Honduras - Guayape Regional Development Project

Document of FILE COPY The World Bank FOR OFFICIAl, USE ONLY Report No. P-2 320-HO REPORT AND RECOM1MENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO-THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF HONDURAS FOR THE GUAYAPE REGIONAL DEVELOPMENT PROJECT May 4, 1978 'This document has a restricted distributieni and may be used by recipients only in the perforitiance of their of ficial duties. Its contents may niot otherw ise be disclosed witliotit 'A'orld Banik authorization.  CURRENCY EQUIVALENTS US$1.00 = L 2.00 (Lempiras) L 1.00 = US$0.50 L 1,000,000 = US$500,000 WEIGHT AND MEASURES Metric System and 1 manzana = 0.7 hectares (ha) ABBREVIATIONS AND ACRONYMS BANAFOM - National Development Bank BCH - Central Bank of Honduras CABEI - Central American Bank for Economic Integration CIDA - Canadian International Development Agency COHDEFOR - National Forestry Corporation DARNO - Agricultural Directorate for the North East Region IDB - Inter-American Development Bank INA - National Agrarian Institute NNR - Ministry of Natural Resources SECOPT - Ministry of Public Works and Communications -uRH - Department of Hydrological Resources FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY HONDURAS GUAYAPE REGIONAL DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Republic of Honduras Amount: US$10.5 million Terms: Twenty years including five years of grace at an interest rate oiE 7.5 per annum. RelendinR Terms for Agricultural Credit Component: Government to BANAFOM at 9 percent; BANAFOM to subborrowers at 11 percent with repayment terms for investment projects not to exceed 16 years including up to 3 years of grace, and for working capital not to exceed 12 months with no grace. Project Description: The project would be the first phase of a Guayape River Watershed scheme for development of the entire Valley. The objective of this first phase is to provide an integrated package of assistance and services for about 1,200 small farmers and 70 agrarian reform settlements with over 1,500 families in selected areas of the Valley. This package will include investment and production credit, extension services, machinery pool services, small scale irrigation schemes for some settlements, rural road improvement, and improved research facilities. The project will include technical assistance and training for th,e project unit and preparation of an agricultural project for possible future Bank lending. The risks associated with the project are possible lack of farmer acceptance of the technological packages, and weak insti- tutiornal support because of scarcity of qualified personnel and poor coordination between responsible agencies. In order to deal with these potential problems, a modest sized project has been designed with a project unit which will have adequate staff and authority to carry out the project, and the technology to be utilized will be based on the traditional pattern of farming activities in the project area. This document has a restricted distribution and may be used by recipients only in the performance of their oMcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Cost: US$ Millions Local Foreign Total On-Farm Investment Small Farmers 1.5 1.2 2.7 Rainfed Settlements 0.6 0.9 1.5 Irrigated Settlements 1.1 0.9 2.0 Tractors * 0.2 0.2 Sub-total 3.2 3.2 6.4 Supporting Investment Machinery Pool Equipment 0.1 04 0.5 Catacamas Research Station * 0.1 0.1 Rural Roads (35 km) 0.4 0.5 0.9 Sub-total 0.5 1.0 1.5 Technical Assistance Consultants * 0.5 0.5 Project Preparation.Study * 0.8 0.8 Sub-total - 1.3 1.3 Project Administration 1.8 0.6 2.3 Total Baseline Costs 5.5 61 11.6 Contingencies Physical 0.2 0.2 0.4 Price 1.3 1.3 2.6 Total Project Cost 7.0 7.6 14.6 * Less than US$0.1 million. Financing Plan: (US$ Millions) Local Foreign Total Percentage Bank 2.9 7.6 10.5 72 Government 3.8 - 3.8 26 Beneficiaries 0.3 - 0.3 2 Total 7.0 7.6 14.6 100  - iii - Estimated Disbursements: Bank FY79 FY80 FY81 FY82 FY83 Annual. 