Philippines - Aurora - Penaranda Irrigation Project

CIRCULATrNG COPY FIlE COPY X BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1419-PH REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND DEVELOPMENT CREDIT TO THE REPUBLIC OF THE PHILLIPPINES FOR THE AURORA-PENARANDA IRRIGATION PROJECT April 17, 1974 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 It may not be published, quoted or cited without Bank Group authorization.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 Unit - Peso (P) US$1 - 6.729 p 1 - US$.149 p 1,000 - US$149 P 1,000,000 3 US$149,OQ0 Fiscal Year G July 1 to June 30  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND DEVELOPMENT CREDIT TO THE REPUBLIC OF THE PHILIPPINES FOR THE AURORA - PENARANDA IRRIGATION PROJECT 1. I submit the following report and recommendation on a proposed loan for an equivalent of US$9.5 million and a proposed development credit for an equivalent of US$9.5 million to the Republic of the Philippines to help finance an irrigation development and rehabilitation project in Luzon. The loan would have a term of 25 years including seven years of grace with interest at 7-1/4% per annum. The development credit would be on standard terms. PART I - THE ECONOMY 2. The most recent Economic Report - "Current Economic Position and Prospects of the Philippines" (No. 78-PH of April 20, 1973) was circulated to the Executive Directors on May 2, 1973 (R73-85). Since imposing martial law in September 1972, the Government has re-formulated its development strategy by introducing a number of important and potentially far-reaching economic and social reforms through decrees in such areas as agrarian reform, taxation, customs administration and tariffs, banking and government organi- zation. These reforms provide an opportunity to improve the performance of the Philippine economy. Aided by the recent commodity boom in the inter- national markets, economic activity in the Philippines gained considerable momentum and registered a strong recovery in 1913. The growth rate in real GNP, which had been about 5% a year for more than a decade, is estimated to have doubled and reached a level of 10% in 1973. This high growth rate resulted mainly from increased agricultural production, a recovery in the industrial sector including a growth of manufacturing exports, a boom in export incomes and an expansion in public and private investment. However, the economy is now threatened with a possible slowdown due to increased oil prices. The long-term implications of the current energy crisis for domestic production, the balance of payments, costs and employment, as well as other aspects of the recent economic developments are being examined by an economic mission now in the field. Annex I contains the country data. 3. The strong recovery of the Philippine economy in 1973 was led by the agricultural sector followed by manufacturing, mining, utilities and services. The agricultural sector, which had suffered from adverse weather conditions during the previous three years grew by 11% in 1973. Rice pro- duction during the present crop year is estimated to have increased by 30% over the level of the previous year when floods had reduced production levels. This increase has been mainly due to favorable weather conditions, increased use of fertilizers, more supervised credit and increased investments in sup- porting rural services as part of a general investment drive for rice self- sufficiency. The Government has also accomplished more in the last year than in the previous ten years in implementing agrarian reforms which were accorded high priority in its development efforts. These reforms involve transferring titles to tenants and improving supporting services.  4. The increased activity of the agricultural sector has provided the base for renewed expansion of the industrial sector. The growth of indus- trial production for exports has also been stimulated by the Government's industrial export drive which included a range of export incentives. Non- traditional industrial exports, which have been increasing since 1970, are estimated to have doubled in 1973 to about $200 million. The prospects for increased profitability in this area are attracting a large amount of new investments into industries like plywood, textiles and garments, handicrafts, light consumer durables and electronics. The Board of Investments, in its attempt to exercise a measure of control over the pattern of private indus- trial investment, is placing emphasis on investments which are labor-intensive and heavily dependent on domestic raw materials. Recent Government policies also encourage the development of small and medium-scale industries by adopt- ing an integrated approach for assistance in the areas of finance, technology, promotion, procurement and marketing. 5. The growth in production was also assisted by the sharply acceler- ated public development outlays in 1973 made possible by a significant im- provement in the financial position of the Government. After martial law was imposed, the Government implemented a series of long-needed tax reforms and improvements in tax administration, such as customs and tariff reform, tax amnesties, reforms in corporate and local taxation, continuation of the export tax, and increased taxation on luxury items and on gasoline. These reforms resulted in a 38% increase in tax revenues in 1973. Sustained im- provement in tax administration, further tax reforms and a continued strong recovery in income growth should permit a real revenue growth of about 8% a year in future. This would provide increasing local resources for the Government investment program which before the increase in oil prices called for an outlay of about P 13 billion on infrastructure and other public in- vestments during FY 1974-77. This would mean doubling the proportion of these expenditures to GNP from 1.7% in FY 1968-72 to about 3.5% in FY 1974-77. Implementing this program would also call for continued improvements in public sector management which has already been strengthened by the Government re- organization. 