household in accordance with community participationprocedures as outlined inthe M a y 2004 Procurement Guidelines - Section 3-17. 5. Italian Trust Fund Grant: A total o f US$4.3 million o f climate change equipment, waste treatment facilities and vehicle would be required. Bank procurement methods and thresholds as set out for the Bank Loan above would similarly apply to all goods procurement under the Grant. 53  Selection of Consultants 6. IBRD Loan: A total o f about US$O.9 milliono fconsulting services would be required under this project. The consulting services would include technical assistance for breed improvement, support services, environment protection and management, project management, design and supervision. The services for technical assistance would be provided by individual consultants or by consulting firms. The consulting contracts which are expected to cost more than US$200,000 equivalent would use the Quality and Cost Based Selection (QCBS) or Quality Based Selection (QBS) if quality i s the key element o f the selection. The Selection Based on Consultants Qualifications (CQ) would be used for the consulting contracts which are estimated to cost less than US$200,000 equivalent per contract. Chinese universities, and design and research institutes as sources o f consultants may be included inthe shortlist. Insuch cases, QBS or CQ would be used instead o f QCBS. Short lists o f consultants for services estimated to cost less than US$300,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions of paragraph 2.7 o f the Consultants Guidelines. Individual consultants would be selected and contracts awarded in accordance with the provisions o f paragraphs 5.2 through 5.3 o f the Consultants Guidelines. Under the circumstances described in paragraph 5.4 o f the Consultants Guidelines, individual consultants may be selected and awarded on a sole-source basis, subject to the Bank's prior approval. 7. Italian Trust Fund Grant: A total o f about US$0.35 million would be required under this Part, The services would include pasture management, animal waste management, and environment protection and management. The consulting services would be provided by both consulting firms and individual consultants. Selection methods would be similar to those described above for IBRDLoan. Training and Study Tours 8. IBRD Loan: A total o f US$2.5 million for training and study tours would be required. Detailed programs would be developed by the PMOs duringproject implementation and included in the project annual work plan for Bank's review. Actual expenditures incurred in accordance with the approved detailed programs would be used as the basis for reimbursement. 9. Italian Trust Fund Grant: A total o f US$ 0.05 million for training and study tours would be required. Detailed programs would be developed by the PMOs during project implementation and included inproject annual work plan for Bank's review. Actual expenditures incurred in accordance with the approved detailed programswould be used as the basis for reimbursement. Competitive ResearchGrant 10. Italian Grant: A total o f about US$1.1 million would be provided as grants to research organizations to carry out studies o f grazing land management, treatment o f crops residues and treatment o f animal manure. Proposals for grants would be evaluated on predetermined criteria by the Research Committee established in Provincial P M O in accordance with the procedures set forth in Annex 16 of the PAD. Non-Bank Financing 11. A total o f about US$36.04 million o f other costs would be required for the project. These costs are largely related to land requisition, local training, project management, monitoring and evaluation, 54  recurrent costs, and interest costs during implementation. These costs would be financed by the project counterpart funds. Assessment of the Agency's Capacity to ImplementProcurement 12. Procurement activities would be carried out by PMOs established at provincial, city and county levels. P M O i s staffed by about eight technical, procurement and financial officers. The PMOs at city and county level are staffed by 5-7 officers. The Animal Husbandry Department at each level would participate in the project preparation and implementation and provide technical support. Consultants would be also hired to supplement inadequate staffing at each level. 13. An assessment o f the capacity o f the implementing agencies to implement procurement actions for the project was carried out by the Bank's Beijing Office in August 2004 and April 2005. The assessment reviewed its organization structure and functions, past experience, staff skills, quality and adequacy o f supporting and control systems, legal and regulatory framework. The overall project risk for procurement i s average. 14. The agreed actions to address the weaknesses include: (a) the roles and functions o f PMOs at each level are to be defined and documented in the Operational Manual; (b) procurement training to be organized for procurement officers by Provincial PMO to introduce the Bank's new Guidelines; (c) the procurement plan for the initial 18 months is to be submitted to the Bank for review prior to loan negotiation; (d) a procurement filing system must be put inplace; and (e) qualified international and local consultants are to be hired no later than loan signing to provide technical support for livestock procurement. ProcurementPlan 15. The Borrower has developed an initial 18 months procurement plan for project implementation which provides the basis for the procurement methods. The plan has been agreed to by the Borrower and the Project Team before negotiations. The Procurement Plan i s available at the PPMO and would also be available in the project's database and on the Bank's external website. The Procurement Plan would be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements ininstitutional capacity. World BankPrior Review 16. All contracts in excess o f US$300,000 for goods and US$1 million for works, all contracts for consulting services in excess o f US$lOO,OOO for firms and US$50,000 for individual consultants, and all contracts awarded under single-source selection would be subject to prior review by the Bank. All other contracts would be subject to ex post review by supervision missions and the post review sampling ratio would be one out o f five contracts. Frequencyof ProcurementSupervision 17. Inaddition to the prior review to be carried out Bank's Office inBeijing, the capacity assessment o f the Implementing Agency has recommended at least two supervision missions per year to visit the project to carry out procurement post review. 55  Table A IBRD Loan TotalProject Costs by Expenditure Category (inUS$millionequivalent) 2. Goods 14.50 3. Livestock 86.96 4. Consultant Services 0.90 4. Training and Study Tour 2.50 5. Front End Fee 0.25 6. Non Bank Financing11 36.04 Total 168.55 Note: Land acquisition, local training, recurrent costs, project management, monitoringand evaluation, and interest I I during implementation would be financed by counterpartfunds. Table B ItalianTrust FundGrant TotalProject Costs by ExpenditureCategory (inUS$millionequivalent) 2. Goods 4.30 3. ConsultantServices 0.35 4. Training and Study Tour 0.05 5. Competitive Research Grant 1.10 Total 10.40 56  Table C Thresholdsfor ProcurementMethods and PriorReview Expenditure Category Contract Value Threshold (US$thousands) ProcurementMethod 1. Works >1,000 NCB 2. Goods >300 ICB/NCB 3. Services >100for firms QCBSIQBS/CQ/SS >50 for individual consultants all sole source contracts Table C-1 Allocationof IBRDLoanProceedsbyDisbursementCategory Expenditure Amount in Disbursement Percentage Category U S $ million 1.Works 7.40 25 percent for all project components except for households and demonstration farms 2. Goods 8.95 100percent o f foreign expenditures; 100percent o f local expenditures ( ex-factory cost) and 75 percent o f local costs for items procured locally for all project components except for households and demonstration farms 3, Livestock (imported and Domestic): 82.00 100percent 4. Consultant Services 0.90 100percent 5. Foreign Training & Study tours 0.50 100percent 6. Front end fee 0.25 100percent Total 100.00 57  Table C-2 Allocationof ItalianGrant ProceedsbyDisbursementCategory Expenditure Amount in Disbursement Categorv US$ million Percentage 1.Works 2.30 50 percent 2. Goods 2.20 100 percent o f foreign expenditures; 100 percent of local expenditures ( ex-factory cost) and 75 percent o f local costs for items procured locally 3. Consultant Services 0.35 100percent 4. Training 0.05 100percent 5. Competitive Research Grants 0.60 55 percent Total 5.5 58  Annex 9: Economicand FinancialAnalysis HEILONGJIANG DAIRY PROJECT-PRC EconomicAnalysis Summary of ProjectBenefits: 1. The project would approach the development o f the dairy industry in Heilongjiang with an integrated set o f activities aiming at ensuring the environmentally and economically sustainable growth o f the dairy sector. The project's components are mutually re-enforcing. For example, households purchasing dairy cows under the project's Dairy Production Development component would also benefit from the Breed Improvement component through genetic improvement o f the province's dairy herd. The Heilongjiang livestock sector would benefit from improved pasture management, improved animal feeding practices, and the use o f treated animal manure as a saleable fertilizer, in addition to global environmental benefits derived from the Climate Change Mitigation component. 2. The project would produce benefits (a) within the project area, (b) for the whole province, and (c) global and regional beyond Heilongjiang province. The main benefits include: Direct economic benefits. The main direct economic benefits would arise from smallholder farmers' increased incomes generated by investments in dairy cows, improved productivity o f dairy cows through better livestock management and genetic improvement of the herd, and improved milk quality. Other direct economic benefits also include those derived by investors in dairy parks, milking stations, and demonstration farms. Employment would also be created in the dairy parks, milking stations, and demonstration farms. Direct and indirect economic benefits at the provincial level. The benefits o f the Dairy Breed Improvement component would accrue beyond the project's herd to the provincial dairy herd. In addition, dairy production development would contribute to employment creation in the milk collection and processing industry.Opportunities would also be created for farmers to supply animal feed to respond to the growing needs o fproject beneficiaries. Social benefits. The project would support the development o f dairy farmers' associations with a view to increasing the organizational capacity o f dairy farmers and, eventually, their representation in the Heilongjiang Dairy Industry Association. The project would also promote the participation o f farmers in the joint-ownership companies established between the public and the private sector for investments in dairy parks, milkingstations and demonstration farms. Local environmental benefits. The project would promote improved waste management in dairy production activities, inparticular through training and technology transfer. Global environmental benefits. The project's Climate Change Mitigation component would pilot the use of innovative technologies in three areas: (a) pasture improvement to increase carbon sequestration and combat desertification; (b) treatment o f crop residues to improve their quality and usage in animal feeding, and thereby reduce methane emissions and on-field burning o f residues; and (c) treatment o f animal manure to reduce methane emissions. A research program would also assess other climate change experimental technologies. 59  Main assumptions: 3. Analytical approach. An integrated cost-benefit analysis o f all quantifiable benefits generated by the project has been conducted. It has not been possible to quantify all indirect benefits o f the project, such as additional employment creation and social benefits. The total benefits quantified in the analysis should therefore be considered as a lower bound estimate. The economic analysis o f the project focuses on the following quantifiable benefits: (a) incremental revenues o f smallholder farmers; (b) incremental revenues o f investors in dairy parks, milkingstations, and demonstration farms; and (c) at the provincial level, incremental farmers' benefits from increased milk productivity through genetic improvement. Global environmental benefits are discussed below, although it has not been possible to quantify them fully at this stage. They would be quantified during project implementation under the Climate Change Mitigation component. Potential benefits are discussed below. The economic analysis i s based on a five- year project implementation period and the following assumptions: The quantified economic benefits are derived using saleable incremental livestock products (milk, heifers, meat). In view o f the growing domestic demand for livestock products, it i s assumed that the ... incremental output i s saleable. Dairy production activities' costs and benefits have been evaluated over 20 years. A discount rate o f 12percent has been used inthe economic and financial analysis. All cost-benefit calculations are in2004 constant prices. Economic prices. World market reference prices are calculated for major traded products such as milk, corn, soybean, and wheat. In the case o f milk, in view o f the cyclical nature o f international milk prices, a five-year average has been used as a reference price. As a result o f the lowering o f tariffs on dairy products over the past five years (as per China's WTO commitments) and o f the changing demand of the domestic market towards liquidmilk products (about 70 percent o f the total Chinese dairy consumption in2004), the Heilongjiang processing industry has been converting from milk powder production to liquidmilk products (including for sales outside the province), a market segment in which local production i s competitive compared to imports. A calculation o f the economic price o f milk based on liquid milk products (and reconstituted milk from imported milk powder) results in a higher economic price for milk. However, a calculation based on the more competitive milk powder market segment has been used for the economic analysis, resulting in a lower economic price for milk and corresponding to a lower bound estimate o f project benefits. Whole milk powder has been used as the reference for milk, as Heilongjiang province produces very small quantities o f skim milk powder. A 5 percent quality discount has been applied to milk powder produced in Heilongjiang. For all other products, financial prices observed in Heilongjiang province have been used. A conversion factor o f 0.8 has been applied to the wage rate o f 20 RMB/day for farm and unskilled labor, in order to reflect the opportunity cost o f labor in the project area. The detailed calculation o f economic prices i s presented inTable 1a and 1b (Appendix 1). 4. Evaluation of Economic Benefits. The estimated incremental stream o f benefits is derived from a comparison o f the "without" and the "with" project situation, The "without" project case assumes a continuation o f the present milk quality level and o f the present productivity level o f dairy production activities. The "with" project case reflects an increase in milk production from better livestock management and genetic improvement o f the herd, and an improvement in milk quality, as a result o f project activities. All project costs have been included in the analysis. Evaluation o f the project's net benefits i s based on the following analytical modules: 60  Models: In order to estimate benefits for smallholder farmers, the analysis was conducted usingtwo farm models, for an initial investment in (a) two cows and (b) six cows. The models are indicative, and farmers would be free to choose within the project's investment range, based on their income level and debt repayment capacity. Models have also been used to assess the financial and economic viability o f demonstration farms, dairy parks and milking stations. To evaluate the benefits o f Component 2 (Breed Improvement), a model simulating the evolution o f the production o f the herd covered under the DHIP has been used. Herd Structure: The evolution o f the herd structure would depend on given technical parameters over the time period considered for the analysis (fertility rate, mortality rate and adult death losses, culling rate) and farmer's management decisions (number and age o f animals sold, number o f replacement heifers kept), In order to meet their debt servicing needs, farmers and demonstration farm managers would have to sell livestock to complement milk revenues (heifers in the first two to three years, then a mix o f heifers and older cows), while maintaining a constant number o f in-milk cows. Indairy parks, the total number o f cows i s also limited by the park capacity, and farmers would sell animals and aim at keeping an optimum ratio o f cows inmilk to total heads inthe park. Production parameters: For households' on-farm investments, death rates have been maintained at the status quo level. It has been assumed that due to access to farmer training, quality feed and better semen, per cow production would increase at an annual rate o f 1 percent compound from PY 4 on, and that the calving interval would drop to 400 days. In dairy parks and demonstration farms, death rates have been reduced by 1 percent for the immature stock, and calving intervals have been reduced to 400 days. Production i s assumed to increase by a liter per day at the first lactation and thereafter to increase by 1.5 percent compound per annum. In demonstration farms, first lactation production has been assumed at 1liter per day more than the dairy park herds, increasing at 1.5 percent compound per annum over the period considered. It i s also assumed that surplus heifers produced through demonstration farms would attract a 20 to 25 percent premium as a result o f the superior genetic background o f the herd and the use o f highquality imported semen. Variableproduction costs: Feeding costs represent the main variable production cost. Under the project, improved feeding practices would be introduced and training would be provided on the use o f least-cost feeding formulas. Feed costs used in the models are based on costs observed in the project area and improved feeding formulas. 