Mexico - Tropical Agricultural Development Project

Wmk. j! Document of FILE copy The World Bank FOR OFFICIAL USE ONLY Report No. P-2287-M& REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A TROPICAL AGRICULTURAL DEVELOPMENT PROJECT April 12, 1978 This document has a restricted distribuion and may be used by recipients only in the performane of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Unit - Peso (Mex$) The fixed exchange rate of US$1 = Mex$ 12.50 which had prevailed since 1954 was abandoned on September 1, 1976 and the Mexican peso has been floating since then. In recent weeks the rate of exchange has fluctuated in the range of Mex$ 22-23 to the US dollar. On March 30, 1978 the peso traded at 22.75 per US dollar. Fiscal Year January 1 to December 31 Glossary of Abbreviations CPNH - National Water Plan Commission CSAT - College of Tropical Agriculture FIRA - Agriculture Trust Funds of the Bank of Mexico INCAFOR - General Directorate for Forestry Training and Research INIA - National Institute for Agricultural Research INIP - National Institute for Livestock Research PIDER - Investment Program for Rural Development PRONDAAT - National Program for Agricultural Extension in Rainfed Areas SARH - Secretariat of Agriculture and Water Resources SRA - Secretariat of Agrarian Reforms  FOR OFFICIAL USE ONLY MEXICO TROPICAL AGRICULTURAL DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.A. Guarantor: United Mexican States Proiect Executing Agency: Secretariat of Agriculture and Water Resources Amount: US$56 million equivalent Terms: Payable in 17 years, including 4 years of grace, at an interest rate of 7.5 percent per annum. Relending Terms: Nacional Financiera, S.A. would transfer US$11.3 million of the proceeds of the proposed loan to the Agricultural Trust Funds (FIRA) of the Bank of Mexico, which would rediscount subloans to farmers. Interest rates to ultimate borrowers would vary from 11 to 17 percent per annum depending on loan purpose and size, and farmer's income level. The lowest rate would be applied to first time borrowers with low levels of income (annual income of less than 1,000 times the daily minimum wage rate), and. the highest would be applied to loans for farmers with higher incomes (para. 45). Project Description: The proposed project is envisaged as part of a long- term program for intensifying agricultural production in Mexico's humid tropical areas. The project consists of three parts: (i) development of six pilot projects, of about 4,000 ha each, introducing technical pack- ages for annual and perennial crops and livestock; (ii) improvement and expansion of agricultural and livestock extension programs in the humid tropics, with emphasis on the areas of influence of the pilot projects; and (iii) support for the tropical agricul- tural and livestock research programs. The technical, soc:ial, and administrative packages developed as a result of the project would be applicable to a wider area of about 660,000 ha having similar ecological and socio-economic conditions. The proposed pilot projects would directly benefit about 3,000 small holders and cooperative farmers, the majority of which have incomes beLow the relative poverty level in Mexico. Project 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 IFC authorization.  - ii - beneficiaries' incomes are expected to double within five years. Project risks are primarily ensuring: (i) farmers' acceptance of new technology; (ii) bene- ficiary participation in project planning and execution; (iii) coordination between implementing agencies. The project design attempts to minimize such risks to acceptable levels (para. 60). Estimated Cost: The total estimated cost of the project is US$149.0 million of which US$51.5 million is in foreign exchange: ------US$ Millions-------- Foreign Component Local Foreign Total Exchange I. Pilot Proiects 30.4 26.4 56.8 46 a. Area Development and 18.5 15.2 33.7 45 Infrastructure b. On-farm Development 11.1 7.4 18.5 40 c. Agro-industries 0.8 3.8 4.6 83 II. Research 25.8 7.9 33.7 23 a. Buildings, Vehicles, and Equipment 6.9 3.0 9.9 30 b. Technical Services 0.4 3.5 3.9 90 c. Incremental Salaries and other Operational Costs 18.5 1.4 19.9 7 III. Extension 14.5 1.7 16.2 10 a. Buildings, Vehicles, and Equipment 1.9 1.5 3.4 43 b. Incremental Salaries and other Operational Costs 12.6 0.2 12.8 2 IV. Total Base Line Cost 70.7 36.0 106.7 34 V. Physical Contingencies 5.5 4.7 10.2 VI. Price Contingencies 21.3 10.8 32.1 VII. TOTAL COST 97.5 51.5 149.0  - iii - Financing Plan: US$ Millions % Government 91.3 61 Beneficiaries 1.7 1 Bank 56.0 38 TOTAL 149.0 100 Estimated Disbursements: Bank FY 1979 1980 1981 1982 1983 1984 ------------ US$ Millions ------------- Annual: 2.1 9.2 11.8 14.1 12.3 6.5 Cumulative: 2.1 11.3 23.1 37.2 49.5 56.0 Economic Rate of Return: The estimated economic rate of return of the pilot projects is 17 percent based on the two pilot projects for which feasibility studies have been completed. These two pilot projects represent 33 percent of total pilot project investment; nine other pilot projects are under study of which four with acceptable rates of return of 12 percent or more would be financed under the project. All six pilot projects would account for 58 percent of project cost. The rate of return for the remaining items - research and extension - has not been. quantified. Staff Appraisal Report: Report No. 1864b-ME, dated April 3, 1978.   