Philippines - Magat River Multipurpose - Stage Two - Project

FI0L Te Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2 31 0-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE MAGAT RIVER MULTIPURPOSE PROJECT: STAGE II April 28, 1978 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 authorizatlon.  CURRENCY EQUIVALENTS US$1.00 - Pesos (P) 7.40 P 1.00 - US$0.135 WEIGHTS AND MEASURES - METRIC SYSTEM 1 hectare (ha) - 2.47 acres 1 kilometer (km) - 0.62 miles 1 kilogram (kg) - 2.2 pounds .1 cavan (paddy) - 50 kg 1 megawatt (MW) - 1,000 (kW) 1 gigawatt hour (GWh) - 1 million kilowatt hours (kWh) 1 kilovolt (kV) - 1,000 volts (V) ABBREVIATIONS ADB - Asian Development Bank AMIADP - Angat Magat Integrated Agricultural Development Project MARIS - Magat River Irrii&ation System. MECO - Manila ElectriG Company HRMP - Magat River Multipurpose Project NBC - NIA Board of Consultants NEA - National Electrification Administration NIA - National Irrigation Administration NPC - National Power Corporation SIFRIS - Siffu River Irrigation System SPO - Special Projects Organization UPRP - Upper Pampanga River Project USBR - United States Bureau of Reclamation GOVERNMENT OF THE PHILIPPINES FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY PHILIPPINES MAGAT RIVER MULTIPURPOSE PROJECT: STAGE II Loan and Project Summary Borrower: Republic of the Philippines Beneficiary; National Irrigation Administration Amount: US$150 million equivalent Terms: The loan would be for a term of 20 years, including a grace period of 5 years at an interest rate of 7.5% p.a. Project Description: The project is Package II of the Magat River Multi- purpose Project Stage II which consists of the following four packages: (a) Package I - consisting of preconstruction works (access roads, permanent camp, etc.), dam foundation grouting, drainage gallery tunneling and the river diversion tunnels, together with consulting services associated with these activities. (b) Package II - consisting of all civil works for the main dam, and appurtenant structures, reservoir resettlement, installed mechanical equipment and consulting services. This Package is the subject of the present report and the proposed Bank loan. (c) Package III - consisting of the civil works for the power component, together with the supply and installation of penstocks, turbines, generators, electrical and mechanical equipment and transmission lines. (d) Package IV - consisting of construction of the Baligatan diversion dam and the civil works for irrigation development of 27,000 ha of currently rainfed land. 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.  - ii - The Project (Package II) consists of: (a) construction of the main dam across the Magat river consisting of a concrete spillway, a power intake section and adjoining rockfill embankment sections; (b) construction of the rockfill Baligatan dike running from the right abutment of the main dam to the left abutment of the Baligatan creek dam; (c) construction of the rockfill Baligatan creek dam, together with an outlet conduit and control works; (d) resettlement within the service area of the dam of about 500 families affected by construction of the dam; and (e) provision of consulting services to assist NIA and NPC in design and construction supervision. Some 8,000 farm families and 4,400 landless laborers' families, most of whom are below the poverty line, would benefit from the increased rice production and additional employment. The power capacity of 360 MW would generate about 1,200 GWh annually and contribute to the Government policy of reducing dependence on oil-fired thermal electric power and expanding rural electrification. A delay in completion of the diversion tunnels or occurrence of abnormally high wet season floods at the early stages of dam construction would constitute the principal risk factor. Estimated Cost of Stage II Development: ____ _ Costs Local Foreign Total Package ---- (US$ million) --- I. (Diversion works) 44.2 15.8 60.0 II. (Main dam) 168.0 178.0 346.0 III. (Power) 20.5 68.5 89.0 IV. (Irrigation) 37.3 23.7 61.0 Total 270.0 286.0 556.0  - iii - Estimated Cost of the Project (Package II): Foreign Local Foreign Total exchange ------ (US$ million) ------ (%) Reservoir clearance and resettlement 7.1 0.2 7.3 3 Civil works 106.4 122.6 229.0 53 Gate supply - 13.2 13.2 100 Consulting services 1.7 5.2 6.9 75 Engineering, supervision and administration 19.6 0.4 20.0 2 Base cost estimate 134.8 141.6 276.4 51 Physical contingencies 10.3 12.0 22.3 54 Expected price increases 22.9 24.4 47.3 52 Total project cost 168.0 178.0 346.0 51 Financing Plan of Stage II Development: (a) Package I ($60.() million) the Government; (b) Package II ($346.0 million), Bank $150 million; supplier credit $16 million and Government $180.0 million; (c) Package III ($89.0 million), NPC through supplier credit; (d) Package IV ($61.0 million) Government with part Bank assistance. Estimated Disbursements of the Loan for Package IL: Annual Cumulative Bank's fiscal year disbursements disbursements -------------------- US$ million ------------------ 1979 34.4 34.4 1980 47.1 81.5 1981 27.6 109.1 1982 23.8 132.9 1983 12.1 145.0 1984 5.0 150.0 Rate of Return: The economic rate of return of the entire Stage II Development is 12%. Appraisal Report: No. 1911-PH dated April 28, 1978.   REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR THE MAGAT RIVER MULTIPURPOSE PROJECT: STAGE II 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for an equivalent of US$150 million for the second stage of the Magat River Multipurpose Project. The loan would have a term of 20 years, including 5 years of grace, with interest at 7.5% per annum. PART I - THE ECONOMY /1 2. An economic mission visited the Philippine in July/August 1977 and its report, "The Philippines: Country Economic Memorandum" (No. 1765-PH of October 26, 1977), was distributed to the Executive Directors under Secretary's Memorandum PHL77-2 on October 27, 1977. A basic economic report, entitled The Philippines: Priorities and Prospects for Development (SecM-76/366), was previously distributed to the Executive Directors on May 18, 1976. Macroeconomic Performance 3. During the 1960s, the Philippine economy grew in real terms at an annual rate of about 5-1/2%. However, the rate of growth was less than what might have been achieved if the country's considerable natural and human resources had been utilized more effectively. The benefits of growth were also distributed relatively unevenly, both with respect to regions and income classes. While overall agricultural growth was reasonably satisfactory, repeated food deficits were experienced. The growth of productive employment opportunities failed to keep pace with the expansion of the population and labor force. Low levels of taxation resulted in inadequate public expenditure for necessary infrastructure and social services. Poor export performance combined with the heavy import dependence of domestic industry led to chronic weakness in the balance of payments. 4. The growth of thre Philippine economy accelerated slightly to an annual rate of 6% in the 1970s. Fluctuations, however, have been significant. In the period 1970-72, when the effects of a balance of payments stabilization program initiated in 1970 were being felt, the economy grew less rapidly, exports and imports of goods and services were ioughly equal, and the shares of public and private fixed investment in GNP were stable at still relatively low levels. Economic growth was unusually good in 1973 as sharply higher prices for traditional export commodities stimulated demand, agricultural production rebounded strongly from the natural disasters of the previous /1 This section of the report is the same as that of the Rural Electri- fication Project (SecM/78-63), which was approved by the Executive Directors on April 4, 1978.  -2- year, and the balance of payments registered a substantial current account surplus. The export-led income boom of 1973 was followed by an investment boom. The resulting high investment rate, together with favorable sugar prices, temporarily sheltered the economy from the impact of the oil price increase in late 1973 and the following world recession, and real GNP growth was maintained at 6% in 1974-75. The first half of the 1970s also saw significant structural changes in the economy, the most important of which were an increase in the level of public investment, financed in large part by a greater tax effort, a recovery in export growth, a shift of the domestic terms of trade in favor of agriculture, and the slowing of the population growth rate. 5. The collapse of sugar prices in late 1975, following earlier declines in the prices of other major export commodities, altered the external situation dramatically. The terms of trade dropped by 23% in 1975, and as a result the current account deficit rose to 6% of GNP, and the overall balance of payments deficit to $500 million. Thus, the necessity of restoring balance to the external accounts was superimposed on the Government's longer-term objectives of faster economic growth and a better distribution of its benefits. To maintain the momentum of growth and investment, the Government adopted a policy of increasing capital inflows in the near term to finance the resulting expanded current account deficits while accelerating export growth in the longer term. In 1976-77, the economy - led by exports, public investment, agriculture and construction - has continued to grow at 6% per year. Unfor- tunately, much of the stimulus from an expansion in export volume was offset by further deterioration in the terms of trade. However, inflation, which reached a peak of 31% in 1974 as a result of externally generated pressure on domestic prices, has slowed to a rate of about 