Sri Lanka - Dairy Development Project

Report No. 427-CE Appraisal of the FILE COpy Sri Lanka Dairy Development Project June 5, 1974 Asia Projects Department Not for Public Use Document of the International Bank for Reconstruction and Development International Development Association 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 It may not be published, quoted or cited without Bank Group authorization.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 US$1 = Sri Lanka Rupees (Rs) 6-74M Rs 0.01 = Sri Lanka Cent Rs 1 US$0.148 Rs 1 million = US$148,368 WEIGHTS AND MEASURES (British System) 1 long ton 2240 lbs = 1.016 metric tons 1 hundredweight (cwt) 114 lbs = 50.8 kg 1 bushel (bu) 45 lbs (of paddy) 1 pint 0.57 liters (1) 1 acre 0.405 hectares (ha) 1 mile 1.609 kilometers (km) 1 gram (g) 0.035 ounce (oz) 1 inch = 25.4 millimeters (mm) ABBREVIATIONS APHD = Animal Production and Health Division (in the Ministry of Agriculture) CRB = Cooperative Rural Bank DCS = Dairy Cooperative Society MPCS Multipurpose Cooperative Society NMB = National Milk Board PTU = Project Technical Unit APC = Agricultural Productivity Center FISCAL YEAR January 1 - December 31 /1 The Sri Lanka rupee has been tied to the pound sterling since June 1972 at Rs 15.60 per pound and has consequently been floating with it. The US dollar rate is thus dependent upon the cross-rate between the pound and the dollar. The rate of US$1 = Rs 6.74 was established by the Central Bank of Ceylon on December 31, 1973. Under the Foreign Exchange Entitlement Certificate Scheme (FEEC's), a levy of 65% is applied to most non-food imports. Since the major items to be imported by government agencies under the proposed Project are subject to the FEEC's, the exchange rate used in this Appraisal Report is US$1 = Rs 10, which is the approximate average FEEC rate between June 1972 and the time of project appraisal.  SRI LANKA DAIRY DEVELOPMENT PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS ............................... i - i I. INTRODUCTION ........ ............. ..................... II,, BACKGROUND ...................... ...................... A. General . .......................................... 1 B. Agricultural Sector .............................. 2 C. Milk Marketing and Processing .................... 3 D. Development Support Services ..................... 4 III. THE PROJECT AREAS ..................................... 6 IV. THE PROJECT ........................................... 7 A. Description ...................................... 7 B. Detailed Features ................................ 8 C. Cost Estimates ................................... 10 D. Proposed Financing ............................... 12 E. Procurement ...................................... 13 F. Disbursement ..................................... 14 C. Reporting and Auditing ........................... 14 V. ORGANIZATION AND MANAGEMENT ........................... 15 A. Administration ................................... 15 B. Management and Technical Services ................ 15 C. Lending Operations ............................... 17 VI. MARKETING, PRICES, SUBSIDIES AND PRODUCER BENEFITS .... 18 A. Marketing and Prices ............................. 18 B. Subsidies . ........................................ 20 C. Producer Benefits ........ ........................ 21 VII. ECONOMIC BENEFITS AND JUSTIFICATION ....... .. .......... 21 VIII. AGREEMENTS REACHED AND RECOMMENDATION ............. ... 22 This report is based on the findings of a mission composed of R. Bailey (IDA), H. Groenewold (FAO/IBRD Cooperative Programme) and T. Haworth (Consultant) that visited Sri Lanka in June/July 1973.  -2- ANNEXES 1 - The Dairy Sub-Sector 2 - National Milk Board 3 - Pricing and Subsidies Relating to the Dairy Sector 4 - Recent Legislation: Land Reform and Agricultural Productivity 5 - Agricultural Cooperatives 6 - The Lending Banks 7 - Dairy Farm Development Projections 8 - Management, Technical Assistance and Pilot Units 9 - Terms of Reference for Technical Assistance Specialists 10 - Terms of Reference for Milk Collection and Transport Consultancy 11 - Project Costs by Investment Categories 12 - Estimated Schedule of Disbur3ements 13 - Financial Rates of Return 14 - Economic Rate of Return MAP  SRI LANKA DAIRY DEVELOPMENT PROJECT SUMMARY AND CONCLUSIONS i. Agriculture plays a major role in the economy of Sri Lanka through its large contribution to GNP, foreign exchange earnings, and government revenue. In 1973 the agricultural sector accounted for nearly 33% of GNP, about 77% of export earnings, and 50% of total employment. While livestock farming has considerable potential it is now of minor economic importance, contributing only about 7% of the gross value of agricultural production. ii. The proposed Project would be the Bank Group's fourth in agri- culture in Sri Lanka and the first IDA Credit in the livestock sector. It would provide for on-farm development on about 42,000 acres, comprising about 1,800 small (5-10 acres) and 600 larger (40-50 acres) farms in the Coconut Triangle and Mid-Country, including purchase of about 10,400 local and 3,200 imported heifers. Existing milk collection and transport services of the National Milk Board (NMB) and cooperatives would be expanded and improved. Technical assistance is also prov:lded in the form of pilot programs to develop and demonstrate systems of communal calf rearing and techniques for milk production in the Dry Zone area, as well as for in-service training. iii. Project cost is estimated at US$12.7 million equivalent, includ- ing working capital required during the on-farm investment phase, and covers a five-year period, from 1974 to 1978. The proposed IDA credit of US$9.0 million would finance foreign exchange costs of US$5.5 million and about 502 of local currency costs. Government would establish a project account with the Central Bank of Ceylon through which the proceeds of the IDA credit would be channeled. The major part of the credit ($5.5 million) would be for on-farm development and milk collection and transport investments and would be relent by the Borrower to two participating banks - People's Bank and Bank of Ceylon - for 12 years including three years of grace with interest at 6% p.a., for subsequent relending to dairy farmers, NMB and cooperatives. The participating banks would augment these funds by contributing about $1.5 million of their own resources to the financing needs of the project bene- ficiaries. Relending terms to project beneficiaries would be: (a) to farmers at 10% p.a. for 12 years; (b) to NMB at 8% p.a. for 10 years; and (c) to cooperatives at 8% p.a. for 12 years; all including a three year grace period. The remainder of the credit ($3.5 million) would be for imported livestock, the Project Technical Unit and pilot operations and would be disbursed through the Ministry of Agriculture, complemented by Government's contribution of about $0.5 million. Government would also contribute about $0.9 million in the form of pasture development subsidies to participating farmers. Farmers would contribute about $0.9 million in labor, cash and kind toward the cost of on-farm development and livestock. iv. In order to ensure overall coordination, a Project Committee would be established under the chairmanship of the Ministry of Planning and Econo- mic Affairs. It would include representation from all agencies and banks  - ii - concerned in the Project. Responsibility for executing dairy farm develop- ment, livestock procurement, techuical services and pilot operations provided under the Project would lie with PTU, which would be established in the Mtinistry of Agriculture. The PTU would be headed by a Project Director who would report to the Deputy Director of Agriculture responsible for the Animal Production and Health Division (APHD) and who would be supported by inter- nationally recruited personnel, including a technical director and experts on tropical pasture and calf-raising. Responsibility for milk collection, transport and marketing would lie with NMB and be coordinated through the Project Committee. v. International competitive bidding, in accordance with IDA guide- lines, would be used for the purchase of imported milk storage equipment and vehicles and mobile testing units to be purchased by NMB - about US$0.6 million. Heifers valued at about US$1.4 million would be imported from selected countries free from foot and mouth disease in accordance with pro- cedures acceptable to IDA. As most major vehicle manufacturers are represented in Sri Lanka, local competitive bidding would be used for purchase of imported vehicles required by PTU - about US$0.3 million. Seed and materials for pasture planting would be purchased from local suppliers. Local contractors would be used for construction of selected buildings, and water supply facilities which would be of a small and scattered nature. Local cattle would be procured from both Government herds and from private farm herds through auctions organized by PTU. vi. Participating farmers are expected to benefit from higher net incomes at full development, expected in 1981, and the smallest farmers would more than double their incomes. Additional milk production would be about 43 million pints annually, amounting to about 25% of 1972 imports of dairy products giving estimated annual foreign exchange savings of about $2.0 million. The estimated financial rate of return to the farmers' invest- ments would range from 15% to 19%. The economic rate of return for the proposed Project is estimated at 15%. The project would create new jobs for about 1,500 people. vii. The proposed Project would also assist the Government in its planned diversification from marginally productive tea on 14,000 acres in the Mid- Country. In addition, the extension and research activities in pasture deve- lopment, communal calf rearing and milk production would encourage sound animal husbandry not only on project farms but also in the surrounding areas. Moreover, the experience gained in financing development of small farmers under the Project is expected to contribute significantly to improved and expanded credit operations in the dairy sector. viii. The proposed Project is suitable for an IDA credit of US$9.0 million.  SRI LANKA DAIRY DEVELOPMENT PROJECT I, INTRODUCTION 1.01 The Government of Sri Lanka has applied for Bank Group assistance in financing a part of its Five Year Plan (1972-76) in the dairy sector. The proposed Project would support dairy development on small to medium- sized farms, and help expand essential milk collection and transport facil- ities. The Bank Agricultural Sector Mission of October 1971 identified the Project. It was subsequently prepared by an interagency team from various Sri Lanka Government departments, with assistance from the FAO/IBRD Coopera- tive Programme. 1.02 This would be the Bank Group's fourth agricultural sector project in Sri Lanka. Credits 121-CE' for US$2.0 million in 1968 and 168-CE for US$2.5 million in 1969 supported irrigation and land reclamation. Loan 653-CE/Credit 174-CE for US$29.0 million in 1970 supported power and irriga- tion. Although there were initial delays, progress on the three projects is satisfactory. 1.03 This report is based on the findings of a mission composed of R. Bailey (IDA), H. Groenewold (FAO/IBRD Cooperative Progratme) and T. Haworth (Consultant) that visited Sri Lanka in June/July 1973. Consultation with the Government of Sri Lanka regarding dairy pricing and other policy matters were undertaken following the field appraisal. II. BACKGROUND A. General 2.01 The Republic of Sri Lanka covers an area of 25,300 sq mi and has a population of about 13.5 million which is growing-by slightly more than 2% annually. Various governments since independence in 1948 have concentrated heavily upon a wide range of social welfare programs, expenditures for which have tended to depress the rate of economic growth. The real GDP growth rate, which has averaged about 4% over the period 1960-1970, dropped to less than 1% in 1971 but recovered to about 2% in 1972 and to 2.5% in 1973. Per capita income in 1971 was estimated at US$100. Activity in the private sector remains depressed; unemployment is high, particularly among the young; export earnings in real terms have declined sharply in recent years, and, with increasing prices for oil and other imports, the balance of payments is under strong pressure. 2.02 Sri Lanka's economy is predominantly agricultural. Agriculture is the largest productive sector, accounting in 1973 for nearly 33% of GNP, 50% of total employment and 77% of all export earnings through the sale of  - 2 - tea, rubber and coconut products. In contrast, food imports, which have averaged about US$150 million p.a. in the past five years (over 50% of all foreign exchange earnings), have increased. 