Ecuador - Milagro Irrigation Project

CIRCULATING c0PY TO BE RETURNED TO REPORTS DESK ANKFop REONTRUJCTIoN AND DEVELOpMENT TOF INTERNATIONAL B E EOPMENT ASSOCIATION >-2 r Not For Public Use Report No. P-1241a-EC REPORT.AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF ECUADOR FOR AN IRRIGATION PROJECT June 22, 1973 Thsreportwas prepared for offiial usteonybythe Bank G roup. it may not be pu sh orcitedwithoutankGrupauhorit Bank Group does not acc rsponsibilitY  RATE OF EXCHANGE Currency Unit Sucre (S/) US$1 = S/25 S/1 = us$o.oh S/1,OOO = us$40 S/1,ooo,ooo = us$ho,o0o Ecuador Fiscal Year - January 1 to Decemnber 31  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBIIC OF ECUADOR FOR AN IRRIGATION PROJECT 1. I suhqit the following Report and Recommendation on a proposed credit to the Republic of Ecuador in an amount equivalent to $5.5 million on standard IDA terms to help finance an integrated irrigation and agricul- tural development project in the area of Yilagro, east of the City of Guayaquil. PART I - THE ECONCMY 2. The economy of Ecuador is dealt with in paragraphs 2-8 of the President's Report dated June 1h, 1973 on a proposed loan to the Republic of Ecbuador for a Second Development Finance Companies Project (Report No. P-1231a-EC). These paragraphs are attached as Annex I, which also includes a Country Data Sheet. PART II - BANK GROUP OPERATIONS IN ECUADOR 3. The proposed credit would be IDA's sixth operation in Ecuador. In addition, the Bank has made nine loans bringing the total of Bank Group funds lent to Ecuador to $102.7 million, net of cancellations, as of May 31, 1973. For a review of Bank Group lending to Ecuador, reference is made to paragraphs 9-13 of the above-referred President's Report on the proposed Second Development Finance Companies Project. These paragraphs are included in Annex I. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of May 31, 1973, and notes on the execution of on-going projects. PART III - AGRICULTURE IN ECUADOR 4. The agricultural sector accounts for about one-third of GDP and over half of employment in Ecuador. Although the expected rapid expansion of petro- leum and manufacturing output in the next few years will diminish the relative importance of agriculture's contribution to GDP, Ecuador is likely to remain a primarily agrarian economy for some time, and the development of the sector will continue to be decisive in the country's economic and social welfare. 5. The structure of agricultural production is dictated by the country's varied topography and climate. The coastal lowlands, which contain 45 percent of the population, have a tropical climate ranging-from semi-arid in the south to humid in the north. Annual crop cultivation occurs in the south, where irrigation is available, while the north is suited to perennial crop production. Much of the remainder is used as natural pasture. The Andean highlands, where about half of the country's population is concentrated, comprise valleys and  - 2 - plateaus at altitudes of 2,000-4,000 meters. Rainfall varies considerably, but is suLfficient to support one crop annually over much of the region. Some irrigation is available in many of the valleys, but heavy population pressure and major problems of erosion from cultivation on hillsides have resulted in serious productivity problems. The eastern lowlands are largely uninhabited and unexplored. The climate is hot and humid, but poor lateritic soils limit the potential fc,r crop cultivation. 6. In spite of agrarian reform legislation, land distribution in Ecuador has not changed significantly since the first such law was passed in 196L. In 1968 the top 10 percent of owners had title to about 76 percent of the land, whereas the smallest 30 percent of the farmers owned only one percent of the land. The majority of farms are owner-operated - 75 percelnt of the farms and 83 percent of the farmland were owner-occupied in 1968; most of the balance was farmed by tenants or sharecroppers. The situation today is believed not to be much different from that in 1968; the Government has indi- cated, however, that it intends to broaden its land tenure reform through new programs in the Guayas River basin expected to benefit some 50,000 families over the next five years. 7. Agricultural production (including forestry and fisheries) grew at an average annual rate of 3.6 percent (based on constant 1971 Drices) cvrel the period 1960-70. However, considerable fluctuations over time anid along commodities occurred. Thus, while during the 1960's production of cotton, sugarcane, beans, barley, coffee and animal products grew rapidly, production of other comodities was disappointing. In 1969 and 1970 agricultural pro- duction increased by 5.2 and 6.2 percent largely due to good weather and improved banana output in response to previous investment. Performance of the sector was inadequate in 1971 with growth falling to 1.7 percent as production of major exports stagnated. Preliminary data for 1972 show some improvement over 1971, but the production growth rate e.siinated at 2 to 3 percent was again lower than the rate of population growth of about 3.4 percent. 