Sri Lanka - Tank Irrigation Modernization Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-1940-CE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF SRI LANKA FOR A TANK IRRIGATION MODERNIZATION PROJECT November 15, 1976 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Until recently, the Sri Lanka Rupee was pegged to the Pound Sterling at a parity rate of L 1.00 = Rs 15.60. On May 24, 1976, the Sri Lanka Rupee was officially linked to a basket of currencies with the initial parity rate based on the prevailing Rupee/Pound rate. The current Rupee/US Dollar rate is about US$1.00 = Rs 8.70. The rate below, in effect during the preparation of the report, has been used throughout the report, except where stated to the contrary. 1/ US$1 = Rs 7.5 Rs 1 = US$0.133 Rs 1 million = US$133,333 WEIGHTS AND MEASURES 1 long-ton = 2,240 lb = 1.016 metric tons 1 hundredweight (cwt) = 50.8 kg = 112 lb 1 bushel (bu) of paddy = 45 lb 1 pint = 0.57 liters 1 acre (ac) = 0.405 hectare (ha) 1 mile (mi) = 1.609 kilometers (km) 1 square mile (sq mi) = 640 ac (259 ha) 1 foot (ft) = 30.5 centimeters (cm) 1/ Through the sale and purchase of Foreign Exchange Entitlement Certificates (FEECs), Sri Lanka effec- tively practices a dual exchange rate. Most non- food imports have to pay a surcharge of 65% through the purchase of FEECs. Most non-traditional exports receive a 65% premium over the official rate through the sale of FEECs.  FOR OFFICIAL USE ONLY PRINCIPAL ABBREVIATIONS AND ACRONYMS USED APC - Agricultural Productivity Committee ARTI - Agrarian Research and Training Institute CC - Cultivation Committee CP - Cooperative Program DA - Department of Agriculture DME - Department of Machinery and Equipment FAO - United Nations Food and Agriculture Organization FEEC - Foreign Exchange Entitlement Certificate GA - Government Agent GDP - Gross Domestic Product GNP - Gross National Product GOSL - Government of Sri Lanka ICB - International Competitive Bidding ID - Irrigation Department IRRI - International Rice Research Institute M - Million MAL - Ministry of Agriculture and Lands MDB - Mahaweli Development Board MIPH - Ministry of Irrigation, Power and Highways O & M - Operation and Maintenance PMB - Paddy Marketing Board SLTC - Sri Lanka Trading (Tractor) Corporation GLOSSARY District - The principal administrative sub-division Ganga - Major river Maha - Northeast monsoon season (October to January) Oya - Minor river Rotational Irrigation - Intermittent igation Yala - Southwest monso ' season (April to July) FISCAL YEAR January 1 - December 31 This document ha raetrictod distribution and may be used by recipients only in the peormalonce of their official duties. Its contents may not otherwise be disclosed without World Bank authoriation.   INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF SRI LANKA FOR A TANK IRRIGATION MODERNIZATION PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Republic of Sri Lanka for the equivalent of US$5.0 million on standard IDA terms to help finance a project for the mod- ernization of five existing tank irrigation and drainage schemes, aimed at increasing farm production in the tank command areas. Co-financing arrange- ments have been made with the United Kingdom (U.K.) which will contribute US$6.0 million equivalent as a grant. PART I - THE ECONOMY 2. The latest economic report, "Sri Lanka: Country Economic Memorandum" (Report No. 1019a-CE, March 15, 1976) was distributed to the Executive Directors on March 16, 1976. Country data are provided in Annex I. The latest sector report, "Republic of Sri Lanka - Agricultural Policy and Program Review" (Report No. 579a-CE, February 1975), was distributed to the Executive Direc- tors on February 28, 1975. 3. The economic difficulties that presently beset Sri Lanka can be traced principally to two basic characteristics of the country's economic and social system: first, the dependence of the economy on three export crops -- tea, rubber and coconut -- and, second, a political commitment to the welfare state. This commitment found its expression in two policy tenets which, for the past quarter century, successive Governments have followed in varying degrees: the supply of mass consumption goods, principally food and textiles, at low prices, and the provision of public services -- mainly educa- tion, health and transport -- free of charge or substantially below cost. 4. Sri Lanka's progress in social fields has been noteworthy. Public services are widely available at little or no cost and a more equal distri- bution of income has been achieved by maintaining relatively high wages, subsidizing services, and distributing food free or below cost. The welfare state has been based mainly on the earnings of the export sector. A major concern, however, is that Sri Lanka has experienced a pronounced weakening in the market for tea and rubber beginning since the mid-fifties. Its effects on the earnings of the traditional export sector, combined with the failure to establish new sources of growth, seriously affected the ability of the economy to generate a surplus in the form of savings and exports, which in turn was one of the main reasons for little economic growth in the past two decades. Between 1969-70 and 1974-75, GNP at constant prices increased at an annual rate of about 2.8%. With population growing at a rate of about 1.8% p.a. between 1969-70 and 1974-75, there was only a slight improvement in per capita gross income.  - 2 - 5. Against this background, Sri Lanka has had to face in the recent past (i) the shocks of sharply escalating costs for imported foodstuffs, which absorbed over 60% of the country's earnings from merchandise exports in 1975; (ii) a near tripling of the oil import bill; and (iii) sharp increases in the prices of imported raw materials, spares, and investment goods. Despite considerable rises in export prices for rubber (1973-74) and for tea (1974-75), Sri Lanka emerged as one of the developing countries most seriously affected by the recent worldwide price inflation. 6. The Government of Sri Lanka (GOSL) has responded since October 1973 to the changed world economic conditions by lowering the amounts and raising the prices of food supplied at subsidized prices, doubling the price of petroleum products in 1974 and raising them again in 1975, and increasing transport tariffs by 50% or more. Furthermore, in response to the cost increases of imported raw materials, public corporations and enterprises increased prices to their customers. 