5. Benefits and benefits distribution: The following assumptions have been used in the models to . estimate benefits to farmers and investors: Since milk would be produced under more hygienic conditions with lower bacteria counts under the project, whether at milkingstations, in dairy parks or in demonstration farms, the producer would receive . a RMB 0.10 per liter premium ex-farm gate; Models for investors in milking stations assume that revenues are generated from a standard RMB 0.15 per liter margin perceived on milk collected, as i s the practice in the project area. Other revenues would include AI and health services. Models for investors in dairy parks assume that revenues are generated from (a) a similar margin on milk sales; (b) a RMB 0.01 per kg margin on feed provided to farmers; (c) a rental fee per head for each animal kept in the park; (d) sale o f manure; (e) health services . provided to farmers; and (f) AI services; In dairy parks, the distribution o f benefits between investors and farmers is mainly dependent on the rental rates. In the analysis, those rates have been kept to the minimum required to ensure financial viability for investors. Under the project, the establishment o f fair contractual arrangements between park 61  managers and farmers would be sought to ensure that benefits are shared in a manner acceptable to all parties and are not captured by investors to the detriment o f farmers. Phasing: Investments under the Dairy Production Development component are phased over the first three years o f project implementation. It has been assumed that the benefits would start accruing the year following the initial capital investment. The sensitivity analysis conducted evaluates the impact on the project's economic rates o f return o f a one-year delay inproject benefits. Economic valuation of environmental benefits. The value o f environmental benefits generated by project activities can only be partially assessed at this stage. The valuation o f global environmental benefits o f the project's activities would be conducted as part o f project implementation under the Climate Change Mitigation component. Carbon sequestration. The benefits o f improved pasture and rangeland management under the project in terms o f increased carbon sequestration are described in detail in annex 15. Pastures in the project area vary widely in productive capacity and potential carbon storage per hectare. Average production has been estimated at 3000kg OM/ha o f which 80 percent would oxidize to C02, leaving an organic residue o f 600 kg OM/year/ha, or approximately 300 kg percent C/hdyear. The rate o f carbon sequestration would remain relatively high for about 10 years, and then decrease until a balance i s achieved. For a total o f 250,000 mu rehabilitated (16,667 ha), total carbon sequestered would amount to an estimated 5,000 ton C/year. Using a conservative estimate o f US$ 5/ton price, this translate into a US$ 25,000 benefit per year. Total environmental project benefits would depend on the area to be rehabilitated. The exact carbon sequestration capacity o f the project sites would be further evaluated duringproject implementation. Reduction of methane emissions. The project would support the use o f maize silage which results in less harvest loss and more nutrients gathered per hectare than with hay. Higher quality forage generates less ruminal methane. Non-managed manure disposal from dairy production results in anaerobic fermentation with methane production and may lead to nitrate leakage into the aquifers. This creates a potential health risk to village residents and can degrade surface and ground water. Organic digestion can be used to convert the material in organic compost. Digestion o f manure in open concrete basins in sheds i s just beginning to be used and the costs o f operation are being determined. Designed systems from other countries would be tested in Heilongjiang, and economic costs and benefits quantified. The project would assess and quantify environmental benefits in terms o f methane emission reduction under local conditions. Ammoniation of crop residues. Much o f the corn residue in Heilongjiang i s currently burned, while residue ammoniation allows their conversion to a low quality feed. The value o f ammoniated corn stover or other crop residue i s difficult to calculate since it i s not currently used in Heilongjiang. This activity i s experimental and the economics would have to be tested. Detailed carbon and GHG balance models would be developed under the project. 6. Economic Rate of Return (ERR). The total ERR o f the project is 23 percent. The capitalized value o f total project net benefits (NPV, discounted at 12 percent) i s RMB1, 064.1 million (US$131.20 million at the current exchange rate). The ERR and economic N P V o f the different activities have also been evaluated (see Table 2). They show that on-farm investments at the household level, under Component 1, and Component 2 (Breed Improvement) are key activities to ensure higher economic returns from the project. 62  ERR NPV (at 12 percent) in percent million RMB Component 1 (Dairy Production) 16 212.8 I Households on-farm investments 19 134.4 Milkingstations I l6 I I New dairy parks (households + investor) 14 51.2 Existing dairy parks (households + investor) 21 27.8 Component 2 (Breed Improvement) 63 924.9 Total project (all components) 23 1,064.1 7. Sensitivity analysis. The sensitivity analysis shows that the total project returns are robust in the case o f a decrease in total project benefits, an increase in investment costs, or a delay in project benefits (Table 2). A 50 percent decrease intotal project benefits or a 95 percent increase in total investment costs are needed to bring the project's ERR down to 12 percent. However, the economic viability o f investments in new dairy parks i s compromised by a moderate (above10 percent) decrease in project benefit, or a moderate (above 10 percent) increase in investments costs. Duringproject implementation, special attention would have to be given to the quality o f milk and to overall management o f dairy parks to address that risk. Similarly, special attention to design and construction o f parks would be needed to keep investment costs at acceptable levels. Demonstration farms are also sensitive to a moderate increase (10 percent) in investments costs or decrease inproject benefits (10 percent). It should be noted, however, that the benefits quantified for the demonstration farms only include direct on-farm benefits (from dairy and related activities), and not additional benefits to farmers from training and demonstrations (which have not been quantified). The figures below therefore represent a lower bound estimate o f the economic benefits derived from the demonstration farms. Table 2: Results of Sensitivity Analysis (ERR) Base +10 +20 10 20 1year scenario percent percent percent percent delay of investment investment benefits benefits benefits costs costs decrease decrease Component 1 (Dairy 16 14 12 13 11 13 Production) percent percent percent percent percent percent Households on-farm 19 17 15 16 14 16 investments percent percent percent percent percent percent Milkingstations I 16 14 13 14 12 13 percent I percent I percent I percent I percent I percent I 63  1 New dairy parks (households I I I 1 + investor) 14 12 11 12 10 percent percent 1Ipercent percent percent Existing parks (households + 21 18 17 18 15 ercent FinancialAnalysis 8. Financial returns. The total project financial rate o f return (FRR) is 26 percent, with an NPV o f RMB 1,387.8 million. The results o f the financial analysis at the household and investor level, which has been conducted using farm models and milking station, dairy park, and demonstration farm models, are presented in Table 3 below. Incremental cash flows are derived from the individual activity budgets available in the project files (electronic files o f the farm models are available upon request). The FRR o f project activities are in the range o f 25 percent -27 percent for smallholder on-farm investments, and 25 percent-26 percent when households keep their cows in dairy parks. Additional benefits o f dairy parks for households, not quantified in the analysis, include time available for other remunerative activities and space provided in the dairy park (when farm size does not allow the development of dairy activities). 9. For a milking station, the FRR i s 30 percent, assuming that the station i s working at its full capacity o f 450 cows per day. In the case of a new dairy park, the FRR for the investor i s 11.5 percent, assuming that rental rates are kept at a minimumto allow acceptable financial returns for the investor, and that farmers' cash flows and debt repayment capacity are not affected (or, in other words, higher rental rates would increase the FRR for the investor and decrease those for farmers). For demonstration farms, the FRR i s 17 percent. Table3: Resultsof FinancialAnalysis Model Investment (RMB) NVP(at 12 %t) FRR O h 1. On-farm 2-cow investment 37,720 41,187 25 2. On-farm 6-cow investment 110,760 114,442 27 3, In-park 2-cow investment 32,140 32,810 25 64  10. Sensitivity analysis/Switching value of critical items. The major risks for the financial sustainability o f the project's investments include: (a) an increase in investment costs; (b) an increase in the cost o f feeding, which i s the major input cost; or (c) a reduction inthe price o f milk.The sensitivity o f the FRR has been tested against the following assumptions: a 10 percent and a 20 percent increase o f total investment costs; a 10 percent increase in feeding costs; a 10 percent and a 20 percent decrease in milk price. The results are presented inTable 4 below: Model Base scenario: +10 Yo +20 Yo +10 Yo -10 YOmilk -20 % milk FRR investment investment feeding cost price price NPV (12 'Yo) costs costs 1. On-farm 2- 25 % 23 % 21 % 22 % 21 % 18 % cow investment RMB41,187 RMB 37,819 RMB 34,451 RMB 32,882 RMB 29,509 RMB 17,832 2. On-farm 6- 27 % 25 % 23 % 24 % 23 % 2 0 % . 3. In-park 2-cow 1 2 5 %I 23 % 21 % 22 % 21 % 17 % investment RMB 32,810 RMB 30,000 RMB 27,131 RMB25,498 RMB 22,397 RMB 11,923 4. In-park 6-cow 26 % 24 % 22 % 23 % 22 Yo 18 % investment RMB 101,165 RMB 92,526 RMB 83,886 RMB 80,604 RMB71,597 RMB42,029 Investors: 5.Demonstration 17 % 15 % 14 % 15 % 14 % 11% farm RMB 7,090,111 RMB RMB RMB RMB RMB 5,423,326 3,756,540 4,757,938 3,078,139 (933,832) 6. New dairv 11.5 % 10.2 % 9 % 10.9 Ya a/ 11 % bi 10.5 % bl park RMB(117,827) RMB(480,803) RMB(843,880) R M B (273,144) RMB RMB(366,260) (242,044) 7. Renovated 33 Yo 30 % 28 % 32 % a/ 31 Yobl 30 % bl dairy park RMB 621,202 RMB585,690 RMB 550,178 R M B 579,876 RMB 571,623 RMB 522,044 8. Milking 30 % 27 % 25 % Minimum 25 Yo bl 20 % bl station RMB 704,840 RMB635,059 RMB565,278 248 cowslday RMB492,987 RMB281,133 Dairy herdunder the Milk RecordingSystem (Component 2) 9. Dairy 66 % 63 % 61 % 65 % 62 % 57 % herdhreeding RMB RMB RMB RMB RMB RMB 1,091,620,264 1,040,260,176 1,035,591,077 1,001,980,281 892,818,255 740,707,234 11. The sensitivity analysis shows that the returns for smallholder farmers are comparatively more sensitive to a decrease in milk prices. Although trends in milk prices in Heilongjiang and the continued unmet demand for dairy products in the short and medium term indicate that a decrease in milk prices is unlikely (Milk Marketing Study, January 2005), prices paid to producers would be affected if insufficient attention i s given to milk quality or unfavorable contractual arrangements allow milking statioddairy park owners to reduce prices to farmers in order to maximize their own profit. Special attention will be given to those two aspects during project implementation. Mechanisms to mitigate risks for farmers include: (a) farmers training on herd management and feeding, and on milk quality; (b) the use o f contracts between farmers and dairy parks or milking stations with a minimum guaranteed price; (c) participation o f farmers in the DHIP (breed improvement); and (d) improved health services through milkingstations and dairy parks. 12. The sensitivity analysis also indicates that investments in dairy parks are generally riskier than other project activities. In particular, the financial viability o f investments in new dairy parks i s sensitive to increases in investments costs (and conversely, small decreases in investment costs for dairy parks quickly improve their financial viability). Design and construction o f the parks would require close attention to avoid extra costs. 65  13. In the case o f milking stations, the sensitivity analysis indicates that both investment costs and milk prices (which are based on milk quality) would be important factors to ensure the financial viability o f the investment. A minimumo f about 250 cows per day would have to be milked to ensure acceptable returnsfor the investor, which is well below the capacity o f such milkingstations. 14. The analysis has been conducted assuming that all investments (land acquisition, civil works, equipment, etc.) are priced at full market value. In the case o f milking stations, dairy parks and demonstration farms, financial returns would increase in cases where equipment is provided free o f charge by processors, or when land i s made available free o f charge by local governments, as i s being considered in some counties. 15. Cash flows and debt repayment.The following assumptions, based on existing loans offered by commercial banks (RCC) to farmers in the project area, have been used to assess cash flows and debt repayment capacity o f households: (a) a minimum 20 percent equity; (b) a six year repayment period, with a one year grace period (interest payment only); and (c) a 10.8 percent interest rate. 16. For investors in milkingstations, dairy parks and demonstration farms, the analysis was based on: (a) a minimum50 percent equity; (b) eight year repayment period with a three year grace period (interest payment only); and (c) a 5 percent interest rate. Total investments o f farm households from around RMB 38,000 for a two-cow investment to RMB 111,000 for a six-cow investment per household. It i s expected that some households would seek loans from other sources (including informal loans) to raise some o f the equity. This represents an additional risk for the household and would have to be considered as part o f assessment o f individual households' debt repayment capacity. Similarly, the financial situation o f investors in dairy parks, milking stations and demonstration farms would need to be assessed on a case- by-case basis. 17. Household annual debt servicing varies up to a maximum o f RMB 8,60O/year in the case o f a two-cow investment and RMB 25,40O/year in the case o f a six-cow investment. Although these figures are high compared to average farmers' disposable income without project (in the range o f RMB 4,600- 6,500 per year, based on the socioeconomic survey conducted during project preparation), with the loan conditions described above debt repayment needs can be covered at all times by revenues from dairy production (milk and livestock sales) and for some years by the use o f additional disposable income. After the loan has been repaid, average annual net income from dairy production i s around RMB 13,300 for households with a two-cow on-farm investment, around RMB 11,000 for a two-cow investment in a dairy park, around RMB 34,000 for a six-cow on-farm investment, and RMB 30,000 for a six-cow investment ina dairy park. 18. At the household level, an additional risk is the loss o f animals, which would affect the household's debt repayment capacity. Livestock insurance i s available in Heilongjiang, and i s an option for farmers. For those not interested or not eligible for such an insurance, the Heilongjiang Finance Bureau indicated that debt rescheduling could be considered on a case-by-case basis for households facing repayment difficulties. Finally, the project design includes the provision o f health services by milkingstations and dairy parks. Fiscalimpact 19. As part o f incentives for the development o f the dairy industry, the Heilongjiang province government i s not taxing milk production. The fiscal impact o f the project i s expected to be marginally positive, though increased collection o f taxes (such as VAT) on processed milk and dairy products. 66  Appendix 1 Table l a and lb: Derivationof Economic Farm GatePrices Table la: Milk Notesto table above: Table lb: Cereals 67  Annex 10: SafeguardPolicyIssues HEILONGJIANGDAIRY PROJECT -PRC EnvironmentalGuidelines Summary The Project The scope o f the proposed project includes a project area that covers 120,000 km2with a total population o f 20 million people that are supported by 2.67 million ha o f cultivated land. It extends from the eastern zone city o f Qiqihar, north to Heihe and through to the central zone centered on Harbin city to the western zone areas around the cities o f Jiamusi and Mudanjiang. The primary objective of the project i s to increase dairy production and farmers' incomes inthese selected areas o f Heilongjiang province. The project would raise the productivity o f existing small householder dairy farmers establish new small holder dairy farms and larger dairy parks and demonstration farms o f up to 1000head each. Itwould also strengthen the capacity and scope o f support services to dairy farmers inthe form o fanimal health, breeding, dairy cow nutrition andnatural resourcemanagement services. The second objective o f the project is to improve the sustainability and impact o f dairy farming on the local and global environment. To pursue this objective, the project includes a climate change component that would demonstrate and pilot innovative technologies to increase carbon sequestration and mitigateheduce GHG emissions resulting from the expansion o f dairy farming in Heilongjiang. This component would include equipment, civil works, technical assistance and training o f staff and project beneficiaries for: (a) pasture improvement for the purpose o f increasing fodder production, carbon sequestration and combating desertification; (b) treatment o f crop residues to improve their quality and usage in animal feeding, decrease methane emissions and reduce the burning o f residues; and (c) treatment o fmanure to reduce methane emissions and convert it into saleable fertilizer. Potentialenvironmentalissues Environmental and safeguard issues mainly concern the management o f natural and improved grassland areas; the management o f animal manure (quality and capacity o f storage, composting treatment to fertilizer, land applications); the discharge o f dairy waste-water from breeding farms, dairy parks, milk stations and households to land; excess nutrient loading o f receiving land for animal manure, and protection o f surface and ground water resources; and the veracity o f treatment and discharge o f waste- water from dairy processing plants. Potential environmental impacts from dairy parks and beef breeding farms and dairy processing plants could also include smoke, airborne particles, gaseous discharges, transport and machinery noise. These would need to be mitigated to China National Standards and Bank Standards (see Annexes 3 and 4) by incorporating the necessary controls and treatment systems in the design and, during procurement, by specifying equipment and processes that meet these standards. Processors would also need to incorporate national safety measures for personnel in the vicinity o f operating machinery. The project is not expected to produce any significant environmental impacts from other aspects o f the project components. However, some investments may involve minor environmental issues related to, for example, milk hygiene and milking techniques, the use and storage o f agricultural chemicals and animal medicines, natural resources management in rural areas, biodiversity, and location or site preparation for facilities for dairy cattle housing. 