Peru - Fifth Agricultural Credit Project

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use FILE COr Report No. P-119la-PE REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECtuKb ON A PROPOSED LOAN TO THE BANCO DE FOMENTO AGROPECUARIO DEL PERU WITH THE GUARANTEE OF THE REPUBLIC OF PERU -:FOR AN AGRICULTURAL CREDIT PROJECT July 9, 1973 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 It may not be published, quoted or cited without Bank Group authorization.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.  RATE OF EXCHANGE Currency Unit Sol (SW.) US$1 S I/. 38.70 S/. 1 = US$0.0258 S/. 1,000 = US$25.80 S/. 1,000,000 = US$25,800 Peru Fiscal Year - January 1 to December 31  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE BANCO DE FOMENTO AGROPECUARIO DEL PERU WITH THE GUARANTEE OF THE REPUBLIC OF PERU FOR AN AGRICULTURAL CREDIT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Banco de Fomento Agropecuario del Peru (BFA) with the guarantee of the Republic of Peru for the equivalent of $25 million to help finance a three-year agricultural credit program. The loan would have a term of 18 years, including 5 years of grace, with interest at 7-1/h percent per annum. PART I - THE ECONOMY 2. A report entitled "Current Economic Position and Prospects of Peru" (No. 136-PE) was distributed to the Executive Directors on May 25, 1973. Annex I summrarizes the main economic and social indicators. 3. The rich and varied mineral resources have been since colonial days one of the major sources of Peruts wealth, and in later years a limited but quite profitable export agriculture and a large-scale fishmeal industry have been developed. While exports are based almost exclusively on the country's own primary production, they are nevertheless diversified, and with major new mineral developments under way the medium-term'outlook for exports and - given a continuing good economic management - growth seems quite favorable. 4. The main challenge that has faced Peru for some time can be sum- marized as the need to break the historical pattern of development without impairing growth. In the past Peru has achieved a respectable overall growth accompanied, however, by wide disparities in productivity, employment opportunities and income levels, as well as other welfare indicators, between the modern and the traditional sectors, the coast and the rest of the country, the urban and the rural population. There are many facets to this challenge: the need effectively to integrate into the social and economic fabric large groups of Indian descent who until now have hardly been touched by modern development, the need to combat the high levels of un- and underemployment, the need to raise the very low productivity and income of the labor force outside the modern sectors, and the need to reduce the excessive dominance of the Lima-Callao area in virtually all aspects of development. This challenge is made all the more formidable by the country's extreme topog- raphy and climate which make transport and communications very difficult and costly and set narrow limits to its agricultural land use. 5. The military Government that took over after an economic and political crisis in 1967-68 has been able to restore stability and growth  - 2- in the economy. It has also taken vigorous steps to effect structural re- forms which it sees as necessary preconditions for a more equitable social and economic development pattern. "Basic legislation" has been issued, establishing ground rules in the various sectors, including agriculture, fishing, mining and industry. In agriculture a new law in 1269 made the previously existing agrarian reform legislation more comprehensive and its implementation more effective. Special emphasis was given to the promotion of cooperatives and other forms of collective management, which are tra- ditional among the Indian population. In mining the new legislation pro- v.ded for the reversion to the State of private concessions not being ex- ploited and for which no agreed program for exploitation could be established within a short period, and also for a gradual State monopoly of mineral exports. Six "basic" industries were reserved for the public sector - iron and steel, refining of non-ferrous metals, cement, petrochemicals, fertil- izers, and paper - while legislation on labor commnunities was introduced in industry, mining and fishing to bring about workerst participation in profits and ownership. In parallel, comprehensive reforms of the public administra- tion were launched and a number of State enterprises set up to implement the new policies. 6. As could be expected, the break with past policies has caused con- troversy and has deterred to some extent private new investment, particularly in industry and agricrllture. The Government is aware, however, that even if the Dublic sector is to play a much more important role than in the past in the economy and the managc.nent of the economy is to be in Peruvian hands, with broad popular participation, a dynamic development in Peru requires active participation of the private sector and foreign capital and know-how are indispensable in some sectors. The Goverrnmentts approach has thus been pragmatic. It hao agreed to the developmert of the largest new copper mine (Cuajone) by a foreign company (Southern Peru Copper Company), made arrange- ments for foreign participation in the recent oil exploration in the Amazon basin, and is actively trying to attract foreign participation in joint ventures for important industrial projects. A regime of 50 percent tax exemption applies to reinvestment of profits in the industrial sector, and even higher incentives are given to investment outside the Lima-Callao area. Further, agrarian reform bonds may be usedi as payment of up to half the amount their shareholders are williLng to invest in industries and, to overcome the uncertainty felt by individual farmers, a new effort has been launched to provide documents exempting from expropriation the owners whose fanrs are in compliance with the size provisions of the law, and who in addition are complying with relevant labor and other social legislation. Recently the Governrment has expropriated some 90 private enterprises in the fishmeal and fishoil industry, with 10 percent of the compensation for the expropriated assets to be paid in cash and the rest in 6 percent tax-free bonds, denomLnated in soles and redeemable in ten yearly equal installments. As in the case of the agrarian reform bonds, these bonds can be used for financing -up to half of investmerts in certain priority industries. This latest seizu-re is renewaing open discussion of the Government policies toward the private sector. 