7. Despite these constructive -- and politically difficult -- measures, the budgetary position in 1975 deteriorated as compared with 1974. This was due largely to (i) a sharp decline in paddy production, from about 77 million bushels in 1974 to 55 million bushels in 1975, as a result of a severe drought, and (ii) a reduction of export duties on rubber and an elimination of duties on coconut, adopted so as to provide some relief to the producers in the face of declining world prices of these products. The volume of rice imports in 1975 for the food distribution program was 50 % larger than in 1974, and the net food subsidy reached one billion rupees (21 % of current expenditure of the budget) despite the further steps taken in April 1975 to reduce it, i.e., de-rationing the flour issue and liberalizing the sale of off-ration sugar. Other current expenditures also rose, mainly because of increases in wages, social services and interest payments. Since the total current revenue hardly increased in 1975, there was a current account deficit of almost Rs 300 million as compared to a surplus of over Rs 100 million in 1974. 8. Capital expenditures are now estimated to have risen in 1975 by about Rs 500 million (40%) compared to 1974. Considering the likely rate of price increase, this implies a much lower rate of increase -- probably around 20% -- in real terms. Because of the lack of Government savings, capital expenditures in 1975 were financed entirely from borrowing, estimated to have risen to about Rs 2.0 billion, 80% above the 1974 figure. About 63% was borrowed domestically, mainly from the state savings bank and pension and insurance funds, and the remainder abroad. A worrisome aspect of this picture is the rapid rise in the debt service burden, mainly as a result of increasing external borrowing through short-term and suppliers' credits. 9. The budget for 1976 envisaged a current account surplus of Rs 71 million. A 15% increase in current revenue was projected on the basis of the expected decline in the volume and prices of food imports which would permit an increase in imports of items subject to payment of FEECs and relatively high import duties. The actual increase in current revenue may, however, be smaller than projected since, owing to severe drought, the volume of foods imports in 1976 is expected to be at least as much as in 1975. Only a small increase in current expenditure is projected, based on the assumption that world market prices for Sri Lanka's major imports, including foodstuff,  - 3 - will either decline or stabilize at their 1975 levels. As the total capital expenditure is planned to be less than in 1975, the cash deficit is expected to decline below Rs 1.8 billion. 10. The significant feature of the 1976 budget was the effort to en- courage economic activity in the private sector. Together with measures such as the removal of the ban on private paddy/rice trading, the budget represented a change in the Government's attitude towards the private sector. Among the steps intended to stimulate private business were encouragement to banks to provide finance to the private sector and an effort to attract foreign banks and businessmen to invest in the country, along with new tax incentives linked to investment performance. Nevertheless, little progress has been made in this area due largely to political factors in face of the forthcoming elections. 11. Sri Lanka was not able to take full advantage of rising world com- modity prices in 1973-74 because of the difficulties faced in increasing the production of its traditional export commodities. Replanting of tree crops had been particularly inadequate because of depressed prices, and more re- cently because of insecurity of tenure. Unfavorable weather conditions and inadequate use of fertilizer were also among major factors accounting for the depressed levels of tree crop production. However, with the help of favorable weather and satisfactory prices, the volume of tea exports in 1975 reached the third highest and its value a record level. Rubber and coconut exports, too, showed substantial volume increases in 1975, but, because of declining world prices for these commodities, their contributions to the total foreign ex- change earnings were less than in 1974, particularly in the case of rubber. 12. A major development in 1975 was the taking over by the State of about 415,000 acres of tea, rubber and coconut land (close to a quarter of total tree crops acreage) owned by the estate companies, which were excluded from the provisions of the Land Reform Law of 1972. The Agency Houses, which were managing the estates prior to takeover, were appointed temporarily as statutory trustees. Around 175,000 acres have now been handed over to the Ministry of Plantation Industries to be managed by the State Plantations Corporation. About 240,000 acres will be managed by the newly established People's Estate Development Board (Janawasama). It is expected that a portion of the acreage (probably less than 10%) consisting of marginal and uneconomic land suitable for diversification would be distributed to landless peasants. The Government is planning to formulate state-aided development projects to assist these settlers. As regards the management of the estates by the Jan- awasama and State Plantations Corporation, it is the Government's intention to retain the services of experienced planters, factory officers and other employees. Arrangements are also being made to meet the financial require- ments of the estates. The Government is confident that, through these pro- grams, interruptions in production will be avoided and a smooth transition effected. Some progress has already been made in the management of the estates. Nevertheless, the continuing loss of experienced staff to the private sector has become a major problem. However, the Land Reform has removed the uncertainty about the future of the ownership of estates and should assist in resolving a problem which has contributed to deterioration of the most impor- tant assets in the economy.  