1.3 2.8 2.9 2.4 1.1 Cumulative 1.3 4.1 7.0 9.4 10.5 Rate of Return: 21 percent. Appraisal Report: 1953-HO, dated May 5; 1978>   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF HONDURAS FOR THE GUAYAPE REGIONAL DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Honduras for the equivalent of US$10.5 million for the Guayape Regional Development Project. The loan would have a term of 20 years, including a grace period of 5 years, with interest at 7.5 percent per annum. PART I - THE ECONOMY 1/ 2. A report entitled "Memorandum on Recent Economic Development and Prospects of Honduras" (1856-HO) was distributed to the Executive Directors on January 10, 1978. The main findings of the Report are summarized below. Country data sheets are attached as Annex I. Long-term Development Trends 3. The long-term growth rate of the Honduran economy has been exceed- ingly low. Between 1950 and 1975, real per capita GNP grew by only 1 percent a year and was estimated at US$390 in 1976, one of the lowest levels in the Western Hemisphere. Honduras' poverty is evident from a variety of indicators. Malnutrition is severe: about three-quarters of pre-school children are believed to suffer from protein and caloric deficiencies, and infant mortality is estimated at 118 per thousand live births. It is estimated that roughly 60 percent of the population has no access to piped water and about 80 percent lives without any form of sanitary waste disposal. Furthermore, these are country averages which conceal substantial regional disparities, as living conditions in the rural areas, which account for about two-thirds of the population, are much poorer than in the cities. 4. A major reason for Honduras' poor growth performance has been the continued dependence of thLe economy on the production and export of a few agricultural commodities, especially bananas, whose prices depend on a fluctuating world market situation and whose output may be greatly influenced by domestic weather conditions. The latter was dramatically illustrated when extensive destruction of the banana plantations by Hurricane Fifi in 1974 reduced the volume of bananas exported in 1975 to about one-half the level of 1973 and contributed to a drop in per capita income of about 3 percent. 1/ Substantially unchanged from the President's Report for the Second Education Project (P--2243-HO) dated February 23, 1978.  -2- 5. There are many reasons for the continued dominance of bananas in the Honduran economy. Known mineral deposits are not extensive. A serious lack of basic infrastructure and deficieni deveLorme rt o4-<-ci-, in the past have left Honduras' agricultural resources underutilized. In addition, the mountainous topography of the countr,y has made the expansion of the road network slow and costly. There has been progress, however, since 1960, and major achievements include the establishment of a basic transportation net- work connecting the main population centers, and a considerable expansion of electric power service. 6. Much land suitable for agriculture is still available, and the country has sizeable forest resources, but agricultural output only grew at about 2 percent yearly between 1950 and 1975. Uneven land distribution and deficient credit, technical services and development programs have kept agricultural growth far below its potential. 7. Manufacturing industry, which is highly concentrated in the cities of San Pedro Sula and Tegucigalpa, now accounts for about 16 percent of GDP and provides employment to about 10 percent of the labor force. During the 1960s, the manufacturing sector grew at a low annual rate (3.8 percent) owing to the small size of the domestic market, the lack of infrastructure, and the inability of domestic firms to take advantage of the opportunities offered by the Central American Common Market. Manufacturing growth, however, almost doubled in the 1970s (during 1970-76, real value added grew at an annual rate of 7 percent) because of the increase in both domestic and foreign demand and the consequent expansion and modernization of existing and new plants. Government Development Efforts 8. Since 1972, development efforts have increased substantially and several measures have been taken to lay the basis for the current improved economic outlook over the longer term. A land reform program which began in December 1972 aims at greatly improving land utilization as well as increasing the income and employment of the poorest peasants through the transfer of unutilized or poorly utilized land from large landowners to landless rural families. Another major policy development was the national- ization of timber rights in January 1974. A new forestry law established guidelines for private sector participation in forestry development and created the Corporacion Hondurena de Desarrollo Forestal (rOHDEFOR). COHDEFOR is in charge of all forest industry policies and activitics. and `Ls expected to exploit forest resources more rationally, increase lumber exports, and provide more employment for rural Hondurans. The third major achievement was an improvement