7% because of the deceleration in international inflation and a conservative monetary-fiscal policy. Development Strategy 6. The Government's development objectives and policies, which were recently set out in a Five-Year Development Plan for the period 1978-82, call for further acceleration of economic growth, first to 7% and then to 8%. The development strategy focuses on an expansion of more productive employment opportunities at a rate of 3.6% per annum, reduction of income disparities, greater selfsufficiency in food and energy, strengthening the balance of payments, and increased development in rural areas. In addition, the Plan includes strategies for development in each of the country's thirteen regions. In general, the Plan is an elaboration of the policy directions pursued by the Government in recent years. It is also broadly consistent with the Bank's basic economic report, although investment, manufacturing output, and exports are projected to grow more rapidly than visualized therein. It should be feasible to accelerate the overall growth rate to 7% as the terms of trade stabilize, but more rapid expansion of manufacturing is necessary to do so, and effort needs to focus on improving the efficiency of investment. Agriculture 7. For a country with fairly good soils and a reasonably literate rural population, agricultural yields in the Philippines are relatively low. Possible reasons for this situation are the low quantity and quality of  - 3 - irrigation facilities and high vulnerability to weather risks; land tenure patterns; and weak agricultural credit, extension, and other supporting services. Agricultural production has, nevertheless, grown at an average rate of 4-1/2% per year in the 1970s. The performance of the sector was exceptionally strong in 1976 and 1977, as production increased by 7%, and the Philippines has been virtually self-sufficient in rice, its main staple, for the past three years. 8. The Government gives high priority to agriculture and rural development. It has undertaken a number of steps to increase the availability of irrigation and supporting services, and has also expanded programs to improve living conditions in rural areas, including rural electrification, health and family planning, and rural roads. However, while irrigation investment has been raised substantially, improvements.in the quality of supporting services - particularly credit and extension - are necessary. 9. For historical reasons, land ownership in the Philippines is inequitably distributed. The land transfer program, which has been in operation for five years and covers rice and corn growing areas, proceeded quite rapidly when larger landholdings were the focus of concentration, but progress has been slower recently as the focus has been on a larger number of medium-sized holdings, which often belong to middle-class landowners. As of June 1977, an estimated 120,000 tenants, or 30% of the total tenants under the program, had received Certificates of Land Transfer, which established their claim to the land. Despite the difficulties in the process of implemen- tation, the transfer program remains an important part of the Government's rural development strategy. Industry 10. During the 1960s, Philippine industrialization was promoted by high tariff protection and subsidized finance, and consequently industrial growth was primarily in the area of import-substitution with a high capital intensity. Performance was disappointing with respect to employment, exports, and the overall rate of growth of output. In the early 1970s the Government floated the exchange rate, which then depreciated significantly, and introduced policy changes to reduce tariffs and realign industrial incentives. Further efforts to reduce remaining biases in favor of import substitution and capital intensity will still be needed, however, to accelerate the rate of industrial growth as projected in the Five Year Development Plan. 11. Manufacturing industry has grown at a relatively slow average rate of about 6% in the 1970s. Moreover, due to the slow increase in national income and demand because of the decline in the terms of trade in the last two years, manufacturing growth has also slowed, and investment has stagnated. On the other hand, industries producing nontraditional exports have expanded rapidly from a very low base as their exports increased almost fivefold in the four-year period 1973-76 in response to exchange rate adjustment and special measures designed to alleviate existing restrictions on imports and thus reduce the bias towards production for the domestic market. As noted above, further efforts in this direction will be needed if industrial exports are to continue to grow at a rapid rate. The construction industry has also grown  - 4 - rapidly as the expansion of relatively construction-intensive public investment and large tourism investments in the Manila area raised construction expendi- ture from 6% of GNP in the early 1970s to 12% in 1976. Employment, Incomes and Population 12. Employment increased by about 4.6% annually during 1973-76, a considerable improvement over the historical growth rate of 2.4%, and was able to keep pace with the rapid growth of the labor force. Particularly noteworthy was the growth of employment in manufacturing, which essentially stagnated during 1970-74, but grew by 8% annually during 1975/76, resulting in part from the growth of labor-intensive production for export. However, because manufacturing's share of total employment is small, agriculture and services continue to function as residual sources of employment and account for most of the growth in total employment. 13. Preliminary survey data show that the share of income received by the poorest 40% of families, which remained constant during the 1961-71 period, increased from 12% in 1971 to 15% in 1975. The income share of the top 20% of families remained about the same as in 1971, while that of middle income families declined correspondingly. Due to the improvement in agricul- ture's terms of trade, the growth of agricultural production, the decline in urban real wages following the devaluation in 1970, and the stagnation of industrial employment until 1975, the ratio of the average rural income to the average urban income rose from 48% in 1971 to 57% in 1975. Real per capita consumption increased by about 2% annually in 1971-75. Hence, after allowance for price increases, real incomes in rural areas, where most of the poor live, have probably increased somewhat, while real urban incomes have remained about the same. 14. The population is estimated at 43.3 million in 1976 and is currently growing at 2.8% as compared to a 3.0% growth rate during the 1960s. The Philippines has an active family planning program registering approximately 650,000 new acceptors per year. Although the number of new acceptors has reached a plateau as the program faces the increasingly difficult problem of reaching rural areas, the estimated proportion of married women of reproductive age practicing family planning increased from 20% in 1974 to 25% in 1977. Investment and Savings 15. Due largely to the buoyant export performance in 1973 and the subsequent increase in incomes, investment boomed in 1974-75. Private investment rose from 14% of GNP in the early 1970s to 20% in 1975. Public investment was raised from 2% to 4% of GNP with the growth in revenue from international trade taxes, improvements in tax administration, and improved project implementation capacity. Subsequently, public investment has been raised further to an estimated level of 6-1/2% of GNP in 1977. The private investment rate, on the other hand, has fallen somewhat to an estimated 18% of GNP. Although the private investment rate is well over the 14% average of the early 1970s, the revival of private investment is an important short-term problem. Furthermore, the high incremental capital-output ratio, the relatively modest growth of manufacturing output and employment, and the structural underutilization of capacity in some industries suggest that the efficiency of investment also needs to be improved.  - 5 - 16. Aggregate savings performance has improved during the last decade and is comparable to that of other countries at a similar stage of economic development. In 1976-77, gross domestic savings maintained the level of 25% of GNP achieved in 1975 and financed about 80% of total investment, with the balance coming from foreign savings. In order to increase the efficiency of financial markets in intermediating between savers and investors, the Govern- ment has made significant improvements in financial policy. Organized banking institutions have been strengthened. Interest rates were realigned in 1976 and again in 1977 to encourage a greater flow of financial savings into time and savings depcsits relative to short-term deposit substitutes, and to reduce the spread betweten borrowing and lending rates. Further reforms are required to increase the availability of long-term domestic currency resources. Special credit programs have been adopted to expand lending to the credit-short agricultural sector and rural areas and to serve the needs of medium- and small-scale industries. However, a deterioration of loan recovery rates has been experienced by all government financial institutions and credit programs, creating a difficult policy dilemma. On the one hand, the programs have become costly means of achieving their objectives, and the growth of arrears reduces the overall efficiency of resource mobilization and allocation. On the other hand, the programs do redress imbalances in the availability of credit so that arrears have to be reduced without closing necessary credit channels. Government Expenditures and Revenues 17. Public expenditures and