7. After the initial stabilization of the economy in 1969, the Govern- ment has also ;7een careful to follow a policy of moderate fiscal and monetary expansion, and, while there are now some signs of increasing pressures on prices, the resumed growth has on the whole been managed without creating serious disequilibria. Current budget expenditures, including'defense  outlays, have been kept under control, and have actually decreased as a share of national product. The need to finance a growing public invest- ment - directly and indirectly through transfers to State enterprises - has, however, led to a growing fiscal deficit, and at the end of 1972 the Goverrnent took action to substantially raise tax revenues. This includes the substitution of a sales tax at producers' and wholesalers' level for a large number of stamp taxqs, and modifications to the income tax system. These measures are estimated to represent an additional tax yield of at least S/. 3.5 billion per year on average during the 1973-74 budget period, equivalent to 9 percent of the 1972 tax revenues. The Government expects to raise some further S/. 3 billion in 1974 by additional measures to be taken this year. This is largely in lne with the increased fiscal revenues estimated to be required in the 1972 Bank economic report. 8. In the pursuit of its development goals the Government is in- oreasingly stressing the role of planning. Its first medium-term develop- ment plan - covering 1971-75 - puts the achievement of the structural reforms and a substantial reduction of un- and underemployment as the highest prior- ity objectives. More employment is to be created in agriculture by better land utilization in the reformed areas and in industry by a vigorous indus- trialization drive including a strong expansion of State enterprises and joint ventures with foreign firms. In addition, mining investment plays an important role, as it is recognized that most of the needed foreign exchange will continue to originate from the mining sector. The plan also provides for substantial investment in a number of major irrigation projects designed to increase the available agricultural land, since even with all farms brought in compliance with the size provisions of the reform law there will not be enough land to provide a sufficient income base for the present rural population. 9. Clearly the 1971-75 plan projected too large investment levels, and this was due to the fact that these levels were primarily set to provide challenges for the executing agencies rather than realistic sectoral targets. In terms of accomplishments, the experience of the first year of the plan period, 1971, was rather disappointing. Many agencies were new, or newly reorganized, the lead time required before project execution could actually start had been underestimated, and there was a general lack of experience with how to actually turn the public sector into a dynamic leader of growth. As a result, project implementation fell far short of what had been hoped for, with agriculture being the sector with the worst shortfall. 10. The record for 1972 indicatep, however, a better performance, with overall public investment increasinig about 20 percent, twice as much as the year before. For the future) it is important to note that Mineroperu, the State min`nghenterprise, has Signed contrc6ts during 1972 with a UK syndicate of banks, the Canadian ExTcort Development Corporation and Japanese suppliers for financing of the large Cerro Verde copper mining project and a copper refinery, and further mining expansion projects are under active consideration. Furthermore, the promising indications of petroleum deposits in the Peruvian part of the Amazon basin have added a new _acet to the investment program. Petroperu, the State Petroleum ezterprise, has signed contracts with seventeen foreign companies or grDup.s of companies for exploration investment, and has embarked on a Sizeable program of its own. As development of Peru's mineral resources  - 4 - remains the key element for the balance of payments prospects of the country and its creditworthiness, the recent progress arid new possibilities in this sector are very promising. We intend to follow closely further progress in this field, in the context of our continuing analysis of the countryts credit- worthiness. 11. There was at the time of the 1967-68 crisis serious concern about the external debt situation of Peru. External indebtedness had risen very rapidly and the debt service situation for the f'ollowing years was going to be difficult. Discussions had to be taken up with major creditors and some relief was obtairned in two rounds of debt renegotiations. However, debt service requirements have continued at high level (they accounted for 18 percent of export earnings in 1972) and, in order to achieve the needed net capital inflow, the Government during 1972 successfully negotiated a number of medium-term bank loans for some $90 million for refinancing purposes, in addition to a growing volume of direct development loans. Meanwhile, a successful repatriation of capital held abroad and favorable price develop- ments for the export products during 1970 enabled Peru to build up a comfort- able level of foreign reserves, close to $400 million. It is clear, however, that debt service, even if manageable, remains a heavy burden for the country and that more than medium-term bank loans for refinancing is required to fundamentally alter the situation, especially in view of the present uncertainty concerning the future of fishmeal exports due to the virtual disappearance of the anchovy since mid-1972. The Government is aware of this and is seeking to obtain long-term project loans in support of its investment program. 12. External capital requirements for the 1973-76 period will be sub- stantial. In addition to the current account de1'icit foreseen - some $1,150 million over the period, based on an average rate of growth of exports of about 9 percent and of imports of about 12 percent per annum - amortization of the external debt will require $855 million. The gross capital requirements will thus amount to about $2,000 million fcr the period, rising from $450 million in 1973 to $550 million in 1976. On the basis of a plausible financing pattern of capital inflow, draw down of reserves, and disbursements and commitments of new loans, annual requirements for new project loan commit- ments would increase from $295 million in 1973 to $470 million by 1976. Expressed in terms of export earnings, the debt service would remain at about 19 percent over the period. Looking beyond 1976, this situation will ease significantly die to the increased export earnings from the new copper mining developments. 