2.03 In its effort to reverse the deteriorating economic trend, Govern- ment is concentrating attention on both export expansion and import substi- tution programs, looking particularly to increasing domestic production of rice and subsidiary food products, including meat and milk. The Bank Group is already assisting rice production through irrigation projects and with the proposed Project would provide effective support to development of the lagging dairy sector, aimed at increasing supplies of milk and reducing the country's dependence on imported milk powder. In 1972 these imports were worth about US$8 million representing about 43% of the liquid milk sales of NMB. Even with imports at this level, the per capita availability of milk is only about 45 g per day compared with about 113 g per day in India. This is inadequate to meet even minimal daily nutritional require- ments, estimated at about 150-200 g per capita. B. Agricultural Sector 2.05 Sri Lanka's patterns of agricultural production are extremely diverse, reflecting varied climat..c and topographic conditions. The Wet Zone (i.e. the highlands and the southwestern region) receives both monsoons; the annual rainfall varies from 75 to 200 inches. This Zone covers 25% of the area and contains two-thirds of the area under permanent agriculture. The Dry Zone, the northern and eastern 75% of the island, receives 35-75 inches of rainfall mostly during the four-month November-February period. Rainfed crop growth is severely limited during most of the other months (Map). 2.06 Of a total land area of 16 million acres, only one-fourth is under permanent agriculture; most of the remainder is forest or bush, natural grassland and scrub. Tree crops, mostly tea, rubber and coconut, are grown on both estates and smallholdings and cover nearly 60% of the permanent cultivated area. Rice accounts for 30% of the cultivated area and, along with a great diversity of other crops as well as livestock, is produced mainly on peasant smallholdings. Farm sizes are generally small: of nearly 1.2 million total land holdings at the 1962 Census, only about 6,000 were larger than the 50 acre maximum subsequently imposed by 1972 land reform legislation and 85% were smaller than 5 acres (Annex 1, Table 4). Livestock and Milk Production 2.07 Cattle and buffaloes, numbering 1.6 and 0.7 million respectively, are the most important farm animals. Most herds are very small, with the animals kept primarily for draught and milk on widely dispersed smallholdings throughout the island. About 90 million lb of beef (mostly by-product), 20 million lb of other meat (chiefly pork and poultry), and 225 million pints of milk (bevond that fed to calves) were produced in 1972, accounting in total for about 7% of the gross value of agricultural production. Consump- tion of livestock products is low, averaging about 7 lb of beef, 1.5 lb of  - 3 - other meats and 29 pints 1/ of milk (of which 12 plnts were imported) per capita in 1972. Including eggs and milk, all livestock products combined account for only 6% of all food protein consumed. 2.08 Total livestock output lhas increased since 1960 at an average rate of about 4% annually. Growth was confined to the early 1960's, however, and slaughter of all types of farm animals has increased since 1965 leading to a considerable decline in cattle and buffalo numbers. 2.09 With only 40% of the total cattle numbers, the Wet Zone has great potential for dairy development. Conditions for pasture growth are such that it is possible to produce milk on a year round basis. Most cows in this area produce up to 10 pints per day during a 160-day lactation period compared with 2-3 pints in the Dry Zone. Basic information on pasture development in the two main milk producing sub-zones in the Wet Zone (the Coconut Triangle and the Mid-Country) is available. The potential for increasing production from these sub zones is considerable, both through the application of known pasture technology and the greater use of crossbred and purebred European dairy breeds. By contrast, pasture management technology has yet to be proven in the Dry Zone. Animal Health 2.10 Sri Lanka is free of rinderpe;t. Foot and mouth disease, hemorrhagic septicemia, black quarter and anthrax are prevalent but are effectively con- trolled through disease control programs (Annex 1). Foot and mouth disease ordinarily causes only a temporary reduction in performance. Hemorrhagic septicemia is normally fatal unless animals are vaccinated at six month in- tervals. Piroplasmosis and anaplasmosis do not affect indigenous cattle, but all importations require preimmunization. Internal parasites can be controlled by drenching. Leeches attack grazing cattle on pastures above 1,200 feet elevation and cattle are customarily housed to prevent reduction in milk production. Calf mortality is a serious problem in the Mid and Up- Country where calves are normally separated from their mothers after birth, suffer from malnutrition and are made more vulnerable to disease. A pilot project to develop techniques for collective calf rearing is proposed (para 4.12). C. Milk Marketing and Processing 2.11 About 75% of the milk produced domestically for sale is marketed locally either directly or more commonly through middlemen who pay the farmer 35-40/pint. The remaining 25% is sold through the Government-owned National Milk Board (NMB) which processes and markets mainly in the larger population areas. 1/ Liquid milk equivalent of all milk products consumed.  - 4 - 2.12 The role of NMB. The NMB is the biggest milk marketing organiza- tion in Sri Lanka and the only one with processing facilities. However, until May 1973 when the procurement price was increased from 40i to 60i per pint, the Board had great difficulty in obtaining regular supplies. Today more farmers are selling regularly to NMB through their cooperatives and its supply position is improving. However, many potential suppliers are unable to sell to NMB because of inadequate collection facilities. 2.13 Currently NMB has about 30 milk collection centers throughout the island with another 20 coming up by 1974. Processing capacity in NMB's five plants is now 281 million pints/year with the recent commissioning of a milk powder factory at Ambewela and a heat treatment plant at Colombo in 1973. At maximum operating capacity NMB could process nearly six times the quantity of milk collected in 1972. 2.14 Since late 1972, NMB has purchased milk almost exclusively from cooperative societies which collect milk from farmers and deliver it to NMB collection centers (para 2.20). NMB pays cooperatives monthly for whole milk delivered; cooperatives pay their suppliers one or two days later, after deducting a collection charge which by recent cabinet directive cannot exceed 5 cents 1/ per pint. Previously, collection charges ranged up to 11 cents. 2.15 NMI's financial structure, management and operating performance are presently weak (Annex 2). NMB's price policy is rigidly controlled by Government. The procurement price for;4% butterfat milk, which averaged 40 cents per pint (extremely low by international standards) over 1970-72, was increased to 60 cents in May 1973. Consumer prices of NMB milk products, which historically have been set below cost, were increased by 20-85% in May 1973, but the price of NMB's two major products, powder and condensed milk, were reduced a few days later, due to public protest and political pressure, to a point above their previous level but below cost (Annex 2 and paras 5.07-5.08). D. Development Support Services Research, Extension and Education 2.16 The Animal Production antd Health Division (APHD) of the Department of Agriculture and Lands (Ministry of Agriculture) has primary responsibility or p,licy formulation, research, veterinary and extension services in the livestock sector. With 92 veterinarians filling most key positions on its total staff of 500, animal health has been given more emphasis in programs and services than has animal production, particularly with respect to extension services. 2.17 Pasture and forage research is conducted at Government farms (para 2.19), the University of Ceylon, the Coconut Research Institute and 1; Sri Lanka cent, equivalent to Rs 0.01.  - 5 - the Agricultural Research Station at Maha Illupallama. Pasture species adapted to conditions in the proposed Project areas have been proven and planting materials are produced and sold by both Government and private nurseries. 2.18 Four year B.Sc (Agriculture) and B.V.Sc degree courses at the University of Ceylon have produced 30-40 graduates per year; admissions have now been increased to 100 annually. A two-year animal husbandry diploma course at the Kundesale School )f Agriculture graduates about 100 per year, most of whom join the Department of Agriculture as inspectors, and two to six-month training courses in animal husbandry are offered on Government farms and at the APHD Training Institute at Peradeniya. While numbers of graduates are adequate to meet the manpower requirements for the Government services concerned, it is anticipated that further training of personnel to staff the proposed project will be required and conducted by the Project Technical Unit (para 4.03). Government Farms 2.19 Three Government farms maintain herds of improved dairy cattle for research and training, multiplication and sale of bulls and heifers to private farmers, and for milk production to supply nearby NMB milk processing plants. The farms alsc serve as quarantine stations for large scale imports of cattle. More emphasis has been placed on milk production than on the other service functions (Annex 1). Agricultural Cooperatives 2.20 The cooperative structure in Sri Lanka, at the primary level, consists of 368 large sized Multipurpose Cooperative Societies (MPCSs), most of whose main activity has beeti to run consumer stores, and a number of specialized societies including 29 Dairy Cooperative Societies (DCS) and seven coconut producers' cooperatives. Two major changes significant to the proposed Project have occurred in the functions of the MPCSs following completion of a drastic reorganization in 1971 (Annex 5). They, along with DCSs, have taken a much more active and generally efficient role in collect- ing milk for NMB (from 5% of NMB purchases in 1969 to 65% in 1973); further increases are expected and encouraged by NMB. Second, a program to estab- lish Cooperative Rural Banks (CRBs) within the MPCSs has been actively pursued, with CRBs increasing from 20 in 1967 to 350 in April, 1974. Estab- lishment of CRBs in nearly all of the 368 MPCSs (152 in the proposed Project areas) by the end of 1974 is planned; each with deposit and agricultural lending facilities and with access to Peoples Bank for banking advances (para 2.22 and Chapter IV). Details of the perfortiance of the Banks are given in Annex 6. Banking and Agricultural Credit 2.21 The commercial banking system in Sri Lanka consists of four local banks and eight foreign banks. The former account for 77% of the deposits of all banks and of these, the Bank of Ceylon and the Peoples Bank are the largest, each with deposits of about Re 1 billion. Some 10% of the advances  by the! Bank of Ceylon are for agriculture, mostly to the larger tea and rubber estates. Of the advances by the Peoples Bank, 20% are for agricul- ture, mainly to coconut farmers and cooperatives. The Bank of Ceylon, set up in 1938, is now fully state-owned, while Government and Cooperatives share about equally in ownership of the Peoples Bank. The Central Bank of Ceylon, which exercises supervisory powers over all banks in the country, provides rediscount facilities to banks from its general funds for short-term advances, and from its Medium and Long-term Fund for long-term (up to 15 years) advances. Interest rates vary from 8 to 12% for agricultural advances depending on collateral offered and period of the loan. 2.22 Two significant developments in banking and agricultural credit are in process. First, under the Agricultural Productivity Act of 1972 (Annex 4), over 400 Agricultural Productivity Centers (APCs) will be built (150 open at April 1, 1974), each to include a branch or sub-branch of the Bank of Ceylon. Bank of Ceylon is pressing the branch establishment program, consistent with a policy decision to participate more actively in small- holder farmer financing. Second, a network of CRBs is being established by cooperatives with support of Peoples Bank. Plans are for about 90 Bank of Ceylon branches (or sub-branches) and 100 CRBs to be operative in the proposed Project areas (in which both banking systems are expected to parti- cipate as on-lenders) by the end of 1974. This rapid expansion is straining the supply of experienced management, particularly at local (branch/CRB) level, and both banking systems are recruiting and expanding their management training programs. Bilateral and Multilateral Support 2.23 The proposed project was designed with the benefit of the ex- perience gained under the UNDP/FA0 Project (CEY 22 "Agricultural Diversifica- tion of Uneconomic Tea and Rubber Lands") which is identifying alternative land uses including the development of improved pastures in the Mid-Country. 2.24 Dairy development is aided by various assistance programs, many of which are a part of the International Scheme for Coordination in Dairy Development (ISCDD) initiated by FAO in 1969/70. Bilateral aid includes a pledge of US$2.1 million from Sweden (SIDA) for artificial insemination, vaccine production and veterinary services; technical milk processing assistance and a soft loan for heifer imports from Denmark; US$0.2 million for pasture development fertilizer from Federal Republic of Germany; US$0.3 million an- nually from Australia for veterinary equipment and services; and in addition the United Kingdom has indicated it would probably consider favorably a request to finance a consultancy study of milk collection and transport for MMB (para 4.10). III. THE PROJECT AREAS 3.01 The proposed project would be located in the Wet Zone where con- ditions for dairy farming are most favorable. It would be concentrated in the two existing main milk producing sub zones --the Coconut Triangle and the Mid Country. The Coconut Triangle is located along the South West Coast  - 7 - with genexally flat terrain at elevations below 1,500 feet. The Mid Country sub zone is located to the east of the Coconut Triangle between 1,000 and 3,000 feet. The terrain is generally hilly. 