68  Responsibility Sub-projects financed through the project must be in compliance with the environmental laws and regulations o f the PRC and Bank safeguard policies. The HEPB environmental protection regulations define EA category I11to include livestock farms with less than 100 dairy cattle. This category o f project is required to complete a Registered Statement o f the enterprise activities. N o further EA i s required. In the project, the Guidelines for Environmental Screening and Monitoring (HDP EIA Report Annex 5) define a procedure for simple screening by the county PMO (or contracted animal husbandry specialist) o f each individual householder. This would determine: (a) the relevant sustainable farming practices applicable to the activities of the individual householder's proposed dairy herd expansion and to compare this with that stated by the householder; and (b) by site inspection, check the veracity o f environmental data provided by the householder. This provides a basis for the P M O to accept or reject the proposal on environmental grounds. An EIA is mandatory for intensive livestock farms with over 290 dairy cattle and for intensive breeding areas where more than 400 dairy cattle are managed as a unit. It would therefore be mandatory that dairy parks, demonstration farms and milking stations complete an EIA and prepare an Environmental Impact Report (EIR), together with an Environmental Management Plan (EMP), to comply with this regulation and conditions for financing under the Bank Loan. The Guidelines for Environmental Screening and Monitoring o f the Project defines a procedure for two-stage screening by the county PMO (or contracted environmental specialist) o f each project component to determine: (a) the relevant E M P associated with the activities o fthe proposed project and to compare this with that proposedby the proponent; and (b)by site inspection, the veracity o f environmental data provided by the proponent. This would provide a basis for the local county P M O to accept or reject the proposal on environmental grounds. Selected Safeguard and Environmental Categories The project i s likely to have minimal or no potential adverse environmental impacts on important sites within the project areas and, in all cases where risks are predicted, mitigation measures have been recommended to address the protection o f the environment and improve environmental performance. In view o f this, the environmental Category B and safeguards category SZare considered appropriate for this project. Table - 1: Bank Safeguard Policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [X 1 [I Natural Habitats (OP/BP 4.04) [I [X 1 Pest Management (OP 4.09) [I Cultural Property (OPN 11.03, being revised as OP 4.1 1) [I Involuntary Resettlement (OP/BP4.12) [X 1 Indigenous Peoples (OD 4.20, being revised as OP 4.10) 11 [X 1 Forests (OP/BP 4.36) [I [X 1 Safety o f Dams (OP/BP 4.37) [I XI Projects in Disputed Areas (OP/BP/GP 7.60) [ I Projects on InternationalWaterways (OP/BP/GP 7.50) [I 69  ChineseEnvironmentalLaws andRegulations Under Chinese law, demonstration farms and dairy parks proposed for the project would be classified as construction projects with the potential to have major environmental impacts on the environment and an EIA would needto be conducted. An EIRwould be requiredto be prepared, listing and evaluating the key potential environmental impacts with measures for preventing, minimizing or mitigating for adverse environmental impacts detailed. HEPB environmental protection management regulations for various categories o f construction projects classify animal husbandry and grazing as having the potential significantly to affect the environment. Under recently introduced EIA legislationg it is understood that the previous animal husbandry and grazing project category for the purposes o f EIA has been more closely defined to separate two intensive livestock production categories. First, a category o f intensive livestock breeding farm that can be applied to the individual household component under this project. Second, the intensive livestock breeding area which i s relevant to the dairy park and breeding farm components. Additionally, many special laws exit that are relevant to pasture land, land degradation, water resource and other environmental protection regulations (such as waste discharges o f livestock and poultry breedingindustries)." Their application, however, is fragmented and enforcement i s executed by various agencies, thus causing considerable problems in the move towards integrated ecosystem management. Probable Sub-project Activities The Project comprises four components selected by the PPMO, which include the development of: (a) Seven demonstration farms o f 1000cows each. (b) 70 dairy parks with 50-70 individual households each with up to six cows. (c) . Assistance to more than 10,000 individual households, each with up to six cows. (d) Support service systems for the dairy industry including the development o f farmers' associations, animal breeding services including herd recording, herd husbandry and management including herd health, information management and extension. (e) 250,000 mu o f improved pastures, crop residue treatment in dairy parks and households; seven large manure treatment facilities in the demonstration farms and 13 medium size manure treatment units in dairy parks, and a number o f competitive research grants to explore and demonstrate innovative climate change technologies. A. EnvironmentalScreening of Sub-projects EnvironmentalScreening The Guidelines for Environmental Screening and Monitoring o f the Project are discussed in Annex 5 o f the Environment Impact Assessment report for the project. These define a procedure for two-stage screening by the County PMO (or contracted environmental specialist) o f each sub-project component to determine: (a) the relevant EMP associated with the activities o f the proposed sub-project and to compare this with that proposed by the proponent; and (b) by site inspection, the veracity o f environmental data PRC EIA Regulation effective September 2003 lo2001 Management Method to Control Pollutants caused by Livestock and Poultry Breeding GB 18596 - 2001 Discharge Standard for Pollutants o f Livestock and Poultry Breeding HJ/T81- 2001 Technical Standard for Preventing Pollution from Livestock and Poultry Breeding 70  provided by the proponent. This provides a basis for the local PMO to accept or reject the proposal on environmental grounds. The EIR and associated EMP completed for demonstration farms and dairy parks would support their proponent's project proposals through the screening process o f the local PMO. The EMP should incorporate (a) measures to protect the environment from the farm or dairy park operations; (b) environmental monitoring procedures; (c) environmental reporting; (d) integration o f environmental improvement plans with quality management; (e) occupational health and safety standards; (f) appointment o f a designated environmental officer; and (g) annual budget provisions to finance implementation o f the EMP. Environmental Monitoring The country PMO, in collaboration with HEPB and HAHB staff at the county level, would be required regularly to monitor the effectiveness o f EMPs. Environmental screening formats are described in Annexes 10-12 o f the HDP Environmental Impact Assessment report. Environmental monitoring requirements are recommended for all dairy breeding production enterprises, with EMPs a mandatory requirement for all lending for demonstration farms, dairy parks and milking stations. An environmental statement o f individual dairy household enterprises giving details o f the operational practices and environmental protection measures would be required for sub-project approval. Institutional and training requirements for the provision o f appropriate environmental services are described for the project. Provision i s also made to strengthen the environment monitoring capacity o f the HEPB. Project Supervision (Environmental) Project supervision should include an environment specialist. Monitoring reports should be available before each supervision mission and any anomalies or concerns investigated during supervision. The supervision missions should check the physical activities o f the sub-project against the EMP and establish that mitigation and monitoring measures are functioning as designed and are adequately controlling any pollutants or environmental issues within the law and regulations. In cases o f unsatisfactory performance, an environmental audit and revised EMP may be required. B. Social Safeguards 1, Involuntary Resettlement (OP 4.12). The PPMO hired a resettlement specialist to investigate land acquisition issues for the project. His report (see 2 below) confirmed the PPMO's affirmation that the project would not involve any significant involuntary land or productive assets acquisition. However, in the event that small land parcels are affected by project acquisition or rental, a Resettlement Policy Framework (RPF) for the various project sub-components (see below) would be implemented and the following guiding principles regarding land acquisition or rental by project components has been agreed upon: (a) All efforts would be made to avoid or minimize the taking o f farmland for project use. (b) If land is rented for project use, all efforts would be made to avoid renting of farmland. (c) Ifthe use or rent of farmland or productive assets is unavoidable, then the PPMO would proceed to compensate for losses according to the guidance o f both the Bank's OP 4.12 on Involuntary Resettlement and relevant Chinese laws and regulations, including the People's Republic o f China's Land Management Law and applicable provincial regulations. 71  2. Involuntary Resettlement Report. An "Involuntary Resettlement Report for the Heilongjiang Dairy Project" was submitted by Professor Shi Guoqing o f the National Research Center for Resettlement based on field research conducted during October 2004. Its findings and recommendations were as follows: (a) Findings. (i) In most subprojects, participants would use their own land and no issues relevant to land acquisition and house demolition would arise. (ii) A few sub-projects would rent lands from the village communities or other land users but these rented lands mostly are wasteland. Nevertheless, any rent would be distributedbased on the investment affected. (iii) Only very few demonstration farms, dairy parks and milking stations may have outright lands acquisition and resettlement. (iv) All dairy production activities within the farmer's family would not cause any lands acquisition or resettlement. These farmers all use their existing lands. (v) The demonstration farms or dairy parks will whenever possible use their own lands, but the majority o f this land have been used for other proposes such as the farming, stock farm, poultry and would require rearranging the jobs that are usingthe land. (vi) The land acquisition and resettlement can be avoided in most subprojects. (b) Recommendations. (i) To avoid or minimize land acquisition and resettlement as much as possible, duringthe process of selection, planning and design o f sub-projects. (ii) The Heilongjiang PPMO should prepare an Involuntary Resettlement Policy Framework and Implementation Procedures for the project, which can be used when involuntary resettlement can not be avoided." 3. Cultural Property (OP 4.11). Although unlikely, some civil construction works might conceivably affect cultural property sites. The PPMO, in collaboration with the Provincial Cultural Relics Bureau, thus: (a) Confirmed that there are no sites in the project area (milking stations, dairy parks or demonstration farms) that are under the protection o f cultural relics protection units above the county level nor does any project sub-component site affect any historical and cultural sites recognized by any local relics bureaus. One site which was determined to be in such a site was dropped from the project. (b) Explicitly pledged that if any culturally or historically significant finds are encountered during project implementation, China's laws on protection o f cultural relics and the Bank's QP 4.11 would be invoked, leading to the immediate cessation o f work, followed by an initial survey o f the site, its later excavation, and comprehensive protection o f the site. (c) Agreed that all project civil works construction contracts would include a provision stating that if cultural relics are found work would immediately cease and a report to the local cultural relics bureau would be made for the purpose o f relics preservation. 4. Indigenous Peoples (OD 4.20). Indigenous Peoples (Koreans, Manchus, Mongols, and Daur, among others) exist in the project areas, overall comprising about 5 percent o f the project's potentially affected people (see Table in Appendix 1). A minorities nationality expert was engaged by the PPMO to explore the likely ethnic indigenous dimensions o f the project. This report (see 5. below) indicated that: 72  (a) no special cultural tailoring o f the project was necessary to ensure that minority nationalities participate fully and appropriately in the project and that no negative effects were foreseen either, and (b) the province's most significant minorities were adequately included in the project with the sole exception o f the Daur nationality. To rectify this omission, the project added two Daur villages to host project sub- components. With this inclusion, no Indigenous Peoples Development Plan was deemed necessary or useful. 5. Indigenous Peoples Report. An "Indigenous Peoples Report for the Heilongjiang Dairy Project" was written by Professor Jin Zhiwei o f the China Cross-Cultural Consulting Center o f Zhongshan University based on fieldwork conducted inNovember 2904. Its key conclusions were: (a) The ethnic minority population in Heilongjiang Province accounts for less than 10 percent o f its whole population. Although they inhabit a relatively small proportion o f the land, they have been living in the same community with Han nationality people, and their production activities are also farming and herding. The people o f the ethnic minorities, especially the people below 60 years o f age can speak Han Chinese fluently and basically use Chinese characters for daily writing. They are nearly the same on daily life, production and customs as the Han nationality. Five ethnic minority villages investigated duringthis tour completely confirmedthe above conclusion. It is not necessary to make special design for the implementation o f the project aiming at the language and culture o f the ethnic minorities. (b) "The ethnic minorities inthe countryside o f Heilongjiang Province are mainly Manchu, Korean, Mongolian and Daur nationalities. For the current project sites, except the Daur nationality, the former three ethnic minorities have villages to participate in the project. With consideration to Daur as one o f China's smallest ethnic minorities, as compared with Han nationality, it i s a relatively economically poor group, and the Heilongjiang Province i s the main place inhabited by the Daur nationality. It i s strongly recommended that at least two Daur villages should participate in the project, so as to help them have equal development opportunity." C. ResettlementPolicyFramework and ProceduralGuidelinesfor Heilongjiang Dairy Project 1.LegalFramework In China, the resettlement policy consists o f two parts. For rural land acquisition and resettlement it is based on the Land Administration Law (1998) and relevant provincial implementation measures which clarify land rights and provide the basic legal structure and policy framework for addressing all land acquisition and resettlement issues. For urban demolition and relocation, it i s based on the "Urban Building Demolition and Relocation Regulation o f PRC" and relevant municipality implementation measures, which provide the basic legal structure and compensation principles for urban relocation and resettlement. The following are a brief summary o f key provisions inthis law. Land Tenure (ownership): Urban land is state owned while rural land i s owned by rural collectives. The collectively owned rural land belongs to village collectives and would be managed by them. The collectively-owned land could be contracted, managed and used by collectives or individuals (Articles 6, 7 and 12). 73  Land Acquisition (Eminent Domain): The state could acquire land belonging to the collectives. The constructionunit should apply to above county level Land Administration Bureaus with approved project documents from proper authorities. With the approval o f the Land Administration Bureau, the state construction project could acquire land. The current land owners (users) should comply with the land acquisition decision in order to meet the state needs. After land acquisition, the state would have the land ownership while the land user would only have land use right (Articles 23 and 24). Land Compensation In land acquisition, the new land user should pay land compensation to the current land owners. For cultivated land, compensation rate ranges from 600 to 1000 percent multiples o f the average annual output value inthe past three years (Article 27). Resettlement Subsidies: In addition to land compensation, resettlement subsidies should also be paid, based on the agricultural population to be affected by land acquisition (the number of affected people i s equal to the amount o f cultivated land divided by per capita cultivated land before land acquisition). For every affected farmer, the resettlement subsidy ranges from 400 - 600 percent o f the average annual output value in the past three years. The total resettlement subsidy per mud should not exceed 20 times o f average annual output value (Article 28). If the resulted job compensation could not restore farmers to theirprevious livingstandard, it could be raised again, providedthat combined landcompensation andjob compensation would not exceed 3000 percent o f the average annual output value (Article 29). All land compensation and resettlement subsidy funds, except for young crops and properties belonging to individuals, should be paid to village collectives in order to develop a new production base, provide jobs and provide a living allowance for the elderly. No individual or collectives should use this fund for other purpose (Article 30). For surplus labor caused by land acquisition, jobs should be provided by developing sideline activities and setting up village enterprises. Anyone still unemployed could be assigned to work in other state or collectively-owned enterprises, with their job compensation being paid to the hiringenterprises (Article 31). Consultation and Disclosure: When a plan for land compensation and resettlement subsidy is decided for requisitionedland, the local government concerned would make it known to the general public and solicit comments and suggestions from the affected collective villages and individuals (Article 48). Following this provision, the practice o f making "compensation rates" and "rehabilitation measures" known to the general public and soliciting comments from affected villages and individuals before finalizing the compensation agreement has been adopted by provincial and county land administration bureau. For urban resettlement, "the new land user shall provide compensation to the owners o f removed houses and auxiliaries including agents and manager o f the city owned houses ...." In terms o f compensation policy, "two methods would be adopted for house demolition, including property rights exchange and cash compensation. Existing housing area would be used as the basis for calculating housing compensation. The cash compensation would be based on location housing price and the existing area o f removed house." 2. ResettlementPrinciples and Eligibility for Compensation Following Chinese laws and regulations on land acquisition and resettlement and the Bank's OD 4.30 and OP4.12 on involuntary resettlement, the basic principles o f land requisition and resettlement for the proposed project would include the following elements: (a) Minimize negative impacts as much as possible; 74  (b) Carry out resettlement and compensation in order to improve or at least restore the pre-project income and living standards o f the affected people; (c) Fully inform and consult closely with affect peoples on compensation options and the Resettlement Plan; (d) Provide assets and resettlement at replacement rates; (e) Provide compensation for lost assets and resettlement subsidies in full prior to land requisition and house demolition; and, (f) Disbursement for each subproject would be conditional upon the Bank's approval o f the sub- project Resettlement Plan. All project-affectedpeople would be provided with compensation and rehabilitation if their land area or income source is removed; if their houses are to be demolished; or iftheir other property (crops, trees, and other facilities) or access to these properties i s to be removed or damaged due to land acquisition. All affected people, regardless o f their legal status, would be provided compensation and rehabilitation based O n the policies adopted by PRC. Lack o f legal paper o f their customary rights o f occupancy certificates would not be an obstacle for obtaining compensation for them. The resettlement policy would apply to all components under the project whether directly funded by the Bank. The policy applies to all displaced persons regardless o f the total number affected or the severity o f impact. Particular attention would be paid to the needs o f vulnerable groups among those displaced; especially those below the poverty line, the elderly, women and children, indigenous groups and ethnic minorities. Since the project i s a sector project, most sub-projects have not yet been fully identified and the feasibility reports are being prepared. As a result, for many sub-projects the detailed compensation standards for land acquisition and building demolition would not be identified until project implementation. However, following national laws and provincial regulations, and current practice, a range o f minimum compensation rates could be established and basic rehabilitation approaches could be identified, which would provide a general guideline for resettlement preparation and implementation among all sub- projects. 