Philippines - Rural Roads Improvement Project

Document of FL C The World Bank FILE Copt FOR OFFICIAL USE ONLY Report No. P-2 802-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 A RURAL ROADS IMPROVEMENT PROJECT May 5, 1980 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 Currency Unit = Pesos (P) US$1.00 = P 7.40 (January 1980) P 1.00 = US$0.135 WEIGHTS AND MEASURES Metric System Metric British/US equivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 square kilometer (sq km) = 0.386 square mile (sq mi) I kilogran (kg) = 2.205 pounds (lb) I metric ton (m ton) = 1.1 US short tons (sh tons) = 0.98 British long tons (Ig ton) ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank BBR - Bureau of Barangay Roads of the MPH BCM - Bureau of Construction and Maintenance of the MPH BOC - Bureau of Customs ERR - Economic rate of return MLGCD - Ministry of Local Government and Community Development MOTC - Ministry of Transportation and Communications MPH - Ministry of Public Highways NEDA - National Economic and Development Authority PDS - Provincial Development Staff PEO - Provincial Engineer's Office PDAP - Provincial Development Assistance Program PPDO/MPH - Planning and Project Development Office of the MPH SMQCS - Soils and Materials Quality Control Service of the MPH UNDP - United Nations Development Programme USAID - United States Agency for International Development FISCAL YEAR January 1-December 31  FOR OFFICIAL USE ONLY PHILIPPINES RURAL ROADS IMPROVEMENT PROJECT Loan and Project Summary Borrower: Republic of the Philippines Amount: $62 million equivalent Terms: 20 years, including 5 years of grace, with interest at 8.25% p.a. Project Description: The objectives of the project are to: (a) improve high priority rural roads through reconstruction, restoration and improved maintenance; and (b) strengthen planning, adminis- trative, engineering and maintenance capabilities of provin- cial highway authorities under the overall direction of the Ministry of Local Government and Community Development (MLGCD). The Project includes: (a) construction and improvement of about 730 km of provincial and barangay roads in six provinces; (b) a rural road maintenance program composed of construction or improvement of workshops and procurement of maintenance equipment, machinery and tools; (c) improvement of about 150 km of national and provincial roads in Occidental Mindoro and provision of a new central soils and materials laboratory for the Ministry of Public Highways (MPH); (d) technical assistance to MLGCD, the six project provinces, the National Economic and Development Authority (NEDA), and the Ministry of Transportation and Communications (MOTC); and (e) consultancy services to MLGCD, MPH and the project provinces for design and construction supervision of project roads and soils and materials laboratories and for preparation of a future rural roads improvement project. The project roads would provide rural farmers with opportunities to market their products, and to improve the quantity and quality of their yields through prompt, low-cost delivery of agricultural inputs. In Occidental Mindoro, improvement of national and provincial roads would give access to an area hitherto only approachable by sea. The population served by the project roads generally have per capita incomes below the absolute poverty level for the Philippines. Because of the new approach being taken by the project in decentralizing responsibility and authority, the main risks are associated with the performance of MLGCD and the provinces in imple- menting the project. The project's technical assistance components and action programs agreed with the Government should help minimize this risk. 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 Local Foreign Total Costs:/l ---- ($ million) ---- Construction and improvement of rural roads 21.7 7.6 29.3 Provincial workshops and laboratories 0.5 0.3 0.8 Procurement of equipment 0.3 8.7 9.0 Technical assistance and con- sulting services for MLGCD and provinces 2.1 5.3 7.4 Construction and improvement of national and provincial roads in Occidental Mindoro 10.9 6.0 16.9 Construction of new central soils and materials laboratory for MPH 1.0 1.5 2.5 Technical assistance and consul- ting services for MPH, MOTC/ NEDA and for project preparation 0.2 2.5 2.7 Total Base Costs 36.7 31.9 68.6 Physical contingencies 3.7 3.2 6.9 Price contingencies 12.5 8.4 20.9 Land acquisition 8.5 - 8,5 Total Project Costs 61.4 43.5 104,9 Financing Plan: Proposed Bank loan 18.5 43.5 62.0 Government funds 42.9 - 42.9 Total 61.4 43.5 104.9 Estimated Bank Fiscal Year 1981 1982 1983 1984 1985 Disbursements: ------------ ($ million) ----------- Annual 0.5 9.5 18.5 23.0 10.5 Cumulative 0.5 10.0 28.5 51.5 62.0 Rate of Return: 28% Staff Appraisal Report: No. 2896-PH, dated April 30, 1980 /I Excluding customs duties and taxes for direct purchases from which MPH and MLGCD are effectively exempt.  