6. Another impressive feature of 1973 was the increase in net foreign exchange reserves which rose by $553 million to reach $835 million by the end of 1973. This was mainly due to booming world prices for primary commodities. These reserves, equivalent to about five months of imports, considerably im- proved the balance of payments outlook prior to the energy crisis. Export receipts increased by 55% in 1973 and the merchandise trade account recorded a surplus of about $280 million, a significant change from the $43 million deficit in the previous year. Invisible earnings also increased in 1973 by about 180%. Merchandise exports are projected to increase by about 50% for the entire period FY 1974-78. Most of this increase is attributable to larger earnings from minerals and the projected 20% a year growth in non- traditional industrial exports. With the improved outlook for domestic food production and foreign exchange reserves position, but without considering the impact of increased oil prices, we estimated late last year that the Philippines should be able to sustain a growth in imports of raw materials, intermediate and capital goods sufficient for a real GNP growth of 7-8% a year.  - 3- 7. Prior to the increase in oil prices, we projected foreign exchange requirements for the period 1974-78 at around $4 billion. About three-fourths of these would be provided by transfers, direct investments and private me- dium and long-term loans while the remainder would come from official devel- opment loans. Foreign private investors have been attracted to the Philippines recently for two main reasons namely the increasing profitability of indus- tries especially in the export sector, and the relaxation of restrictions on the repatriation of profits and capital. At the time we made the projections, commercial and medium-term public loans of about $1.5 billion during the pe- riod of 1974-78 appeared quite consistent with sound debt management and the Philippines' debt servicing capacity. These projections did not include financing for new lumpy public investments being considered, such as, an integrated steel mill and a nuclear power station. The Philippine Consulta- tive Group reviewed the improved foreign exchange position at its meeting in May 1973 and accepted the need for some official commodity aid in addition to rising levels of commitments for development projects to support the Philippines' increased development program. During 1969-73, over 40% of the total disbursements of official development assistance came from the Japanese Government (of which, more than three-quarters was in commodity loans) followed by about 28% each from the US Government (of which more than 85% was in commodity loans) and the World Bank Group. 8. The projections set out above do not take account of the long term implications of recent increases in petroleum prices since we do not yet have enough information to analyze the problem fully. Our preliminary analysis suggests that the net oil import bill (c.i.f.) for 1974 could exceed $700 million compared with $200 million in 1973. Despite this sharply increased oil import bill, the balance of payments this year would not be cause for undue concern. Provided the prices of Philippine exports hold up as expected, the Philippines appears to have the capacity to absorb the increased cost of fuel imports in 1974, while maintaining minimum ade- quate reserves and providing for growth of imports at the projected rate of 8% in real terms. In 1975, however, the deficit would be much larger due to higher import prices and additional long-term financing would be needed if the Philippines is to avoid a sharp decline in her international reserves. Thus efforts will be needed both to increase the flow of official project loans and to maintain the 1972-73 levels of quick-disbursing commodity assistance. 9. Prior to the energy crisis it was our judgment that, provided ade- quate levels of official commodity and project assistance are forthcoming a.d particularly if the improvement in export prices was maintained, management of the Philippines' external debt and debt servicing should not present serious problems. Thus in the absence of the need for additional finanzce because of the energy crisis, the debt service ratio was expected to improve from the present level of about 21% to about 18% in the latter part of the decade. When the economic mission returns in early May, a detailed analysis of the impact of higher oil prices on the longer term outlook and on the external position will be undertaken.  -4- 10. Whatever the outcome of this analysis, the Philippines' development program will continue to require resources in excess of the foreign capital which will become available for financing the import component of development projects. Part of these resources will be provided from commodity assistance. In addition, some financing of local currency expenditures will be justified especially for projects of economic and social importance which need only limited amounts of foreign exchange. Given the poverty of the Philippines, its continued debt problems and the general improvement in the management of the country's economy, it is appropriate that we continue our policy, begun in April 1972, of blending in a limited amount of IDA credits along with our bank lending to the Philippines. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 11. The Philippines has received 22 Bank loans and two IDA credits totalling $375 million, net of cancellations. About 60% of the Bank/IDA lending, about $232 million, has been for infrastructure projects in power, transportation, water supply and for education. The remainder has been divided about equally between agriculture and industry. About $85 million of this has been for irrigation, livestock, rice processing and rural credit and about $65 million for industry in three loans to the Private Development Corporation of the Philippines. There has been a marked improvement in the way our projects in the Philippines have been executed in the last two or three years compared with experience in the 1960's when shortages of peso counterpart funds combined with poor administration caused serious problems. Apart from the rice processing project, where some major changes made neces- sary by changed circumstances have been proposed, all our projects are now going well. Annex II contains a simiary statement of Bank loans, IDA credits and IFC investments as of February 28, 1974, and notes on the execution of on-going projects. 