Nicaragua - Agricultural Credit Project

CIRCULAING COPY TO. BE RETURNED TO REPORTS, DESK FC . ., DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1311-NIa REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE CENTRAL BANK OF NICARAGUA WITH THE GUARANTEE OF THE REPUBLIC OF NICARAGUA FOR AN AGRICULTURAL CREDIT PROJECT October 31, 1973 Latin America and the Caribbean Regional Office This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS Currency Unit = Cordoba (C$) uS$1.0oo = C$7.oo C$1.oo = us$ 0.14 c$1,ooo,0ooo us$142,900 FISCAL YEAR January 1 - December 31  INTERNATIONAL BANK FOR REFCONSTRUCTION AND DFVE,LOPMTFT REPORT AND RF,COMMENDATION OF THE PRFSID7NT 10 THE EXECUTIVE, DIRECTORS ONJ A PROPOSED LOAN TO THE CENTRAL BANK OF NITCARA`YUA WIThi THE GUARANTEE OF THF, REPUBLIC OF NICARAGUA FOR AN AGRICULTUPAL CREDIT PROJEFCT 1. I submit the following report and recommendation on a proposed loan to the Central Bank of Nicaragua for the equivalent of US$8.5 mil- lion to help finance a three-year orogram of credits for livestock and agricultural development in Nicaragua. The Republic of Nicaragua will guarantee the loan and assume the exchnnge risk. The loan would have a term of 16 years, including 5 years of grace, with interest Pt 7-1/h percent per annum. The proceeds of tte loar would be relent through the state-owned Banco Nacional de Nicaragua (BN) and six private participating banks to ranchers and farmers for terms of up to 12 years, including not more than 4 years grace. Smaller beneficiaries would pay interest of 10.25 percent per annum; larger sub-borrowers would nay interest of 11 percent per annum plus an appraisal and supervision fee at an annual rate of one percent. PART I - THE ECONOMY 2. A report entitled "The Effects of the December 23, 1972, Earth- ayake upon the Economic Position and Prospects of Nicaragua't (139-NI) was distributed to the Executive Directors on April 26, 1973 (R73-82) in con- nection with the Credit for the Earthquake Reconstruction Project. A further economic report, which reviews the economic growth of Nicaraguan since 1950 and analyzes the medium-term growth and balance of payments prospects in the light of the country's reconstruction needs, is scheduled to be distributed to the Executive Directors in the next few weeks. The following paragraphs summarize the conclusions of Report No. 139-NI and the preliminary conclusions of the forthcoming report on medium-term pros- pects. A country data sheet is attached as Annex I. 3. After several decades of virtual stagnation, the Nicaraguan economy after World War II began a period of strong growth. Real gross domestic product increased at an annual average rate of about 6.1 percent during the period 19h6-71, so that, even with a population growth rate of 2.9 percent per annum, real per capita incomes increased significantly, reaching about US$44o in 1971. The main determinant of growth has been production of agricultural conmodities. mainly cotton and coffee, for export. This in turn has meant that the upward trend has been markedly uneven. as the vagaries of weather and changes in world market conditions for the principal primary commodities have caused periodic sharp variations from the long-term trend. Nicaraguals heavy dependence on cotton and coffee, however, has been gradually lessening. Manufacturing industry, which has since become the most dy-namic sector of the economy, now accounts  for around one-fifth of value added, as increasing agricultural incomes, in turn, expanded the demand for domestic manufactured goods. However, a good part of the stimulus resulted from Nicaragua's successful promotion of beef and sugar exports to trie U.S. and of competitive industries in the Central American Common Market (CAGM). The growth of manufacturing production has been on the basis of relatively simple activities such as the mixirg of chemicals and processing of agricultural products. The latter is by far the most important branch of industry, and has contributed significantly to the develoDment of internal linkages in the economy and to raising the value of exports, especially beef. 4. The growth of recent years has not, however, contributed to mitigating the traditional inequalities in the distribution of wealth and income. The major gains in agricultural output and income have been made by a small number of large farmers who occupy about 4Q0percent of total farm land. In recent years, however, the Government has started some programs aimed at thFe lower income groups in the rural areas. Foremost amongst thiese are an AID-financed rurel electrification program through cooperatives assisted by the National Power Company, various land titling and settlement schemes of the Agrarian Institute of Nicaragua (IANT), credit for handicraft industries, a special small ferm credit program (credito rural) operated by BN, and the construction of rural primary schools and health centers with assistance from AID. So far, the impact of the individual Drojects has bee-n. small, but, taken as a whole, they represent a promising step in the direction of raisirng rural living stan- dards. 