Afghanistan - Second Khanabad Irrigation Project

FILE Copy Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2249-AF REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE REPUBLIC OF AFGHANISTAN FOR A SECOND KHANABAD IRRIGATION PROJECT March 9, 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 authorization.  CURRENCY EQUIVALENTS Calendar 1977 December 1977 Currency Unit = Afghani (Af.) US$1 = Afs. 46.1 Afs. 43.0 Af. 1 = US$ 0.02169 US$ 0.02326 FISCAL YEAR March 21 to March 20 Note: A depreciated exchange rate (Afs. 47.5 : US$ 1) has been used in calculating project costs. See paragraph 50 for detailed explanation. GLOSSARY OF ABBREVIATIONS AgBank - Agricultural Development Bank of Afghanistan AMSCO - Agricultural Machines and Services Company GDADE - General Directorate of Agriculture Development and Extension KEU - Khanabad Extension Unit KIPD - Khanabad Irrigation Project Department of the Ministry of Water and Power WAPCOS - Water and Power Development Consultancy Services, Ltd. (India)  FOR OFFICIAL USE ONLY AFGHANISTAN SECOND KHANABAD IRRIGATION PROJECT CREDIT AND PROJECT SUMMARY Borrower: Republic of Afghanistan. Beneficiaries: Khanabad Irrigation Project Department (KIPD), General Directorate of Agriculture Development and Extension in Kunduz (GDADE), Agricultural Development Bank of Afghanistan (AgBank) and Malaria Institute Amount: US$22 million. Terms: Standard IDA. Relending Terms: Government would on-lend to AgBank amounts required for agricultural credit, estimated at about US$3.3 million, at 4.5 percent interest repayable over 15 years including 5 years of grace. Prolect The proposed project, a continuation of the first Khanabad Description: Irrigation Project financed by IDA, aims to develop agri- culture by rehabilitating and extending existing irrigation and drainage schemes, extending agriculture credit to farmers and providing an efficient extension service. It also aims at controlling malaria in the project area, and includes a feasibility study for a dam about 90 km upstream of the project area for water resources development. It aims to increase agricultural productivity and production on about 41,500 ha and to benefit about 12,000 farm families. Absolute rural poverty level in Afghanistan is currently estimated at US$84 per capita. After the implementation of the first Khanabad project, 55 percent of the project farmers will still be in absolute poverty. These would be addressed by the proposed project. The project would within 9 years increase average income of owner operators by 40 percent and sharecroppers by 20 percent. A risk exists that the extension service might not become fully effective by 1982 and that there would be some shortfall in the maximum projected yield. The project, however, would still be viable even if an effective extension service were sig- nificantly delayed or hampered. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Costs: Foreign Total Foreign Total as % of Item ----(US$ million)---- Total Asqalan and Yanghareq Areas 2.2 2.0 4.2 50 Gostepa and Larkhabi Areas 2.1 1.8 3.9 46 Alchin Terrace 0.6 0.9 1.5 60 Upper Khanabad Area 2.0 2.2 4.2 52 Esantop Pilot Area - 0.1 0.1 73 Buildings, Equipment and Vehicles 0.4 0.9 1.3 70 Agricultural Extension 0.3 0.7 1.0 69 Training - 0.2 0.2 90 Feasibility Study for Warsech Dam 0.2 0.7 0.9 80 Malaria Control Program 0.2 0.4 0.6 68 Agricultural Credit 1.4 2.3 3.7 63 Base Cost 9.4 12.2 21.6 57 Physical Contingencies (7%) 0.7 0.8 1.5 50 Price Contingencies (25%) 2.5 3.1 5.6 55 Total 12.6 16.1 28.7 56 Financing Plan: Government US$ 5.58 million Project Farmers US$ 0.38 million AgBank US$ 0.74 million IDA US$22.00 million Total US$28.70 million Estimated Disbursements: $ Million IDA FY 79 80 81 82 83 Annual 0.5 3.5 6.0 7.5 4.5 Cumulative 0.5 4.0 10.0 17.5 22.0 Rate of Return; 25 percent Appraisal Report: Report No. 1703a-AF dated March 1, 1978  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF AFGHANISTAN FOR A SECOND KHANABAD IRRIGATION PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Republic of Afghanistan in the equivalent of US$22 million on standard IDA terms to help finance a second Khanabad irrigation project. The equivalent of US$3.3 million of the proposed development credit would be relent to the Agricultural Development Bank of Afghanistan for 15 years, including 5 years of grace, with interest at 4.5 percent per annum. PART I - THE ECONOMY 1/ General 2. A report entitled "Afghanistan: Economic Memorandum (1030-AF)" dated June 7, 1976 has been distributed to the Executive Directors. A basic economic mission visited Afghanistan in April-May 1977 and a draft report was discussed with the Government in December 1977. The final version of the report is currently under preparation. The conclusions of the report are reflected in the following analysis. Country data sheets are attached as Annex I. Economic Structure 3. Afghanistan is an extremely poor, landlocked economy with severe structural problems. With a population estimated at about 14 million and a per capita income of around US$160 in 1976, it is one of the largest countries designated as "least developed" by the United Nations. The country's prospects for development are limited by a rugged physical terrain, arid conditions and a paucity of physical and skilled human resources. The adult literacy rate is only about 14 percent and the availability of physicians and hospital beds are one per 12,900 and 5,200 persons, respectively. Agriculture accounts for about half of GNP and engages about 54 percent of the labor force. Nomads constitute an estimated 11 percent of the population, and an estimated 14 per- cent of the total population live in the cities. Other structural features of the economy are: the low degree of monetization, a low share of government revenues in national income, heavy dependence on foreign assistance for financ- ing the public investment program and the relatively heavy burden of servicing foreign debts. 4. Since the establishment of the Republican Government in July 1973, Afghanistan has made significant economic progress. This has also been accom- panied by a degree of political stability which has permitted the Government 1/ Identical to the corresponding section of the President's Report distributed to the Executive Directors on March 9, 1978 for the Fruit and Vegetable Export Project.  -2- to s:nae mnor socio-economic changes such as land reform and a graduated land tax aimed at agricultural incomes which have been hitherto untaxed. Indicative of the Government's determination to pursue land reforms has been - -_nt law t-vin survey, settlement, and registration of land which provides for land registration and settlement of disputes and checks tax declaration data. The cadastral survey is continuing and a new department of land reform has been established in the Ministry of Finance. 5. There has been some improvement in public administration partic- ularly in relation to development planning and project implementation (e.g. reorganization of the Ministry of Planning, creation of the semi-autonomous Water and Power Authority which has recently been upgraded as the Ministry of Water and Power). Attempts are also being made to improve the institutional support for the country's export trade. An Export Promotion Bank has been recently established and two international trucking companies established for efficient transport of goods to USSR and continental Europe have also started operations. Some promotional efforts have also been aimed at encouraging private industrial investment (e.g. 1974 General Customs Tariff and 1976 Investment Tariff, small scale industry credit facility at the Industrial Development Bank and improved procedures for approval of such industries). A Seven-Year Development Plan (1976/77 to 1982/83) is currently in the third year of its implementation (see para. 15). Recent Economic Performance 6. Afghanistan's economy suffered a major setback from the droughts in 1970 and 1971 followed by the severe winter of 1971/72 which caused declines in wheat, fruit and livestock production, and especially heavy losses in the livestock population. Since then agricultural output has recovered rapidly due to improved weather conditions and increased use of farm inputs. Agri- cultural output during the fiscal year 1975/76, particularly wheat and cotton, was at a record level with an estimated increase of 7 percent over 1974/75 which in itself was already a very good crop year. Poor weather conditions, however, resulted in a slowdown in agricultural production in 1976/77. The increase in the food grains crop, the bulk of the agricultural produce, was at a lower rate than in 1975/76 while production of seed cotton, the main cash crop, was the same as in 1975/76. The slowdown in output growth illustrates the continued dependence on variable precipitation and the need for investment in irrigation. The performance in large scale manufacturing in 1976/77 compared to 1975/76 has been mixed. Production of urea has hardly increased, constrained by large factory stocks from 1975/76. Ginned cotton, however, has performed quite well, the estimated rate of increase being about 20 percent. 