13. An encouraging development in recent years has been the increase in the share of non-traditional exports in total exports. In addition to measures taken in 1970 to promote minor export crops, the Government's policies since 1973 have been providing fiscal and financial incentives to export-oriented industries. Tourism and gem exports, which have good pros- pects for further development, have now become important sources of foreign exchange earnings. Manufactured exports, however, have almost stagnated in volume terms during the last two years following a successful surge in 1972-73. The reason is partly the recession in the markets for industrial exports and partly the increasing difficulties faced by Sri Lanka's exporters in market- ing and attaining the necessary quality standards. 14. The composition of imports has undergone significant changes in re- cent years. Because of increases in prices of food, petroleum and fertilizer, their share of the import bill increased to 67% in 1975, compared to 49% in 1972. The 1976 import program envisages substantial increases in imports of investment goods and intermediate goods other than petroleum products. However, such increases are contingent upon Sri Lanka obtaining a substantial increase in external assistance. 15. The composition of capital movements showed significant changes recently compared to the early 1970's. Suppliers' credits, which were $8-$10 million in 1971-72, rose to $50-$60 million in 1974-75. The use of medium- term borrowing has gained in importance, with the result that the outstanding debt with one to five years' maturity increased from a negligible amount at the end of 1972 to almost $100 million (about 15% of total external debt) at the end of 1974. One important consequence of these developments has been a sharp increase in debt obligations. In 1974, owing to the relatively sharp increase in foreign exchange earnings mainly as a result of price increases, the debt service ratio remained just below 13%, almost the same as in 1973. However, the debt service ratio rose to over 17% in 1975 and is expected to rise further to about 19% in 1976. 16. In the latest economic report, it was estimated that Sri Lanka would need a net capital inflow of nearly US$250 million in order to finance the current account deficit. The Government's latest balance of payments projec- tion for 1976 indicates a modest increase in export earnings, which would re- duce the size of the financing requirement to about US$200 million. 17. An Aid Group for Sri Lanka, for which the Bank acts as the Chair- man, was formed in 1965 and has held twelve meetings. At the twelfth meet- ing, held in Paris in April 1976, the members recognized Sri Lanka's need for continued assistance, particularly in agriculture, and gave indications of aid of about US$180 million. This amount fell short of the 1975 indica- tions of over US$220 million, of which only US$30 million were disbursed during 1975. 18. Because of its substantial financing gaps, Sri Lanka had to cut its import programs to a significant extent in 1974, with disruptive effects on investment and production in the economy. Although the import volume rose in 1975, the level remains inadequate and is not likely to be sustained in  1976. Net external reserves are so low that they should not be drawn upon. Since servicing of external debt is now imposing a heavy burden on the pay- ments position, it is important that, in the coming years, the external finance required be obtained as far as possible on highly concessional terms. PART II - BANK GROUP OPERATIONS IN SRI LANKA 19. Since the beginning of its operation in Sri Lanka in 1954, the Bank Group has made eight loans totalling US$73.4 million (net of cancellations) and nine credits totalling US$79.1 million (net of cancellations and exchange adjustments) in support of fifteen projects. About 39% of Bank Group assis- tance has been for power, 38% for agriculture (irrigation and agricultural and dairy development), and the remainder for DFC operations, highways and a program credit (mainly involving the import of raw materials for industry). Three early power loans, the two DFCC loans, the Mahaweli Ganga Development Credit, and the program credit were satisfactorily completed and fully dis- bursed. At the request of the Borrower, a loan/credit for highways was cancelled in 1970, after disbursement of US$0.8 million of the credit, follow- ing the Government's decision to make major changes in the scope of the project. The IFC's only investment in Sri Lanka, US$3.25 million to the Pearl Textile Mills, Ltd. (Ceylon), was made in January 1970, but cancelled the same year at the request of the Company. Annex II contains a summary state- ment of Bank Group operations as of September 30, 1976, and notes on the execution of ongoing projects. 20. The Bank Group's current strategy is focused on the agricultural sector. It is designed to help alleviate the foreign exchange constraint by supporting measures to increase agricultural output. A project for the ex- pansion of the Mahaweli Ganga irrigation network (in part a follow-on to the Mahaweli Ganga Development.Project) was prepared, with the assistance of the IBRD/FAO Cooperative Programme, appraised in April/May 1975, and is expected to be presented to the Board in FY77. A fourth operation for the Development Finance Corporation of Ceylon and a water supply project were appraised in September and October, respectively, and both are expected to be presented to the Board in FY77. A project for diversification of crops on marginal lands under tea and rubber is being prepared by GOSL and an FAO/UNDP team with IDA assistance, and is expected to be appraised in April, 1976. A second Drainage and Land Reclamation project, a Sugar Cane Development project, and a Fisheries project, are being considered for possible IDA financing. 21. The Bank Group presently accounts for over 11% (and the Bank alone for about 6%) of Sri Lanka's total external debt outstanding, and about 8% (with IDA negligible) of debt service. It is projected that the Bank Group's share in total external debt will decline to about 9% by 1980 (and the Bank's share alone to fall to less than 2%). The Bank and IDA shares in the debt service will also show a slight decline.  