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 A RURAL ROADS IMPROVEMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for the equivalent of $62 million to help finance a Rural Roads Improvement Project. The loan would have a term of 20 years, including 5 years of grace, with interest at 8.25% per annum. PART I - THE ECONOMY /1 2. An economic mission visited the Philippines 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 PHL-77-2, dated October 27, 1977. An updating economic mission visited the Philippines in May/June 1979, and its report, entitled "The Philippines: Domestic and External Resources for Development" (No. 2674-PH), was distributed to the Executive Directors under SecM79-822, dated November 16, 1979. Macroeconomic Performance 3. During the 1960s, the Philippine economy grew in real terms at an annual rate of about 5-1/2%, but with more effective economic management the rate of growth could have been higher. The pattern of growth was also structurally unsatisfactory in a number of respects. The benefits of devel- opment were distributed relatively unevenly, with respect to both regions and income classes. W{hile overall agricultural growth was reasonably satisfactory, repeated foodgrain deficits were experienced. The growth of productive employment opportunities failed to keep pace with the expansion of the labor force. Low levels of taxation resulted in inadequate public expenditure for necessary infrastructure and social services. Finally, poor export performance combined with heavy import-dependence of domestic industry led to chronic weakness in the balance of payments. 4. During the 1970s there were significant improvements in economic management. Public revenues have been increased substantially, public sector implementation capacity has been strengthened, and the ratio of public investment to GNP raised from 2% in the early 1970s to 5.5% in 1976-78. Private investment also increased, and the ratio of total fixed /1 This section of the report is substantially the same as that of the President's Report for the Third Urban Development Project, distributed under R80-40, and approved by the Executive Directors on March 25, 1980.  -2- investment to GNP rose from 16% in the early 1970s to 25% in 1976-78. As a consequence of higher levels of investment, the construction industry boomed. Agriculture has performed well in response to the spread of irrigation and higher yielding rice varieties, more favorable price policies, and some improvements in supporting services. Selective steps were taken to promote nontraditional manufactured exports, which have grown rapidly. On the other hand, the performance of that part of the manufacturing sector oriented to the domestic market has remained only "fair" in a comparative sense and has been inadequate in relation to the Philippines' need to generate productive employment opportunities. The net effect of the above developments has been acceleration in the trend GNP growth rate by one percentage point to 6-1/2%. 5. An important constraint has been placed on Philippine development options by the sharp deterioration of the country's terms of trade since 1975, stemming from the increase in oil prices, acceleration of international inflation and depressed prices for some major Philippine commodity exports. As a result, real national income has been growing more slowly than real national product, and, with the higher level of investment, the dependence of the economy on foreign savings has increased. Although the terms of trade have recently stabilized, the current account deficit is still about 6% of GNP. Development Strategy 6. The Government's development objectives and nolicies, which were 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 productive employment opportunities at a rate of 3.6% per annum, reduction of income disparities, greater self-sufficiency in food and energy, a strengthening of the balance of payments and increased development of rural areas. In addition, the Plan includes growth strategies for 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 assessment of priorities, although Plan projections for overall growth, investment, manufacturing output, and exports are somewhat higher than Bank staff estimates. Agriculture and Rural Development 7. In recent years the trend growth rate of the agricultural sector has been about 5%, which by international standards is quite good. However, variations among subsectors have been considerable. Due to the spread of irrigation and high yielding varieties, irrigated rice production has increased rapidly. The Philippines, once a chronic importer of rice, actually exported 100,000 tons of rice in 1978. With the completion of large irrigation projects now under implementation, continued rice  -3- self-sufficiency appears assured for the 1980s. On the other hand, locally adapted technologies for improving yields of rainfed grains, particularly corn, are still under development, and rainfed agricultural a as have a high incidence of poverty. Productivity in the coconut sector is relatively low because of a large number of overaged trees, but a major replanting program is scheduled for the early 1980s when a sufficient number of high yielding variety seedlings will become available. Increasing pressure of population on the land and inadequately controlled logging have led to soil erosion and deterioration of some forest areas. The Plan calls for a major reforestation effort, but this will require substantial upgrading of Government administrative capabilities in this area, development of new hill cropping technologies, and resolution of difficult land tenure problems. 