Philippines - Second Grain Processing Project

Document of FILE COPY The World Bank FOR OMCIAL USE ONLY Report No. P-1851-PH REPORT AND RECOMMENDATION OF THE PRESIDENT INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A SECOND GRAIN PROCESSING PROJECT May 13, 1976 This document has a restricted dlstributon 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 US$1.00 = Pesos 7.50 Pesos 1,000 = US$133.00 Pesos 1 million = US$133,000 FISCAL YEAR Through 1976: July 1 - June 30 Beginning 1977: January 1 - December 31 ABBREVIATIONS DBP - Development Bank of the Philippines GPD - Grain Processing Division (of DBP)  FOR OrFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A SECOND GRAIN PROCESSING PROJECT THROUGH THE DEVELOPMENT BANK OF THE PHILIPPINES 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for an equivalent of $11.5 million. The loan would have a term of 18 years, including five years of grace, and an interest rate of 8.5 percent per annum. Of the proceeds of the loan, $11.2 million would be relent to the Development Bank of the Philippines (DBP) on the same terms as those of the Bank loan for on-lending to the private sector for specific grain processing enterprises and the balance would finance a post-harvest grain losses study to be administered by the Department of Agriculture. PART I - THE ECONOMY i' 2. A basic economic mission visited the Philippines in April/May 1975 and its report, "The Philippines: Priorities and Prospects for Development," is expected to be distributed to the Executive Directors in the next few days. Paragraphs 3-21 below are a summary of that report. The previous economic report "Current Economic Position and Prospects of the Philippines" (No. 568-PH of November 7, 1974) was circulated to the Executive Directors on November 11, 1974. Annex I of this President's Report contains country economic data. 3. During the 1960s, the economy grew in real terms at the rate of 5-6 percent per annum. However, the rate of growth was less than the level that might have been achieved if the considerable natural and human resources of the Philippines had been ex)loited more effectively. Moreover, the bene- fits of growth were not distributed widely, and unemployment rose. Low levels of taxation resulted in inadequate public investment in necessary infrastruc- ture and social services. Relatively weak export performance, combined with a failure to reduce the import dependence of domestic industry, resulted in a steady deterioration in the balance of payments position. 4. During 1970-72, the authorities adopted policies of monetary and fiscal restraint in order to lay a firm basis for future growth. With assistance from the Consultative Group, they succeeded in improving substan- tially the maturity structure of the external public debt. Real GNP during that period increased at about 5 percent a year. In 1972, the Government initiated a series of social and economic reforms in the country including an agrarian reform program, tax reforms, and an administrative reorganiza- tion. These programs are beginning to show results. 1/ This part, except for paragraph 11, which has been added, is the same as in the President's Report for the Chico River Irrigation Project - Stage I (Report No P-1783-PH) dated March 11, 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.  - 2 - 5. In 1973 there was a sharp Increase in the level of economic acti- vity in the Philippines. This upsurge was led by the international commodity boom, which resulted in higher export incomes in the Philippines, a strong recovery in agricultural and industrial production for the domestic market and an expansion in public and private investment. The growth in real GNP doubled to 10 percent. 6. Like most countries, the Phillppines was profoundly affected by the tumultuous events in the world economy that began with the jump in the prices for food and petroleum in late 1973. With international trade the equivalent of almost half of its GNP, the Philippines proved quite vulner- able to the impact of world inflation, the increase in oil prices and the prolonged recession in the industrialized countries. This sequence of events has temporarily frustrated the Government's attempt to accelerate the rate of development, and in 1974 GNP increased by only about 6 percent in real terms. While adverse effects of the recession were cushioned some- what in 1974 by a modest improvement in the external terms of trade, the Philippines has been even more seriously affected in 1975 by the continued rise in import prices and reduced demand for Philippine exports. The real growth of GNP in 1975 is estimated to have been at about the 6 percent rate of the previous year. Improvement in the growth performance in 1976 can be expected only if recovery takes place in the economies of the Philippines' main trading partners. 7. Agricultural production has grown at an averaoe rate of 3.2 per- cent per year during the 1970s, a period which has been affected by unusually adverse weather conditions. Rice production increased by 25 percent in 1973-74, but due to serious damage by typhoons, it grew by only 1 percent in 1974-75, and the Government had to import 200,000 tons in the first half of 1975 to ensure adequate stocks. However, initial indications are that the outlook for rice production in 1975-76 is bright. The Government is giving the highest priority to increasing agricultural production and has initiated a'number of programs designed to expand the use of fertilizer, irrigation and supervised credit. It has also intensified efforts to expand social services needed in rural areas, including rural electrification, health and family planning services as well as small-scale road and irrigation projects. 