PART III - THE AGRICULTURAL SECTOR AND IRRIGATION 22. Agriculture is dominant in Sri Lanka's economy, accounting for over four-fifths of export earnings, more than half of all employment, about one-third of the gross national product (GNP), and much of the Government revenues. And yet, despite considerable potential for higher output levels, growth in agricultural production has been slow in recent years. In the tree crop sector, during the decade ending in 1973, the level of tea production remained stagnant and coconut production declined by about 2% per annum; only rubber production expanded significantly increasing by 3% per annum. Follow- ing a poor crop in 1974, tree crop production increased substantially in 1975 owing mainly to favorable weather conditions (para. 11). In food crop sector, production increased at an annual rate of 3.1% during the decade ending in 1973, but it too has stagnated since. Paddy production in 1970, under favor- able weather conditions, reached a record 77 million bushels, but subsequent harvests have been disappointing due to unusually severe drought. The 1975 paddy crop totalled only about 55 million bushels--about two-thirds of the 1970 production. 23. The sluggish performance of the tree crop sector is largely a result of inadequate investment due to poor financial returns and uncertainty over future ownership. Production of field crops has suffered from poor water management, lack of adequate farm power for tillage, inadequate atten- tion to extension, marketing and credit facilities, and the system of con- trols and subsidies which work to reduce incentives of the farmer. In light of its major objective of increased food self-sufficiency, the Government is concerned about the stagnation in agricultural production. Historically, the country had depended upon the export earnings from tree crops to provide for the import of foodgrains and other goods. The worsening terms of trade, particularly within the last few years, have prompted a reexamination of the Government's past strategy. In the tree crop sector, nationalization of all Sterling and Rupee estates has given Government total control over production and investment. 24. Among the measures taken in recent years to increase production in- centives at the farm level are: increases in guaranteed support prices and elimination of compulsory paddy procurement; reduction in free and subsidized rations; and import restrictions on subsidiary crops, such as chillies, onions, potatoes and pulses. In addition, to promote more efficient utilization of agricultural resources, the Government has established Agricultural Producti- vity Committees (APCs) as the principal regulatory bodies for all agricultural activities at the field level and has placed increased emphasis on efficient water utilization and management. These important measures are expected to result in significant increases in agricultural production. 25. About half of Sri Lanka's total cultivated area of 5 million acres is under field crops, primarily paddy (1.3 million acres). Where sufficient water is available, it is common practice to produce two or more crops a year. In the dry zone, however, where cultivation in the Yala season is entirely dependent upon irrigation (and partially dependent even in the Maha season), the cropping intensity is only about 110%. A large part of the problem is  that farmers in Sri Lanka follow traditional methods of irrigating paddy, letting the water run continuously and ponding it on the fields. In addition to meeting the consumptive use requirements of the crop, this method assists in weed control. It is highly wasteful in the use of water, however, particu- larly on soils with high permeability. Also, in the tank schemes, paddy is normally sown only after the tanks are deemed to be sufficiently full to assure an adequate water supply to mature a maha crop. If the tanks do not fill until late in the monsoon, sowing is correspondingly delayed. The net effect is that, in some years of the monsoon, rain is not utilized for crop production. With improved methods of irrigation and proper operation and management of the irrigation systems, it would be possible to increase sub- stantially the irrigated area with the existing water supply. PART IV - THE PROJECT 26. The proposed Project was identified and prepared by several missions from the FAO/IBRD Cooperative Program (CP). Originally, it was proposed that the processing of this Project be linked with the second Mahaweli Ganga Development Project (para. 20), and that co-financing for the two projects would be dealt with as a package. At the request of the Government, the two projects were appraised in April/May 1975. The appraisal mission was accompa- nied by representatives from four prospective co-financing countries: Canada, the Netherlands, U.K. and U.S.A. A follow up appraisal mission, including representatives from Canada and U.K. visited Sri Lanka in January/February 1976. Following discussions among the Government of Sri Lanka, prospective co-financiers, and IDA, it was agreed that, since this Project would be ready for presentation to the Board substantially sooner than the proposed second Mahaweli Ganga project, and in order to simplify procurement and disbursements, only the U.K. would participate in the co-financing. Contributions from the other co-financiers would be used for the proposed second Mahaweli Ganga project. A report entitled "Sri Lanka - Appraisal of the Tank Irrigation Modernization Project" (No. 951a-CE) is being distributed separately to. the Executive Directors. Negotiations were held in Washington, D.C., during May 7-13, 1976. The Government was represented by Mr. T. Sivagnanam, Secretary, Ministry of Irrigation, Power, and Highways, and Mr. S. Velayutham, Director, External Resources Division, Ministry of Planning and Economic Affairs. A. Project Description 27. The Project would provide for the modernization of five tank irriga- tion schemes (small reservoirs with earth-filled dams, typically with a storage capacity of a few thousand acre-feet) in the north-central dry zone, serving a total irrigable cultivated area of 31,500 ac. By rehabilitating and improving the existing dams and conveyance systems, and with improved water management and agricultural supporting services, the