1/ Although production of cement and sugar have hardly increased, their production levels were at the limit of their current utilizable capaci- ties. 2/ Production of cotton textiles, however, is estimated to have declined 1/ Although production of seed cotton in 1976/77 remained static at the 1975/76 level, this did not impede ginning operations because of a large backlog of unginned cotton from 1975/76. 2/ Some of the machinery is very old and sometimes inoperable; machine- rated capacities thus often exceed their utilisable limits.  -3- by about 22 percent; there are demand constraints facing cotton textiles, an export ban and high level of imports encouraged by exchange rate appreciation (see para. 12) have dampened the demand for the domestic textiles. 7. The Bank Group in 1976 conducted a sector survey on industry which reviewed its problems and prospects. 1/ The modern sector is dominated by the public sector with very little private sector participation. The problems of the public sector are, briefly, over-centralization of the management struc- ture, lack of proper financial control, and inadequately trained management personnel. The private sector, which consists almost entirely of import- substituting consumer goods industries, is currently stagnating and is con- strained by various practices such as export restrictions on textiles and strict application of income tax regulations without an adequate appeals pro- cedure and a statute of limitations on past liabilities. It is also being hampered by the lack of a clear Government policy on the role of the private sector in industrial development. The findings of the Bank study, including various recommendations of possible policy measures to deal with these prob- lems, have been submitted to the Government. Of late, the Government has shown a greater awareness of the large potential 2/ for private sector indus- trial investment (see para. 5). 8. Afghanistan during 1976/77 successfully continued its efforts to mobilize domestic resources. Public revenue increased by about 13 percent over the previous year while current surplus increased by about 9 percent over 1975/76, roughly as projected in the budget. Development expenditures, although falling short by about 18 percent over the budgetary estimate of Afs. 14.0 billion, increased no less than 90 percent over the previous year. This reflects the steady improvement in Afghanistan's absorptive capacity. The shortfall in development expenditures did not, however, result in a fall in the budgetary deficit because of a large shortfall in the inflow of foreign aid due to a slowdown in commitments from major donors. 3/ Contrary to the budgetary estimate of about Afs. 9.3 billion of gross foreign aid inflow, actual receipts were about Afs. 5.4 billion. Part of the shortfall in aid receipts was, however, made up through deficit finance of about Afs. 2.9 billion, compared with debt retirement by the Government of about Afs. 0.8 billion during the previous year. 1/ Industrial Sector Review of Afghanistan, IBRD Report No. 1245-AF. 2/ The forthcoming basic economic report will elaborate on this. 3/ Despite recent improvements, Afghanistan's low absorptive capacity remains a continued concern (see paragraph 14). The slowdown in aid commitments in 1976/77 was not, however, due to a lack of project prep- aration, rather due to delays on the part of the donors. The Government has partially compensated for it by committing its own resources.  - 4 - 9. Although gross aid receipts in 1976/77 were only 58 percent of the budgeted figures, they still increased by about 16 percent over the previous year's total. This however contrasts sharply with the 40 percent annual growth rate projected in the seven year development plan. Commitments by major aid donors have been very limited in 1976/77 and considerable shortfall in the plan's projections of such commitments is likely. Foreign aid receipts can be expected to be a major constraint on achieving the investment targets of the plan. Additionally, there is evidence that the newer donors are lend- ing on less concessional terms so that the debt service burden may again emerge as a serious problem. 10. The rate of increase in money supply 1/ during 1976/77 has been sub- stantial, about 33 percent; this reflects the effect of a large budgetary deficit (see para. 8) and the increase in foreign assets (see para. 11). There has been, however, no corresponding increase in the prices which are estimated to have increased by only about 3 percent. While significant exchange rate appreciation (see para. 12) helped to keep the prices of imported consumer goods down, the main restraint on prices may have come from a massive volume of hoarding of the domestic currency as pure asset accumulation. It is likely that the effect of the large increase in money supply was not fully reflected in the 1976/77:prices because of both lags and cash hoarding. As lags work through and cash hoardings are run down because of anticipated crop losses, inflationary pressures could emerge and will need to be closely monitored. 11. With regard to foreign trade, export earnings during 1976/77 increased by about 32 percent over 1975/76, compared to only about 2 percent during 1975/76. While export prices increased by about 22 percent, the increase in export volume was 8 percent. About 90 percent of the increase in export earnings came from fruits and nuts and ginned cotton which benefitted from high prices. Simultaneously, imports in 1976/77 also marked a consid- erable increase over their 1975/76 level due to the rising volume of develop- ment expenditures and the effect of continued exchange rate appreciation (see para. 12) on private imports. However, the rate of growth (about 24 percent) was less than the rate for exports so that the trade deficit was reduced from $42 million to $33 million in 1976/77. Of the other current account items, interest payments were about $9 million compared to about $5 million in 1975/76. The 1976/77 interest payments were, however, still less than their 1974/75 level, reflecting the 1975 rescheduling of the USSR debt. Net foreign aid flows were about $112 million, compared to about $94 million in 1975/76 and foreign exchange reserves increased by about $68 million. Current foreign exchange reserves are about $241 million, equivalent to about two-thirds of the current annual import flows. Apart from the improving export performance and increasing net aid flows in recent years, the continued rise in foreign exchange reserves also reflect an additional factor - central bank purchases of foreign currency from the "bazaar" (i.e. free foreign exchange market). This has helped to moderate the appreciation of the Afghani resulting largely from sizable remittances by Afghans working abroad. 1/ Including quasi-money (i.e. time deposits and foreign currency deposits).  - 5 - During the first half of 1976, the central bank had suspended its :Lg activities in the "bazaar" and this led to a resumption of the appre- ;aton of the Afghani 1/ during the six months ending September 1976 from ifs. 55: US$1 to Afs. 40: US$1. Exports were, however, insulated from this -.,preciation through export earnings being converted at the rate which pre- vYailed in February 1976, Afs. 56: US$1. Since September 1976, the central )nk has resumed its buying activity in the "bazaar" and by end-March 1977 -he "bazaar" rate has increased to Afs. 47: US$1, as a consequence of purchase 3f about $16 million. Simultaneously, however, the central bank has reduced the export exchange rate first to Afs. 50: US$1, and then in June 1977 to Afs. 48: US$1. These actions to reduce the spread between the "bazaar" rate (i.e. at which the central bank sells foreign exchange to the private sector) and export exchange rate (i.e. at which it purchases foreign exchange from the private sector), will substantially reduce the budgetary burden which is incurred on this account. Besides the impact on the Government budget, the appreciation of the export exchange rate by about 17 percent could affect export incentives in the longer-term. The IMF is reviewing this question with the Government. There is, however, no evidence yet of any slack in exports. Demand for fruits and nuts and raw cotton constituting more than half of the exports has been particularly buoyant in 1976/77. Recovery of production by competing foreign suppliers and thereby a reversal of the recent high export prices should be anticipated in the near future and a depreciated exchange rate could then become a necessity. Development Prospects and Constraints 13. The large undeveloped human, agricultural and mineral resources of Afghanistan provide the basis for a favorable assessment of the country's long-term development potential. The commitment of the Government to develop- ment and economic and social reforms gives rise to hope that this potential can be realized. Recent offers of aid, notably from the Islamic oil producing countries, are likely to increase further the external capital flow into the country in the near future. Although foreign aid receipts during the seven year development plan (see para. 15) may fall short of the target, a substan- tial acceleration over the levels achieved in recent years may reasonably be anticipated. 