8. As well as providing greater support for agricultural production, the Government has substantially expanded programs such as water supply, electrification, and health in rural areas. An agrarian reform was also instituted in 1972 which provides for transfer of tenanted holdings of rice and corn land in excess of seven hectares and enforcement of leasehold instead of sharecropping on remaining tenanted holdings. As of July 1979, about 75% of land transfer beneficiaries had received Certificates of Land Transfer (the initial step in the process of establishing their claim to the land), and about 18% had completed all steps necessary to begin amortization payments. About 67% of leasehold beneficiaries cultivating rice and corn land had established written contracts with their landlords. Industry 9. Manufacturing has grown at an average rate of about 6-1/2% during the 1970s. The greater part of the sector, oriented to the domestic market, has been promoted by high tariff protection and an incentive system which has favored the use of relatively capital-intensive production techniques. Relatively little employment has been generated in relation to Philippine factor endowments. Macro statistics such as the incremental capital-output ratio suggest that the efficiency of investment has been low, and most manu- facturing plants have located in the Greater Manila area. Reforms of tariffs and other industrial incentives to bring these into line with development objectives are presently being considered by the Government. 10. Beginning in 1970, selective measures have been introduced to promote nontraditional manufactured exports, including various arrangements to permit firms in selected export industries to import needed goods free of duty. Entrepreneurs have responded to these opportunities, and receipts from nontraditional manufactured exports increased from just over $100 mil- lion in 1972 to an estimated $1.3 billion in 1979. Population Growth, Employment and Income Distribution 11. The 1979 population is estimated at 46.7 million. The population growth rate fell from 3.0% in the intercensal period 1960-70 to 2.8% in the intercensal period 1970-75. 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 has faced the increasingly difficult problem of reaching rural areas, the estimated proportion of married women of reproductive age practicing family planning increased from 15% in 1973 to 27% in 1978. However, by East Asian standards, this index is still relatively low. 12. Employment increased by about 4.6% anually during 1973-78, a con- siderable improvement over the historical growth rate of 2.4%, and in recent years has kept pace with the rapid growth of the labor force. With the exhaustion of most new land resources suitable for cultivation and the exploitation of the most easily irrigable areas, industry will have to provide employment for about one half of the new entrants to the labor force in the next decade. Employment in manufacturing essentially stagnated during 1970-74, but grew by 7% annually during 1975-77, 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 still continue to function as residual sources of employment and accounted for most of the increase in total employment. 13. For historical reasons, income distribution has been highly skewed in the Philippines, and there is a small elite which is conspicuously wealthy. Due to a structural improvement in agriculture's terms of trade, the growth of agricultural production, the decline in urban real wages following the devaluation in 1970, and subsequent acceleration of interna- tional inflation and the stagnation of industrial employment until 1975, the ratio of the average rural income to the average urban income rose from 0.48 in 1971 to 0.57 in 1975. Nevertheless, the incidence of poverty remains high, at 40-45%, in both rural and urban areas, and malnutrition is widespread. Public Finance 14. The public sector has 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; public 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 this situation and has raised both the overall level of expenditures and the shares going to economic services and public investment. By 1978, government expenditures reached an estimated 16% of GNP, and public investment equaled about 5.5% of GNP. This expansion of public expenditures has brought about badly needed improvement in basic infrastructure particularly in transpor- tation, power and irrigation, as well as the development of more effective programs in the field of urban development, health and family planning.  