Project is aimed at increasing farm production in the tank command areas. It would be a prototype for future tank modernization projects, since the variety of water supply/demand conditions, size of area served by the individual tanks, and soil conditions are such that the five tanks schemes are representative of nearly all of the approximately  180 major schemes in the dry zone, serving a total cultivated area of about 400,000 ac. 28. The Project would include construction works for improving irriga- tion and drainage facilities. To enable farmers to cope with the tightened crop calendars and to intensify cropping patterns, the Project would also provide for a substantial increase in farm equipment for land preparation and plant protection. The agricultural supporting services would be strengthened, particularly the extension service, and supplies of farm inputs would be improved. For proper handling of the increased farm production, farm roads would be improved. Finally, the Project would provide technical assistance for improving the operation and maintenance of the irrigation systems. 29. The Project would ensure an equitable water distribution through strictly-enforced rotational delivery schedules. The proposed improvement in water use would include the rehabilitation and modification of the existing conveyance system, the measurement of water flows at various points along the canals, the reduction in delivery losses, and improved water use on the fields. B. Detailed Features Project Implementation 30. The Department of Irrigation (ID), Ministry of Irrigation, Power and Highways (MIPH), would be responsible for implementing the Project. It would prepare final plans and designs, procure the necessary construction materials, and undertake all irrigation and drainage improvements, including the construction of necessary farm roads along the embankments of canals, distributaries and field channels. The ID's permanent staff of about 1,200 is well-qualified for these tasks. Its operations, however, are currently hampered by the lack of adequate equipment and vehicles. 31. With the necessary equipment and vehicles to be provided under the Project, the ID should have no difficulty in carrying out the civil works. The field organization for the construction would be headed by a Chief Pro- ject Engineer with the overall responsibility for the management and super- vision of the program. A Chief Project Engineer with the necessary experience and qualifications acceptable to IDA has already been appointed. Construction would be done by two field units, each capable of modernizing about 6,000 ac per construction season. Each unit would be headed by a Project Engineer. 32. The Sri Lanka Trading (Tractor) Corporation (SLTC) would be respon- sible for allocating the farm tractors and equipment provided under the Pro- ject to the dealers within the Project area for resale to Project area farm- ers and APCs. In line with Government Policy, the APCs would be encouraged to buy and operate the farm equipment on a co-operative basis. However, as the APCs are relatively new organizations, inexperienced in running efficient commercial operations, it is expected that private custom operators would con- tinue to play a major role in providing farm equipment on a rental basis. To  - 9 - ensure the availability of farm equipment in the Project area on a priority basis, and to ensure reasonable rental rates, the private operators would be approved and supervised by the APCs. Also, a condition of sale to the private operators would be that they agree to do custom work within the Project areas during the peak cultivation periods as specified by the concerned APCs. 33. The Department of Agriculture (DA), under the Ministry of Agricul- ture and Lands (MAL), would be responsible for the reorganization and strength- ening of the extension service by reducing the number of programs, and elimi- nating the overlap, paying increased attention to up-to-date research efforts, and preparing a well-defined work program for field staff. Assurances were obtained that the Government would maintain, by March 1, 1977, an extension organization in the Anuradhapura District to implement a work program which is acceptable to IDA (Section 3.07 of the Development Credit Agreement). Working closely with the APCs, the extension service would be responsible for the timely distribution of seeds, fertilizer, and agro-chemicals and application equipment. The motorcycles and bicycles provided under the Project for ex- tension staff would be sold to the staff by the DA on terms and conditions satisfactory to IDA. 34. Marketing, processing and storage facilities for the farm produce would be provided by the Paddy Marketing Board (PMB). With assistance from the International Rice Research Institute (IRRI), Ford Foundation, and USAID, PMB is undertaking a phased program for strengthening its operations to handle the increased farm output. 35. The Bank of Ceylon and the People's Bank, acting on the advice of the APCs, would provide, at prevailing commercial terms, short-term credit to farmers for farm inputs and longer-term credit to individuals and groups of farmers for financing the purchase of farm equipment. 36. The Project implementation would take five years. Tender documents for construction equipment have been prepared and issued and awards would be made for delivery by March 1977. Staff mobilization would begin in January 1977 and construction in April 1977. However, due to the need to establish logistical support in the field and put together the necessary construction organization, the progress in the first construction year (1977) would only amount to about 15% of the total. The construction tempo would pick up sub- stantially during the next two years (1978-1979) and the work would be com- pleted by 1980. The field channel lining program on the first tank (Mahawil- achchiya) would be completed in the first year (1977) so that the results in terms of both costs and water savings would be available for guidance in the modernization of other tanks. To minimize interference with crop production, and also to take advantage of the favorable construction season, most of the field work would be performed each year during the seven-month period from April to October. No water would flow through the canals during that time and many of the farmers could be employed on project works.  - 10 - Field Operation 37. In regulating agricultural activities in the field, the APCs are assisted by village Cultivation Committees (CCs). The committees are respon- sible for ensuring that the agricultural lands are used to the maximum bene- fit of the country. Towards this end, they have far-reaching powers in pre- scribing the cropping patterns, distribution of water, and field channel maintenance to be followed in their areas, as well as in the allocation of inputs such as seeds, fertilizer, agro-chemicals and application equipment, tractors, and farm credit. Members of the APCs and CCs are appointed by the Minister, MAL. Both APCs and CCs are assisted on technical matters by the administrative, engineering and agricultural officers in the District Offices. 38. The CCs would make recommendations to the ID with respect to crop- ping patterns and calendars and the water-issue periods for the distribu- taries. The CCs would also recommend minimum flows for domestic purposes and livestock. With this information, the ID would then establish the operating calendars for the various tanks which would be strictly followeds The suc- cess of this program would require complete cooperation of the CCs and the APCs in the adopted water management plans. Maintenance 39. Responsibility for the maintenance of the construction machinery and equipment would be with the Department of Machinery and Equipment (DME), MIPH, which operates a regional workshop near the tank sites at Anuradhapura. The ID would be responsible for the operation and maintenance (O&M) of the major project works, both during construction and thereafter. Assurances were obtained that the Government would provide sufficient funds for the proper O&M of the Project facilities (Section 4.02(a) of the Development Credit Agreement). 40. Adequate repair facilities and workshops exist in the private sec- tor to provide maintenance services for the farm equipment to be provided under the Project. Motorcycles and bicycles sold to the extension staff would also be maintained by private workshops. The DA would provide a mile- age allowance to the extension staff for the operation and maintenance of these vehicles. The maintenance of the other extension equipment and vehicles would be the responsibility of the DA. Funds for such maintenance as well as for fuel, personnel and operating supplies would be provided through the annual budget of the DA. Assurances were obtained that the GOSL would continue to make available adequate funds and personnel for the agricultural extension services in the Project areas (Section 4.02(b) of the Development Credit Agreement). 41. The CCs acting under the general supervision of the APCs, and advised by Irrigation Engineers and Agricultural Extension Officers, would be responsible for the maintenance of the field channels and for the distri- bution of water among the various users on each distributary. The ID would oversee the maintenance and water distribution operations of the CCs, and  - 11 - would report any deficiencies to the APCs or higher authority. In case remedial action is not taken, authority would be given to the ID to take over these functions and to assess the costs against the water users with such charges to be collected by the Government Agent (GA). Assurances were obtained that all measures required for establishing and maintaining adequate standards of maintenance of field channels in the Project area would be under- taken in accordance with agreed appropriate engineering practices (Section 4.03 of the Development Credit Agreement). Project Coordination 42. Committees have been established at the Central, District and Tank levels to facilitate inter-agency coordination. The committee at the Central level is chaired by the Secretary, MIPH, and includes senior representatives from the concerned departments and agencies. The Director of Irrigation is the member secretary of the committee. The committee is responsible for the overall project execution and coordination. It would meet quarterly, or more often if necessary, and would make policy decisions, review work programs and progress, and approve budgets for the various agencies. The committee is also responsible for submitting quarterly and annual progress reports to IDA and for corresponding with IDA on project matters. The committees at the District and the Tank levels are respectively chaired by the Chief Project Engineer and the Project Engineers and include appropriate staff from the various concerned agencies. The committees would provide day-to-day field coordination for scheduling the work program of the various agencies, The District Level com- mittees are also responsible for reporting project progress, future work pro- grams and any unresolved inter-agency problems to the central committee. Assurances were obtained that the committees would continue to function in a manner satisfactory to IDA (Section 3.03 of the Development Credit Agreement). Assurances also were obtained that quarterly and annual progress reports would be sent promptly to IDA (Section 3.03(b)(iii) of the Development Credit Agreement). Technical Assistance 43. The ID would employ a well-qualified water management consultant to advise on the design and the operating criteria for each of the five tank schemes. The consultant would also work in the field with the extension ser- vice and the Project operating personnel to effect a viable water management plan compatible with the proposed rotational irrigation. Assurances were ob- tained that, by March 1, 1977, the Government would employ a specialist, with experience and qualifications acceptable to IDA (Section 3.02 of the Develop- ment Credit Agreement). 44. For evaluating the impact of the Project, the Government has retained the services of the Agrarian Research and Training Institute (ARTI). ARTI has submitted a detailed proposal for evaluation which is being reviewed by IDA.  - 12 - C. Project Cost and Financing 45. Total Project costs are estimated at US$30.0 million equivalent, including about US$7.0 million in import taxes and duties. The foreign exchange component is estimated at US$9.3 million or about 40% of the total, net of taxes and duties. At unit prices at January 1976 levels, and on the basis of preliminary design, base Project costs are estimated at US$21.5 million. The major elements included in the cost estimate are civil works (US$8.7 M), construction equipment and vehicles (US$5.6 M), agricultural equipment and vehicles (US$5.6 M), technical assistance (US$0.3 M), and engineering and administration (US$1.3 M). To this cost, physical con- tingencies of US$1.7 M (20% of civil works costs) and price contingencies of US$6.8 M (29% of the base cost plus physical contingencies) are added to bring the total Project cost to US$30.0 M. 46. Co-financing arrangements have been made with the U.K. which will contribute US$6.0 M equivalent as a grant for equipment and civil works. Together with this cofinancing arrangement, the proposed contribution of US$5.0 M by IDA would finance the full foreign exchange costs of US$9.3 M and US$1.7 M in local costs, or about 48% of the total Project cost net of taxes and duties. Commercial banks and the buyers of the farm equipment (tractors and sprayers) would provide about US$6.0 M for financing the farm equipment. Net of receipts from taxes and duties on Imported project items, the Govern- ment's contribution would be about US$6.0 M, or about 26% of the Project cost net of taxes. Assurances were obtained from the Government that it would provide adequate funds to the agencies concerned to cover all Project costs, and that it would furnish to IDA, not later than November 1 each year, a de- tailed plan for the implementation of the Project with related financial re- quirements for the following fiscal year (Section 3.01(b) of the Development Credit Agreement). A condition of effectiveness would be the effectiveness of the U.K. Grant Agreement (Section 6.01 of the Development Credit Agreement). D. Cost Recovery 47. Although not directly part of Project cost recovery, the Government, under the Sale of State Land (Special Provisions) Act of 1973, is selling the State lands included in the Project (i.e. nearly all the Project area) to the existing settlers. The holdings generally include 3 acres of paddyland, and 2 acres of highland for a homestead site. The land sales are expected to be completed by December 1977. On the average, the sale price amounts to about Rs 8,500 per family, to be paid in cash or in 20 equal annual installments at 4% rate of interest, or about Rs 600 per family per year. 48. The present value of the Project investments (in economic terms) is estimated to be about Rs 97 million or about Rs 3,100 per ac (at a dis- count rate of 10% per annum). In addition, the O&M of the irrigation system would require an annual expenditure of about Rs 75 per acre. Assuming that  - 13 - water charges are introduced in phase with the construction schedule, but with a one-year grace period, it would require an average annual charge of Rs 625 per ac -- Rs 550 for recovery of capital costs (over 30 years) and Rs 75 for O&M costs -- to recover fully all the expenditures of this Project. These charges would represent about 50-60% of the net incremental farm income, before accounting for family labor. 49. Analysis of the farmer's ability to repay the Project costs indicates that, on the basis of "project rents", it should be possible to recover full Project costs. However, the following considerations argue for significantly lower recovery rates: (i) present below-average income levels of the Project area farmers will be further depressed by recoveries under the Sale of State Land (Special Provisions) Act; (ii) the tradition of not charging for irriga- tion water gives rise to opposition to setting the charges "too high"; and (iii) the need to persuade the farmers to adopt the proposed intermittent rice irrigation methods. 50. The institutional mechanism for cost recovery is based on the Land Betterment Charges Act of 1976, under which the Government is able inter alia to impose annual charges in irrigation and drainage schemes taking into account factors such as amount and dependability of irrigated water, increased agricul- tural production, cropping intensity, and capital and O&M costs. Detailed regulations for the actual implementation of land betterment charges are under preparation and expected to be enacted by early 1977. Work is also underway to revise, update and prepare the land registers necessary for the adminis- tration of land betterment charges. Assurances were obtained that, by January 1, 1978, the Government would complete all measures necessary to enable it to impose and collect appropriate land betterment charges from within the Project Area and other major irrigation and drainage schemes throughout the country (Section 3.08 (a) of the Development Credit Agreement). 51. Assurances were obtained that the Government would collect from the Project beneficiaries charges adequate to recover full O&M and an appropriate portion of the construction costs in accordance with a cost recovery plan acceptable to IDA (Section 3.08 (b) of the Development Credit Agreement). The initial charge for O&M costs would be Rs 30 per ac, to be gradually in- creased to cover full O&M costs in the fifth year. For construction costs incurred after land purchases under the Sale of State Land (Special Provisions) Act, the Government would charge an amount equivalent to 20% of the net average incremental farm incomes (subject to a maximum of Rs 300 per ac annually, in 1976 prices). It is estimated that, for the five Tank command areas included in the Project, this would amount to a capital recovery charge of about Rs 200 to Rs 250 per ac to be applied not later than eighteen months after completion of each Tank scheme. Such a charge would lead to about 50% of cost being recovered. The Government intends to review and revise, if necessary, on a regular basis every three years, the level of charges collected under the Project.  - 14 - E. Procurement and Disbursement 52. Equipment supplied under the U.K. grant would be procured from within the U.K. and in accordance with U.K. procurement guidelines, while equipment financed by IDA would be procured through international competitive bidding (ICB) procedures in accordance with Bank Group Guidelines. Small off-the-shelf items costing less than US$10,000 each, which cannot be bulked into packages suitable for international tendering, would be purchased through normal Government procurement procedures which are satisfactory to IDA. Such purchases would, however, be limited to an aggregate total of US$100,000. 