Philippines - Magat River Multipurpose Project

LE-PX!U3h CCIRCUILATIhG CGPY Y4w.EJ TO BE RFEi'U,.:ED TO REPORTS DEK DOCUMENT OF INTERNATONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use OIRCULATING COPY Report No. P-I167SPH 10 BE RETURNED TO REPORTS DESK REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE MAGAT RIVER MULTIPURPOSE PROJECT - STAGE I July 3, 1975 s report was prepared for official use only by the Bank Group. nt MaY rot be pbulise qote | a or cited Without Bank GrouP authorization. The Bank Group does accurmcy or c;ompleteness of the ireport.  CURRENCY EQUIVALENTS Currency Unit = Peso (P) US$1 = 6.90 p 1 = US$0.145 P 1,000 = US$145 P 1,000,000 US$145,000 Fiscal Year - July 1 to June 30  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILLIPINES FOR THE MAGAT RIVER MULTIPURPOSE PROJECT - STAGE I 1. I submit the following report and recommendation on a proposed loan for an equivalent of US$42 million to the Republic of the Philippines to help finance the first stage of a multipurpose project in the Cagayan Valley of Northern Luzon. The loan would have a term of 25 years with seven years of grace with interest at 8.5 percent per annum. PART I - THE ECONOMY 2. The most recent Economic Report - "Current Economic Position and Prospects of the Philippines" (No. 568-PH of November 7, 1974) was circu- lated to the Executive Directors on November 11, 1974. A basic economic mission was in the Philippines in April/May and is currently preparing its report. Annex I contains country data. Recent Developments 3. In the past two years there has been a sharp increase in the level of economic activity in the Philippines. The growth in real GNP, which had been about 5-6% a year for more than a decade, doubled to 10% in 1973. The strong recovery in 1973 was led by the international commodity boom and resultant increased export incomes in the Philippines, by a strong recovery in agricultural and industrial production for the domestic market, and by an expansion in public and private investment. The increased domestic out- put, and a 28% improvement in the external terms of trade, resulted in a 14% increase in gross national income in real terms in 1973 compared with about 1% in 1972. Underemployment and unemployment remain quite high, how- ever, and in common with most other countries, the rate of inflation in- creased appreciably since 1973. The Government has pressed ahead with a number of important and potentially far-reaching economic and social reforms in such areas as agrarian reform, taxation, customs administration and tariffs, banking and government organization. 4. The agricultural sector, which has suffered from adverse weather conditions during the previous three years, grew by 7% in 1973. Rice pro- duction in crop year 1973-74 increased by 23% over the level of the previous year when floods reduced production. This increase was mainly due to fa- vorable weather conditions, increased use of fertilizers, more supervised credit and increased investments in supporting rural services as part of a general drive for rice self-sufficiency. The impact of typhoons and flooding in December 1974 appears to have been significant and as a result no in- crease in rice production is likely for the crop year 1974/75. 5. The boom in export incomes and increased activity in agriculture has provided the base for renewed expansion of the industrial sector which  -2- grew by about 11% in 1973. Non-traditional industrial exports, which have been increasing since 1970, are estimated to have doubled in 1973 to about $200 million. The growth of industrial production for export was also stimulated by the Government's industrial export drive which includes a range of export incentives. More recently, however, industrial output and exports have been affected by the recent dampening of domestic demand and a slowdown in the economies of k4ey trading partners, and industrial export earnings grew more slowly in 1974. 6. The growth in production was also assisted by increased public development outlays in 1973 made possible by a significant improvement in the financial position of the Government. The ratio of public investment to GNP is expected to reach about 3% in FY75 as compared with 1 .8% in FY72. The Government has 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, aided by the increased economic activity, the boom in export incomes, and domestic inflation, resulted in a 30% increase in tax revenues in FY73, and an estimated 50% in FY74. As a result, the ratio of national and local Government tax revenues to GNP has increased from an average of 9-10% in recent years to an estimated 13% in FY74. 7. High prices for the Philippines chief exports, including coconut products, sugar, copper and wood products, were largely responsible for an increase in merchandise receipts of almost 70% in 1973. The merchandise trade account recorded a surplus of about $270 million, as compared with a $150 million deficit in the previous year. International reserves rose by about $600 million during the year and stood at $876 million, equivalent to about five months of imports, at the end of December 1973. However, since mid-1974, a large trade deficit appeared, largely because the growth in export prices had moderated while import prices had continued to rise rapidly. As a result of this trade deficit, the overall balance of payments surplus fell from about $700 million in 1973 to less than $100 million in 1974. By the end of 1974 international reserves were about $1.2 billion, equivalent to roughly four months imports. Net reserves were about $900 million. 