Document of The World Bank FOR OFFICIAL USE ONLY FILE COPY Report No. 1892a-CE SRI LANKA TREE CROP REHABILITATION (TEA) PROJECT STAFF APPRAISAL REPORT May 12, 1978 Agriculture Division B South Asia Projects Department This dotcAment has a restricted distribution and may be used by recipients only in the performance of their efkicial duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS US$1 = Rupees (Rs) 16 Rs1 = US$0.06 WEIGHTS AND MEASURES (the metric system was recently adopted) 1 kiLometer (km) = 0.62 miles 1 meter (m) = 1.09 yards 1 kiLogram (kg) 2.2 pounds 1 hectare (ha) 2 = 2.47 acres 1 square metre (m ) 10.76 square feet SRI LANKA FISCAL YEAR January 1 - December 31 ABBREVIATIONS CIDA - Canadian International Development Agency FBD - Fluid Bed Drier GOSL - Government of Sri Lanka ICB - International Competitive Bidding JEDB - Janatha Estates Development Board LRC - Land Reform Commission MPI - Ministry of Plantation Industries PC - Project Coordinator PCC - ]?roject Coordinating Committee SPC - State Plantations Corporation TSDA - Tea Smallholdings Development Authority TRI - Tea Research Institute VP - Vegetative Propagation GLOSSARY Broken Orange Pekoe (BOP), BOP Fannings (BOPF), and DUST I are among top tea grades. They are listed in descending order of particle size. Ability to vary grade proportions permits responsiveness to changing market conditions. Clonal or vegetatively propagated tea gardens outyield seedling tea because the bushes are identical and selected from superior mother bushes; seedling tea is heterogeneous and contains poor yielding bushes. FOR OFFICIAL USE ONLY SRI LANKA TREE CROP REHABILITATION (TEA) PROJECT Table of Contents Page No. I. SECTOR BACKGROUND ............................. I II. PROJECT AREA .................................. 5 A. General .................................. 5 B. Tea Production ........................... 7 III. THE PROJECT ................................... 9 A. Objectives and Brief Description ......... 9 B. Detailed Features ........................ 10 IV. PROJECT COSTS AND FINANCING ................. .. 18 A. Cost Estimates ........................... 18 B. Financing ................................ 19 C. On-lending Arrangements .19 V. PROJECT IMPLEMENTATION ............ .. .......... 20 A. Organization and Management .... .......... 20 B. Estate and Factory Rationalization ....... 26 C. Implementation Schedule ..... ............. 26 D. Procurement and Disbursements .... ........ 26 E. Accounts, Audits and Monitoring .......... 29 VI. PRODUCTION, MARKETING AND FINANCIAL RESULTS ... 30 VII. ECONOMIC BENEFITS AND JUSTIFICATION .... ....... 34 VIII. RECOMMENDATIONS ............................... 36 This report is based on the findings of an IDA appraisal mission to Sri Lanka in October/November 1977, comprising Messrs Thornley, Aitken (IDA), and Taylor (Consultant). 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- CONTINUATION - Table of Contents SCHEDULE A - Project Lending Terms and Conditions CHARTS Implementation Schedule Procurement Schedule ANNEXES 1 Detailed Cost Tables 2 Production Projections 3 Financial Price Projections 4 Cash Flow Projections (JEDB, SPC, GOSL, Sraallholder, Bank of Ceylon) 5 Economic Analysis 6 Se]Lected Documents and Data Available in the Project File MAP IBRD 13'382 SRI LANKA TREE CROP REHABILITATION (TEA) PROJECT I. SECTOR BACKGROUND The Agricultural Sector The Role of Agriculture in the Economy 1.01 Agriculture plays a major role in Sri Lanka's economy, accounting for 37% of GDP, 55% of total employment, about 80% of export earnings and a large share of public revenue. Approximately 80% of the country's total population lives in rural areas. Thus economic growth in the country depends largely upon performance in the agricultural sector. During the 1960's, con- siderable progress was made in increasing food production as GOSL pursued a firm policy of increasing food self sufficiency. Paddy production expanded from 840,000 tons to 1.6 M tons (6.5%/year), as a result of area expansion (175,000 ha), increasing yields - from 725 kg/ha to 1,050 kg/ha - and in- creased cropping intensity. After 1970 area expansion continued at a similar rate but yields and cropping intensity declined so that production grew at only 0.7%/year. Major reasons for the fall-off in productivity were farm power shortages - reflecting foreign exchange constraints - and high fertilizer prices. However by 1977 Sri Lanka was 68% self-sufficient in rice compared with 50% in 1960. 1.02 While GOSL's basic policy of promoting food production was sound it was unfortunately combined with systematic neglect of the tree crop sector, which in the early 1960's accounted for over 90% of the value of merchandise exports. During the 1960's production grew at only 1% per annum, and that mainly from rubber which was benefiting from substantial replanting in the early 1950's. Since 1970 conditions in the tree crop sector have further deteriorated, with output of tea, rubber and coconuts all tending downward. Declining quality has also been evident, especially in the tea industry. The disappointing production trends in the tree crop sector were primarily a reflection of declining profitability, associated with lower prices and high taxes, the uncertainties associated with GOSL land reforms and inadequate foreign exchange allocations for vital inputs such as fertilizer and spares and replacements for machinery and vehicles. 1.03 The importance of the traditional export crops (tea, rubber and coconut) lies not only in the fact that, in the foreseeable future, they will continue to be the main source of foreign exchange earnings, but also in their vital importance for all aspects of the economy. These three crops account for 70 to 80% of export earnings, about 45% of agricultural employment, 40% of the value added in the agricultural sector, and in addition, are expected to contribute about 50% of government revenues according to the 1978 budget. Tea alone accounts for approximately half of the value of the country's total merchandise exports. -2- Land Reform 1.04 The first phase of land reform, initiated in 1972, limited private holdings to: (i) 25 acres if exclusively paddy land or (ii) 50 acres if not exclusively paddy land, with paddy land not to exceed 25 acres. In the first phase takeovers, implemented in 1973 through 1975, about 225,000 ha of land were vested in rhe Land Reform Commission (LRC). Of this about 60% was under tree crops which included about 23% of the total tea area, 15% of the rubber area, and about 10% of the coconut area. The State Plantations Corporation (SPDC), under the Ministry of Plantation Industries (MPI) was given about 40 of the larger well--maintained tea and rubber estates, covering about 10% of the tree crop land taken over. The management of most of the remainder was placed in the hands of cooperatives. 1X05 In the second phase, initiated in October 1975, all land owned by Sri Lankan and foreign companies, which included the country's major tea and rubber estates, was vested in the LRC. About 65,000 ha were assigned to SPC and nearly 95,000 ha to the Janatha Estates Development Board (JEDB) which was established for the purpose under the Ministry of Agriculture. The com- pensation tenrms for foreign-owned plantations were agreed in 1976 and payments have commenced. Comipensation negotiations for rupee company a-nd private estates are still in progress. 1.06 Of Sri Lanka's 240,000 ha total tea area, nearly 135,000 ha (56%) are: vested in the LRC. In late 1977 the management of much of this land was significantly rationalized. JEDB was transferred to MPI and the Upcountry Estate Development Board and Electorate Level Cooperatives, which had mis- managed the estates they controlled, were disbanded and their estates divided between JEDB and SPC. Now, over 70% of the tea estate land vested in the LRC is managed by governTrent corporations with most of the remainder still managed by various cooperative groups. In addition, tea smallholders own 48,000 ha (average holding 0.39 ha) and 42,000 ha are owned by individuals with an average holding of 15 ha. The Tea Industry 1.07 Tea production in Sri Lanka rose from 100 M kg in 1933 to an average level of 223 M kg over the four years 1965 to 1968. Since 1969, production has never exceeded 218 M kg and in the last three years (1974-76) has averaged 205 M kg. This deterioration in output is partly attributable to drought, but mostly to a policy induced neglect of the sector, which has resulted in inadequate replanting, fertilization and weeding, and other pocr management practices. Fertilizer use, for example, declined steadily from 43,000 tons of nutrients in [965 to 24,000 tons in 1973, and then recovered slightly to 30,000 tons in 1975. This low usage was due to pre-nationalization uncertain- ties, rising fertilizer costs, low returns, the transfer of fertilizers from tea to other crops, and persistent drought. Fertilizer availability to the tree crop sector may improve in the post- nationalization phase, but neglect of replanting, particularly in the mid 1970s, will continue to affect produc- tion adversely over the next decade. Thus, for example, even on an optimistic calculation, 70% of the tea bushes in Sri Lanka in 1985 will be over 50 years old, and as much as 50% will be over 70 years old. - 3 - 1.08 Nearly 90% of the country's tea lands are planted to seedling tea. The rate of replanting with higher yielding clonal tea has fallen from a peak of 2,770 ha in 1970 to 890 ha in 1976 in spite of subsidies, because of land reform uncertainties and temporarily higher prices which discouraged uprooting of old tea. Government's replanting goal, of 3,000 hectares per year, is unlikely to be realized before the early 1980s and tea output in 1990 is expected to be in the region of 227.0 M kg, still below the 1965 peak of 228.2 M kg. 1.09. Institutions. The Sri Lanka Tea Board was created in 1975 with wide powers including: sales promotion; advising government on tea policy; administering tea subsidies; collecting and collating industry statistics; and, through its agency the Tea Research Institute, carrying out tea research. The Chairman is appointed by the Minister of Plantation Industries, the Secretary of the Ministry is an ex officio Board member. A Tea Smallholdings Development Authority was established in 1976, responsible for overseeing tea growers who do not have their own manufacturing facilities. Its major func- tions are to provide extension advice and to ensure that smallholders receive fair treatment from greenleaf buyers. However it is poorly staffed and has barely started work. 1.10 SPC and JEDB between them manage 105,000 ha of tea estates (SPC 45,000 ha and JEDB 60,000 ha). Their chairmen are appointed by, and respon- sible to, the Minister of Plantation Industries. Policy making, marketing, financial control and input supply functions are centralized in Colombo, while responsibility for day-to-day management is decentralized to regional offices. Largely because of recent high tea prices, it is projected that the 1977 trading profit for SPC will be about Rs 77 M (US$5.0 M) and for JEDB, Rs 106 M (US$7.0 M). 1.11 Marketing. Over 90% of Sri Lanka's tea production is sold at the Colombo auctions (the world's largest), most of the rest at the London auc- tions. All the major buyers are represented in Colombo and the marketing system operates well. The only problem of any significance has been the delay sometimes experienced in transporting tea from the estates to Colombo; delays occur because transport contractors cannot provide satisfactory service, being unable to obtain spares and replacement vehicles. 1.12 Most SPC and JEDB managerial staff were previously employed by es- tate owners or agency houses. After land reform takeovers some were employed on terms poorer than they had pre-reform, others, the majority, were employed on their pre-reform terms but only on a temporary basis. This resulted in poor staff morale. GOSL has recently introduced new staff terms but staff reaction to them is not known. 1.13 Labor Supply. Tamil workers continue to be the majority of the labor force on the estates, especially in higher areas. With the continuing program of Tamil repatriation to India, and the difficulty of attracting Singhalese into the industry, some estates in high areas now have labor shortages during peak periods. Major disincentives to potential new workers are the generally low health and welfare standards on the estates, particularly the overcrowded and primitive housing. GOSL, however, intends to address the basic needs of the estate workers. - 4 - 1.14 Taxes and Subsidies. For many years the tea industry has been sub- ject to excessive taxation and thus inadequate incentives. In its November 1977 budget GOSL changed the tax structure to take account of a substantial devaluation of the-rupee. However tea prices are declining and the new tax rates, if not adjusted, will soon be excessive once more. 1.15 The tea industry benefits from the universal 75% subsidy on ferti- lizer. Replanting costs - about R 48,000/ha - are partially offset by a GOSL payment of R 14,800/ha. This is not strictly a subsidy (though commonly re- ferred to as such) because the funds come from an industry cess. The replant- ing "subsidy" is paid in installments upon completion of successive replanting operations spread over 5 to 7 years. It has not been sufficient to induce an adequate replanting rate in the past nor, unless amended, is it likely to be in future for the considerable amount of privately owned tea, particularly that owned by smallholders. The impact of the subsidy on a smallholder's cash flow is shown at Annex 4, Table 7. Factory rehabilitation is also subsidized - one-third of capital cost and half of interest charges - and so are tea chests and diversification out of tea. 1.16 The system of taxation and subsidization is costly to administer and its overall impact is unknown. A "Tree Crop Incentive Study", a component of the Agricultural Development Project (Credit 595-CE), is presently being under- taken to provide GOSL with a policy framework, indicating clear alternatives, such as the trade-off between using the sector as a major source of taxation while at the same time attempting to enhance exports and employment. 