revenues have historically claimed a much smaller share of national resources in the Philippines than in many other developing countries. In the early 1970s, general government expenditure averaged only 12% of GNP, pufblic investment was strikingly low at about 2% of GNP, and tax revenues stood at 11% of GNP. Government expenditures were dominated by general administration and social services, particularly education. This situation had resulted from a variety of factors including difficulties in raising tax revenue and weak implementation capacity in the public sector. Since the early 1970s, the Government has taken steps to correct the situation and raise both the overall level of expenditures and the share going to economic services and public investment. By 1977 govern- ment expenditures had reached an estimated 18% of GNP, and public investment, which has risen very rapidly in the last two years, equaled about 6-1/2% of GNP. 18. Recognizing that a large increase in tax revenues would be required to finance expansion of t]he public investment program, the Government has undertaken a comprehensive program of tax reform to raise the needed revenues equitably and efficiently. In the-short term, needed revenues have been raised through revisions in indirect taxes. In the long term, structural changes are to be made to raise the built-in elasticity of the tax system, to reduce distor- tions in economic incentives and dependence on cyclically volatile taxes on international trade, and to improve equity by increasing the proportion of revenues coming from direct taxes. The Government has increased the ratio of domestic taxes to GNP by an impressive 1.5 percentge points between 1975 and 1977 through new tax measures and vigorous efforts to improve taxpayer compli- ance and collection performance. However, much of the success in mobilizing  revenue from domestic sources has been offset by a sharp decline in the yield of export taxes and import duties due to cyclical fluctuations. Total tax revenues, which had been raised from 11% of GNP to 13.6% by 1975, rose to only an estimated 14.1% in 1977. Greater resource mobilization by government financial institutions and government corporations, whose investment programs have grown rapidly, is also needed. External Trade and Capital Flows 19. Largely as the result of a 23% decline in the terms of trade in 1975, the current account recorded a deficit of $900 million, or 6% of GNP. To meet the immediate payments problem, the Government drew down its international reserves, obtained loans under various IMF facilities, and expanded its borrowing program to finance necessary imports. For the longer term, a strategy was adopted of accelerating export growth both to hold the current account deficit about constant, while it declined relative to GNP, and to meet the debt service payments on the higher level of external borrowing. 20. Some progress in these directions was made in the last two years. In 1976, in spite of a further 11% deterioration in the terms of trade, a substantial increase in export volume and slow growth of import payments narrowed the trade deficit and partly offset the higher net interest payments. Although somewhat larger than in 1975, the current account deficit was stabil- ized at 6% of GNP. Net capital inflows were nearly doubled to $1.1 billion. Most of the inflow was from medium- and long-term loans, two-thirds of which were public loans reflectingin part increased disbursements from official sources. Estimates for 1977 show a further substantial expansion in export volume which, with little expected change in the terms of trade, import volume, services or transfers, would reduce the current account deficit to 4% of GNP and eliminate the overall payments deficit. Hence, on the whole, the balance of payments position has strengthened significantly. 21. To achieve a 7% growth rate in real GNP, as projected for the period 1978-82, imports will have to grow faster than they have recently and a net capital inflow of at least $1 billion per year will be required. Assum- ing continued sound debt management and the maintenance of a balanced maturity structure of foreign borrowings, the overall level of external debt of the Philippines is expected to remain within reasonable limits. The ratio of debt service payments to exports and nonfactor services would average about 19%, of which 7% would be public debt service, during the plan period (1978-82). 22. In order to ensure that the long-term capital transfer is commensu- rate with the level of development expenditures which will be required during 1978-82 and that debt service obligations remain within reasonable limits, the Government sought commitments of official assistance of $750-800 million in 1978 at the meeting of the Consultative Group for the Philippines, held in Tokyo on December 1 and 2, 1977. This amount is likely to be available. However, since many of the planned projects which are to be financed from external sources have a low foreign exchange component, some local cost finan- cing is necessary, in appropriate cases, to meet the Philippines' external financing requirements.  PART II - WORLD BANK OPERATIONS 23. As of March 31, 1978, the Philippines had received 51 Bank loans (of which two were on Third Window terms) amounting to $1,332.5 million and three IDA credits amounting to $32.2 million./l At that date, IFC investments totalled $96.3 million. The share of the Bank Group in total debt disbursed and outstanding is about 11% and its share in total debt service is about 5%. These ratios are expected to increase to about 19% and 8%, respectively, by the end of the present decade. Annex II contains a summary of IDA credits, Bank loans and IFC investment as of February 28,1978 as well as notes on the execution of ongoing projects. 24. The Bank Group has financed projects in virtually all sectors of the economy with particular emphasis on agriculture and basic infrastructure which have each accounted for about one third of total Bank Group lending. In agriculture, emphasis has been given to expanding irrigation systems to increase food production and to credit programs to support food grain produc- tion and processing, livestock and fisheries production and tree farming. Support has also been provided for integrated rural development projects in low income areas. The Bank Group also provided large amounts of assistance in developing power and transportation because substantial improvement in basic infrastructure has been needed to compensate for many years of past neglect and to provide the basis for future growth of the productive sectors. In the industrial sector, the Bank's main thrust has been on strengthening the capacity of public and private development finance institutions with increasing attention given to meeting the needs of small and medium industries. In the social sectors, the Bank Group has provided support for education programs, designed to improve the quality of primary and secondary education and to meet trained manpower requirements in agriculture and industry. In urban areas, assistance has been provided for water supply projects and for programs to upgrade living conditions in low income urban areas and to develop low cost sites and services. Support has also been provided to the Philippines population program through assistance for the construction of multipurpose rural health units and for training of family planning staff. 25. There has been a marked improvement in the execution of Bank financed projects in the last five years compared with the experience in the late 1960s, when there were serious problems caused by a shortage of peso counterpart funds and weak administration. Almost all ongoing projects are now being implemented reasonably well and the results of supervision and project completion reports indicate that the economic benefits for most projects are likely to be in line with appraisal estimates. However, the overall rate of disbursement is marginally below what would be expected given the generally good project implementation and the Government is currently reviewing disbursement performance on an agency-by-agency basis to identify possible reasons for disbursement lags and to find appropriate solutions. /1 Since then, a loan of $60 million for rural electrification was approved by the Executive Directors on April 4, an IDA credit of $28 million for a rural infrastructure project on April 11 and a loan of $15 million for Philippine Investment Systems Organization (PISO) on April 27.  - 8 - 26. As noted in Part I of this report, the Government's Five-Year Devel- opment Plan highlights a strategy which focuses on the expansion of productive employment in agriculture and industry, reduction in income disparities, greater self-sufficiency in food and energy and increased development in rural areas. The Bank Group's future lending program has been designed to assist the Government in achieving these objectives. Agriculture and rural development will account for the largest part of future lending, with continued emphasis on food production and increasing the productivity and incomes of small farmers. However, the program provides for several new initiatives, including a first loan to support the strengthening of the national agricul- tural extension service and a first loan for developing multiple cropping systems in rainfed areas, where there is substantial rural poverty. Increased support will also be provided for integated rural development projects which will support the Government's objectives of redressing regional imbalances in income. Substantial assistance will also continue to be given to industry with special attention being given to expanding the development of labor- intensive, small and medium industries outside the Metropolitan Manila area. The share of lending for social sector projects is expected to continue to increase as a result of greater emphasis on construction of urban water supply and sewerage systems and further assistance to the lower income urban areas through low cost sites and services projects. The Bank Group will also continue to provide support for improving the quality of education and for expanding the Government's population program in rural areas. While the Bank Group will continue to provide support for transportation and power infrastruc- ture projects needed to support the Philippine development effort, the share of Bank lending for these sectors will decline somewhat in the years ahead primarily because alternative sources of financing are available to finance a large part of the power generation program. 