13. In view of the need to mobilize development capital abroad, the Consultative Group for Peru, which had been dormant since 1966, was recon- vened in February 1972, at the initiative of the Government, to discuss Peru's public investment program and external capital requirements. The members of the Group recognized the serious development eff'ort of the Government and agreed that external financing commitments at a level of about $260 million per year would be required ov-er the period 1972-74. The response in 1972 of  the multilateral and bilateral lending agencies has been mixed. Overall, Peru has been able to obtain a record $U44 million in overall commitments of external loans during 1972, but only a minor part of it has come from official sources, at long-term (for details, see page 3 of Annex I). The Inter-American Development Bank (IDB) granted one loan of $12 million, while the US Agency for International Development (AID) made available $27.6 million for disaster relief in areas affected by the earthquake or floods. It should be noted that agreement in principle has been reached with the Federal Republic of Germany and France for substantial amounts of concessional financing, (i.e., loans exceeding 15 years at interest rates lower than 5 percent), although in these two cases the projects to be financed have not yet been fully prepared. As a result of the better terms now offered, Peru has also begun a process of replacing some earlier loans with new ones which have better conditions. During the first half of 1973, Peru contracted $200 million, mostly for non-project purposes, including debt refinancing, and obtained recently from IDB a $6 million loan for a mining credit project. On June 19-20, 1973, another meeting of the Consultative Group was held. The Group commended Peru's achievements, in particular the Government's efforts to combine economic growth with social justice and its policy of stimulating exports through mining and petroleum expansion. The Group urged the Government to create and maintain a climate of confidence necessary to encourage private investment, and a reassuring statement on the subject was made by the Minister of Economy and Finance, head of the Peruvian delegation. Several participants indicated that they would consider extending part of their assistance on concessionary terms. 14. As documented in the economic report, the Peruvian Government is showing great pragmatism in its economic management and has shown genuine concern for a more equitable distribution of the fruits of development. The project preparation and execution capacity of the various public sector agencies is improving and, while debt service is going to be a burden for the country for several years to come, Peru is clearly creditworthy for substantial amounts of additional borrowing. There is, however, a case for substantial grace and repayment periods, so as not to increase the debt service probles of the next few years, before additional export earnings from the new mining projects begin to accrue. There is also need for some local currency financing, as the resource transfer required to support the development program is not likely to be fully achieved if all lending is restricted to the foreign exchange component of projects suitable for external financing. PART II - BANK GROUP OPERATIONS IN PERU 15. Since 1952, the Bank has made 24 loans to Peru for a total net of cancellation of about $243 million. Of this amount, about 48 percent has been for transportation (eleven loans, mainly for highways and ports), 27 percent for electric power, 24 percent for agriculture and the remainder for industry. IFC commitments to date have been about $9 million - all in  industry - of which $0.4 million is held by the Corporation. A statement on Bank loans and IFC investments as at May 31, 1973,and notes on ongoing projects are attached as Annex II. Bank loans to Peru constitute about 11 percent of total outstanding debt, including undisbursed, and absorb about 7 percent of the country's debt service obligations. 16. As indicated to you in August 1970, when a loan was approved to assist Peru in the aftermath of the earthquake, the Bank became concerned in 1967 about the rapidly deteriorating fiscal situation and a balance of payments crisis that ultimately led to the devaluation of the sol in September 1967. Also, after the new Government came into power in 1968, it took over the International Petroleum Co. (IPC) properties in Peru, in connection with a dispute that had existed for rany years, and agreement on compensation was not reached. In 1969, we informed the Government of Peru of our concern for the fiscal position, the resulting lack of local currency resources for ongoing Bank projects in Peru, and possible adverse consequences on Peru's balance of payments and capacity to service external debt of the disputes with the US Government regarding compensation claims. I therefore made clear in 1970 that the road reconstruction loan was proposed without prejudice to the question of when and how the Bank might resume normal lending to Peru. Since then, however, the general economic management has improved considerably, the budgetary and balance of payments outlook has also improved, and the international financial community, both governmental and private, is showing increasing interest in Peru, as evidenced by the recent external borrowing record and the arrangements made with private investors for mining and petro- leum expansion. Settlements with foreign investors have been reached in the cases of Banco Continental, formerly 60 percent owned by Chase Manhattan Bank of New York, and of International Telephone and Telegraph Corporation. Other investment disputes continue to shroud the horizon, but recent develop- ments have given some grounds for hope that these problems will also find a solution. 