in Government planning and executing capacity, particularly in infrastructure, which has resulted in a substantial increase in public fixed investment from 3.3 percent of GDP in 1972 to 6.6 percent in 1974 and about 7.6 percent in 1976. The Government has also made an effort to increase investment in the social and productive sectors and strengthen public finances through tax reforms and better tax administration. A 1975 tax reform made the tax on coffee exports an ad-valorem tax with marginal rates ranging from  -3- 10 percent to 20 percent depending on coffee prices, substituted a 3 percent value added tax for the sales tax, and raised the tax rates on beer, cigarettes and liquor. Recent Economic Developments 9. While Honduras was adversely affected by one of the worst hurricanes in its history in 1974, it had also to contend with the oil price rise of that year and the later OECD recession. As a result, during 1974-75, total GDP remained almost stagnant, severe balance of payments difficulties arose and the country's savings capacity was seriously reduced. Import prices grew almost three times as rapidly as export prices, and the terms of trade deteriorated by about one-fifth. The resource gap, which was equal to about 1 percent of GDP during 1972-73, averaged 11.6 percent during 1974-75. The rise in consumer prices, which had averaged 2.7 percent a year between 1966 and 1973, accelerated to 13 percent in 1974 before declining to 8 percent in 1975. 10. A high level of public investment, the gradual recovery of banana production and the doubling of coffee export prices were the major factors responsible for an improvenient of the economic situation in 1976. Real GDP grew at about 6 percent. Merchandise export earnings grew by about 31 percent in current terms over 1975, about half of it as a result of higher coffee prices. Government tax revenues increased from 10.8 percent of GDP in 1972-73 to 12.8 percent in 1976 and, while there was a substantial increase in public current expenditures, public savings were estimated at 2.7 percent of GDP in 1976 compared to an average 2.2 percent in 1972-73. However, as investment expenditures for hurricane reconstruction and development purposes were stepped up considerabLy, the overall deficit of the Central Government increased from 2.5 percent of GDP in 1970 to 4.9 percent in 1976. 11. In 1977, economic expansion continued, with real GDP growth estimated at about 7 percent, due mainly to the expansion of export volumes (about 9 per- cent) and of public investmnent (over 15 percent), and to continuing high coffee prices. The balance of payments improved, with larger coffee and banana export earnings reducing substantially the current account deficit and adding significantly to foreign exchange reserves. Growth Prospects 12. The growth prospects for 1978-82 are good. Real GDP is expected to increase at an annual rate of about 6 percent, barring natural disasters. Real exports should be able to grow at about 7 percent a year, reflecting continued recovery of banana production from the September 1974 hurricane, increased coffee production owing to higher yields and new plantings, expansion of sugar production, an increase of lumber exports made possible by the currently planned expansion of sawmill capacity, increased beef production, also the result of an ongoing program, expansion of fruit and vegetable production for export and promotion of tourism. Coffee prices, although declining from the unusually high 1977 level, are expected to remain above the 1976 level for two  - 4 - more years. In addition, the Government plans to accelerate economic growth over the medium-term through an ambitious public investment program designed to alleviate the most significant bottlenecks to the country's development process. The presently designed development strategy calls for large public investments in infrastructure, in export diversification through forestry development and tourism, and in agriculture to implement the agrarian reform program and increase productivity. 13. The expansion of the public sector's investment expenditures together with the necessary increase of complementary current expenditures creates a need for additional increases in taxes and the tariffs of public enterprises in the 1979-82 period as well as for careful control of other current expendi- tures. The Government is developing a series of proposals to mobilize addi- tional domestic resources in support of its development program. However, given the present and foreseeable poverty of the country, even with a greater revenue effort and current outlay control, Honduras needs external assistance in excess of the foreign exchange component of development projects suitable for international finance to enable the Government to implement the public investment program. 