8. Although progress has been slower than initially planned, the Government has made some progress with Its agrarian reform for the nation's one million tenant farmers who grow rice and corn. By December 1, 1975, the Government had issued Certtficates of Land Transfer in respect of 208,000 of the 424,000 tenants on holdings of over 7 ha; thus, title to 366,000 ha of the total of 825,000 ha farms occupied by such tenants has been trans- ferred. The Government has raised the cash portion of the compensation pack- age to landlords to reduce their resistance to land reform, but strong ad- ministrative efforts will be necessary to ensure continued progress in the implementation of the program. 9. Industry accounts for almost 30 percent of net domestic product, one-third of total fixed investment and 15 percent of total employmeent. In- dustrial production, whi-h grew hy 12 percent in 1973, was adversely affected in 1974 by the world-wide economic slowdown and grew by only 3.6 percent in  1975. This decline is primarily a result of depressed demand for Philippine exports on the part of the country's main trading partners and the concomitant slowdown in the rate of economic growth in the Philippines. Nonetheless, the long-term prospects for industrial growth are favorable because of the natural and human resource endowment of the Philippines and a very active private sector. 10. The Government has made significant progress in increasing public investment. The ratio of public investment to GNP is currently about 3 per- cent compared with 1.8 percent in FY72. The Government has also implemented a series of long needed tax reforms and improvements in tax administration. These reforms, aided by the increased economic activity, the boom in export incomes, and domestic inflation, resulted in a 36 percent increase in national government tax revenues in FY73, and an estimated 47 percent in FY74. As result, the ratio of national government tax revenues to GNP has increased from an average of 9 percent in recent years to an estimated 12.3 percent in FY74 and stayed at this level in FY75. 11. Significant financial reforms have also been enacted. At the begin- ning of 1976, the Central Bank issued circulars designed to help rationalize the level and structure of deposit and lending rates, and deposit rates were raised for the second time in 18 months; long-standing statutory ceilings on the long-term lending rates of banking institutions were increased from 12-14 percent to 19 percent per annum, and the ceilings on short-term lending rates were also raised. Efforts were also made to control short-term money market operations and strengthen the organized banking institutions. These actions are important steps in improving the mobilization and allocation of domestic resources in the Philippines. 12. In the latter part of 1973, inflation emerged as a major problem in the Philippines and in 1974 consumer prices rose by almost 40 percent. The rise was caused by the large increase in liquidity that came with the export boom in 1973-74, and by a number of cost-push factors, including the higher rate of world inflation. To deal with this problem, the Government adopted contractionary monetary and fiscal policies, and attempted to reduce the impact of inflation on consumers by subsidizing such essential goods as wheat, imported rice, and cooking oil. As a consequence of the Government's measures, the annual rate of inflation decreased to less than 20 percent at the end of 1974 and less than 10 percent in 1975. 13. The rapid inflation in 1974 exacerbated the decline in real wages which had begun in 1970. Overall, there was a decline of about 20 percent in real wages during 1974. In order to offset the deterioration of real wages in urban areas, the Government increased the salaries of Government employees and directed private firms to grant emergency cost of living ad- justments to employees earning less than P 600 per month. Nevertheless real urban wage incomes declined and reduced the demand for manufactured products, which contributed to the poor performance of the manufacturing sector in 1974. The depression in the urban areas was partly offset by the improvement in rural incomes that stemmed from continued high prices for agricultural commodities.  14. On the external side, the Philippine balance of payments bene- fitted considerably from the international commodity price boom during 1973. High prices for the country's chief exports, including coconut products, sugar, copper and wood products resulted in a 70 percent boost in export earnings and a balance of payments surplus of about $670 million. Since mid-1974, the external trade position has deteriorated, due to the sharp increases in the prices of oil and other imports, less favorable prices for Philippine exports, and reduced volume of some exports resulting from the recession in the economies of the Philipines' main trading partners. As a result, the overall balance of payments surplus fell to about $100 million in 1974, and a deficit of about $400 million was recorded in 1975. International reserves stood at around $1.1 billion at the end of 1975, the equivalent of about three months imports. 