8. Traditionally the country has depended for its food needs on agriculture in the central highlands. Domestic demand has outgrown, however, the productive capacity of this region, which is constrained by the division of the land into very small units and over-population. This has resulted in in- creasing food imports and has encouraged the Government to attempt to diversify agriculture in the western lowlands, which in the past have been used mainly to produce livestock and export crops (such as sugar and bananas) on large private estates. This region has exceptionally favorable conditions for agricultural production, particularly in the provinces of Guayas and El Oro. A survey of the Guayas river basin by Canadian consultants has shown that more than 200,000 ha could be developed for double cropping under irrigation, making it, potentially, one of the best areas in the country for increasing production of both export and import substitution crops. Two projects have been selected by the Government for initial development in the basin: Babahoyo (11,000 ha) for rice production, financing of which is expected from the IDB; and Milagro. This shift of empha-  - 3 - sis to the coastal area has not meant, however, the abandonment of irriga- tion development work in the highlands, where rehabilitation or constrac- tion of selected schemes is planned or underway. One such new scheme is the Montufar Project (3,500 ha) receiving financial assistance from the IDB. 9. In the past, priority was given to export agriculture, which pro- vided the foreign exchange needed to meet the economy's import requirements. The emergence of petroleumn as a new source of foreign exchange should now make it possible to increase the importance of production for the domestic market in the development strategy of the Ecuadorian Government. Because of the large proportion of active population depending for its living on domestic oriented agriculture, tasks such as improving productivity and increasing employment and income opportunities in this sector would have a significant impact on the overall living conditions in Ecuador. It would also reduce migration into the Guayaquil and Quito areas, which is creating new demands for jobs and urban facilities that are increasingly difficult to satisfy. 10. The Government is aware of the urgent rural needs and, with the prospects of additional income from oil exports and improvement of its credit position, expects to undertake a number of measures to improve agricultural production and the economic conditions of the rural population. Land reform will be a key element in this regard and new programs in the Government's Five-Year Transformation and Development Plan will aim at bringing inefficient large holdings and uncultivated lands into production under new forms of ownership, such as cooperatives and associations. Productivity increase will be a major target of these efforts, for which expanded irrigation is expected to play an important role. PART IV - THE PROJBCT 11. A report entitled "Appraisal of the Milagro Irrigation Project" (No. 113a-EC, dated June 6, 1973) is being distributed separately. The main featilres of the project and the proposed credit are summarized in Annex III. 12. The proposed credit would be the fourth Bank Group operation in Ecuador's agricultural sector, the first three having supported livestock development. The initial feasibility study for the Milagro project, financed by AID, was carried out by consultants in 1965-67. An FAO/IBRD cooperative program mission visited the area in 1968 and recommended that additional studies be undertaken, which the Government agreed to do. The preparation of this additional work took longer than anticipated and, with the assistance of the FAO/IBRD cooperative program, was finally completed in mid-1972. The project was appraised in October 1972, and negotiations were held in Washington from May 4 to 9, 1973. The Borrowerts delegation was led by Mr. Cristobal Flores, Advisor in the Ministry of Finance, and included Messrs. Jaime Bustamante, Luis Carrera and Carlos Arana, respectively Executive Director, Chief of Planning and Legal Counsel of the Instituto Ecuatoriano de Recursos Hidraulicos (INERHI).  