8. In the latter part of 1973, inflation emerged as a major problem in the Philippines. Starting in mid-1973 consumer prices began to rise at an annual rate of more than 40%. This was caused by the large increase in liquidity since the export boom began in 1973, and by a number of factors, including the higher rate of world inflation, domestic food shortages and the increased cost of petroleum. Aided by monetary and fiscal policies aimed at absorbing the excessive liquidity expansion, the rate of inflation slowed to less than 20% by the end of 1974. Other factors that helped moderate the rate of inflation include the substantial reduction in the balance of payments surplus in 1974 and the considerable increase in rice production in crop year t973/74. Indications are that the rate of domestic inflation has significantly subsided in 1975. However, the recent inflation has exacerbated the decline in real wages which fell by a total of about 25%  -3- between 1969 and 1973. The urban wage earners have been most affected while agricultural and entrepreneurial incomes appear to have improved very substan- tially. Money wages will have to be raised in the near future if further deterioration in the living standards of urban wage earners is to be avoided. Growth Prospects 9. The abrupt deterioration in the external terms of trade since the middle of 1974, and the recession in the economies of key trading partners, together with uncertainty about how quickly they will recover, now threatens some of the Philippines' recent economic gains even though the Government remains committed to maintaining the growth momentum which began in 1973 to provide for a continued increase in incomes and employment. The high priority accorded to expanding employment opportunities - in the short-term as well as the long-term - stems from the fact that unemployment and underemployment are still high and the labor force continues to grow at 3% a year. 10. Priority is also being given to expanding food production for the domestic market, to expanding export production and to accelerating develop- ment of local energy resources. The difficulties experienced during the last two years in importing sufficient quantities of food at reasonable prices, especially cereals, have increased the Government's resolve to achieve food self-sufficiency as soon as possible. The Government rightly recognizes that the increased cost of petroleum and other imports cannot be financed indefinitely by borrowing abroad and it is actively encouraging both local and foreign investors to expand the productive capacity of ex- port industries and to undertake major new import-replacing investments. Because it will take time for these investments to have an impact on the balance of payments, the Government is seeking increased support from the international financial community to help carry out its development program and to ease the adjustment to higher petroleum and other import prices. Be- cause of the substantial improvement in the external debt burden and inter- national reserve position in the last two years the Philippines now has the capacity to borrow externally larger amounts of capital in support of its development program, if capital is made available. 11. Maintaining a GNP growth rate of about 7% a year in real terms during the next few years will have to depend heavily on the expansion of output for the domestic market rather than on growing export markets. The prospects are for continued expansion in agriculture with a 4-5% increase in production in the year ahead. With a few exceptions, industries are operating at relatively high levels of capacity utilization. Increased investments will be needed in a wide range of consumer and intermediate goods industries. A number of big projects are proposed in metals, fertilizer, steel and ship- building which are likely to push up the private investment rate from recent levels of about 16% of GNP to perhaps 22% by the latter part of the decade. The public infrastructure program that was approved in 1973, which called for outlays of about P 1-2 billion at current prices in FY74-77, has become out- dated because of the subsequent rapid inflation and changes in investment  -4- priorities as a result of the energy crisis. A new program has not been finalized, but the Government is putting more emphasis on developing nuclear and indigenous power resources and on irrigation, feeder roads and other projects to support increased food and export production. The Government has made considerable progress in recent years in building up its capacity to prepare and execute projects. However, there will be a need for continued efforts to strengthen this aspect of administration. The ratio of public investment to GNP is projected to rise from the present level of 3% to about 4% by 1977. Balance of Payments 12. Merchandise export receipts are estimated to decrease somewhat in 1975 but rebound again by about 30% in 1976 mainly due to an increase in volume. Import payments are projected to increase by a total of over 35% in the same period, including a 14% increase in prices. A cumulative decline in the external terms of trade of about 27% during this period would probably wipe out the gains made in the recent export price boom and return the terms of trade to the level preva:Lling in 1972. However, the outcome for the balance of payments is quite sensitive to assumptions about external prices and without the projected deterioration in the terms of trade, for example, the projected trade deficit of $1.2 bil-lion in 1976 would be reduced by about $1 billion. 