15. The outlook for 1976 is for exports to increase by about 12 percent in real terms on the assumption that there will be some international economic recovery. Imports will need to grow by about 7 percent in real terms in order to maintain the growth of the economy. Due to a modest deterioration of the terms of trade, the current account deficit may reach about $1.0 billion compared to $860 million in 1975. Medium and long term capital inflows are expected to finance most of this deficit, producing an overall balance of payments deficit of about $200 million. Such a deficit can be managed without serious pressure on reserves through utilization of IMF facilities and by short-term foreign borrowing by the Central Bank. 16. The overall level of debt of the Philippines is expected to remain within reasonable limits, as the ratio of debt service payments to exports and non-factor services would average about 16-17 percent during the rest of this decade. At present, the Bank/IDA share in total debt outstanding is about 10 percent and its share in debt-service is about 4 percent. These shares are expected to increase somewhat in the years ahead. 17. Foreign assistance on concessional terms will be essential to help to finance the larger investment expenditures which will be necessary for the country's development. In order to ensure that disbursement of external assistance reaches levels commensurate with the level of development expend- itures which will be required during the latter part of the decade, total commitments of official assistance will need to be maintained in real terms at least at the level of about $500 million which was achieved in 1974. The Consultative Group for the Philippines at its meeting in Paris on October 1, 1975, agreed that it would be reasonable for the Philippine Government to seek aid commitments of about $600 million during 1976; another meeting of the Consultative Group has been called for June 15 and 16, 1976 mainly to review prospects and needs over the next 5-10 years, which were analysed in the Bank's most recent economic report. Growth Prospects 18. Despite the slowdown in the growth of the economy, which is primarily a result of worldwide economic conditions, the Government remains committed  to regaining the growth momentum which began in 1973 to provide for a con- tinued increase in incomes and employment. High priority must be accorded to expanding employment opportunities - in the short-term as well as the long-tenm - because unemployment and underemployment are still high, and the labor force continues to grow at 3 percent a year. 19. Priority must also be given to expanding food production for the domestic market, to expanding industrial export production and to accelerating development 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 self-sufficiency in rice and corn as soon as possible. The Govern- ment rightly recognizes that the increased cost of petroleum and other imports cannot be financed indefinitely by borrowing abroad, and it is active- ly encouraging both local and foreign investors to expand the productive capacity of export 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. Because of the substantial easing of the external debt burden which has taken place in the last several years, the Philippines now has the capacity to borrow externally larger amounts of capital on appropriate terms to support its development program. 20. Given the likely availability of resources and the expected growth in various sectors, it is reasonable for the Government to plan for a longer term growth in GNP of about 7 percent a year in real terms. To achieve this objective, increased investments will be necessary in a wide range of industries. Public investments also need to be increased. A new public infrastructure program is being prepared, and the Government is putting emphasis on developing nuclear and indigenous power sources and on irrigation, feeder roads and other projects to support increased food production. The Government has made considerable progress in recent years in building up the capacity of public sector agencies 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 will need to rise from the present level of 3 percent to at least 5 percent by 1980. To support this level of investment, the Government will need to intensify its tax efforts so that the ratio of national taxes to GNP continues to rise from its present level of 11-12 percent to 14 percent by 1980. 21. The Government's ambitious development program will continue to require foreign resources in addition to the capital which would become available for the financing of the foreign exchange component of develop- ment projects. Some financing of local costs is justified, especially for projects of economic and social importance which need only limited amounts of foreign exchange. In view of the Philippines balance of payments and ex- ternal debt position, and taking into account the country's performance in economic development and its relatively low per capita income, the Philip- pines is considered eligible for Third Window loans from the Bank. One Third  - 6 - Window loan of $25 million for the Third Education Project has already been approved by the Executive Directors, and one additional Third Window loan of $10 million is proposed as part of the financing for the Manila Urban Development Project. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 22. By April 30, 1976, the Philippines had received 35 Bank loans and 3 IDA credits totalling $886.7 million, net of cancellations. About 33 per- cent of the Bank/IDA lending, $293 million, has been for infrastructure proj- ects in power, transportation, and water supply and $63 million has been for population and education projects. Of the remainder, about $280 million has been for agriculture and about $250 million for industry. 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 on-going projects are now being implemented reasonably well. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of March 31, 1976 and notes on the execution of ongoing projects. 23. The Bank's lending program has been designed to continue to support the 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 of $165.1 million in FY74 and $208 million in FY75 compared to an average of about $30 million a year in the preceding five years. 24. Five loans totalling $212 million have so far been approved in FY76. This proposed loan for the Second Grain Processing Project, which is being presented at the same meeting as a proposed loan for the Second Fisheries Project, and proposed loans for the Manila Urban Development Project, which may be also be presented before the end of this month, are the last loans for the Philippines scheduled for consideration during this fiscal year. Loans for a highways and a power project may be ready for presentation to the Executive Directors in the first half of FY77. 25. IFC has made commitments in the Philippines totalling $76.2 mil- lion for investments in 13 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 March 31, 1976, $19.1 million had been sold, $0.4 million cancelled and $3.7 million repaid, leaving a net portfolio of $53.0 million. On the same date, all commitments were fully disbursed. Preliminary proposals have been received for an aluminium smelter and other projects in the pulp and paper, dinnerware, metal alloys and shipbuilidng fields.  PART III - THE AGRIACULTURAL SECTOR 26. Agriculture is the predominant sector in the Philippine economy accounting for approximately one-third of the gross national product, about one-half of total employment and about 70 percent of export earnings. Over 70 percent of the total land under cultivation is used for production of cereals, almost exclusively rice and corn. Much of the remaining land is taken up by export crops including sugar, coconuts, abaca, pineapples and tobacco. 27. The performance of the agricultural sector will be crucial in determing whether the Philippines can increase income both rapidly and equit- ably. At present, the domestic market for industrial products is const-r-led by relatively low rural incomes. Although in recent years there has been i substantial change in the internal terms of trade in favor of agriculture the problems of poverty and income distribution continue to be particularly acute in the rural areas; of the 15 million people in the bottom 40 percent of the income scale, 12 million live in rural areas at or below the minimum sub- sistence level 1/. The Government is aware of these problems and is dealing with them by increasing investment and institutional support in the agricul- tural sector, implementing the land reform program and initiating a number of other rural development programs. 28. A major Government objective is to increase rice and corn produc- tion as a means of increasing incomes of small farmers and attaining national self-sufficiency in foodgrains. Rice production increased rapidly in the 1960s, primarily due to the introduction of high yielding varieties (HYVs), but production was adversely affected during the early 1970s by unfavorable weather conditions and crop disease. In the past two years, rice yields have recovered and production has increased. Attaining self-sufficiency in rice will depend to some extent on bringing additional land under cultivation, but largely on improving yields through expansion in the area under irrigation, increased use of HYVs and other agricultural inputs and the provision of adequate credit and supporting services. Corn production, which is con- centrated in Mindanao, has increased by about 5 percent a year during the 1970s, mainly due to the expansion in the area under cultivation. The Philippines has long been self-sufficient in corn for human consumption, but has become a steady importer of corn for animal feed. 29. Rice and corn mills in the Philippines are predominantly privately owned, although the National Grains Authority (NGA) is starting to build up its own capacity. The millers are virtually all small- to medium-sized local entrepreneurs, operating usually one and seldom more than two or three mills. Even the larger mills are generally family operations. The two main types of entrepreneurs are the very small millers, who process grain 1/ The per capita income in the Philippines necessary to sustain a minimum subsistence level in 1971 was estimated to be $140 equivalent.  - 8 - for a fee, and the larger millers, who trade in grain. The latter often provide credit to farmers and small grain traders as a means of helping ensure an adequate supply of grain for their mills. Because there are many relatively small mills, which need to procure adequate grain for efficient operation, the industry is competitive in most areas of the country. 30. To support the Government's rice and corn production programs, substantial investments in grain processing facilities will be necessary to provide the drying, milling and storage capacity needed to accommodate in- creased production and to reduce the very substantial losses which presently occur between harvest and final consumption. When harvests are good, trans- portation bottlenecks develop and grain storage shortages are severe, partic- ularly in the southern areas of the country. At present, about 95 percent of grain is sun dried, which often results in high grain losses. Small mecha- nical grain driers are not viable financially and the best means of expanding mechanical drying is to introduce larger units in the rice and corn mills. Overall rice milling efficiency is low because 35 percent of paddy production is milled by the oldest type of mechanical mill (kiskisan) 1/, which provides recovery rates of only about 60 percent compared to the more modern types of mills (cono 2/) with recovery rates of 65-69 percent. About one-third of corn milling is done by traditional grinders and the remainder by more efficient roller mills. Total corn milling capacity is adequate for present production, but additional milling capacity will be needed where corn production is increasing rapidly, especially Mindanao. 