15. Recognizing that a large increase in tax revenues would be required to finance expansion of the public investment program, the Government has undertaken a program of tax reform to raise the needed revenues equitably and efficiently. The overall tax ratio was raised by more than two percenr- age points between 1975 and 1978 through a series of new tax measures and vigorous efforts to improve taxpayer compliance and collection performance. However, the recent rapid growth of the public investment program has made the Government's budget position quite tight in 1978-79. Continuation of a strong revenue effort, both by the Government and the government corporatio:s-, is necessary to allow for further expansion in infrastructure and social services. Private Savings and the Financial Sector 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. Gross domestic savings now finance about 85% of total invest- ment, with the balance coming from foreign savings. In order to increase the efficiency of financial markets in intermediating between savers and investors, the Government has made significant improvements in financial policy. Organized banking institutions have been strengthened. Interest rates have been realigned to encourage a greater flow of financial savings into time and savings deposits relative to short-term deposit substitutes and to reduce the sprea.' between borrowing and lending rates. Further reforms are required to increas] 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. A deterioration of loan recovery rates have been initially experienced by all government financial institutions and credit programs. The Government has taken a number of steps to improve collections; continued efforts in this direction are necessary to improve financial discipline and ensure an adequate flow of credit to the productive sectors without burdening the public finances. 17. In response to the large balance of payments deficit in 1975 (see para. 5 above), the Government adopted a strategy of accelerating export growth both to hold the current account deficit about constant in absolute terms, while letting it decline gradually relative to GNP, and to meet the debt service payments on the higher level of external borrowing. External Trade and Capital Flows 18. The current account initially behaved as anticipated - averaging $1.0 billion per year but declining from 6.2% of GNP in 1976 to 4.1% of GNP in 1977. However, since then actual developments have deviated from the original scenario. First, the volume of commodity exports, particularly sugar, has increased less rapidly than expected. Second, real import growth has, on the other hand, been more rapid than anticipated, partly as a result of a recovery of private investment and partly because of speculative  importing in 1979. Third, although prices for some commodity exports (coconut products, copper) have increased substantially, the terms of trade in 1979 were only marginally better than in 1976-77 due to the increased price of petroleum imports and the acceleration of inflation in the OECD countries which supply most of the Philippines' non-oil imports. The combined effect has been a widening of the current account deficit to an estimated $1.8 billion in 1979. 19. In order to maintain growth and investment rates in the face of the worsened external environment, major structural adjustment is necessary to improve the balance of payments position. Initial steps have already been taken with respect to export promotion, and major changes in trade, industrial and financial policies are currently under consideration. However, such adjustments will require a number of years to effect the needed structural improvement in the balance of payments. The medium-term outlook, therefore, is for high current account deficits although falling as a percentage of GNP from 6% in 1980 to 4.7% in 1982. 20. Net capital inflows doubled from the 1975 level of $580 million to an estimated $1.2 billion in 1979, leaving an overall deficit of about $500 million. Most of the capital inflows came from medium- and long-term loans, with about 40% from official sources. In 1980, a net capital inflow of at least $1.8 billion will be required, increasing to $2.2 billion per year in 1981 and 1982. The ratio of debt service payments to exports of goods and nonfactor services is expected to rise from an estimated 20% in 1979 to an average level of 22% during the 1980-82 period, and to decline thereafter. 21. In order to ensure that debt service obligations remain within reasonable limits, the Government sought commitments of official assistance of at least $1.0 billion in 1980 at the last meeting of the Consultative Group for the Philippines, held in Washington, D.C. in December 1979. The Group endorsed the Government's request. 22. Satisfactory progress has been made in domestic resource mobiliza- tion (paras. 