3. CompensationRate According to officials from three provinces, the process o f land requisition and resettlement for the proposed sub-projects would follow the new Land Administration L a w with increased compensation standards and consultation procedures. In other words, the total compensation on land (including both land andjob compensation) would be set at a level at least 10 times the average annual output value in the past three years. The land requisition from each affected village would be limited due to the small sub- projects; the economic impacts on the existing villages would be relatively small. In addition, most these villages in those regions would have at least 5 percent cultivated land inreserve which would be allocated to those land loss individuals losing land in order to restore their existing production bases. For the affected villages, adequate compensation on land with at least 10 times annual output value would provide them with badly-needed capital to develop village production, improve village infrastructure and assist the vulnerable individuals. As a result o f different economic conditions and different annual output values, specific rates on land compensation andjob compensation vary from county to county. The Heilongjiang provincial land bureau issuedaverage annual yields for different types o f cultivation indifferent regions. Based on this yield data and on the principle o f the 10 times multiple, the compensation rates would be at least Y75,OOO -Y90,500 per ha for dryland; Y90,OOO-Y 117,000 per ha for paddy; and Y270,OOO - Y375,OOO per ha for vegetable land. 75  For temporary land occupation, in general compensation would be paid directly to affected persons for the time o f occupation, based on average annual yield o f different types o f cultivated lands, plus the cost o f land rehabilitation. The compensation for temporary land occupation is set at two times the average annual yield, which means that, for one year o f occupation, affected people would receive two years o f output value, plus land recovering cost. BuildingCompensation With regard to the compensation rates for demolished structures, the basic strategy is to provide affected people with the replacement value o f lost structures, transfer assistance and new housing plots in order to allow them to rebuild their new houses with equal or better conditions. Due to the low population density in the project regions, and serious efforts o f minimizing the resettlement impacts during the design process, the number of households which will need to be relocated i s or very small. The PPMO and City PMOSwould review the documents o f the sub-projects and confirm that house demolition is confined to sub-projects owner's houses. Ifthere is householdrelocation, those inurbanareas, would be providedwith replacement housinginthe urban location with larger size and better facilities, or equivalent cash compensation at market price, which would allow them to purchase replacement housing in a similar location. For those in rural areas, they would be given housing compensation o f replacement value and a free housing plot within existing villages. All relocated households would be moved a few hundred meters within their existing villages, and no significant economic and social impacts are expected. The relocation and resettlement might provide unique opportunity for some resettlers to improve their housing conditions in these cases. Due to different economic conditions, and different prices for construction materials, some variation does exist among these counties. The list below gives a general range o f compensation for rural houses. For demolishedurban houses, a land price would be provided which would allow the relocated households to buy replacement housing with same at least the size in urban locations. In addition to the compensation rates for structures and other properties, transfer assistance would also be provided with YlOO per household for moving and Y100per household for temporary accommodation. Inaddition, each relocated household would be provided a new housing plot free o f charge with equal size and condition in the affected village, and a one time payment for site preparation, electricity connection and road construction. 0 brick concrete structures Y300 - Y500 per m2 0 wood brick structures Y200 - Y400 per m2 0 earthstructures Y180 Y300 per m2 - 0 storage (brick) Y100- ~ 2 2 per m2 0 0 storage (earth) Y50 - Y200 each 0 young trees Y20 - Y50 each 0 mature fruit trees Y80 - Y100each 4. RehabilitationApproaches In general, the impacts o f the project could be classified as permanent land losses, temporary land occupation, and building demolition and relocation. In addition to compensation, detailed rehabilitation measures would be developed for different types o f affected persons. For permanent land loss, all agreed 76  compensation including land compensation and resettlement subsidies, would be paid directly to the village committees. The compensation for crops would be paid directly to the affected individuals. Given the fact that land acquisition in each affected village would be relatively small, and most rural areas inthe three provinces have relatively high areas o f farmland per capita, after land readjustment within affected villages, economic impacts on individuals would be quite limited. The affected villages could easily restore their income by using land compensation to expand irrigated farmland and improve farming conditions. Such payment could be used to change the planting structure by developing more greenhouse vegetable and to invest in other sideline activities which could bring much higher revenue than grain production. The land compensation find would be paid directly to the affected villages to be used to improve irrigation conditions and improve village access and infrastructure. For the affected laborers, the Project owners would employ them and help them restore their income in the new dairy station or enterprises as much as possible. Those affected by temporary land occupation would be paid with average output value based on the duration o f land occupation at the rates stipulated by provincial implementation regulations. Inaddition, a payment o f land recovery cost would be paid to the village committee or affected households at the rates stipulated by provincial regulation, and the village committee or affected households would recovery the landby the end o fproject construction. For those affected by house demolition and relocation, depending on their locations, two approaches would be adopted. For those affected households in urban locations, they would either be provided with replaced new housing with similar size and better facilities, or- cash compensation to cover the replacement value o f lost structures and the value o f the housing plot. Such compensation would ensure that all relocated households would be able to purchase replacement housing from the market with similar size and better conditions. Relocated households in rural areas would be paid the house Compensation at replacement value. For each household, a new housing plot would be provided in the existing village free o f charge, along with payment for site leveling and on-site infrastructure. The affected households would rebuild their houses by themselves with compensation received and construction materials from their old houses. For those vulnerable households, the village committees would provide assistance in house rebuilding. 5. InstitutionalArrangementfor Resettlement Planningand Implementation The Heilongjiang Province Project Management Office (HPPMO) would have full responsibility to coordinate all sub-project offices interms o f project planning, implementation and financing. Within each sub-project office, if the resettlement cannot be avoided, the City or County P M O would be responsible for preparation and implementation o f the Resettlement Plan (RP), including asset valuation, consultation, and delivery o f entitlements. The local city and land management bureaus would assist sub-project office to implement the agreed-upon RP, and be responsible for land recording and acquisition approvals. Field tasks such as paying entitlements, selecting replacement land, providing livelihood support and monitoring would be the responsibility o f township and village officers. The PPMO would ensure that the PMOSo f sub-projects are briefed on these RP arrangements for sub- project developments and on RPs once they are prepared. The PPMO would ensure that resettlement budgets are delivered on time to sub-project offices, that payments are made directly and on time to villages and the individuals affected, and that any shortfalls required in meeting resettlement objectives are made good. The entitlements would be given to the affected people before ground leveling and demolition start, or else income support would be provided for the period o f dislocation. 77  6. Resettlement Funding, Cost Estimate, Flow of Funds The resettlement budget for the relevant sub-projects would be fully included in the total project cost, which would be funded by the Bank loan and local counterpart. In order to ensure that resettlement programs are implemented smoothly, during the resettlement planning efforts would be made in developing realistic cost estimates for resettlement programs which would include land compensation, resettlement subsidy, compensation for lost structures, income restoration, and transfer assistance. In addition, in order to ensure smooth implementation o f the RP, the resettlement budget would also include other related cost, such as survey and resettlement planning, resettlement monitoring and evaluation and overall administration. Given the time required for implementation, and level o f accuracy o f initial survey, a contingency fund would be set into total project budget for covering cost changes due to inflation or unexpected situations duringthe implementation. In order to minimize problems in deliveringcompensation, PPMO and sub-project offices would ensure that the flow o f resettlement fund would be direct and transparent. Usually for compensation to affected households, the fund would flow from the Compensation Office and township government to affected individuals (householders) witnessed by project offices, village representatives, and village heads. For the compensation to affected communities such as land compensation fund, the funds would flow from land administration bureaus to affected villages witnessed by project offices and local township governments. 7. Consultation, Disclosure,and Grievance Redress The consultation with the affected people would take place inthe early process o f resettlement planning. Before the socio-economic survey o f resettlement impacts being conducted, the professional staff from resettlement offices and design institutes would carry out a reconnaissance survey to identify the people and villages affected by the project. Duringthe survey, comments and opinions o f local governments and affected communities on the project would be collected and passed on to project planner. Continued consultation and participation would take place during the comprehensive socio-economic and inventory survey. During the survey, every affected household would be visited and survey results would be reviewedby the affected people. Inaddition, in the process o f developing the resettlement action plan, the local governments and affected people would be given opportunities to review the compensation policies, rehabilitation instruments, and make site selection for the replacement land. The RPs in the Chinese language would be made public in the county and township offices. Resettlement Information booklet reflecting the key elements o f the RP would be distributed to affected people prior to resettlement implementation. Such consultation and participation would be continued through the resettlement implementation, which include the signing o f the compensation contract, delivering compensation to affected people, providing replacement land and restoring community infrastructures. Complaints and grievance procedures would be established in each RP. Grievances would first be lodged with the village committee. Ifno settlement is reachedwithintwo weeks, the complainant would have one month to elevate the grievances to the county land management bureau or buildingdemolition office. If it still unresolved within two weeks, the case can be sent to sub-project office. Final appeal i s available in the civil courts as established by the Regulations for Administrative Redress. 8. Resettlement Monitoringand EvaluationArrangement Following the requirements o f the Bank, during the resettlement implementation both internal and external resettlement monitoring and evaluation exercises would be carried out in order to monitor resettlement implementation and ensure that all affected people or villages are compensated adequately 78  and their income and livelihood are restored after resettlement and rehabilitation. The internal resettlement monitoring would be carried out by the project affice in each level. The main purpose i s to have an overview o f the resettlement progress during project implementation. Every month, local resettlement staff would report resettlement implementation progress through the municipal project office to the PPMO. The PPMO would compile these individual project reports into an overall resettlement progress report for the sub-projects in each city, to be submitted to the Bank as part o f quarterly report for the project. For external resettlement monitoring and evaluation, an independent institution such as a university or social research institute would be selected to carry out external resettlement monitoring and evaluation. The selected institution should have extensive experience in social survey and resettlement monitoring for Bank-funded projects in China. The main Objective, through independentlymonitoring and evaluating the resettlement implementation, i s to see whether the objective o f resettlement i s achieved or not and to provide a basic assessment on resettlement implementation and restoration o f livelihood for the affected people. The scope o f monitoring and evaluation includes the implementation progress, resettlement policies, delivery o f compensation and replacement land, changes o f income and livelihood among affected people, consultation and participation and development o f local communities. The method o f resettlement monitoring and evaluation would be based on a combination o f sample household survey and rapid appraisal in the field. The resettlement monitoring and evaluation report should be prepared each six months during project implementation. 9. Procedure Guidelinesfor RP Preparation For the sub-projects yet to be identified which would involve significant land acquisition and resettlement, a RP needs to be prepared by each sub-project according to the Bank's Involuntary Resettlement Policies. A RP would include the following elements: 0 Resettlement objectives, policies and strategies 0 Institutionalresponsibilities 0 Community participation and integration with host populations 0 Socio-economic survey 0 Legal framework on resettlement 0 Impacts, which includes the number o f affectedpeople and the extent o f their losses 0 Appeals procedures 0 Arrangements made for asset valuation, compensation, relocation, rehabilitation and environmental protection 0 Identification o f alternative sites and selection 0 Valuation o f and compensation for lost assets 0 Land ownership, tenure, acquisition and transfer 0 Access to training, employment, and credit 0 Shelter, infrastructure, and social service 79  0 Schedule for land acquisition and resettlement measures 0 Implementation schedule, M&E 0 Cost estimate andbudget 0 Consultationand grievance mechanisms for people affected 0 Monitoringand evaluation D. SocialAssessment Report The Social Assessment was conducted by the New Zealand consulting firm Lincoln International during the spring o f 2004 and the Report was issued in June o f that year. The following i s reproduced from that report (tables have been re-numbered). "This social assessment is based on a socio-economic and production survey (SEPS) o f 300 randomly selected farmers in the project area". The SEPS surveys included key interviews with eight village leaders and 300 households in the villages o f Baoshan, Hezui, Changyong, Yongzhi, Jinan, Erjie, Liu Jingzi and Diuxi. The purpose o f the survey was to establish baseline data about rural HHs and to provide indicators and measurements to evaluate the effects o f the project. Resource Situation in Surveyed Villages The physical resources and dairy farming activities in the survey villages are detailed in Table 1and Table 2. The total village land area was 175,879 mu o f which 24660 mu was public land, included 23500 mu o f grazing land. All villages had some HHs breeding dairy cows and of the 4,615 HHs, 1,075 HHs bred cows (23.3 %). Only two villages had access to significant areas o f grazing land, suggesting that pasture would have a limited role in animal nutrition in much o f the project area. The cost o f renting public grazing land varied, but was generally not at levels that would support sustainable maintenance o f the pasture through fertilization and periodic renovation. I'Heilongjiang Dairy Project Social Assessment 80  Table 1:Village Agricultural Situation _ _ _ _ _ _ _ ~ Village Village No. o f No. No. o f No. o f No. of Animal Health name area HHs o f dairy milking dairy (mu> dairy parks stations factories Has had Location Cost ofvet. HHs foot and Of healthper p per disease mouth station health year Baoshan 4323 175 18 0 0 0 N Town 80 Hezuo 5750 236 17 0 0 0 N Town 100 Changyong 30000 700 160 2 1 0 N Park 200 Yongzhi 30000 740 286 1 1 0 Y Town 200 Jinan 12280 645 45 0 0 0 N Village 200-300 Erjie 11000 870 15 1 1 0 N Town 200 LiuJingzi 32526 606 120 1 1 0 N Village 300-600* Duixi 50000 643 414 1 4 0 N Village 200 Total 175879 4615 1075 6 8 0 Table 2: Village Public Land Village name Village public land ~ ~~~ ~ ~~~ Area Grazed Crop Cost for Distanceofthe Other land (mu> land land rentingpublic public landfrom (not suitablefor (mu) (mu) land center o fvillage grazing) (Yuan/mu) (li) ~ ~~ ~~ Baoshan 180 0 180 0 1 N Hezuo 800 500 300 113 6 Y(uncu1tivated) Changyong * 20 0 20 333* 10 N Yongzhi 220 0 220 120 2 N Jinan 60 0 60 70 2 N Erjie 380 0 380 80 4-5 Y(uncu1tivated) LiuJingziVillage 13,000 13,000 3-5 6 N DuiziVillage 10,000 10,000 35 4 N Total 24,660 23,500 1,040 *Rent for crop landis higherthan for grazingland Village Changes in Past Ten Years Baoshan Village in Tangyuan town is a poor village and i s the poorest of the eight villages in the study. During the past 10 years village representativemeetings have been set up. As a result everyone in the village is more aware o f things that are going on in the village. The meetings have improvedpublic security a lot. The village has very little land(4,323 mu including180mu of public land). This is due to its geographical positionnear a mountain. This limitedlandspace has hada detrimentaleffect onpoverty levels. Villagers have onlyjust had enough food and clothes. Of the villages surveyed, Baoshanhas the smallCEst population. One year ago Guanmin Dairy Company set up a factory in Tangyuan town. 81  Eighteen HHs in Baoshan village now have cows. All those on the village committee breed cows. These people are younger. Hezuo village in Tangyuan town i s also a poor village. During the past 10 years villagers have had enough money to afford adequate clothing, however, before this time; this was not always the case. New technological knowledge has had a positive and important effect on agriculture. Because o f the Guanmin Dairy Company operating inTangyuan town, there are now 17 HHs inHezuo village that have cows. Changyong village in Xingfu little town i s a slightly better o f f village, which has more infrastructure. This is largely due to the dairy factory and related dairy farms in the area. Most villagers are from the minority ethnic group Manchu. There are some Han also in the village. About 10 years ago the Wahaha and Nescafe company set up factories in Shuangcheng county. Dairy farming in Changyong village developed. Villager's lives improved as a result. Most HHs live inbrick houses. The roads to the village are good. The level o f education i s relatively high. Because o f the dairy industrydevelopment most HHs plant corn and feed the cows with this. In Youngzhi village, Xingfu little town most people are from the minority ethnic group Manchu. There are also some Han people. A number o f the HRs have cows because o f the establishment o f the Wuhaha and Nescafe factories. Living standards o f villagers have improved each year because o f dairying. Most HHs live in brick houses. People in the village have relatively more assets and greater spending power than other villages. The HHsplant corn to feed the cows. Jinan village in Changwu town is one o f the richest villages. Cow numbers in Jinan village have decreased during recent years. This i s because the S M dairy factory had to close due to competition. N o other companies were prepared to come and collect milk from Jinan village. While adversely affecting dairy farmers, villagers have begun to farm other animals, particularly beef cattle and pigs, and have improved their living standards. HHs would like to breed more animals and would like to plant crops to feed these animals. Erjie village in Changwu town i s another o f the richest villages. Erjie village has the largest number o f HHsinthe villages surveyed. Only a small number o f HHshave dairy cows, but those that do have large herds. Duringthe past 10years, village infrastructure has improved a lot. Improvementshavebeen made especially to infrastructure including roads, schools, and the water supply. Twenty % o f HHs depend on breeding cows, beef cattle and chicken for their livelihood. These HHs are reasonably well off. The other 80 % o f HHs get their livelihood by growing crops. These HHs are still poor. The price for corn i s low. The gap between rich and poor i s large. Most o f the dairy HHs live in the dairy park or take their cows to live in the park. The number o f cows in the park i s high. The Yili dairy company gives loans to HHs. HHsplant corn to feed cows and other animals. InLiu Jingzi village, Linyuan town the agricultural situation has changed a lot during the past ten years. Villagers are planting crops that reach better prices than corn, such as green bean, yellow bean and sesame. Infrastructure in the village has improved a lot. The village now has a very attractive primary school, Villagers have been breeding cows for more than 10years. However the number o f cows per HH i s low. This i s because the people are buyingthe cows with their own money. In recent years, the Yili dairy company started operating in Daqing and has employed some o f the Liu Jingzi villagers. The standard o f living o f villagers has improved since this time. Villagers have lots o fpublic grazing land and the rent for this is inexpensive. 