1.17 Policy Development. In May 1976 IDA unsuccessfully appraised a GOSL project the main components of which were tea diversification and rehabilita- tion. A major problem was lack of a policy framework for tea industry develop- ment, particularly important following almost a decade of declining production and the major upheavals of land reform. At IDA's suggestion GOSL agreed to prepare a Master Plan for tea industry development. Preparation began in January 1978, with assistance from the Canadian International Development Association (CIDA), and is expected to be completed in early 1979. The Master Plan will recommend on industry structure, fiscal policy and investment pro- grams and priorities. Financing of Tea Development in Sri Lanka 1.18 Under existing Bank Group policy, as stated in Mr. McNamara's memo- randum to the ]Executive Directors of August 17, 1973, (Document No. R73-206), no financing of projects involving tea production is to be undertaken, except: (i) "financing for increases in output in countries with no investment alter- natives yielding an acceptable rate of return; and (ii) financing for rehabi- litation involving no increase in output (this implies reduction in acreage and encouragemient to diversification)." 1.19 It would be difficult to establish that alternative projects "offer- ing an adequate rate of return" do not exist or cannot be developed in Sri Lanka. The proposed project, however, qualifies under the second exception (paragraph 12 of the policy paper): -5- "Financing for replanting or rehabilitation projects could be considered if the project does not lead to increased production in the near or medium term. Such projects would lead to increases in yield, and these would have to be offset by shifting the acreage saved to other purposes. Tea bushes last with slowing declining yield, for 75 years and more. Since the alternative to replanting or rehabili- tation is usually to allow old bushes to continue their slow decline, the principal result of such projects is the long run extension of the period of production. The dis- counted present value of their effects upon world tea prices is, therefore, likely to be very small. The purpose of such a policy would be to give encouragement to diver- sification. The Bank is prepared to provide financing for this purpose." (emphasis added). 1.20 Sri Lanka is the only major tea-producing country suffering a long- term structural decline in its tea production; its share of world production declined from an average of 18.6% in the late 1960s to about 12.2% in 1976. The primary purpose of the proposed project would be to support a replanting program designed to prevent further decline in Sri Lanka's production rather than to increase output over its historic peak levels. Tea production in 1995 in Sri Lanka, including the proposed project, is estimated to be about 227 M Kg, still below the peak reached in 1965; at this level Sri Lanka's share of world production would have declined to about 8.6%. This estimate does not take into account any diversification of tea lands, yet GOSL has an ongoing diversification program and is expected to assign to the Agricultural Diversification Division in the Ministry of Agriculture and Lands the tasks of: (i) preparing an inventory of lands suitable for diversification; (ii) assigning development priorities to the inventory; and (iii) preparing future diversification projects. GOSL has also requested IDA support to finance an initial project in the Kandy area which will diversify 4,850 ha of marginal tea to spices and food crops, dairying, and forestry. This project was ap- praised concurrently with the project now proposed, and is expected to be presented to the Board in FY78 or early FY79. It is expected that together these two projects would be a first step in the critically important task of revitalizing the Sri Lankan tea industry. II. PROJECT AREA A. General 2.01 GOSL is preparing a Master Plan for development of the tea industry which will be complete by early 1979. In order not to delay an obvious priority, tea estate rehabilitation, GOSL decided to go ahead with the pro- posed project, selecting a high potential area to avoid preempting Plan policy options. The economy of the project area is almost entirely dependent on tea to which there is no economically attractive alternative. Area teas command -6- among the highest prices in the world. The average area yield (1,150 kg/ha), though not high is well above the Sri Lankan average (850 kg/ha) and the yield potential, as clemonstrated by existing clonal blocks, is excellent for high altitude areas producing quality teas. The estimated project yield for clonal tea of 1,900 kg/ha compares well with the Kenya estate tea average of 1,600 kg/ha. 2.02 The project area is located about 80 km east of Colombo, in the plant- ing districts of Maskeliya and Upper and Lower Dickoya in the Northwestern portion of the administrative district of Nuwara Eliya. The area includes about 18,000 ha of tea, managed by the State Plantations Corporation (SPC) (.0,000 ha in 30 estates) Janatha Estates Development Board (JEDB) (7,600 ha in 29 estates), and by small scale producers (300 ha owned by 183 individuals). 2.03 Climate. The area has a mean annual temperature of 21 C, and a mean annual rainfall of 5,403 mm. Temperature is almost constant throughout the year. Rainfall varies from a low monthly mean of about 100 mm in January, to a high of 900 mm in June, and is fairly predictable. 2.04 Soils and Topography. The area ranges in altitude between 1,000 m and 1,800 m with the greater part in the range 1,200 m to 1,500 m. Topography is broken and steep. Soils are mostly red-yellow podsols and wet mountain regosols, which are markedly acid, with pH around 5. Neither soils nor tcipography are well suited to land uses other than tea, forestry or pas- ture. The areav embraces large portions of the watersheds of the Castlereigh and Maskeliya Reservoirs which are the impoundments for hydro-electricity generation supplying about 90% of the island's power. Declining standards of estate management over the past several years have led to increased soil erosion which could curtail the useful capacity of the two reservoirs. 2.05 Socio-economic Conditions. The economy of the project area is al- most entirely dependent on tea. Hatton and Maskeliya are the only substantial urban areas, and they exist to serve the tea industry. There are few of the traditional village settlements which characterize the mid and low country tea areas, and the majority of the area's population, mostly Tamil, 1/ lives on tea estates. This population is declining, because of GOSL's Tamil repa- triation program, causing labor shortages at times of peak demand. To prevent labor shortages becoming a critical constraint, non-traditional labor will have to be attracted onto the tea estates. 2.06 lypical accommodation for an estate laborer's family consists of a tiny (20 m ), two room row house. Families share toilet facilities and water supplies. Housing areas are usually congested because estate developers de- sired to minimize housing costs and to maximize tea area. Most housing is in poor repair. Poor housing is a major factor in the sub-standard health of estate labor (para 2.07) and is a major impediment to attracting Singhalese labor into the tea industry to replace the traditional Tamil labor. 1/ Mainly non-citizen Tamils of Indian origin. - 7 - 2.07 Education of estate labor, until recently an estate responsibility, has now been assumed by the Ministry of Education. The quality of estate schools is below the national average, a fact accepted by GOSL. Remedial action is proposed as an integral part of the policy of bringing the social welfare of the estate population into line with the rest of the country. Medical facilities are below national standards, though there are base hos- pitals in Hatton and Maskeliya, district hospitals in Bogawantalawa, Dickoya, Maskeliya and Wattawala (all in, or immediately adjacent to, the project area), and all estates have dispensaries, some equipped for minor surgery. Infant mortality in the project area has been increasing in recent years and is now twice the national average. Overall mortality is about 50% above the national average. 2.08 Communications are good. Hatton is served by rail and there is a good network of public all-weather roads through the area. This is supple- mented by a considerable network of gravelled estate roads providing good access to most areas. B. Tea Production Field 2.09 Average yield in the area is about 1,150 kg/ha, well above the national average of about 850 kg/ha but about the same as the average for all JEDB and SPC managed estates. Yields vary greatly, from 500 kg/ha for seedling tea to over 3,000 kg/ha for clonal tea. SPC managed estates in the project area yield on average about 80 kg/ha more than JEDB estates. SPC generally took over estates which were better managed pre-land reform; this is reflected in the levels of replanting: Project tea area in hectares Total Seedling Mature VP Immature VP Grass /a SPC 10,077 7,939 1,339 (13.3%) 438 (4.3%) 361 JEDB 7,590 6,366 810 (10.7%) 253 (3.3%) 161 Private 302 249 24 ( 7.9%) 12 (4.0%) 17 TOTALS 17,969 14,554 2,173 (12.0%) 703 (3.9%) 539 /a For rehabilitation prior to replanting. Nationally about 13% of the tea area had been replanted with clonal material by 1976, thus the project area is slightly better than average in this regard. Replanting is economically justified when yields are below 560 kg/ha, assuming Bank forecast prices. Fields yielding above this level should be in-filled to maintain plant population (bush deaths are continuous from pests, diseases, and failure to withstand stresses, such as from pruning). However, in-filling has not been widely practiced for many years and vacancies are now common. 2.10 Fertilizer application is generally based on comprehensive Tea Research Institute (TRI) recommendations which cover the ranges of plant maturity, yield levels and fertilizer materials. These recommendations have remained essentially the same for many years, despite the fact that fertilizer and tea prices have changed dramatically; an illustration of the need for an economic focus to TRI's research (para 5.19). 2.11 Weeding is mainly by hand and is very expensive, costing about Rs 2,000/ha/year. The weed problem is aggravated by the low plant densities of old seedling tea and the low pruning level adopted which lead to poor ground cover for the first two years of each four year pruning cycle. Major reliance on hand weeding coupled with poor ground cover and absence of mulch (para 2.12) accentuates the serious soil erosion problem (para 2.13). A change to major reliance on chemical weed control would: reduce costs; minimize tea root damage; and reduce soil erosion. 2.12 Removal of Prunings. Reflecting a national problem the project area lacks fuelwood. As a result most tea factory driers are fueled with imported oil. More serious, however, is the fact that the laborers remove all prunings for firewood. This is the start of a chain of events which must significantly reduce production and productivity. The removal of prunings prevents the build up of surface mulch which would: suppress weeds; encourage the development of surface feeder roots which would improve the efficiency of fertilizer utilization; and prevent pan formation by pluckers, thus obviat- ing the need for the deep forking now practised which is expensive and damages tea roots. 2.13 Erosion. The soils of the project area are inherently quite stable, though the steeply broken terrain creates an erosion hazard. This has long been recognized and land being developed for planting was almost always well protected with soil conservation structures. Latterly, in common with gen- erally reduced management standards, maintenance of soil conservation works has been neglected and erosion has increased. In areas being replanted soil zonservation structures are rebuilt to a good standard. 2.14 Plucking standards are generally adequate. Plucking efficiency however, is poor. Because of a great shortage of green leaf transport, pluckers spend unnecessary time carrying leaf over long distances. Lack of green leaf transport also adversely affects made tea quality. Leaf is handled excessively and packed too tightly, both resulting in bruising and premature fermentation. The damage is worsened because too much time elapses between plucking and manufacture. Manufacture :2.15 All 59 factories in the project area manufacture by the orthodox process, producing quality teas which command high prices in world markets. tiost of the factory buildings are between 30 and 45 years old and are struc- turally sound., Withering takes place on tats - multiple tiered wire racks - on which green leaf is thinly spread. In modern factories tats have been replaced by withering troughs, which are more efficient and occupy far less - 9 - space, but only a few have been installed in project area factories. Through- put could be greatly increased if troughs were installed universally; and this potential for increasing capacities would permit substantial factory ration- alization. 