17. Taking all things into account, I have reached the conclusion that the Bank might Droperly respond to the present situation by resuming lending to Peru on a moderate scale. Besides the proposed agricultural credit project, the Bank has under consideration loans for three other projects, in secondary and vocational education, roads and power. Presentation of these projects to the Board will, however, await a further review of the status of outstand- ing investment disputes. PART III - AGRICULTURE IN PERU 18. The importance of agriculture in Peru is greater than indicated by the 1 percent it contributes to the gross domestic product. It provides the livelihood for about half of the total population, and is also important for the balance of payments; in value,exports of agricultural products are currently higher than imports, but insufficient production growth in the face of rapidly rising demand could easily increase the import bill to un- comfortable levels. The growth rate of agricultural production during the last two decades appears to have been under the population growth rate (which was of the order of 3 percent per year) and well under the rate of growth  of incomes. The supply-demand balance at the present imnort level is very precarious and a bad agricultural year such as 1972 immediately causes serious shortages. Aware of the situation, the Government is trying to improve the internal distribution system so as to avoid regional supply im- balances, has introduced rationing of beef, and is promoting the consumption of fish. 19. The agricultural sector is characterized by widespread underemploy- ment, low average productivity outside export agriculture, and therefore low inzome levels for most of the rural population. Since neither industry nor other urban activities can possibly provide adequate employment for all the surplus rural population, except possibly in the very long run, it is clear that Peru, despite the fact that it does not have abundant agricultural resources, must make a strong effort to improve both labor productirity and labor absorption in agriculture. 20. The Government is attacking the problems of agriculture in several ways. In 1969 it issued a new agrarian reform law, which considerably ex- panded the scope of the l9L64 law and also sought to speed up its implementa- tion process. Unlike the old law, the new one covers also efficiently managed units such as the sugar estates on the coast and large livestock ranches in the Sierra, most of which have already been expropriated and organized in the form of production cooperatives. The agrarian reform aims also at putting into production idle and abandoned lands, land under -public oawnership and areas reclaimed or improved for agricultural production under State financed irrigation and drainage schemes. Finally, the aim is also to consolidate excessively small holdings into cooperatives and thus to estab- lish more viable units. 21. The Government is giving very high priority to the implementation of the agrarian reform. Between 1964 and 1972 some 4.8 million hectares of land had been expropriated, including 3.3 million since the new law was passed. This compares with an estimated total of some 12.7 million hectares of "expropriable" land under the two laws. Revised plans now envisage that about 10 million hectares will be covered by 1975 and that all redistribution of land now in large farms will have been completed by then. It should be pointed out that, despite the rather rapid rate of expropriations, the reform has had no detrimental effects on production, as has been the case with other agrarian reform schemes. 22. Meanwhile, the inevitably drawn-out reform process and the multi- plicity of grounds which the law gives as possible causes for expropriation havecreated considerable uncertainty among farm owners, even if they know that they are in basic compliance with the size provisions of the law, and hm-z negatively influenced their willingness to make new investrnents. In order to overcome this problem, the Government has undertaken a review of all agricultural land in the richest valleys in the country, to determine their priority for land reform purposes and identify those where the reform could be considered completed. The Government has also issued documents which exempt a number of farm from expropriation. These documents are being issued taking into account the size of the farms, their productivity, the ov.-nerls compliance with social regulations, and other factors.  - 8 - 23. The second way in which the Goverrment is trying to solve the problems of the agricultural sector is by inoreasing the availability of land through investment in irrigation (mainly on the coast) or large-scale land clearing (mainly on the eastern slopes of the Andes). Thus several extensive irrigation projects have been started and the Government is trying to find external financial assistance for further projects; several new colonization projects are also being prepared, some of which are based on studies under the IDB/FAO cooperative program and are designed as integrated ru.ral development programs. While the objectives of these programs are praiseworthy, they are very costly and their rates of return may be meager. There is also a definite risk that the Government may overextend itself in pursuing too many of these projects with long gestation periods at the same time, to the detriment of less glamorous but in the short run more productive invest- ments in small irrigation rehabilitation and drainage projects, better water management facilities and practices, and, generally, aid to small farmers to increase productivity on land already under cultivation. The Bank has discussed these issues with the Government, and plans to continue impressing upon it the need for well-defined and effective policies in this field. 24. In addition to the irnpovement of the landholding system and the provision of new and improved lands, the C-overnment is paying attention to other important factors affecting production and income in agriculture. Extension services are thus being strengthened and the 1973-74 budget pro- vides for a substantial increase in the number of technicians who work in or close to the field. Foreign financial and technical assistance to agri- culture is being sought: the currently proposed loan, in conjunction with a loan made in 1972 by IDB, is designed to increase the funds available for medium and long-term agricuLtural credit, which have been in very short supply over the past severaL years. 