INTERNATIONAL BANIK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSEI LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GIJARANTEE OF UNITED MEXICAN STATES FOR A TROPICAL AGRICULTURAL DEVELOPMENT PROJECT 1. I submit the folLowing report and recommendation on a proposed loan to Nacional Financiera, S.A. with the guarantee of United Mexican States for the equivalent of US$56.0 million to help finance a tropical agriculture development project. The :Loan would have a term of 17 years, including 4 years of grace, with interiest at 7.5 percent per annum. US$11.3 million of the proposed loan would be relent through the Agricultural Trust Funds of the Bank of Mexico (FIRA) to f,armers for on-farm investments and establishment of agroindustries. Farmers would pay interest rates ranging from 11 to 17 percent per annum depending on size of the loan and its purpose and the income level of the borrower. PART I: THE ECONOMY 1/ 2. Some of the major features of the Mexican economy were analyzed in "An Updating Report on the Economy of Mexico" (1110-ME), distributed to the Executive Directors on March 23, 1976. An economic mission visited Mexico in April-May 1977 and its report is now in preparation. The discussion which follows reflects the preliminary findings of the mission. Past Performance 3. For most of the three decades preceding the mid-seventies, Mexico was outstandingly successful in achieving rapid economic growth while main- taining stability in prices and the balance of payments. From 1940 to 1970, average GDP growth exceeded 6 percent per year in real terms, inflation averaged less than 5 percent per year from the mid-1960s to 1972, and the dollar value of the peso, fixed in 1954, was maintained until the September 1976 devaluation. The Government's role in this achievement was to carry out direct investments in infrastructure and in key industries such as power, steel and petroleum, while creating a stable regulatory and institutional framework, as well as good profit prospects, to induce private sector growth. 4. This strategy produced rapid growth, but led to a sharpening of contrasts within the Mexic:an economy. While land redistribution under the reform of 1915 was continued, most of the peasants who received land could not improve their economic status in the absence of basic infrastructure, credit and technical assistance. Rapid population growth made social equity even more difficult to achieve, Population growth in Mexico accelerated steadily, 1/ Part I is substantially unchanged from the President's Report for the Tourism Development Project (R 78-35 of February 16, 1978).  - 2 - primarily as a result of reduced death rates, and reached 3.5 percent per year by 1970. Despite economic growth, the high demographic growth rate made adequate absorption of the labor force in productive employment difficult. Some 40 percent of the labor force is either relatively unproductive and poorly paid, or openly unemployed. 5. During the 1970s, Mexico experienced increasing public sector deficits, inflation, large balance of payments deficits, capital flight and a marked slowdown in the real rate of growth of GDP, which dropped to 2 percent in 1976-- the lowest annual growth rate experienced by Mexico since the mid-thirties. On September 1, 1976 the authorities abandoned the fixed exchange rate of 12.50 pesos per dollar that had remained unchanged since 1954 and let the peso float; in recent months it has remained rather stable at rates fluctuating between 22 and 23 pesos per dollar. Following the devaluation, Mexico obtained major support from the IMF. In the last quarter of 1976, Mexico was able to draw on the Fund for US$480 million. For 1977-79, an Extended Fund Facility accompanied by a comprehensive three- year stabilization program was negotiated, which could provide as much as an additional US$861 million once the increase in Fund quotas becomes effective. Thus, total IMF support for the Government's program may exceed US$1.3 billion. The new Government ratified the agreement with the IMF shortly after taking office on December 1, 1976, and to date has complied with the program agreed upon with the IMF. Current Economic Policy 6. The present Government inherited a difficult situation upon taking office on December 1, 1976. High inflation, large public sector deficits, in- creasing foreign indebtedness and lack of confidence in economic management indicated a need for economic stabilization. However, the situation also called for more expansionary policies; economic activity had slowed down, net private investment was virtually nil, and the gap between new job creation and growth of the labor force was increasing. High world prices for petroleum offered profitable investment opportunities in the petroleum sector; indeed, increased production for export of these products seemed by far the best way to meet a large part of Mexico's high debt service requirements in the coming years. 7. Faced with these conflicting needs and opportunities, the Mexican authorities are adopting a mixed strategy aimed at reducing lower-priority public expenditures and increasing public revenues, while proceeding with petroleum and other high-priority investments. The objectives of the Govern- ment's program include progressive control of inflation together with a return to high rates of economic growth by the end of 1978. Better manage- ment of public sector expenditures, more rational pricing and cost control in public sector enterprises, promotion of private savings, limiting wage increases to justifiable levels, and more effective cooperation with the private sector are important parts of the Government's economic strategy. 8. The measures instituted by the new Administration have already produced good results. Inflation in the twelve months of 1977 slowed to 20.7 percent (January-December) as compared to an annual rate of 60 percent in  - 3 - the last three months of 1976. The deficit in the current account of the balance of payments has been reduced, and is estimated preliminarily at US$2.2 billion for 1977, compared to US$3.5 billion in 1976. Total public sector financial requiremients dropped from 10.3 percent of GDP in 1976 to 7.9 percent in 1977. Mobilization of savings by the banking system is increasing. Perhaps most importantly, there is a general feeling of increased confidence in the Government's economic policy. 