2.16 Processing machinery varies tremendously in age and condition and much of it needs replacement to safeguard or restore quality and to increase efficiency. New rollers and driers are the major requirement. Material handling, from green leaf to made tea, is generally inefficient and labor consuming; particularly important because labor is becoming scarce. 2.17 Power supplies are satisfactory except that additional standby gen- erating capacity is required to provide minimal back-up during power failures. In several factories machines are indirectly, and inefficiently, belt driven from steel line shafting. Almost all factories are inadequately lit. This not only provides an unpleasant working environment but makes it impossible to keep factories clean - an important factor in maintaining quality. Vehicles 2.18 For many years hardly any foreign exchange was available to purchase replacement vehicles - a national problem. The IDA financed Agricultural Development Credit (595 CE) has provided some relief and the new Government has recently liberalized imports. Nevertheless, the majority of personnel transport, trucks and tractors in the project area are beyond their economic- ally useful life. They are old, unreliable and expensive to maintain. 1II. THE PROJECT A. Objectives and Brief Description 3.01 Principal project objectives would be to increase the quantity, quality and efficiency of tea production in a selected high potential area with no economic alternatives. The project would improve living conditions for about 150,000 members of estate labor families. It would be a first step in implementing a comprehensive rehabilitation and rationalization program for the tea industry which would be carried out in parallel with a diversification program and which would help to integrate the hitherto isolated population of the tea estates into the main stream of national life; an important Government goal. Through a pilot component the project would also examine means to in- clude smallholders in the tea industry development program. 3.02 The project would comprise the rehabilitation of tea estates and tea factories in an 18,000 ha block of some of Sri Lanka's best tea in the Maskeliya, and Upper and Lower Dickoya planting districts. Thirty SPC estates and 29 JEDB estates would be involved as well as a limited number of smallholders. Main components of the proposed five year project are: - 10 - (a) field works: expanded programs of replanting and infilling; renovation of soil conservation works; and establishment of fue]wood plantations. Quantities are (ha): JEDB SPC Private Total Replanting 545 - 15 560 Infilling 3,000 3,500 40 6,540 Soil Conservation 7,500 8,500 - 16,000 Fuelwood 340 250 - 590 (b) expanding and rehabilitating 42 factories (JEDB 17; SPC 22; Private 3); (c) providing vehicles for personnel, green leaf and made tea transport; (d) constructing new houses, rehabilitating houses and improving water supplies for estate labor. Numbers are: JEDB SPC Private Total New 2,900 3,300 400 6,600 Rehabilitation 2,950 3,350 400 6,700 (e) improving project area health services; (f) developing a training institute for tea industry personnel; and (g) updating tea area statistics. B. Detailed Features Replanting 3.03 The project would assist JEDB to increase its project area replant- ing program from 420 ha to 965 ha over the project period. (SPC would not increase planned levels of replanting because of the labor constraint; its incremental field development effort would be restricted to infilling, fuel- wood planting, and conservation). Areas for replanting are selected by Estate Superintendents in consultation with Visiting Agents and Regional Managers. Areas chosen usually yield below 600 kg/ha 1/ and have a vacancy rate of at least 50%. 1/ The yield level at which replanting is indicated varies, being dependent on the yield potential of clonal tea in the particular area. - 11 - 3.04 The replanting technique in use is good and would be continued. Replanting, using only clonal material, is on the contour at the rate of 12,500 plants/ha, 80% above the old seedling tea density. An adequate range of clones is recommended for the project area; most commonly used are from the 2,020 series developed by TRI (2,025, 2,026, 2,023), but estate selections such as K145, DN and N2 are also used. Most estates have adequate mother bushes to supply cuttings, shortages would be made up from neighboring estates. Nursery techniques are also good. Project costs include provision for nursery expansion, based on the cost of planting material - Rs 0.30/plant. 3.05 Replanting operations and direct costs per hectare are shown below. In addition, the project would provide additional equipment for the expanded replanting and infilling programs (winches, sprayers, pumps and sprinklers - details at Annex 1). Replanting Operations and Costs Rupees per Year Hectare 1 Uprooting old tea and grass planting 15,000 2 Grass maintenance 3,350 3 Replant tea 15,300 4 Maintain immature tea 6,550 5 Maintain immature tea 7,500 6 Plucking starts - Total costs 47,700 Less: Replanting subsidy 14,825 Fertilizer subsidy 11,550 Net cost to grower 21,325 Infilling 3.06 Infilling would be carried out in fields not earmarked for replant- ing in which vacancies average about 25%. The infilling programs of JEDB and SPC would be 3,000 ha and 3,500 ha respectively. Infilling would be carried out in the year of pruning - to minimize competition for the new plants - in units of 15 plants or more, and at a spacing of 120 cm x 60 cm on the contour giving 80% greater density than seedling tea. The infilled blocks would therefore not conform to the planting geometry of the surrounding seedling tea. However, plucking and other husbandry related disadvantages would be outweighed by more rapid development of cover and greater yield. Infilled areas must be managed the same way as the rest of the block which surrounds them. For this reason TRI recommends infilling with clones which can be treated like seedling tea, amongst these are DN, CY9 and N2. - 12 - 3.07 Infilling costs are: Rupees per Year Hectare 1 Infilling 13,060 2 Maintain infilled area 10,765 3 Plucking starts - Total costs 23,825 Less: Fertilizer subsidy 7,290 Net cost to grower 16,535 3.08 Smaillholder Assistance. Reliable data on smallholder yields, pro- duction costs; and returns are not available, and the proposal to assist the approximately 180 small growers in the project area would be largely of a pilot nature. Experience gained would be used in the subsequent preparation of wider ranging programs to assist smallholders. As the illustrative small- holder budget at Annex 4 shows, on a smallholding achieving only average yields replanting depresses income for several years even when credit and subsidy are available. The regional officer of the Tea Smallholdings Develop- ment Authority (para 5.21) would therefore encourage only the better small- holders to undertake modest replanting and infilling programs. It is esti- mated about 25% of the smallholders would participate, replanting and infilling 15 ha and 40 ha respectively. 3.09 To minimize administrative costs, financial assistance for replant- ing would be restricted to units of not less than 0.25 ha. To minimize the temporary negative effect on income, farmers should not replant more than 25% of their tea area; replanting would therefore be confined to smallholders growing over 1 ha. Smallholders with less than 1 ha of tea would be advised to infill and replace old bushes gradually as the family labor supply permits. Arrangements would be made for smallholders to obtain planting material and fertilizer from the estates to which they were supplying green leaf. When the findings of the Tree Crop Incentive Study are being discussed with GOSL (para 6.14) particular attention would be given to the replanting subsidy with a view to making it better suited to smallholder needs. Renovation of Soil Conservation Works 3.10 SoiL conservation works would be completely renovated in replanted and infilled areas. They would also be repaired on 16,000 ha of seedling tea scheduled for future infilling (JEDB 7,500 ha, SPC 8,500 ha). The estimated cost is Rs 18.8 M (US$1.2 M). Fuelwood Plant:ations 3.11 To remedy the fuelwood shortage JEDB and SPC would plant 340 ha and 250 ha respectively of Eucalyptus spp. Most would replace uneconomic tea - 13 - on areas unsuitable for replanting, the balance would occupy wastelands such as valley bottoms. There are estimated to be 1,195 ha suitable for fuelwood plantations but only 590 ha would be developed under the project because of labor constraints. Establishment is not expected to present technical diffi- culties, and the Forestry Department would be available to advise on species and site selection. Seedlings would be produced on estates or obtained from Forestry Department nurseries. Where fuelwood was to replace degraded tea the bushes would be killed by cutting them off near ground level and painting the stump with arboricide. In contrast to the present practice of interplanting, this would eliminate unmanaged tea as a disease source, and reduce competition for the Eucalyptus seedlings. Estimated establishment costs per hectare are: Rupees per Year Hectare 1 Plant 1,460 2 Maintain and infill 620 Total costs 2,080 Less: Fertilizer subsidy 750 Net cost to grower 1,330 Factory Rehabilitation - Corporations 3.12 Factory rationalization, discussed at para 5.22, would reduce the number of public sector factories manufacturing tea from 54 to 39; JEDB 17 and SPC 22. These would be expanded and rehabilitated to improve efficiency and the quality of manufacture. The major change would be replacement of tats by withering troughs at an estimated cost of Rs 14.3 M (US$0.9 M). This would be the key to rationalization and expansion of throughput. To handle the larger throughput worn out driers would be replaced and new ones added, mostly fluid-bed driers (FBD), a highly efficient drier designed, patented and, at present, only manufactured in Sri Lanka. FBD cannot handle big bulk teas, 1/ with their poor flow characteristics, therefore some drying capacity would be provided in the form of conventional endless chain pressure driers. Estimated cost of driers is Rs 21 M (US$1.3 M). 3.13 In traditional orthodox manufacture leaf is processed through a series of rollers to rupture leaf tissue and induce fermentation. Rollers basically comprise a 36" to 48" horizontal round table over which the leaf is rolled by an eccentrically rotating upper plate. Between rolls - four is normal - the leaf is sifted to remove the portion (a dhool) which has been sufficiently rolled. In project area factories some rollers would be replaced. However outlays would be modest (Rs 1.7 M), partly because serviceable rollers would be salvaged from factories to be closed and also because some rotorvanes would be introduced in place of rollers. 1/ The course, stalky material remaining after rolling. - 14 - 3.14 Rotorvanes comprise basically a 4' by 8" or 15" tube in which re- volves a central shaft bearing angled vanes. Operating like a screw the vanes force leaf through the tube rupturing tissue in the process. Rotorvanes have a higher output than rollers and can produce finer particles, particularly from tougher leaf. Using rollers and rotorvanes in series, as proposed, would increase factory capacities and would provide flexibility to alter grade per- centages in response to market conditions. In particular, it would be possible to significantly increase the proportion of BOPF and Dust grades which are required for the increasingly important tea bag trade. Present and possible future top grade outturns are as follows: Grade Present Future BOP 40 20 BOPF 27 45 Dust I 8 10 75 75 Estimated cost of rotorvanes is Rs 5.9 M (US$0.4 M). 3.15 In addition to these major investment items a further Rs 25 M (UJS$1.6 M) wouLd be spent on a wide range of smaller items. Included would be equipment to: expand and improve sorting and packing capacity (Rs 8.0 M, U',$0.5 M); improve material handling (Rs 3.5 M); provide standby power (Rs 5.0 M); and improve lighting (Rs 1.7 M). A small provision (Rs 2.2 M) is made for structural alterations. These would include ducting to convey hot air from drying rooms, which would be exhausted to atmosphere or used to heat air flow to withering troughs; and installation of heating units, from scrapped driers, as independent heat sources for withering troughs. The lattter arrangement would be more efficient than the present practice of run- nding driers solely to produce hot air for withering. Full details and costs of factory equipment are at Annex 1. Factory Rehabilitation - Private 3.16 The project would supply machinery and equipment to improve three privately owned factories in the project area which manufacture their own leaf plus leaf bought from smallholders. Development would be similar to that in cc,rporation factories. Major requirements are: withering troughs, rotorvanes, and sorting machinery. Total estimated cost is Rs 0.9 M (US$0.6 M). Vehicles - Corporations 3.17 To improve plucking efficiency, and to ensure that green leaf arrives at factories in top condition, 121 tractors and 363 trailers would be provided for green leaf transport at an estimated cost of Rs 23 M (US$1.4 M). This would provide one tractor (45 HP) and three trailers for approximately every 140 ha of tea. Provision of three trailers would allow tractors to be ope- rated on a shuttle basis, and to be free for other jobs. Trailers would be - 15 - constructed to carry 1,800 kg, with wire bodies to permit maximum ventilation of tea during loading and transport. To get the best use from trailers, and to maximize plucking efficiency, each plucking gang would be accompanied by a weighing clerk so that pluckers could weigh-in regularly without long waits. The weighing station (trailer) would be kept as close to pluckers as possible to reduce walking. 