15-18). However, because of the increase in the Philippines' external financing requirements arising from the deterioration in the terms of trade, and the fact that many of the projects planned for official assistance have low foreign exchange costs, the necessary resource transfer can be achieved only with some financing of local costs of projects, and/or through nonproject lending. PART II - WORLD BANK OPERATIONS /1 23. As of March 31, 1980, the Philippines had received 65 Bank loans (of which two were on Third Window terms) amounting to $2,181.9 million and six IDA credits amounting to $122.2 million. At that date, IFC investments /1 This section is substantially the same as that contained in the President's Report for the Third Urban Development Project (R80-40) approved by the Executive Directors on March 25, 1980.  -7- totalled $93.7 million. The share of the Bank Group in total debt disbursed and outstanding is currently about 13% and its share in total debt service is about 6%. These ratios are expected to be about 23% and 16%, respectively, by 1985. Annex II contains a summary of IDA credits, Bank loans and IFC invest- ments as of March 31, 1980, 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 the irrigation system to increase food production and to credit programs to support foodgrain produc- tion and processing and livestock, fisheries and tree farming production. Support has also been provided for integrated rural development projects in low income areas. The Bank Group has also provided large amounts of assis- tance in developing power and transportation to provide the basis for future growth of the productive sectors. Substantial improvement in basic infrastructure has been needed to compensate for many years of past neglect due to low levels of public expenditure. 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. 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 supervision and project comple- tion reports indicate that the economic benefits for most projects are likely to be in line with appraisal estimates. 26. As noted in Part I of this report, the Government's Five-Year Development Plan highlights a strategy which focuses on the expansion of production and employment in agriculture and industry, reduction in income disparities, greater self-sufficiency in food and energy, and increased development in rural areas. The Bank's future lending program has been designed to assist the Government in achieving these objectives. Agricultural and rural development will account for the largest part of future lending with continued emphasis on food production and programs to increase the productivity and incomes of small farmers. However, the program provides for several needed new initiatives, including support for strengthening the national agricultural extension service through Loan 1626-PH (National Exten- sion Project) and for developing multiple cropping systems in rainfed areas, where there is substantial rural poverty, through Loan 1815-PH (Rainfed Agri- culture (Iloilo) Project). Increased assistance will also be provided for integrated 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 considerable  - 8 - attention given to policy reform and to expanding the development of labor-intensive, small and medium industries outside of the Metropolitan Manila area. A program loan to support major adjustments in industrial and trade policies has been appraised. The share of lending for social sector projects is expected to continue to increase primarily as a result of greater emphasis on construction of urban water supply and sewerage systems and further assistance for slum upgrading and low-cost sites and services projects. The Bank Group will 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 infrastructure 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. This is the eighth loan to the Philippines to be presented to the Executive Directors this fiscal year. Loans for watershed management and livestock/fisheries projects have been appraised and are scheduled for Board presentation in the next one or two months. PART III - THE TRANSPORT SECTOR 28. In the last decade, the Philippines made significant advances in the transport field, far exceeding progress in any previous decade both in terms of funds expended and results achieved. Annual public transport expenditures, representing about one-third of total public investment outlays, increased rapidly from P 282 million ($38 million) in 1968 to P 2.9 billion ($392 million) in 1978, with highways absorbing about 74% of the transport total. Of the remainder, airports received about 10%, ports 9%, and railways, 7%. These transport expenditures were necessary to expand and improve the hitherto neglected transport system to meet the increased demand for movement of goods and passengers resulting from higher income and increased population and industrial and agricultural production. As a result of the increased investment in highways, the road network expanded rapidly and in 1979 encompassed about 152,800 km. For the first time it provided access to the important population centers in the interior of the two largest islands, Luzon and Mindanao, which together comprise about 70% of the country's land area and three-quarters of its 46.7 million population. 