82  InDuixi village, Linyuan town the structure o f crop planting has changed a lot during recent years, with 80 % o f HHs now planting wheat. The income structure o f the village has also changed: 30 % o f HHs are rich, 40 % are average, and 30 % o f HHs are poor. Duixi village HHs have beenbreeding cows for more than 10 years. There are many HHs with small numbers o f cows. The public land i s all grazing land and the rent for this is inexpensive. Surveyed Households Of the respondents from the 300 HHs surveyed, 0 151were male and 149 were female; 81were from poor households'; 0 the age range of respondents was from 21 to 70 years, with an average o f 41.2 years (35 were aged below 30; 107 were 30 to 40 years; 92 were 40 to 50 years; and 66 were over 50); 0 twenty three heads o f HHswere women and 277 were men; 0 household size ranged from 2 to 8 people, with an average o f 3.9 people per HH (14 HHs had 2 people, 120 HHs had 3 people, 88 HHshad 4 people, 49 HHshad 5 people, 24 HHshad 6 people, 3 HHshad 7 people, and 2 HHshad 8 people); and 0 the average time respondents had lived in the village was 37.9 years Major characteristics o f the surveyed households are detailed inTable 3 to Table 8 below. Table 3: HHLandHoldingSize byVillage Village Average Land Range o f Land Holding Holding (mu> (mu> Baoshan 20.33 8.6 - 32.5 Changyong 22.64 0 - 123 Duixi 22.03 8-40 Erjie 13.36 0 - 32.5 Hezuo 10.01 0 -25.5 Jinan 26.90 9-60 LiuJingzi 57.08 15- 80 Yongzhi 23.78 12-45 * Thereare three maintypes of poor families as identified by village leadersandconfirmedby the survey team: 1. Familiesshort of land, 2. Familieswith some landonly and no animals, and 3. Familieswhere nobody goes out to a job (they are afraid to go afield to look for work). Many poor familiesmust support childrento go to school, but don't have muchmoney to do so, and would borrow to do this. 83  Table 4: HHHighest EducationalAttainment Village Name Primary PrimaryMiddle HighMiddle University (%) ( %) (%) ( %) Baoshan 13.5 61.6 16.2 2 Hezuo 13.2 51.9 23.1 5.3 Changyong 13.2 68.4 15.8 2.6 Yongzhi 13.5 78.4 8.1 0.0 Jinan 7.9 68.4 23.7 0.0 Erjie 13.5 67.6 13.5 5.4 LiuJingzhi 10.8 48.6 29.1 10.8 Duixi 15.8 60.5 15.8 7.9 Table 5: HHAnimal Ownership by Village Village cows BeefCattle Geese Pig Sheep Horse Chicken Donkey Baoshan 12 2 7 1 1 Hezuo 14 4 3 1 Changyong 18 1 3 1 Yongzhi 15 1 1 Jinan 21 26 1 2 1 2 1 Erjie 10 2 2 1 3 2 LiuJingzi 13 2 5 3 3 Total 115 31 23 15 12 4 2 1 Table 6: HHswith Dairy Cows, Other Animals and Cropland Village Name No. of HHswith No. o f HHs with No. of HHs with dairy cows other animals cropland Baoshan 12 11 3 1 Hezuo 14 8 31 Changyong 18 5 33 Yongzhi 15 2 36 Jinan 21 33 38 Erjin 10 10 34 LiuJingzi 13 13 31 Duixi 12 15 38 Total 115 9 1 284 84  Table 7: Crop Yield by Village Village Maize Rice Soybean Green Sunflower (kg Sesame (kg per year) (kg per year) (kg per year) Legumes per year) (kg Per year) (kgPer year) Baoshan 85,000 22,820 Hezuo 26,500 133,845 8,770 Changyong 353,750 Yongzhi 400,850 4,500 5,100 Jinan 472,900 Erjie 199,985 - LiuJingzi 503,000 13,750 27,765 4,400 Duixi 418,650 400 5,450 Total 2,560,635 133,845 50,240 33,215 5,100 4,400 Table 8: HHDaily Activities Non-dairy HHs-off season (winter) Dairy HHs Women Men Time 4 t o 5 a m Get up and have breakfast. Getup andhave breakfast. 2 t o 3 p m Have lunch. Have lunch. 8 t o 9 p m Go to bed. Go to bed. Other times Stay at home (and do nothing). Stay at home (and do nothing). Non-diary HHs- busy season (summer) Dairy HHs Women Men Time 4 t o 5 a m Get up and have breakfast. Get up and have breakfast. 85  6 to 11 am Farmon the land. Farm on the land. 11 to 12pm Have a rest andhave lunch. Have a rest and have lunch. 1 t o 7 p m Farm on the land. Farmon the land. 7 t o 8 p m Eat supper and have a rest. Eat supper and have a rest. Profileof Poor Households A profile o fpoor HHs inthe SEPS study, indicating both quantitative and qualitative data is given below. Data about poor HHs i s compared with the total HHs surveyed (300 HHs). Of the 81 poor HHs surveyed: The average HH size was 3.96people and the range was from 2 - 8 people. The average and range o f HHsize for the total sample was the same; The highest level o f educational attainment o f at least one member o f the poor HH was elementary school for 27.5 %, junior high school for 55.0 %, senior high school for 11.3 % and university for 6.3 %. This compares with the highest level o f education attainment o f at least one member o f the total sample o f elementary school for 12.6 %, junior high school for 64.6 %, senior high school for 18.3 %, and university for 4.3 %. Thus overall poor HHs were less educated than the total sample o f HHs. It i s o f note that none o f the husbands and wives from these poor HHs attended university, only other family members who are most likely to be their children; Te average land holding size was 25.01 mu with the range being 0 - 95 mu. The average land holding size for the total sample was 24.5 mu, which i s smaller than for poor HHs, and the range was from 0 - 123 mu; Only 2.4 % o fpoor HHs had dairy cows (one HHhad one milkingcow and the other HHhad one young cow and one adult dry cow). This compares with the total sample o f which 38.3 % o f HHs had cows, which is a higher per cent than for poor HHs; Only 33 % had other large animals (including one o f the HHs that had dairy cows). These animals included geese, beef cattle, sheep, pigs and donkeys. This compares with the total sample of which 64.6 % o f HHshad other large animals which i s a higher per cent than for poor HHs; The average income o f these HHs was 10,046 yuan and the range o f income was 600 - 55,000 yuan per year. This compares with a higher average income o f 21,894 yuan per year and a range from 600 - 166,150 yuan per year for the total sample; Farm costs averaged 4,335.95 yuan per year and the range was from 0 - 41,752 yuan per year. This compares with higher average farm costs o f 8953 yuan per year and a range from 0 - 48,140 yuan per year for the total sample; Family costs averaged 6,502 yuan per year and ranged from 1,000 - 23,400 yuan per year. This compares with higher average family costs o f 10,627 yuan per year and a range from 0 - 74,600 yuan per year for the total sample; and Income after both farm and family expenditure averaged 791.84 yuan per year. This compares with a higher average income after both farm and family expenditure o f 5,069 yuan per year for the total sample. As indicated earlier, three types o f poor HHswere found inthe survey; those that had no land, those with no or few animals, and those who were afraid to seek work elsewhere. Other more qualitative characteristics o f these poor HHswere found to be as follows: As the level o f education is lower in non-poor HHs, their ability to keep up with technological advances was limited. 86  When a husband or wife gets sick and cannot work the HH cannot make money. HHs need to borrow money to pay for medicine. High health costs means that HHs become poor through paying for medical treatment. Most poor HHs don't have savings and have debt. They are not able to make any investments because o f this. Every year income from poor HHs barely meets their costs. Should an accident happen, they only become poorer. HHs size is large and as these HHs have more than one child, they must pay for this. These children often do not have a chance to get an education so are not able to improve their positions when they are older. Part o f the reason for having a larger family i s to try and have a son. A son i s expected to carry on the family name and support the parents when they are old. Government loans are available to support poor families, however, in rural areas every HH can apply for assistance, i.e. not only poor families. This sometimes results in poor families missing out on this assistance. Limited information and lack o f means o f communication, such as telephones and computers, results in limited information being available to HHs and low aspirations o f HH members. Poor HHs only want to get enough food and clothes. These HHs are afraid of going out o f the village to get work. They would like someone to personally take them and help them do this because they don't know how to do this on their own. Poorer people live with animals. This i s convenient for them because they save money and time when they live together. However, the living environment o f these HHs and also the natural environment deteriorates as a result. It is traditional for HHsto pay for a house or provide a gift or dowry inmarriage. Many HHsput their whole savings into such expenses and as a result get into more debt. Bad weather or natural disasters can reduce crop output. When this i s accompanied with taxes and other fees that MHs must pay, poor HHs become poorer; and Heilongjiang HHs have more land than other provinces. People can get enough food, although it i s not necessarily good food. This makes Heilongjiang HHs different from HHs in other provinces. It is anticipated that involvement inthe project o f many o f the 81 poor HHs identified in the survey and other poor HHs in the project area would result in these HHs no longer being burdened by some o f these characteristics. The transition to non-poor HHs should be observable over time and specifically through data gained duringmonitoring o f the project. Gender Issues Qualitative features o f women's status at HHlevel in the SEPS study were found to be as follows: e If the wife and husband both have a high education, the wife's status was higher than the husband's. e In poor HHs, the status o f women is inferior. Women must be responsible for housework, childcare and farm labor. These women consider this their fate. e Women's status i s low because o f Chinese history. However, because o f communism, women's status has improved significantly, as they were able to go to work. Women's status has improved particularly inurban areas. The status o f women inrural areas is not as high. e Although women have the same opportunity o f education as men, men are first to take up educational training and other opportunities. e Few rural women join social public activity, especially political activity. In the survey most women participated in the survey when they were specifically asked or when accompanied by their husband. 87  0 Men are not always heads o f HHs. Ina few HHs women control everything, for example when the husband gets ill,when women make more money, or when women have more ability than their husbands. 0 Women can do farming and dairy work very economically. For example, one dry year Tangyuangwomen proved themselves to be more economical in irrigating land than men; and 0 inmost HHs women control the money, but they only take care o f the money. Husbands make most important decisions. The husband often ends up spending the HHmoney. Monitoring and evaluation o f the project would pick up any changes in these gender features and would help ensure that the status o f women increases or at least maintains the existing levels. Social Considerations in Project Planning The following social considerations arising from the SEPS study are provided to assist in the socio- economic planning for the project. Project Components Loans for Two Cows HHs that want a loan to buy two cows would be required to raise 20 % o f the cost (this would include start up costs also). Many o f these HHs are anticipated to be poor HHs. These HHs would most likely want to buy one cow in year 1 and a second cow in year 2. Most HHs would need to borrow from relatives or friends to raise the equity. They would most likely pay for the second cow from profits from the sale o f milk and maybe from selling another animal if they have one. Arrangements for loan repayments would need to be flexible especially for those HHs that have education and other costs to meet. Some HHswould require several years to pay back their loan. Loans for Six Cows HHsthat require a loanto buysix cows would needto raise 20 % o fcosts. These HHsare not anticipated to be poor. They would most likely want to buy the six cows within two years. These people would mostly have some savings and be able to get a loan from a credit organization. Some o f these HHs would require several years to pay back their loan. Dairy Parks and Breeding Farms There are three important points about the formation o f dairy parks: 1. Dairy parks need the support o f local government for matters such as acquiring land. 1. It is essential that dairy companiesjoin the project insome form. 1. HHs (in dairy parks) and/or the dairy parks must have contracts with the dairy company to take the milk. 1. Insurance needs to be part o f the package offered to HHs due to their vulnerability. Dairy Associations Village leaders supported the concept o f developing dairy farmer associations. They considered a dairy association would decrease the costs o f dairy breeding and enlarge the dairy industry. Village leaders, however, anticipated many problems with forming a diary farmer association including, a lack o f 88  financial support, difficulty o f HHs to pay fees, difficulty in getting information about new technologies to individual HHs, HHs not interested because they don't foresee benefits and numbers being too small to form a sustainable branch. It is suggested that an informal dairy association is formed initially with the purpose o f discussing and exchange ideas about dairy breeding. A formal association with more focused objectives could then evolve. There are, however, some key aspects about establishing a formal dairy association that need to be considered. They include the need for the association to be a legal entity; the association to have a workable structure and a charter; people would need to be employed in the association; funding arrangements would need to be organized; benefits o f having a dairy association would need to be known to potential members; good linkages and information flows need to be established between members, between branches and with outside organizations and individuals; these linkages and flows must allow for new technological information to be brought into the association and disseminated among members; and there needs to be sufficient numbers o f members to make it viable. Training Training relating to the project should be provided at village level. The purpose o f providing training about social matters (and economic, environmental and health matters) relating to dairy breeding is: a) to manage the project well, and b) gain maximum social and other benefits from the project. Training provided at village level should link with training provided at town, county and provincial levels. There i s a need to have a two-way flow o f information between each level. The PPMO would need to ensure that this linkage and flow o f information occurs. Training at village level would involve individual HHs, which includes HHs in villages and dairy parks. Women, poor HHs and minority groups must be identified and proactively included in village level training. Their specific needs are to be recognized e.g. women should be invited for training. Poor HHs may require all training and resources to be free. Training particularly for HHs new to dairying should include how to breed cows, animal health, hygiene, safety, environmental and HHmanagement as well as animal husbandry, and good dairying practices. ProjectComponentsand InvoluntaryAcquisition of Land The proposed 71 Dairy Parks and seven Demonstration Farms in the project areas would require acquisition of land. Each Dairy Park farm would need to accommodate 500 cows. As a consequence the size of each dairy park would be large and would most likely be located on the outskirts o f a village or town. At this stage no specific land areas have been identified for the Dairy Parks and Demonstration Farms. Several HHs in the survey indicated they would like to have / or be in a family dairy park. It i s envisaged that these HHs would either form a family dairy park on family land themselves, or go to a newly designated dairy park. It i s anticipated that individual HHs who want to buy into project dairy cows would accommodate the cows on their own land. Milking stations would also be required. At this stage the number, location and ownership details o fmilkingstations are unknown. The matter o f involuntary acquisition o f land for this project resulting in involuntary resettlement has been discussed with the PPMO. The PPMO have indicated that involuntary acquisition o f land and involuntary resettlement would be avoided and would not be features o f this project. Details o f WB social safeguard policies were given to the PPMO in May 2004 for their records and the PPMO has been advised that, in the event o f involuntary resettlement they would be required to prepare a resettlement plan, based on the agreed resettlement policy framework. The PPMO has also been made aware o f the 89  World Bank's policy on indigenous people should indigenous people be adversely affected Given the unlikelihood o f any involuntary resettlement under the project it is not considered that a resettlement policy framework would be required. To avoid any adverse effects o f involuntary acquisition o f land, the PPMO would conduct screening of sites for dairy parks and Demonstration Farms at an early stage to ensure that there are no involuntary resettlement issues for the project and would not consider a location site for the project that could possibly involve the relocationo f HHs. Project Monitoringand Evaluation Fundinghas beenprovided for the PPMO to establish process and impact monitoring programs under the project. The effects monitoring should be applied at both Community level with village leaders and key stakeholders (e.g. representatives o f ACWF and CCYP) and at HH level. Indicators for monitoring at community level would include the numbers employed in dairying in the village, their educational attainment, their status o f health; and the services and facilities in village. Indicators at HH level would reflect the number of dairy cows for the HH, HH income, BH livestock and land, HH crops grown, yield and consumption and HH milk production and consumption. Household occupations, assets, education levels, credit status and future plans should also be recorded together with daily activities and decision making disaggregated by gender and satisfaction with the project. Process monitoring would be used to monitor and evaluate the performance o f agencies and individuals involved in implementing the project against a performance schedule. The process monitoring would include recording regular work and activities o f agencies and individuals involved; evaluating their overall performance; and preparing periodic assessment reports for submission to the PLG and the World Bank. Provision i s made for the PPMO to contract out the impact monitoring. The SEPS database and survey population should provide the baseline and future contact points respectively for impact monitoring. Process monitoring would be the responsibility o f the PPMO monitoring and evaluation officer. Conclusion From the social assessment o f the project area, the following conclusions are made: It is anticipated that the benefits o f the project would far outweigh any dis-benefits. The components o f the project would allow poor and non-poor HHs, and women as well as men to benefit through income and employment opportunities. The dis-benefits are negligible; there was considerable support for the project at village level and this support should be followed through during implementation by involving village leaders at the initial stages, and include all HHs that have indicated they want to be involved inthe project; to maximize capacity building, it would be important to gain the assistance o f the ACWF and the CCYP intraining o f HHs at village level; the SEPS study and databases provide valuable baseline data and benchmarks for use by the PPMO to monitor and evaluate the project; and it is anticipated that involuntary acquisition o f land resulting in involuntary resettlement o f HHswould not be an issue with this project." 