3.02 Coconut Triangle. The population of the Coconut Triangle is about 4.3 million, including the city of Colombo. About 20% of the country's cattle and 33% of its buffaloes are located in the Coconut Triangle where they are used traditionally for coconut harvesting and transport purposes. They are grazed under the coconut trees by day and housed and fed cut forage by night. Traditionally, milk is produced for home consumption. Any surplus is sold either fresh or as ghee. Average yields from local dairy stock and their crosses with Indian dairy bulls are about 1,200 pints per lactation. 3.03 Most of the area is well served with all-weather roads and almost all the settlements have electricity. NMB has two milk processing plants and seven collection centers in the area; three further centers are under construction. Presently 15 DCS and 107 MPCS are in operation. The area is estimated to have over 18,000 farm holdings of 10 to 50 acres in size. 3.04 Mid-Country The population of the Mid-Country is about 1.6 million. In this area, the Government is encouraging the replacement of marginal tea and rubber with more profitable and reliable forms of production. Milk pro- duction is an attractive alternative. The area has about 7% of the island's cattle and buffaloes. Most farmers own cattle, almost all of which are up- graded crosses of native and Indian breeds stallfed on fresh indigenous roughage and home-mixed concentrate, and produce an average of 2,400 pints per 250 day lactation. The temperate climate is suitable for European breeds of cattle when they are given shelter against the heavy rains and external parasites. 3.05 The area is well served with narrow but mostly sealed all-weather roads. NMB has one milk processing plant and two collection centers in the area; eight further centers are under construction. Six DCS and 45 MPCS are in operation. The area is estimated to contain 12,000 farms of 5-10 acres and 4,200 of 10-50 acres in size. IV. THE PROJECT A. Description 4.01 The proposed Project would provide an integrated program for the development of milk production on about 42,000 acres comprising about 2,400 dairy farms in the Wet Zone. It would provide technical support and credit to farmer participants and would ensure adequate support for milk collection and transport and marketing. 4.02 Specifically the following activities would be undertaken: (a) credit and technical serrices for on-farm development including purchase of livestock on about 800 farms of 5-10 acres and 400  farms of 40-50 acres in the Coconut Triangle and about 1,000 farms of 5-10 acres and 200 farms of 40-50 acres in the Mid Country; (b) supply and installation of equipment for the expansion and improvement of milk collection and transport services allowing NMB to handle the incremental production expected from the project; (c) credit to MPCS and DCS for the construction or improvement of facilities to house milk collection equipment; (d) establishment of a Project Technical Unit within the Ministry of Agriculture, including technical a,isistance to help execute on-farm development and pilot operations; and (e) establishment of pilot units to (i) demonstrate systems of communal calf rearing through the establishment of a pilot unit with a yearly throughput of 500 heads; (ii) develop pasture management systems for increasing milk production in the Dry Zone using existing government land and livestock in the region. B. Detailed Features Dairy Farm Development 4.03 Approximately 2,400 dairy farms would be developed by farmers selected in the Coconut Triangle and the Mid-Country. This is expected to involve about 42,000 acres of which about 14,000 acres in the Mid-Country is at present under sub-marginal tea or rubber production. An essential feature of the development plans in both areas would be the use of improved dairy cattle to increase herd sizes and production. These would be procured from local sources within and outside the project areas and through direct importation. Credit would also be provided for land clearing (in the Mid- Country), pasture establishment, buildings, fences, water supply and small dairy equipment (details in Annexes 1 and 7). 4.04 In the Coconut Triangle, improved pastures and fodder grasses would he pltnted to replace natural growth under coconut palms and domestically- procured high grade heifers would be purchased which, over a period of herd build-up, would replace indigenous cattle with crossbreds and increase average yield from the present 1,200 pints to 3,000 pints per lactation. Based on the experience of NMB'and the Animal Production and Health Division (APHD) it is estimated that development would take place on about 400 farms of up to 50 acres in size and 800 smallholder farms of around 10 acres. Investments would be phased over three years and total about US$94 per acre for the 50 acre holdings, and about US$80 per acre over two years for the 10 acre farms.  4.05 In the Mid-Country about one-half of the 1,200 farmers expected to participate are now located on marginal tea and rubber lands. They are maintaining crossbred dairy cattle on indigenous forage cut and carried from wastelands and marginal tea (or rubber) gardens. Under the Project the original crops would be uprooted and replaced with improved fodder grasses. Herd sizes and productiiity would be increased by purchase of pure bred (European type) heifers, half of local origin; half imported. Lactation yields would increase from the present 2,400 to 3,600 pints per lactation. It is estimated that about 200 farms of around 40 acres and 400 of 8 acres in size would participate. Investments, phased over three years, would average about US$185 per acre for the 200 forty acre farms expected to participate. Similar but less intensive investments would be phased over two years on the eight acre holdings and would average about US$106 per acre. These investment costs are higher than in the Coconut Triangle because of the need for land clearing. 4.06 The remaining 600 Mid-Country farms which would participate are smallholdings under traditional mixed tree, shrub and vegetable crops on farms ranging around 5 acres in size. Investments in addition to grass establishment would include purchase of one purebred heifer, shelter, water supply and minor equipment for a total of about US$100 per acre. 4.07 The integration of high producing livestock into mixed farming systems is one of the most desirable forms of diversification from both the nutritional and economic aspects. The proposed investments per acre are comparable with those for dairy development in similar environments in Thailand and Burma where pasture and breed improvement are also the two essential com- ponents. Milk Collection and Transport 4.08 It is expected that NMB would participate under the Project as the main outlet for milk produced by farmer-participants and as a sub-borrower for the purchase of essential imported equipment. However, NMB's finaucial situation is poor and measures for its improvement are to be taken, as set out in para 5.08. 4.09 The existing milk collection and storage facilities of NMB in the Project areas are hardly adequate for present levels of production. Expanded and improved facilities are needed to encourage the production of milk under the Project. Funds would therefore be provided for NMB to purchase storage tanks and chilling equipment for about 70 new milk collection centers, two mobile milk testing units, and for about 15 bulk milk tank trucks to transport milk from collection centers to processing plants. Funds would also be pro- vided to cooperatives for construction or improvement of buildings to house the tanks. Tanks and equipment would be owned by NMB and maintained by the cooperatives which would manage and operate the collection centers. The testing units would be acquired in Project year 1 and the tankers in year 2. Construction of buildings and installation of equipment for collection centers would be phased over years 2 and 3, coordinated with the expected flow of milk from participating farms. These investments will be phased following a special study to be undertaken by consultants to NMB (para 4.10).  - 10 - 4.10 Based upon the estimated increases in milk production resulting from the Project, it is anticipated that about 40 of the new collection centers would be located in the Coconut Triangle and 30 in the Mid-Country. However, their exact number, distribution and specific locations as well as the specification of exact transport routes and procedures would need to be based upon the results of a comprehensive collection/transport study expected to be financed by the Commonwealthi Fund for Technical Cooperation and to be completed by qualified consultants employed by NMB. Terms of reference for the consultants were discussed with NMB and are at Annex 10. Agreement was obtained that NMB would engage these consultants, under terms of reference agreed with the Association, not later than 60 days after Credit effectiveness. Technical Services and Pilot Operatl ons 4.11 Project technical support would be provided under the Project to all farmer participants to help them draw up farm investment plans and supervise their development programs. This would be done through a Project Technical Unit (PTU) (See Chapter V), which would also be responsible for setting up and demonstrating systems of communal calf retaring and of milk production in the Dry Zone. 4.12 Facilities for the pilot calf-rearing unit would be constructed near the Veterinary Research Institute at Peradeniya. The unit would have a capacity of 500 heifer calves per year, to be purchased soon after birth from dairy farmers, reared on purchased feed, and re-sold prior to first calving. Finance would be provided for the :onstruction of buildings and purchase of equipment, and to cover the first two years' operating expenses. First estimates have been made which suggest a capital investment of about US$65,000 and that the unit would be self-sustaining after the second year. Detailed planning would be a first responsibility of the calf rearing specialist to be employed under the Project. 4.13 The pilot operation in the Dry Zone would test the feasibility of increasing the low cattle carrying capacity under traditional Dry Zone land use by developing a ley (rotational) farming system in which feed grains and pulses would be rotated with grass and legume pasture for the production of draught animals and milk. Initial attention would concentrate on identification of suitable field crop rotations and adapted grass and legume species for pastures, utilizing Government lands and cattle for experimentation. Finance would be provided for buildings, land clearing and some levelling, and establishment costs. C. Cost Estimates 4.14 Total Project cost, including participating farmers' incremental working capital (US$0.57 million) required during the on-farm development phase, is estimated at US$12.7 million (Annex 11) including contingencies and taking into account the price rises which followed recent crude oil price increases . In particular fertilizer prices are about 250% of those prevailing  - 1 1 - at appraisal in July 1973. 1/ A physical contingency of 5% has been applied to all items and price contingencies have been added as follows: imported cattle 5% p.a. cif; local cattle, farm deve3opment and technical services 6% p.a.; and equipment, fertilizer and fuel 14% and 11% for 1974-75 and 7.5% for 1976 and thereafter. The estimated foreign exchange component is about US$5.5 million, or about 43% of total Project cost. Details of investment costs and foreign exchange components by major categories are given in Annex 11 and summarized in the following table. Total Project Cost Foreign Category Local Foreign Total Local Foreign Total Exchange --(Rupees Million) -- --(US$ '000)----- Dairy Farm Devel- opment 22.9 17.0 39.9 2,288 1,700 3,988 42 Incremental Working Farm Capital 4.5 - 4.5 450 - 450 - Purchased Livestock 10.8 14.5 25.3 1,081 1,447 2,528 57 Milk Collection & Transport Equipment 5.8 5.5 11.3 575 553 1,128 49 Collection Center Buildings 0.9 0.2 1.1 92 16 108 15 Management, Technical Services & Pilot Units 12.5 4.8 17.4 1,252 481 1,733 28 Subtotal 57.4 42.0 99.4 5,738 4,197 9,935 42 Contingencies: Physical 2.9 2.1 5.0 294 205 499 41 Price 12.2 10.8 23.0 1,219 1,082 2,301 47 Subtotal 15.1 12.9 28.0 1,513 1,287 2,800 46 Total ProJect Cost 72.5 54.9 127.4 7,251 5,484 12,735 43 1/ Reflecting a projected farm gate price for urea of US$225 per m ton.  - 12 - D. Proposed Financing 4.15 The proposed IDA Credit of US$9.0 million would finance about 702 of total Project cost. ApproximateLy US$5.5 million of the Credit would finance the full foreign exchange cimponent and US$3.5 million would finance about 50% of the local currency expenditure. The Project would be financed as follows: (Rs Million) Total Category Farmers Banks Government IDA Amount (Amount)--------- (Amount) (%) Imported Livestock - 1.4 - 17.3 92 18.7 Local Livestock - 1.2 - 10.7 90 11.9 Dairy Farm Development 8.8 3.4 8.8 30.7 60 51.7 Incremental Farm Working Capital - 0.6 - 5.1 90 5.7 Sub-Total 8.8 6.6 8.8 63.8 72 88.0 Milk Collection and Transport Equipment - 8.0 7.7 49 15.7 Collection Center Build- ings 0.1 0.2 - 1.0 80 1.3 Mansnagement, Technical Services & Pilot Units _ - 4.8 17.5 78 22.3 TOTAL 8.9 14.8 13.6 90.0 70 127.3 4.16 Government.would establish a project account with the Central Bank through which the proceeds of the IDA Credit would be channeled. The major part of the Credit ($5.5 million) would be for on-farm development, including purchase of domestic.livestock, and milk collection and transport :-quipment and would be relent by Government to People's Bank and Bank of ,.eylon, which would augment these funds by contributing about $1.5 million of their own resources. Funds for on-farm development would be relent to dairy farmers by both banks: by Bank of Ceylon through its branches and by People's Bank to Cooperative Rural Banks (CRBs) and by CRBs to farmers. Funds for milk collection and transport equipment would be relent by Bank of Ceylon to NMB, and funds for collection center buildings would be relent by People's Bank to the cooperatives (see paras 5.09-5.15 for details of lending terms and operations). The remainder of the Credit ($3.5 million) would be for imported livestock, PTU and pilot operations and would be  - 13 - disbursed through the Ministry of Agriculture, complemented by Government' s contribution of about $0.5 million. Government would also contribute about $0.9 million in the form of pasture development subsidies to participating farmers. Farmers would contribute about $0.9 million in labor, cash and kind toward on-farm development and livestock. Execution of subsidiary loan agreements between the Borrower and People's Bank and Bank of Ceylon, as well as provision of acceptable forms of lending agreements between these banks, CRBs, NMB, farmers and cooperatives, would be conditions of Credit effectiveness. E. Procurement 4.17 Contracts with an estimated value of about US$0.6 million net of contingencies would be let under international competitive bidding, in accordance with IDA guidelines, for the purchase of milk storage and transport equipment and mobile testing units which would have to be imported by NMB. Tenders would require the suppliers of milk storage equipment to supervise its installation. Specifications for milk storage and transport equipment, the timetEble for phasing its purchase and installation and the determination of sites for the installation of storage equipment would be set by NMB in accordance with the findings of the milk storage and transport study to be completed by consultants (para 4.10), and would be subject to IDA approv- al. Agreement on these provisions was obtained. 4.18 Approximately 13,600 dairy heifers costing about US$2.5 million net of contingencies would be purchased. Of these, about 3,200 costing US$1.4 million would be imported; 4,000, costing about US$0.5 million, would be purchased from existing Government herds; and 6,400, costing about US$0.7 million, would be purchased from privately-owned herds. All purchase of dairy heifers would be subject to the supervision and approval of the PTU Project Director and, during the first three years, the Technical Director, for quality and suitability of stock. Purchase of imported heifers from outside Sri Lanka would be organized by PTU. Because of the wide variations in breeds, types and adaptability of animals available, and the disease situation in supplying countries, proposals would be obtained from at least three countries free from foot and mouth disease, that can supply heifers of the type required, in accordance with procedures acceptable to IDA. This was agreed during negotiations. The allocation and sale of heifers and young cattle from existing Government herds to Project participants would be carried out by PTU as would the organization of local cattle auctions in the Mid and Up-Country through which sales of privately-owned cattle of suitable breeding to farmer participants in the Project would be conducted. 4.19 Orders for the 19 four wheel drive'vehicles and 90 motorcycles required by the PTU would total less than US$200,000 and be of a piecemeal nature since they would have to be coordinated with the needs of the PTU technical staff which would be built up and trained under a gradually expanding program phased over 3 years to meet increasing demands of the Project. There- fore international competitive bidding would not be appropriate and procurement  - 14 - would be by local competitive bidding. Most major manufactures of imported vehicles are represented in Sri Lanka and are competitive and offer satis- factory follow-up service facilities. PTU wiwuld incur additional costs of about US$0.4 million in direct expenditures on technical assistance salaries and vehicle operations. Pasture planting materials, fertilizer, buildings, water supply and other materials required for on-farm development, costing in total about US$5.3 million, would be obtained by farmers and PTU through local suppliers and contractors. These goods and services would be procured piecemeal over 5 years and could not reasonably be bulked to allow for competitive bidding. However, they are readily available locally and there is keen competition between suppliers in the Project areas. Erection of the collection center buildings, which will be widely dispersed and of simple construction, would be carried out mainly by cooperative members. Any minor contracts required would be negotiated with domestic contractors. F. Disbursement 4.20 The IDA Credit would be used to finance (a) the cif cost of dairy heifers and of milk storage, collection and transport equipment imported specifically for the Project; (b) 90% of sub-loan disbursements to partici- pating farmers on new on-farm development investments approved under the Project including working capital and local cattle but excluding imported cattle; (c) 90% of sub-loan disbursements to participating cooperatives for collection center buildings aplproved under the project; (d) the cif cost of vehicles for the PTU; (e) 100% of the foreign exchange costs of technical specialists and calf rearing and dry land pilot operations; and (f) 80% of all other PTU expenditures on management, technical services and pilot units except for purchases of vehicles. Disbursement requests would be supported by the usual documents. Disbursements against sub-loans would be made on the basis of a statement of expenditures certified by the Central Bank and participating banks. Detailed supporting documentation for local expenditures would not be submitted for review, but would be retained by the Borrower and be available for inspection by the Association during the course of project supervision. 4.21 Disbursement of the Credit would be over five years. The phasing of disbursements for each major investment category and the forecast of estimated disbursements on a quarterly basis are shown in Annex 12. G. Reportlng and Auditing 4.22 Government would maintain a Special Project Account with separate accounts for the several components of the Project, i.e., dairy farm loans, imported livestock, purchased local livestock, milk collection and transport equipment, and PTU (management, technical services and pilot units). It would submit quarterly reports to IDA within 30 days of the close of the quarter. Within six months of the close of the fiscal year IDA would also  - 15 - require annual audited statements covering the Special Project Account, the entire operations of NMB and the Project-related accounts of Bank of Ceylon and Peoples Bank by independent auditors acceptable to the Association. Agreement on these procedures was obtained. V. ORGANIZATION AND MANAGEMENT A. Administration 5.01 Responsibility for overall coordination of the various agency activities related to the Project would be vested in a Project Committee to be appointed by Government under the Chairmanship of the Ministry of Planning and Economic Affairs and to include representation from the Ministry of Agriculture (including the APHD), the Ministry of Finance, the Commissioner of Cooperatives, Peoples Bank, the Bank of Ceylon and NMB. It would be a condition of effectiveness that the Project Comnittee has been established. 5.02 The PTU would be set up specifically for the purpose of the Project, and its establishment would be a condition of effectiveness of the Project. It would be responsible for the execution of on-farm development, livestock procurement and the technical services components of the project including pilot demonstration operations. It would be established as an autonomous unit within the APHD under a Project Director who would report directly to the Deputy Director of Agriculture in charge of APHD. Milk collection and transport components would be executed by NMB. Coordination of these activities with the on-farm development program under PTU would come through the existing APHD representation on the NMB board and also the Project committee. B. Management and Technical Services Project Technical Unit 5.03 The full-time Project Director would be recruited locally. He would probably be drawn from the existing cadre of senior members of the APHD and would be an experienced administrator in livestock development services. It was agreed that the PTU would at all times be headed by a competent Project Director whose qualifications and experience shall be satisfactory to the Government and IDA and that his appointment would be a condition of effective- ness. He would be assisted by an internationally recruited Technical Director who would be experienced in dairy farm development and the management of pastures under tropical conditions. The Technical Director would be responsible for training the technical staff of the PTU and participating banks, particularly in preparation and approval of farm plans, and for the approval of farm plans submitted by farmers for financing under the Project.  - 16 - 5.04 Two additional specialists would be recruited and attached to the PTU staff as follows: (a) a livestock specialist responsible for planning and operation of the calf-raising pilot operation. He would also participate in the livestock aspects of farm development planning and appraisal and PTU staff training; and (b) a tropical crops and pasture specialist responsible for determining and training PTU staff in the most suitable kinds of pasture/fodder crops, production methods and seed multiplication on Project farms. He would also plan and conduct the Dry Zone rotational farming/milk .roduction pilot operation and participate in the technical aspects of a farm development planning and appraisal. 5.05 The Technical Director and two specialists would be recruited in- ternationally on terms and conditions satisfactory to IDA and agreement on these points was obtained. Proposed terms of reference are at Annex 9. The appointment of the Technical Director would be a condition of effectiveness and that the two specialists would be appointed within 6 months of signing of the Credit. Other PTU) staff would be selected largely from members of the APHD with experience in dairy development in the Project areas. Staff requirements are shown at Annex 8. 5.06 To ensure close contact with the farming community and success in promotion of the Project, the PTU would be decentralized with its head office located at Peradeniya (which is the HQ of APHD and where suitable accomodations are available) and branch offices located at the existing APHD Livestock Offices in Nawalapitiya, Kurunegala and Welisara. National Milk Board 5.07 Since its formation in 1954, NMB has, with the exception of small trading profits in 1970 and 1971, operated unprofitably with losses covered annually (only partially in 1972) by Government. With the May 1973 price increases, profits of Rs 19 million were projected for 1973 but at the sub- sequently reduced (and present) prices, losses of up to Rs 11 million may be expected for the year. Further, at present prices and with or without the proposed Project, NMB future losses would likely be even greater (see Annex 2). 