29. The preliminary 1980-83 projections for commodity flows and passenger traffic indicate a larger increase in inter-island movements of freight and passengers between the food-deficit areas of Luzon and the agricultural surplus areas of Mindanao than for road transport within the major islands. Accordingly, the Government plans to increase the share of  ports and airports in the 1980-83 transport infrastructure investment program: 19% for ports, 14% for airports, 9% for railways, and 58% for highways. No significant public funds are allocated for shipping invest,-,> since it is largely financed by the private sector. During 1980-83, transport's share of public investment is expected to decrease from the previous level of 30% to about 20% of the total public infrastructure program because of increasing shares allocated to the power sector to meet the country's energy requirements. 30. Estimates based on preliminary data indicate that road transport is the dominant mode, accounting for nearly 80% of passenger and more than. half of total freight traffic. Privately operated inter-island shipping, serving a population scattered over hundreds of islands, appears to account for nearly all of the remaining freight traffic since relatively short inland distances and low traffic volumes have limited railways to a small fraction of total freight traffic. Air cargo transport is insignificant bui domestic air travel is growing rapidly. Transport Planning and Coordination 31. In addition to increased transport expenditures and system expansion in the 1970s, the Government has taken important steps to improve the organi- zational structure of the planning and administrative units responsible for transport. These urits have been substantially restructured in the major Government reorgani2ition, initiated in 1972, which has resulted in a strengthening of the planning, implementation and operational capabilities of the various transport agencies, and in better coordination of planning responsibilities. 32. Transport planning is currently the joint responsibility of the National Economic and Development Authority (NEDA) and the Ministry of Transportation and Communications (MOTC). As a central planning agency, NEDA has overall responsibility for public capital investments through its Infrastructure Program and Project Office, which reviews and approves investments proposed by each transport operating agency. MOTC, which becam-n operational in July 1979 with a small staff, is not yet fully equipped to discharge the functions of intermodal transport planning, coordination and regulation. The Ministry is still evolving and is in the process of expanding its staff and preparing to absorb the transport planning functiol.s now discharged largely by NEDA. To strengthen the capability of MOTC, the project includes funds to finance advisory services which will complement the technical assistance provided under Loan 1272-T/1282-PH (Manila tUrban Development Project) for a National Transport System Study in preparation for a ten-year transporl: investment program. The study, undertaken jointly by MOTC and NEDA, is scheduled for completion in late 1981.  - 10 - Transport Strategies 33. Transport improvement programs are designed to promote the Govern- ment's rural development objectives of (i) increasing food production and rural incomes; (ii) promoting regional balance in socioeconomic development by establishing growth poles away from Metropolitan Manila; and (iii) expanding industrial production for domestic and foreign markets. The Government strategy, aimed at increasing transport capacity so that it can meet the growing demand, has both investment and operational dimensions. 34. The investment strategy is aimed at: (i) undertaking transport sector and program reviews to determine their consistency with sectoral and overall development objectives such as agricultural and industrial develop- ment, financial resource availability, intermodal efficiency, and agency implementation capabilities; and (ii) strengthening the analytical capacity of transport agencies both at the center and at the regional and provincial levels so that major planning responsibilities can be delegated to regions and provinces. The objective is the assembly of relevant data and informa- tion by local planners to identify specific transport problems, examine alternatives in terms of costs and benefits and rank priorities on the basis of local knowledge. 35. The operational strategy is being directed at improving the effi- ciency of existing facilities and administrative procedures. Greater atten- tion is being focused on the maintenance of roads and ports, and on a restructuring of the management staffing and procedureo for port operations and transport regulations. These operational improvements will make existing and future investments more productive and will yield much higher returns than investments for new projects. Highway Subsector 36. The public highway network (as of 1979) consists of about 152,800 km of roads: 22,900 km of national, 29,000 km of provincial, 13,400 km of city and municipal and 87,500 km of barangay (village) roads. National roads include about 122 km of toll expressways with grade separated intersections north and south of Manila. Except for these toll roads, road classification is often arbitrary as it is not always based on function. In remote areas such as northeastern Luzon and many parts of Mindanao, national roads serve as penetration roads providing the only access to the villages. In many parts of the country, both provincial and barangay roads are characterized by a low volume of traffic and serve limited influence areas, mainly providing the means for moving agricutural inputs and outputs and connecting rural communities with administrative and market centers. 