27. As noted in Part I, the Philippines has experienced a serious deterioration in its international terms of trade in the last several years which has necessitated substantial foreign borrowing. While the overall level of debt remains manageable, the Philippines will need to obtain substan- tial amounts of foreign assistance on concessional terms to support its expanding development program. In view of this consideration, the per capita income of the country and the generally good management of the economy, a limited amount of IDA financing will be proposed for the Philippines; the first IDA credit since 1974 was recently presented to the Executive Directors and a second is scheduled for FY79. 28. This is the eighth loan to be presented to the Executive Directors this fiscal year and would bring total lending to the Philippines to $358 mil- lion. Loans for development finance, urban development and water supply projects are expected to be ready for presentation within the next few months.  - 9 - PART III - THE AGRICULTURAL AND POWER SECTORS The Agricultural Sector 29. Agriculture is the predominant sector in the Philippine economy, accounting for about one third of net domestic product, over one half of total employment, and nearly three quarters of export earnings. Over 70% of the 9 million ha of land under cultivation is used for the production of cereals, of which rice and corn are the most important. The remaining land is taken up by the major export crops: sugar, coconuts, abaca, pineapples, and tobacco. 30. The performance of the agricultural sector will be crucial in deter- mining whether the Philippines can increase incomes both rapidly and equitably. At present, the domestic market for industrial products is limited by relatively low rural incomes. Although in recent years there has been a substantial change in the terms of trade in favor of agriculture, the problems of poverty and income distribution continue to be particularly acute in rural areas; of the 15 million people in the lowest 40% of the income scale, 12 million live in rural areas. The Government is aware of these problems and has initiated a number of programs designed to assist the rural poor. 31. A major Government objective is to increase rice and corn produc- tion as a means of raising the incomes of small farmers and maintaining national self-sufficiency in food grains. If rice production is to increase at a rate sufficient to maintain self-sufficiency on a sustained basis, further expansion of the irrigated area will be necessary. In the longer run, the Philippines may also have the potential for exporting rice to other food deficit countries. At pre!sent, only 0.9 million ha, or 28% of the 3.2 million ha devoted to rice production, are irrigated. The Government recognizes that in order to increase production in both irrigated and nonirrigated areas sub- stantial improvements in the quality of supporting services will be necessary. In 1973, the Government instituted a national program, Masagana 99, for supervised credit for rice production, which greatly increased the provision of production credit, mainly to smaller farmers. However, the levels of arrears under the program have been very high in the last several years and as a result the coverage of the program has declined sharply. The Government is aware of this problem and has taken a number of significant steps to reduce the level of arrears. 32. The Government is also considering the steps necessary to bring about needed improvements in the national extension service. A Bank technical assistance mission visited the Philippines in April 1977 and a report has been given to the Government whaich suggests a number of organizational improvements and better logistical support in the form of training, vehicles and other facilities. Missions visited the Philippines in March 1978 to appraise a national extension project for possible Bank financing and to help the Govern- ment prepare a comprehensive program for strengthening support services (provision of credit, extiension, fertilizer, seeds, and crop protection). 33. Since 1969 the Bank Group has financed nine irrigation projects designed to increase rice production in the country. These projects - three in Central Luzon, two in the Cagayan Valley of Northern Luzon, one on Mindoro  - 10 - Island, one in the Visayas and two for smaller systems throughout Northern Luzon, the Visayas and Mindanao /1 - have set the pattern for the type of irrigation rehabilitation, new construction, and operations needed for increasing rice production. The projects are providing improved irrigation and drainage facilities, better road systems for efficiency of operations and maintenance and for the marketing of farm products, stronger supporting services to assist farmers in adopting the new irrigation techniques needed to increase production, and technical assistance and training to help the National Irrigation Administration (NIA) expand and improve its irrigation program. These projects, would bring about substantial increases in rice production on about 370,000 ha and would benefit nearly 190,000 farmer families, most of whom are smallholders. 34. Work on the first Bank-assisted project, the Upper Pampanga River Project (Loan 637-PH), is completed. Progress in the construction of all the irrigation projects has been generally satisfactory, the economic rates of return on these projects are expected to be in line with appraisal esti- mates, and the NIA has proved itself to be a well managed and technically competent organization. NIA's evaluation of the production results in the UPRP service area found that yields were about 3 tons/ha which is in line with appraisal estimates for the first year of operation. However, the evaluation also identified deficiencies in agricultural support services, particularly with respect to the adequacy of credit and extension services (see paras. 30 and 31). For this reason, the Government has agreed under the Second National Irrigation Systems Improvement Project (Loan 1526-PH) to prepare a plan of action by June 30, 1979, tct strengthen support services in areas served by Bank-financed irrigation projects, and after reviewing the plan with the Bank, to begin to implement it by January 1, 1980. The Power Sector 35. The three major regions of the Philippines are in different stages of power development. Most of past power development has taken place on the island of Luzon, where about half of the population live and most industrialization has occurred. Some grid development has also taken place on the main southern island of Mindanao, particularly in the northern part where the availability of easily developed low cost hydropower has attracted substantial industrial investment. In the Visayas, which comprise all other major islands located in the central part of the Philippine Archipelago, grids are only now beginning to be constructed. /1 The Upper Pampanga River Irrigation Project (Loan 637-PH), Aurora- Penaranda Irrigation Project (Loan 984-PH, Credit 472-PH), Tarlac Irri- gation Systems Improvement Project (Loan 1080-PH), Mindoro Rural Develop- ment Project (Loan 1102-PH), Magat River Multipurpose Project Stage I (Loan 1154-PH), Chico River Irrigation Project Stage I (Loan 1227-PH), Jalaur Irrigation Project (Loan 1367-PH), National Irrigation Systems Improvement Project I (Loan 1414-PH) and National Irrigation Systems Improvement Project II (Loan 1526-PH).  - 11 - 36. The electrification of the country has been progressing steadily. The per capita consumption of electricity in 1976 was estimated at 300 kWh, compared with 490 kWh in Korea, 184 kWh in Thailand and 120 kWh in India. Over 30% of the population is currently served with electricity compared with 23% in 1970. Although regional imbalances presently exist, with 46% of the households electrified in Luzon compared with 15% in Mindanao and 13% in the Visayas, the National Electrification Administration (NEA) rural electrification program is expected to improve the situation. The total electricity supply in 1976, was estimated at about 13.9 billion kWh; 50% was provided by the privately owned Manila Electric Company, 23% by the National Power Corporation (NPC), 20% by self-generating industries, and 7% by small utilities. On the consumption side, industrial consumers represented about 55%; residential consumers, 20%; and commercial, agricultural and other users, 25%. 37. The Government is committed to a policy of rapid industrialization which is central to its objectives of fostering growth, employment and exports. It is also committed to a policy of dispersing industrial growth from the already congested Manila Metropolitan Area to other regions of the country. In order to meet these objectives and to realize the planned annual growth in Gross National Product of 7% during the next 10 years, it is estimated that electricity consumption in the Visayas and in Mindanao will need to grow at annual rates of about 16% and 13%, respectively, compared with about 10% in Luzon. This would result in an overall annual growth in consumption of 11.3%. 