90  Annex 11:ProjectProcessing HEILONGJIANGDAIRY PROJECT - PRC Planned Actual PCN review 04/07/2004 04/07/2004 Initial PID to PIC 04/29/2004 04/14/2004 InitialISDS to PIC 04/29/2004 04/23/2004 Appraisal 0112112005 03/18/2005 Negotiations 09/19/2005 11/21/2005 BoarcURVP approval 01/24/2006 Planneddate o f effectiveness 05/30/2006 Planned date o f mid-term review 12131/2008 Plannedclosing date 1213112010 Key institutionsresponsible for preparationof the project: Heilongjiang Development and Reform Commission and Heilongjiang Finance Bureau with the assistance o f Lincoln International Consultants of New Zealand (Mr. Gerry Smith - Team Leader) under funding fromNew Zealand Aid. Bank staff and consultantswho worked on the projectincluded: Name Title Unit Mohamed N.Benali Task Team Leader EASRD Steven W. Oliver Senior Agricultural Economist EASRD Zhengxuan Zhu Senior Agricultural Specialist EASRD Marianne Grosclaude Agricultural Economist EASRD Jennifer Ifft Junior Professional Associate EASRD Iain Shuker LeadEconomisVCredit specialist EASRD Xiaolan Wang Operations Officer EASRD Andres Liebenthal Lead Environment Specialist EASES MeiWang Senior Counsel LEGEA Yi Dong Financial Management Specialist EAPCO Jinan Shi Senior Procurement Specialist EAPCO Robert O'Leary DisbursemenVLoanOfficer LOAGl Yi-Ling Liu Acting Finance officer LOAG1 Cornelis De Haan Livestock Specialist, Consultant EASRD Gregory E. Guldin Safeguards Specialist, Consultant EASRD Douglas E.Johnson Environment Specialist, Consultant EASRD Matrice Mangum Program Assistant EASRD Serena Brooks InformationAssistant EASRD Brenda Phillips Program Assistant EASRD Sukanya Venkataraman Program Assistant EASRD Wenyan Dong Program Assistant EASRD Hongwei Zhao Team Assistant EACCF LiOuyang Team Assistant EACCF 91  Bankfunds expendedto date on project preparation: 1. Bank resources: USD475,678 2. Trust funds: NA 3. Total: USD475,678 EstimatedApproval and Supervisioncosts: 1. Remainingcosts to approval: USD 30,000 2. Estimatedannual supervision cost: USD65,000 92  Annex 12: Documentsin the ProjectFile HEILONGJIANGDAIRY PROJECT PRC - A. TechnicalReports Heilongjiang Dairy Project: Project Preparation Report; Dairy IndustryRejuvenation Plan of Heilongjiang Province; Charter o f the Dairy Association o f Heilongjiang Province; Brief Introduction to Dairy Industry development in the Reclaimed Area o f Heilongjiang Province, November 2003; The Emerging Dairy Economy in China: Production, Consumption and Trade Prospects (AgribusinessReview); Presentation on Dairy Production inJiamusi Municipality; Italian Environment Grant: Project Proposal Report; Tetra Pack Notes for Heilongjiang Dairy Project (Market study) -01-03-2004; Heilongjiang -Milk Marketing/Processing IndustryNotes; MilkMarket Study (independent consultants) B. ProjectPreparationDocuments Heilongjiang Dairy Development Project: Social Assessment Heilongjiang Dairy Project Resettlement Review Report Heilongjiang Dairy Project Resettlement Policy Framework Heilongjiang Dairy Project Minority Review Report Heilongjiang Dairy Development Environment Impact Assessment Heilongjiang Dairy Development Step-wise Dairy Herd Improvement Strategy Feeding Dairy Cows for Milk Production: Options and Integration with Heilongjiang Grassland Resource Project Costs Financial and Economic Analysis. Project Operations Manual 93  Annex 13: Statement of Loans and Credits CHINA: HeilongjiangDiary Project Difference between expectedand actual Original Amount inUS$Millions disbursements ~ Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Ong. Frm. Rev'd PO75730 2005 CN-HUNAN URBANDEV 172.00 0.00 0.00 0.00 0.00 172.00 0.00 0.00 PO57933 2005 CN-TAI BASINURBANENVMT 61.30 0.00 0.00 0.00 0.00 61.00 1.85 0.00 PO75035 2004 CN - GEF-HaiBasinIntegr.Wat. 0.00 0.00 0.00 17.00 0.00 16.55 0.96 0.00 Env.Man. PO73002 2004 CN-Basic Educationin WesternAreas 100.00 0.00 0.00 0.00 0.00 98.34 -1.66 0.00 PO65035 2004 CN-Gansu& Xinjiang Pastoral 66.27 0.00 0.00 0.00 0.00 61.37 7.50 0.00 Development PO65463 2004 CN - JiangxiIntegratedAgric. Modem. 100.00 0.00 0.00 0.00 0.00 99.00 8.46 0 00 PO66955 2004 CN-ZHEJIANGURBANENVMT 133.00 0.00 0.00 0.00 0.00 131.67 0.92 0.00 PO69852 2004 CN-WuhanUrbanTransport 200.00 0.00 0.00 0.00 0.00 198.00 124.12 0.00 PO84003 2004 CN-GEFGUANGDONG PRDURB 0.00 0.00 0.00 10.00 0.00 10.00 0.00 0.00 ENV PO81749 2004 CN-Hubei Shiman Highway 200.00 0.00 0.00 0.00 0.00 200.00 0.00 0.00 PO77615 2004 CN-GEF-Gansu& Xinjiang Pastoral 0.00 0.00 0.00 10.50 0.00 10.50 1.90 0.00 Deve1op PO77137 2004 CN-4th Inland Waterways 91.00 0.00 0.00 0.00 0.00 91.oo 2.33 0.00 PO75602 2004 CN-2ndNationalRailways(Zhe-Gan 200.00 0.00 0.00 0.00 0.00 200.00 0.00 0.00 Line) PO75728 2004 CN-GUANGDONG/PRD UR ENVMT 128.00 0.00 0.00 0.00 0.00 128.00 0.00 0.00 PO58847 2003 CN-3rd Xinjiang Hwy Project 150.00 0.00 0.00 0.00 0.00 92.81 19.47 0.00 PO40599 2003 CN-TIANJINURB DEV I1 150.00 0.00 0.00 0.00 0.00 143.82 8.67 0.00 PO67337 2003 CN-2nd GEF Energy Conservation 0.00 0.00 0.00 26.00 0.00 14.60 20.97 0.00 PO70441 2003 CN-HubeiXiaogan Xiangfan Hwy 250.00 0.00 0.00 0.00 0.00 116.33 -23.67 0.00 PO70191 2003 CN-SHANGHAI URB ENVMT APLl 200.00 0.00 0.00 0.00 0.00 184.92 15.25 0.00 PO68058 2003 CN-YixingPumpedStorage Project 145.00 0.00 0.00 0.00 0.00 132.52 -0.30 0.00 PO76714 2003 CN-2ndAnhui Hwy 250.00 0.00 0.00 0.00 0.00 238.50 29.83 0.00 PO60029 2002 CN-Sustain.Forestry Dev(Natura1 0.00 0.00 0.00 16.00 0.00 12.08 6.20 0.00 Forest) PO71147 2002 CN-Tuberculosis Control Project 104.00 0.00 0.00 0.00 0.00 71.97 -32.03 0.00 PO58846 2002 CN-Natl Railway Project 160.00 0.00 0.00 0.00 0.00 29.76 11.43 0.00 PO68049 2002 CN-Hubei HydropowerDev inPoor 105.00 0.00 0.00 0.00 0.00 79.75 25.42 0.00 Areas PO70459 2002 CN-InnerMongolia Hwy Project 100.00 0.00 0.00 0.00 0.00 72.81 6.48 0.00 PO64729 2002 CN-SUSTAINABLEFORESTRYDEV. 93.90 0.00 0.00 0.00 0.00 71.77 15.94 0.00 PROJECT PO47345 2001 CN-HUAI RIVER POLLUTION 105.50 0.00 0.00 0.00 0.00 74.60 -30.90 0.00 CONTROL PO51859 2001 CN-LIAO RIVER BASIN 100.00 0.00 0.00 0.00 0.00 52.64 26.11 0.00 PO56199 2001 CN-3rd InlandWaterways 100.00 0.00 0.00 0.00 0.00 68.70 10.87 0.00 PO56516 2001 CN - WATER CONSERVATION 74.00 0.00 0.00 0.00 0.00 29.68 9.98 0.00 PO56596 2001 CN-ShijiazhuangUrbanTransport 100.00 0.00 0.00 0.00 0.00 81.58 60.91 0.00 94  PO58845 2001 Jiangxi I1Hwy 200.00 0.00 0.00 0.00 54.77 52.40 15.50 0.00 PO45915 2001 CN-Urumqi Urban Transport 100.00 0.00 0.00 0.00 0.00 46.16 46.16 0.00 PO64924 2000 CN-GEF-BEIJING ENVMT I1 0.00 0.00 0.00 25.00 0.00 23.11 21.51 8.15 PO45910 2000 CN-HEBEIURBANENVIRONMENT 150.00 0.00 0.00 0.00 0.00 108.46 55.46 0.00 PO56424 2000 CN-TONGBAI PUMPED STORA 320.00 0.00 0.00 0.00 100.00 113.20 109.07 0.00 PO45264 2000 CN-SMALLHLDRCATTLE DEV 93.50 0.00 0.00 0.00 0.00 5.08 1.65 0.00 PO58843 2000 CN-GuangxiHighway 200.00 0.00 0.00 0.00 0.00 74.48 40.48 0.00 PO58844 2000 3rd HenanProv Hwy 150.00 0.00 0.00 0.00 0.00 38.31 22.64 0.00 PO42109 2000 CN-BEIJING ENVIRONMENT I1 349.00 0.00 0.00 25.00 0.00 272.26 201.29 0.00 PO49436 2000 CN-CHONGQING URBANENVMT 200.00 0.00 0.00 0.00 3.70 142.19 84.89 0.00 PO64730 2000 CN - YangtzeDike Strengthening 210.00 0.00 0.00 0.00 0.00 99.91 99.91 0.00 Project PO46564 1999 CN - Gansu & InnerMongoliaPoverty 60.00 100.00 0.00 0.00 13.30 22.26 22.51 -13.24 Red. PO46829 1999 CN-RENEWABLE ENERGY 100.00 0.00 0.00 0.00 0.00 9.03 96.03 6.16 DEVELOPMENT s , PO58308 1999 CN-PENSION REFORM PJT 0.00 5.00 0.00 0.00 0.00 1.16 1.17 0.00 PO03653 1999 CN-Container Transport 71.OO 0.00 0.00 0.00 18.61 2.71 21.32 1.27 PO38121 1999 CN-GEF-RENEWABLE ENERGY 0.00 0.00 0.00 35.00 0.00 21.87 31.40 13.08 DEVELOPMENT PO60270 1999 CN-ENTERPRISE REFORM LN 0.00 5.00 0.00 0.00 0.00 1.80 3.30 3.08 PO41890 1999 CN-Liaoning UrbanTransport 150.00 0.00 0.00 0.00 0.00 18.49 18.49 0.00 PO42299 1999 TEC COOP CREDIT I V 10.00 35.00 0.00 0.00 0.00 33.18 -14.18 0.00 PO43933 1999 CN-SICHUAN URBANENVMT 150.00 2.00 0.00 0.00 0.00 80.95 90.04 33.22 PO57352 1999 CN-RURAL WATER I V 16.00 30.00 0.00 0.00 0.00 17.96 15.95 13.93 PO49665 1999 CN-ANNING VALLEY AG.DEV 90.00 30.00 0.00 0.00 0.00 15.79 14.95 0.00 PO51856 1999 ACCOUNTING REFORM & 27.40 5.60 0.00 0.00 0.00 16.21 16.11 0.00 DEVELOPMENT PO36953 1999 CN-HEALTHI X (Shiyong Wang, Back- 10.00 50.00 0.00 0.00 0.40 30.30 23.17 1.27 UP) PO51705 1999 CN-Fujian I1Highway 200.00 0.00 0.00 0.00 0.00 43.45 43.45 0.00 PO50036 1999 Anhui ProvincialHwy 200.00 0.00 0.00 0.00 9.60 20.23 29.83 0.00 PO41268 1999 CN-Nat Hwy4/Hubei-Hunan 350.00 0.00 0.00 0.00 0.00 37.87 31.21 0.00 PO46051 1999 CN-HIGHER EDUC. REFORM 20.00 50.00 0.00 0.00 0.00 5.69 7.3 1 0.00 PO56216 1999 CN - LOESS PLATEAUI1 100.00 50.00 0.00 0.00 0.00 10.81 12.94 -3.56 PO51888 1999 CN GUANZHONG IRRIGATION - 80.00 20.00 0.00 0.00 0.00 21.30 20.40 0.00 PO36414 1998 CN-GUANGXI URBANENVMT 72.00 20.00 0.00 0.00 10.19 58.34 67.53 36.27 PO03539 1998 CN - SUSTAINABLE COASTAL 100.00 0.00 0.00 0.00 2.06 43.24 45.30 1.43 RESOURCESDEV. PO03566 1998 CN-BASIC HEALTH(HLTHB) 0.00 85.00 0.00 0.00 0.00 33.38 26.05 0.00 PO03606 1998 ENERGY CONSERVATION 63.00 0.00 0.00 22.00 0.00 30.50 20.38 0.00 PO03614 1998 CN-GuangzhouCity Transport 200.00 0.00 0.00 0.00 20.00 98.98 118.98 98.98 PO03619 1998 CN-2nd Inland Waternays 123.00 0.00 0.00 0.00 37.00 14.13 51.13 4.94 PO35698 1998 HUNANPOWER DEVELOP. 300.00 0.00 0.00 0.00 145.00 21.52 166.52 0.01 PO46563 1998 CN - TARIM BASINI1 90.00 60.00 0.00 0.00 2.67 2.55 5.85 0.00 PO45788 1998 CN-Tri-Provincial Hwy 230.00 0.00 0.00 0.00 0.00 15.14 15.14 0.00 PO51736 1998 E. CHINA/JIANGSU PWR 250.00 0.00 0.00 0.00 86.00 33.99 119.99 17.56 PO49700 1998 CN- IAIL-2 300.00 0.00 0.00 0.00 0.00 1.21 1.21 1.21 PO46952 1998 CN - FOREST. DEV. POOR AR 100.00 100.00 0.00 0.00 0.00 21.97 -76.59 14.60 PO36949 1998 CN-Nat Hwy3-Hubei 250.00 0.00 0.00 0.00 0.00 21.15 21.15 0.00 PO40185 1998 CN-SHANDONG ENVIRONMENT 95.00 0.00 0.00 0.00 1.40 20.07 21.47 15.60 95  I .I PO37859 1998 CN-GEF Energy Conservation 0.00 0.00 0.00 22.00 0.00 0.71 22.06 0.00 PO03590 1997 CN - QINBA MOUNTAINS POVERTY 30.00 150.00 0.00 0.00 0.00 3.16 6.55 3.91 REDUCTION PO03654 1997 CN-Nat HwyZ/Hunan-Guangdong 400.00 0.00 0.00 0.00 0.00 21.24 21.24 21.24 PO36405 1997 CN - WANJIAZHAIWATER TRA 400.00 0.00 0.00 0.00 75.00 11.91 86.91 3.20 PO44485 1997 SHANGHAI WAIGAOQIAO 400.00 0.00 0.00 0.00 0.00 68.20 50.20 54.41 PO03650 1997 TUOKETUO POWERlINNER 400.00 0.00 0.00 0.00 102.50 28.32 130.82 28.32 PO03637 1997 CN-NAT'L RURAL WATER 3 0.00 70.00 0.00 0.00 0.00 0.56 3.77 3.35 PO03594 1996 CN GANSU HEX1CORRIDOR - 60.00 90.00 0.00 0.00 0.00 71.13 62.81 0.00 PO03599 1996 CN-YUNNAN ENVMT 125.00 25.00 0.00 0.00 19.48 30.16 5 1.40 15.45 PO03602 1996 CN-HUBEI URBANENVIRONMENT 125.00 25.00 0.00 0.00 47.32 10.77 60.13 3.14 PO34618 1996 CN-LABOR MARKET DEV. 10.00 20.00 0.00 0.00 0.00 5.48 7.61 0.00 PO40513 1996 2nd HenanProv Hwy 210.00 0.00 0.00 0.00 19.00 12.88 31.88 27.88 PO03596 1995 CN-Yangtze Basin Water ResourCEs 100.00 110.00 0.00 0.00 1.92 0.08 4.47 4.47 Project PO03603 1995 CN-ENT HOUSING & SSR 275.00 75.00 0.00 0.00 57.46 37.61 92.94 14.60 PO03639 1995 CN-SOUTHWEST POVERTY 47.50 200.00 0.00 0.00 0.01 1.02 25.11 25.11 REDUCTIONPROJECT PO03540 1994 CN-LOESS PLATEAU 0.00 150.00 0.00 0.00 0.00 0.05 -0.63 0.00 PO03632 1993 CN-ENVIRONMENT TECH ASS 0.00 50.00 0.00 0.00 0.00 0.76 1.31 0.99 Total: 12,001.37 1,612.60 0.00 208.50 827.39 5,153.10 2,773.66 460.03 CHINA STATEMENT OF IFC's Held andDisbursedPortfolio InMillions ofUS Dollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. 2002 ASIMCO 0.00 10.00 0.00 0.00 0.00 10.00 0.00 0.00 2003 Anjia 0.00 2.00 0.00 0.00 0.00 2.00 0.00 0.00 2004 Antai 40.00 0.00 0.00 30.00 0.00 0.00 0.00 0.00 2003 BCIB 0.00 0.00 11.60 0.00 0.00 0.00 0.00 0.00 1999/00/02 Bank o f Shanghai 0.00 24.67 0.00 0.00 0.00 24.67 0.00 0.00 2002 CDH China Fund 0.00 10.92 0.00 0.00 0.00 0.00 0.00 0.00 2003 CSMC 0.00 9.45 0.00 0.00 0.00 8.92 0.00 0.00 2004 CUNA Mutual 0.00 12.00 0.00 0.00 0.00 1.47 0.00 0.00 1998 ChengduHuarong 5.61 3.20 0.00 6.25 5.61 3.20 0.00 6.25 1992 China BicycCEs 4.50 0.00 0.00 0.00 4.50 0.00 0.00 0.00 2004 China GreenEner 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2004 China I1 28.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2004 China Re Life 0.00 15.41 0.00 0.00 0.00 15.41 0.00 0.00 1994 China WaldenMgt 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.00 2004 Colony Capital 0.00 17.31 0.00 0.00 0.00 0.33 0.00 0.00 2004 Colony China 0.00 0.96 0.00 0.00 0.00 0.01 0.00 0.00 2002 Darong 10.00 1.50 0.00 8.00 0.00 0.00 0.00 0.00 1995 Dupont Suzhou 6.23 0.00 0.00 0.00 6.23 0.00 0.00 0.00 1994 Dynamic Fund 0.00 7.79 0.00 0.00 0.00 6.13 0.00 0.00  2004 Fenglin 19.00 6.00 0.00 18.00 0.00 0.00 0.00 0.00 2003 Great Infotech 0.00 3.50 0.00 0.00 0.00 2.80 0.00 0.00 2002 HuarongAMC 9.00 2.51 0.00 0.00 9.00 0.01 0.00 0.00 2004 IB 0.00 52.18 0.00 0.00 0.00 52.18 0.00 0.00 2002 IEC 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2004 Jiangxi Chenming 0.00 12.90 0.00 0.00 0.00 0.00 0.00 0.00 1998 LeshanScana 3.46 1.35 0.00 0.00 3.46 1.35 0.00 0.00 2001 MaanshanCarbon 8.25 2.00 0.00 0.00 8.25 2.00 0.00 0.00 2001 MinshengBank 0.00 23.50 0.00 0.00 0.00 23.50 0.00 0.00 2001 NCCB 0.00 26.58 0.00 0.00 0.00 26.46 0.00 0.00 1996104 NanjingKumho 34.00 2.23 0.00 0.00 0.00 0.00 0.00 0.00 2001 New ChinaLife 0.00 30.70 0.00 0.00 0.00 23.32 0.00 0.00 1995 NewbridgeInv. 0.00 1.95 0.00 0.00 0.00 1.95 0.00 0.00 ' 1997 Orient Finance 5.71 0.00 0.00 7.14 5.71 0.00 0.00 7.14 2003 PSAM 0.00 1.93 0.00 0.00 0.00 0.00 0.00 0.00 2003 SAIC 12.00 0.00 0.00 0.00 5.00 0.00 0.00 0.00 2004 SIBFI 0.00 0.08 0.00 0.00 0.00 0.00 0.00 0.00 2000 SSIF 0.00 4.50 0.00 0.00 0.00 1.02 0.00 0.00 1998 ShanghaiKrupp 26.25 0.00 0.00 57.74 26.25 0.00 0.00 57.74 Shanghai Midway 0.00 16.02 0.00 0.00 0.00 16.02 0.00 0.00 1999 Shanxi 12.61 0.00 0.00 0.00 12.61 0.00 0.00 0.00 1993 ShenzhenPCCP 3.76 0.00 0.00 0.00 3.76 0.00 0.00 0.00 2002 Sin0 Gold 0.00 4.00 0.00 0.00 0.00 4.00 0.00 0.00 2001 Sino-Forest 5.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1995 SuzhouPVC 0.00 2.48 0.00 0.00 0.00 2.48 0.00 0.00 Wanjie High-Tech 12.27 0.00 0.00 0.00 12.27 0.00 0.00 0.00 1996 Weihai Weidongri 0.34 0.00 0.00 0.00 0.34 0.00 0.00 0.00 2004 Wumart 0.00 6.40 0.00 0.00 0.00 6.40 0.00 0.00 2003 XACB 0.00 19.94 0.00 0.00 0.00 0.00 0.00 0.00 2004 Xinao Gas 25.00 10.00 0.00 0.00 25.00 10.00 0.00 0.00 1993 Yantai Cement 3.13 0.00 0.00 0.00 3.13 0.00 0.00 0.00 2003 Zhengye-ADC 15.00 0.00 0.00 7.00 6.14 0.00 0.00 2.86 2002 ZhongChen 0.00 5.00 0.00 0.00 0.00 5.00 0.00 0.00 Total Dortfolio: 329.12 350.97 11.60 134.13 137.26 250.64 0.00 73.99 97  Approvals PendingCommitment FY Approval Company Loan Equity Quasi Partic. 2004 CCB-MS NPL 0.00 0.00 0.00 0.00 2003 Cellon 0.00 0.01 0.00 0.00 2004 ChenmingLWC 0.06 0.00 0.00 0.16 2004 ChinaGreen 0.00 0.00 0.01 0.00 2002 HuarongAMC 0.02 0.00 0.00 0.00 2002 IEC 0.00 0.00 0.01 0.00 2004 NCFL 0.00 0.02 0.00 0.00 2003 Peak Pacific 2 0.00 0.01 0.00 0.00 2004 SIBFI 0.00 0.00 0.00 0.00 2002 SML 0.00 0.00 0.00 0.00 2002 Sino Mining 0.01 0.00 0.00 0.01 2005 Vetroarredo 0.01 0.00 0.00 0.00 2002 Zhong Chen 0.00 0.00 0.00 0.03 ~~ Total pending commitment: 0.10 0.04 0.02 0.20 98  Annex 14: Country at a Glance CHINA: HeilongjiangDiary Project East Lower- POVERTY and SOCIAL Asla 8 middle. Chlna Paclflc Income Developmentdiamond. 2003 Population,mid-year (millions) 1.288.4 1,855 2,655 Life expectancy GNI per capita (Atlas method, US$) 1,100 1,060 1,460 GNi (Atlas method, US$ billions) 1,411.6 2,011 3,934 T Average annual growth, 1997-03 Population (%) 0.6 1 .o 0.9 Laborforce (%) 0.9 1.1 1.2 GNi Gross Most recent estlrnate (latest year available, 1997.03) w a r y capita enrollment Poverty (% ofpopulation belownationalpoveriy line) 5 Urban population (% of totalpopulation) 39 40 50 Life expectancyat birth (years) 71 69 69 - Infantmortality (per 1,000live births) 30 32 32 Child malnutrition (% of childrenunder5) 10 15 11 Access to improvedwater source Access to an improved water source (% ofpopulation) 75 76 81 Illiteracy(% ofpopulation age 75t) 9 10 10 Gross primaly enrollment (% of school-agepopulation) 114 111 112 -China Male 114 112 113 Lower-middle-incomegroup Female 114 111 111 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1983 1993 2002 2003 Economic ratios' GDP (US$billions) 227.4 431.8 1,266.1 1,412.3 Gross domestic investmenffGDP 33.8 43.3 40.4 44.4 Exportsof goods and selviceslGDP 6.3 17.1 28.9 34.3 Trade Gross domestic savings/GDP 34.5 41.8 43.4 47.0 Gross nationalsavings/GDP 35.1 41.8 43.2 47.6 Current account balance/GDP 1.7 -2.1 2.8 3.2 Domestic InterestpeymentslGDP 0.2 0.6 0.3 0.3 savings Investment Total debVGDP 4.2 19.9 13.3 13.7 Total debt service/exports 10.1 9.4 7.9 7.2 Presentvaiue of debffGDP 12.6 Presentvalue of debffexports 41.8 Indebtedness 1983-93 199303 2002 2003 200347 (average annual growth) - Chine GDP 9.5 6.6 6.3 9.1 7.7 GDP per capita 7.9 7.6 7.6 6.4 7.0 Lower-rniddie-incomegroup STRUCTUREof the ECONOMY (% of GDP) Agriculture Industry Manufacturing Services 22.4 32.7 33.5 33.1 1 Privateconsumption 51.3 45.2 43.4 40.4 88 99 00 01 02 03 Generalgovernmentconsumption 14.1 13.0 13.2 12.6 Importsof goods and services -GDI *GDP (average annual growth) Agriculture 4.2 3.4 2.9 2.5 40- 1 Industry 11.9 10.4 9.8 Manufacturing 11.5 10.3 Services 10.7 6.2 7.5 Private consumption 11.0 7.1 6.3 6.6 Generalgovernmentconsumption 9.7 8.5 7.0 5.5 I 88 % 00 01 02 03 Grossdomestic investment 9.2 9.3 13.7 19.6 -Exports +Imports Importsof goods and services 9.9 13.4 27.5 24.8 - The diamonds show four key Indiwtors in the wuntry (in bold) Wmpared with its inwme-groupaverage It data are missing, the diamond will be incomplete 99  Annex 15: ClimateChange Activities DetailedDescription HEILONGJIANGDAIRY PROJECT -PRC The Project Three major types o f actions are being employed to reduce GHG emissions and sequester carbon via project activities. These involve practices that change the way grazing land i s managed, crop residues are used and animal manure i s disposed of. GrasslandRestoration Grazing lands in Heilongjiang are severely degraded and have the potential to produce more vegetation and store more carbon when managed correctly. Changes in grazing land management include restoration o f grasslands and change from continuous heavy use to managed use or cut-and-carry systems. The most costly restoration practice i s tillage (sometimes multiple tillage) followed by reseeding with pasture grasses and legumes. Direct seeding (range seeding) o f grasslands with specialized equipment reduces tillage and seeding costs by 60 percent to 80 percent and only marginally increases the risk o f seeding failure. In most cases, technicians can be trained to recognize sites that have higher risk. Some grazing land can be restored with less intense interventions such as spot seeding, inter-seeding or broadcast seeding which cost even less than direct seeding. Once grasslands are restored, management o f grazing animals or removing grazers and switching to a cut- and-carry harvest system can result in larger amounts o f standing vegetation. This vegetation protects the soil from wind and water erosion. It intercepts rain, reducing the force with which it hits the surface o f the soil. This lessens the compaction o f the upper soil horizon. Roots o f plants are dynamic and as they grow, die and decompose they create macro and micro pores that lift or lighten the soil which increases both infiltration rates o f water and soil aeration. Half or more o f the plant by weight is located below ground, thus a pasture that produces 3,000 kg o f standing above-ground biomass (moisture-free) can have more than 6,000 kg o f total plant biomass. This material turns over as plants grow and decay throughout the seasons leaving organic matter as residue. Plant top-growth that i s ungrazed i s added first to the standing dead component, then to the surface litter component, and finally to organic matter in soil horizons. Surface litter and standing vegetation shade and thermally insulate the soil which improves conditions for plant growth. As organic matter i s added to the soil, the soil structure, the cation exchange capacity and the tilth all improve. About half o f the organic matter fraction o f the soil i s carbon. Although soils can