3.18 To improve management efficiency and reduce transportation costs, most personnel transport in the project area would be replaced. Estate Super- intendents would be given small saloon cars (57 of about 1,500 cc), and Assistants would be given motorcycles (48 of about 150 cc). In addition 52 estates would get a pick-up or four-wheel drive vehicle for field travel, staff transport and light haulage. Estimated cost of personnel transport is Rs 14.9 M (US$0.9 M). 3.19 Larger estates operate small trucks to haul supplies - fertilizer, building materials, etc. The project would supply eleven 3 ton trucks as replacements at an estimated cost of Rs 1.2 M. Ninety 1,200 1 bowsers would be supplied, two per estate, for herbicide transport, to support the expansion of chemical weed control. Estimated cost is Rs 0.4 M. Four 18,000 1 bowsers would be supplied to transport fuel oil from railhead to estates. These would cost Rs 1.3 M. They would operate under the direction of the two regional offices. Vehicles - Private Sector 3.20 The larger private producers who use trucks, tractors and trailers to transport their supplies and green leaf, have been unable to buy replace- ments for many years. The project would provide them one 3 ton truck, and 9 tractors and 27 trailers. Six herbicide bowsers would also be supplied. Total costs for private sector estate transport would be about Rs 1.8 M. 3.21 About twenty-five 5 ton trucks would be supplied to the private transport contractors, who transport made tea from project area estates to Colombo, at an estimated cost of Rs 6.6 M (US$0.4 M). Transporters would be eligible to receive one truck for each 650,000 kg of made tea transported in 1977. Workshops 3.22 Taking advantage of the concentration of estate ownership, each corporation would establish a regional workshop in the project area. They would be located at two of the factories selected to cease manufacture and would be equipped to undertake vehicle maintenance and some repairs; major repairs would continue to be sent to dealers. Modest stocks of fast moving spares would be maintained, a useful facility when private dealers have difficulty supplying spares because of import controls. The workshops would also be staffed and equipped to handle factory machinery maintenance and, again, modest repairs. The workshops would operate as independent profit centers charging for work at rates sufficient to recover all costs. The cost of establishing the two workshops is estimated to be Rs 1.0 M. - 16 - Housing 3.23 Virtually the entire 25,000 units of labor housing on corporation estates in the project area require improvement. In the course of improving existing housing about 50% of families have to be rehoused because some old units are combined and others are knocked down. Thus, for every unit of rehabilitated housing a new unit must be built. To fully rehabilitate exist- ing housing and build necessary replacements would take 10 years. Neither building capacity nor funds would be sufficient for a faster pace. Over the five years of the project, therefore, half the building program would be completed - re'habilitation of 6,300 units and construction of 3,100 new twin cottages. Once rehabilitation is begun it must be completed, to prevent dis- crimination and ensure that adequate labor would be attracted to the industry to replace the repatriated Tamils. An assurance was obtained that housing rehabilitation in the project area would be completed by December 31, 1988. 3.24 Both JEDB and SPC began rehabilitation using slightly different designs; those of SPC being simpler. New standardized designs have now been adopted; the estimated costs of rehabilitation and new construction using these designs are Rs 9,500 and Rs 21,000 respectively. The total cost of tlhe corporations' housing programs is Rs 125 M (US$7.8 M). 3.25 The larger private growers who retain a permanent labor force face the same housing problems as the corporations. They also face a tight labor supply situation and recognize that, if they are to compete for labor, they aLso must upgrade their housing. The project therefore provides for the rehabilitation of 400 units and the construction of 200 new twin units, in private estates. Estimated cost is Rs 8.0 M (US$0.5 M). Water Supplies 3.26 The water supply systems to labor housing are old and need repair; in particular much of the piping needs replacement. New housing units would aLso require water supplies. Repairs and new supplies would be provided under the project at an estimated cost of Rs 1.1 M (US$0.07 M). Health Services 3.27 In the project area the health of the population and the provision of health serv:Lces are much below national standards. For example infant and maternal mortality rates are twice the national average. A recently returned economic mission (November 1977) found that the poor health status on estates is perhaps the single most pressing 'basic needs' problem in Sri Lanka. 3.28 The provision of health services in estate areas is the joint responsibility of the Ministry of Health and the estate operators. The Ministry operates district and base hospitals and the estates provide simple medical care from small dispensaries. In order to improve health services at: the field level the Ministry recently launched a national polyclinic pro- gram. Ten Mediical Officers (MO) were appointed, each responsible for twenty estate dispensaries which they visit for one day each month. The MO expand - 17 - and improve dispensary operation by providing professional advice and assist- ance, particularly in such needy areas as nutrition and pre and post natal health care. Government intends to expand both the area coverage and visiting intensity of the polyclinic program. 3.29 The project would improve the provision of medical services to the project area by: constructing and equipping pre and post natal clinics at the four district hospitals; meeting the cost of four MO to expand polyclinic coverage; and by providing equipment to improve the operation of 45 estate dis- pensaries. The estimated cost is Rs 5.4 M (US$0.3 M). This health component would make little impact on the countrywide problem of inadequate health serv- ices in estate areas. The project would therefore also finance a study to prepare an investment program for the improvement of estate health services countrywide. This study would be coordinated with on-going work in the health sector; the estimated cost is Rs 0.4 M (US$25,000). The consultants would be employed with experience, and on terms and conditions, satisfactory to IDA. Training 3.30 Provision for industry training is at present inadequate. GOSL, re- cognizing the problem, intends to establish a National Institute of Plantation Management which would have responsibility for the training requirements of the entire tree crop sector. The institute will cater to both public and private estates and will also provide training for personnel in related marketing activities. It will be headquartered in Colombo but will make use of the staffs and facilities of the Coconut, Rubber and Tea Research Institutes and of the Agricultural University, in the operation of training courses. 3.31 The project would assist the development of the Institute, and in particular its capacity to train tea industry personnel, through construction of hostel facilities for trainees at the TRI. The project would also finance 30 man-months of technical assistance. This would enable the recruitment of a high calibre training specialist to serve as the Institute's Director during its first formative year and additional specialists on short-term assignments to advise on course development. The specialists would be employed with ex- perience, and on terms and conditions, satisfactory to IDA. The project would also provide for overseas training visits for senior staff from JEDB, SPC and TRI. The estimated total cost of the training component is Rs 3.3 (US$0.2 M). Tea Area Measurement 3.32 Tea area statistics are out of date and inaccurate. Under the pro- ject the Survey Department would re-measure the tea area. Priority would be given to measurement based on an analysis of Landsat data. The Department has experience with Landsat data analysis and could begin work and provide information at an early date. The extent to which it would be possible to classify the tea areas from Landsat data analysis would only be known once work had begun. As necessary the Landsat analysis would be supplemented by aerial photo interpretation. Most of the work would be carried out using the Department's existing manpower and equipment. The project would provide Rs 0.8 M (US$50,000) for the purchase of materials, supplementary computer - 18 - time and for temporary staff for photo interpretation. A major side benefit of this component would be the broadening of the Department's experience with Landsat data analysis and the opportunity which would be presented for further exploration of the natural resource base. IV. PROJECT COSTS AND FINANCING A. Cost Estimates 4.01 The estimated total cost of the five-year project, including contin- gencies, is Rs 493 M (US$31 M equivalent), of which about US$9.7 M (30%) would be foreign exchange. Taxes and duties would amount to approximately Rs 9.0 M, 1.8% of project cost. Details of project cost, summarized below, are in Annex 1. Project Cost Summary Foreign Local Foreign Total Local Foreign Total Exchange ------- Rs 000 ------- ------ US$ 000 ------ Field Works 57,460 19,150 76,610 3,595 1,195 4,790 25 Field and Nursery Equipment 6,235 4,155 10,390 390 260 650 40 Vehicles 17,245 32,025 49,270 1,080 2,000 3,080 65 Housing 100,555 33,520 134,075 6,285 2,095 8,380 25 Factory Equipment 41,405 27,605 69,010 2,590 1,725 4,315 40 MedLical 2,590 3,170 5,760 160 200 360 55 Training 330 2,950 3,280 20 185 205 90 Support /a 1,965 1,310 3,275 125 80 205 40 Total Base Costs 227,785 123,885 351,670 14,245 7,740 21,985 35 Physical Contingencies 11,505 6,195 17,700 720 385 1,105 35 Price Contingencies 98,830 24,700 123,530 6,175 1,545 7,720 20 Total Costs 338,120 154,780 492,900 21,140 9,670 30,810 30 Taxes and Duties 9,000 - 9,000 565 - 565 Net Project Cost 483,900 30,245 /a Details at Annex 1, Table 9. 4.02 Cost estimates are based on findings during appraisal and updated to February 1978, including November 1977 budget changes. Physical contin- gencies are 7.5% for civil works, 5% for factory equipment and field works and 2.5% for the support component. No physical contingencies have been included for vehicles, and field, nursery, health and training equipment. Price contin- gencies, accounting for 25% of total costs, have been compounded at the follow- ing levels: - 19 - Foreign Costs Local Costs 1978 7.5 12.0 1979 7.5 10.0 1980 7.0 8.0 1981 7.0 8.0 1983 7.0 7.0 B. Financing 4.03 An IDA credit of US$21 M is proposed on standard terms to GOSL. This would amount to 68% of total project costs (70% of costs net of duties and taxes) and would cover 100% of foreign costs plus 54% of local costs. The remaining local costs of US$9.8 M would be financed by SPC and JEDB and the Bank of Ceylon with a small contribution from private operators and GOSL. Proposed project financing is summarized below (in thousand US dollars): SPC and Bank of/a Private IDA JEDB Ceylon Operators GOSL Total Field Works and Equipment 3,430 1,610 310 40 50 5,440 Vehicles 2,085 630 220 130 15 3,080 Housing 5,635 1,975 650 120 - 8,380 Factory Equipment 3,320 715 210 10 60 4,315 Training 190 - - - 15 205 Medical 270 - - - 90 360 Support 165 - - - 40 205 Contingencies 5,905 2,120 550 100 150 8,825 Total 21,000 7,050 1,940 400 420 30,810 Percentage Total Cost 68 23 6.5 1 1.5 100 /a Should the financial position of the corporations allow financing of more than 25% of their investment requirements, these amounts would be reduced. C. On-lending 4.04 Government, through the Central Bank, would on-lend up to US$17.2 M of the IDA Credit to the Bank of Ceylon, which in turn would on-lend this, plus US$1.9 M of its own resources, to the two corporations, private truck - 20 - operators, private factory owners and private growers. These sub-borrowers would make a minimum 25% equity contribution to their investments. The balance would be borrowed from the Bank of Ceylon on terms in line with current com- mercial lending; these would be at rates of interest of 12% per annum for factory equipment, vehicles and field development, and at 10% for housing. Loan periods would be: factory machinery 10 years; vehicles 5 years; field development 15 years with one year of grace; and housing 15 years with 5 years of grace. The Central Bank would provide 90% refinance to the Bank of Ceylon for project sub-loans at 6.5% and 8.5%, allowing the Bank of Ceylon an interest margin of 3.5%; this would cover risk, administrative expenses and provide a reasonable profit margin. 