38. The sector investment program required to meet the expected demand increase is huge. It will almost triple the country's generating capacity by expanding it from about 3,540 MW in 1976 to about 8,500 MW in 1985. The Govern- ment has decided to diversify energy resources by developing indigenous hydro and geothermal power and by introducing nuclear energy. If implemented as planned, the program would reduce the preparation of oil-fired generating capacity from 81% of the total in 1974 to 53% in 1985; hydropower would correspondingly increase from 19 to 31%; and geothermal and nuclear power would share the remaining 16%. Although the objective of diversifying energy sources is reasonable, the program is ambitious and involves certain risks. Financial constraints may hinder the timely development of capital-intensive hydropower projects and technical problems may arise in developing nuclear and geothermal sources of energy. The program therefore needs continuous review and, if difficulties do arise, it is possible that additional oil-fired thermal plants will be needed. 39. The Bank has made seven loans and one IDA credit for NPC and one loan for the National Electrification Administration (NEA), amounting to $218.3 million, net of cancellations, to assist in the development of the Philippines' power sector./l Although some of the projects financed either /1 The First Power Project (Binga) (Loan 183-PH); Second Power Project (Angat) (Loan 297-PH); Third Power Project (Maria Christina) (Loan 325-PH); Fourth Power Project (Bataan No. 1) (Loan 491-PH); Fifth Power Project (Bataan No. 2 - Transmission) (Loan 809-PH, Credit 296-PH); Sixth Power Project (Pantabangan) (Loan 1034-PH); Seventh Power Project (transmission) (Loan 1460-PH); and the Rural Electrification Project.  - 12 - exceeded the original execution schedules or experienced cost overruns, all of them are being implemented satisfactorily. Under the loan agreements for the Seventh Power Project, NPC is required to earn an 8% rate of return on its revalued net fixed assets in operation in 1978. In 1977, NPC is estimated to have earned a rate of return of 5%. A major tariff increase has now been introduced in Mindanao, however, and further increases in the Visayas and Luzon are under consideration. 40. The project performance audit report on the Fourth Power Project (Sec. M76-35) suggested that the Bank should agree with NPC on procedures for annual review and revision of tariffs and specific targets for transmission expansion. It also suggested that the Bank should assist in the development of management training programs. These comments have been taken into account in the design of subsequent projects, including Loan 1460-PH to NPC. 41. The proposed project forms part of the least cost development program of NPC and would support the Government's objective of moving from thermal to other sources of energy. It would also complete the irrigation program in the Magat River area of the Cagayan Valley, which is one of the poorest areas of the Philippines. PART IV - THE PROJECT Background 42. In 1973 the National Irrigation Administration (NIA), with US Bureau of Reclamation assistance, completed a feasibility study of the Magat river project, and recommended the development of a multipurpose project on the river. Because of the physical size, large estimated cost and long construc- tion period NIA divided implementation of the project into two stages. Stage I consists of the rehabilitation and upgrading of the existing Magat River Irrigation System (MARIS) and Siffu River Irrigation System and construction of new facilities for a total of 75,000 ha that can be served by run-of-river diversion in the wet season. The Asian Development Bank (ADB) is assisting NIA to rehabilitate 40,000 ha of Stage I under the Angat-Magat Integrated Agricultural Development Project. The remaining 35,000 ha of Stage I are being developed with Bank assistance under Loan 1154-PH. Provision was also made under the loan for engineering studies (Part A) to evaluate the economic feasibility of Stage II development and, if justified, to prepare (Part B) final designs, specifications and bid documents for construction of the dam and appurtenant works. Part A of thB study, completed in September 1976, confirmed the technical feasibility and economic viability of Stage II, which consists of construction of the storage dam and of additional irrigation facilities, to increase the service area to 102,000 ha, together with construc- tion of a power station with an installed capacity of 360 MW and the provision of generating and transmission equipment. 43. Stage II Development. In view of the large size of the development, the high cost, the lumpiness of the investment and the tight, 6-1/2-year con- struction schedule, the Government agreed in 1976 to a breakdown of Stage II development into the following sequence of manageable packages:  - 13 - (a) Package I - consisting of preconstruction works (access roads, permanent camp, etc.), dam foundation grouting, drainage gallery tunneling and the river diversion tunnels, together with consulting services associated with these activities. NIA began work on this Package in 1976 with Government funding and has awarded a contract for construction of the tunnels to a Philippines firm. Implementa- tion is expected to take 3-1/2 years (1976-1979). (b) Package II - consisting of all civil works for the main dam and appurtenant structures, reservoir resettlement, installed mechanical equipment and consulting services. This Package is the subject of the present report and the proposed Bank loan. Implementation is expected to take 4-1/2 years (1978-1982). (c) Package III - consisting of the civil works for the power component, together with thLe supply and installation of penstocks, turbines, generators, electrical and mechanical equipment and transmission lines. Implementation is expected to take 4 years (1979-1982). (d) Package IV - consisting of construction of the Baligatan diversion dam and the civil works for irrigation development of 27,000 ha of currently rainfed land. Implementation is expected to take 4 years (1979-1982). 44. The proposed project, which would finance Package II, was appraised in October/November 1977. Negotiations were held in Washington from March 13, 1978 with a Philippine delegation led by the Honorable Alfredo Juinio, Secretary of Public Works, Transportation and Communications. A Staff Appraisal Report, entitled "Philippines - Magat River Multipurpose Project: Stage II" (No. 1911-PH dated April 28, 1978), is being distributed separately. Supplementary project data are provided in Annex III. The Project Area 45. The Magat river rises in the Cordillera Central mountains and joins the Cagayan near Gainu in Isabela province in Northern Luzon. The service area, about 350 kin northeast of Manila, is almost entirely in Isabela province. The Magat dam would be built at a point some 6 km upstream of the existing MARIS diversion dam across the gorge where the river emerges from the foothills into the plains. The rainfall in the project area, together with river flows in the wtst season, is generally adequate for a single rice crop. Dry-season cropping, however, entails considerably more risk and irrigation is essential for an assured crop. 46. As the mountain blocks around the Cagayan valley were formed in different geological ages and have different rock compositions, the project area is underlain by a coimplex array of metamorphic, igneous and sedimentary rocks. The proposed dam site is located at the transition zone of these rock formations close to faults which form the eastern edge of the Cordillera range and is consequently affected by major geologic structural action. The foundation characteristics of the unweathered portion of the sequence of volcanic rocks at the damsite range from good to excellent. The principal  - 14 - exceptions occur where the rocks are cut by faults, two of which have been identified near the proposed project etructures. The significant fault, designated the Magat fault, was largely covered by weathered rocks and soils and was only discovered after extensive site exploration exposed bedrock. It is located about 500 m downstream of the proposed dam, where it crosses the river parallel to the dam axis and has a total width ranging from 150 to 200 m. Intensive exploration on the left bank of the Magat river exposed a thrust fault, named the Korokan fault. It is not considered to be as significant as the Magat fault and present day earthquake displacement is not probable. As a result of the additional geological information, the axis of the main dam was realigned and the spillway and powerhouse were located on the left bank of the river. The proposed project layout takes full account of the extensive data now available. The concrete structures, the powerhouse and the outfall of the chute spillway would be sited clear of all major shear zones and faults, the spillway plunge pool being located in sound rock just upstream of the Magat fault. Provision has been made for concrete lining of the plunge pool. In the past 79 years at least 146 seismic events larger than Richter Magnitude 5 have occurred within 320 km of Magat dam, although the actual number is probably greater because of inadequate reporting and loss of data. Most of the events were in the ocean immediately offshore of the Pacific coastal areas of Northern Luzon; however, some 30 appear to have had a location along the eastern side of the Cordillera range north of the dam site. The Magat fault also gives evidence of ground displacement due to seismic activity. While these earthquakes have undoubtedly transmitted ground motions to the dam site, no evidence of very recent seismic movement has been observed along any of the major geological structures identified at the site. The faults at the dam site are assessed to be more than 100,000 years old and NIA's international Board of Consultants considers recurrence of movement to be unlikely. Design parameters for the dam take full account of potential loads due to seismic activity and possible small ground movement. 