vary widely in their organic matter contents, soils in cooler regions and areas with more rainfall generally have higher amounts. Heilongjiang, because o f its climate, has soils with high levels o f organic matter that are black or brown in color. Organic matter in these soils ranges from 0.2 percent to 6 percent o f the soil mass although some wetland and marshland soils may have 10 percent or more. Most o f the organic matter i s concentrated inthe upper 30 c m o f soil. Soil organic matter content drops when land i s tilled or overgrazed. Erosion o f the surface horizon compounds organic matter problems and severely overgrazed grasslands, like those in Heilongjiang, have considerable potential to sequester carbon inboth the above-and below-ground components. Soil organic matter is measured as the percentage o f organic matter (by dry weight) in the top 20cm o f soil. Soil scientists in Heilonaiang estimate that soil organic matter percentages o f degraded grasslands are 0.5 percent below those o f sites that are properly managed (Le., a drop from 3.5 to 3.0 percentage OM. Ifthis 100  i s correct, it translates to approximately 56 ton Cha. Studies on heavily grazed grassland in other countries indicate that a change to moderate use can accrue on average 180 kg C per ha-perayr. Because o f its climate and the fact that its grasslands are so severely overgrazed, the grasslands o f Heilongjiang are probably capable o f sequestration rates closer to those found with the Conservation Reserve Program in the United States (200 to 800 kg C per ha-per-yr-)perhaps 300 kg C per ha-pereyr-. Accrual o f carbon would continue untilthe system reaches equilibrium which could take a century. Carbon sequestering can be further stimulated by changes in pasture and rangeland management which involve the introduction o f native legumes or other deep-rooted plant species on pasture lands, introduction o f trees or shrubs, initiation o f agro-forestry systems or otherwise altering management so as to increase the amount o f organic matter incorporated into the soil. Treatmentof Crop Residues Crop residue burning is a source o f CO2, CH4 and N20. It has been estimated that 60 percent o f Chinese crop residues are burned either as fuel or on the field. This production o f GHG could be reduced if crop residues were converted to animal feed or incorporated into the soil. Crop residues are highin fiber and low in digestibility and protein content. Animals cannot grow and produce on these feeds unless they receive supplementation or the residues are treated to increase their nutrient content. Several methods, both chemical and mechanical, are employed but one o f the more promising techniques is ammoniation. Ammoniation can be carried out using several compounds each with its own advantages and limitations butthe most promising for Heilongjiang is treatment with urea. The technology is simple and investment costs are low. Forage quality is improved to about the same level as low quality hay. Treatment i s complicated by cold temperatures inthe fall when crop residues become available and research should be done on techniques for ammoniation in cold temperatures. Leng (1991) has suggested that methane production from ruminants eating ammoniated crop residues i s 38.5 percent less per kilogram o f weight gain than from animals eating untreated residues. Measurement o f ruminal methane dynamics o f animals eating ammoniated maize stover has not been done and the project should encourage Chinese researchers to study this question. It is estimated that for each kg o f ammoniated residue that i s fed rather than burned approximately 20 percent would return to the soil as organic matter provided the manure i s properly distributed and land i s properly managed. Treatmentof Manure Dairy manure treatment in rural Heilongjiang typically follows the following sequence: (a) manure i s removed from pens and milking areas and piled; (b) the piles grow until someone i s either paid or i s willing to remove it for use on fields; (c) it is either composted and spread or directly spread on fields. This poses a health risk for people invillages and the Heilongjiang Environmental Protection Bureau can levy fines o f Y3O/ton o f manure that i s improperly handled. Fines are rarely levied except near urban areas. Specialized manure treatment systems have been designed by researchers at the Harbin Institute o f Technology and by researchers in other countries which digest manure either aerobically or with a combination o f anaerobic followed by aerobic procedures and produce a fertilizer that can be used in the organic food industry. The project should select, purchase and test for several o f these systems, as well as the biogas systempromotedby the Heilongjiang Departmento f Energy. The two principal GHGs that result from dairy manure are methane (CH4) and nitrous oxide (N20). Traditional manure, treatment may produce methane on the interior o f stockpiles, if stockpiles are large. A Canadian study reported that stockpiled manure emitted 1.5 times more GHG than composted manure with methane beingthe dominant gas. Other reports indicate that little methane is produced in stockpiles. This difference is probably the result of the size o f stockpiles and the environmental conditions under which they exist. 101  Nitrous oxide represents most o f the emissions from manure compost processes and a significant portion o f the stockpile emissions. Emissions o f N20are higher in dry manure handling systems that have aerobic conditions with anaerobic pockets due to water saturation. However, nitrous oxide i s primarily produced during nitrification and denitrification o f the organic nitrogen in livestock manure when it i s applied to fields. This release tends occur in pulses, such as when a spring thaw occurs. Because o f the complexity o f manure decomposition systems, the G balance and the fate o f organic matter in each process used by the project should be studied using a systems approach. Researchers in Heilongjiang Universities and Institutes should be encouraged to conduct the studies. Italian Grant Component PastureRenovation - Pasture Restorationby Plowing and Reseeding costs Seed 10 Yuan/mu Fencing and mechanical treatments Y122.8/mu Total 132.8 Yuan/mu Per hectare $18/ha seed $239/ha Improved Pasture Total Cost The benefits are variable because pastures vary widely inproductive capacity Local Estimate for the areas we saw for increasedplant yield 200kg Forage As Fed/mu 3000kg Forage As Fed/ha 1500 kg Forage As Fed/ha (my estimate) Forage value i s 0.3 Yuadkg As Fed Iestimated1500kgofhayproduced/ha 1500*.3Y = 45 Yuan/ha Value Unimproved Range Forage Production 40 kg/mu 600 kg above ground production/ha (I think this is high) 200 kg forage As Fedproduced/ha (my estimate) Carbon Storage Carbon Storage per ha (highly variable - the pastures we saw were severely overgrazed) IestimateProductionat3000kgOM/haofwhich80%wouldoxidizetoCOZ,leavinganorganicresidue o f 600kg OM/year. This i s approximately 3OOkgC/hdyear. The rate o f Carbon sequestration would remain relatively high for perhaps 10 years and then decrease untila balance is achieved. These sites are so severely abused they can probably accrue carbon for many years but we would not know untilsomeone studies the systems. 102  Extent 25 sites with 10,000 mu each Total 250,000 mu (16,667 ha) Total carbon sequestered = 16,667 ha * 300 kgC/ha yr = 5,000,000 kg C/year =5,000 ton C/year. Italian Grant Component - Treatment o f Residue costs Silage Cost 110 Silage Preparation Machines total 20,000 Yuan Balage Cost 50 Balage Machines total 90,000 Yuan Ammoniation o f Crop Residues 600 Ammoniation pits Y 1,800 per pit = 1,080,000 Yuan 800 Ammoniation pits @ Y 810 per pit = 648000 Yuan Maize Residues cost 150 Yuan/ton Urea Cost = Y 100/ton 5 kg o f Urea treats 4m3 o f maize stalks Total Cost o f Ammoniated Maize Stover 250 Yuan/ton Benefits Silage and Balage Maize silage i s commonly used for dairy cattle throughout the world but the practice i s not widespread in Heilongjiang. Maize silage has much higher feed value than corn stalks or other roughages available in winter. Digestible energy i s in the range o f 3.08 McaVkgDM (12.89 MJoule/kgDM) and Crude Protein i s approximately 8 % on a dry matter basis. Maize silage i s quite valuable and sells for approximately Y 36/100kg. Balage i s essentially the same as silage but it i s produced inplastic covered baCEs rather than in pits. It is not widely available but sells for even more (Y 45/100kg). Dry maize stalks are sold for about Y 10/100kg but their nutrient density cannot support highproducing dairy cattle. InHeilongjiang summer rains make it difficult to make good quality hays. The major advantage o f silage i s that maize can be harvested when it i s most nutritious in almost all weather conditions. Silage therefore results in less harvest loss and more nutrients are gathered per hectare than with hay. It is easy to formulate rations with silage since properly made silage i s uniform in quality. Higher quality forages generate less ruminal methane than low quality roughage and there should be an environmental benefit. The project would monitor the system to determine the environmentalbenefits. Ammoniation of Crop Residue The value o f ammoniated maize stover or other crop aftermath is more difficult to calculate since it i s not currently produced and used in Heilongjiang. This component should be view as experimental and the economics would need to be tested. The main environmental benefit i s that much o f the corn residue in Heilongjiang is burned and this technique would convert the material to a low quality feed. Detailed carbon and greenhouse gas balance models would be developed under the project. Italian Grant Component - Manure Treatment 103  costs Purchase o f 20 Manure Composting Systems 1.15 million Yuan Installation and Set-up 95,000 Yuan Total Cost $1,915 million DigestedManure (Organic Compost or Fertilizer) value 600 to 700 Yuan/ton 100 cows yield 6.5 tondmonth Fine for pollution from a dairy operation can be 30,00OY/day Benejts Manure disposal from dairy operations is not closely controlled and results in manure being piled until it can be carted to the fields. This results in anaerobic fermentation in the center o f the pile and methane production. It also creates a potential health risk to village residents and can degrade surface and ground water. Organic digestion o f the manure in either open concrete lined basins in sheds or integrated biological systems in tanks converts the material to organic compost. Digestion o f manure in open concrete lined basins in sheds i s just beginning to be used and the costs of operation are being determined. The operation we saw cost 2,000,000Y to build and was designed for 1,500 head. It had been in operation for only several weeks. Designed systems from other countries would be tested under the Italian Grant component. 104  CHINA HEILONGJIANGDAIRY PROJECT ResearchCommittee Draft Terms of Referencefor Technical (Peer) Reviewers The review criteria and the table below would have to be reproduced separately and sent to the technical (peer) reviewers with the cover TOR. The review sheet would include a recommendation section for the levels, as well as an area for comments for the Research Committee and the Secretariat. The technical (peer) review process is central to the concept o f a Competitive Grants Program, providing technical oversight during the selection o f research projects. As such technical (peer) reviewers are requested to: (i)ascertain, using the table provided, the broad priority area and delivery mechanism that the proposal is addressing and review the proposal against the approved set o f criteria; (ii)evaluate proposals according to the criteria-weighting schedule; (iii)support criteria ratings with detailed comments as necessary; (iv) assign a level o f recommendation to the proposal for consideration by the Secretariat and RC; (v) support recommendations with detailed comments that may be communicated to applicants; and (vi) submit all completed review documentation, including proposals, to the Secretariat by the due date. Reportof Technical (Peer) Reviewers 1. The following table to becompletedby each technical (peer) reviewer: I ~~EvaluationCriteria Points 1.Priorities o fthe Ecological ~ Environment Project (usingthe Italian 25 Grant for reducing greenhouse gas emissions or sequestering carbon) are met, includingpasture improvement, animal waste treatment, and crop residue treatment. 2. The proposed technology initiative i s innovative and can provide 10 practical, affordable and economic solutions to the identifiedproblems. 3. The technology can be expected to have a rapid, quantifiable impact 10 among a large number o f direct (participants inthe proposal) and indirect beneficiaries. 4. Financial and other social, or non- quantifiable, benefits from developing 5 the technology are clearly defined. 5. There is a clear plan for diffusion and transfer o f the technology to 10 others at the community-level. 105  6. The proposed service provider has sufficient capacity and technical 10 expertise to carry out the technical support and technology transfer I 1 activities. 7. There are clearly defined 5 monitoring arrangements including indicators and milestones against which progress and outcomes o f the proposed activities can be assessed. 8. The applicants have a demonstrated 5 capacity and interest to implement the proposal. 9. Proposed cost-sharing 5 arrangements between Competitive Grant Funds and project participants including institutions, dairy producers etc. and service providers exist and are adequate. 10.Researchers and beneficiaries 5 collaborate on project activities. 11. Gender impact must be positive or 5 neutral (equality in malefemale participation in project delivery. Gender issues adequately considered. No negative gender impactfor stakeholders) 12. Environmental impact positive or 5 neutral (projects withperceived negative environmental impacts would not be consideredfor funding) Total 100 2. Summary Recommendation: Technical (Peer) Reviewers should grade proposals on a scale o f 1- 3 as follows: (3) 75 - 100points: recommended for support (2) 60 - 75 points: recommended for support after revision (1) under 60 points: rejected. 3. Additionalcomments: 4. Conclusions Signature of the technical (peer) reviewer Date 106  CHINA HEILONGJIANGDAIRY PROJECT ResearchCommittee Monitoringand EvaluationFramework Draft Terms of Reference The Research Committee (RC) established under the World Bank Project Management Office (PMO) would have responsibility for monitoring and evaluation o f approved research projects. This would be achieved through: i) reviews o f the progress and final technical and financial reports from the contracting Research Organization; ii) periodic on-site visits by a small team o f experts (one external assessor, one Secretariat member, and a P M O financial controller). Recipients o f research funding would be required to provide a technical progress report after the first six months and at the end o f the first year. Guidelines for the report formats are given below. Subsequent progress reports would be prepared annually. Each report would include a work plan for the next period. The project could be terminated if progress is found to be unsatisfactory. A completion report, which covers the entire life o f each individual project, would be required at the end o f the project. Progress would be measured in relation to the stated objectives and the agreed schedule o f actions. Project achievements should be discussed in terms o f scientific, marketing or technology transfer accomplishments, contribution to human resource development, the relevance o f the findings to market development, and the means o f dissemination o f the resulting information/technology. This report would be reviewed by the Secretariat and, if further action were required, it would be referred to the RC for decision. Monitoring would be done through the Secretariat by reviewing the progress reports. The Secretariat would also arrange supervision visits to review project implementation at selected sites. The supervision team would consist o f the appropriate Secretariat member, an external assessor and a PMO financial controller. Besides reviewing progress, the team would also advise on possible changes inproject design and check on the accuracy o f the reports received. Only substantial changes would require RC approval. The P M O Secretariat would undertake a process o f concurrent evaluation through periodic field-visits and studies on sample projects. The purpose would be to follow-up and qualitatively examine the implementation activities and to make recommendations for improving the projects and solving immediate problems. RC members may also participate in field visits ifthis i s deemed appropriate. Evaluation Evaluation would commence inyear three. Expertsselected from the peer reviewer list, but not those who conducted the initial bid evaluation, would carry out the process. These studies would assess whether the projects had achieved their intended results in terms o f outcomes such as development o f sustainable, economically sound technologies that reduce greenhouse gas emission or increase carbon sequestration; information dissemination and adaptation; actual and potential impact on environmentally-friendly dairy farm or dairy industry incomes; or effect on crop or livestock yields, production, processing and marketing. Evaluation would be based on the reports received, the compliance with monitorable indicators (technical and financial) and on-site visits for discussion with participants and beneficiaries. The evaluation report would be presented to the RC. 107  For fulfillment o f its obligations, the RC i s responsible to the Director, World Bank Project Management Office. The R C members would be reimbursed for their time and expenses on the Committee. The executive body o f the RC is its Secretariat. The Secretariat arranges meetings and prepares and compiles meeting reports. The Board would be comprised o f 12 persons including a Chairperson from the PMO, one member from the Dairy Farmers Association, one member from the Dairy Producers Association, one member from Provincial Environmental Protection Research Institute, one from the Provincial Science and Technology Committee, one from the Provincial Animal Husbandry Bureau, Provincial Grassland and Feed Research Center, one from the Meteorological Institute, one from the Chinese Academy o f Science, one from the Academy o f Agricultural Science and one non-voting member respectively from the Italian Embassy and World Bank. RCmembers work for three years. The activities o f the RC would be led by Chairperson and in the case of hidher absence - by one o f the RC members. OBJECTIVES AND MISSION OF THE RESEARCH COMMITTEE The RC has the objective o f supporting the development, testing and transfer o f environmentally and economically beneficial technologies that reduce greenhouse gas emissions and increase carbon sequestration by recommendingthe award o f competitive grants to the various legal and physical agencies that carry out agricultural, ecological, or environmentalresearch. The RC's mission includes: 0 Support o f cooperation between representatives o f research institutes, universities, and technology serviCEs for the development, testing, demonstartion and transfer o f improved technology for environmentally friendly dairy production; 0 Promoting a wide variety o f research, environmental and agricultural interests to take part in the competitive grant proCEss; 0 Disseminatingthe outcomes o f sucCEssfu1 grant projects. RIGHTS & DUTIESOF THE RC The RC i s authorized to: (a) Develop regulations and agenda for submission o f grant proposals, their consideration and award process within the scope o f the RC's program; (b) Passpotential grant projects to local and regional experts for technical review; (c) Prevent the interference o f external bodies into the process o f consideration and approval o f the competitive projects. In the case o f interference by governmental bodies, public organizations, legal or physical persons into the affairs o fthe RC's competence, seek recourse to legal regulations; (d) Together with the PMO, conclude contracts with main legal or physical person responsible for implementingprojects receiving grant awards; (e) Conduct monitoring o f the grant projects' implementation through the R C Secretariat; (f) Apply other authorities definedby these provisions. 