31. The Philippines has developed efficient cono rice mill and roller corn mill equipment manufacturing industries. Domestic mills cost approxi- mately half as much as comparable imports; however some components, including rubber hullers, are still imported. 32. In February 1971, the Bank made a loan of $14.3 million to the Government for a first Rice Processing and Storage Project (Loan No. 720-PH) to assist the Development Bank of the Philippines (DBP) initiate a program of long-term lending to help expand and modernize the grain processing in- dustry. The project was originally designed to help finance construction of integrated modern rice processing mills, including bulk silos and automated grain handling facilities. Sub-loan demand initially did not materialize because the integrated mills proved to be too large and too capital intensive for the Philippine context. Furthermore, grain production fell sharply during the first two years of project implementation, which contributed to a reduction in the demand for sub-loans for grain processing. The project was revised in March 1972, and in May 1974 to permit sub-loans for improvement of existing rice and corn mills, financing of other post-harvest equipment, smaller sub- 1/ A kiskisan mill performs hulling and polishing in a single operation. 2/ A cono mill performs hulling and polishing in two separate operations.  - 9 - loans and sub-loans for certain public entities (SecM 74-244). Since mid-1974, sub-loan approvals have been made at a rapid pace. As of February 20, 1976, DPB had approved 132 sub-loans amounting to about $12 million, had disbursed $4.4 million, and had 30 outstanding applications for sub-loans totalling $4.3 million. The Bank loan is expected to be fully committed by June 30, 1976 and fully disbursed by the revised Closing Date, June 30, 1977. Of the total amount of sub-loans approved, 49 percent is for three large corn silo/ feed mill complexes, 39 percent is for rice mills, 10 percent for corn mills and 2 percent for small feed mills. Most of these sub-projects are being successfully implemented. 33. Under the first project, DBP has developed considerable expertise in lending for grain processing and thus has become the major source of the long-term credit and technical assistance needed to foster the development of the industry. The project has met the need for bulk silos for feed mill complexes and enabled rice and corn production to expand into new areas, particularly in Mindanao. In addition to helping to expand and modernize milling, drying, and storage facilities, the project has supported the develop- ment of the domestic rice and corn mill equipment manufacturing industry. The proposed second grain processing project would help DBP to improve and expand further its lending program for grain processing and thus help support the Government's grain production program. As a result of the experience gained through the first project, several changes have been made in the proposed project. It would de-emphasize large integrated grain mills and bulk silos which initially formed the core of the first project, and would concentrate on raising milling efficiency through the financing of more conventional, medium-size mills equipped with improved milling and ancillary equipment. Any unanticipated future need for large bulk silo facilities would be met under another Bank-financed project, the Second Industrial Investment Credit Project (Loan 1190-PH), approved by the Executive Directors on December 16, 1975 (SecM 75-239). Small on-farm driers have also been excluded for the present because they remain financially unviable due to high operating costs caused principally by the increase in oil prices. The proposed project would also assist DBP to establish an improved reporting system and to improve sub-loan collections. PART IV - THE PROJECT Background 34. The purpose of the proposed project is to help provide the milling, drying, storage and transportation facilities needed to increase the supply of rice and corn in the Philippines by reducing post harvest losses and inducing increased production in areas now without adequate processing facilities. Some of the rice mills would replace old inefficient mills, and the balance of the rice mills and the corn mills would help meet the milling requirements of areas with rapidly increasing grain production and areas with inadequate milling capacity. The project would help improve rural incomes by providing more secure and competitive outlets for farmers' products. It would also help  - 10 - DBP to continue to improve the standards of its lending operations in this sub-sector. The project was prepared by DBP. A Bank mission appraised the Project in August/September 1975, and negotiations were held in April 1976. His Excellency Eduardo Z. Romualdez, the Philippine Ambassador to the United States, led the Government's negotiating team. The Appraisal Report (No. 1045b-PH) on the proposed project is being circulated separately to the Executive Directors. Annex III provides a loan and project summary. Description of the Project 35. The project is expected to finance about 135 rice mills