4.05 Smallholder tea growers have not previously had access to produc- tion credit and are unfamiliar with credit procedures. Furthermore profit from replanting and infilling would depend on above average smallholder yields (para 6.22). Not more than about 25% of growers are therefore expected to be eligible and to take production loans. Applications for credit would be en- couraged, and applicants would be assisted by the local TSDA extension agent, whose written support would be required on the loan application to the Bank of Ceylon. Credit terms would be the same as for the corporations (para 4.04). Under an agreement entered into between the grower, the Bank of Ceylon and the bought leaf factory concerned, loan repayments would be deducted from green leaf sales. The present practice whereby bought leaf factories provide short- term production credit, would also be continued under the supervision of the extension agent. For small areas of replanting and infilling, planting material would also be provided through this source. 4.06 Some areas on which field development would be started during the project would not come into production until 1988. An assurance was there- fore obtained that Government would continue to assist in making credit available under terms and conditions similar to those under the project, so as to bring these tea areas into production. A similar assurance was obtained that credit would be available to enable all estate labor housing in the pro- ject area to be upgraded by the end of 1988. 4.07 Details of proposed on-lending terms and conditions are given in Schedule A. An assurance was obtained that these terms and conditions would be adopted for project lending. An attachment to Schedule A contains the 1975 and 1976 financial statements for the Bank of Ceylon which are satisfactory. The execution of a subsidiary loan agreement acceptable to IDA, between GOSL and the Bank of Ceylon would be a condition of credit effectiveness. V. PROJECT IMPLEMENTATION A. Organization and Management 5.01 Land Reform, executed in two phases in 1974 and 1975, completely changed the ownership and management structure of the tea industry. Some changes were unsuccessful. For example the Upcountry Estate Development Board and the Electorate Level Cooperatives so mis-managed their estates - 21 - that they were recently dissolved and their estates allocated between JEDB and SPC. Now, after two years of post-reform operational experience, the entire institutional structure needs review to determine suitability and GOSL, assisted by CIDA, has begun a study to produce a Tea Master Plan. Pending the outcome oC the study, major institutional changes are not proposed under the project. Assurances were obtained that the findings of the study would be discussed with IDA, and that institutional changes which, in the opinion of IDA, would materially affect project execution, would not be made with- out prior discussion with IDA. Project Coordination 5.02 The Ministry of Plantation Industries (MPI) is responsible for public sector operations in the plantation sub-sector. MPI controls the Janatha Estates Development Board (JEDB) and the State Plantations Corpora- tion (SPC), which manage most GOSL owned tea estates, including all in the project area. 5.03 A Project Coordinating Committee (PCC) has been established to assist MPI in project implementation; members are: Secretary, MPI (Chairman) Chairman (or General Manager), JEDB Chairman (or General Manager), SPC Director General, Tea Board General Manager, TSDA Representative, Department of External Resources, Ministry of Finance and Planning liatton Regional Manager, JEDB Hatton Regional Manager, SPC A Project Coordinator has been appointed as PCC executive officer. The PCC would approve annual development plans and budgets for the project, would meet regularly to review project progress and, on the basis of the recommendations of the Project Coordinator, award all contracts for the supply of goods and services. 5.04 The position of Project Coordinator (PC) has been established at the level of Senior Assistant Secretary in MPI. The PC would have sound administrative and financial experience and a good understanding of the tea industry. He would have a small staff, consisting of an administrative assistant, two clerical assistants and a secretary. A construction supervisor, who would oversee the civil works component, would report directly to the PC. An assurance was obtained that the position of PC would at all times be filled by a person with qualifications and experience satisfactory to IDA. 5.05 The PC would have the following duties: (i) serving as Executive Officer for the PCC; - 22 - (ii) in conjunction with the two Hatton Regional Managers, preparing annual development plans and budgets for the project and submitting them through the corporations to the PCC and IDA. These would be prepared at least six months in advance of each financial year to enable incorporation in corporation budgets; (iii) monitoring project progress and submitting half-yearly reports to PCC and IDA; and (iv) in consultation with the Supply Managers of the Corpora- tionis, and the Hatton Regional Managers, arranging preparation of tender documents (clearing with IDA where required), issuing tenders, opening and evaluating bids and making recommendations for award. The Corporations 5.06 SPC was established in 1958 and operated on a relatively modest scale until it was given management of large areas under the two phases of land reform. SPC now manages about 45,000 ha of tea estates. JEDB was established in 1976 specially to manage land taken over during land reform. lt manages about 60,000 ha of tea estates. The two corporations have similar cirganizations. Their Boards and Board Chairmen are appointed by the Minister cf Plantation Industries, who may terminate these appointments at will. Head ciffices, in Colombo, are divided into functional units under managers - estates, finance, marketing etc. Though structurally similar the corporations have different management styles. Twenty years old, operating until recently on a modest scale, SPC is set in a rather bureaucratic mold. JEDB has adopted a. more vigorous, commercial style. 5.07 Control of field operations is decentralized to seven regional offices and the project area comprises virtually all of the liatton Region of both corporations. The Hatton Regional Managers would have key roles in project implementation, therefore an assurance was obtained that throughout the project both JEDB and SPC posts would be filled by candidates with qualifications and experience satisfactory to IDA. 5.08 At the field level, estate identities have been retained virtually intact since takeover. For this reason, and because estates were assigned mostly on the basis of previous ownership e.g., Sterling or Rupee Company, rather than geography, the pattern of estate operation does not reflect the advantages of unified ownership (see map). Thus, the estates controlled by the two corporations are scattered throughout the Region, complicating super- vision. Furthermore, green leaf from one part of an estate may be taken for processing past the door of a neighboring estate factory. Given unified ownership rationalization of estate management is both desirable and feasible (para 5.22). 5.09 Estates are managed by Superintendents assisted where necessary by Assistant Superintendents, the rate of staffing being about one officer per - 23 - 140 ha. Visiting Agents (VA), selected from senior Superintendents, are used to intensify supervision exercised over estates by regional offices, each covering up to 2,000 ha. The VA visit each estate three times per year and write a comprehensive report for the Regional Manager. VA also contribute to the development of estate budget estimates. The VA system is a sound carry over from pre-reform times and an assurance was obtained that it would conti- nue to operate in the project area for the project period. 5.10 Staffing of the corporations (at least in project related areas) is generally good. Experienced staff did leave the industry as a result of land reform but sufficient remained to form a core of experienced personnel. After land reform deficient performance generally resulted less from lack of ability, than from lack of incentive, because staff terms and conditions of service were unsatisfactory (para 1.12). A GOSL Commission examined and made recommendations on terms and conditions and, in March 1978, staff were offered permanent employment on the new terms. Because of the Government imposed ceiling of Rs 2,500 per month on public sector salaries the incentives for middle and senior management in the new terms appear inadequate. Since early changes in such recently introduced terms would not be feasible an assurance was obtained that the adequacy of terms and conditions of service would be reviewed with IDA before December 31, 1979. 5.11 The Financial Structures and Operations of the corporations are unsatisfactory. Their capital structures are undecided because decisions have not been made regarding transfer of ownership of nationalized estates from the Land Reform Commission to them. This issue should be settled to facilitate sound financial planning and management, and to enhance the security rating of the corporations, a factor which would be important in view of the large increase in bank borrowings envisaged. 5.12 An assurance was obtained that GOSL would transfer the estates to SPC and JEDB, on terms and conditions satisfactory to IDA, before December 31, 1978. Compensation terms for estates taken over from Sri Lankan companies have not yet been agreed. Valuing all the project area estates at the price agreed for foreign owned estates, Rs 660/ acre, the equity values would be Rs 13.6 N and Rs 15.5 M for JEDB and SPO respectively. Payment by five equal, annual installments, the basis agreed for the foreign owned estates, would be within the capacity of both SPC and JEDB to pay (Annex 4 Tables 3 and 4). 5.13 In the absence of a market in large estates, and with estate man- agement having been subject to considerable recent change, there is no imme- diately available alternative basis for estate transfer other than the com- pensation terms. Recognizing that transfer on this basis would give the corporations quite arbitrary asset values, Government intends that the estates would be revalued, by an agency acceptable to GOSL and IDA, before December 31, 1982. Revaluation procedures are to be agreed between GOSL and IDA before December 31, 1981. 5.14 The corporations have only operated on their present scale for about two years. During that time tea prices have been extremely high. The corporations have therefore earned high profits, and have financed - 24 - operating and capital expenditures from cash flow, at the same time trans- ferring substantial surpluses to GOSL's Consolidated Fund. When tea prices fall, as expected, and the corporations are no longer able to finance capital expenditures from cash flows, they would, as a logical extension of present practice, turn for budgetary aid to meet shortfalls. In such circumstances the corporations, instead of operating as commercial entities, would be oper- ating as extensions of government, which is not equipped effectively to make commercial capital and operating decisions. GOSL intends that government owned corporations should operate according to commercial practice. To meet this objective JEDB and SPC should, inter alia, prepare "rolling" five year development programs - geared to expected earning capacity - and should retain sufficient of their operating surpluses to provide a contribution of at least 25% to the financing of these programs. An assurance to this effect was ob- tained. The remaining finance would be borrowed from the commercial banking system. Operating in this manner would provide the forward financial plan- ning essential to the slow gestation typical of tea industry development and would bring the financial discipline of commercial borrowing to bear on the corporations. 5.15 Th,e Finance Act (No. 38 of 1971) controls the financial operations of public corporations. Compliance with certain Sections is cumbersome and reduces operational efficiency; they are: (i) Section 8, sub-section 2 - which requires prior approval of the (appropriate) Minister, and of the Minister of Finiance and Planning, for commitments of capital expen- dilture in excess of Rs 0.5 M, notwithstanding inclusion in a corporation's approved budget; and (ii) Section 10, sub-sections 3 and 4 - which require similar prior approvals for appropriations from net surpluses for write-offs, and for transfers to and from reserves, again notwithstanding that these might have been reflected in an approved budget. GOSL, while accepting this in principle, indicated that it would not wish to exempt JEDB and SPC from these provisions as an exception, but would rather develop a set of criteria, for efficient and profitable operation, which would exempt all corporations meeting such criteria. An assurance was obtained that GOSL would, by December 31, 1978, take measures satisfactory to IDA to enable SPC and JEDB to be exempted from the above provisions of the Finance Act. The execution of the Project Agreement on behalf of SPC and JEDB would be a condition of credit effectiveness. 