13. If the projected deterioration in the terms of trade takes place, the total foreign exchange requirements for meeting the current account deficit and amortizing loans during 1975 and 1976 would be about $2.3 billion. About $700 million would be provided by direct investment and short-term trade finance and about $700 million would come from suppliers' credits and commercial commodity financing. Disbursements of project finance to the public sector, from the present pipeline, would amount to about $300 million. The balance of the remaining capital inflow that may be required of about $200 million in 1975 and $400 million in 1976, could be financed by the Central Bank through short-term borrowing. This would, however, result in a substantial decline in net reserves by 1976. In these circumstances, it would be preferable to finance these deficits with additional medium and long-term loans so that the Government could maintain its growth strategy while avoiding serious deterioration in its reserve position. 14. Recent important gains in reducing the external debt burden and in improving the external reserve position would be jeopardised if the banking system had recourse to short and medium-term borrowing abroad in excess of the $600 million mentioned above. Fortunately, some assistance may be forth- coming from the IMF. In addition, foreign donors hopefully will extend quick- disbursing commodity loans with long maturities, which would make an important contribution to maintaining growth and a manageable balance of payments posi- tion in 1975. There is considerable scope for additional medium and long- term loans from foreign donors to finance the much larger capital goods imports projected for 1976. The Philippine Consultative Group reviewed the foreign exchange position at its meeting in December 1974 and accepted the need for  -5- some official commodity aid in addition to rising levels of commitments for development projects to support the Philippines' increased development pro- gram. If the projected capital inflows are forthcoming with an appropriate combination of medium and long-term maturities management of the external debt would not present serious problems. Medium and long-term debt out- standing would rise from $2 billion this year to about $3 billion by 1976 but the ratio of debt service payments to exports would fall from 15% this year to about 13% in 1976. The Philippines would still be in a position to contract substantial amounts of external debt during the final years of the decade and this would lead to an increase in the debt service ratio to about 16-17% by 1980. The Philippines is already creditworthy for substantial Bank lending. At present, the Bank/IDA share in total debt outstanding is about 9% and its share in debt service is about 5%. Even with a substantially higher level of Bank lending, these shares would not be expected to increase significantly in the years ahead. 15. During the last three years, the Government has significantly im- proved its fiscal performance with taxes increasing by more than an average of 40% each year. Nevertheless, the Government's ambitious development program, which would increase public investment from the current level of 3% of GNP to about 5% by the end of the decade, will continue to require resources in excess of the foreign capital which will become available for financing the import component of development projects. Thus 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. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 16. The Philippines has received 30 Bank loans and three IDA credits totalling $680.2 million, net of cancellations. About 48% of the Bank/ IDA lending, about $306 million, has been for infrastructure projects in power, transportation, water supply and for education whilst $25 million has been for population. The remainder has been divided about equally be- tween agriculture and industry. About $168 million of this has been for irrigation, livestock, rice processing, rural credit and rural development and about $175 million for industry in four loans for the Private Develop- ment Corporation of the Philippines, one loan for the Development Bank of the Philippines and one for small and medium industries. There has been a marked improvement in the way Bank financed projects in the Philippines have been executed in the last three years compared with experience in the 1960s when shortages of peso counterpart funds combined with poor administration to cause serious problems. All these projects are now going reasonably well. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of May 31, 1975 and notes on the execution of on-going projects.  -6- 17. The Bank's lending program has been designed to continue to sup- port the increased Philippine development effort with its particular emphasis on agriculture and infrastructure. Shortages of domestic revenues led to low investment for these purposes in the past. The last three years have seen major changes which have helped to overcome these constraints and both the ambitious Philippine development program and the Bank's lending program have been designed to make good past neglect and to meet future needs. Commitments in FY74 amounted to $165.1 million, and in FY75 $208 million compared to an average of about $30 million a year in the preceeding five years. 18. Seven loans in the Philippines totalling $208 million - Population, Sixth Power, Inter-Island Shipping, Fourth Private Development Corporation, Tarlac Irrigation, Rural Development and Small and Medium Industries Devel- opment have been approved by the Executive Directors in FY75. In addition to the proposed project, other projects which may be ready for Board con- sideration in FY76 include livestock, fisheries, grain storage, education, industrial investment, urban development and rural development. 19. IFC has made commitments in the Philippines totalling $76.1 million for investments in thirteen companies in the fields of development banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibers. Of these investments, as of May 31, 1975, $18.1 million have been sold, $0.4 million cancelled and $2.9 million repaid, leaving a net portfolio of $54.7 million. On the same date $7.0 million was undisbursed. Preliminary proposals have been received for an aluminum smelter and other projects in the pulp and paper, dinnerware, metal alloys and shipbuilding fields. PART III - THE AGRICULTURAL SECTOR-1/ 20. 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 70% 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. 21. During the first half of the last decade, agricultural production increased by only 2.4% a year. However, with a breakthrough in rice pro- duction following the increased use of high-yielding varieties, fertilizers and irrigation in the sixties, the rates of growth for rice and corn pro- duction were at about 5% and 8%, respectively, by the latter part of the 1/ A detailed Report entitled "Agricultural Sector Survey - Philippines" (No. 39a-PH of May 2, 1973) was circulated to the Executive Directors on May 21, 1973 (R73-111).  - 7- decade. The sector suffered from adverse weather conditions including severe typhoons during 1971 and 1972. These disasters slowed progress towards self-sufficiency in food crops and annual imports of about 300,000 tons of rice were needed in 1972 and 1973. For crop year 1973-74 due to good weather, increased use of fertilizers, more supervised credit and increased investments in supporting rural services, the harvest reached a record 3.7 million tons of milled rice equivalent. The more recent typhoons, however, again caused significant damage to the rice crop and production for 1974-75 is expected to be slightly lower than 1973-74. 22. The performance 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 rural incomes. Problems of poverty and income distribution 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. The Government is aware of these problems and is dealing with them by undertaking agrarian reform, by increasing institutional support to agriculture to raise the productivity of small farmers, and by laying the base for future diversification. 23. A major Government objective is achieving self-sufficiency in cereals, particularly rice and corn. For rice, moving towards self- sufficiency 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. High yielding varieties, which were largely responsible for the increase in production since the late 1960s require a much higher degree of water control than is possible under rainfed conditions or with the typical unimproved irrigation systems in the Philippines. At present, only about 900,000 ha or less than 30% of all land under rice is irrigated. A program to upgrade and expand irrigation in rice lands involving 50,000 ha a year for the remainder of the decade would be needed to meet domestic rice demand. Investment in irrigation is therefore of high priority. 24. Nearly half of expected Bank lending for Philippine agriculture in the next five years is likely to be for irrigation. The proposed project would be the fourth Bank-assisted project aimed at improving irrigated rice cropping on the island of Luzon. The first three projects, all in Central Luzon, set the example for the type of rehabilitation, new construction and operation needed for large scale rice production in the Philippines. The proposed project would follow the same approach to improving and expanding national irrigation systems in the Cagayan Valley of Northern Luzon. The Valley exports rice to other regions of the Philippines and has large land and water resources which could be developed to increase rice production. It is also one of the poorest regions in the country. The National Irriga- tion Systems Improvement Study recently financed under the Tarlac Irrigation Systems Improvement Project (Loan No. 1080-PH) will help identify and pre- pare similar projects in other regions for future Bank lending.  -8- 25. After many years of little progress, the Government is giving high priority to agrarian reform. The present program covers only rice and corn tenant farmers, who nnumber about one million, and includes the transfer of titles from landlords to tenants, an expanded program of rural credit and increased investments in supporting rural services. In the first two years of the new program the Government concentrated its efforts on the larger tenanted estates of over 24 ha. It has recently broadened its focus to include smaller landlord holdings down to 7 ha. Nevertheless, land re- form remains a difficult and slow moving program. Perhaps the most critical difficulty is landlord resistance to land valuation, associated with their view that the present compensation package is unacceptable. The Government is seeking ways to improve its approach to landlord compensation without a sudden shift in basic policy. In November 1974 the Government commenced a number of steps to keep the program moving. It decided to proceed with transfers on holdings in the 7-24 ha range and accelerated the process of identifying landlords and tenants on such holdings; it provided stiffer penalties for violators of the Agrarian Reform Code, and it is adopting streamlined procedures for land valuation. The critical issue remains firm enforcement of existing laws and decrees. However, progress is still slow and, as of June 2 of this year, the Government had issued Certificates of Land Transfer covering 199,000 tenants farming a total of 347,000 ha in 64 provinces. This is out of a total of 424,000 tenants on holdings over 7 ha covering altogether 825,000 ha. PART IV - THE PROJECT Background 26. The proposed Magat River Multipurpose Project consists of a portion of Stage I of the rehabilitation and upgrading of two national and several small communal irrigation systems now serving a total of 52,000 ha and the expansion of these systems to serve an additional 23,000 ha and permit a cropping intensity of 140% on the total 75,000 ha area. The Asian Develop- ment Bank is assisting the rehabilitation of systems serving 40,000 ha of Stage-I under the Angat-Magat Integrated Agricultural Development Project (AMIADP) with only 10% of the financing being used for constructing new facilities. The ADB made a loan of $9.6 million for this project in June 1973., The part of Stage I proposed for Bank assistance includes the re- habilitation of facilities serving 12,000 ha (35%) and construction of new facilities on 23,000 ha (65%). The AMIADP portion is designated Stage IA and the Bank-assisted portion, Stage IB. For operation and maintenance after construction, the entire Stage I area of 75,000 ha would be treated as a single unit. Stage II of the Project envisages the construction on the Magat river of a storage dam and power plant with an installed capacity of 300 MW, the development of irrigation facilities on an additional 29,000 ha and an increase in cropping intensity to 200% on the total project area of 104,000 ha.  -9- 27. The project was prepared by the National Irrigation Administration (NIA) with assistance from the U.S. Bureau of Reclamation. A Bank mission appraised the Stage I project in November/December 1974 and negotiations were held in May 1975. The leader of the Government negotiating team was Ambassador Eduardo Z. Romualdez. The Appraisal Report (No. 727a-PH) on the proposed project is being circulated separately to the Executive Directors. Annex III provides a loan and project summary. The Project Area 28. The project is located in Isabela province in the Cagayan Valley of Northern Luzon, which accounts for about 11% of the nation's rice area and 13% of total production (see Map). About 30% of the province's rice production is exported to Manila and Southern Luzon. The area is well served by banking, processing and storage facilities. It is connected by national highway to Central Luzon and Manila in the south and to the port of Aparri on the Babuyan Channel to the north. Agrarian Reform in the Projlect Area 29. The Department of Agrarian Reform has identified all tenants and holdings in Isabela province down to 7 ha. There are about 14,000 tenant farmers operating 40,000 ha in the total project area of 75,000 ha. The transfer of about 20,000 ha of landlord holdings larger than 7 ha will benefit some 7,000 tenants. In addition, there are at present about 10,000 owner-operators cultivating 35,000 ha. Thus, when the land transfer is complete some 17,000 owner-operators or 70% of the farmers in the project area will cultivate 55,000 ha or 75% of the land. The remaining 7,000 tenant farmers on holdings under 7 ha would no longer be sharecroppers but would have written lease agreements providing for payment of fixed rents. Description of the Prolect 30. The proposed project would upgrade to standards adopted in the Tarlac Irrigation Systems Improvement Project (Loan 1080-PH) 890 ha of the Magat River Irrigation System (MARIS), 10,000 ha of the Siffu River Irrigation System (SIFRIS) and 1,300 ha of small communal irrigation systems in the MARIS service area, and would extend the MARIS and SIFRIS to include an additional 22,810 ha of currently rainfed rice land. The main components of the project are: (a) Modification of the existing MARIS diversion dam; (b) Rehabilitation of two existing NIA irrigation and drainage systems and several local communal systems serving a total area of about 12,190 ha; (c) Extension of the NIA systems to serve an additional area of about 22,810 ha;  - 10 - (d) Upgrading or construction of about 830 km of project roads; (e) Construction of an air strip, access roads and a bridge across the Magat river near the MARIS diversion dam; and (f) Procurement of vehicles and equipment. The project would also provide for detailed engineering studies and economic evaluation of the proposed Magat dam and reservoir, a water management training program and technical assistance to NIA in systems operation and construction management. 