5.08 Strengthening of NMB's financial management and restoration of the organization to a sound financial position through, inter alia, revision of its pricing structure are essential to its effective participation in the Project. NMB intends to recruit a competent finance manager empowered to achieve these goals, and appointment of a person whose qualifications and experience are satisfactory to IDA would be a condition of effectiveness. In addition, it has been agreed that:  - 17 - (a) Government would take all measures necessary to ensure the financial viability of NMB and to enable NMB to realize, by the end of its fiscal year 1977, and maintain a rate of return of 8% on NMB's total capital employed. These objec- tives could be attained initially if the schedule of milk and milk product price increases introduced by Government on May 26, 1973 but subsequently retracted, were re-established fully by January 1976 (see Annex 2, Table 4) with necessary adjustments for inflation; and (b) Government would provide NMB with the funds necessary to enable NMB, not later than December 31, 1975, to write off all its losses accumulated up to December 31, 1974, such funds to be used by NMB to reduce its current liabilities. C. Lending Operations 5.09 Sub-borrowers under the Project would be NMB, Cooperatives and about 2,400 farmers approved by PTU. Initially the farmers in those areas nearest the main chilling and collection centers and with established banking services would be brought into the Project. After the PTU and Bank staffs have been trained and had experience in these operations they will move to more isolated areas. Both the Bank of Ceylon, through its branches, and Peoples Bank, through CRBs would serve as on-lenders of Project funds for dairy farm development. In addition, Bank of Ceylon would serve as on-lender to NMB, and Peoples Bank would on-lend to cooperatives for construction of buildings to house milk collection equipment. Both Bank of Ceylon and Peoples Bank recruit and conduct training programs designed to provide competent managers for the 90 branches and 100 CRBs scheduled to be operative in the Project areas by end-1974. Government has undertaken to ensure the establish- ment of these banking facilities as well as any additional facilities neces- sary to carry out the project. Procedures 5.10 Dairy Farm Development Loans. The PTU technicians would collaborate with the participating banks and MPCS in the Project areas in the initial promotion of the project. This is considered an essential prerequisite to success, since many farmers lack familiarity with improved livestock and pasture management. However, the limited experience to date in the project areas has shown that farmer interest in dairy development credit can be fos- tered with good promotion and advice. Farmer applications for development credit (including purchase of cattle), would be submitted either to one of the participating banks or to a PTU farm planning technician located in the Project areas. Proceeding concurrently, the Bank would initiate investigation of the applicant's creditworthiness and, if need be, title to property offered for mortgage; the PTU technician, in cooperation with the applicant, would prepare a farm development plan for submission to the PTU Technical Director  - 18 - (or his appointed representative) for approval which would be based on lend- ing criteria as set forth in Annex 6, Appendix 1 and contingent upon assur- ance that timely payment would be made by Government to the applicant of the appropriate pasture development subsidy (para 6.08). Upon receipt of the approved development plan from PTU the participating bank, with power of approval limited to the applicant's creditworthiness, would secure mortgage of property, obtain an assignment from the borrower on his sales of milk and proceed with execution and disbursement of the loan. 5.11 Equipment and Building Loans. After receiving IDA approval of specifications and bids, NMB would apply to the Bank of Ceylon for loans to finance the purchase of imported milk storage, transport and testing equipment. Cooperatives would apply to Peoples Bank for loans to finance buildings to house collection center equipment. 5.12 Relending Terms. Relending terms for IDA funds from Government to Bank of Ceylon and People's Bank would be at 6% for 12 years. Bank of Ceylon wiould relend to farmers at 10% for 12 years and to NMB at 8% for 10 years. 1eople's Bank would relend part of its proceeds to CRBs at 7-1/2% for 12 years and the CRBs would relend to farmers at 10% for 12 years. People's Bank would relend the remainder of its proceeds to cooperatives (MPCS and DCS) at 8% for 12 years. All relending terms include a grace period of three years, These terms are consistent with prevailing terms for similar loans in Sri Lanka. The interest spreads would be sufficient to cover administra- tive costs and credit risks. Agreement has been reached that the above interest rates may be increased to reflect future increases in the interest rates charged by banking institutions in Sri Lanka on loans for agricultural purposes. VI. MARKETING, PRICES, SUBSIDIES AND PRODUCER BENEFITS A. Marketing and Prices 6o01 NMB marketed about 215 million pints of milk equivalent in 1972, equal to about half the country's consumption. About 160 million pints of this was reconstituted from imported milk powder while about 55 million pints of raw milk was collected locally and sold as processed milk. The balance of the domestic production of about 170 million pints was sold by producers oither directly or through collection agents to local rural customers. 6.02 The demand for milk and milk products has invariably exceeded supply over recent years. Although consumer prices have been controlled at levels that have stimulated demand, domestic production has stagnated due mainly to controls on producer prices which, up to recently, offered no in- centive for commercial milk production. In addition, Government has re- stricted importation of milk powder. Over the next decade, Government plans to increase domestic production by 4-5% per year through a package of higher  - 19 - producer prices, subsidies and improved technical services. However, this increase, if realized, will barely keep pace with increasing demand which Government estimates will increase by 5% per year. The Project incremental production of 43 million pints annually would have a significant impact in reducing import requirements. 6.03 Prices paid to most milk producers did not increase between 1960 and 1972 and, in fact, actually fell in the Mid and Up-Country. However, NMB raised its procurement price from 40 to 60 cents/pint (55 cents/pint net of collection charge) in May, 1973. Many small producers, having only three to six pints to sell daily, are outside NMB's existing collection system and get 30-35 cents/pint from middlemen. In some production areas raw milk can be retailed directly by producers at 50-55 cents/pint but most producers now appear to turn readily to the NMB channel when accessible. However, with the recent increase in fertilizer prices the financial benefits to the farm- ers have been so reduced that unless procurement prices are increased there will be little incentive for investment in dairy farming. At current costs and prices the milk procurement price would need to be increased gradually from 60 to about 75 cents per pint by January 1977 in order to guarantee farmer interest. Agreement has therefore been reached that Government and NMB would keep milk procurement prices continually under review, adjust prices whenever necessary to ensure that production incentives for dairy farmers are maintained, and consult with IDA semi-annually on the suitability of the production incentives. 6.04 Consumer milk price structure tends to follow NMB's pricing since NMB supplies half of the market. NMB's price structure is set by Government, and reflects the long-standing national policy of consumer (estecially foodstuffs) subsidization (Annex 3). Thus liquid milk, which is almost exclusively consumed by the more affluent urban consumers, is priced relatively higher than powder which, because of its keeping quality, is consumed by the urban and rural poor. However, neither product is sold at prices that cover all costs. Powder, which at present world prices costs about 92 cents/pint equivalent to import and repack, is sold at 77 cents. The price of 91 cents/pint received by NMB for liquid milk covers direct costs but results in a substantial net loss when overheads and depreciation are deducted. 6.05 Consumer prices of milk products were adjusted upwards by from 77% to 90% on May 26, 1973 but, due to public reaction and political pres- sures, prices of powder and condensed milk were brought back close to their previous levels and below NMB's costs. The Project requires Government to adjust milk prices and/or take such other actions as may be required to ensure NMB's financial viability as specified in paras 5.08 and 8.01 (c). 6.06 With lagging domestic production of beef and imports restricted to hotel requirements, retail prices for beef have increased more rapidly than those of other foodstuffs. Retail prices per pound range upwards from the controlled price of Rs 1.75 in Government shops to Rs 2.40 in unregulated private butcher stalls. To market animals legally for slaughter (through  - 20 - Government shops) proof of registration and ownership is required. However, most producers do not register their animals, hence must sell to middlemen who arrange for the necessary documents, act as wholesalers, control supplies and set producer prices at low (Rs 0.30-0.40/lb liveweight) levels. However, the Project animals would all be registered under the Animals Regulations Act and surplus males or cull females could therefore be sold into the domestic market for beef at reasonable prices. 6.07 Surplus dairy heifers are traded at about Rs 600 to 1,300 per head, depending on quality, with the prices - particularly for low producing cat- tle - reflecting beef prices. Prices of imported purebred dairy cattle to farmers are subsidized at f.o.b. cost in country of origin -- about Rs 1,300 per head for heifers, and comparable purebred heifers from Government farms are priced at the same level. Because of the unattractive producer prices for milk and unorganized marketing, there has been, until recently, a lack of enthusiasm for dairy operations. However, the incentives offered under the Project should correct this situation and Project output of surplus breeding heifers which would be available in number from about 1980 should find a ready market. An increased supply of quality stock will be essential to meet the Government plans for expanded milk production. B. Subsidies Producer Subsidies 6.08 Four direct input subsidy schemes are available to dairy producers in the proposed Project areas. These are described in detail in Annex 3 and summarized as follows: (a) Rs 500 per acre for pasture establishment in the Mid-Country (for diversification from tea and rubber); (b) Rs 120 per acre for establishrent of improved pastures under coconut palms; (c) 50% subsidy on pasture fertilizer cost after establishment of pasture in (b); and (d) pricing of imported cattle to dairy producers at f.o.b. cost in country of origin. 6.09 The pasture development subsidies serve as an incentive to farmers to shift from traditional land uses and farming practices to the different uses and more sophisticated technologies required under the Project. They are consistent with Government's goal of increased production of food crops and livestock products. Similarly, the subsidy on imported dairy cattle is an incentive for farmers to change from their low producing native  - 21 - breeds to proven high producing dairy breeds and consistent with goverment policy for a rapid build up of a high producing dairy herd. As new technology developed by the project becomes widespread, increasing the availability of high quality dairy cattle, and milk procurement prices rise gradually (para 6.03) the need for these subsidies will disappear. C. Producer Benefits 6.10 Parmers participating in the Project are expected to benefit from higher net incomes at full development. During appraisal it was es- timated that the 600 smallest farmers, (five acres in the Mid-Country) would double their incomes (from Rs 700 to Rs 1,400) at year seven, with an in- crease again to 2,400 after debt retirement in year nine. Similar financial benefits would also accrue to the estimated 1,200 small farmers in the Mid- Country and Coconut Triangle with 8-10 acres. In the case of the 600 larger 'farmers with 40-50 acres their net incomes currently derived from dairying are mLrginal and would increase under the Project to about Rs 5,000 to Rs 9,500 at full development in year 7. The financial benefits from these investment models are detailed in Annex 7 and show financial rates of return of 18% to 26%. The time required to reach full development ranges from 6 to 8 years. Although no substantial cash incomes are generated until years five to six for large and small farmers in the Coconut Triangle and the larger farms in the Mid Country, experience has shown that many farmers in the area are willing to forego higher initial incomes and rely on existing sources provided they can see that their investments will eventually result in considerable improvement of their income and nutritional levels. 6.11 With fertilizer prices adjusted to reflect a projected farm gate price for urea of US$225 per ton, the rates of return at the present producer price for milk range from 7% to 11%. Phased increases of Rs 0.05 per pint per year 1975-77 (total increase Rs 0.15) in the producer price of milk would bring the rate of return into the 15 to 19% range. For this reason agreement has been reached that Government and NMB would keep milk procurement prices continually under review and adjust the prices whenever necessary to maintain producer incentives (para 6.03). VII. ECONOMIC BENEFITS AND JUSTIFICATION 7.01 The Project would assist Sri Lanka in the development of its livestock potential and, by substantially increasing domestic milk produc- tion, help conserve scarce foreign exchange resources. At full development, expected in 1981, additional milk production from project farms would be about 43 million pints annually, amounting to about 25% of 1972 imports of dairy products and savings of about US$2.0 million in foreign exchange. In addition, meat production in the form of cull animals from project farms is likely to be 1,250 tons liveweight annually (valued at US$418,000), equivalent to about 3% of domestic production in 1971. Also, the 1,400 head of purebred and 1,350 head of crossbred surplus breeding heifers, together valued at  - 22 - US$780,000, available annually from the project will offset the number of imported stock otherwise needed for a rapid build-up of the national herd. 7.02 Non-quantified but significant benefits would result from the support that the project would provide in the implementation of the Govern- ment's plans relating to milk production. In general terms, it would en- courage the integration of livestock into the farming system and the adop- tion of mixed farming which in turn would have marked effect in improvement of soil fertility and structure. Specifically, the extension and research activities in calf rearing and pasture management would encourage sound animal husbandry and effective pasture management not only on project farms but also in the surrounding areas and improved animal husbandry and pasture technology adapted to Sri Lanka's tropical environment would emerge. In addition, the experience gained in financing development of about 1,800 small farmers of about 5-10 acres under the Project should contribute materially to the improvement and expansion of credit operations for small farmers throughout the Island. 