47. Total population in tie 102,000 ha service area of the proposed dam is estimated at about 282,000 people. The rural population of the Stage I project area consists of about 24,000 farm families and some 9,000 other families occupied principally or entirely in agricultural production, while in the Stage II area there are 8,000 farm families and about 4,400 other rural families. The average size of farm in the service area is 3.2 ha. After completion of the land transfer process initiated under the Government's program of agrarian reform some 21,500 owner operators, the equivalent of 67% of the farmers, would cultivate 74,000 ha, or 73% of the project area. The remaining 10,500 farmers would be leaseholders. Project Description 48. (a) Main Dam and Spillway. The main dam would be 1,800 m long, made up of a concrete spillway and power intake section 450 m long, a left abutment rockfill embankment section 350 m long and a river closure and right abutment rockfill embankment section 1,000 m long. Maximum height of the spillway section would be 60 m and of the embankment section 114 m. Design of the main dam has evolved after two years of intensive site investigations and takes full account of the usual problems inherent in large dam construction, as well as the particularly complex problems of geology, seismicity and hydrology found in north-eastern Luzon.  - 15 - 49. The spillway ancd power intake structure would be a concrete-gravity section situated on the left bank of the river. The location was determined by site geology and economic consideration of alternative dam designs. The spillway would have seven radial crest gates for flood water discharge and two low level orifice gates for irrigation or emergency draw-down water releases. Spillway discharge would be into a 450 m long reinforced concrete open chute with terminal flip-buckets and plunge pool. Detailed hydraulic model and simulation studies of the spillway outlet structures are in progress to ensure optimum energy dissipation. The power intake structure would provide six gated conduits to connect with steel penstocks to be constructed as part of the proposed power development. 50. (b) Baligatan Dike and Baligatan Creek Dam. The Baligatan dike would be 1,450 m long and would have a maximum height of 35 m, but would only be about 20 m high for most of its length, with a volume of fill of about 1.9 million cu.m. Construction of the dike would utilize material from required excavations in the external shells and transition zones. The Baligatan creek dam would be 700 m long with a maximum height of 50 m. and a volume of fill of about 1.1 million cu m. 51. (c) Reservoir Resettlement. The proposed dam would create a reservoir with a surface area of 45 sq km at full supply level of 193 m. NIA has established a Resettlement and Reservoir Division (RRD) with responsibility for resettling the familiies affected by the reservoir in three resettlement sites. Some 500 families, 300 from the reservoir and 200 from the resettlemefit area, would be affected by the program. All resettlement sites would be provided with year round irrigation. NIA would purchase the land and provide each family to be resettled with a 3 ha farm plot, the limit for irrigated holdings under agrarian reform legislation, together with a house plot in a newly established barrio site. NIA would pay compensation for land, houses, and all improvements to land submerged by the dam. Each family would be provided with an NIA-built house and each of the three new barrio sites would have water, electricity, a school, church and community center built as part of the project. The resettled families would have to repay for their new homes and land in 15 equal annual installments at an interest rate of 6% per annum, in the same way as land reform beneficiaries. Provision would be made under the project for financial assistance to the resettled families in the way of crop production inputs and subsistence until they have harvested the first crop in their new areas. A Resettlement Committee has been established, consisting of all concerned central and provincial government agencies, the mayors of the affected municipalities and the barrio captains from the reservoir area communities. The Committee is responsible for reviewing all plans and proposals for the reservoir area to ensure that resettlement takes place smoothly and with the minimum amount of dislocation. It has been agreed that NIA would keep the Bank informed of the arrangements to be made for resettle- ment of the affected population and that the Bank would have an opportunity to comment before they were implemented (Section 3.07 of the draft Loan Agreement). 52. (d) Consulting Services. The project would provide for consultant services to cover the exnected period of construction from July 1978 to December 1982. NIA proposes to use the same joint venture of expatriate and local consulting firms that has been involved in the preconstruction phase  - 16 - of the project. Negotiations for provision of consulting services have been completed. It is estimated that about 1,130 man-months of consultant services would be required, with the expatriate firms providing 540 man-months at an average cost of about $7,900/man-month (exclusive of transportation, equipment and price escalation) and the local associates providing 590 man-months at an average cost of $2,500/man-month. Direct NIA counterpart and support services to the consultants would total some 1,640 man-months. The consultant contract would provide for special on-the-job training, together with 90-day periods of overseas training in Canada and the U.S.A. for 14 of NIA's engineers. NIA has engaged consultants satisfactory to the Bank under terms of reference and conditions approved by the Bank to assist in final design and supervision of construction. 53. The NIA Board of Consultants (NBC), a specialist technical review panel established in May 1977 in accordance with Bank requirements, has met four times during the preconstruction phase of the project, and has made most valuable contributions. It has been agreed that NIA would maintain the Board of Consultants for the duration of construction of the dam and that NBC would be consulted prior to implementation of all significant changes in the design and construction plans for Magat dam as detailed in the contract drawings and specifications (Section 3.03 (b) of the draft Loan Agreement). Construction Schedule 54. NIA proposes to award the Magat dam contract by June 15, 1978. Construction of the main dam, Baligatan dike and Baligatan creek dam would form part of a single contract. The contractor world also be responsible for installation of the spillway, power intake and Baligatan creek gates which would be supplied under a separately financed contract. The staging of construction to safelv pass the large wet season river flows and timely completion of the diversion tunnels would be critical factors in meeting the planned timetable. Availability of materials on the site, particularly cement, will be of paramount importance. There are no cement factories in the Cagayan valley and all cement would have to be delivered to site from Central Luzon factories by road haulage over the Philippine - Japan Friendship Highway. This would impose a considerable risk factor in view of the suscep- tibility of the highway to damage during heavy rainfall. To minimize the risk the dam contractor would be required to ensure provision of cement storage facilities near the site. Project Cost and Financing 55. The total project cost is-estimated at $346.0 million, of which $178.0 million, or 51% is foreign exchange. The direct foreign exchange requirement is estimated at $146 million and the indirect foreign exchange at $30.0 million. A physical contingency factor of 7% was used for the spillway gates and 9% for the civil works and reservoir clearing and resettlement. Costs due to expected price increases over the implementation period amount to about 16% of base cost plus physical contingencies, assuming the following annual inflation rates: civil works and services 3% in 1978, 7.5% in 1979, and 7% in 1980-82; equipment and vehicles 7% in 1978 6.5% in 1979 and 6% in 1980-82.  - 17 - 56. The total estimated cost of development, including the dam, hydro- electric works and irrigation facilities is estimated at $556.0 million, with a foreign exchange cost of $286.0 million. The proposed financing plan is: Costs Local Foreign Total Package --- (US$ million) --- Sources of Foreign Assistance I. (Diversion works) 44.2 15.8 60.0 None II. (Main dam) 168.0 178.0 346.0 Current Bank loan/supplier credit for gates III. (Power) 20.5 68.5 89.0 Supplier credit IV. (Irrigation) 37.3 23.7 61.0 Future Bank loan Total 270.0 286.0 556.0 57. The proposed Bank loan for Package II of $150 million would finance 84% of the foreign exchange cost of the project and would cover 43% of total project costs. NIA intends to procure the supply of the spillway, power intake and Baligatan creek gates ($16.0 million) by supplier financing. With the assistance of the consultants, NIA has prequalified potential suppliers and expects to call for bids for the supply of the gates by the middle of 1978 and to proceed with award of the contract by the end of the year. It has been agreed that NIA would make arrangements satisfactory to the Bank with a qualified supplier for their timely provision (Section 3.09 of the draft Loan Agreement). The balance of project costs would be provided from the Government budget. To ensure a timely and continuous flow of funds, it has been agreed that the Government would cause NIA to set up a special fund to service the project which would be replenished by the Government at monthly intervals to a level equivalent to the estimated requirement for the next two months. Establishment of the fund would be a condition of effectiveness of the loan (Section 5.01 of the draft Loan Agreement). 