12. The size of our lending program will increase substantially this year reflecting the ambitious development program of the Government and its improved capacity to prepare and implement projects. If our projects come forward as planned and are approved by the Executive Directors, our lending in the Philippines could exceed $160 million in FY 1974 compared to an aver- age of about $30 million a year in the previous five years. Future Bank/IDA lending will continue to concentrate on public infrastructure and agricul- ture. We will also continue to help industry and provide more assistance for projects in the social sectors. The following projects are among those which should be ready for Board consideration during the remainder of FY 1974 and in FY 1975 - Industrial Investment, Rural Credit III, Population, Power VI, Inter-island Shipping, Tarlac Irrigation and Mindoro Rural Development. 13. Bank/IDA lending to the Philippines could continue at a relatively high level provided that the economy is managed reasonably well and that the Philippines continues to improve its capacity to prepare and implement projects. During the past five years the Bank/IDA has provided about a third of the total commitments of official development assistance. Our higher level of lending, during the next five years, could increase this  -5- share. The Bank/IDA present share in total debt outstanding is about 9%, and its share in debt service is about 5.5%. On the trends expected before the increase in oil prices, the Bank/IDA share in total debt outstanding would rise to about 17% by 1978 while its share in debt service would be about 10%. Our future level of lending will be re-examined in the light of the findings of the economic mission now in the Philippines. 14. IFC has made commitments in the Philippines totalling $66.0 million for investments in nine companies in the fields of development banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibers. Of these invest- ments, as of February 28, 1974, $18.2 million have been sold, $0.4 million cancelled and $1.6 million repaid, leaving a net portfolio of $45.8 million. On the same date $14.2 million was undisbursed. Preliminary proposals have been received for an aluminium smelter and other projects in the pulp and paper, dinner ware, metal alloys and shipbuilding fields. PART III - THE AGRICULTURAL SECTOR 15. Agriculture is the predominant sector in the Philippine economy generating approximately one-third of the gross national product, accounting for one-half of total employment and about three-quarters of export earnings. Over 60% of the total land under cultivation is taken up by cereals, of which rice and corn are the most important. The remaining land is primarily taken up by the major export crops: sugar, coconuts, abaca, pineapples and tobacco. 16. During the first half of the last decade, agricultural production increased by only 2.4% a year. However, with a breakthrough in rice produc- tion following the increased use of high-yielding varieties, fertilizers and irrigation in the sixties, the sector was growing at a rate of almost 7% a year by the latter part of the decade. During the past three years the sector has suffered from adverse weather conditions including severe typhoons. These disasters slowed progress towards self-sufficiency in food crops and imports of about 600,000 tons of rice were needed in 1972 and 1973. However, due to favorable weather conditions and a crash rice production program called "Masagana 99", 1/ a harvest of 3.7 million tons of milled rice equiva- lent is expected this year - an increase of 30% over the 1972/73 harvest. In this past year, fertilizer use on food crops (mostly rice) tripled and supervised credit increased almost eight fold. 1/ "Masagana 99" is a drive by Government with a target of achieving 99 cavans of paddy per hectare (4.4 tons/ha) country wide. In Tagalog "masagana"l means abundant.  17. The major export crops have not been seriously affected by the natural calamities and have provided increasing foreign exchange revenues mainly because of favorable world commodity prices. Livestock and poultry production, which accounts for about 15% of agricultural output, is not sufficient to meet the demand for meat, requiring imports of about $6 million a year. 18. The perfor-imance of the rural-agricultural sector will be crucial in determining whether the Philippines can increase incomes both rapidly and equitably. At present, the domestic market for industrial products is limited by relatively low and stagnant rural 'ncomes. Problems of poverty and income maldistribution are particularly acute in the rural areas. Of the 15 million people in the bottom 40% of the income scale, 12 million live in rural areas. This represents 45% of the rural population. The Government is aware of these problems and is moving in the right direction by stressing self-sufficiency in cereals, laying the base for future diver- sification, reforming the tenancy structure, and increasing institutional support to agriculture. 19. Achieving self-sufficiency in cereals, particularly rice and maize, is a major Government objective which is important not only to strengthen the balance of payments, but also as a means of raising incomes for an important segment of the rural population. Most increases in rice production will have to come primarily from the present land under cultiva- tion since the scope for area expansion in rice is very limited. Thus, attaining self-sufficiency before the end of the present decade will depend largely on increasing yields through expansion and rehabilitation of the area under irrigation, increased use of fertilizers and agro-chemicals, and provision of adequate credit and other supporting services. At present, only 900,000 ha or less than 30% of all land under rice cultivation is irrigated. Investment in irrigation is therefore of high priority. Accord- ing to the Bank's Philippines Agricultural Sector Survey of May 2, 1973, meeting the domestic demand for rice by the end of the 1970's will require a program of irrigation rehabilitation and new construction in rice lands of 50,000 ha a year for the remainder of the decade. 20. Apart from rice, considerable potential also exists in feed grain and corn production, livestock, fisheries and forestry development. Diversi- fication is important not only to meet the growing domestic demand for food and raw materials, but also to improve incomes in poor areas less suited to rice production. Better conservation of natural resources can be achieved by developing the l