108  The RC, incollaboration with the SecretariaUPMO, is obligedto: (a) Encourage participation o f scientific academies, research institutes, universities and their representatives; (b) Develop and submit to the PMO, for its approval, terms o f reference and forms (forms o f competitive project submission, criteria for selection; list o f successful projects and their brief characteristics, regulations and samples o f forms for submission o f quarterly, completion and financial reports, on implementation of funded programs); (c) Advertise through mass media details o f the grant competition, according to the priority directions that reflect the objectives o f the Ecological Environment Project usingthe Italian Grant; (d) Draw up the list o f skilled local and regional peer reviewers, corresponding to the needs o f the Ecological Environment Project, and ensure the confidentiality o f the list; (e) Consider conclusions and recommendations made by peer reviewers for competitive grant programs, provide for the analysis and summary o f the recommendations, according to the criteria for competitive grant selection, and select the successful programs for grant award; (f) Instruct the RC Secretariat to prepare contract documents for the successful projects for grant award; (g) Overview the implementation o f the program contracts; (h) Beresponsible for RC decisions; (i)Periodically, considercurrentandfinancialreportsofon-goinggrantprogramsand,ifnecessary,take measures to resolve problems and disagreements in accordance with the service contract; (j)Collaborate extensively with state, non-governmental and private organizations, farmers, agro- industry,traders and representatives o fmass media; (k) Approve the Secretariat work program and budget and ensure the efficient operation o f the Secretariat, as well as o f other obligations envisaged by these provisions; (1) Submit semi-annual reports on program implementationto the World Bank P M O Director; STRUCTUREOF THE RC, ORGANIZATIONOF ITS ACTIVITIES &TIMETABLE The RC comprises the chairperson and members. The RC is ledby the Chairperson; other members o fthe R C are appointed and dismissed by the PMO in agreement with the World Bank. The R C Chairperson can be dismissed through a majority vote o f no confidence by the RC members. Changes in the RC structure are made by Ministerial Order. The Chairperson o f the RC shall be appointed by the PMO. The Chairperson governs the activities o f the R C on the basis o f annual work plans. The Secretariat - the executive body o f the RC - i s responsible for carrying out day-to-day operations o f the Research Committee. The Secretariat prepares RC meetings, drafts the agenda, and submits it 5 days before the meetings to the RC Chairperson for approval. After approval o f the agenda by the Chairperson, at least 3 working days before the meeting, materials are passed to the RC members. Additional issues may be introduced to the meeting with agreement of the Chairperson. Only RC members attend RC meetings. The PMO Director may also attend PMO meetings as an observer. The meetings shall be held in a confidential and impartial way. The members o f the RC shall keep meeting debates confidential. The Chairperson conducts the meeting; in the case o f hidher absence, one o f the members replaces hidher by decision o f the members. The RC meets annually or when deemed necessary by the Chairperson. 109  The RC decisions and recommendations are recorded in an appropriate form drawn up by the secretary and are signed by the Chairperson and the acting R C Secretary. The RC i s not authorized to meet when less than two-thirds o f the members are present. Decisions on selection of the successful grant projects are made on the basis o f a vote decided by simple majority. Committee members would be asked to review projects on the basis o f a checklist. Each member o f the RC has one vote. Inthe case o f equal votes, the Chairperson's vote i s decisive. Decisions made on the RC meetings can not be re-considered. Within 3 days after the meeting, the acting RC Secretary registers minutes in accordance with notes, instructions and decisions made. The meeting minutes and recommended projects would be sent to the World Bank Project Management Office Director for approval. Subsequently, the contract would be prepared and signed with the successful applicants. 110  Annex 16: Line of Credit Arrangements(OP 8 30) - HEILONGJIANGDAIRY PROJECT - PRC A. Relevance of OP 8.30 to the Project FinancialIntermediation. 1. The rural finance system in China i s heavily regulated by the People's Bank o f China interms o f the banks licensed to lend to the rural sector and the interest rates charged by financial institutions. There are two financial institutions that lend to the agricultural sector in Heilongjiang. The first i s the Rural Credit Cooperative System (RCC). Even though the RCC system is going through a restructuring program, it would currently not meet the minimum prudential requirements to qualify as a financial intermediary for the purposes o f on-lending Bank loans under OP 8.30. The other financial institution i s the Agricultural Bank of China. This is a state-owned bank and would also not meet the prudential requirements o f OP 8.30. As a result, the Bank and the Government o f China have agreed to use a combination o f project management offices (PMOs) and the Ministry o f Finance disbursement system (Finance Bureaus) to intermediate sub-loans under this project. 2. The PPMO and lower-level PMOs FBs involved in e on-lending would not be classified as commercial financial intermediaries according to OP 8.30. The PPMO and PMOs are part o f the Provincial Development and Reform Commission. Their role is to plan for the overall economic development o f the geographical area under their jurisdiction and oversee the implementation o f projects invarious sectors o fthe economy. The function o f the FBs at the provincial and other levels is to collect taxes, prepare the provincial budgets and provide budget support to finance the activities for all public institutions in the province. The PPMO, PMOs and FBs are government institutions whose primary activity i s not on-lending O D A funds. They have been selected for this activity as a temporary measure because there i s no viable commercial financial system that could perform this task adequately. PMOs and FBs are not considered to be commercial financial institutions and there i s no intention to convert them into banks. 3. Based on the agreement from the Bank's Line o f Credit QER review meeting for this project, it i s recognized that the project i s not designed as a vehicle to address the financial sector issues o f China and that the government agencies involved in on-lending should not be considered as commercial financial intermediaries as defined by OP 8.30. Since commercial financial intermediaries are not being used to on-lend funds under the project, the evaluation o f commercial financial intermediaries typically required by OP 8.30 is not necessary or possible. However, the procedures used by the government administered system for appraisal, monitoring and collection o f sub-loans has been evaluated. These procedures have been appraised by the Bank and found to meet the minimum standards required for the purposes o f this project. The financial flows and procedures are documented below. B. On-lending Procedures Credit Management ProcedureManual 4. A credit management procedure would be documented by the provincial FB and would be part o f the Project Operations Manual (OM). This document would cover the terms and conditions o f loans, appraisal, disbursement, collection, monitoring procedures, recording and reporting norms, and credit officer's responsibilities. A brief summary o f the procedures i s provided below. 111  Flow of Funds. 5. Flow o f Bank loan funds would follow the traditional Ministryo f Finance route: The World - - SA Municipal County - Suppliers Bank managedby finance bureaus -b finance Beneficiaries H P F B bureaus Recovery o f loans would follow a similar flow but in reverse. Repayment i s received by the county FBs and passed on to the city-level FB and on to the provincial FB. It is the provincial-level FB that would repay the loan to MOF in US dollars or US dollar equivalent in RMB, with the Provincial FB taking the exchange rate risk. The prefecture, city and county level FBs receive the loan proceeds in local currency and repay it to the provincial FB in its entirety. It is they who bear the commercial risk o f on-lending, All funds repaid by beneficiaries to the FB would be returnedto the budget. There is no revolving fund facility. InstitutionalArrangements. 6. The PPMO would be responsible for all aspects o f project administration, including program management, screening and selection o f project beneficiaries, procurement, financial management, and monitoring and evaluation. The PPMO would receive policy guidance from a PLG, and a Technical Working Group as regards technical issues and coordination. The provincial and lower-level FBs would be responsible for evaluating the creditworthiness of borrowers, disbursing loan proceeds, monitoring loan performance and collecting loans. On-lending would take several forms: (a) in-kind for cows (against a loan agreement signed by the borrower, cosignerdguarantors and the relevant CFB; (b) against approved contracts and delivery statements for equipment, civil works and services. Full-timestaff from the International Finance Division o f the FB from each level would be appointed to be the credit officer for managing the sub-loans made under this project. All those staff have been working for several years and have a minimum qualification requirement o f a college degree, most having majored in finance and economics. A banking specialist would be hired as technical assistance to help design the on-lending system which includes sub-loan appraisal, disbursement, monitoring and collection. The staff would receive credit management training, especially on loan assessment and administration, with the emphasis beinggivento long-term loans, delinquency management, collections and monitoring. SelectionCriteriafor ProjectEnd-Borrowers. 7. During project appraisal, a set o f selection criteria for sub-borrowers was agreed with the Heilongjiang authorities. These include: (a) selecting at least half o f the townships in a project county with per capita rural annual income below the county average; (b) at least half the project sites would be located in villages below their county's annual rural per capita income; (c) to ensure appropriate minority ethnic group inclusion in the project, park sites and project beneficiaries selection would include minority ethnic group villages and households in proportion to their representation in the project counties; and (d) the household selection process would be conducted transparently, with the agreed selection criteria weighted, usinga points system, by a publicly-announced selection group and with results posted locally. 112  8. It is further agreed that the following criteria would be enforced by PMOs and CFBs when they select the households applying for the loans: (a) at each project site, to the extent that demand permits, at least half o f the Project participants should be households which currently have no dairy cattle; (b) education: at least one household member should be literate; (c)at least one household member should be experienced/skilled with livestock raising, either as an owner or as a worker; (d) participation should be voluntary and households should have sufficient labor; (e) ability to repay loan: factors to consider include projected household cash flow, credit history, current debt load, current household income status, cosignatories/guarantors; and (f) for the individual household sites, space should be available for shed and the household's relative distance to the milkingstation. LoanApplicationand Approval Procedures. 9. When an individual or a firm wishes to obtain a loan from the project for one or more cows (individual) or for the construction o f dairy park (firm) or milking station (firm or association), they contact the village/township/county government and request to be listed among the potential end- borrowers o f the project. For the farm households borrowing, a joint-liability borrowing group would be set up among several interested households. Each of the group's members would fill out the loan application form, which would contain information related to the activity and level o f loan financing required; equity contribution, if any; basic household information including per capita income; indebtedness to formal and informal credit sources; household assets and loan security. The written requests would be communicatedto the county PMOs, which records them and then forwards them to the County AHB for technical screening. The AHB would visit the house o f the farmer to determine, inter alia, ifthe size/quality o f the shed is appropriate, ifadequate feed can be made available and ifthere i s an adequate and competent labor force within the households. 10. At the same time that the technical screening is taking place, the county FB would conduct an assessment o f the credit worthiness and debt repayment capability o f the farmer. The CFB requests from farmers: a list o f assets to be usedas collateral inaddition to the dairy cows; (b) co-signatures o f thejoint- liability group; and (c) the existing income status o f the borrowing households. If the farmer is determined to be credit worthy and meets all o f the other criteria for raising dairy cows, he/she would be listed as the end borrower. The AHB would develop a set o f livestock management guidelines. When the dairy cows (yearlings), to be procuredby the project become available the farmer would be given his cows after signing a loan contract with the County FB. The contract, a copy o f which is kept by the farmer, defines the amount o f the loan, the interest to be paid and the repayment schedule, as well as the penalties for late repayment. 11. Less than 15 percent o f the Bank's loan would be extended to finance up to 60 percent o f the investment cost o f the dairy parks, demonstration farms and milking centers. The financial status o f the shareholders o f these economic entities and their collateral would be carefully appraised. The FB i s planning to hire external banking specialists to help with the evaluation o f the creditworthiness o f the larger borrowers. Credit Monitoringand Collection of Loans. 12. A credit management and information system would be established under the project by the Provincial FB to undertake monitoring o f the credit program. The system would monitor loan appraisal dates and amounts, disbursement dates and amounts, recovery dates and amounts, overdues, default and breach o f obligations and main reasons for their occurrence, remedies taken, and debt write-offs. The monitoring system would be computer-based within each county FB. This information would be 113  aggregated by the county FBs on a monthly basis and provided to the city and provincial FBs. If a sub- loan i s overdue, recovery follow-up visits would be undertakenby the township branch o f the county FB. 13. To improve loan collection and repayment and in order to leave the repossessiodseizure o f collateral assets as a last resort, the Heilongjiang FB plans to enforce the following methods: (a) contracts with end borrowers prohibit the sale o f cows before their corresponding loan i s fully paid; (b) joint- liability group members would be responsible for the overdue payment o f other member; (c) loan repayment would be through a systematic withholding system. At the dairy park level and at the village milking stations a systematic withholding system would be implemented. A portion o f the proceeds o f the sale o f milk would be withheld to pay for the cow and other loans contracted by the end-borrower from the county FB. The modalities, amount and scheduling o f the withholdings would be registered in the loan agreement booklet that end-borrowers would sign with the finance bureaus; and (d) loan collection rate would contribute to the overall performance reviewo f the staff-in-charge from the FB. ProposedOn-lendingTerms to FinalBeneficiaries, 14. Interest rates in China are controlled administratively by the Central Bank. They have recently moved from a fixed interest rate regime to operating within specified interest rate bands. These interest rate bands vary by industry. There are two potential interest rate anchors for on-lending to final sub- borrowers under this project. Both the RCCs and the ABC make medium-term loans for the financing o f dairy production. In the recent past, RCC branches in six o f the 68 counties in Heilongjiang Province, o f which two were in the project area, have provided a limited number o f loans to farm households to raise dairy cows. These loans had a 3-5 year maturity and an annual interest rate in the range o f 10 - 11.7 percent. After the appraisal mission, the Heilongjiang Government carried out a more comprehensive survey and determined that the ABC had lent about Y35 million inthe dairy sector duringthe period from 2000 to 2005 in at least four counties, o f which three were in the project area. These are medium-term loans with an interest rate o f about 8 percent per year. Among the borrowers, there are 2,870 households borrowers and the loan size ranges from Y3,OOO to Y50,OOO. 15. Based on the above analysis o f the prevailing interest rates for similar loans, the government has proposed that the interest rate anchor for on-lending to final sub-borrowers under this loan be the lower o f the prevailing commercial banks rate for similar term loans. This rate would be set administratively and adjusted on an annual basis based on a survey o f the interest rates prevailing on January 1 each year (starting in 2007) for commercial financial institutions acceptable to the Bank making loans for dairy production inthe project area. At the current time, the A B C rate i s the lower rate at about 8 percent This rate i s positive in real terms, because the inflation rate in China i s currently about 4 percent and is expected to remain within that range or even lower in the medium term. 16. The government would borrow funds at the IBRDvariable rate for U S dollars, which is expected to fluctuate between 2 and 4 % over the life o f the project. The provincial government would assume the currency conversion risk. Since the Yuan i s pegged to the US dollar and i s likely to appreciate against the US Dollar over the period o f the project, the risk o f currency conversion losses to the provincial government i s small. As a result, the on-lending margin would be a minimum o f between 4 and 6 %. This margin is expected to cover the cost o f on-lending and defaults, provided that loan repayment rates remain above 97 percent. Repayment rates would be monitored and the interest rates adjusted if loan repayment rates do not meet these expectations. 17. There is also a political dimension to the provincial government's request to set the interest rate at the lower o f the ABC and RCC rates. The central government is concerned with the growing divide between rural and urban incomes and has instructed all Provincial governments to adopt policies that 114  support farm incomes. The Heilongjiang provincial government is concerned that it would be seen to be exploiting farmers if it borrows funds at the IBRD rate and on-lends at a rate that i s higher than that o f other institutions lending to the agricultural sector. The initial proposal o f the Provincial government was to on-lend at the IBRDrate, without a mark-up. This was clearly unacceptable to the Bank. During and after appraisal, through a process o f negotiation and analysis o f the ABC and RCC lending rates, a rate equal to the lower o f the RCC or A B C rate for lending to the dairy sector for similar term loans was agreed. This was the highest rate that the Heilongjiang provincial Government was willing to accept, while still being technically acceptable to the Bank. 18. Duringappraisal it was agreed that there would be only two loanproducts inorder to simplify on- lending procedures. Each o f these loan products would have different fixed maturities. Sub-loans to households raising dairy cows, to the legal entities which run milking stations and demonstration farms would have a loan maturity o f 6 years, including a two year grace period. Sub-loans for dairy parks investments would have a loan maturity o f eight years, including a three year grace period. The proposed loan terms are based on the financial projections and cash flow analysis for these types o f operations. Financial analysis modeling has also showed that the financial viability o f these operations was sensitive to shorter repayment and grace periods. 115