58. The Government, through the National Power Corporation (NPC), plans to implement Package III by calling for competitive bids on a turnkey basis - supply, erection of equiprnent and civil works complemented with financing. Bid invitations will be sent out by June this year and award will be made later in the year. A number of suppliers have already submitted initial proposals for the power component and NPC should have no difficulty in securing financing on reasonable terms for this package. For the irrigation component, Package IV, a loan is scheduled in the FY79 lending program for the Philippines for this package which was appraised in April and we propose to present it to the Executive Directors in December. The financing arrangements and timetable for the supply of spillway gal'es and the implementation of the power component set out above are satisfactory. It has been agreed that the Government would  - 18 - implement the full investment program in accordance with an agreed timetable, provide all necessary funds for this purpose, the procurement procedures for all packages would ensure economy and efficiency, and all contractual documents for financing the investment would be subject to Bank review (Section 4.01 of the draft Loan Agreement). Procurement 59. Materials testing equipment and vehicles costing about $0.4 mil- lion, would be procured after international bidding in accordance with Bank Group Guidelines. A preference limited to 15% of the c.i.f. price of imported goods, or the custom duty, whichever is lower, would be extended to local manufacturers in the evaluation of bids. Local shopping is appropriate for off-the-shelf items costing less than $10,000 each because the advantages of international competitive bidding would be clearly outweighed by the administrative costs involved. The total cost of such items would not exceed US$300,000. Civil works on the Magat dam and appurtenant structures (S229.0 million) were widely advertised internationally and prequalification of prospective bidders has been completed according to Bank Group Guidelines. Following technical and financial evaluation, nine companies were prequalified. Bidding documents were issued to the nine prospective bidders in January 1978 and bids are due on April 27, 1978. Work associated with clearing of the reservoir and resettlement of the affected population ($2.4 million) would be carried out mainly by local contractors. Bank staff have reviewed the local procedures for competitive bidding and they are acceptable. There is poten- tially adequate competition and foreign firms can participate. Disbursements 60. Disbursements would be made at the rate of 100% of the foreign exchange cost of directly imported equipment, and 100% of the ex-factory price of locally manufactured equipment and 65% for imported equipment procured locally. Disbursements for civil works would be 40% of certified monthly progress payments or expenditures. For civil works contractors' mobilization and equipment, disbursements would be at the rate of 100% of foreign exchange cost. For costs of consultants, disbursements would be at the rate of 100% of total cost. Organization and Management 61. The Special Projects Organization (SPO) of NIA is responsible for implementing Stage I of the Magat Dam Multipurpose Project (MRMP). A Project Manager was appointed, with an Assistant Project Manager directly in charge of three construction divisions, dealing respectively with the ADB-assisted rehabilitation of MARIS and the Bank-assisted MARIS extension and SIFRIS rehabilitation and expansion (Loan 1154-PH). The MRMP Project Manager subsequently assumed overall responsibility for the construction of the nearby Chico River Irrigation Project (Loan 1227-PH) and for the Cagayan Integrated Area Development Project, with day to day responsibility for MRMP in the hands of an Assistant Project Manager. The MRMP Project Manager has thus become Regional Manager for SPO projects in the Cagayan Valley. In view of the scope and engineering complexity of the Magat dam construction,  - 19 - NIA, after consultation with the Bank, has transferred to the MRMP senior engineering staff with expertise acquired on the recently completed Pantabangan dam (Loan 637-PH). Managetment of construction of the Magat dam would be the responsibility of the senior staff engineer from this group who would be designated Project Manager, MRMP Dam. It has been agreed that NIA would periodically review with t:he Bank the effectiveness of the proposed project management organization ('ection 3.08 of the draft Loan Agreement). As the dam would be operated primarily for irrigation, NIA would be responsible for its operation and maintenance. 62. Responsibility iFor construction of the planned power component (Package III) lies with Nl'C. As design of the power components is fixed by the dam, spillway and power intake physical layout, the critical factors will be scheduling of contract awards, equipment delivery and installation and commissioning of the generating units and transmission lines. A joint NIA/NPC Technical Committee has been established to coordinate implementation of the dam and power facility. I[t was agreed that NPC would establish an effective organization, in consultation with the Bank, to implement the power component and that it would periodically review the effectiveness of the organization with the Bank (Section 4.06 of the draft Loan Agreement). Agreement was also reached that the Bank wou'Ld have to be satisfied with the economic and techni- cal justification for any increase in the initial installed capacity of four power generating units of 90 MW each (Section 4.01 (b) of the draft Loan Agreement). Safety of Dam 63. It has been agreed that NIA would make arrangements to have a suitable maintenance and inspection program for the dam and to advise the Bank in writing not later than December 31, 1981 as to how it proposes to meet this obligation. The NIA proposal would include a description and scheduling of the maintenance program and inspections to be made, the designation of the experts, if any, to be employed, and, if applicable, a copy of their terms of reference. The Bank would have an opportunity to comment on the proposals before they were adopted (Section 4.05 of the draft Loan Agreement). Environmental Effects 64. Construction of the dam would have a significant impact on the downstream hydrology of the river. The short (6 km) stretch down to the MARIS diversion dam would become a reregulating reservoir with wide surface fluctuations. Flows below the diversion dam would be noticeably altered, particularly during the dry season. As the reservoir is lowered every year the shoreline is expected to shift laterally by as much as 3 km in the vicinity of Planas. Such widely fluctuating reservoir levels would preclude the development of vegetation below the full supply level and would lead to the creation of mud flats. As the river enters the reservoir there would be a decrease in the flow velocity, followed by deposition of the larger particles of sediment to form a delta in the upper reaches of the reservoir, with a consequent raising of the river bed and water surfaces in the river reach immediately above the reservoir. Studies indicate that flooding of additional areas upstream of the reservoir might occur at some point in the future as a  - 20 - result of back water and aggradation caused by the reservoir. Agreement was reached at negotiations that NIA would include observations on riverbed aggradation as part of a wider reservoir sedimentation monitoring program, in order to allow adequate lead time for remedial measures. Construction of the dam and formation of the reservoir would have no effects on existing health conditions in the area. Cost Recovery 65. The cost recovery index was examined for the combination of MRMP Stages I and II since part of the irrigation benefits of Stage II accrue to areas under Stage I. Based on financial projections of NPC, it is expected that NPC would sell energy in 1983 at $0.0317 kWh. At this tariff level, NPC could carry on its account the cost of the power house, power equipment, and about 73% of the cost of the dam and still obtain an 8% rate of return on its assets. It has been agreed that, within three years of loan signature, a proposal for allocation of the costs of the dam between the two agencies would be presented to the Bank for review (Section 4.04 (b)(i) of the draft Loan Agreement). In view of NPC's need for funds, and in order to maintain its creditworthiness, it would be desirable that the cost of Magat dam allocated to power would be assumed by the Government partly in the form of equity contributions to NPC. However, a final decision on the issue would be taken by the Government as part of the cost allocation determination. Since the project would provide a more reliable supply of water than other Bank-assisted irrigation projects and since the average farm size in the project area is somewhat larger, an increase in the irrigation water charges in the service area is justified. Therefore, an increase equivalent to 1 cavan of paddy/ha above level charged under other Bank-financed projects of 3.5 cavans/ha in the wet season and 4.4 cavans/ha in the dry season would be appropriate. It has been agreed that, within a period of five years after full development, water charges would be gradually increased to these levels (Section 4.04 (b)(ii) of the draft Loan Agreement). Based on the above water charges and power tariff levels, the overall cost recovery index at discount rates of 8%, 10%, and 12%, is 62%, 47%, and 37% respectively. Assuming that the powerhouse, power equipment and 73% of the dam were allocated to NPC, the cost recovery index of the irrigation component would be 17% at a discount rate of 10%. Project Benefits and Justification 66. The investment in the dam cannot be justified without assuming further investments in irrigation and power and the resulting benefits and the economic evaluation is therefore based on the total investment to be undertaken. 