9. The stabilization effort during 1977 was absolutely necessary, but its price has been the continuation of economic stagnation; for a second year in a row GDP grew only by about 2 percent in real terms, implying a further decline of real per capita income. While control of inflation will remain as the overriding short-term objective--the Government's announced target is to reduce inflation to about 12-15 percent during 1978--the 1978 economic program aims at a simultaneous recovery of economic activity, through a recovery of private and public investment. Increased public sector savings, further strength,ening of the financial system and therefore in- creased availability of credit to the private sector, and continuation of a carefully managed wage policy (the annual increase in minimum wages agreed upon in January 1978 averaged about 14 percent) are the main means the Govern- ment will rely upon to attain the above objectives. Economic Issues and Prospects 10. As Mexico looks ahead, the key problems that its economic policies must address would seem to include the following: (a) Many Mexican families have not participated in the sustained economic growth of the last several decades. As of 1975, about 4,600,000 Mexican families--45 percent of the total-- receive incomes equal to less than one-half the national average. The rmembers of most of these families work--more than half of them in agriculture--but they produce little and receive little. Mexico's labor force is now growing even more rapidly than in the past--it will grow at about 3.6 percent per year over the next decade, which implies an average annual increase by some 670,000 workers during 1978-82; during the 1960s the growth rate was 2.7 percent per year. The challenge of providing productive jobs for both new entrants and existing under-productive workers is an awesome one. (b) Crop and livesitock production in Mexico, which had grown by 6 percent per year during 1945-55 and 4.2 percent per year during 1955-65, grew at only 2.1 percent per year during 1965-75. This near-stagnation of agricultural production signals the end of the strategy in which growth of agricul- tural production came from newly irrigated land, while rain- fed agriculture was relatively neglected. The continued expansion of large-scale irrigation, so successful from 1945 into the 1960s, has brought lower and lower returns as the works became costlier and easily accessible export markets for high-value crops became more nearly saturated. New approaches are required now to assure both production growth and increases in income for Mexico's poor rural families.  -4- (c) The size and role of the State in the economy has been a subject of much discussion in Mexico in recent years. During 1970-76, private investment slowed down, and virtually stagnated since 1975. This was, in part, a consequence of the pre-emption of credit by the public sector (during the six-year period, the share of the public sector in the economy grew from 15.0 to 21.5 percent), combined with infla- tionary financing and accompanied by what some perceived as an "anti-business" attitude. Public statements by the present Administration indicate that it wants to reverse this trend. (d) The present large foreign debt and sizable public finance deficit are mainly the direct outcomes of past public sector inability to mobilize adequate financial resources. By the early 1980s, large increases in export revenues, mainly from petroleum and related products, should make both the foreign debt problem and public finances much easier to manage. In the meantime, however, larger public sector savings are required to reduce inflationary pressures and to release credit for the private sector. (e) The rapid growth and heavy concentration of people and production in Mexico City, and the scarcity of employment opportunities and services in rural areas, are important challenges which have to be confronted. Both equity and efficiency considerations imply a need for diversion of some of Mexico City's future growth to other regions, as well as the provision of basic public services and enhanced employment opportunities in selected villages and small towns. 11. In the medium term the prospects for resumption of economic growth with relative price stability are good. Poverty will remain a problem but the Government is taking steps to address it. The alleviation of the external constraint on growth brought about by the expected petroleum earnings (para. 14), together with the Government's efforts to increase public sector savings and to stimulate private investment, could produce economic growth of 7 to 8 percent per year in the remaining five years of the present Administration. Resumption of economic growth combined with the intensification of the Government's family planning program (on October 28, 1977 President Lopez Portillo announced the ambitious goal of reducing the population growth to 2.5 percent per year by 1982, then progressively to 1.8 percent by 1988, 1.3 percent by 1994, and 1 percent by the year 2000), the new emphasis on rainfed agriculture, and the implementation of specific programs aimed at increasing productive employment should help to address the structural problems mentioned above (para. 10). 12. In agriculture, the Government's quick action to defuse tensions created by land invasions and expropriations at the end of 1976, and its decision to review the legislation concerning land and water use, should  -5- reduce uncertainty and induce a better use of the available land and water resources. In addition, tlhe new emphasis on rainfed agriculture--which had been relatively neglected in the past--should lead to an increase in the production potential of vast areas currently under-exploited and to a reversal of the past trend towards larger income disparities between the modern and traditional agricultural subsectors. Development of intensive agriculture in the tropics and of a nationwide program to construct small irrigation and drainage works are new features of the Government's agricultural policy. These initiatives, together with the more realistic exchange rate and remunerative support prices, promise a resumption of growth of production for both domestic and export markets and increase the possibilities of an improvement in the living conditions of the rural poor. 13. Industry has potential for considerable growth in many sectors, including efficient import substitution in chemicals, petrochemicals and capital goods as well as exports of many different manufactured products. Increases in tourism export earnings are also expected. 