14. To realize the development potential of the country, however, requires timely and vigorous action to remove a number of obstacles that severely inhibited the country's economic and social development in the past. Included among these are: (a) Inadequacies in project preparation and the resulting shortage of projects to absorb the external economic assistance which was potentially available; and 1/ The average bazaar exchange rate for Afghanis to US dollars has in- creased from Afs. 80.5: US$1 in 1972/73 to Afs. 47.4: US$1 in 1976/77.  -6- (b) inadequacies in public administration and manpower development which have led to inefficient implementation of policies and projects. The Government is well aware of these problems and has begun to take action to solve them. Particular attention is being given to improving the taxation system. The organizational changes as mentioned in paragraph 5 also indicate this awareness. Much, however, remains to be done and will be focused on in the forthcoming basic economic report. 15. The Government has begun implementing a seven-year development plan (1976/77-1982/83). The plan has an estimated expenditure total of about Afs. 174 billion ($3.7 billion) 1/ thus envisaging a more than three-fold rise in the average annual development expenditure as compared to 1975/76. The plan aims at an annual rate of growth in GNP of about 6 percent. With population expected to grow at about 2 percent per annum, the per capita income growth is expected to be around 4 percent. However, in its present form the plan is better viewed as a shopping list of projects providing a range of choice to donors than as a feasible program with a well-defined framework for the examination and coordination of policies. Thus the plan probably contains more projects than the country can prepare and implement. Moreover, the projected foreign aid inflow of about $2.8 billion may be more than can be expected from the major aid donors. The shortfall in external aid cannot be met from domestic resources given the need to increase current expendi- tures on social services in the plan period. External Debt 16. During the period between 1972/73 and 1976/77 about two-thirds of public investments in Afghanistan have been externally financed with gross aid inflows ranging from about $60 to $130 million annually. As of March 31, 1977 Afghanistan's external debt amounted to $1,748.5 million of which $911.2 million was disbursed. The major creditors are USSR (62 percent of the total outstanding debt), USA (6 percent), IDA (6 percent), and the Federal Republic of Germany (5 percent). The People's Republic of China and Saudi Arabia, both relatively new creditors, hold 4 percent and 3 percent respectively of the total outstanding debt. Loans from governments account for about 92 percent of all disbursed external public debt. Afghanistan concluded, in July 1972, an agreement with USSR to reschedule $30.2 million of some $152.4 million in debt service obligations that were due during 1972/73-1976/77. In addition, in early 1973, USSR agreed to convert some $16.5 million of loan commitments to grants. In February 1975, an agreement was concluded for the rescheduling of another $136 million of debt obligation due during 1975/80. 17. With the past emphasis on long-gestation infrastructure projects with little export-generating or import-saving impact, the growth of Afghanistan's debt servicing capacity has been outstripped by the debt-servicing obligations. Thus, although most of the borrowing over the past 20 years was on quite soft 1/ At the March 1977 exchange rate of Afs. 47.5 to 1 US dollar which remained the same until June 1977 (see para. 50 below).  terms, the impact of debt service has become heavy and in the recent past had to be mitigated by substantial rescheduling. The debt-service ratio in 1976/77 was 8.3 percent, as against 17 percent in 1974/75, but the decline was entirely the effect of the 1975 rescheduling of the debt-service payments to USSR, the principal lender. Given the country's debt burden, its poverty and its development stage, Afghanistan does not have the capacity to service additional external borrowing on conventional terms. It is also probable that the terms of aid committed and disbursed during the seven year plan period will be less concessionary than earlier anticipated. Accordingly, it is esti- mated that the debt service ratio would climb to about 21 percent in 1982/83. This raises the probable need for a further rescheduling of debt as happened in 1975. Afghanistan also requires special consideration from external lenders, including IDA, in financing the local costs of development projects, in view of its relatively narrow tax-base and low domestic savings capacity. PART II - BANK GROUP OPERATIONS IN AFGHANISTAN 1/ 18. IDA has provided fourteen development credits totalling US$115 mil- lion (net of cancellations) to Afghanistan. IFC invested $0.3 million in the Industrial Development Bank of Afghanistan (IDBA) in July 1973. However, IDBA has been nationalized and IFC has been fully paid back its investment by the Government. Annex II contains a summary statement of IDA credits and IFC investments as of January 31, 1978, and notes on the execution of the ongoing projects. 19. Bank Group lending in Afghanistan began in 1964 with a $3.5 million credit (Cr. 68-AF) for an education project, but in July 1970, before any con- struction took place, a major portion of the credit was cancelled at the request of the Government following education policy changes. A resident mission was established in Kabul in 1969 and since that time, with a consider- able input of staff time and effort on project preparation, the Bank Group has provided financial assistance to Afghanistan at an average level of about $13 million annually. IDA has made six credits totalling $69 million in the agricultural sector, three credits totalling $19 million in the transportation sector, one credit of $2 million for an industrial development bank project, one credit of $9 million for a water supply project, one credit of $10 million for a thermal power project and one credit of $6 million for a second educa- tion project. The credits for a Fruit and Vegetable Export Project ($18 mil- lion) and this proposed project ($22 million) would be the seventh and the eighth for the agricultural sector. 20. Difficulties have been experienced in disbursing the proceeds of the IDA credits made since 1971. The main reasons were substantial delays in fulfilling effectiveness conditions, slow progress with the selection of consultants, minor project changes and, in the case of the Industrial Develop- ment Bank (IDBA) Project, a lack of sub-projects. These problems have now 1/ Identical to the corresponding section of the President's Report dis- tributed to the Executive Director on March 9, 1978 for the Fruit and Vegetable Export Project.  - 8 - been corrected satisfactorily, with the assistance of the Bank's resident mission in Afghanistan, but in the case of the irrigation and livestock proj- ects, the delays incurred aggravated the effect of very heavy inflation on the project costs. Disbursements are now proceeding on a normal schedule. In close cooperation with IDA staff, the Government is trying to remove obstacles to satisfactory project implementation for those projects which are currently being prepared or whose implementation has just started. For instance, a proj- ect implementation unit for the Second Education Project was fully established soon after the negotiations, and a project unit has already been established in preparation for the fruit and vegetable export project. 