and 20 corn mills and associated mechanical and solar driers, warehouses, trucks and ancillary equipment. The distribution of mills by size is expected to be similar to those financed under the first project. About one half of the rice mills would be in the medium-size range of about one ton per hour capacity, and the remainder divided equally between half-ton and two-ton mills. All of the rice mills would be cono types and all of the larger ones would be equipped with more efficient rubber hullers, in addition to the traditional stone hullers. The bulk of the corn mills would also be in the one-ton range, but about six would have five-ton capacity. All rice and corn mills would have solar driers, and the larger mills would also have mechanical driers. All mills would have their own warehouses, and all, except the half-ton mills, which would be designed to serve an immediate local area, would have their own transport facilities. The rice mills would be fairly widespread geographically, while most of the corn mills would be in Mindanao. 36. The rice mills are expected to operate about 2,000 hours per year, about the national average for cono mills. Their combined throughput would be about 300,000 tons of paddy per year, which is about 4.3 percent of pro- jected 1979 rice production in the Philippines or 33 percent of projected incremental production between 1976 and 1979. The corn mills would operate about 2,500 hours per year, and would mill about 110,000 tons of corn per year, which is about 3.7 percent of projected 1979 corn production or 37 percent of projected incremental production between 1976 and 1979. 37. The project would also include assistance to the Department of Agriculture to undertake a study of post-harvest grain losses, which would identify more precisely the causes and extent of grain losses between harvest and final consumption and would recommend a program of action to reduce these losses. The terms of reference for the study would be agreed with the Bank and the findings submitted to the Bank for review (Section 3.09 of the Loan Agreement). Project Execution 38. As under the first Rice Processing and Storage Project, the credit component of the proposed project would be administered by DBP, a wholly Government-owned development bank which operates in all sectors of the eco- nomy. It is the largest and most important institutional source of long-term finance in the Philippines. Since its inception in 1958, it has provided  financial assistance, including ioan guarantees, totalling nearly $3 billion and, as of June 30, 1975, its total assets amounted to $1 billion equivalent. DBP's lending operations have increased parttcularly rapidly in FY75 and reached a level of $320 million, compared to $39 million in 1974. This increase more than offsets a deliberate reduction in DBP's guarantee opera- tions, which decreased from $373 million in FY74 to $106 million in FY75. Equity investments, mainly in Government enterprises, were approved total- ling $28 million in FY75, a much higher level than in the previous year. The volume and diversity of its operations give it a prominent and unique role in financing development programs. DBP has administered a number of Bank-assisted projects in the industrial, shipping, and agricultural (fish- eries, livestock, and rice processing) sectors; the implementation of these projects has been satisfactory. 39. DBP's overall capabilities and financial position were described in detail in the President's Report (SecM 75-239) on the proposed loan for the Second Industrial Investment Credit Project (Loan No. 1190-PH), approved by the Executive Directors on December 16, 1975. Since then DBP's present management has continued successfully to strengthen the institution and raise the standards of its operations. As a result, noticeable improvements are taking place in the functioning of individual departments and in operational and financial planning. DBP has a total staff of about 3,000, over half of whom are located in branch offices. The calibre of the staff is generally good, although there still remains a need for greater depth at the middle management level. 40. DBP's financial position is reasonably sound. Its liquidity position is secure (current ratio 2:1) as is its long-term capital structure (long-term debt-equity ratio 4.5:1). In order to increase DBP's long-term domestic resources, the Government is taking actions, agreed with the Bank, to increase DBP's equity and convert $53 million of short-term Treasury deposits into a loan with a five-year maturity. DBP's net income for FY75 was $10 million, a decline of 21 percent from the previous year. The dec- line in income reflected mainly a decline in collections, as a result of the effects of the economic downturn in FY75 on many of DBP's clients. To improve its financial position, as agreed with the Bank, DBP in January 1974 increased interest rates, penalty charges and fees; is now introducing prompt reminder procedures for overdue accounts and is planning steps both to improve its system of reporting and recording arrears and to improve its collection performance on industrial accounts. 