31. Stage II of the project, construction of which is not to be financed under the loan here recommended, calls for the construction on the Magat river of a storage dam and power station upstream of the MARIS diver- sion works. While preliminary field work has indicated satisfactory founda- tion conditions at the proposed site, additional investigations of the dam and reservoir geology are needed. Engineering studies are also required to develop more detailed design and cost data upon which to base a final economic evaluation. Consultants would be engaged under the project to assist NIA with the studies, which would be divided into two phases. The first phase would include additional geological and hydrological investi- gations, a review of reservoir sizing, updating of designs and cost estimates and a full economic evaluation of the proposed Stage II. The second phase of the studies, which would depend on the outcome of the first phase, would consist of the preparation of final designs and tender documents for con- struction of the dam and appurtenant structures. The results of the evalua- tion phase, which are expected to be available in January 1977, would be subject to Bank review and the second phase would be implemented only if the Bank is satisfied that the evaluation justifies proceeding with the final designs for Stage II. If proceeding with final design is not justified, the Bank may cancel up to $2 million allocated at present for this purpose. (Schedule I paragraph 3(a) and (b) to the draft Loan Agreement). Project Execution 32. The project would be implemented by the National Irrigation Ad- ministration (NIA) over a five year period. NIA was formed in 1964 to de- velop, operate and maintain all national irrigation systems in the Philippines. NIA is a well managed institution which is successfully executing the Upper Pampanga River Irrigation Project, the Aurora-Penaranda Irrigation Project, the Tarlac Irrigation Systems Improvement Project and the irrigation com- ponent of the Rural Development Project (financed by Loan 637-PH, Loan 984- PH/Credit 472-PH, Loan 1080-PH and Loan 1102-PH, respectively). To meet the requirements of the Government's accelerated irrigation development poli- cy, NIA is being reorganized. One of the first results of the reorganiza- tion has been the creation of a Special Projects Office headed by an Assistant Administrator to manage the major externally-assisted projects. This Office would be responsible for carrying out the proposed project.  33. Day-to-day responsibility for construction of Stage IA rests with an Assistant Project Manager who reports to the AMIADP Project Manager on all matters concerning Stage IA. The Assistant Project Manager would also be responsible for construction of Stage IB and would report on all matters concerning that Stage to the NIA Regional Engineer for Cagayan Valley, who would be appointed Project Manager of the Magat River Multipurpose Project. Both Project Managers would report to the Assistant Administrator for Special Projects who would be in overall charge of both the AMIADP and Magat projects. The key personnel have already been identified and are on the job. Two construction units would be set up for Stage IB (in addition to the one now responsible for constructing Stage IA). NIA is expected to complete the setting up of an implementation organization satisfactory to the Bank within the next three months, and this is a condition of effectiveness of the loan (Section 5.01(b) of the draft Loan Agreement). 34. For operation and maintenance the entire project area of 75,000 ha would be administered by a single Project Manager. The whole area would be brought to the same standards of on-farm water distribution and drainage as the Bank-assisted irrigation projects in Central Luzon, and NIA would take all necessary steps to ensure complete compatibility of standards and facilities between Stages IA and IB (Section 3.07(a) of the draft Loan Agreement). To coordinate the provision of agricultural services to farmers, the Government would set up an Agricultural Development Coordinating Council based on Isabela province (Section 3.08 of the draft Loan Agreement). In addition, within six months of loan signing, NIA would set up an Agricul- tural Development Division similar to the one operating in the Central Luzon project areas to monitor the deployment of extension and water management personnel, pace of land reform, cropping patterns, use of inputs and credit, incidence of pests and diseases, and other related matters (Section 3.07(b) of the draft Loan Agreement). Cost Recovery 35. NIA's record of irrigation fee collection nationally has shown a steady improvement over the last few years although the collection rate is still low. Total collections have risen from P4.8 million in FY69 to P9.2 million in FY74. Over the same period, the collection rate, as a percentage of fees charged, has improved from almost 50% to about 66%. However, suf- ficient information is currently not available on the cost of the facilities or the level of service provided by the NIA systems to determine whether the rates charged are appropriate. It is possible that in some cases farmers are charged for water they do not actually receive, and therefore they might be justified in not paying. There are also indications that collection rates are better where NIA is providing a reasonable level of service. Thus NIA's program of irrigation improvement should result in improved collections. The first phase of the National Irrigation Systems Improvement Study (NISIS), financed under the Tarlac project, will inventory the national irrigation systems and when the results,expected by the end of 1975, are available it should be possible to make a better judgment on the appropriateness of the water charges and whether NIA's collections have been adequate.  - 12 - 36. For this project, as for the other Bank-assisted irrigation proj- ects in Central Luzon, NIA has agreed to gradually increase the water rates in the project area over a period of five years from completion of construc- tion to a level sufficient to cover operation and maintenance costs and to recover (without interest) the total investment cost over not more than the 50-year life of the project taking into account farmers' incentives and ca- pacity to pay. A gradual increase in irrigation fees from a level equivalent to about 2.5 cavans (125 kilograms) of paddy per ha in the wet season and 3.5 cavans (175 kilograms) in the dry season to a level equivalent to about 3.5 cavans (175 kilograms) of paddy per ha in the wet season and 4.4 cavans (220 kilograms) in the dry season would meet these requirements (Section 4.03(b) (ii) of the draft Loan Agreement). The rates to be introduced would vary between 12% and 17% of farmers incremental net value of production (before water charges) _depending on present and future cropping intensities. Prolect Cost and Financing 37. The project is estimated to cost a total of US$84 million equiva- lent of which US$29 million would be in foreign exchange. The Bank would finance US$42 million or one-half of the total project cost; that is the foreign exchange cost plus US$13 million of local currency requirements (for justification see paragraph 15 above). The Government would finance the balance of $42 million. To ensure a timely and continuous flow of funds, the Government would as a condition of effectiveness of the Loan Agreement, set up a special fund for the project and replenish it at monthly intervals to a level equivalent to the estimated total amount of payments for goods and services required for the project during the next three months less the estimated amount of payments to be made by the Bank to suppliers, contractors and consultants (Section 5.01(a) of the draft Loan Agreement). The fund would ensure rapid payment of civil works contractors which would help at- tract small contractors. Procurement 38. Equipment and vehicles for force account construction, operation and maintenance, for the Stage II studies and for water management training, costing about US$4.5 million would be procured after international competitive bidding in accordance with Bank Group Guidelines. A preference limited to 15% of the c.i.f price of imported goods, or the customs duty, whichever is lower, would be extended to local manufacturers in the evaluation of bids. Local shopping is appropriate for off-the-shelf items costing less than US$10,000 each, because the advantages of international competitive bidding would be clearly outweighed by administrative costs involved. The total cost of such items would not exceed US$300,000. 39. Works on the modification of the MARIS diversion dam and intake structures (US$6.1 million) would be let as one contract, subject to inter- national competitive bidding. Works on the project service area (US$37.8 million) would be scattered over a wide area and include a large proportion of rehabilitation works. These would have to be executed on short notice  - 13 - to avoid the growing season and bad weather and would have to be phased with irrigation releases. When similar works were advertised under the Upper Pampanga River Irrigation Project, the NIA failed to attract even local contractors. NIA is carrying out all work in Stage IA of the project by force account and in the process should build up a substantial construc- tion capability, which would be available for employment in Stage IB. It is unrealistic, however, for NIA to expect to undertake all work in the project by force account. NIA will therefore investigate ways of expanding the execution of civil works by contract (Section 3.07(c) of the draft Loan Agreement); the amount of work done by force account will not exceed 40% of the total cost of the work (Schedule 4 paragraph 4(b) to the draft Loan