21. The Bank Group's lending strategy recognizes that special efforts are required to help Afghanistan which is among the 29 least developed coun- tries designated by the United Nations. Its landlocked position, its extreme poverty and difficult economic problems, the structure of its political and economic system, the underdeveloped state of physical resources and shortage of trained manpower impose severe limitations on the country's absorptive capacity and thus inhibit its development. Considerable staff time is required, therefore, to help identify, prepare and implement future projects. During the forthcoming years, we expect to establish a basis for financing an average of three projects each year, which would assist in institution building, expand production, increase the foreign exchange earning capacity, improve absorptive capacity and enlarge government resources for development. To that end, technical assistance will continue to be an important feature of most future projects. 22. An appraisal report is being prepared for a water supply and sewer- age project. The Government is preparing the preinvestment studies for a third education project by utilizing the expertise available within the Government and limiting outside help to the minimum. A grain storage project is ready for appraisal on the basis of a study financed by the British Gov- ernment. After completion of an FAO/IBRD CP preparation report on a rural development project, the Government is taking further preparation steps in consultation with IDA. The project should be ready for appraisal by June 1978. Preparation of the third irrigation project is also well advanced. Preparation of a second Industrial Development Bank project will depend on further development of overall industrial investment policies by the Govern- ment, particularly for the private sector, and the initial experience of the program to support small and medium scale industry (see para. 5). PART III - THE AGRICULTURAL SECTOR IN AFGHANISTAN I/ 23. Agriculture is the key sector in the economy of Afghanistan. It employs about 54 percent of labor force and accounts for about 50 percent of GDP and about 60 percent of total exports by value. About 85 percent of the 1/ Paragraphs.23-27 are identical to the corresponding paragraphs of the President's Report distributed to the Executive Directors on March 9, 1978 for the Fruit and Vegetable Export Project.  - 9 - total land area of 63 million hectares is comprised of mountains, desert and forests, unsuitable for cultivation. Afghanistan has an extreme continental climate, with its hot, dry summers and severe, cold winters. Afghanistan is very poorly endowed with surface water. High evapo-transpiration rates in summer make the Afghan economy vulnerable to climatic changes. The drought between 1970 and 1971 followed by a severe winter in 1971/72 caused a more than 20 percent drop in agricultural production. Climatic and topographical factors together with inefficient traditional irrigation systems and the institutional problems as described below act as severe constraints to the improvement of agricultural productivity and consequently to the development of the country. 24. Grain crops, of which 75 percent consist of wheat, are grown on 80 to 90 percent of the cropped land. About 30 to 40 percent of the unarable land is used for livestock grazing, mostly for sheep. During the past three years, Afghanistan achieved a long-standing Government objective of self- sufficiency in foodgrains particularly in wheat. About 2.9 million tons of wheat are estimated to have been produced in 1976/77 as compared to 2.4 mil- lion tons in the pre-drought year of 1969/70. Rice production has also in- creased from 407,000 tons in 1969/70 to 450,000 tons in 1976/77. Production of the two major cash crops, sugarbeet and cotton, almost doubled between 1969/70 and 1976/77. The value of agricultural exports increased by over 100 percent for the period 1971/72 to 1975/76, due to a 50 percent price increase and a similar increase in volume. However, the year 1977/78 may again require imports of about 200,000 tons of wheat due to low rainfall. 25. The average size of land holdings is estimated at around 3.5 hec- tares of cultivable land, but the distribution of land ownership varies considerably among the regions. The majority of the estimated 1.5 million agricultural households have less than 0.5 hectare, and rely on sharecropping arrangements with landlords. Fragmentation and multiple ownership, resulting from the traditional inheritance law, discourages investment in mechanization and improvements including the introduction of fertilizers and other inputs. The landlord may invest little or nothing in his land but often acquires a substantial part of any production increase achieved by the tenant. In an effort to break through these socio-custom constraints, the Government has recently introduced a land reform law and a graduated land tax system and, under the current seven year development plan, proposes to expand greatly its program for the settlement of landless farmers. As the first step to support the Government efforts in this area, the Third Agricultural Credit Project for which an IDA credit of $12 million was approved in June 1977, includes credit facilities for farmers resettling under the Government land settlement program. 26. The agricultural sector in Afghanistan still faces a number of institutional constraints including insufficient credit facilities, cumbersome administrative regulations, inadequate domestic financial resources, a short- age of trained staff, inadequate extension services and above all, cultural and social constraints including the fact that about 90 percent of the popula- tion is illiterate. Although harsh topographic and traditional socio-economic  - 10 - custoais restrain optlmism in the Government s efforts in solving these prob- lenma, there have been some encouraging signs of improvement in these fields particularly during the past few years. The previous IDA credits for the '"r;'1 se-or have started to address, on a project basis, several of tnese constraints. In addition to their main objectives for production increases, the irrigation, livestock and agricultural credit projects are cc.'i tributing to streamlining administrative arrangements, strengthening institutions connected with these projects and training staff in these fields. Furthermore, the recent second education project is designed to increase the number of middle level agricultural extension agents and to improve general teacher training. 27. The Ministry of Agriculture is the main administrator of agricultural development in Afghanistan, but its achievement and influence in agricultural development has been rather limited due to a shortage of trained and expe- rienced staff, limited budgetary allocations and an unsatisfactory administra- tive framework including overcentralization of authority. The transfer in 1975 of the responsibility for irrigation development from the then Ministry of Agriculture and Irrigation to the Ministry of Water and Power and the creation of Department of Rural Development in the Prime Minister's office has improved efficiency in irrigation development, but these two Ministries and the Depart- ment of the Rural Development continue to face the same major constraints as listed above for the Ministry of Agriculture. With the three IDA credits amounting to $30 million as the main financial support, the Agricultural Development Bank of Afghanistan (AgBank) has developed a financially and institutionally strong basis and established itself firmly as the leading agricultural development institution in the country. Its reorganization and strengthening in 1969 with assistance from UNDP and IDA were the first major steps to make institutional credit facilities available to farmers. The first agricultural credit project has been successfully completed and a completion report for the project has been finalized. The second agricultural credit project is being implemented successfully and is shortly to be phased into the third agricultural credit project which became effective in September 1977. Since its establishment in October 1973, the Afghan Fertilizer Company has contributed greatly to increasing the use of agriculture and improving the supply and distribution network of fertilizers with strong support from the United States Agency for International Development (USAID). The Afghan Seed Company, a recently organized Government organization, is expected to increase production and contribute to multiplying and distributing improved crop seeds particularly of wheat and cotton. The company is being assisted by a $14 million loan from the Asian Development Bank, and would also be supported by the IDA credit of $18 million for a Fruit and Vegetable Export project. The Herat Livestock Development Company organized under the First Livestock Development Project, for which an IDA credit of $9 million was made in 1973, bas been expanding its activities into an extensive animal health program tuder the Second Livestock Development Project, for which an IDA credit of $15 million was made in July 