5. Nicaragua's economic fortunes suffered a major set-back with the earthquake which struck Managua lastDecember, killing some 6,000 to 8,000 persons and injuring some 20,000 others. it destroyed or rendered unusuable practically all of the central zone of Managua, including most Government offices, the important financial and commercial sections and about 2,500 shops engaged in small-scale manufacturing. About 32,000 housing units (almost 45 percent of the housing in the Managua area) were destroyed. The cost of replac ng the physical assets destroyed by the earthquake is estimated at some US$300 million. This is equivalent to about one-third of 1972 GNP and about 10 percent of the nation's capital stock. Given the magnitude of the damages in relation to the size of the Nicaraguan economy, the tas'k of re2onstruction is likely to take many years. G. PuPbl:ic sector finances have been seriously affected by the earth- qualce. For 1'73 and 1974 together, the loss in receipts is estimated at US$61 million, or about 10 nerce-nt of total projected revenues. AdditiomAl expenditures in the two-year period are estimated at US$29 million, raisinig the net budgetary impact to about US$90 million. However, emergency tax measures introduced by the Government (taxes on traditional exPorts and on civil servaAt salaries) will provide about US$46 million and disbursement oierrthquake recornstruction loans ehould provide another US$2L million. It should be nossible to finance the remaining US$20 million from domestic sources withnout unduly inflating domestic demand and creating balance-of- peyments problems.  7. As a result of a number of favorable factors, Ticaraguals overall balance-of-payments position remains satisfactory in spite of the earthquake. International reserves are high, the prices of traditional exports are favorable, and substantial amounts of reconstruction assistance are being mobilized. Emergency import requirements - foodstuffs, medicines, tents - were met by grant assistance. Fxport earnings will hardlv be nffected by the earthquake; while this year's cotton crop is belowT normal because of a severe drought, total export earnings should be slightly above the 1972 level in 1973 and well above it in 1974. Demand pressures, arising from the earthquake reconstruction effort, and increasing import prices, are pushing internal prices up at a higher rate in 1973 than the historical 2 - 2.5 percent rate of inflation. However, the Government can be expected to follow the same prudent monetary policies as in the past, thus reducing inflation to modest levels and protecting the long-standing exchange rate with the U.S. dollar. 8. An important issue over the next several years will be the natuire and scope of reconstruction and the ability of the economy to incur these additional expenditures while maintaining a satisfactory level of invest- ment in other activities and avoiding a build-up of external debt on terms which would be difficult to manage in the future. Between 1965 a7d 1971 Nicaragua's external public debt, outstanding and disbursed and repayable in foreign exchange, rose from US$68 million to TJS$225 million; debt service payments rose from US$7 million to US$31 million, and the debt service ratio rose from 4.2 to 13.7 percentof export earnings. Service payments fell slightly in 1972, and the debt service ratio dropped to 10.3 percent. In order to obtain the estimated external capital required over the next few years (gross disbursements of around US$77 million per year in 1973-80) on satisfactory terms, Nicaragua will have to borrow increasingly from the bilateral and multilateral agencies, and correspondingly, de-emphasize borrowing from commercial sources. There are good prospects that some 80 percent of external debt commitments can be obtained on the favorable terms of bilateral and multilateral institutions in tne next few years. On this basis, the debt service ratio is projected to remain below 18 percent during this decade. Nicaragua thus will remain creditworthy for subst-nntial amounts of external borrowing, always provided that policies are pursued that address the country's fundamental social and economic problems. Strengtlhening the development policy and planning mechanism and preparing its investment program in a form suitable for long-term external financing will be one step in this direction; of more lasting importance, of course, will be the degree to which the program will be successful in reconciling equity, growth and stability objectives. The share of IBRD and IDA in Nicaragua's total debt service payable in foreign currency, which was less than 12 percent in 1972, is expected to fall in 1973-75 and remain at around 11 percent during the late seventies, while the Bank/IDA share in total debt outstanding and repayable in foreign currency should remlain at less than 25 percent throughout the decade. External Financing 9. Apart from the Bank, external financing is provided principally by USAID, the Inter-American Develolment Bank (IDB) and the Central American Bank for Economic Integration (CABEFI). USAID has made loans for highways, industry  -4 - ru.al electrification, housing, education and health. In agriculture, AID has made loans for technical assistance to the Ministry of Agriculture and IAN, and