53. Because most of the civil works would be simple, individually very small, labor-intensive, scattered over a wide area, restricted to seasonal construction, and could not be grouped into large contracts, they are unsuit- able for international competitive bidding. Work such as excavation of field and collector drains, enlargement of distributaries and field channels, and brick lining would be done through unit-cost contracts with local laborers. The repair of tank sluices and the repair or replacement of structures in the main or branch canals and distributaries would be done by the ID on force account. 54. Disbursements for 100% of the foreign expenditures for equipment, vehicles and spares earmarked for the U.K. would be made from the U.K. grant. Disbursements from the proposed IDA credit would be made for (i) 100% of the foreign expenditure for directly-imported equipment, vehicles and spares (other than those financed by the U.K.); (ii) 50% of total expenditure for locally-procured equipment, vehicles and spares; and (iii) 100% of foreign expenditure for technical assistance. In addition, disbursements would be made for 24% of the expenditures -- 12% by IDA and 12% by the U.K. -- on civil works performed under force account or small unit cost contracts. Disburse- ments against (i), (ii) and (iii) would be fully documented. Disbursements against civil works would be made against statements of expenditure, the doc- umentation for which would not be submitted but would be retained for review during the course of project supervision. During implementation, the dis- bursement percentages would be adjusted, if necessary, to disburse fully the aid package by the completion of the Project. Also, the U.K. equipment list would be revised, if necessary, to keep the total U.K. disbursements against equipment at US$4.5 M equivalent. Disbursements from the U.K. grant would be administered directly by the U.K. It is expected that disbursements would be completed by June 30, 1981, approximately six months after the Project completion. F. Project Benefits and Risks 55. The dry zone of Sri Lanka has some 180 major tank irrigation schemes, serving a total cultivated area of about 400,000 ac. Deterioration of the water conveyance systems, poor water management and inadequate agricultural  - 15 - supporting services, are the prime constraints limiting agricultural produc- tion in the schemes. The proposed Project would be a prototype for bringing these schemes up to their full potential. Successful implementation of this Project would open the way for eventual modernization of all the tank schemes which could potentially add one-quarter of a million tons to the food- grain production of the country (about 30% of current unusually large imports and about 40% of "normal" imports). 56. More directly, the Project-related increase at full development of about 22,300 tons in foodgrain production (rice, 16,600 tons; cereals, 3,400 tons; and pulses, 2,300 tons) would represent an annual gross foreign exchange saving of US$5.4 million. Allowing for the added imports of fuel, fertilizers, agro-chemicals and farm equipment, this would represent an annual net foreign exchange saving of US$4.0 million. 57. The labor-intensive civil works proposed under the Project would provide a total of 3 million man-days of employment during project implemen- tation. The more intensive cultivation envisaged under the Project would generate annual employment of 0.6 M man-days in on-farm works. Also, there would be a substantial increase in secondary employment in activities such as marketing, processing, and supply of farm inputs. All this would help to relieve the large unemployment and underemployment prevailing in the area. 58. The Project will directly benefit some 10,000 small farm families operating mostly about 3 acres each. Present farmer incomes in the Project area are substantially below the national average. At full development of the Project, farmers are expected to have more than double their present incomes, bringing them up to the national average. 59. The Project's economic rate of return is estimated at about 23%. The most serious risk to the Project relates to the possibility that the rotational irrigation proposed under the Project will not be fully accepted by the farmers, with the result that irrigation efficiency and hence cropping intensity will be less than projected. To minimize this risk, in addition to modernizing the physical works, the Project would reorganize and greatly strengthen the existing agricultural extension services. Sensitivity tests indicate that, even with a reduction from the projected 160% to 125% of the cropping intensity at full development, the economic rate of return would be about 14% and the Project would still be viable. 60. Further sensitivity tests with a variety of adverse assumptions about costs and benefits indicate that the Project remains viable, with economic rates of return ranging from 13-22%. Tests were also made to determine the viability of each tank on its own, indicating economic rates of return ranging from 20-29%.  - 16 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 61. The Development Credit Agreement between the Republic of Sri Lanka and the Association, the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement, and the text of a draft resolution approving the proposed Credit are being distributed to the Executive Directors separately. 62. Features of the Development Credit Agreement of special interest are referred to in paragraphs 33, 39-43, 46, 50 and 51 of this Report. 63. The effectiveness of the U.K. Grant Agreement (para 46), would be a condition of effectiveness. 64. I am satisfied that the proposed Development Credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 65. I recommend that the Executive Directors approve the proposed Credit. Robert S. McNamara President Attachments November 15, 1976  Pig _1 of I4 pages SRI LANKA- SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KH2) -