1976. Since lack of an efficient extension service system has hindered the agricultural development in Afghanistan, IDA has recently made a US$6 million credit for a second education project which  - 11 - mainly aims at producing middle level extension agents. Although there are about 2,600 extension agents in Afghanistan their quality is low and addi- tional extension agents are needed to provide adequate services to farmers. Irrigation Subsector 28. Irrigation is a key factor in the development of the Afghan economy. Since agriculture dominates the economy and since water is a major constraint on agricultural expansion, the Government continues to put emphasis on irriga- tion development. Although Afghanistan is poorly endowed with surface water, it is the main source of irrigation. The ground water potential is considered to be significant, but no nationwide investigation of it has been made. Some regional investigations have been underway since the late 1960s when UNDP initiated a groundwater study to demonstrate modern methods for exploring and assessing resources in representative areas. However, the results of these investigations are relatively limited, and there is a need to confirm and expand them to indicate additional areas suitable for well drilling and digging and to establish a nationwide order of priorities for groundwater development. 29. Mainly due to the rugged topography, only about 6 percent, or about 4 million hectares, of the total land area is cultivated annually, of which about 2.4 million hectares are irrigated. Of the irrigated land only about half receives enough water annually, and an average of I million hectares of the 2.4 million hectares are usually left fallow. In most irrigated areas served by traditional schemes, farmers rely on either seasonal diversion of river water by using weirs of stone, or brushwood, or ancient underground water courses which are inefficient. Many such diversion structures get washed away during high flows interrupting irrigation supplies during the low flow periods. Canal breaks are also frequent, and heavy seepage losses and operational wastes are experienced. 30. Effective development of irrigation has been constrained mainly by inadequate control at diversions and seasonal shortages in available flows, construction of main canals too far ahead of their distribution systems and inadequate operation and maintenance. Until the recent establishment of the Ministry of Water and Power, the division of responsibility among concerned ministries hampered effective coordination, and resulted in slow development. 31. Since the Republican Government came to power in July 1973, it has put great emphasis on irrigation improvement and directed its efforts to large scale irrigation projects. The current seven year development plan contains fifteen large carry-over irrigation projects and ten new large scale irriga- tion projects with a total target capacity of about 390,000 ha. These proj- ects are well distributed throughout the country. The plan aims at more than a 300 percent increase in the total irrigated area during the seven-year period, leaving at the same time more than 300,000 ha as a carry-over target from the same projects into the next plan. The current plan is ambitious in view of the fact that only about 60,000 additional ha became irrigated between 1966 and 1975 under large scale projects. However, the Government is rightly  - 12 - giving the first priority to the further development of irrigation. The Gov- ernment realizes that large scale irrigation projects have long gestation periods, but because of the prime importance of irrigation improvement, it is committed to achieving at least the major part of the planned targets. 32. There is also some emphasis on the development of minor irrigation schemes. The Rural Development Department has been formed to take up respon- sibilities in this area. The small scale irrigation works will be coordinated with the construction and improvement of rural feeder roads, bridges, wells and other related rural development works. 33. The construction of distribution and drainage systems has failed to keep pace with major canal construction in some of the large scale projects. To avoid this problem, the proposed project follows up the Khanabad Irrigation Project for which the original IDA credit of $5 million has been increased to $15 million by a supplementary credit. This project was designed as a first phase to modernize the existing irrigation system in the Khanabad Valley and to prepare a feasibility study for a project to develop the area further. The implementation of the first project has been slow due primarily to delays in Government ratification of the original credit and in appointing consultants. This led to a considerable cost overrun which resulted in a supplementary credit of $10 million approved by the Executive Directors in January 1976. However, satisfactory progress is now being made on the construction of this project which is expected to be completed in December 1978. As a result of the works under the first project including the construction of a diversion weir on the Khanabad River, a more regulated water supply for canals in the project area is assured. This opens the door for additional rehabilitation of the irrigation networks in the Valley, which is being proposed now under the second project. PART IV - THE PROJECT Project History 34. In mid-1975, Afghanistan requested IDA to assist in financing a second Khanabad irrigation project to increase agricultural benefits and con- tinue the support given to agricultural development under the first Khanabad Irrigation Project. This would be the eighth IDA credit for the agricultural sector in Afghanistan. The proposed project was identified by an FAO/IBRD CP mission in October 1975, and prepared by the consultants to the Ministry of Water and Power financed under the first Khanabad Irrigation Project. The project was appraised in March 1977 and negotiations were held in Washingtoni from January 9 to 25, 1978. The Afghan delegation was headed by His Excellency Farid Isaaq, Deputy Minister of Water and Power and included a representative of the Ministry of Planning. The Project 35. The project would increase production through irrigation rehabili- tation, drainage and supporting agricultural services on an area of 41,460 ha  - 13 - comprising 26,600 ha included under the first Khanabad Irrigation Project, 13,660 ha of land in the lower part of the Khanabad Valley, and construction of new irrigation facilities on 1,200 ha. It would also include a 20 ha pilot area for testing different irrigation methods on loess soils, which represent a potentially irrigable area of about 9,000 ha. A malaria control program would also be carried out in the project area to improve the health of the project farmers. The project facilities are described below: (a) Asgalan, Yanghareg, Gostepa and Larkhabi Areas (13,660) remodelling and rehabilitation of the existing main canals, including construction of intake regulators, water distribu- tion and drop structures, gravelled roads along canals, remodelling of an existing drain and land reclamation works on about 4,800 ha. (b) Alchin Terrace (1,200 ha) construction of pumping stations, a regulator, irrigation and drainage networks, and land levelling of 430 ha. (c) Upper Khanabad Area (26,600 ha) construction of two new drainage networks, water distribution and control structures on existing canals, offtake regulators for lateral canals, and gravelled canal roads. (d) Esantop Pilot Area (20 ha) a pilot project for a study of soil subsidence under different irrigation methods and the most suitable irrigation method on the loess soil. 36. About 190 km of roads would be gravelled under the project along the main canals for maintenance of project works and movement of agricultural inputs and produce. An extension service would be established to cover the project area. Consultant services would be provided for (a) implementation of the project works and the pilot project on the Esantop Terrace, and training of local staff and (b) review at a national level of the effectiveness of the agricultural research and extension services and setting up an effective exten- sion service in the project area and training local staff in modern extension techniques (see paras. 41-43 below). Productive credit for investments in modern inputs would be made available through AgBank to farmers in the project area (see paras. 44-46 below). A feasibility study for a dam for water resource development at Warsech on a tributary of the Khanabad River, about 90 km upstream of the project area, would be carried out under the project. 