7.03 The Project would also assist the Government in its planned diversification of marginally productive tea operations on 14,000 acres in the Mid-Country. Displacement of about 3,000 tons of present green leaf tea production is expected. The Project would increase the utiliza- tion of family labor and create employment for additional 1,500 full time workers. 7.04 To reflect the shortage of foreign exchange, an average FEEC rate of Rs 10 - US$1 was used in the economic rate of return calculations. Local crossbred animals were valued at the full domestic market prices as was all labor. The value of the lost tea production is taken equal to the cost of its production since mainly only the marginal operations are being sacrificed. All imports for and imports displaced as a result of the Project were valued at international prices. On these assumptions the economic rate of return for the Project has been estimated at 18% (Annex 14). No account was taken of the recent fertilizer price increases in this calculation. When this is included, and assuming no change in commodity prices, the economic rate of return is 15%. To test the Project against changes in investment costs and production results a sensitivity analysis was done. By increasing both investment and operating costs by 20% without changing the operating results, the return to the economy would drop to about 13%. Similarly, by reducing benefits by 20% without changing costs, the rate of return would be 12%. Additional sensitivity tests are given in Annex 14. VIII. AGREEMENTS REACHED AND RECOMMENDATION 8.01 During negotiations, agreement was reached on the following principal points: (a) NMB would employ, not later than 60 days after Credit effectiveness, qualified consultants to carry out, under terms of reference agreed with the Association, a study of milk collection and transport in the Project area  - 23 - '.r-a 4. 0, and specifications for milk storage and transport equipment to be imported by NMB and the sites for the collection centers would be subject to IDA approval (para 4.17); (b) PTU's Technical Director, Crops and Pasture Specialist, and Livestock Specialist would be recruited internationally on terms and conditions satisfactory to IDA, and the two Specialists would be appointed within 6 months after signing of the Credit (para 5.05); (c) Goverament would (i) take all measures necessary to ensure the financial viability of NMB and to enable NMB to realize, by the end of its fiscal year 1977, and maintain a rate of return of 8% on total capital employed and (ii) provide NMB with the funds necessary to enable NMB, not later than December 31, 1975, to write off all its losses accumulated up to December 31, 1974, such funds to be used by NMB to reduce its current liabilities (para 5.08); (d) Government would keep milk procurement prices continually under review and adjust prices when necessary in light of the review to ensure that production incentives for dairy farmers are maintained (para 6.03). 8.02 Agreement was also reached on the following as conditions of credit effectiveness: (a) Subsidiary loan agreements acceptable to IDA between the Borrower and the Bank of Ceylon and the Peoples Bank had been made (para 4.16); (b) acceptable forms of the proposed lending agreements between the participating banks, intermediary institutions and project beneficiaries have been furnished to the Association (para 4.16); (c) establishment of the Project Committee and the PTU (paras 5.01, 5.02) and appointment of the Project Director (para 5.03); (d) appointment of the Technical Director (para 5.05); and (e) appointment of the finance manager by NMB (para 5.08). 8.03 The proposed Project is financially and economically sound and would be suitable for an IDA credit of US$9.0 million.   ANNEX 1 Page 1 SRI LANKA DAIRY DEVELOPMENT PROJECT The Dairy Sub-Sector Livestock In Sri Lanka Agriculture 1. Agriculture plays a major role in the economy of Sri Lanka through its large contribution to GNP, foreign exchange earnings, and government revenue. In 1973 the agricultural sector accounted for nearly 33% of GNP, about 77% of export earnings, and 50% of total employment. While livestock farming has considerable potential it is now of minor economic importance, contributing only about 7% of the gross value of agricultural production. 2. Cattle and buffaloes are the most important farm animals, being widely dispersed on smallholdings and numbering about 1.6 million and 0.7 million, respectively (see Table 1 for livestock numbers). In the paddy and coconut growing areas of the south-west, cattle and buffalo numbers are linked to draught power requirements. In the dry north and east, cattle and buffalo grazing is based on the communal use of natural grass- lands, and their numbers exceed the local requirements for draught power. Most cows are milked after parturition but yields are typically low. In the past some tea estates have used higher yielding European type cattle to supply milk for their laborers. This type of milk production has virtually ceased, the cattle having been transferred to small-holders and estate laborers with milk used largely for home consumption. 3. There is no specialized beef production in Sri Lanka; all beef is the by-products of traditional cattle and buffalo husbandry for draught and milk. Goat and sheep populations are relatively small and located predominantly in the Dry Zone. Pig numbers have remained constant at about 100,000, concentrated in small units on the west coast. Encouraged by gov- ernment programs including the suspension of all imports of poultry products, poultry production increased rapidly in the 1960's. A network of private hatcheries and commercial production units around the consumption centers developed, but a serious setback to the poultry industry occurred in early 1973 when concentrate prices rose to an all-time high due to poor coconut harvests and the continued substantial export of dessicated coconut and of coconut cake (poonac). 4. Livestock output has increased since 1960 by about 4% annually, growth rates being higher in the early 1960'.. Since 1965, slaughter rates of all farm animals have increased and reportedly have caused con- siderable declines in cattle and buffalo numbers. 1972 estimates indicate that the slaughter rate in cattle still exceeds their rate of natural  ANNEX 1 Page 2 increase, but that buffalo numbers are increasing again. Total production of beef (including edible offal) was about 90 million lb in 1971, equivalent to about seven lb per capita per year (see Table 2 for present livestock production). Average consumption of all other meats is estimated at about 1.5 lb per capita per year. Ii 1970, about 220 miilion eggs were produced, corresponding to about 17 eggs per person. It is estimated that at present about 610,OCO pints of milk are available daily for human consumption from local production. This corresponds to about 224 millon pints total production per year and, including 1972 imports of about 160 million pints of fluid milk equivalent, gives an estimated average annual per capita consumption of about 30 pints. All livestock products combined account for only 6% of all food protein consumed in Sri Lanka, less than half as much as fish. Milk Production Production Systems 5. Present conditions and development potential of milk production can best be considered by referring to the different ecological zoues of the island (see Map and Tables 3 and 4). 6. The Dry Zone consists of about 11 million acres. There are about 400,000 individual holdings covering about 1 million acres of irrigable land, 2 million acres used for shifting cultivation (chena), 2 million acres of natural grasslands and 6 million acres of jungle. Most villages derive their subsistence food and income from the production of rice on individually owned lands. The Dry Zone has about 60% of the country's cattle and more than 50% of its buffaloes. Cattle herds average 10-15 head of indigenous stock. All animals are privately owned but collectively grazed during the day on the village or government owned natural ranges and jungle clearings around the villages. About three acres of unimproved rangeland are required per animal but grazing is seasonal and insufficient in quantity and quality during the long dry season from March until October. No concentrates are fed. After calving, most cows are milked; with once a day morning milking they produce 2-3 pints per day over a 160 days lactation: they produce a total of no more than about 500 pints of milk for home con- sumption or for curd production, and feed their calf. 7. NMB has four milk collection centers in the area around Polonnaruwa; only about 5 million pints out of widely dispersed total annual production of about 95 million pints are collected. Although not much of the milk produced in the Dry Zone is available for consumption outside the area, this region provides the rural areas and urban populations of the southwest with large numbers of draught and slaughter cattle. 8. The Coconut TriLangle covers about 1.6 million acres in the southwest of the island. An area of about 1.2 million acres is under coconut palms, 280,000 acres on valley floors are used for paddy production.  ANNEX 1 Page 3 The area has about 20% of the country's cattle population, traditionally used for transport work in coconut harvest, and about one-third of Sri Lanka's buffaloes used for paddy cultivation. 9. Grazing for the cattle is provided by the grasses, mainly Axonopus species, and shrubs which grow under mature coconut trees. On larger farms cattle are grazed free during the day; on smaller holdings they are tethered. All cattle are housed and fed cut forage at night when lactating cows are separated from their calves so that they can be milked next morning. Average yields from indigenous stock and their crosses with Indian dairy bulls (Sahiwal, Red Sindhi, Haryana) are about 1,200 pints per lactation in addition to calf requirements. All cattle have traditionally been given substantial amounts of coconut cake and rice bran and, on average, all nutrients required for the milk produced are derived from the daily average ration of about 6 lb of concentrates per cow. Improved grasses for grazing on larger holdings and for a cut-and-carry system on smaller farms have been planted only receatly to improve the forage supply for cattle. 10. It is estimated that about 36 million pints of milk are produced annually in the Coconut Triangle. Of this, about 6 million pints are delivered to NMB milk collecting centers. So far, most milk delivered to the collecting centers is from larger holdings of about 40-50 acres average, as the owners of smaller farms with one or two lactating cows find it unattractive to bring the small quantities they produce to the collection centers and as very few cooperatives have taken up milk col- lection. 11. The Mid-Country occupies 1.3 million acres in the hill areas between 1,000 and 3,000 feet above sea level. The topography is generally undulating to steep, the flat valley floors being used for paddy pro- duction. Tea is the predominant crop and occupies about 500,000 acres. Paddy and other annual crops are grown on about 130,000 acres, the remainder is taken up in about equal parts by rubber and forest gardening (mixed tree, shrub and vegetable production). The Mid-Country is the area where government policy is to replace marginal tea and rubber with more profitable land uses. This area has at present about 7% of the country's cattle and buffalo populations. 12. Generally, all animals are housed day and night throughout the year and stallfed with 80-100 lb of cut, fresh forage. Panicum maximum grows freely on the edges of roads and fields, and in empty spaces of tea or forest gardens and provides sufficient amounts of fodder throughout the year even for landless cattle owners. Most farmers own cattle, and the typical forest gardener with about five acres of land has fresh fodder collect- ed daily in a radius up to one mile around his property, saving the more easily collected small amounts of fodder which grows on his own lands for festive days. There is competition for free growing fodder. Many tea estates have been subdivided during the last 20 years into holdings of 5-10 acres. Most of these farmers find sufficient fodder for their cattle on their own lands.  ANNEX 1 Page 4 Sowe of the larger, owner-managed tea farms have started to keep dairy cattle in order to make use of those lands which cannot be used for tea and are now under indigenous or planted grasses. Lactating cows received about 5 to 6 lbs. daily of a home-mixed concentrate consisting of poonac and rice bran. Most cattle area of a non-descript type, being crosses between the native stock and Indian dairy breeds and then upgraded to imported European dairy stock. Lactation yields average about 2,400 pints in 250 days. Most cows are milked without their calves at foot. 13. It is estimated that about 41 million pints of milk are produced annually in the Mid-Country. Of this, about 18 million pints are deliv- ered to NMB collection centers. Most of this milk is produced on small- holdings, particularly of the forest garden type, and is collected and sent to the NMB centers through cooperatives. 