25. In the -past, several BanK maissions iLndicated the need fir the Govern'ment to develop a comprehensive policy of production promotion to complement the agrarian reform. In particular, they recommended action irn the field of prices so as to give greater production incentives to farmers for certain products, especially beef and milk, for which prices were low related to costs and the imports of which had been increasing. The actual price for beef to domestic producers has increased because in practice most domestically produced beef is now graded as "extra quality", for which the normal ceiling price does not apply, and toward the end of 1972 the price of pasteurized fresh milk -- i.e. of most of the domestically produced milk - was set free. These producer prices are now at levels that enable the average farmer -to achieve reasonable rates of return with available technology. However, there is some uncertainty as to the future. The Government currently seems to be moving towards a greater emphasis general- ly on price regulation and direct market interventions - a general price control law was passed early in 1973 outlawing all price increases not explicitly authorized. In the past, the Government has tended to adopt an ad hoc approach towards agricultural price problems rather than evolving a comprehensive price strategy. The Government is now considering adopt- ing such a strategy, which would involve a balancing of competing objectives,  - 9 - such as, the desire to stimulate production of certain products, to raise incomes of the rural population, to keep urban cost of living from rising too rapidly, and to contain the budgetary burden of keeping consumer prices down in the face of rising import prices and domestic production costs. The Bank intends to continue closely to follow the question of agricultural policy in Peru and to review with the Government the need to give high priority to production objectives whenever these objectives are not ac- corded adequate weight. In this connection, the Bank agreed with the Govern- ment to undertake a detailed sector survey later this year. 26. In summary, the Government is pursuing a number of important policies designed to improve the performance of the agricultural sector. The comprehensiveness of the agrarian reform legislation and the Govern- ment's dedication to its implementation hold out the promise of a substan- tially improved ownership and increase production in a few years' time. At the same time the reform process has introduced a great uncertainty among the - so far - unaffected individual farmers, and the Government would do well in continuing the type of action it has tentatively begun to allay the existing fears by clearly indicating farms that definitely will not be touched. There is no doubt, however, that the Government is genuinely dedicated to the alleviation of the lot of the rural population while recognizing the need to promote increased agricultural output and that financial assistance by external lending agencies to assist in these endeavors is warranted. PART IV - THE PROJECT 27. The proposed project is the eighth Bank operation for agriculture in Peru and would be the fifth agricultural credit to be provided through Banco de Fomento Agropecuario del Peru (BFA), practically the only source of medium and long-term financing for agriculture in Peru. A Bank mission ap- praised in June 1967 an earlier proposal by BFA, but the general situation in Peru hindered further processing of this loan (see paragraph 16 above). Subsequently, in May 1971 and March 1972, two Bank missions renewed prepara- tion work on the project. The Government submitted the final proposal to the Bank in August 1972, and the Bank appraised the project in September/ October 1972. Negotiations were held in Washington the week of May 21, 1973; the Borrower's delegation was headed by its Financial lManager, Mr. A. Mastrokalo, and the Guarantor was represented by the Director of Public Credit, Mr. F. Reus. 28. An Appraisal Report on the project (No.55-PE) is being distributed separately to the Executive Directors. A summary statement on the proposal is given in Annex III. The loan is designed to provide support for a three- year lending program of 5-15 years loans to help finance investment programs of small and medium size individual farmers and cooperatives. It would finance the development of livestock farming, annual crop production, perennial crops and agro-industrial investments. The total project cost, excluding interest during execution, is estimated at $41.7 million, of which $19.0 million is in foreign exchange. Financing would be provided by the proposed Bank loan (60 percent), EFA through increased capital contributions  - 10- of the Government (20 percernt) and the project beneficiaries (20 percent). The beneficiaries' contribution of 20 percent, which would include family labor, is in line with what can be expected from their financing capabilities. The proposed loan would therefore cover the foreign component of the project, as well as $6 million of local costs, an amount justified by Peru's overall resource transfer requirements (see para. 14). The Government's contribution would be made in three approximately equal part,s, with payments to be made respectively prior to the e'fectiveness of the loan, by mid-1973 and mid-1974. The Government would cover the foreign exchange risk on the proposed Bank loan. The proposed loan would complement the 1972 IDB loan to BFA, which is to be on-lent to 70 newly formed cooperatives, and a proposed loan for an animal health program currently being considered by IDB. In order to maximize the coverage of the combined IDB and B3ank credit projects, on- lending under the proposed Bank project will not be made to cooperatives which are beneficiaries under the IDB loan. The overall demand for agri- cultural credit by cooperatives is expected to leave ample room for the combined programs of IDB and the Bank. 29. The proposed loan has a threefold objective. First, it aims at 8 supporting the agrarian refcrm program by financing the long-term investment requirements of cooperatives, for which 50 percent of the loan is earmarked, and by providing firnancing, with the other 50 percent of the loan, for the investments of small and medium size farmers, who have so far refrained from investing because of the uncertainties and shortage of funds referred to above. The resulting increase of production would help to improve Peru's balance of payments position, mainly by substituting imports of meat, milk products and grain: annual foreign exchange savings, net of increased import of inputs, are expected to reach about $11 aillion a year at the projectls full development. To ensure a good supply of funds to coopceratives, sub-loans under the project will be limited to those cooperatives which shall not have a substantial surplus available nor good prospects of securing capital from other sources to finance their proposed investments. On the whole, the economic rate o0' return of the project is estimated at 26 percent, wnile the financial ra-tes of return accruing to the farmers and cooperatives would range between 19 and 39 percent. 