37. Through the above project components, including the establishment of an extension system, the provision of productive credit and technical assis- tance, the project would help increase agricultural productivity particularly  - 14 - in food rai-,s and industrial raw materials and would also improve farm tech- nJlogy and management. These improvements would support the Government's objectives of attaining self-sufficiency in food grains, increasing production - r -^ -'-nge earning crops and raising Government revenue. These are ail in line with the objectives of the Government's seven year development plan. The Credit and Project Summary describes the major features of the oposed project. The Appraisal Report (No. 1703-AF) entitled "Appraisal of Khanabad II Irrigation Project" is being distributed separately to the Execu- tive Directors. Organization and Execution 38. The planning, construction, operation and maintenance of the irri- gation and drainage works, and the implementation of a feasibility study for the Warsech Dam would be the responsibility of the Khanabad Irrigation Project Department (KIPD) of the Ministry of Water and Power. The agricultural exten- sion component of the project would be implemented by the Khanabad Extension Unit (KEU) to be set up in Kunduz under the General Directorate of Agricultural Development and Extension (GDADE) of the Ministry of Agriculture. Both KIPD and KEU would be assisted by consultants to be employed under the project. The agricultural credit component of the project would be implemented by AgBank. The malaria control program in the project area would be carried out by the Malaria Institute of the Ministry of Public Health. Khanabad Irrigation Project Department (KIPD) 39. KIPD was established as the department responsible for irrigation and drainage development under the first Khanabad project, and has been the main contact point with the Association in implementing that project, includ- ing the supervision of consultants' work. The headquarters of KIPD would continue to be located in Kunduz. Its staff would be expanded to include the Operation and Maintenance Division, which would consist of 3 sections, each would be headed by an engineer who would be assisted by two or three tech- nicians. The President of KIPD would report to the Minister of Water and Power. The Government would make adequate and timely budgetary allocations to keep the project facilities in good working condition (Section 4.01(b), Development Credit Agreement). Annual operation and maintenance costs of the primary irrigated and drainage facilities are estimated at about $0.6 million or about $15/ha. 40. Under the supervision of and guidance from KIPD, project farmers would continue to be responsible for operation and maintenance of the second- ary and tertiary irrigation and drainage networks as well as farm roads. Through elected water masters (mirabs), the farmers arrange for distribution of water and call for labor contribution to carry out maintenance work. E'armers pay to the mirab a fixed amount in cash and kind per unit area. 41. The project consultant to be employed by July 31, 1978 would carry out the detailed designs, prepare construction drawings, supervise construc- tion, and carry out a feasibility study for the Warsech Dam (Section 3.03 (a), Development Credit Agreement). This consultant would also assist KIPD in the  - 15 - operation and maintenance of the project facilities and to train local staff. It would also assist KIPD in preparing a training program to be submitted to IDA for approval prior to December 31, 1978, (Section 3.04 (a), Development Credit Agreement). Khanabad Extension Unit (KEU) 42. The first Khanabad Irrigation Project did not provide for an extensive extension service because USAID was supporting a research and extension program in the area, and a French cotton mission working in the neighboring area was considering expanding its activities to the project area. However, the USAID program has been completed, and the French cotton mission has not expanded its services into the area. Thus, extension services in the project area are currently inadequate and need to be strengthened to ensure the expected benefits of the project. Under the proposed project, the Khanabad Extension Unit would be set up by December 31, 1978 exclusively to cover the project area under the General Directorate of Agricultural Development and Extension in Kunduz of the Ministry of Agriculture (Section 3.05, Development Credit Agreement). It would have two sub-units, each of which would have four sectors. KEU would be headed by an agriculturalist director, and its two subunits would be headed by agricultural technicians. Sixty-four extension agents, all vocational high school graduates, would be placed under the four sectors and live in project villages. 43. A team of expatriate agricultural consultants would assist in set- ting up and organizing KEU, training extension agents, and reviewing at the national level the existing agricultural and research services. The team will be employed by September 30, 1978 (Section 3.03(b), Development Credit Agreement). Agricultural Development Bank of Afghanistan (AgBank) 44. Institutional credits would be made available to farmers in the project area through AgBank for farm equipment and on-farm development. AgBank would also finance one-year loans for productive inputs for about 50 percent of the project farmers. AgBank would continue to be reimbursed by the Government for one-year loans to farmers which are more than twelve months overdue. By March 31, 1979, AgBank would reorganize and upgrade its office in Kunduz increasing its staff, responsibilities and functions to meet project requirements (Section 2.01(c)(i), Project Agreement). 45. AgBank would be provided with a workshop under the project and would be responsible for supplying and servicing agricultural equipment in the proj- ect area (Section 2.01(c)(ii), Project Agreement). AgBank's Supply Department is being separated to form AgBank's wholly owned subsidiary company, the Agricultural Machines and Services Company (AMSCO). AMSCO, when fully estab- lished, would assume the responsibility for supplying and servicing agricul- tural equipment. 46. Since its reorganization in 1969 under a UN Special Fund technical assistance project for which the Bank continues to be the executing agency,  - 16 - and through the financial and technical assistance supplied by IDA through three credits, AgBank has achieved a remarkable transformation from an ineffi- cient and small-funding channel into the leading agricultural development institution in the country with a professionally competent staff and the ability to generate revenues. The proposed IDA credit would be the seventh to be wholly or partly channeled through AgBank; about $3.3 million of the proposed credit would be channelled through AgBank for this project. AgBank continues to make generally satisfactory progress in its agricultural develop- ment operations. Malaria Institute 47. The Khanabad Valley has been known for its malaria hazard, and the Government has been making efforts to control malaria incidence in the valley. However, inadequate funds usually are earmarked for the valley. The project would provide funds to carry out a malaria control program in and around the project area for the duration of the project. The Malaria Institute of the Ministry of Public Health, already well established under assistance from UNPD and WHO, would monitor the incidence of malaria and use its best efforts to control malaria in the project area in accordance with a program which would be prepared by the Institute and satisfactory to IDA (Section 3.15, Develop- ment Credit Agreement). No disbursement for the malaria control program would be made from the proposed IDA credit until a satisfactory program has been furnished to IDA (para 4, Schedule 1, Development Credit Agreement). Land Ownership Patterns and Tenancy 48. The land ownership pattern in the project area is complex and avail- able information incomplete. A sample analysis of individual villages carried out under the first Khanabad Irrigation Project indicates that over 60 percent of the landowners are holders of less than 4 ha. However, earlier surveys indicated a more skewed pattern. The recently enacted Law of Land Survey, Settlement of Land Disputes and Registration of Lands (the Land Survey Law) provides for cadastral surveys, settlement of ownership and boundary disputes, classification of lands and issue of land titles and enables the Graduated Land Tax Law of 1975 to be applied. The Land Reform Law of July 1975 defines ceilings on land holdings and provides for redistribution of land in excess of the stipulated limits to landless farmers. Although implementation of the Land Reform has not yet begun due to delays in compiling necessary by-laws and regulations, the other two laws are being implemented in the project area. The Government would carry out land surveys, settlement of disputes and regis- tration of land in the project area according to the Land Reform Law and the Land Survey Law. Since lack of land titles and insecure tenancy arrangements hinders access to agricultural credit, the Government would take necessary steps to make available to the project farmers, whether landowners or not, an adequate volume of short-term agricultural credit on reasonable terms. By December 31, 1980, the Government would distribute the land to be irrigated under the project on the Alchin Terrace in individual parcels in accordance with the Land Reform Law and the Land Survey Law (Section 3.06 (a), (b), (c"), Development Credit Agreement).  - 17 - Monitoring and Evaluation 49. The Government would cause the implementing agencies to maintain adequate records and to submit necessary information through periodic reports to IDA to measure project implementation against the proposed schedule and project performance against the expected project benefits. Within six months of the closing date of the proposed credit, the Government would prepare a project completion report and furnish it to IDA (Section 3.08 (a), (b), (c), Development Credit Agreement). Prolect Cost and Financing 50. The estimated total cost of the project is $28.7 million equivalent, of which the foreign exchange component is about $16.1 million or 56 percent. Details of the costs are given in the Credit and Project Summary. This esti- mate is net of duties and taxes as no taxes are levied in Afghanistan on IDA financed projects. About 700 man-months of consulting services would be pro- vided under the project at an average cost of $2,500 per man-month including contingencies. The exchange rate used for the calculation of project costs - US$1:Afs 47.5 - dates from March-June 1977 as compared to the December 1977 exchange rate of US$1:Afs 43.0. The exchange rate in Afghanistan is highly volatile, responsive to seasonably variable but significant flows of workers' remittances as well as capital flight from neighboring countries, and inter- vention by the central bank. It is, therefore, preferable to use an exchange rate which reflects more stable trends. The proposed IDA credit of $22 million would finance the full foreign exchange component and $5.9 million equivalent of the local costs, and would amount to 77 percent of the total project cost. IDA's financing of local costs in Afghanistan is justified for the reasons given in para. 17 of this report. The Government would be the borrower and would bear the exchange risk. The remaining local funds needed to finance the project would come from the Government ($5.6 million), AgBank's own funds ($0.7 million) and sub-borrowers ($0.4 million). Costs per beneficiary family, excluding price contingency but including agricultural credit, amount to about $1,900. 51. Through its budgetary allocations, the Government would make avail- able $18.7 million out of the proposed IDA credit of $22 million to KIPD, KEU and the Malaria Institute for the implementation of the project. The Goven- ment would on-lend to AgBank the remaining $3.3 million of the credit proceeds for AgBank's lending operations in the project area, at 4.5 percent interest with a repayment period of 15 years including 5 years grace. AgBank's sub- borrowers would benefit from various types of loans with a duration of up to 12 years. For medium-term loans of 6 years, the interest rate would be 8 percent with a grace period up to one year. The same interest rate would be applied to long-term loans of up to 12 years with a grace period up to 5 years. Short-term loans for fertilizer, pesticides and seeds would be made at 10 percent interest with up to 12 months repayment period. On all these loans, a one percentage point interest discount would be given to borrowing cooperatives. The interest rates adequately cover AgBank's increasing admin- istrative and personnel expenses and costs of borrowing, and allow for a sufficient level of reserves against defaults on medium- and long-term loans;  - 18 - in .3ddition, they are expected to assist AgBank in strengthening its general reserves, thus placing it in a stronger position gradually to assume some risks on short-term input loans in the future. Procurement Of the total Project cost of US$28.7 million, the cost of works, equipment and vehicles and other goods, including physical and price contin- gencies, would amount to US$23.5 million. Of this cost, goods estimated to cost about US$21.3 million (91%) would be procured either following inter- national competitive bidding (88%) or after local competitive bidding (3%); the remaining 9% (about US$2.2 million) consisting of fertilizer, seeds and other inputs to be financed under short term agricultural credit might be pro- cured by the recipients of such credit through normal commercial channels. Therefore all procurement would be in accordance with the Guidelines for Pro- curement under World Bank Loan or IDA Credits - March 1977. 53. All irrigation and drainage works, estimated to cost about US$16.6 million, would be constructed under one contract, which would be awarded following international competitive bidding amongst prequalified bidders. Equipment and vehicles, drugs for the Malaria Control Program and farm equip- ment, estimated to cost about US$4.0 million, would be grouped into suitably sized contracts, which would also be awarded following international competi- tive bidding. Domestic bidders for civil works contracts would be granted a margin of preference of 7-1/2 percent for the purpose of evaluation and comparison of bids; for locally manufactured goods a margin of preference of 15 percent would be applicable. Procurement estimated to cost about US$0.7 million, and consisting of (a) contracts for equipment and vehicles estimated to cost less than US$20r,000 each; (b) contracts for buildings estimated to cost less than US$200,000 each; and (c) farm equipment and implements esti- mated to cost less than US$20,000 each would be arranged following local com- petitive bidding procedures provided the aggregate cost of contracts awarded under these categories did not exceed respectively US$150,000; US$800,000 and US$200,000. Disbursements 54. The proposed IDA credit of $22 million would be disbursed over five years to finance: (a) 80 percent of total expenditures for irrigation and drainage works; (b) 40 percent of total expenditures for buildings; (c) 100 percent of foreign expenditures and 75 percent of local expenditures for equip- ment, vehicles, and malaria control drugs; (d) 100 percent of foreign expendi- tures for consultants and training; (e) 100 percent of total expenditures for salary supplements to local staff. The agricultural credit component would be financed in accordance with the following percentages: (a) 100 percent of oreign expenditures and 75 percent of local expenditures for tractors and other farm implements; (b) 70 percent of the amount disbursed by AgBank for on-farm development; and (c) 70 percent of the amount disbursed by AgBank during the first 12 months of the project and thereafter 70 percent of the annual incremental disbursements for sub-loans for fertilizers, seeds and other inputs. No disbursement would be made from the proposed credit for the  - 19 - malaria control component of the project until a satisfactory malaria control program has been furnished to the Association (para 4, Schedule 1, Development Credit Agreement). The estimated annual disbursement schedule for the credit is given in the Credit and Project Summary. Environment and Health 55. The works to be constructed under the project would neither adversely affect the environment of the project area nor exacerbate the incidence of malaria. The construction of new drains and the remodelling of existing canals and drains would make these waterways hydraulically more efficient, thereby improving the general environment. The malaria control program under the proj- ect would help improve the health of the inhabitants of the project area. Cost Recovery 56. The existing irrigation channels in the project area were constructed by the inhabitants of the area over 60 years ago without assistance from the Government. The farmers' right to receive irrigation water from the existing canals without payment of any water charge, therefore, has existed for over half a century. Most of the existing traditional irrigation schemes in the country were originally built and maintained in the same manner as in the project area, and the Government finds it extremely difficult to levy water charges for recovery of investment or operation and maintenance costs of any traditional scheme that has been remodelled or rehabilitated through Government investments. However, the Government collects