5.16 Day-to-day financial control is adequate. Regional offices parti- cipate in the preparation of annual budget estimates for each estate and forward approved versions to the head offices. Estates submit monthly progress reports. This system is good but, to improve efficiency, a standard and more concise reporting format should replace the diverse forms inherited from pre-reform managements (para 5.38). - 25 - The Tea Board 5.17 The Board was established in 1975 with wide powers to promote the development of the tea industry. The Board was conceived when the majority of estates were privately owned, and there was need for a forum to discuss industry development. Following land reform, the Board is not the pivotal institution suggested by the Act, and its appropriate role will be among the issues addressed by the Tea Master Plan. The Tea Board does control two key industry agencies - the Tea Research Insitute, and the Tea Commis- sioner's Department. 5.18 The Tea Research Institute (TRI) is near the project area, at Talawakale in the high country. Established in 1925, it is responsible for all aspects of tea research covering both growing and manufacture, and had earned an international reputation. As in the rest of the industry, deter- iorating employment conditions led to staff resignations, and replacement has not been entirely successful. TRI thus lacks vitality, though recent moves should bring improvement. The IDA assisted Agricultural Development Credit (595 CE) will provide 20 cars; a recommended salary increase should improve staff morale and recruitment prospects; and a UNDP project is pro- viding much needed scientific equipment. 5.19 A major TRI deficiency has been lack of firm direction. A standing committee of the Tea Board is char.ged with guiding tea research, but is at present inactive. Appropriate research, and research guidance, will also be examined by the Tea Master Plan. The largest research gap is the complete absence of economic work. However, UNDP funding has been made available to finance one or two positions for economic researchers and one position was filled in March 1978. 5.20 The Tea Commissioner's Department administers subsidies and col- lects statistics. The Department's functions will be reviewed by the Tea Master Plan, and subsidies are already being examined in the ongoing Tree Crop Incentive Study. It is worth making two points: collection of statistics has not kept pace with recent major changes in the industry, in particular the official tea area of 241,000 ha is generally believed to exceed the producing area, perhaps by as much as 20,000 ha; and the application of taxes, duties and cesses, and offsetting subsidies, is unnecessarily complicated. Tea Smallholdings Development Authority (TSDA) 5.21 The TSDA was recently created by MPI, and is intended to focus more attention on tea smallholders in the hitherto estate dominated industry. The TSDA will administer subsidies and provide extension advice to smallholders. It will be staffed mainly by transferring personnel from the Tea Commissioner's Department. The TSDA would locate a regional officer with a small support staff in the project area to organize smallholder development activity. Project costs include a vehicle, office equipment, and operating costs for this unit. - 26 - B. Estate and Factory Rationalization 5.22 Proposals for rationalization are shown on the map. Transfers of estate lands between the corporations would accomplish two levels of rationalization. Some transfers, usually of parts of estates, are necessary to consolidate estates around the better factories, which would be rehabili- tated and expanded, to obviate unnecessary green leaf transport. Additional transfers should be made to consolidate the regions of the two corporations to improve supervision efficiency. Through rationalization about 15 factories could be shut down, and proposals for factory rehabilitation and expansion assume these closures. Before implementation starts a more detailed ratio- nalization plan and factory investment proposal must be prepared. Terms of reference for a study to prepare these proposals have been agreed with GOSL and a study team has been selected and data collection started. Completion of a study satisfactory to IDA would be a condition of disbursement for the factory component. C. Implementation Schedule 5.23 An implementation schedule is at Chart 1. Implementation would be spread fairly evenly over the five year project period, the pace of field development being determined by labor availability and weather. There would be no difficult critical steps and, provided there are no abnormally wet monsoons, there should be no difficulty in meeting targets. 5.24 The pace of factory rehabilitation would be governed by the limited off-peak time available each year during which factory alterations could be carried out. Equipment supply could also be a constraint if procurement were not kept to schedule. The critical steps in the factory rehabilitation schedule would be first, completion of the factory rationalization plan, and then completion of procurement procedures on schedule. 5.25 The pace of the housing program would be mainly determined by building capacity. To achieve the planned schedule, it would be critically :important to finalize tender documents on time, and thereafter to complete procurement procedures on schedule. 5.26 The timing of procurement of vehicles and minor equipment is not critical to other activity. D. Procurement and Disbursements Procurement 1/ 5.27 Procurement for the corporations would be directed by the PC, a procurement schedule is at Chart 2. With the exception of fluid bed driers, 1/ All value amounts stated under this heading exclude contingencies. - 27 - and fuel and herbicide bowsers and trailers, all factory equipment, tractors and vehicles for the corporations (US$5.9 M) would be procured through inter- national competitive bidding (ICB) in accordance with IDA guidelines. Bids from domestic manufacturers would receive a margin of preference--15% or the prevailing customs duty, whichever is lower--in the evaluation of bids from competing foreign suppliers. Fluid bed driers (US$0.2 M) are patented and manufactured by only one firm which is located in Sri Lanka and would be pur- chased direct. Prices for these driers are considered reasonable and the firm is capable of meeting required orders. Fuel and herbicide bowsers and trailers- for the corporations (US$0.6 M) would be procured on the basis of competitive bidding advertised locally, following procedures acceptable to IDA, since pro- curement would be in small lots not expected to attract international bidding. 5.28 All equipment and vehicles for private tea producers, and trucks for made-tea transport (US$0.6 M) would be purchased directly by private operators on the basis of customer preference due to the fact that procurement is expected to be made in small lots not suitable for ICB. 5.29 Civil works (housing) would consist of many small individual units constructed over a five-year period and would not, therefore, be suitable for 1CB. Contracts for construction of new cottages (US$4.3 M) would be awarded on the basis of competitive bidding advertised locally, following procedures acceptable to IDA. To encourage small contractors, tenders would be invited for multiples of five cottages. The Project Coordinator's Office may undertake bulk procurement of such items as cement, iron sheets and timber for small contractors; in this instance procurement would be on the basis of competitive bidding advertised locally, following procedures acceptable to IDA. The rehabilitation of existing estate housing (US$4.0 M) would be undertaken by estate labor on force account, with provision for outside contractors should estate labor capacity be inadequate. 5.30 Field development works (US$4.8 M) would be undertaken by estate labor on force account. Water pipe and tanks, and workshop, office, field, dispensary and nursery equipment (US$0.8 M) consist of many very small indi- vidual items which would not be suitable for ICB and which would be procured on the basis of local shopping. Sufficient local manufacturers and agents are available to ensure competitive prices. 5.31 Civil works for hospitals, and civil works and equipment for the training institute (US$0.2 M) would be procured on the basis of competitive bidding advertised locally following procedures acceptable to IDA. Vehicles and equipment for hospitals and the polyclinic program would be purchased direct from suppliers to ensure standardization with those already in use by the Ministry of Health (US$0.14 M). 5.32 The balance of project costs (excluding contingencies) of US$0.2 M would consist of incremental staff expenses and consultant costs. 5.33 For all tenders for vehicles and equipment worth over US$100,000, technical specifications and draft tender documents would be submitted to IDA - 28 - before bidding documents were issued, and for individual contracts for goods worth over US$100,000, bid evaluations would be submitted to IDA for approval before awards were made. Specifications and draft tender documents for hous- ing contracts would be submitted to IDA before the first bidding documents were issued. After IDA approval of these initial documents, further IDA clear- ance would onLy be required if significant changes were to be made in them. For all individual housing contracts in excess of US$100,000 bid evaluations would be submitted to IDA for approval before awards were made. I)isbursements 5.34 An estimated schedule of disbursements is given below. Disburse- ments would be made for: (a) 100% of foreign expenditure for directly imported vehicles and equipment, or 100% of local expenditures (ex factory cost) if manufactured locally or 75% of expenditures for imported goods procured locally (US$8.5 M); (b) 55% of the total cost of civil works done by contract and civil works performed under force account by SPC and JEDB estate labor (US$5.9 M); (c) 50% of total estate field development expenditures on replant- ing, infilling, soil conservation works and timber planting (US$4.7 M) (this is equivalent to 70% of incremental expenditures); and (d) 100% of the cost of overseas training and technical assistance (US$0.3 M). 5.35 Disbursement would be made against project expenditures and not against sub-loans to borrowers under the project. The PC would be responsible for project disbursement claims. Disbursements would not be made for civil works undertaken by force account on privately owned estates, or for field and nursery equipment. Disbursements for SPC and JEDB civil works and field development carried out by force account would be made against statements of expenditure, the documentation for which would be audited and retained by the Project Coordinator for examination by IDA staff during supervision missions. All other disbursements would be made against full documentation. Any amounts not disbursed for the project would be cancelled. - 29 - Estimated Schedule of Disbursements Amount Amount In Quarter In Quarter Fiscal Million Disbursed Fiscal Million Disbursed Year Quarter Dollars Cumulative Year Quarter Dollars Cumulative 1980 2 .5 .5 1983 1 0.5 12.5 3 1.0 1.5 2 1.0 13.5 4 1.5 3.0 3 1.0 14.5 4 1.0 15.5 1981 1 1.0 4.0 2 1.0 5.0 1984 1 1.0 16.5 3 1.0 6.0 2 1.2 17.7 4 1.5 7.5 3 1.3 - 18.0 4 1.0 20.0 1982 1 1.5 9.0 2 1.0 10.0 1985 1 1.0 21.0 3 1.0 11.0 4 1.0 12.0 E. Accounts, Audits and Monitoring 5.36 Assurances were obtained that SPC, JEDB, the Bank of Ceylon, TSDA and MPI would maintain separate accounts for the project, which would be audited annually, together with disbursement documents, by the Auditor General's office or other independent auditors acceptable to IDA. Certified copies of these accounts would be sent to IDA within six months of the close of the Sri Lanka fiscal year. The audit report would include, inter alia, a statement that funds disbursed against statements of expenditure had been used for the purpose for which they were provided. Auditing of SPC accounts is overdue because of SPC delays in the preparation of accounts. An assurance was ob- tained that SPC accounts would be brought fully up to date by December 31, 1978 and would be fully audited by June 30, 1979. 5.37 The Project Coordinator would arrange the preparation of an annual project budget and half yearly project monitoring reports for submission to the Project Coordinating Committee. Assurances were obtained that the committee would submit to IDA: (a) an annual project budget, showing details of planned physical works and financial expenditure, not later than two months prior to the commencement of the Sri Lanka fiscal year; and (b) copies of half yearly project monitoring reports (in a form satisfactory to IDA), within two months of the close of each half year. - 30 - 5.38 The estate monthly reporting formats used by the two corporations are not standardized. An assurance was obtained that SPC and JEDB would, by ])ecember 31, :1978, introduce and maintain a standard format for their estates' aonthly reports satisfactory to IDA. VI. PRODUCTION, MARKETING AND FINANCIAL RESULTS Tea Production 6.01 Old seedling tea accounts for about 80% of tea land in the project area. Much of this has a high bush vacancy rate and is past its economically productive life. Without a sizeable infilling program and improved standards of management, seedling tea yields will decline as country-wide data indicate they have over the last decade. Without the project, and in the absence of infilling, seedling yields are projected to decline by an average of 1% per year. 6.02 As a result of replanting poor tea areas, infilling, and diversi- fication into timber of the worst tea land, average yields in the project area are estimated to increase from 1,210 kg per hectare in 1979 to about 1,720 kg by 1998. Without the project a limited replanting program would result in a 1998 average yield of approximately 1,340 kg per hectare. The incremental impact of the project after 20 years, therefore, would be to increase annual tea yields in the project area by nearly 30%. 