Agreement). Competitive bidding in accordance with local procedures is appropriate for the balance of the work. Bank staff have reviewed the procedures for both local shopping and local competitive bidding and they are acceptable. There is potentially adequate competition and foreign firms can participate. Disbursements 40. Disbursements would be made at the rate of 100% against the c.i.f. cost of directly imported equipment, 100% against the ex-factory cost of locally manufactured equipment and 65% for imported equipment procured locally. For services of consultants and for technical assistance, disburse- ments would cover 100% of foreign exchange cost or 60% of total cost at the discretion of NIA. Disbursements for civil works would be at 42% of certified monthly progress payments or expenditures. For civil works contractors' mobilization and equipment, disbursements would cover 100% of foreign exchange cost. Benefits and Justification 41. The proposed Stage I project would contribute to the Philippine Government's objectives of attaining self-sufficiency in food grains and improving the productivity of small farmers. In so doing, it would help strengthen the balance of payments and raise rural incomes. The project would provide better water control and would extend the area under run-of- the-river irrigation from 40,000 ha to 75,000 ha in the wet season and from 19,000 ha to 29,000 ha in the dry season. Yields would increase due to improved irrigation, drainage and agricultural supporting services. At full development, annual paddy production in the project area would increase from the present level of 189,000 tons to 422,000 tons. The increase would provide enough rice to feed about one-and-a-half million people per year. Net foreign exchange savings as a result of reduced rice imports would be about US$27 million a year. Per capita incomes on average size farms would increase from a weighted average of about US$105 at present to about US$220 in 1985 (at constant 1975 prices). The project would benefit directly some 24,000 poor paddy farmers who, with their families, comprise about 144,000 people.  - 14 - 42. Since the newly irrigated areas are currently being farmed under rainfed conditions and since Stage I would provide additional water for only modestly increased double cropping, the project would give rise to only a small increase in the demand for farm labor. The increased rice production from the project would, however, tend to generate additional jobs in the transport, processing, marketing and service sectors. The im- proved farming practices brought about through the proposed project would make it easier to shift to full double cropping if and when dry season ir- rigation water becomes available through construction of Stage II. In that case, an additional 8.5 million man-days of farm labor would be needed. 43. In the economic analysis, Stage I was treated as a unit since its division into sub-stages is purely for administrative convenience (para 8). Assuming a 50-year project life, prices for rice and fertilizer based on the Bank's commodity price forecasts and a seasonally variable shadow wage rate for unskilled farm labor, the economic rate of return on the Stage I project would be about 18%. Sensitivity analysis indicates that even under a number of adverse assumptions, the rate of return would not fall below 12%. PART V - LEGAL INSTRUMENT AND AUTHORITY 44. The draft Loan Agreement between the Republic of the Philippines and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and the text of the Resolution approving the proposed loan are being distributed separately to the Executive Directors. The draft Agreement conforms to the normal pattern for loans for irrigation projects. The setting up of an organization to carry out the project and the setting up of the Special Fund referred to in paragraphs 33 and 37 would be conditions of effectiveness of the loan. 45. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 46. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments July 3, 1975  ANNEXI Page 1 of 3 COUNTRY DATA - PHfILIPPINETS ARIA POP'ULATION DENSITY 300,000 kn2 39.04 million (mid-1972) I.Pe 1-2 of arblc land SO.CIAL INDICATORSS Unfarence Cloantries Phi liapinan ~Thailand T.rkny Korea* 1960 1970 1970 1970 1970 GNP FUR CAPITA ES$ (ATLAS EASES) 1/ 160 a 220 nf22 hI 370 h/ 310 6/ DEOGROQAPHIC Crude birth rate (Per th-onand) 45 4 43 c/ 40 d/ 29 Erude death rate (per thoos.ed) *.12 rl 13 c 15 !Il 9 Infant martality rata (per thousand liva hirtha) 60 90-90 120-150 Life penpotancy at birth (Years) M1 tI 58 59 33 i5 Groan roprd-otion rate 2/ ..3.3 3.2 2.9 2.3 Papolatiaa g-ati rate 3/ 3.0 3.00/ 3.1lf 2.3 I/ 2.2 C Popolatiac growth rate - orban 2 gi/ 4h4/ 3 7 41 6 11 Age rtuctor- (peroant) 0-14 46 43 ..42 40 r15-64 31 33 ..54 36 63 aad ore 3 4 ..4 4 Dependency ratio 4L/ 0.3 j 1.3 lo! ..1.0Y jl .4 _1/ Urban population a pnrPe-t of total 30 &_h 32 4/ 23 i/ 39 41 41 ji/ Family planning: No. of aoeptorae raulatiro uthaan.) .. 409 490 822 No. of aenre (% of maried -ono) -. 10 4 Tatal labor force (them..) 9,103 03,200 ad! 16,900 m/ 16,000 10,230 of! Pnr-enrgn neplayed In agrioultor 61 54( of.! 77 66 47 of! Percentage oaanployed i72L 6f 3 af INCOME DISTRIBUTION Fero.artaf oational -n-narcived by high-nt 37. 29 23 ai_d. 17