14. While real exports are expected to increase at about seven percent a year during 1978-82, Honduras' terms of trade are expected to deteriorate. As the import needs of the economy expand, in particular the imports related to the investment program, the current account deficit is expected to increase to US$200 million by 1981 and US$250 million in 1985, and large capital inflows will be required. The bulk of the external financing requirements will have to be met through public borrowing. Honduras will require an estimated total gross capital inflow of US$900 million for the six-year period 1977-82, of which about US$255 million will be disbursed from commitments made through the end of 1976. 15. Honduras' public external debt repayable in foreign currency is esti- mated to be US$418 million at the end of 1977, US$766 million if undisbursed commitments are included. In the past, Honduras managed to keep its external debt service ratio fairly low, because foreign loans were almost all on concessionary terms. It is important that the country continue to borrow on reasonably soft average terms, in view of the country's poverty, the fact that it will continue to depend on exports of a few commodities with volatile price prospects, and because, historically, natural disasters have sharply reduced the volume of exports every few years. Even if Honduras is successful in obtaining about two-thirds of the financing it needs for its investment program on terms similar to those offered by the international lending agencies, the debt service ratio is likely to rise from about 6.5 percent in 1977 to about 13 percent by the mid-1980s. 16. Although the IDB was Honduras' largest creditor as of December 31, 1977 with loans outstanding -- including undisbursed -- totaling US$269.6 million, 71 percent of this estimated total is repayable in local currency, so that IDB's share of the public debt repayable in foreign currency of US$766 is about 25.1 percent. The Bank Group holds 27.5 percent of the public debt outstanding -- including undisbursed -- repayable in foreign currency. CABEI  -5- accounts for 16.2 percent of the total, the US Government for 15.0 percent, Venezuela for 6.6 percent, privately held debt for about 7.2 percent and other debt for 2.4 percent. 17. In terms of the sectoral thrust of lending by the principal external agencies apart from the Bank, AID has concentrated on agriculture and educa- tion, IDB on transport, agriculture and forestry, health, education and housing, and CABEI on transport, industry, power and housing. It is expected that AID and CABEI will continue lending primarily in the same sectors in the future, while IDB would concentrate on agriculture, forestry, transport, industry and power. The lending of the external agencies from 1950-1977 was as follows: IBRD IDA AID IDB CABEI TOTAL Total Gross Lending 1950-1977 177.5 53.2 113.4 294.7 199.2 838.0 Gross Lending 1950-1965 25.9 12.5 26.7 27.2 8.1 100.4 Gross Lending 1966-1977 151.6 40.7 86.7 267.5 191.1 737.6 Sectoral Lending 1966-1977 Transport 88.3 5.0 - 32.1 74.7 200.1 Power 60.3 9.5 - - 20.9 90.7 Telecommunications - - - 14.7 10.1 24.8 Education 3.0 3.0 10.5 17.4 - 33.9 Health - - 2.6 33.2 10.2 46.0 Housing - - 5.0 12.5 16.5 34.0 Agriculture and Forestry - 23.2 48.5 155.4 4.1 231.2 Industry - - 5.0 2.2 33.2 40.4 Other - - 15.1 - 21.4 36.5 PART II - BANK GROUP OPERATIONS IN HONDURAS 18. Beginning with a loan of US$4.2 million for roads in 1955, Honduras has to date received sixiteen Bank loans totalling US$177.2 million and ten IDA credits totalling US$57.6 million, both net of cancellations. As of December 31, 1977, a tot;al of US$89.0 million remained to be disbursed on eleven operations for ports, electricity, roads, livestock, education and agricutural credit. The proposed loan would raise the total of Bank Group assistance from US$234.8 million to US$245.3 million. Execution of projects financed by the Bank Group has, on the whole, been satisfactory. Annex II contains a summary statement of Bank loans and IDA credits as of December 31, 1977, and IFC investments as of January 31, 1978, as well as notes on the execution of on-going projects.  -6- 19. In the past, Bank< Group lending was heavily concentrated in trans- port and power, witele r- fac fi