a loan for grain production. IDB is financing water supply and sewerage, higher education, transoort and agriculture. IDB has made loans for poultry and swgine production, a loan for dairy development in the Matagalpa department, and a l'oan to EN for beef cattle development which is expected to be fully committed by the end of 1973. CABEI is financing projects with regional impact, principally in transport, industry and power inter-connection. The lending of these agencies through 1972 is summarized below. Future IDB lending is expected to em-phasize transport, education, power, telecommunications, agro-industry, colonization and forestry. AID is likely to focus primarily on technlical assistance in health, education and agri- culture. CABEI's financing is expected to follow closely the patter-n of thp Dast, with lending concentrated in the transport and induistrial sectors. ITRD IDA AID IDB CABEI (U ~7illio g7 Lending 1950-1965 35.6 3.0 20.7 42.4 13.3 Lending 1966-1972 Transoort - - 2.8 3.5 27.3 Power and telecommunications 44.3 - 15.0 - 11.8 Education 4.0 - 2.0 0.3 0.7 Health 6.9 - 6.2 8.4 - Housing - - 3.7 6.o 6.5 Agriculture - - 17.4 19.7 -- Industry - - 5.0 - 16.9 Other - - 9.0 1.0 0.1 Total 90.8 3.0 81.8 81.3 76.6 o' which is repayable in local currency - - 6.8 21.5 10.6 PART II - BANK GROUP OP?EFAT-IONS' IN NICAR4GUA .10. Nic.ragua has to date received 18 Bank loars and two IDA credits. totalling, US$124.8 million, net of cancellations. AE of September 30, 1973 a total of JUS$62.1 million rempined to be disbursed on four loans for eucati4on, wnter surply, power and ports and on the '_arthouake Recon- struction Credit. Ihe Reconstruction Credit, w-hicnh was sigfned J-une 6. 1973, became effective on Aiigust 7. 1-73. Annex II contains a summary stater,er,t of nanic ioars, IDA credits arnd IFC investments as of September 30, 1973. and notes on the execution of orn-going, propects.  - 5 - 'i I The Bank Group's current lending program is designed to respond to Nicaragua's development requirements in several different ways. One of the main objectives is to support the Government's export diversification efforts. The proposed agricultural credit project supports this objective through a large component for the production of beef, the commodity which appears to have the largest potential for export growth through the remainder of the decade. The Bank is also exploring possibili- ties of lending for manufacturing irndustry and tourism through the Central American Bank for Economic Integration (CABEI). A second major objective is to assist in the strengthening of institutions important for developments in this group are the principal power company, the port authority, the water supply company, the Banco Nacional (through the proposed loan) and the telecommunications company. A third major objective is to continue assistance in the earthquake reconstruction effort, with the shape and timing of possible further lending in this area to be determined as the Government's reconstruction program develops and in accordance with progress under the recent Earthquake Reconstruction Credit. Finally, wherever possible, the Bank seeks to associate its financing in Nicaragua with projects which contribute to a wider distribution of the benefHts of economic growth. Proposed lending for reconstruction, agricultural credit and education would be designed to cont;ribute to this objective. 12. UFCts activities in Nicaragua consist of a loan (fully disbursed) and equity participation made in 1967 and totalling US$2.1 million equivalent in a new cotton and synthetic fiber textile company (FABRITEX). Marketing problems, partly associated with the difficulties in the operation of the Central American Common Market, resulted in low sales, large inventories and a shortage of working capital. The earthquake has further aggravated FABRiTEX's financial situation. In December 1972, IFC agreed to reschedule principal payments, and other long-term lenders have also agreed to take similar action. PART III - THE AGRIC-ULTURAL SECTOR 13. Agriculture in recent years accounted for about 25 percent of Nicaraeuats GDP, 70 percent of merchandise exports, and from 50 to 60 percent of employmert. There are three distinct agricultural zones which are clearly differentiated on the basis of rainfall and predominant soil type. The Pacific zone has volcanic soils and is one of the richest agricultural areas in Central America. There is a marked dual structure in this zone of small farms growing basic grains (corn, beans, sorghum and rice) and larger farms specializing largely in export-oriented crops and livestock. The mountainous Central zone has lower rainfall than the Pacific and generally poorer soils;  -6- it is mainly devoted to coffee and livestock. The extensive, largely urndeveloped Atlantic plain has heavy rainfell and relatively poor soils. A begirnning has been made in recent years to exploit this zone's potential for livestock and forestry. While Nicaragua has brought considerable new land into production over the last two decades, mainly in tne Central and Atlantic zones, the existence of much underutilized land on existing farms, as well as a still largely untouched reserve in the Atlantic zone, evidence the substantial long-term growth potential of Nicaraguan agriculture. 