14. Among the benefits of recent public sector investments are the new possibilities opened to the Mexican economy through the recent discover- ies of rich petroleum fields. The Government has decided to use these large hydrocarbon resources to help manage Mexico's heavy debt service burden and to enhance the country's over-all development prospects. To meet this objective, PEMEX (Petroleos Mexicanos, the State-owned oil monopoly) has launched an ambitious six-year investment program amounting to US$17.0 billion in 1977 prices (about 25 percent c,f total public investment). This program would: (a) almost triple the production of oil and condensates, from 292 million bbl/year in 1976 to 818 million bbl/year in 1982; (b) more than double the country's primary distillation capacity, from 270 million bbl/year in 1976 to 577 million bbl/year in 1982; (c) substantially increase production of primary petrochemicals (ammonia, ethylene, benzene, etc.) as well as downstream products (styrene, vinyl-chloride, polyethylene); and (d) enable export of natural gas at a rate of 2.0 billion cubic feet/day by 1982. Under this program, the value of exports of oil and related products would increase over ten times, from about US$0.9 billion in 1977 to more than US$10.0 billion in 1982. If this program were to be carried out on schedule, and incentives maintained for non petroleum exports, the balance of payments on current account would shift from a deficit of US$2.1 billion in 1977 to a surplus of about US$3.0 billion in 1982.  - 6 - 15. The prospect of rapidly rising petroleum exports, as well as previously mentioned prospects for increases in tourism earnings, recovery of agricultural exports, and resumption of growth of manufactured exports, have greatly strengthened the balance of payments outlook. Even on the basis of somewhat more conservative projections of petroleum production and exports than those mentioned above, the current account deficit can be expected to decline steadily over the next several years and become slightly positive by 1982, thus reducing Mexico's net external borrowing requirements (Annex I). The debt service ratio has been increasing over the recent past, reaching 46 percent in 1977. It is expected to peak in 1979 at slightly over 50 percent and decline sharply thereafter to levels around 30 percent in the early 1980's. Debt service on Bank loans amounts to about 4 percent of public debt service; this ratio is projected to decrease over the next two years and to increase to some extent afterwards. The Bank currently holds about 8 percent of Mexico's total medium- and long-term public debt, and this ratio is likely to increase to some extent over the next few years. Mexico remains creditworthy for borrow- ing on conventional terms considering the country's strong medium- and long- term potential and the comprehensive economic strategy which the Government has adopted to realize it. PART II - BANK GROUP OPERATIONS IN MEXICO 1/ Bank Operations 16. As of February 28, 1978, Mexico had received 50 loans from the Bank amounting to US$2624.4 million net of cancellations and terminations; of these, 33 loans totalling US$1486.4 million were fully disbursed. As of February 28, 1978, the Bank held US$2142.2 million of which US$787.2 million had not yet been disbursed. Some 35 percent of Bank lending has been for agriculture and rural development (15 loans for US$923.4 million), 27 percent for power (12 loans for US$704.8 million) and 21 percent for transportation projects (12 loans for US$546.7 million); the remaining 17 percent has been for industry (US$205.5 million), water supply (US$130 million) and tourism (US$114 million) projects. Mexico is carrying out a stabilization program and because of scarcity of counterpart funds, some projects fell behind schedule in 1976 and 1977. Following review with the Government, a steel loan was terminated (Sec M77-258 of April 5, 1977), the scope of an irrigation project was reduced and US$100 million from the original US$150 million loan were cancelled (R77-305 of December 13, 1977) and the scope of several other projects has been modified. Other projects under implementation and affected by the stabilization program are being reviewed by the Government, and further discussions will be held with the Bank shortly. By and large, adequate budget support for the ongoing projects has now been secured. Annex II contains a summary statement of Bank loans as of February 28, 1978 and notes on the execution of ongoing projects. 1/ Part II is substantially unchanged from the President's Report for the Tourism Development Project (R78-35 of February 16, 1978).  -7- IFC Operations 17. As of February 28, 1978, IFC has made 13 investment commitments in Mexico, for a total of US$69.5 million, of which US$38.3 million had been sold, repaid or cancelled. The balance held by the Corporation, US$31.2 million, consists of US$2o.2 million in loans and US$5.0 million in equity. A summary statement of IFC investments as of February 28, 1978 is presented in Annex II. Bank Strategy 18. The main objectives of Bank lending in Mexico have been to: (i) support policies and programs leading to a wider distribution of the benefits of economic growth; (ii) strengthen policies and programs leading to continued economic growth, by helping to finance projects that are to make directly or indirectly significant contributions to output, exports, and employment; and (iii) help resolve critical adjustment problems that Mexico is currently facing. In support of the administration's economic stabilization efforts, it is proposed that limited finance of local costs be provided in 1978 and 1979 for priority projects of a social nature in which the foreign exchange costs are low. The Bank is preferentially supporting projects that make relatively modest demands on budgetary resources and have a strong positive balance of payments effect, projects of high social priority that help the rural or urban poor, projects that promote higher levels of employment and production and those that help to decentralize economic activity. The pro- posed tropical agricultural development project, although requiring substan- tial budget support over its five year implementation period, meets several of the other criteria: it would benefit the rural poor, introduce modern agri- culture in the humid tropics, and has the potential of significantly expanding the agricultural base of Mexico. 