14. The Up-Country is the area above 3,000 feet occupied, typically by Agency-House-managed tea estates. 1/ There are about 310 tea estates in the Up-Country. Some areas on hill tops are under grass cover (patua), some others have been planted to wattle, pines or are still under virgin forest. The Up-Country has about 6X of Sri Lanka's cattle population. 15. Most cattle in this area are owned in units of one or two cows by estate laborers for the augmentation of family income. European type cattle of Friesian and Ayrshire descent are kept in fully enclosed sheds and fed about 100 lb of indigenous grasses which are cut daily by family members on the waste areas accounting for about 5% of estate lands. On a few estates, centrally managed dairy herds are maintained. Very few pastures have been established so far on Up-Country tea estates. All cattle receive large rations of concentrates; 6-7 lb of a poonac/rice bran mixture would be typical for a lactating cow. Averaga lactation yields are about 2,400 pints, without calf at foot. 16. Total annual milk production in the Up-Country is estimated to be about 38 million pints. Nine-tenths of this is produced by estate laborers and about 24 million pints or 65%, is collected by NNB collecting centers. 17. Southern Wet Zone. There are about 1.6 million acres, not included in the Coconut Triangle and the Mid- and Up-Country, located in the south and southwest of the island at elevations up to 1,500 feet. About 60% of this land is held in smallholdings of less than five acres for rice and tree crop production. Most of the remaining cultivated lands are under plantation crops (rubber). This area has about 8% of the cattle and buffalo populations. 18. Cattle husbandry is generally similar to tnat in the Coconut Triangle, but because of high temperature and rainfall neither European breeds or upgraded cattle perform well. Cattle are mainly kept for 1/ Foreign owned.  ANNEX 1 Page 5 draught and lactating cows are milked once a day but with low production and only one NHB center in the area collecting about 1 million pints annually the bulk of the 14 million pints produced per year is for home consumption and processing into curd. Cattle Breeds and Performances 19. The vast majority of cattle are of the indigenous (Bos indicus) type which thrives well under the local conditions. A number of Indian cattle have been used with limited success to increase the milk production potential and body size of Sinhala cattle. For a long time higher yielding purebred European dairy breds, mostly Friesian, Jersey, Ayrshire and Shorthorn, hav, been used on Up-Country estates. Their offspring and crosses with indigenous cattle have been passed on to the Mid-Country and, to a limited extent, also the Coconut Triangle where they have proven to be higher yield- ing than the indigenous cattle particularly when attention is paid to their nutrition. It is estimated that 90% of all cattle in the Up-Country and 50% in the Mid-Country are of European descent and their crossbreds. Only about 5-10% of cattle in the Coconut Triangle are European crossbred, but their number, particularly from crossing with Jersey bulls, is increasing rapidly. 20. Productivity of all cattle is low and generally less than genetic potential, largely reflecting low levels of nutrition and management. The calving rate approached 50% on a national level and is about 65% in the Mid- and Up-Country. Deficiency and seasonality of feeding are the major cause of reduced fertility. Calf mortality is probably as high as 20% on the more intensively operated dairy farms whereas adult mortality is quite normal at about 5%. Average liveweight of mature Sinhala cattle is 700-800 lb in bulls and 500-600 in cows. First calving occurs at three years of age. Cattle Disease Situation and Calf Mortality 21. Sri Lanka has been free from Rinderpest since 1964. Diseases of major economic importance are haemorrhagic septicaemia, foot-and-mouth disease, black quarter and anthrax. Haemorrhagic septicaemia is normally fatal; it requires vaccination at six-monthly intervals. 0 and C type viruses are the causes of foot-and-mouth disease which normally only causes a temporary reduction in performance. Piroplasmosis and anaplasmosis are present. They do not affect indigenous cattle, but all importations require preimmunization. Internal and external parasites are widespread. Leeches attack grazing cattle on pastures above 1,200 feet elevation, cause considerable loss of milk production through blood loss and disruption of grazing, and necessitate housing of animals. 22. Calf mortality is a serious problem where calves are separated from their dams after birth and not needed for milk let-down in their mothers. This is normally the case in the Mid- and Up-Country, whereas in the Coconut Triangle and Dry Zone calves run with their mothers during the day and get some milk in the morning when they induce milk let-down. Most farmers try to sell all the milk they produce and, in the absence of  ANNEX 1 Page 6 milk replacers, many calves are subjected to malnutrition for a very critical period before they become true ruminants. This malnutrition, often combined with Lo-hygienic and unhealthy stables, predisposes young calves to a series of contagious diseases, like white scours or pneumonia, which then are the final cause of death. Calf mortality is above 20X on many farms and represents a serious loss of valuable animal resources. Forage Productivity 23. This section summarizes information obtained from discussions with private farmers and at various research centers regarding recent experiences with pasture/fodder production in Sri Lanka. 24. To provide cattle regularly with as much low cost energy as possible is the key objective of pasture/fodder species selection. Con- siderable progress has been made during recent years and the following results can be substantiated: (a) In the Up-Country, Kikuyu graiss (Pennisetum clandestinum) grows well throughout the year; with a fertilization of 200 lb of N per acre, one acre can support 1.5 animal units. Nutrient intake is sufficient for maintenance plus three to four pints of milk in lactating cows. (b) In the Mid-Country, Napier grass (Pennisetum purpurem), Guinea A and B (Penicum maximum), Nandi grass (Setaria sphacelata) and various Brachiaria species grow well, With proper fertilization they will remain productive through the short dry seasons. At a fertilization level of 100 lb of N per acre, which seems the pro- bable practice on small holdings, about 1.0 - 1.2 animal units can be maintained per acre. Nutrient intake provides for maintenance requirements plus six to seven pints of milk. (c) In the Coconut Triangle, Brachiaria miliiformis and B. brizantba are the most promising grasses for grazing, and Hybrid Napier or Guinea grasses for cut- and-carry systems. In areas with more than 75 inches of rain, coconut yields will not be depressed if the undergrowing grasses are fertilized with 150 lb of N and 100 lb P205 per acre, plus K20 where required. With average intensity of shade in mature coconut groves, about 1.5 acres and 1.2 acres per animal unit are required under cut-and-carry and under grazing con- ditions, respectively. In both caaes, about four pints of milk can be produced from grass.  ANNEX 1 Page 7 (d) In the Dry Zone Brachiaria miliiformis and B. brizantha and Pangola grass (Digitaria decumbens) grow well. About four acres are required to support one animal unit. Forage conservation is not necessary in spite of the long dry season, if they have access to low lying grass- lands (Villu) which remain productive during the dry season when inundation from the rivers terminates. 25. Little experience is available in Sri Lanka concerning the role of tropical legumes in pastures. They are probably of little value in tall growing grasses uader zero grazing and heavy application of nitrogen, but their role for less intensively managed pastures for grazing animals in the Coconut Triangle and in the Dry Zone has priority for opera- tional field research. Production Support Services Institutional Support 26. The Animal Production and Health Division (APHD) of the Depart- ment of Agriculture and Lands has primary responsibility for policy form- ulation, research, veterinary and extension services in the livestock sector. Its headquarters is in Peradeniya. It is headed by a Deputy Director of the Department of Agriculture, with assistants in charge of the four sectors: government livestock farms, production promotion, animal health and research. APHD has a staff of about 500 of which 92 are quali- fied veterinaries, a few are graduates in agriculture. About 310 of APHD staff is located at village level as agricultural extension workers. Veterinary Services 27. There are about 40 veterinary hospitals and dispensaries spread over the country. Each is under a veterinarian who with his staff carries out the various field programs of the Division (vaccination, castration, etc.). Treatment is carried out free of charge at the hospitals and also at the owner's property against a fee for mileage and services. All veterinarians employed by APED are permitted to practice privately in their own time and to retain the fees earned. Some veterinary hospitals have diagnostic labora- tories. During recent years about 80% of all analyses were of poultry. The veterinary diagnostic services are expected to be strengthened by bilateral support from SIDA during the next year. 28. Vaccines and medicines required for the diagnosis and prevention of contagious diseases are produced in sufficient quantity locally. About 500,000 cattle are vaccinated annually against various diseases. This is done without charge under nationally sponsored program but cattle owners have to pay small fees if vaccinations are carried out at their request.  ANNEX 1 Page 8 Production Extension 29. APHD provides extension services through nine regional livestock offices. As most of these are under veterinary graduates, extension has a strong veterinary bias and insufficient attention is given to crop produc- tion, farm management and other related aspects of livestock production. The nine livestock officers are assisted by about 70 field staff who frequently have gone through several years f in-service training at government livestock farms. The entire livaostock extension service is weak technically and has very little contact with the livestock farmers in the vicinity. This is partly due to a grave shortage of vehicles and travel funds. Recruitment of additional staff, preferably graduates in agriculture, is needed to meet the needs of the proposed Project. A shift in program emphasis to give greater attention to the neglected (non-veterinary) aspects of livestock farm development is also needed and would be facilitated by the Project. Additional training, particularly in pasture/fodder development and the techniques of farm development planning is also provided under the Project. Education and Training 30. Four year courses leading to B.Sc. (Agr.) and B.V.Sc. degrees are provided by the university at Peradeniya. So far graduates in agriculture from this university have not been accepted for employment in the professional category by APHD, although the university is relatively strong in its animal production sector. The School of Agri- culture at Kundesale graduates, after a two year training program, about 100 students each year who become Agricultural Inspectors by joining the Department of Agriculture. Six month training courses for about 40 junior staff of APHD staff and different groups of livestock farmers are given at the Peradeniya In-Service Training Institute with teaching assistance from APHD headquarters staff. A new cattle production in-service training institute is under construction at the government livestock farm near Kegalle. Research 31. The Veterinary Research Institute and government livestock farms carry out research in animal production. Some research is also conducted by the University at Peradeniya, the Coconut Research Institute at Lunuwila and the Agricultural Research Station at Maha Illuppallama. The Veterinary Research Institute at Peradeniya does research in para- sitology, bacteriology, virology, animal breeding, animal nutrition, pastures and fodder production. Adaptable pasture species have been proven for the various agro-climatic zones. The University carries out trials on pasture and forage, fertilizer, yields, and feed value. At Maha Illuppallama several grasses and legumes useful under irrigation have been demonstrated and the Coconut Research Institute has identified and demon- strated pastures suitable under coconut. While a reasonably adequate base of research data relevant to the proposed Project is available, experience  ANNEX I Page 9 In its application at farm level is limited. The project will afford the opportunity to widen this experience particularly in determination of the most suitable varieties and mixtures for forage and fodder, cultural tech- niques inc(luding seeding and fertilization rates, stocking rates and live- stock management systems most suited to the various micro ecological environments within the Project areas. Artificial Insemination (AI) and Bull Distribution 32. AI services were started in 1950 and the number of inseminations increased slowly to about 19,000 in 1971/72. Two bull centers collect semen from 42 dairy bulls and dispatch it thrice weekly by train to the 39 veterinary hospitals from where the inseminations are carried out by assistants on request. Charges are Rs 10 for the first insemination and Rs 5 each for two re-inseminations. The 90-day non return rate is claimed to be about 65%: acceptable for these tropical conditions. The AI center at Kundesale has been selected to become the center of Swedish bilateral assistance, which will also strengthen the use of deep frozen semen. 