41. The Grain Processing Division (GPD) in the Cereals Group of DBP would be responsible for the processing of sub-loans financed under the project. It has a division chief and a staff of four engineers, two financial analysts and one economist. Three of the engineers began work in early 1975 in line with the recommendation of a Bank supervision mission. Although GPD's ap- praisal standards have improved considerably, it needs additional trained staff in order to improve the analysis of the economic and marketing aspects of sub-projects; GDP is taking steps to recruit additional staff in these areas of expertise to fill positions recently authorized. The proposed pro- ject would entail only a very moderate increase in the rate of sub-project  - 12 - commitments experienced under the first project and GPD should therefore be able to carry out the proposed project effectively. A summary of operating policies and procedures for sub-loan administration under the project is set out in Schedule 3 of the draft Loan Agreement. 42. Loan collection has been a serious problem in DBP's operations in the grain processing sector due in part to poor appraisal work and inadequate collection efforts. As of December 31, 1975, DBP had 806 loans outstanding for grain processing totalling $13.3 million equivalent, of which $7 million equivalent or 54 percent was overdue. DBP has also had to advance $6.6 mil- lion on two rice mills whose supplier credits it guaranteed, and is liable for an additional $1.3 million. DBP is aware of these problems and has undertaken to review its grain processing portfolio, prepare a detailed plan of action for reducing arrears by June 30, 1977 for discussion with the Bank, to im- plement the plan thereafter in accordance with a timetable to be agreed with the Bank and to provide arrears information to the Bank with DBP's regular quarterly reports (Section 4.06 of the Loan Agreement). 43. To improve its overall reporting and monitoring systems, GPD is introducing a system of reports from all project sub-borrowers showing, on a monthly basis, the utilization of milling, storage and drying facilities (Section 3.08 of the draft Loan Agreement). The form of these reports has been discussed with the Bank and summary information would be forwarded to the Bank. In addition to the information on the utilization of project facilities, DBP's quarterly reports to the Bank would also include summary data on sub- loans applications, approvals, disbursements and repayments; working capital loans; and civil works and equipment procurement (Section 3.07 of the Loan Agreement). Project Cost and Financing 44. The total cost of the project is estimated to be $28.5 million, including working capital requirements of $3.8 million; the estimated foreign exchange cost is $11.2 million. Cost estimates include price contingencies amounting to 31 percent of base line costs to take into account the effects of international and domestic inflation expected during the project implementation period. The proposed Bank loan of $11.5 million would finance the estimated foreign exchange cost of the sub-loans made by DBP under the project and the full amount of expenditures to be agreed between the Bank and the Government for the post-harvest grain losses study, including the cost of local consul- tants. These agreed expenditures would not include normal Government bud- getary costs associated with administering and carrying out the study. The loan would have a term of 18 years, including a grace period of 5 years. The loan would be made to the Government, which would relend $11.2 million of the proceeds to DBP on the same terms as those of the Bank loan. The Government would bear the foreign exchange risk. The execution of a subsidiary loan agreement, satisfactory to the Bank, would be a condition of effectiveness of the proposed loan (Section 5.02 of the Loan Agreement). The balance of the loan of $300,000 would be used by the Department of Agriculture to finance a study of post-harvest grain losses.  - 13 - 45. DBP would lend the proceeds of the Bank loan, together with funds from its own resources, to private individuals and corporations with prior experience in the grain industry. Each sub-borrower would contribute from his own resources at least 20 percent of the investment cost of each sub-project. Sub-loans would have a maximum repayment term of 14 years, including a maximum of two years of grace. DBP would provide out of its own resources working capital loans needed by sub-borrowers to finance their requirements during the sub-project implementation period (Section 3.04 of the Loan Agreement). Sub-loans, including working capital loans to the same sub-borrower, of more than $600,000 would be subject to the prior approval of the Bank and the minimum sub-loan size would be $4,000. It is expected that with this free limit about 10 percent by number and 30 percent by amount of the sub-loans would be subject to the Bank's prior approval. Interest rates on sub-loans and working capital loans would be in accordance with DBP's interest rate policy; at present DBP charges 12 percent for loans secured by land and 14 percent for loans secured by other forms of collateral but an increase in these rates is being considered in close consultation with the Bank. In addition, subloans over $400,000 equivalent would be subject to a service charge of up to 2 percent per annum of amounts outstanding to cover DBP's costs of sub-loan appraisal and supervision. Procurement 46. Civil works contracts of more than $200,000 would be awarded by sub-borrowers on the basis of international competitive bidding in accordance with Bank Group Guidelines. As under the first project, DBP would be permitted to prequalify contractors after international advertisement and would update its lists of prequalified contractors at intervals of not more than eighteen months. Civil works contracts of between $100,000 and $200,000 are not ex- pected to attract foreign bidders because the works are small and geographic- ally scattered; sub-borrowers would, therefore, award such contracts on the basis of competitive bidding advertised locally in accordance with acceptable procedures. For civil works contracts of less than $100,000, sub-borrowers would select contractors through ordinary commercial channels with due regard for economy and suitability. 