67. Completion of Stage II MRMP development would provide an additional 27,000 ha of rice land with year round irrigation. At present, in the wet season a rainfed rice crop is grown on 21,200 ha of this land, while 5,800 ha are irrigated by small run-of-river and pump irrigation systems. In the dry season only 2,100 ha are cropped to irrigated rice. Construction of the Magat dam would also provide irrigation water to a further 46,000 ha in the dry season. This area, equipped with irrigation facilities under Stage I of MRMP, presently remains uncultivated in the dry season due to lack of water. On completion of Stage II development, approximately 8,000 farm families and 4,400 landless laborers' families would benefit from increased production and  - 21 - additional employment within the Stage II area, together with about 15,000 farm families, and 5,500 landless families in the Stage I area. The incremental annual demand for farm labor would be of about 7.2 million man-days equivalent to some 36,000 full time jobs. Present cropping intensity is 107% which is expected to remain unchanged without the project. With the project, cropping intensity is expected to reach 200%. Paddy production at full Stage II development would increase by about 356,500 tons annually resulting in a yearly import saving of about $69.0 million. After deducting the cost of impDrted fertilizer and chemicals, the net foreign exchange saving would amount to about $62.0 million. 68. The present per capita incomes for the average 3.0 ha farm size, ranging from $80 for a leaseholder to $135 for an owner operator, are below the estimated per capita absolute poverty level of $193 (at 1978 prices), and vary from 16% to 27% of the estimated 1978 per capita GNP of US$507 for the Philippines. With the project, the per capita incomes of these farms would increase to about $475 for an owner operator and $305 for a leaseholder. Thus, average incomes in the project area would rise above the 1978 poverty income level by the time of full development, and would range between 41% and 64% of the 1987 projected per capita GNP of $745. The comparison indicates that the project would increase incomes in the project area considerably and would help narrow the income gap between the project area and other parts of the country, and between urban and rural areas. 69. With an installed capacity of 360 MW, the project would generate about 1,200 GWh annually. In quantifying power benefits, ideally both the capacity and energy contri.bution would have to be given economic values. As a simplification, these benefits have been expressed in terms of the price per kWh consumers would be willing to pay for the energy. Since it was not possible to measure willingness to pay directly, the retail tariff was taken as a minimum measure of the consumers' willingness to pay ignoring consumers' surplus and the possibility that the market clearing rate might be higher than the actual tariff. 'In Luzon, the retail prices charged by cooperatives, some of whom buy power from NPC, range from P 0.24/kWh to P 0.94/kWh, averaging around P 0.33 per kWh. Retail tariffs charged by cooperatives which buy cheap power from the NPC grid are generally lower than the retail tariffs charged by cooperatives which generate their own power. Based on these data, electricity consumers are willing to pay at least P 0.33/kWh for energy. At P 0.33/kWh, the value of MRMP's output, after accounting for a 9% loss due to transmission and distribution, would be $43.8 million. Since MRMP's energy output has been valued at the retail level, an incremental investment of about $60.0 million, for transmissicn and distribution facilities, was deducted from this value. The annual cost of operation and maintenance of the transmission and distribution facilities has been estimated at $1.35 million. 70. Using the foregoing assumptions, shadow pricing for foreign exchange and farm labor, and discounting investment costs and irrigation and power benefits over a 50 year evaluation period, the economic rate of return of the project is 12%. Sensitivity analyses indicate that the rate of return was most sensitive to a combination of cost overruns and delays in benefits.  - 22 - 71. To see whether the Stage II investment is the least costly way of providing the expected irrigation and power benefits, it has been compared to alternative irrigation and power projects. The only feasible alternative irrigation project would be the present Stage II investment minus the power generation facilities. This alternative would have a capital cost of $372.6 million and an annual operation and maintenance cost of $1.3 million. Because the long-range development program beyond 1987 is not yet well defined, the comparison of alternative power developments to meet energy requirements in the Luzon grid in 1983 has been confined to comparing the power output of Magat with a thermal alternative. A thermal plant with installed capacity of 300 MW would be required. Studies indicate that the best solution would comprise a combination of a 100 MW steam plant and a 200 MW gas turbine plant. The capital cost for the steam plant, with an economic life of 25 years, has been estimated at $450/kW and for the gas turbine plant, with a life of 15 years, at $250/kW. Annual operating costs for these plants have been estimated at $29.2 million which include fuel costs for generating 1,200 GWh at an average cost of P 0.18/kWh. Comparison of the Stage II investment to these alternative series of investments shows that the net present value of the MRMP investment is lower for all discount rates below 43%, which is the equalizing discount rate. At a discount rate of 10%, the net present value of the Stage II investment is lower than that of the alternative by $181 million. 72. Risks. NIA has successfully completed the construction of a large multipurpose dam at Pantabangan in Central Luzon (Loan 637-PH) and the experi- enced senior personnel fro'm that job are now assigned to the proposed Magat dam. In addition, despite the fact that a remarkable amount of exploratory work has already been carried out at the site adequate provision has been made in the estimates for unexpected contingencies. Thus, while no major problems are anticipated in construction of the Magat dam and appurtenant works, a delay in completion of the diversion tunnels or the ocurrence of abnormally high wet season floods at the early stages of dam construction would constitute the principal risk factor. Such events could result in the loss of one construction season and a reduction in the economic rate of return. PART V - LEGAL INSTRUMENTS AND AUTHORITY 73. The draft Loan Agreement between the,Bank and the Republic of the Philippines and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank are being distributed separately to the Executive Directors. Special conditions of the project are listed in Section III of Annex III of this report. 74. An additional condition of effectiveness of the Loan Agreement would be the establishment of the special fund (para. 57). 75. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 23 - PART VI - RECOMMENDATION 76. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D. C. April 28, 1978   ANNEX I TABLE 3A Page 1 of 4 pages PHILIPPINES - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KM2) ---------------------------____________________ _______________ PHILIPPINES REFERENCE COUNTRIES (1970) TOTAL 300.0 MOST RECENT AGRIC. 109.6 1960 1970 ESTIMATE THAILAND IURKEY KOREA SOUTH ** GNP PER CAPITA (USS) 140 0* 230.0* 410.0*/a 210.0 * 500.0* 280.0* POPULATION AND VITAL STATISTICS _______________________________ POPULATION (MID-YR. MILLION) 27.4 36.9 43.3/a 36.3 35.6 32.2 POPULATION DENSITY PER SQUARE KM. 91.0 123.0 144.0 a 71.0 46.0 327.0 PER SO. KM. AGRICULTURAL LANE 326.0 375.0 395.0 a 263.0 65.0 1371.0 VITAL STATISTICS CRUDE BIRTH RATE (/THOU, AV) 45.1 44.2 43.8 44.3 40.6 35.0 CRUDE DEATH RATE (/THOU,AV) 17.9 13.2 10.5 13.7 14.4 11.4 INFANT MORTALITY RATE (/THOU) 84 [ R1 72.n 80.0 153.0/a LIFE EXPECTANCY AT BIRTH (YRS) 49.4 55.6 S8.5 55.5 54.4 85.0 GROSS REPRODUCTION RATE 3.5/a 3.3 3.3 3.2 2.6/b C 2.6 POPULATION GROWTH RATE (X) TOTAL 3.0 3.0 2.8 3.1 2.5 2.3 URBAN 4.0 4.0 3.9 4.9 4.9/d 6.4 UROAN POPULATION (% OF TOTAL) 25.3 27.6 29.8 15.0 38.7 41.2 AGE STRUCTURE (PERCENT) 0 TO 14 YEARS 45.7 45.6 43.2 45.1 41.7 42.1 15 TO 64 YEARS 51.6 51.6 54.0 51.8 54.0 54.5 65 YEARS AND OVER 2.7 2.8 2.8 3.1 4.3 3.4 AGE DEPENDENCY RATIO 0.9 0.9 0.9 0.9 0.9 0.8 ECONOMIC DEPENDENCY RArIO t.3/b I.S 1.3/b 1.1 1./a 1.4 FAMILY PLANNING ACCEPTORS (CUMULATIVE, THOU) .. 320.0 4065.0/a 470.0 .. 4424.7 USERS (% OF MAARIED WOMEN) .. 2.0 25.0/a 10.0 8.2 42.0 EMPLOYMENT TOtAL LABOR FORCE (THOUSAND) t0100.0 12400.0 15400.0/a 16700.0 14500.0/f 10200.0 LABOR FORCE IN AGRICULTURE el e.o/c 55.0/a 52.6 79.0 67.0 50.4/a IINFgCFm