19. In view of the difficult structural problems of Mexico's agriculture and the sector's crucial importance to the country's further development, the Bank has made agriculture the leading sector for its lending. Consistent with the overall framework of country and sector objectives, a three-tier approach has been developed. First, to strengthen infrastructure development and agricultural credit programs so as to meet the demands of a rapidly growing population more adequately and to generate the foreign exchange needed for rising import requirements. Second, to raise the incomes of the rural poor and improve their standards of living through a combination of directly pro- ductive, support and social infrastructure investments. Third, to strengthen Mexico's institutional capability to use scarce agricultural resources more efficiently. In support of this strategy, the Bank has made seven loans over the past four years, totalling US$579 million, for irrigation, rural develop- ment and agriculture and livestock credit programs. In FY77, the Executive Directors approved a US$120 million loan for an Integrated Rural Development Project--PIDER II--under which some 46,000 poor farm families will benefit from directly productive activities. In addition to the proposed tropical agricul- tural development project, an agricultural credit project has been appraised and will be submitted to the Executive Directors in a few weeks.  -8- 20. Bank lending for industry has been aimed at assisting the Govern- ment's efforts to reduce the balance of payments deficit and decentralize industrial activities away from the major (and increasingly congested) urban areas. Thus, a major steel project which the Bank helped finance has recently started operating in a previously underdeveloped area on the west coast of Mexico, and the Executive Directors approved a US$50 million loan in FY75 to support a fertilizer project which promotes new poles of development in the resource-rich southeast region and the north central area. A third Industrial Equipment Fund project and a fertilizer project are currently being processed for submission to the Executive Directors in the coming months, and a project to promote small- and medium-scale enterprises is being submitted for consideration on April 25. 21. As regards infrastructure, the Bank's operations have been focused on investments in key areas of the country as well as on institutional reforms and sector policies aiming, inter alia, at suitable pricing mechanisms to help generate additional resources for investment financing: the Airports Development Project (FY74) was designed to support the Government's policy of regional integration; the Third Railway Project (FY76) supported improve- ments of institutional aspects and financial management of the sector. The Mexico City Water Supply Project (FY73) has been instrumental in the estab- lishment of a specialized institution for efficient supply of bulk drinking water in the Mexico Valley, and in the pricing of water at levels more closely related to costs. 22. The Government and the Bank have long recognized the regional economic disparities prevailing in Mexico. In June 1976 the Government adopted the Law of Human Settlements to provide a new institutional framework to deal with the pressing problems of over concentration of economic activi- ties in the larger metropolitan areas, and several projects are now being prepared to meet the needs for basic urban services for poor families in selected priority cities. One such project, to assist in the development of the Lazaro Cardenas conurbation area, is being considered by the Executive Directors on April 25. 23. The Government, pressed to reduce the external deficit on current account, is giving emphasis to the tourism sector to generate higher foreign exchange earnings and promote employment. In support of this policy, the Bank has granted three loans for tourism projects in Mexico; two to provide infra- structure in new poles of tourism and one, approved by the Executive Directors earlier this year, to help finance tourism superstructure. PART III - THE AGRICULTURAL SECTOR 24. The Mexican agricultural sector is marked by wide disparities in resource endowment, technology, productivity and income. On the one hand, it includes commercial farms under the management of efficient and sophis- ticated rural entrepreneurs who contributed decisively to Mexico's success in satisfying the demand of a rapidly growing population and in transforming the country from a net importer to a net exporter of agricultural products. On the other hand, it comprises a large number of small-holders in subsistence agriculture with small plots, many in unfavorable ecological conditions. These farmers work by traditional methods, barely participate in the market economy, live in poor social conditions and subsist on a modicum of food production from their farms.  -9- 25. More than 22 million people live in Mexico's rural areas. Agri- culture is by far their most important employment and income source. Over 3 million families, representing close to 40 percent of Mexico's labor force, depend on agriculture for their livelihood. These people comprise three distinct groups of nearly equal size: (i) those who work on land owned by others; (ii) private landholders; and (iii) ejidatarios 1/. In sp-ete of extensive migration to urban areas, the number of landless agricultural workers is increasing rapidly, a consequence of limited farm land and limited rural employment opportunities. 