6.03 TotaL project area production is estimated to increase from about 20 M kg in 1979) to 27 M kg in 1998. On a 'with' and 'without' project basis, inacremental production in 1998 is projected at 4.4 M kg or an increase of nearly 20%. Detailed estimates of project yields and production are in Annex 2. 6.04 The incremental impact of the project would be marginal in terms of Sri Lanka's overall production, about 2%, but would be an important first step in stemming the decline in the country's tea output. Production in 1976 was 196.6 M kg, dowm from a peak of 228.2 M kg in 1965. Sri Lanka's tea production in 1995 (when replanting investments reach maturity) including the proposed project, would be an estimated 227 M kg; slightly below the peak 1965 level oi 228.2 M kg. This output projection takes account of probable replanting pe!rformance. Details and key assumptions are contained in Annex 2. 6.05 GOSL is pursuing a program of diversification of marginal areas out of tea. As part of this program, IDA assistance has been requested for a project to diversify approximately 4,800 hectares of tea in the Kandy area. This area typifies large areas of tea, mostly in the mid-country, which are degraded, rapidly declining in yield and unsuitable for replanting to tea. The Kandy project area now produces about 2.5 M kg of tea, however production would soon become uneconomic and be abandoned. Rehabilitation and increased output from high potential areas is essential to replace such lost output. - 31 - Fuelwood Production 6.06 Locally significant amounts of fuelwood would be produced under the project. Yields are estimated at 120 m per hectare on a 10 year rotation basis. During the five year period of the IDA project, 590 hectares of timber w3uld be planted, giving a total output of fuelwood per rotation of 70,800 m Marketing 6.07 The majority of Sri Lanka tea output is sold at the Colombo auc- tions, the world's largest. Of the total 1976 crop of 197 M kg, 182 M kg were sold in Colombo, with almost all the remainder (mainly better quality, high grade teas) being shipped to the London auctions. 6.08 The auction system in Sri Lanka, which is largely operated by six Colombo brokerage houses, has operated successfully for many years and all the world's major buyers are represented. Recently, there have been some complaints from these buyers of a general deterioration in tea quality and poor standards of tea packaging. The project would improve quality through improvements to green leaf transport and handling, and through factory rehab- ilitation. 6.09 About 90% of tea sold at the Colombo auctions is subsequently exported; the major markets being Pakistan, USA, the Middle East and UK, in that order. In the period 1961-63, exports from Sri Lanka accounted for 34.5% of total world exports. However, as the country's production declined and that of other exporters (especially African countries) increased, this market share declined to 27.5% in the period 1972-74. Sri Lanka's domestic consumption has remained quite stable in recent years and in 1976 was approx- imately 21 M kg, or about 1.5 kg per caput. 6.10 In the medium term, tea consumption in developing countries is expected to grow somewhat faster than previously; at 4.4% per year from 1972/74 to 1985, compared with 3.9% per year between 1961/63 and 1972/74. Total world consumption is, however, unlikely to be greatly affected. It is projected to grow by only 3.4% per annum between 1972/74 and 1985, slightly faster than the 1961/63 to 1973/74 rate of 3.3%. This is because consumption growth in developed and centrally planned economies is expected to decline. In line with consumption, world tea production is expected to increase by about 3.4% per annum from 1972/74 to 1985, compared with 3.3% annually from 1961/63 to 1972/74. 6.11 Since 1975, world tea prices (average London auction all teas) have increased sharply; from 60 pence per kg in 1975, to 85 pence in 1976 and a record high of 255 pence in April 1977. Since then prices have fallen steadily, and at the end of November stood at just over 100 pence per kg. The average price for the 11 months January through November 1977 was 160 pence per kg. - 32 - 6.12 The major factor behind these tea price increases has been the 'pull' of sharply increased coffee prices. The FAO Secretariat has predicted that unless future coffee prices, in real terms, greatly exceed recent levels (about 60% above the 1972/74 levels) tea consumption will not increase much as a result. Barring further frosts in Brazil, the real price of coffee is expected to decline to pre 1975 average levels by 1981. Tea prices are, therefore, expected to fall from their present high levels of US200 per kg to 175 cents in 1980 and 170 cents in 1985 (IBRD projections, constant 1977 terms). Negotiations, on the establishment of an international commodity agreement to support the price of tea, are continuing under the auspices of IJNCTAD. Such an agreement could strengthen long-term tea prices, however, lhe negotiations are not likely to be finalized for 12 to 18 months and their outcome cannol: be predicted at this stage. 6.13 Pro2ject financial price assumptions (Annex 3) are based on IBRD projections for London auctions, with allowance for freight and other selling expenses, Sri Lanka sales tax and export duty, and expected quality differ- entials. Projject incremental output, amounting to less than two tenths of one per cent of world tea output, would not significantly affect world tea prices. 6.14 After appraisal GOSL, in its November 1977 budget, devalued the rupee and, as a complementary measure, introduced a flat rate tea export duty of Rs 15.5/kg. Ihis rate does not allow a sufficient return on capital invested in rehabilitation projects, which include housing, even for well managed estates (para 6.20). Furthermore tea prices are expected to fall. GOSL has stated that it intends to modify the rate of tea export duty so as to maintain reasonable profitability as prices fluctuate. Pending the findings of the Tree Crops Incentive Study definitive recommendations on an appropriate overall prices and incentives structure cannot be made. Assurances were tlherefore obtained that GOSL would adjust the prices and incentives structure as necessary to maintain tea industry profitability at the level established by the November 1977 budget, and would discuss the findings of the study with IDA before December 31, 1978. 6.15 Without the project, both tea quality and the percentage of top grades would siteadily decline as a result of continuing deterioration in factory equipment. The project would upgrade this and add greater flexi- bility to the maanufacturing process. It is expected that after 10 years, 'with' project prices would average 5% more than prices on a 'without' project basis. Projected prices are: (Rs per kg) 1979 1980-84 1985 1986-88 1989+ With Project 13.0 10.9 10.0 10.1 10.2 Without Project 13.0 10.7 9.7 9.7 9.6 - 33 - 6.16 3 Timber prices are difficult to predict; the current price of Rs 32 per m has been used for projection purposes. Given the increasing scarcity of fuelwood, this may prove conservative. Production Costs 6.17 A detailed study of 22 estates in the project area indicates that current production costs per kg are inversely correlated to yield. Based on an examination of the proportions of fixed and variable costs, production costs can be predicted for yield levels higher than those now obtained. On a 'without project' basis cost of production would be affected by three factors. The most important, increasing yield, would lower costs. Partially offsetting this, factory machinery and vehicle maintenance costs (presently Rs 0.20 per kg) would increase by an estimated 2.5% a year, and decreasing drier efficiency would increase fuel costs (presently Rs 0.25 per kg) also by an estimated 2.5% per year. 6.18 With the project, increasing yields would again have the greatest impact on costs. While costs of operating and maintaining green leaf tractors and trailers, and of factory electricity, would increase, costs for plucking, factory labor, and withering fuel would decrease (costs for maintenance of labor housing would also increase, but these have been treated separately from production costs in the cost table). 6.19 The net impact of differing yields, and the other changes mentioned, is that after 10 years 'with project' production costs are 16% lower than 'without project' costs, while after 20 years the margin increases to 22%. Financial Results 6.20 Without the project, the lack of adequate housing would have made it impossible to replace the departing Tamil labor and productivity would have declined as a result of labor shortage. This decline in productivity is difficult to quantify. As a proxy, the situation has been accounted for in the financial analysis by prorating housing costs on the basis of the proportion of the project area benefiting from the housing component, and from which incremental benefits flow. Of a total tea area of 18,000 ha, 7,000 ha (40%) would be replanted and infilled under the project. As incre- mental project benefits will flow only from this area, 40% of housing costs have been included in the financial analyses. Incremental financial rates of return for the corporations (Annex 4, Tables 1 and 2) are 14.5% for SPC and 12.5% for JEDB. Without prorating, the financial rates of return to SPC and JEDB would be 8.5% and 8.0% respectively. It is, therefore, evident that the corporations bear a financial burden in undertaking Government's housing program. This is illustrated in the sources and application of funds projections (Annex 4, Tables 3 and 4) which indicate that though borrowings can be serviced, annual net cash surpluses decline as the program continues. Government recognizes this problem and has directed that the Tree Crop Incentive Study should pay particular attention to the financial burden imposed on the industry by the labor housing improvement program, and that - 34 - a minimum financial rate of return of 12% on investment in rehabilitation projects would be the objective required to establish sufficient incentive for investment. Forecast project cash flows for the Bank of' Ceylon and Government are in Annex 4. Mainly through the generation of additional tax- able production the project would increase GOSL's revenues by an estimated Rs 50 M (US$3 M) annually at full development. 6.21 Preliminary 1977 profit and loss statements for SPC and JEDB (Annex 4) indicate large surpluses, mainly as a result of high tea prices during the year. Substantial surpluses are also budgeted for 1978; an operating profit of Rs 365 M for SPC, and for JEDB, a surplus of Rs 85 M. However, as neither c:orporation has yet had to purchase, or pay rental for, the estates it operates, these surpluses are misleading. 6.22 An illustrative budget for a one hectare holding based on average smallholder yields of 600 kg/ha and 1,050 kg/ha for seedling and clonal tea respectively, is at Annex 4. It indicates that the financial rate of return f'or a smallholder undertaking modest investments in replanting and infilling, would be about 13.5%. This is not an attractive return to a smallholder. M[ore importantly the replanting program has an adverse effect on cash flow for about 5 years. It is therefore assumed that only 25% of above average smallholders would participate in the project. The TSDA has been created to assist smallholders increase their production and a major means of so doing is replanting. The possibility of making the replanting subsidy better suited to smallholder needs would be addressed during the GOSL/IDA discussion of the findings of the Tree Crop Incentive Study (para 6.14). 6.23 The financial rate of return to private owners who purchase and operate trucks for made tea transport is estimated at 18% (Annex 4, Appendix 1). This assumes that the benefits resulting from the lower costs of operating the new trucks would flow entirely to the truck operators and not to producers in the form of lower transport charges. VII. ECONOMIC BENEFITS AND JUSTIFICATION Principal Benef-its 7.01 The project's major benefit would derive from higher revenue gen- erated through improved efficiency of tea production, which would increase yields and lower production costs by nearly 20% after 20 years, and through imsproved quality due to replacement of obsolete machinery and equipment. 7.02 Another large, though unquantified, benefit would be the improved living standards of the 60,000 strong labor force and their families because of improved labor housing and estate medical facilities. 7.03 Project incremental production (4.4 M kg after 20 years) would be a marginal 2% in terms of Sri Lanka's total tea output, but would help to arrest the current declining production trend, and would still leave the country's total production below the peak reached in 1965. - 35 - Other Benefits 7.04 Project field works would need an average additional 3,000 labor units per year over the five year investment period. Most of this would be supplied by present estate labor working after normal working hours, adding approximately Rs 6 M a year to estate labor income. 