'S0. A second objective of t.he loan is to reinforce the improvement of I agricultural credit policies that has recently taken place in Peru. In the past, many agricultural and livestock activities have been isolated from market forces through various f'orms of price control programs and subsidized credit. With the recent IDB loan, BFA's effective interest rate to coopera- tives has increased from 7 percent to about 9 percent, with terms tailored to the cash flow requirements of beneficiaries. Since the proposed Bank- financed project would yield relatively high financial returns to individual farmers and cooperatives, it is proposed that the sub-loan commitments to cooperatives be made at 9 percent per annum for the first 15 months and at 10 percent (or other interest rate to be agreed between BFA and Bank) there- after, and at 13 percent to individual farmers, with the maturity of the loans tailored to the cash flow requirements of the individual investments. A certain period has been allowed before increasing the interest on sub-loan c:lr'mu.mC11ts to the co-operatives, because such interest was recently increased, ''a; i soinfe discontent among the farmers. The average interest rate of  - 11 - sub-loans made during the first 15 months woul1d therefore be 11 percent per annum, resulting in an average real interest rate, at the current level of inflation, of around 3-4 percent. At the present rate of inflation, these interest rate levels would allow BFA to carry out the project on a financially sound basis and would be in line with what we consider appropriate levels to secure adequate factor pricing. The lower interest rates for cooperatives, besides supporting the Government's agrarian reform effort, would reflect the lower unit cost of handling loans to cooperatives. In order to create a floor for real interest rates on sub-loans, should inflation in any fiscal year surpass 9 percent, the Government, the Borrower and the Bank would review the interest rate level at which project funds would be on-lent. 31. Finally, this loan would support institutional changes in EFA that are needed because of its expanding operations. BFA provides 80 percent of institutional credit to the agricultural sector, exercises the State market- ing monopoly in natural rubber and jute, and acts as trustee for the agrarian reform bonds and as fiscal agent for special purpose Government funds. Under previous Bank loans, BFA underwent a partial reorganization with the assist- ance of consultants, who strengthened the accounting procedures and separated the banking activities from its other ventures. Due, however, to rising staff costs and the need to ration scarce medium and long-term funds, BFA reduced the authority of its branches to approve loans and gradually increased central- ization of decision making in the Lima head office. Under the proposed loan BTA undertakes to make a review of means of improving its operational and administrative costs by mid-1974, discuss the findings with the Bank, and put them into effect thereafter in order to improve cost efficiency. BFA also undertakes to review by end 1974 its overdue portfolio, which accounts for 30 percent of the total portfolio of BFA, exchange views with the Bank on the result of such review, and take the necessary actions thereafter. In addition, BFA is to decentralize the decision making authority in the granting of loans by giving branches authority to approve medium and long-term loans up to S/.1.2 million. With this new procedure, the flow of information, supervision and coordination between head office and branches will need strengthening. For this purpose, BFA is to appoint, in consultation with the Bank, an advisor, prior to the effectiveness of the loan. It is expected that with these commitments, BFA's operations will be expanded and made more dynamic. 32. Under the proposed project, procurement through international competitive bidding would be inappropriate because of the diversity of items and small size of individual purchases. Accordingly, local commercial channels will be used. Peru has a good network of dealers in agricultural inputs with a wide representation of makes. Competition among suppliers is keen, which should ensure fair pricing of equipment and supplies, and facilities for maintenance and servicing of machinery are adequate. The Bank would reimburse to BFA 75 percent of the loans made by it to the farmers.  - 12 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 33. The draft Loan Agreement between the Bank and BFA, the draft Guarantee Agreement between the Republic of Peru and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the text of a resolution approving the proposed loan are being distributed to the Executive Directors separately. 34. The draft agreements contain provisions to reflect the various arrangements described in Part IV above, including the usual covenants for agricultural credit projects. 35. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 36. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D.C. July 9, 1973  ANNEX I Page 1 of 8 COUNTRY DATA - PERU AREA POPULATION-Y DENSITY 1,280,219 km2 14.4 million (mid-1972) 11.2 per 2/ Rate of Growth: 3.1% (from 1965 to 1972) 500 per km of arable land- POPULATION CHARACTERISTICS (1971)1/ HEALTH (1970) Crude Birth Rate (per 1,000) 42 Population per physician 2,070 Crude Death Rate (per 1,000) 11 Population per hospital bed 435 Infant Mortality (per 1,000 live births) 75 INCOME DISTRIBUTION DISTRIBUTION OF LAND OWNERSHIP3/ % of national income, lowest quintile .. % owned by top 10% of owners highest quintile %. % owned by smallest 10% of owners ACCESS TO PIPED WATER (1971) ACCESS TO ELECTRICITY % of population - urban 60 % of population - urban - rural 14 - rural NUTRITION (1970) EDUCATION (1970) Calorie intake as % of requirements 94 Adult literacy rate % 66 Per capita protein intake 58 grams/day Primary school enrollment % 82 GNP PER CAPITA in 1972-': US $ 476 GROSS NATIONAL PRODUCT IN 1972 ANNUAL RATE OF GROWTH (%, constant prices) US $ Mln. % 1961-67-/ 1969-1972-/ 1972 GNP at Market Prices 7,692 100.0 5.9 6.2 5.5 Gross Domestic Investment 915 11.9 9.4 4.6 3.0 Gross National S,ving 873 11.2 4.0 o -2.8 Current Account Balance -101 -1.3 Exports of Goods, NFS 1,126 14.6 2.7- -0.8 2.5 Imports of Goods, NFS 1,129 14.7 12.9 4.7 4.5 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1971 Value Added Labor Force-T81 V. A. Per Worker US $ Mln. % Thous. % US S Agricultu e 1,199 17.7 1,961 44.4 610 40 Industry- 2,356 34.8 872 19.8 2,700 175 Services 3,221 47.5 1,440 32.6 2,240 145 Unallocated . 