26. The dualistic naLture of Mexican agriculture is shown by wide variations in productivity. The fifteen percent of Mexican farmers with irri- gated holdings produce sixty percent of Mexico's agricultural goods. Most of the remaining farmers aLre of such low productivity so as to barely subsist; half of Mexico's farm units produce less than one percent of total national agricultural production, whereas the 7 percent of farms using modern technology produce 34 percent. 27. A program of large scale irrigation works resulted in a five fold growth in production over the period 1940 to 1965, a growth that is among the highest in Latin America. The concentration of public investment, technical assistance, and farm crediLt in the irrigation districts enabled the 3 percent of Mexico's farms so affected to provide 80 percent of the growth in production between 1950 and 1960. At: the same time, very little was invested in improving rainfed agriculture, although the rainfed areas comprise about 75 percent of the total cropped area of Mexico and contain about 85 percent of the country's farm enterprises. 28. Mexican policy also stressed social justice through the implementa- tion of a pioneering agrarian reform program. Between 1940 and 1965 over half of Mexico's arable and pasture lands were distributed to landless families. Most of the farmers benefitting from irrigation programs also benefitted from this massive land redistribution program, but as mentioned in the preceeding paragraph, those who did not benefit from irrigation received few public services and therefore were seldom able to exploit the land intensively. In an effort to correct this imbalance and to bring redistributed land into more productive use, the Secretariat of Agrarian Reform (SRA) has recently embarked on a program to provide technical, promotional, and organizational assistance to farmers while encouraging the participation of credit and marketing agencies. 29. There has been a marked deceleration in the growth of agricultural production in the last decade (para. 10 b). In an effort to reverse this trend, the Government has adopted a strategy of making small holders more productive. This should result in a more equitable income distribution and increased rural employment opportunities. Some of the more important efforts are the following: 1/ Ejidatarios are members of an ejido, which is a form of group land tenure based on usufruct.  - 10 - (i) Rural development programs designed to increase the productivity of the poorest rural residents are under implementation. The largest of these, the Investment Program for Rural Development (PIDER) presently covers 100 micro-regions with a high concen- tration of rural poor. (ii) A program of small scale irrigation and drainage works benefitting groups of small holders is being expanded. (iii) Increased amounts of development credit and technical assistance have been extended to low income farmers through the private and public banking system as a result of new banking regulations and promotional activities of the Agricultural Trust Funds of the Bank of Mexico (FIRA). (iv) A progranm to promote better use of irrigation water was developed and is being applied to irrigation districts. (v) Rainfed districts were created to promote the channeling of inputs, credit, and technical assistance to rainfed areas. An improved extension service for rainfed areas (PRONDAAT) has been developed. (v) The Government has prepared a program to develop the under-utilized agricultural potential of the humid tropics. The proposed project is part of this program. Agriculture in the Tropics 30. The tropical lands of Mexico located on the Gulf Coast and southeast region of the country (see map IBRD 13209) represent the largest underexploited agricultural region of Mexico. This area includes about 8.3 million ha of arable lands with medium to high agricultural potential of which about 3.6 mil- lion ha are virtually unused and the remaining 4.7 million ha are devoted primarily to extensive livestock. These figures compare to a total of 35 million ha of arable lands in all of Mexico of which 17 to 20 million ha are currently cropped. The arable areas in the region have considerable potential for intensive production because of the generally high and reliable rainfall. In many places double cropping is possible without irrigation while in others only modest supplementary irrigation systems would be required. More than 60 percent of the lands is in the hands of ejidatarios or small private farmers, the holdings averaging 8 ha per ejido family and upwards of 20 to 30 ha per small private farmer. 31. Agricultural production in the humid tropics is presently charac- terized by extensive land use with low yields and a generally low level of farm management, processing, marketing and agricultural services (extension, research, credit). Much of the land is also poorly drained and subject to flooding. As a result, a majority of the rural families are at subsistence levels. Livestock production both from beef and dual-purpose beef/milk operations is the most widespread activity. About 7 million head, or about 25 percent of the national herd, are located in the humid tropics and represent  - 1 1 - an important source of supply to the Mexico City market. Corn, beans, and sugar account for 90 percent of the cropped area; the remaining areas are devoted to rice, cocoa, vegetables, rubber, coffee, bananas, pineapples, and other fruits. Average yields are low but information and experience exists that could be applied to iLncrease yields significantly. The main constraints for development -f intensiLve agriculture are: (i) frequent flooding and poor drainage of much of the fLat, fertile soils; (ii) lack of data on many aspects of agricultural production; (iii) lack of support services, particularly a well integrated extension service; (iv) generally inefficient farmers' orga- nization and on-farm management; and (v) unclear land use rights. 