7.05 The project would diversify marginal tea land into timber which would provide locally significant quantities of fuelwood for estate labor and for factory use. Soil conservation drains throughout the project area would be rehabilitated. This, and diversification of marginal land, would reduce soil erosion; particularly important since the project area comprises a large proportion of the catchment of the country's most important source of hydro-electricity generation. 7.06 Other project benefits would include: (a) provision, for the first time, of extension services and production credit to 180 smallholder growers; (b) fewer delays in the movement of made tea from estates to the coast; (c) improved training for estate management; (d) a substantial stimulus for local building contractors; and (e) improved tea area statistics. Economic Rate of Return 7.07 In the economic analysis (Annex 5) adjustments have been made for taxes and subsidies (most importantly taxes on tea exports and the fertilizer subsidy) and a shadow wage rate equal to 95% of the financial wage. Housing costs have been prorated as in the financial analysis. Price assumptions are based on IBRD projections; project incremental output at full development (1998), would be less than two tenths of one per cent of expected world out- put, and would have negligible affect on these assumptions. In the November 1977 budget the exchange rate was unified, and the rupee was devalued to Rs 16 to US$1. Given the continued existence of sizeable import duties and other restraints on trade, the equilibrium rate is assumed to be Rs 18 to US$1 and this rate has been used in the economic analysis. 7.08 On the above assumptions, the economic rate of return (ERR) of the project is 25%. The project is relatively insensitive to changes in costs and benefits. An increase/decrease of 10% in tea prices would change the ERR by about one and a half points either way. The same level of increase/ decrease in costs would change the ERR by about two percentage points either way. - 36 - 7.09 Project benefits include prevention of production cost increases and quality deterioration which would occur without the project. If produc- tion costs and quality could be maintained at present levels without the project, and prevention of this loss were not included as a benefit, the ERR would be 20.5% rather than 25%. Project Risks 7.10 Apart from the temporary and unpredictable impact of adverse weather, the technical risks of the project are no greater than would normally be expected with operations of this nature. The major risks are organizational/ managerial in nature. As a consequence of land reform, the tea industry in Sri Lanka has been subject to tremendous change in recent years. Two large government corporations are now handling the work that previously was the responsibility of a large number of tea agency houses, and they have had some problems. However, the performance of the corporations is improving with experience. Furthermore, the ongoing Tea Master Plan is examining the insti- tutional structure of the industry in detail and is to make recommendations. In the meantime the organizational/managerial structure is adequate for project implementation in view of the limited areas of operation, recent improvements noted and changes under the project, notably establishment of a Project Coordinating Committee, appointment of a Project Coordinator, and increased delegation at regional level. VIII. RECOMMENDATIONS 8.01 During negotiations the following major assurances were obtained t:hat: (i) GOSI. would continue to assist in making credit available, under terms and conditions similar to those under the pro,ject, so that areas uprooted during the project could be brought to full production and so that housing programs could be completed (para 4.06); (ii) the on-lending terms outlined in Schedule A would apply to all project lending (para 4.07); (iii) the findings of the Master Plan study would be discussed with IDA (para 5.01); (iv) institutional changes which, in the opinion of IDA, would materially affect project execution, would not be made without prior discussion with IDA (para 5.01); (v) tea estates in the project area would be transferred to the corporations before December 31, 1978 in accordance with methods of transfer and payment satisfactory to IDA (para 5.13); - 37 - (vi) the corporations would be allowed to retain sufficient of their operating surpluses in investment reserves to finance contributions of at least 25% to their investment programs (para 5.14); (vii) GOSL would, by December 31, 1978, take measures satisfactory to IDA to enable SPC and SEDB to be exempted from the pro- visions of Sections 8 and 10 of the Finance Act (para 5.15); (viii) GOSL would discuss the findings of the Tree Crop Incentive Study with IDA before December 31, 1978, and would adjust the prices and incentives structure as necessary to maintain overall operating profitability of the industry at about November 1977 levels (para 6.14). 8.02 The following would be conditions of credit effectiveness: (i) the execution of a subsidiary loan agreement, acceptable to IDA, between GOSL and the Bank of Ceylon (para 4.07); and (ii) the execution of the Project Agreement on behalf of SPC and JEDB (para 5.15). 8.03 It would be a condition of disbursement for the factory component that a rationalization study satisfactory to IDA had been completed (para 5.22). 8.04 With these conditions and assurances, the proposed project is suitable for an IDA Credit of US$21 M to GOSL. SCHEDULE A Page 1 SRI LANKA TREE CROP REHABILITATION (TEA) PROJECT Project Lending Terms and Conditions The following lending terms and conditions would be applicable to the project and would not be altered without IDA concurrence. 1. Interest Rates Interest Margin IDA to GOSL 0.75 GOSL to Bank of Ceylon Housing refinance 6.5 5.75 Other 8.5 7.75 Bank of Ceylon to Sub-Borrowers Housing loans 10.0 3.5 Other loans I/ 12.0 3.5 2. Other Terms and Conditions (a) The Central Bank would provide refinancing of up to 90% of project sub-loans made by the Bank of Ceylon. (b) The Bank of Ceylon would provide loan finance to sub-borrowers of up to 75% of approved project investment expenditure for housing, vehicles, field development and factory machinery. (c) (i) Factory machinery sub-loans would have a 10 year term, there would be no grace period and principal repayments would be made in 10 equal annual installments. 1/ Sub-loans for factory machinery, after the 50% subsidy would bear an effective rate of interest of 6%. SCHEDULE A Page 2 (ii) Field development sub-loans would have a 15 year term, with one year of grace. In years two through six, replanting subsidies would automatically be directed to principal reduction; the remaining balance being paid in nine equal annual installments. (iii) Housing sub-loans would have a 15 year term with five years of grace; principal repayment would be made in 10 equal annual installments. (iv) Vehicle sub-loans would have a five year term, there would be no grace period and principal repayment would be made in five equal annual installments. SCHEDULE A ATTACEMNT SRI LANKA TREE CROP REHABILITATION (TEA) PROJECT Bank of Ceylon Financial Statements for the Year Ended 31st December 1976 1975 Sri Lanka Sri Lanka FINANCIAL RESOURCES WERE PROVIDED FROM Rupees Rupees -000 000 Operations: Profit before taxation 39,975 29,650 Non-cash items (Provision for Depreciation, fall in value of investments and transfers to contingency reserves) 16,138 10,193 Total from Operations: 56,113 39,843 Increase (Decrease) in Deposits and Other Accounts: Demand Deposits 423,891 ( 50,770) Time Deposits 53,869 43,994 Margin and Other Accounts 113,143 ( 3,889) Total Increase (Decrease) in Deposits and Other Accounts: 590,903 ( 10,665) Increase (Decrease) in Central Bank Refinance 26,228 ( 791) Total Financial Resources Provided: 673,224 28,387 FINANCIAL RESOURCES WERE USED FOR Increase in Advances: Trade Bills 136,566 2,778 Advances to Customers 342,049 147,679 Total Increase in Advances: 478,615 150,457 Increase in Short Term Funds 522 4,864 Investments in Government Securities 96,995 61 Investments in Subsidiaries and Other Companies - 1,000 Additions to Bank Premises and Equipment 24,518 8,620 Payment of Income Tax, Dividends and Contribution to the Consolidated Fund 24,975 20,455 Total Financial Resources Used: 625,625 185,457 Increase (Decrease) in Cash and Due from Banks 47,619 (157,070) 673,244 28,378 January 20, 1978 SRI LANKA TREE CROP REHABILITATION PROJECT (TEA) (Implementation Schedule) Year 1978 1979 1980 1981 1982 1983 Activity Quarter 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 PRE-NEGOTIATION ACTIONS_J NEGOTIATIONS PROCUREMENT BEGINSZ/ FACTORY EQUIPMENT VEHICLES HO US ING FIELD DEVELOPMENT INFILLING CUTTINGS IN NURSERY - - - - | - | | - - - _ - - -| PLANTING MAINTAIN - - m - - - - _ FREPLANTING UPROOT OLD TEANon PLANT AND MAINTAIN GRASS - - - = CUTTINGS IN NURSERY - - l - l - PLANT TEA MAINTAIN TEA -- SOI L CONSERVATION TERRACING DRAIN REHABILITATION FORESTRY SEEDLINGS IN NURSERY PLANTING MAINTAIN - - - _ FACTORY REHABILITATION RATIONALIZATION PLAN RECEIVE& INSTALL EQ EUIPMENT 2 f d j rkj a j iBESS I-. 1 / See paragraph 8.0 1 Z/ See Chart 2 for detail World Bank -18585 SRI LANKA TREE CROP REHABILITATION PROJECT (TEA) Procurement Schedule Year 1978 1979 1980 1981 1982 1983 MonthJJMAMJ ~A JJAS J JMH1J1AISOINI J+AJF J JAJ O NIDJF+AJM.lJ JAI OJN)J?F AJJ S DJj F J JAS NOJ FACTORY EQUIPMENT Recruit Rationalization Study Team Prepare Plan and Tender Documents * _ Clear Documents with IDA 0 Advertise and Receive Bids Evaluate and Clear with IDA I_ Order m _ Deliveries Begin HOUSING Prepare Standard Plans and Specifications Prepare Tender Documents Clear Documents with IDA M Advertise and Receive Bids Evaluate Sign Contracts U m m m m Start Work VEHICLES/TRACTORS Prepare Tender Documents Clear Documents with IDA Advertise and Receive Bids Evaluate and Clear with IDA 1111111IN X Order Deliveries World Bank - 18584 02 SRI LANKA TREE CROP Ri3ILITATION (TEA) PROJECT Total Pro ject Costs 1/ 2/ Total Total Percentage Percentage YEAR I YEAR 2 YEAR 3 YEAR 4 YEAR 5 Local Foreign Total Local Foreign Total Foreign Project (Rs 000) (Rs 000) (Rs 000) (Rs 000) (Rs 000) ____- Rs 000 ---- ------ uS$Exchange Costs Field Works 11,130 14,845 16,745 17,045 16,845 57,460 19,150 76,610 3,595 1,195 4,790 25 15 Field and Nursery Eauipment 2,175 2,140 2,025 2,025 2,025 6,235 4,155 10,390 390 260 650 40 2 Factory Eauipment 12,600 16,120 11,825 12,170 16,295 41,405 27,605 69,010 2,590 1,725 4,315 40 14 Vehicles 22,995 25,890 385 - - 17,245 32,025 49,270 1,080 2,000 3,080 65 10 Housing 26,815 26,815 26,815 26,815 26,815 100,555 33,520 134,075 6,285 2,095 8,380 25 27 Medical 1,520 1,240 1,040 1,080 880 2,590 3,170 5,760 160 200 360 55 1 Training 820 1,370 590 250 250 330 2,950 3,280 20 185 205 90 1 Support Components 1,155 1,530 330 130 130 1,965 1.310 3,275 125 80 205 40 1 Total Base Line Costs 799755 59,515 63,240 227,1785 123,885 351,670 14,245 7,740 21.985 35 71 Physical Contingencies 3,235 3,670 3,545 3,525 3,725 11,505 6,195 17,700 720 385 1,105 35 4 Price Contingencies 12,510 23,220 22,455 28,540 36,805 98,830 24,700 123,530 6,175 1,545 7,720 20 25 Total Project Costs 94,955 116,840 85,755 91,580 103,770 338,120 154,780 492,900 21,140 9,670 30,810 30 100% Duties and Taxes 9,000 565 Net Project Cost 483,900 30,245 It Rounded to nearest Rs 5,000. X P 2/ At US$1.00 to Rs 16.00 and rounded to nearest $5,000. April 26, 1978 TRIS DtWI8ARTATION (7M) 1A2JNCT Field Costs (iD RAs 000) SootYost ~~~~~~~~~~YEARS I YAR I YEAR) 71Y3651 YEARS 51TA, FoeAldSe ft..~e (/A SPC JNDB HELS 2. TDIAL SPC J2DB 'ROEA 7DTRIAL SPC JN B S'H LDA N TRTAL SPC JARB LLOD7N TOIAL SPC 71B 6S'R0LRNN TAL SPY AL5 SC J2B S 5 TOTAL Ltobr ttihn UPo r ts 3. -.. 2t33 77 7910 - 22395 75 2371 75 I 305 1 340 75 1215 - 750 75 825 8370 375 SR745 75 4 SoRes 3,349 - - - - - 090 17 R52 - 5Th 7 590 - 997 16 917 - 255 13 270 - SYRS 653 1767 752 AS I,70 60 175 25 4 PEAetIo6 15,300 _ _ _ _ _ 20 75 2965 73 24E5 1375 35 5455 - 6 6565 225 6030 50 25 SIoorEAAo A,075 - - - - - - - 122,9 97 1275 - 11FF 33 1035 - 2247 71 23SF 35 55~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~127 10 3 135 47 2I 1 iintLLn 7,500 - - - - - - ~ 1415 4A 1455 _ 1415 40 S455 30 53 tIFOFOO ~~~~~~~~7,500 - - 2- %bS bTtal 47,700 - 2b09 75 0)12 2930 9S 302Z 4755 165 4920 520 FF0 5220 4795 240 5035 F313S 770 21105 7 r3t 7F r 19,95) 72970 o) 1970 30 4280 22 90 1559 92 42dO 2 '90 1209 95 722 U 22 ,7 19 b7 950 42- 22SF 09SF 30 4280 11450 9800 150 21400 60 15 Second 7ear lC,713 - - - - L LY 161l 2 525 13 7 25 615 275 3725 185 1615 35 0514 7540 6460 100 14100 30 60 SuEb TIol 23,d25 7200 1060 30 420d 4175 3575 55 7805 4175 3575 55 7805 4175 3575 55 7F05 4175 3575 55 7805 18990 1626F 150 35500 45 35 Sotl CoIeeLVRBtSOf T-rreolFF 16.277 I220 2930 - 3279 2720 203Y - s29) E'' 207C - 3250 12720 2039 37270 1220 2030 - 320S 6100 10150 - 16250 100 70110551 b1 L 277 241 _ S1 5 270 24.5 h 77 21,5 _ 513 277 2 1 2 245 515 13 1225 - 2575 100 _ Rob T.oS cl410 1497 2270 . 3765 1490 2275 3705 1490 2F75 - 3765 1490 22 15 - 3765 1490 2275 - 3765 7450 11375 - 18825 100 - Forest PlaoE725j Sires leer 1,460 75 lOC - 177 75 1C9 _ 175 75 1)9 _ 17 75 LA) _ 175 60 100 _ 160 360 500 - 860 55 25 S e c dl Y sa r 6 27 _ - _ - 90 70 _ b O 5. 1 S O - d o 3 0 5 0 - Ad3 3 0 5 0 - R 0 11 0 70 - 3 2 0 5 5 1 0 Sub Total 2,060 75 100 _ 175 105 150 255 105 150 - 255 105 150 - 255 90 150 - 240 4A0 700 - 1180 55 20 Iot. 0 B -ee ine loots 3755 7172 _ Oo 10190 S70 1 1 4d45,, 1779 fl7o 720 1
Группа Всемирного банка · Staff Appraisal Report
Sri Lanka - Tree Crop Rehabilitation (Tea) Project
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