public revenues from farmers, which can be considered as contributing to the cost recovery of rural invest- ments, through a Graduated Land Tax which takes into account the productive capacity of land related to the water availability. Government also generates revenue through the cotton marketing mechanism. The Government controls the purchase price of seed cotton and has a monopoly for processing and marketing ginned cotton. The differential between the purchase and processing costs, and the selling or export prices represents Government revenue. Following the full development of cotton production under Khanabad I and II Irrigation Projects in 1987, such revenue is estimated to increase by 330 percent from the present level of $0.8 million to $4.1 million. Land tax and revenues are estimated to increase from about $0.1 million to $0.2 million. Thus the incremental revenues generated as a result of both projects would amount to about $3.4 million. If this method is considered as an indirect mechanism for the recovery of operation, maintenance and investment costs for both Khanabad I and II Projects, then it is estimated that, over the project's life and at a 10 percent discount rate, 100 percent of operation and maintenance costs and about 50 percent of investment costs would be recovered. The level of recovery is well in line with that achieved by most other countries on similar investments; it is high especially considering that the majority of benefi- ciaries are in the rural poverty group. 57. However, the present mechanisms for cost recovery could be improved to achieve more equity among water recipients and more efficient use of irrigation water. The Government recognizes the need for preventing waste of  - 20 - water and promoting more efficient and equitable water management especially when the present practice may often result in inequitable water distribution among the upper and the lower farmers on a canal. Under the provisions of the first Khanabad Irrigation Project, a comprehensive study of charges to be levied on the farmers benefitting from the project, having due regard to their means and capacity to pay, was required to be made, and in the light of the results of this study appropriate steps were to be taken by Government to ensure recovery. Although a study has been recently completed, it needs to be supplemented to provide an adequate basis for Government's decisions which have far reaching national implications. 58. Keeping all of the above factors in view, the following assurances were obtained during negotiations: (a) by September 30, 1979, a study with terms of reference acceptable to IDA and supplementary to the study carried out under the first Khanabad Project would be completed in order to analyze and recommend measures which could be taken for the recovery of operation, maintenance and investments costs of the works provided under both Khanabad projects; (b) by December 31, 1979, the supplementary study would be furnished to IDA along with Government's comments; (c) Government would exchange views with IDA on the recommendations made in the supplementary study and make such modifications to these recommendations as appropriate. The Government would then implement these recommendations in accordance with a program acceptable to IDA: and (d) until such time as the recommendations had been implemented, the Government would continue to carry out its indirect cost recovery policies and mechanisms with respect to land taxation and the generation of revenues from the marketing of cotton as in force on January 1, 1978 (Section 3.12 (a), (b), (c), Development Credit Agreement). Benefits 59. The project would directly benefit about 12,000 farmers and their families or about 108,000 persons, through increased production of various farm commodities. The project is expected to increase production of rice and wheat by about 20,500 tons, cotton by about 18,000 tons and other crops including maize, melon and vegetables by about 14,000 tons. The incremental wheat and rice production would replace imports of wheat and contribute to self-sufficiency of food. Wheat and rice from the project area would be shipped to food deficit areas, in particular Kabul, and facilitate the Govern- ment's efforts to set up an expanded wheat stabilization program. Seed cotton will be purchased by a government company to be processed into ginned cotton, vegetable oil and various other by-products for which international and local markets are confirmed. Other commodities such as maize, melon and vegetables are expected to be absorbed without problem by the local market. 60. At the moment, 60 percent of the farmers in the project area have per capita income below the absolute rural poverty level of $84. The average owner operated farm's income is already increasing gradually to a level of $845, or $94 per capita, under the first Khanabad project whose physical construction is expected to be completed in December 1978. About 55 percent of the project farmers in the area will, however, still have incomes below the absolute poverty level. These will be addressed in the proposed project  - 21 - under which the average owner operated farm's income is expected to increase to $1,180. Cotton sharecroppers household income would increase similarly from $372 to $460 and rice sharecroppers household income from $325 to $370. The overall economic rate of return for the proposed project is estimated at 25 percent; exclusion of investments on the feasibility study and the malaria control program would improve it to 29 percent. If this project is considered together with the first Khanabad Irrigation Project, the combined rate is estimated at 20 percent. The economic rate of return is estimated at 25 percent for the Asqalan/Yanghareq area, the cost of which is $4.2 million, 22 percent for the Gostepa and Larkhabi areas, the cost of which is $3.9 million, 25 percent for the Alchin Terrace, the cost of which is $1.5 million, and 42 percent for the Upper Khanabad area, the cost of which is $4.2 million. The project would also result in the following unquantifiable benefits: (a) insti- tution building and training of staff of the project implementing agencies,; (b) improvement in public health through malaria control; (c) improvement in the general communications in the project area; and (d) contributions to the development of the country through the studies for the Warsech Dam, Esantop pilot area, the cost recovery and the agricultural research and extension at national level. Risks 61. There is some uncertainty as to whether KEU would be able to estab- lish an efficient agricultural extension service in the project area. The project would still be viable even if the establishment of an efficient extension service is significantly delayed or hampered. A French cotton mission has been successfully training local extension agents and working with about 5,000 cotton farmers in neighboring areas. The success of the French mission suggests that with the right methods and approach, the overall weakness of extension services in Afghanistan can be overcome. KEU with its consultant team is expected to maintain close coordination with the French mission. PART V - LEGAL INSTRUMENTS AND AUTHORITY 62. The draft Development Credit Agreement between the Republic of Afghanistan and the Association, the draft Project Agreement between the Association and AgBank and the Recommendation of the Committee provided for in Article V, Section I (d) of the Articles of Agreement of the Association are being distributed to the Executive Directors separately. 63. Features of the project of special interest are listed in Section III of Annex III. 64. Special conditions of effectiveness of the IDA credit are as follows (Section 6.01, Development Credit Agreement): (a) the execution of the Project Agreement on behalf of AgBank has occurred after having been duly authorized or ratified by all necessary corporate and governmental action; and  - 22 - (b) the execution of the Subsidiary Agreement on behalf of the Borrower and AgBank, respectively, has occurred after having been duly authorized or ratified by all necessary corporate and governmental action. 65. No disbursement would be made from the proposed credit for the maiaria control component of the project until a satisfactory malaria control program has been furnished to the Association (para 4, Schedule 1, Development Credit Agreement). 66. I am satisfied that the proposed IDA credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 67. I recommend that the Executive Directors approve the proposed development credit. Robert S. McNamara President Attachments March 9, 1978 Washington, D.C.  AN= I TABLE 3A Page 1 of 4 pages AFGHANISTAN - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KM2) - ------------------ TOT