33. In areas where AI is not feasible, i.e. particularly in remote areas of the Dry Zone, young bulls of improved types are issued to villages or individual farmers under the Bull Calf Exchange Scheme. In this scheme, recipients are expected to return to APHD an equivalent weight of mature, local males and to give an undertaking to castrate all other males in the herds concerned. About 1,500 bulls are issued and 26,000 castrations carried out by APHD field staff annually. Government Farms 34. Three farms, or groups of government farms are of importance to dairy development. Two of these are located in the Up- and Mid-Country and one in the Dry Zone. One additional farm with milk buffaloes is located in the southern Wet Zone. All the three first mentioned farms have NMB processing facilities nearby. 35. All government farms maintain improved dairy stock. Indian dairy cattle and buffaloes are kept at the Polonnaruwa farms in the Dry Zone, and European type dairy breeds at the Kegalle farm in the Mid- Country and the Ambewela farm complex in the Up-Country. Surplus bulls and heifers are sold to private farmers. Farmers apply to APHD for female stock which are normally sold at 12-14 months of age for Rs 600-700 each. APHD receives about 2,000 applications per year. The government farms in the Mid- and Up-Country are at present fully stocked and carry about 2,400 cows; considering actual calving and wastage rates, about 420-500 young females can be sold to the private sector each year. 36. Government farms also serve as quarantine stations for large scale cattle imports. European type imparted heifers are transported at once to the Ambewela farm complex for pre-immunization against tick-borne diseases under strict veterinary supervision.  ANNEX 1 Page 10 Cattle Marketing 37. The marketing of live animals follows traditional lines. No organized cattle markets exist from where draught animals, dairy replace- zunt cattle or stock for slaughter could be collected. Instead, middlmen and their agents visit rural communities at irregular intervals and try to obtain the kind of stock for which they have an outlet. Marketing channels are uncertain and margins excessive. Regular local auctions, with inspection and grading services are badly needed. 38. Marketing of cattle for slaughter is subjected to the Animals Regulations Act of 1968 which requires the registration of all cattle and buffaloes within 18 months of birth and proof of ownership when passed on for slaughter. The act is poorly implemented. It strengthens the bargaining position of the middlemen who normally arrange for the necessary documents. There is also a reluctance for religious reasons to sell ani-als directly for slaughter which further allows the intermediaries to purchase at low prices. Wholesale and retail prices of beef are supposed to be controlled at Re 1.00 and Rs 1.10 per lb carcass weight. Although these prices are not adhered to, they are the basis of price negotiations used by the middlemen. Accordingly, many iroducers obtain only Rs 0.30-0.40 per lb liveweight for beef which then is sold in unregulated butcher stalls for about Rs 2.40 per lb without bones. 39. A Livestock Development Board was established in 1972 within the Department of Agriculture and Lands with the objective, inter alia, to (a) establish a series of slaughterhouses suitable for veterinary inspection and by-product utilization, (b) establish a series of livestock and meat markets, and (c) introduce a beef-grading system. The Board is not yet operational. A Chairman was appointed in early 1972, and a study concerning the location and equipment of the required abattoirs was completed in July 1973 with assistance fromn Denmark. 40. Supply of dairy cattle is organized in two different ways: (a) by approaching APHD and requesting the allocation of surplus stock from government far",- (b) by approaching an intermediary. Due to the low farm gate price of milk until the end of Hay 1973 and very high concentrate prices, demand for dairy cattle has been low during the last year. However, a considerable number of pure-bred or high-grade dairy stock would be required under the envisaged dairy development project and in order to organize the procurement of all locally available cattle of suitable breeding, close cooperation between the project, AfPD and the Livestock Development Board would be essential. With a proper announcement campaign it would be possible to organize dairy cattle sales at regular intervals at the Grama Sevaka Division level. 1/ Milk marketing is described in Annex 2.  ANNEX 1 Page 11 41. It has been estimated that between 420-500 dairy heifers could be released from government livestock farms annually. Assuming that 90% of all cattle in the Up-Country, and 50% of cattle in the Mid-Country are of suitable dairy merit, and accepting the performance parameters used in Table 3, it would appear that about 1,700 three-year old heifers would become available from the private sector. Obviously, it would depend on the effi- ciency of the dairy cattle marketing to be organized, but the number which could become available from local sources would be about 2,100 to 2,200 heifers per year. Feed Supplies and Industry 42. Locally produced coconut cake (poonac) and rice bran are the main ingredients of concentrates in Sri Lanka. About 60,000-70,000 tons of poonac and 30,000 tons of rice bran come on to the market per year. The State Flour Mill produces about 15,000 tons of good quality wheat bran from imported wheat, but this is normally re-exported to earn foreign exchange. Availability of high energy feed grains for the modern pig and poultry sectors is critical. About 10,000 tons of maize are produced now, mainly under shifting cultiv4tion and Rs 3.25 million has been accumulated under a World Food Programme (WFP) poultry feeding project in order to increase the local production of maize. 43. Most milk producers, even the smallholders, mix poonac and rice bran on their own farms. The feed industry consists of two large government mills, the Ceylon Oils and Fats Corporation operating under the Ministry of Industries, and the British Ceylon Trading Corporation operating under the Ministry of Commerce and Trade. Together, the two mills have a single shift capacity of about 100,000 tons per year which is at present utilized to about 50-55%, predominantly for the poultry industry. The bulk of the compounded dairy cattle feeds goes to the government livestock farms. Both mills have facilities for simple chemical analyses. An animal nutritionist from APHD visits the mills twice monthly to assist in ration formulation. 44. Attractive world market prices in 1971/72 led to a sharp increase in the export of dessicated coconut. This, together with a general depres- sion of coconut yields due to drought, resulted in a serious shortage of poonac toward the end of 1972. Local prices of poonac rose from about Rs 350 per ton in early 1972 to Rs 1,000 per ton in November 1972 and effected similar price increases in all other ingredients. Government has banned the export of dessicated coconut and of poonac since early 1973 in an effort to salvage the poultry industry and to halt the decline in milk production. These measures had reduced the price of poonac to Rs 850 per ton in May 1973. It is estimated that the future price of poonac will be about Rs 650-700 per ton, and that adequate supplies will be available.  ANNEX 1 Page 12 Bilateral and Multilateral Support 45. Dairy development in Sri Lanka has been and is being aided by various foreign assistance programs, many of which are part of the International Scheme for Coordination in Dairy Development (ISCDD) initiated by FAO in 1969/70. (a) Sweden has pledged US$2.1 million for the strengthening of artificial insemination services, vaccine production and veterinary diagnostic services. (b) Denmark is providing funds for an expatriate milk plant manager during the running-in period of the Ambelwela spray drying plant and a soft loan for 480 in-calf Jersey heifers to be flown in during September 1973. (c) The Federal Republic of Germany has provided fertilizers at a value of US$200,000 for pasture development and indicated its willingness to consider similar contribu- tions in the future. (d) Australia gives about US$300,000 per year for various veterinary equipment and will provide an expert to develop the techniques of pre-immunization against tick-borne diseases; a gift of dairy heifers is also under consideration. (e) The United K gd is considering financing a con- sultancy study of milk collection and transport. (f) The WorldFood Programme (WFP) sponsors a dairy cattle feed grain project under which, over a five year period, WFP-donated maize will generate a revolving fund of about US$3.1 million. These funds are available to government to finance infrastructural development (in-service training, artificial insemina- tion, milk recording) and pasture development in the Coconut Triangle and the Dry Zone. (g) FAO/UNDP Prolect CEY "Agricultural Diversification of Uneconomic Tea and Rubber Lands" is engaged in deter- mining the extent to which diversification should be pursued and the types of alternative land uses to be recomended. The project operates in the Mid-Country. (h) Numerous overseas training programs are executed with the assistance of various foreign donors.  ANNEX 1 Page 13 Government Programs-and PIlans 46. Past livestock development policy has been principally concerned with veterinary programs and development of Government livestock farms. Livestock diseases of economic itportance are now under control, and improved breeding stock, as well as advice on the establishment and management of pasture/forage crops, can now be provided disseminated to the private sector. 47. The Five Year Plan (1972-76) aims at increasing milk production to attain the 1963 level of consumption by utilizing the existing facilities and services for developments in the private sector. Rs 50 million, 47Z of total allocations for animal production in the Plan, have been earmarked for dairy development. Plan implementation is the responsibility of APHD. The bulk of Plan allocation is for pasture/forage developments in the Mid-Country and the Coconut Triangle, for dairy cattle importation and for AI development. 48. The Divisional Development Councils (DDC) and the UDA-RATA Estates Development Board also are involved in dairy development. The former are local authorities which may prepare, with government support, development proposals eligible for public financing. DDC projects receive preference in the allocation of cattle from government farms. The UDA-RATA Board has been entrusted by government to develop 27 estates (total about 8,000 acres) which the government has acquired in the Mid- Country. Dairy development is under consideration for some of these estates. 49. Government supports milk production developments through various subsidies (described in detail in Annex 3). (a) The Tea and Rubber Controller issues Rs 500 per acre for the uprooting of uneconomic tea and pasture establishment, including fertilizer, soil conservation measures and fencing. (b) The Coconut Cultivation Board issues Rs 120 per acre for the planting of pasture/fodder grasses under coconut palms. Thereafter the permit holder is entitled to purchase fertilizer at half cost in the second year. (c) Cabinet Paper June 1971 provides for government subsidy to allow distribution of imported stock to purchasers at cost in country of origin. The subsidy amounts to between Rs 3,000-3,500 per imported animal.   ANNEX 1 Table I SRI LANKA DAIRY DEVELOPMENT PROJECT Livestock Population in Sri Lanka ('000 head) 1960 1965 1970 Cattle 1,552 1,90h 1,593 Buffaloes 813 1.,051 736 Goats 419 600 556 Sheep 52 35 27 Pigs 76 117 108 Poultry 3,409 6,090 6,856 Source: Village Headman's Returns as reported by Department of Census and Statistics. October 10, 1973  ANNEX 1 Table 2 SRI LANKA DAIRY DEVELOPMENT PROJECT Estimates of Production and Consumption of Livestock Products (Millions of Units) Milk Beef Mutton Pork Poultry Meat Eggs 1972 1971 1970 1970 1970 1970 (Pints)/ -----------------(Pounds)---------------- (Number) Total Production 224 90.6 10.5 6.0 4.5 219 Total Imports 160 - - - - - National Consumption 384 90.6 10.5 6.0 4.5 219 Average per Capita Consumption ]/ 29 7 0.8 0.5 0.3 17 j,f Based on a yield of 70% from cattle and buffaloes, including edible offal. g,/ Liquid milk equivalent y/ Units (pints, pounds or number) per capita Source: (a) Consumer Finance Survey, November 1969 - October 1970. (b) Mission Estimates October 10, 1973  SRI LANKA DAIRY DEVELOPIMENT PROJECT Livestock Distribution And Cattle Paraneters Unit Dry Zone Coconut Mid- Up- Southern Total Triangle Country Country Wet Zone A. Ecological Characteristics Elevation Feet 0-1,000 0-1,500 1,000-3,000 above 3,000 0-1,500 - Temperature /