47. Procurement of equipment and materials would not be suitable for international competitive bidding because of the need to take into account sub-borrowers justified preferences for particular types of equipment and to permit them to purchase spare parts and additions to their existing equipment. To reflect sub-borrowers preferences for equipment and to take advantage of competition among suppliers, procurement would be on the basis of quotations received from prequalified suppliers. For this purpose, DBP would advertise internationally, inviting firms to indicate their capabilities and interest in being included in the list of prequalified suppliers for goods likely to be financed under the project; the list would be updated annually. For equipment estimated to cost over $20,000 DBP would send the full list of prequalified suppliers to all sub-borrowers, and require them to obtain written quotations from at least three of the prequalified suppliers on DBP's list and to justify to DBP any selection other than the lowest bidder. In addition, for equipment  - 14 - estimated to cost $100,000 or more, DBP and the sub-borrower would together establish the design criteria and performance specifications required. Equipment estimated to cost less than $20,000 would be procured through normal commercial channels with due regard for economy and suitability. Disbursement 48. The proposed Bank loan would be disbursed over four and one-half years. The Bank would reimburse 56 percent of DBP's disbursements for sub- loans (excluding working capital) to project beneficiaries, against support- ing evidence of disbursements by DBP; and would disburse against 100 percent of the agreed expenditures for the post-harvest grain losses study. Benefits and Justification 49. The proposed project would continue the process of replacing old or inefficient mills by modern, high recovery mills, and would help pro- vide the milling, drying, storage and transport facilities needed to support increased rice and corn production in the Philippines. The proposed project would also help improve rural incomes by providing more secure and competi- tive outlets for farmers' products. It would cause virtually no degradation of the environment. 50. At full development, the 135 rice mills and 20 corn mills to be financed under the project would produce annually 207,000 tons of milled rice with a wholesale value of $48 million, 72,000 tons of milled corn with a value of $11.4 million and 60,000 tons of by-products (mainly bran) with a value of about $7 million. The improved facilities would reduce post- harvest grain losses by an estimated 17,000 tons of grains per year, would increase rice milling recovery rates resulting in a net increase of about 7,000 tons of milled rice per year, and induce increased production of about 21,000 tons of grains in areas now without adequate processing facilities. The project is expected to result in foreign exchange savings of about $11 million per year. The estimated financial rates of return on invest- ments vary from 25 percent for one ton capacity rice mills to 28 percent for the corn mills, with a weighted average of 27 percent. The correspond- ing economic rates of return range from 16 to 30 percent, with an overall weighted average for the project of 28 percent. 51. In addition to these quantifiable benefits, the project would continue to help DBP's Grain Processing Division to improve further its appraisal and supervision procedures and its collection performance. During the project implementation period, particular emphasis would be given to improving the economic and marketing analysis of projects, reporting and monitoring procedures and loan collection methods. The post-harvest grain losses study is expected to assist Government in identifying more precisely the causes and extent of such losses and to develop long-term programs for reducing them.  - 15 -- PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. 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 a draft reso- lution approving the proposed loan are being distributed separately to the Executive Directors. A subsidiary loan agreement, satisfactory to the Bank, would be entered into between the Borrower and DBP, and its execution would be a condition of effectiveness of the Loan Agreement. The draft Loan Agree- ment conforms to the pattern for previous loans for lending programs carried out by DBP. The operating policies and procedures governing the onlending of the proceeds of the loan are set forth in Schedule 3 to the draft Loan Agreement. 53. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 54. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments May 13, 1976   ArNNE I P.g. I of 4 page. TABLE SA PHILIPPONESSOCIAL_ONDICATIRS_SATA SUEET LAMB AREa (THOU RN2) ~ ~ ~ ~ ~ ----- -- - ~~~~~~~~~~~~~PHILIPPINES REVEBENCE COUNTRIES (1910) TOTAL 3 00.0 RUOST RECENT ARAOA.E ..1960 1976 ESTIMATE TNAILANO PUI SET KOREA, REP, OF * !!P PER CAPITA (USA)13. 22. 20. 60 400 270 POPULATION AND VITAL STATISTICS POPULATION (PIDO-R. MILLION) 27.4 36.9 40.2 36.3 35.2 31.4 POPULATIO N OEMSt PER SQARE R.91.0 123.0 134.0 71.0 45.0 319.0 PER :UUARE KM.: ARABLE LAND ..140.0 749.o VITAL STATISTICS CRUDEaBIRTH R ATE PER THOUSAND .. 45.0 44.0 43.0 38.0 /a 26.0 CRUDE DEATH RATE PER THCUSANSD .. 12.0 11.0 10.0 1i.c 7- e.0 INFAMT MORTALITY RATE 0HOU) .. 6.0 66. 6.0 145.0 LIE ECTTAC T IT AY5O10 a