Project Description 13. The proposed project would consist of integrated irrigation and agricultural development of 7,000 ha in the Mlagro area, some 40 km east of Guayaquil, Ecuador's largest city. The area, adjacent to the Rio Chimbo, whose waters it would utilize, is only partially (1,200 ha) irrigated at present and production is mainly dependent on rainfed cropping during the wet season. Irrigation of the entire area during the dry season would greatly increase production and benefit some 825 farms with a population estimated at about 6,000 persons. Except for the granting of titles to some farmers, a process of land reform has been completed in the area. One-third of the farmers have farms of less than 5 ha, and another one-third has farms of 5-10 ha. Only 10 farms are more than 50 ha in size. Engaged in subsistence type agriculture, the farmers of Milagro have had little or no access to credit or extensio71 services. The absence of modern technology does not permit the use of all the available land and results in extremely low productivity. 14. The main activities under the project include: (a) the rehabilitation of the existing main canal and intake structure and the construction of irrigation and drainage systems and roads to serve a net area of 7,000 ha with outlets to each of the 825 farms; on-farm development ,,works consisting of land clearing, land levelling, farm ditches and drains; and the construction of buildings (including a warehouse and a maintenance shop) for project administration and services; (b) acquisition of equipment for construction, operation and maintenance, administration and agricultural development; (c) the establishment within INTERI of a field-based Agricultural Production Unit to provide farmers with production inputs, marketing assistance, storage, transport, drying facilities and machinery services; (d) the production of improved seeds and th.e carrying out of a seed multiplication program; (e) a feasibility study for the extension of irrigation to an area of 10,000 to 15,000 ha west and south of the presently proposed project area. 15. The project also involves the granting of titles to about 20 percent of the farmers who have not yet been issued such titles, and the realignment  - 5 - of existing farm boundaries in order to facilitate the layout and construction of the irrigation and drainage systems and roads. This realignment may result in a partial loss of land by some farmers and a gain by others. In those cases not resolved by simple land exchange between adjacent farms, the Instituto Ecuatoriano de Reforma Agraria y Colonizacion (IERAC) would acquire the excess land and transfer title thereon to the farmer designated by INERHI for the purpose. These transfers would be done under the terms and conditions provided for in the Agrarian Reform Law, and credit would be provided to the acquiring farmers. 16. Based on the designed cropping pattern, it is estimated that of the net irrigation area of 7,000 ha, about. 3,600 ha would be in perennial crops (sugarcane, 1,400 ha; bananas, 1,700 ha; cocoa, 500 ha) and about 3,400 ha would be double-cropped with seasonal crops (rice and maize in the wet season and groundnuts and soybeans in the dry season). Essentially, this cropping pattern would eliminate the present low-yielding crop mixture of fruit trees (4,200 ha) and sugarcane (2,300 ha), and would introduce oil crops and increase the production of bananas, cereals and sugarcane. 17. The agency responsible for constructing the project and for operating and maintaining it thereafter would be INERHI, a quasi-autonomous agency under the aegis of the Mlinistry of Agriculture; the Minister presides over INERHI's five-member Board of Directors. Created in 1966 to develop Ecuador's irriga- tion and drainage systems and ensure the rational use of water resources, INERHI has now a staff of about 175. INERHI's strength has been on the engineering side rather than on the agricultural development and field operations aspects of irrigation, but studies for reorganizing and strengthening the institution are currently underway as part of the IDB-supported Montufar project. 18. INERHI would set up an office in the field to be managed by a Project Director responsible for overall project execution and day-to-day operations; the appointment of the Project Director, in consultation with the Association, will be a condition of effectiveness. INERHI will also employ three consultants to advise the Project Director on supervision of construction, implementation of on-farm works, and management of the Agricultural Production Unit. INERHI would carry out the construction of the civil works using local contractors, and would be assisted by the Ministry of Agriculture, the Federation of Agricultural Cooperatives (FECOPAM), the Agricultural Research Institute (INIAP), and IERAC in carrying out the agricultural development aspects of the project. Credit to the farmers for production purposes would be provided by the National Development Bank (BNF). For the agricultural development phase, INERHI would set up an Agricultural Production Unit, as part of the field office, to be headed by a general manager. The Production Unit would be responsible for providing farmers with a broad range of essential supporting services, including a machinery rental service whose operational procedures would require the Association's approval prior to purchasing the machinery. The Unit's work would be taken over at the end of the development period by a farmers' cooperative to be organized with the assistance of FECOPAM. A condition of effectiveness of the proposed credit would be the execution of project implementation agreements, satisfactory to IDA, between INERHI and the aforementioned agencies.  - 6 - 19. Because of seasonal limitations, the project area would be divided in three sections to permit completion of all on-farm development work in each section during a given dry season. Production would be interrupted during one cropping period in each section, requiring appropriate compensation to the affected farmers. The Government has agreed to establish a fund, esti- mated at about S/10 million, to compensate eligible farmers for the value of the crop loss. Financing 20. The estimated cost of the project is $10.2 million, of which $5.3 million, or 51 percent, is in foreign exchange. The proposed credit would be for $5.5 million, and the proceeds would be made available by the Government to INERHI under a transfer agreement, the execution of which would be a condition of effectiveness. In addition to covering the foreign excharnge costs of equipment and supplies, consultants and contingencies, the credit would provide financing of $0.2 million for local contracting of topographic, land-use and cadastral surveys for the feasibility study. This small amount of local expenditures financing would enable IDA to assist in a crucial part of the project and in developing much needed local expertise in these types of surveys. The balance of the project costs, equivalent to $4.7 million, would be financed by the Government. A condition of effectiveness of the proposed credit would be that budgetary funds of about S/1L.o0 million be deposited in a special project account to be established by INERHI. Procurement 21. Because of the relatively small size of the project, and the fact that construction work will need to be interrupted during the wet season (December-June) each year, foreign contractors are not expected to be interested in submitting bids for the civil works. Therefore, INERHI will construct tYLeOe works, to be financed by the Government, using Ecuadorian contractors selected through local bidding. Contractors would prov de skilled and unskilled labor and locally available material and supplies; INEaIl would provide the construc- tion equipment ($2.1 million) financed by the proposed credit and procured in accordance with the Bank/IDA procurement guidelines. Equipment for the agri- cultural development phase (agricultural machinery and vehicles) and well- drilling and testing equipment for the studies, amounting to $0.8 mdllinc in all, would also be procured through international competitive bidding. Miscellaneous equipment and supplies ($0.9 million financed by the credit) for irrigation, engineering, office and laboratory, which could not be practically grouped, would be procured through normal commercial channels on the basis of a minimum of three quotations. Consultant services ($1.0 million) would be obtained by INERHI through contracts with individual consultants or consulting firms under terms and conditions satisfactory to IDA. For purposes of bid comparison and contract awarding, Ecuadorian manufactured goods will be granted a preference of 15 percent or the level of import taxes payable by a non-exempt importer, whichever is lower. Goods manufactured in other member countries of the Latn American Free Trade Association and the Andean Group (Cartagena Agreement) will be granted a preference over goods manufactured in countries outside those regional organizations equal to 15 percent or the difference in the level of the respective import taxes actually payable by INERHI, whichever is lower.  -7 - 22. INERHI is empowered by law to impose charges for irrigation services uifficient to cover operation and maintenance costs and up to the full amount of investments. Until now, however, INERHI's charges on existing projects have not even covered the actual operation and maintenance costs. For the Milagro project INERHI has agreed to introduce charges that would cover operation and maintenance costs and permit it to recover, within not more than forty years, a substantial proportion of the project investments. In determining the initial level of charges, one important consideration has been to assure the fatrmers' cooperation and provide sufficient incentive to maintain their participation. Two types of charges would be imposed: (a) a charge for "irrigation service"t to be gradually increased over a 5-year period on a per hectare basis, commencing at S/500 per ha in the first year of receiving irrigation and reaching S/1,500 per ha in the fifth year; and (b) a "better- ment levy", progressive with farm size, to be paid annually from the first year of irrigation onwards as follows: no levy in farms of