14. Landholdings are highly concentrated.- About one-half of all farms, ranging in size from about one to seven hectares, cover only 3.5 percent of farm area, while the largest 1,500, or 1.5 percent of the total, occupy 41 percent of farm area. Insecurity of tenure is a major problem, especially in the Pacific zone, Despite the efforts of the Agrarian Institute of Nicaragua (IAN) since 1964, roughly one-fifth of the farm area is still occupied by families which have no title to the land they occupy. 15. The "traditional" sector of farmers holding less than 7 ha. includes over 50,0oo units which orovide the main but inadequate means of support for about one-third of the rural population. The main crops are corn, beans, rainfed rice and sorghum. Supplementary cash income is derived from small livestock operations,coffee growing and wage labor at harvest time. Small farmers use few, if any, modern inputs and remain basically untouched by support services. Per capita income, including wages from harvest labor on coffee, cotton and sugarcane plantations. is believed to be about half as much as urban incomes in marginal occupations. 16. A relatively efficient export-oriented sector of larger farmers holds much of the best land, uses modern inputs and achieves yields and production costs generally enabling it to compete in world markets. Exports absorb from 30 to 40 percent of gross agricultural production at the troughs and peaks of cycles, respectively. The major products of this sector are cotton, coffee, sugarcane and beef cattle, while tobacco, sesame, cotton-seed and bananas are also exported. Nicaragua is gradually developing export-oriented agro-industries, i.e., boneless beef, processed wood and cottonseed products, but most agricultural exports are still unprocessed commodities, e.g. cotton fiber and green coffee. By the end of the 1960s, agriculture supplied about one-third of industry's raw materials compared to roughly one-fifth ten years earlier.  - 7 - 1, The livestock sub-sector, currently contributing about 9 percent of GDP, has grown rapidly over the last decade. ThLe absolute value of livestock production rose from US$28 million in 1960 to US$100 million in 1971. According to preliminary data, there are nowT about 2.6 million hesd of cattle in Nicaragua. Most of the commercial cattle are an adnixture of Criollo (native cattle) and introduced breeds, mainly Brahman and Bronm Swiss. Many herds are dual-purpose (beef and milk), but specialization is gradually taking rlace, as is stratification of beef production into breeding, growing a,id fattening zones. Ranchers are becoming receptive to advice, but the proportion of the Lndustry that has adopted new technology remains limited and over-all livestock productivity remains low. Under the influence of rising world market prices, beef production has come to occupy a dominant position in the sub-sector, and beef exports rose from US$3 million in 1960 to roughly US$29 million in 1971, with only a very small part of the increase coming from substitu- tion of previous live cattle excorts. The substantial increase in the quantity exported was achieved without sacrificing per capita domestic consumption (about 11 kg. annually) because older animals, which were previously unexploited, were slaughtered for domestic consumptio.i. Beef marketing is dominated by the operations of four exporting slaughterhouses, which currently handle 60 percent of total cattle slaughterings. Most of the remainder is slaughtered by licensed butchers in ill-equipped municipal slaughterhouses. Sales to export abattoirs are generally made on a liveweigpht basis and there is need to introduce r.uality differential payments. For this purpose a marketirg study would be financed by the 'Loan. There is also a need to improve facilities for the marketing of live animals, and the project contains provisions for this purpose. 19. The Government's efforts in the agricultural sector have been largely in support of export crops and larger farmers. The main instrument of public policy in this connection has been agricultural credit, mainly through FN arid, to a lesser extent, the National Development Institute (INi'ONAC). a-Wi, whose agricultural loan portfolio increased from '52 million in 1952 to 0462 million in 1971, accounts for about two-thirds of the total agricultural portfolio of the banking system. The only credit program directed at smLall farmers has been itls rural credit prmgram. It is estimated that about 20,000 small and mediim-sized farmers, about one-half of them farming 10 ha. or less, have received loans under this program. These farmers have clearly benefitted in the sense that this credit is much cheaorr than funds from alternative sources (mainly private money lendere), and the proqnm: has enabled thenr to raise production,expecially of corn.However,the developmenrt imepact  of; th-le -orogrL-n so far has ;oeen limiteld because of a lack of complementary serv- ices, particiularlj exte..sion and marketing. INFGIN'AC's agricultural port-o io consists mainly oJf long-term investmec^,ts for tobacco and banana ur