142 3.2 _ Total/Average 6,776 100.0 4,415 100.0 1,535 100 GOVERNMENT FINANCE General Government Central Government (Soles Bln.) % of GDP (Soles Bin.) % of GDP 1971 1971 1969-71 1971 1971 1969-71 Current Receipts 50.3 19.2 19.3 41.0 15.6 15.9 Current Expenditure 42.0 16.0 16.0 35.9 13.7 13.8 Current Surplus 8.3 3.2 3.3 5.1 1.9 2.1 Capital Expenditure 14.8 5.6 4.9 12.7 4.8 4.0 External Assistance (net) -0.1 - 0.0 0.3 - 0.2 - 0.1 0.3 1/ Projected figures, based on 1961 census. 2/ "Arable" defined as actually cultivated plus areas officially given as "cultivable but not used". 3/ Latest figures are from 1961; in view of the very significant Agrarian Reform going on in Peru these are thought irrelevant today. 4/ The Per Capita GNP estimate is at 1970 market prices, calculated by the same conversion technique as the 1972 World Bank Atlas. All other conversions to dollars in this table are at the average exchange rate prevailing during the period covered. 5/ As there was a severe economic crisis in Peru 1967-68, it would not be meaningful to show the usual period 1965-70. Instead the chosen periods are "before the crisis" and "since the crisis". 6/ No trend discernible after the crisis. A record export surplus brought about a sharp peak in 1970; for other years savings have fallen short of the earlier trend. 7/ Refers to 1962-68. Total labor force: unemployed are allocated to sector of their normal occupation. "Unallocated" consists mainly of unemployed workers seeking their first job. 3/ Comprisen Manufacturing, Construction and Mining. All l3'l data are preliminary estimates .. not available not applicable  ANNEX I Page 2 of 8 COUNTRY DATA - PERU MONEY, CREDIT and PRICES 1965 1970 1971 1972 (Billion Soles outstanding end period) Money and Quasi Money 26.5 55.9 63.1 74.8 Bank Credit to Public Sector (net) 4.4 12.2 18.1 21.1 Bank Credit to Private Sector 20.8 39.8 48.1 58.9 (Percentages or Index Numbers) Money and Quasi Money as 7, of GDP 23.0 23.7 24.1 24.9 General Price Index (1963 = 100) 199 219 229 248 Annual Percentage Changes in: General Price Index 13.4 6.8 4.8 8.4 Bank Credit to Pu.blic Sector 51.3 5.4 47.8 16.6 Bank Credit to Private Sector 25.6 16.2 20.6 22.5 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1970-72) 1970 1971 1972 US S Mln 7 (Million US $) Fish products 320 8 33.7 Exports of Goods, NFS 1.223.9 1,081.0 1.126.4 Copper 203.5 21.4 Imports of Goods, NFS 971.6 1,042.2 1,129.6 Sugar 67.5 7.1 Resource Gap (deficit = -) 252.2 38.8 - 3.2 Iron ore 67.1 7.0 Silver 57.3 6.0 Interest Payments (net)l/ -34 o -50.4 -33.9 Zink 53.2 5.6 Other Factor Payaents (net) -98.7 -54.3 -97.2 All other commodities 182.0 19.2 Net Transfers 82.0 39.1 33.3 Total 951.4 100.0 Balance on Current Account 201.5 -26.8 -101.1 EXTERNAL DEBT, DECEMBER 31, 1972 Direct Foreign Investment -69.6 17.0 38.9 Nct MLT Borrowing US $ Mln Disbursements 242.3 250.2 323.0 Amortization 191.3 226.7 216.9 Public Debt, incl. guaranteed 1,018.4 Subtotal 51.0 23.5 106.1 Non-Guaranteed Private Debt Total Outstanding and Disbursed SDR-allocation 14.3 14.2 14.1 Other items n.i.e. 599q -89.5 -16.0 DEBT SERVICE RATIO FOR 19722/ Increase in Reserves (+) +2571 -h1.6 +42.1 Gross Reserves (end year) 496 h70 521 Net Reserves (end year) 409 347 389 Public Debt, incl. guaranteed 17.8 Non-Guaranteed Private Debt Total Outstanding and Disbursed RATE OF EXCHANGE IBRD/IDA LENDING, (Nay 31, 1973) (Million US$) US $ 1.00 = S/. 38. 70- IBRD IDA S/. 1.00 = US 5 0.0258 Outstanding and Disbursed 131.5 UndisbursedinlUnibre 2.5 Outstanding 17c Undisbursed 1/ Public sector only, interest on private debt included in "Otner Factor Payments." 2/ Ratio of debt service in foreign currency to exports of goods and non-factor services. 3/ This is the main rate (certificate rate); there is also a secondary rate (draft rate US$ 1.00 = S/. 43.38) at which about 15% of transactions are concluded. ;1ll 1972 data are preliminary estimates. not available not applicable  ANNEX I Page 3 of 8 PERU: Puiblic and Publicly Guaranteed Loans Contracted Between January 1971 and May 1973 (in millions of US dollars) 1/ 1/ Jan.-May Total - Jan.1969 1969 1970 1971 1972 1973 through May 1973 Suppliers' Credits 8.4 14.7 115.6 66.9 5.1 210.7 Argentina - - - .1 - .1 Austria - 0.2 - - 0.2 Belgium - 2.2 - - - 2.2 Canada - - 11.4 - - 11.4 France 0.9 2.3 - - - 3.2 Germany, F. R. 2.0 0.5 - 2,7 - 5.2 Italy 3.6 9.0 - 2.7 - 15.3 Japan - - - 45.0 - 45.0 Norway - - 8.0 - 5.1 13.1 Switzerland 1.4 0.5 - - - 1.9 U. S. A. 0.5 - 42.6 16.6 - 59.7 Yt'goslavia - 53.5 - - 53.5 2/ Private Banks 6.3 2.0 25.0 196.2 175.5 405.0 Canada - - - 12.8 - 12.8 France - 2.0 - 6.0 - 8.0 Germany, F. R. - - - 15.5 - 15.5 Italy 1.3 - - 6.0 - 7.3 Luxembourgh - - - 30.0 - 30.0 Switzerland - - - 6.4 - 6.4 U. K. - - 1.5 80.4 100.0 181.9 U. S. A. 5.0 - 23.5 3.1 75.5 107.1 Various - - - 36.0 - 36.0 Governments 16.4 59.9 47.3 144,8 20.9 289.3 Belgium 3.2 - - - - 3.2 Canada 2.6 11.6 - 21.1 - 35.3 Czechoslovakia - - 6.1 7.2 - 13.3 Finland - - - 6.1 - 6.1 France - 13.1 - - - 13.1 Germany - 28.0 - - - 28.0 Hungary - - 10.4 17.0 - 27.4 Italy 0.6 - 1.5 - - 2.1 Japan - - - 57.1 17.5 74.6 Netherlands - 1.0 5.7 3.4 10.1 New Zealand 10.0 - - - - 10.0 Spai.w - 4.8 - 3.0 - 7.8 U.K. - 2.4 - - - 2.4 U. S. A. 3/ - - 28.3 27.6 - 55.9 International Organizations - 79.8 35.2 12.0 - 127.0 CAF - 5.5 - - - 5.5 IBRD - 30.0 - - - 30.0 IDB 4/ - 44.3 35.2 12.0 - 56.5 Unclassified - - 29.3 21.0 - 50.3 TOTAL 31,1 156.4 252.4 440.9 201.5 L,082.3 lJ The loan amounts shown in this table for 1971 and 1972 differ somewhat from the figures shown in the recent Economic Report (136-PE) since new information has recently been made available by the Peruvian authorities. 