32. The Government undertook a major review of national agricultural and water resources that was financed by the UNDP and for which the Bank was the executing agency. The conclusions were published as the National Water Plan Study of 1975. A major conclusion of the study was that the vast underutilized humid tropical areas offer Mexico the greatest potential for increases in agricultural production in the medium term. As a result, the Government formed the National Water Plan Commission (CPNH) within its Secretariat of Agriculture and Waf:er Resources (SARE) and charged it with formulating a development strategy for the humid tropics and preparing specific projects. The proposed project is a major step in this effort to develop the humid tropics. Bank Experience in Other Sector Projects 33. Bank lending in the agricultural sector has concentrated on irriga- tion, rural development, and agricultural credit projects. Experience has generally been satisfactory with project goals met or likely to be met. The irrigation projects and one rural development project, however, have suffered from some managerial deficiencies and a shortage of counterpart resources during the Government's economic austerity program, thereby leading to delays in project execution and substantial cost over-runs. The Government is taking corrective measures, and improvements in project execution have recently been noticed. Successful experiences from previous agricultural and rural development projects have been incorporated in the design of the proposed project. The PIDER rural development program (Loans 1110-ME and 1462-ME) and the Papaloapan Rural Development Project (Loan 1053-ME) have demonstrated the effectiveness of the approaches to extension, farmer organization, agrarian reform, and inter-agency coordination that would be applied to the proposed project. The Rio Panuco Irrigation Project (Loan 969-ME) is employing the cooperative farming approach that would be promoted under the proposed project. PART IV - THE PROJECT Background 34. A staff appraisal report, entitled "Tropical Agricultural Development Project," No. 1864b-ME dated April 3, 1978, is being circulated separately to the Executive Directors. The project was identified as a result of work done under the National Water Plan Study financed by the UNDP for which the Bank  - 12 - was the executing agency. The project was prepared by the National Water Plan Commission and appraised by a Bank mission in August 1977. Negotiations took place in Washington D.C., from March 17, 1978, to March 29, 1978. The Mexican negotiating team was led by Mr. Arturo Ortiz of Nacional Financiera, S.A. Project Objectives 35. The project would be part of a long-term program to develop and bring into intensive agricultural production 2.4 million ha in the tropical lowlands of Mexico. Basic studies conducted by CPNH (para. 32) indicate that this area with medium to high agricultural potential is among the most promising of the lands that could be brought under cultivation in the medium term, provided that the physical, financial, legal and social constraints to development mentioned in paragraph 31 could be overcome. The proposed project is directed at the resolution of these constraints and would intensify agri- cultural production on 24,000 ha. The project would be carried out over a five-year period and would consist of three major components: (i) development of six pilot projects of about 4,000 ha each that are representative of about 660,000 ha of the tropical lowlands; (ii) improvement and expansion of agri- cultural and livestock research programs in the tropics; and (iii) strengthen- ing agricultural extension services in the tropics. Some 3,000 families would directly benefit from the pilot projects and 40,000 additional families in the pilot projects' areas of influence would benefit from applied research and improved extension services. Pilot Projects 36. In its strategy for development of the humid and semi-humid tropics, the Government has decided to phase development and test techniques before embarking on large-scale programs. To this end, CPNH had identified 23 pilot project areas, ranging from 2,000 to 6,000 ha each, as being representative of ecological and social conditions prevailing in surrounding areas, and in which development strategies could be tested. Under the proposed project, six pilot projects of about 4,000 ha each would be implemented, of which two, Zapotal in Tabasco State and Tesechoacan in Veracruz State, have already been chosen and whose feasibility studies have been completed (see Maps IBRD 13209 and 13210). Studies for selection of the remaining four pilot projects are underway in nine possible areas. Final selection would be based on detailed feasibility studies and investment programs; works in each pilot project would be eligible for finance under the proposed loan only after appraisal by the Bank (Loan Agreement, Schedule 1, para. 3(b)). To ensure their replic- ability and success, the following criteria have been applied in the selection of pilot projects: (i) the pilot area must be ecologically representative of a surrounding area sufficiently large to warrant a future development program in which economies of scale would accrue; (ii) the status of the farmers in the pilot area regarding land tenure and income distribution should also be representative of a much larger surrounding area; and (iii) the areas should possess good potential for intensifying land use and increasing agricultural production.  - 13 - 37. Features common to the six pilot areas would be: (i) improvement of physical conditions of the areas by constructing drainage works, feeder roads, administrative facilities, and, when appropriate, works for supplementary irrigation; (ii) clarification of land use rights for participating ejidatarios and small holders; (iii) organization and training of ejidatarios to encourage them to undertake collective development; (iv) provision of agricu'2ural exten- sion services and applied research to develop technical packages and promote agricultural development in the areas; (v) provision of short and long-term credit for on-farm development, fixed investments and livestock; (vi) establish- ment of agro-industries; and (vii) establishment of an operation and mainte- nance service for the works. 38. The main investment in the pilot projects would be the construction of drainage works to remove existing waterlogging and flooding problems. Works would be compact and simple in design, and project beneficiaries would contribute unskilled labor during construction. The operation and maintenance of these works would be the responsibility of users' associations. Agrarian Reforms and Farmer Organization 39. Two types of agrarian reforms would be carried out in the pilot projects: (i) clarification of land use rights in the ejidos and (ii) purchase of privately owned land to be converted into ejidos. The Government is encouraging collective ejido operations in the region, but to provide flexi- bility in addressing the varying circumstances of each ejido group, three different approaches are envisaged: (i) in ejidos where group farming is not practiced, the ejidatarios would be encouraged to form groups of viable commercial units; (ii) in ejidos like Tesechoacan, where group farming is practiced, efforts would 'be made to strengthen the existing organization, to ensure effective farmer participation in management and decision making, and (iii) in the case of the new ejidos, collective farming would be encouraged to promote adoption of modern technology. SARH would establish a land tenure resident office in each pilot project to implement these actions in coordina- tion with SRA. 40. Proper farmer organization is important for success of the project, and during the first project year, farmers' participation in ejido management and farm development planning would be promoted. To this end, an office responsible for farmers' organization would be established in each pilot project; the office would be made up of CPNH staff supported by the National Institute for the Training of Farmers and assisted by a UNDP/FAO team of technicians. Extension 41. With the exception of the programs operating under the control of the Papaloapan Commission, SARH extension services in the project area are inadequate (less than one extension worker for 1,000 families), and the service offered is generally poor. Under the proposed project, basic insti- tutional arrangements would be made to develop a comprehensive extension service for the tropical regions of Mexico. It would be based on the PRONDAAT  - 14 - approach 1/, and would provide for an intensive coverage of the pilot project areas (one extension agent per 30 to 40 families) and substantially improve coverage in the adjacent areas of influence (one per 150 families). 42. A major bottleneck in the expansion of the PRONDAAT extension system has been the lack of training facilities--presently there is only one training center that cannot cope with the demand. Under the project, a Tropical Center for Extension Training would be established in the state of Tabasco. 43. The total cost of the extension component of the project (including contingencies) is estimated at US$20.5 million, of which US$1.9 million would be in foreign exchange. With a view to making a meaningful contribution to this critical element of the project, it is proposed that the Bank finance not only the foreign exchange component but also US$4.5 million equivalent of local costs on extension services and training. Research 44. Although the existing information and technological base is adequate to ensure development of viable agricultural programs in the Mexican tropics, it is unlikely that the momentum will be sustained without substantially increasing production oriented agricultural research in the region. The project would, therefore, provide for increased assistance to the National Institutes for Agricultural Research (INIA) and Livestock Research (INIP). It would also assist the General Directorate of Forestry Training and Research (INCAFOR) to strengthen its tropical research programs, and the College of Tropical Agriculture (CSAT) to train its teaching staff. These institutions are integrating their research programs to avoid duplication and to develop integrated technological packages for farmers in the humid tropics of Mexico. About $6.4 million from the Bank loan would be applied to the research component of the project, of which $1.4 million would be eligible for disbursement only after the integrated program has been reviewed with the Bank (para. 3(c) of Schedule I to the Loan Agreement). Agricultural Credit 45. About US$19 million of long-term credit (of which about $9 million financed by the Bank loan) would be provided for on-farm development including land and pasture development, small scale drainage and supplemental irrigation works, and for purchase of cattle, farm machinery and equipment. Private and public banks would participate in the credit program; the Agricultural Trust Funds of the Bank of Mexico (FIRA) would discount these loans up to 90 percent. The terms of the sub-loans would be adjusted to the repayment capacity of the 1/ National Program of Agricultural Development in Rainfed Areas (PRONDAAT) is based on the experience under "Plan Puebla" to improve maize cultiva- tion. The extension agent is given a broad developmental role, is responsible for delivering a comprehensive technological package and assists in marketing the produce.  - 15 - sub-borrowers and the type of investment project, and would vary from 3 to 15 years, including grace periods of I to 3 years. The interest rates charged to sub-borrowers and participating banks are summarized below: Rate to Loan Participating Rate to Sub-borrowers Amount Bank Sub-borrower (Thousand Pesos) ------ (percent per annum)