up to 10 ha, S/tOO per ha in farms of more than 10 and up to 20 ha, S/200 per ha in farms of more than 20 and upt 50ha and S/400 per ha in farms of more than 50 ha. On the basis of the initial levels above, when estimated project costs and charges are discounted at 8 percent per annum over the economic life of the project (400 years), the charges would recover, in addition to meeting annual costs of operation and maintenance, about 43 percent of estimated investments costs. Expressed as a percentage of the expected incremental farm income (before charges), farmer's average contribution would vary between 12 percent for the smaller farms and 47 percent for the sugarcane farms. (See Section 4.01 of the draft Development Credit Agreement and Section 4.04(a) and (b)(i) of the draft Project Agreement.) 23. As stated earlier, the agreed charges and levies represent initial assessments. To take account of inflation, INERHI has agreed that not later than December 31, 1975 (scheduled date for completion of irrigation works for the first section), and annually thereafter, the initial charges and levies will be reviewed and adjusted for price increases in accordance with an indexing procedure to be agreed between INERHI and the Association. Also, since the agreed objective is to recover a substantial proportion of the invest- ment costs, INERHI has undertaken to establish a mechanism, in agreement with the Association, that would permit it to review and, if necessary, adjust not later than December 31, 1978 (scheduled date for completion of all project works), and at regular intervals thereafter, the charges and levies on the basis of amounts actually spent and taking into account such factors as farm size, income received and taxes paid by the farmers participating in the project, and the need to maintain economic incentives for the farmers. (See Section 4.04(b)(ii) and (c) of the draft Project Agreement.) Rate of Return 24. When costs and benefits are discounted over a 40-year period, the economic rate of return is about 16 percent. At full project development, eleven years after commencement of works, the net value of production would be about $3.1 million, while the corresponding value without the project would be about $1.0 million. Since the additional production would be for export or import substitution, significant project benefits would accrue to the country in the form of foreign exchange earnings. The project, furthermore, would cause a shift from an underemployment situation to one in which the farm family labor force would be fully used. In addition, the project would absorb annually  - 8 - hired labor equivalent to about 1,500 man-years, cpite evenly distributed over the year. Depending on the size of the farm, income per capita would increase from the present range of about $50 to $320 up to $230 to $720 at full development. No major changes in the ecology of the area are expected as a result of the project. PART V - LEGAL INSTRUMENTS AND AUTIIORITY 25. The draft Development Credit Agreement between the Republic of Ecuador and the Association, the draft Project Agreement between the Associa- tion and INERHI, the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement, and the text of a draft resolu- tion approving the proposed credit are being distributed to the Executive Directors separately. 26. The draft agreements conform to the normal pattern of credits for irrigation projects and contain provisions to reflect the uarious arrangements described in Part IV above. Of special interest are the following provisions: (a) Section 3.02 of the draft Development Credit Agreement and Section 2.10 of the draft Project Agreement concerning the allocation of water rights; (b) Section 3.03 of the draft Development Credit Agreement concerning the granting of land titles to participating farmers; (c) Section 3.02 of the draft Project Agreement concerning regard for ecological and environmental aspects of the project 27. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 28. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President Attachments June 22, 1973  Annex I Page I of 6 COUNTRY DATA - ECUADOR AREA 2, POPULATION!! DENSITY 271,000 kmr- 6.5 million (mid-1972) 24 per km&/ Rate of Growth: 3.4% (froal960 to 1971) 200 per kImZof arable land POPULATION CHARACTERISTICS (1970T HEALTH (1968) Crude Birth Rate (per 1,000) 48 Population per physician 2,770 Crude Death RAte (per 1,000) 14 Population per hospital bed 450 Infant Mortality (per 1,000 live births) 87 a/ cf INCOME DISTRIBUTION (1970T DISTRIBUTION OF LAND OWNERSHIP (1QARf % of national income, lowest quintile 2.7 % owned by top 10% of owners 76 highest quintile 73.2 7 owned by smallest 30% of owners I b,/ d/ ACCESS TO PIPED WATER (1969) ACCESS TO ELECTRICITY L962) % of population - urban 92 % of dwellings 32 - rural 9 NUTRITION EDUCATION ft Calorie intake as 72 of requirements (i961,-66) 71 Adult literacy rate