2 Includes $35.4 million used to prepay loans obtained in earlier years at less favorable terms. Ex' iNcludes U. S. Export-Import Bank guarantees and insurance provided on suppliers' credits and private bank loans to Peru. Amounts were $14.5 million in FY69, $33.8 million in FY70, $19.1 million in FY71, $53.5 million in FY72 and $,34.5 million in the first ten months of FY73. IDB loans in 1970 include $11.5 million both disbursed and repayable in foreign exchange, $23.5 million disbursed in foreign exchange but repayable in local currency and $9.3million both disbursed and repayable in local currency. In 1971, the corresponding commitments were $0.1 million, $22.1 million and $13.0 million respectively. All 1972 lending was disbursed in foreign exchange but repayable in local currency. Source; IBRD Debtor Reporting System. See following tables for details of loans from bilateral sources.  ANNEX I PERU: Loans from Bilateral Sources Contracted Thuring 1969 Page 4 of 8 (in thousands of US Dollars) Creditor Date of Date of Crate Years of Loan No. Debtor Creditor Country Amount Interest Agreement Maturity Period +MaturiLy Purpose SUPPLIERS 0456 Soc. Siderurgica Chimbote ENSID France 896 6.47% 12/69 06/80 2.0 8.5 Steel Tnd-Isrty 0455 Soc. Siderurgica Chimbote Consotcio Italiano Italy 3,576 6.47% 12/69 06/80 2,0 8.5 Steel Industry 0420 Government of Peru Spees Werwalt & Finanz Switzerland 1,360 8.5 to 07/69 07/71 0.5 1.5 Irrigation 0327 Coverniment of Peru Salzgitter Industriesau Germany 454 - 06/69 12/72 0.5 2.5 Irrigation 0259 Govertnment of Peru Salzgitter Industriesau Germany 260 6.5 7. 01/69 06/70 0,5 1.0 Irrigation 0282 Soc. Siderurgica Chimbote Ferrostaal A.G. Germany 1,391 8.0 X 01/69 06/73 0.5 4.0 Steel Industry 0364 Petro Peru Gulf Oil Corporation U.S.A. 500 5.757, 06/69 01/78 0.5 8.5 Petroleum SUPPLIERS TOTAI. 8,437 8,437 PRIVATE BANKS 0419 Government of Peru Medio Banka Italy 1,262 8.25% 05/69 06/73 1.5 2.5 Debt Relief 0424 Soc. Siderurgica Chimbote Franklin National Bank U.S.A. 5,000 8.25% 01/69 10/73 1.0 3.5 Steel Industry PRIVATE BANKS TOTAL 6,262 6,262 LOANS FROM GOVERhMENT 0443 Government of Peru Office National De Dueroire Belgi,,m 3,192 9.30 ' 12/69 12/75 2.5 3.5 Debt Relief 0473 Government of Peru Governmenr of Italy Italy 592 8.25% 12/69 12/76 2.5 4.5 Debt Relief 0446 Government of Peru Canadian Dollar Fund Canada 2,587 6.0 / 09/69 01/81 1.5 10.0 Transport (sea) 0447 EPSA Government of New Zealand New Zealand 10,000 5.75% 12/69 06/80 6,0 4.5 Food LOANS FROM GOVERNMENT TOTAL 16,366 16,366 TOTAL 1969 31,065  ANNEX I PERU: Loans from Bilateral Sources Contracted During 1970 Page 5 of 8 (thousands of US Dollars) Creditor Date of Date of Grace Years of Loan No. Debtor Creditor Country Amount Interest Agreement Maturity Period +Maturity Purpose SUPPLIERS 0444 Cia Peruana Telefono Bell Telephone Manufacturing Belgium 2,187 7.0 % 03/70 10/80 1.0 9.5 Coammunications 0460 Corpuno Steyer Austria 200 7.5 % 02/70 02/81 3.5 7.5 Agriculture 0457 Government of Peru Salzgitter Industrie Bav Germany 452 - 02/70 04/72 0.2 2.0 Irrigation 0464 Soc. Siderurgica Chimbote Ensid France 1,436 9.25% 02/70 06/80 2.6 7.5 Steel industry 0463 Soc. Siderurgica Chimbote Consorcio Italiano Italy 4,640 9.25% 02/70 06/80 2.6 7.5 Steel Industrv 0453.010 Soc. Siderurgica Chimbote Consorcio Italiano Italy 3,487 6.47% 01/70 06/80 1.5 9.0 Steel Industry 0455.010 Soc. Siderurgica Chimbote Consorcio Italiano Italy 931 6.47%7 01/70 06/80 2.0 8.5 Steel Industr, 0454.010 Soc. Siderurgica Chimbote Ensid France 880 6.47% 01/70 06/80 1.5 9.0 Steel lndustry 0461 Enapu Sulzer A.G. Switzerland 539 8.25% 03/70 12/76 2.2 4.5 Port SUPPLIERS TOTAL 14,752 14,752 BANKS 0452 Government of Peru Credit Lyonnais France 2,034 11.0 % 05/70 05/75 0.2 5.0 Debt Relief BANKS TOTAL 2,034 2,034 LOANS FROM GOVERNMENr 0442 Government of Peru Government of Franc France 12,411 9.0 % 04/70 12/76 2.0 4.5 Debt Relief 0441 Government of Peru Government of West Germany Germany 27,968 8.5 % 04/70 10/76 2.0 4.5 Debt Relief 0374 Government of Peru Tresoir Francaise France 710 5.0 % 04/70 12/74 0.5 3.5 Debt Relief 0450 Government of Peru Export Development Co. Canada 3,000 9.0 % 06/70 06/80 3.0 7.0 Tourism 0489 CRYRZA Government of U.K. U.K. 2,400 - 12/70 06/04 8.5 25.0 Emergency (Earthquake) 0448 EPSA Government of Canada Canada 8,578 6.25% 04/70 06/75 0.5 4.5 Food Aid 0440 Government of Peru Consorcio Compensacion Seguros Spain 4,818 8.0% 04/70 12/76 2.0 4.5 Debt Relief GOVERNMENTS TOTAL 60.567 60,567 TOTAL 1970 76671  ANNEX I Pmeue 6 of 8 PERU: Loans from Bilateral Sources Contracted During 1971 (thousands of US Dollars) Creditor Date of Date of Grace Years of Loan No. Debtor Creditor Country Amount Interest Agreement Maturity Period +Maturitv Purpose SUPPLI ERS 0476 EPSA U.S.A. 6,925 5.5 6 01/71 06/75 0.5 4.0 Agricultu,lre 0474 EPSA Can ada 11,429 5.0 4 06/71 12/81 0.5 10.0 Agric;ulture 0467-1-2 Governmnent of Peru Energo Project Yugoslavia 53,526 6.5 6 04/71 11/85 5.1 9.5 Irriaation 0468 Emp. Pub. Harina Pescadc) Divi,ud Lorenl:zen Trading Norway 7,996 7.75/ 10/71 12/80 1.1 S.0 Fisheries 0475 Banco Vivienda Mu,tual Bome U.S.A. 28,281 4.0 7 12/71 12/83 1.5 10.5 Houssing 0364 Petro Perul Gulf Oil Corp. U.S.A. 7,429w 5.75% 06/71 01/78 0.5 7.0 PetroleuLm exploration SUPPLIERS TOTAL 115,586 115,58fi BANKS 0480 Government of Peru U.S.A. 23,500 8.75-/. 12/71 07/77 1.0 4.5 DeUt Relief 0)469 Government of Peru U.K. 1,45() 1.75% 09/71 09/76 1.5 3.5 Debt Relief BANKS TOI'AL 24, 950 24, 950 GOVERNMENT 0810 Cuvernment of Peru Exit Banik U.S.A. 4,31(1 6.() 6 ( 03/71 11/77 3.5 3.0 Transportation (air) 0478 Government of Peru AID U.S.A. 3,000 2.71% 11/71 12/71 4.5 34.5 Rlousing, reconstruction 0470 Government of Peru Magyar Nemzento Bank Hungary 10,400 8.0 6 09/71 09/79 2.0 6.0 Education 0472 Govermnent of Peru Netherlandse tiovesterings Bank Netherland 1,030 6.5 6 10/71 07/96 3.0 11.5 Livestock 0471 Servicios Electricos Nac. Czescolovenska Obchodni Banka Czechoslovakia 6,050 7.0 % 06/71 08/81 2.0 7.0 Power 0473 Government of Peru Government ut Italy Italy 1,544' 8.2551 /71 12/76 1.0 4.0 Debt Relief 0477 EPSA Commodity Credit Corporation U.S.A. 21,000 12/71 12183 1.5 3.5 Debt Relief LOAN FROM GOVERNMENTS TOTAL 47,334 TOTAI 19717 * Committments under old loans.  ANNEX I Page 7 of 8 PERU: Loan.s from Bilateral Sources Contracted Poring 1972 (in thousands of US Dollars) Creditor Date of Date of Grace Years of Loan No. Debtor Creditor Country Amount Interest Agreement Maturity Period