37. Up to 1969, little had been done to improve the roads, and only about 15% of the national roads were paved. Even now only 41% of the national highways and 13% of the provincial road systems are paved (compared with about  - 11 - 95% and 20%, respectively, in Thailand); the rest are either gravel or unsurfaced. Since 1970, the Government has made a substantial effort to improve and develop the road system both through an expanded allocation of domestic budgetary resources and through foreign assistance mainly from Japan, the United States, IBRD and the Asian Development Bank (ADB). During the last six years, more than 13,000 km of roads have been constructed or improved to meet the rapidly growing demand for road transport. However, much work needs to be done to ensure that adequate maintenance is provided for the rapidly expanding highway network. 38. Until recently, data on highway traffic growth were not collected and analyzed on a regular basis. However, judging from increases in the motor vehicle fleet and the volume of gasoline consumed by road transport, traffic growth between 1966 and 1979 was substantial. Fuel consumption during this period is estimated to have increased by 10% p.a. During 1973-75, traffic growth was slowed by an increase in oil prices. Beginning in 1976, however, despite further increases in fuel prices, traffic began to increase more rapidly. Under the Third and Fourth Highway projects (Loans 1353-PH and 1661-PH), the Government began to implement a system for collecting and recording traffic counts. 39. During the 1967-78 period, total highway expenditures, including administration and maintenance, increased approximately ten times in real terms. Construction averaged 60-65% of total expenditures, maintenance about 25%, with administrative expenditures accounting for the remainder. In 1978, the Government's total highway expenditures amounted to P 2.9 bil- lion, of which about P 1 billion were for routine and periodic maintenance and P 1.6 billion for construction, with the balance devoted to administra- tive costs. The amount allocated for maintenance would have been adequate if more efficiently used. Highway revenues are obtained from specific road user charges which include motor vehicle fees, licenses, tolls and a common carrier tax on their gross receipts. Between 1967 and 1978, revenues from these charges increased tenfold. In 1978, revenues from road user charges (excluding import duties) amounted to P 2.2 billion. In the same year, revenues from import duties and taxes were a little over P 1 billion, of which P 136 million should be considered as road user taxes since this amount represents an import surcharge on motor vehicles above the normal rate levied on other consumer goods and machinery. Including this surcharge, revenue from all road user charges fully covered total maintenance and administrative expenditures and 70% of the construction costs (63% without the surcharge). 40. The various road user taxes are collected by different government agencies: the Bureau of Customs (BOC), the Bureau of Indirect Tax of the Ministry of Finance and the Bureau of Land Transport of M4OTC, each attempting to optimize its revenue from these taxes. No reliable data exist on the short-run marginal cost of highway use or on user charges by vehicle type. Without these data it is difficult to determine how variously sized vehicles are contributing towards covering their respective marginal costs through  - 12 - user taxes, and thus the extent of any subsidization or cross-subsidization among different vehicle types. However, judging from the low level of diesel fuel taxes, it can be assumed that heavy vehicles (10-12 tons), which normally use diesel fuel and which incur relatively more damage to the roads, may not cover their short-run marginal cost. In order to understand the present situation better, the Government is assembling relevant data with which to analyze the road user tax structure and to formulate a comprehensive transport pricing policy. Basic Organizational Responsibilities for Roads 41. Responsibility for planning, design, construction and maintenance of the road transport system is divided, with some overlap, among the central government agencies and local authorities. The Ministry of Public Highways (MPH), the recognized technical highway authority, is responsible for planning, constructing and maintaining the national highway system, and providing technical assistance to other agencies of Government. Provincial Engineering Offices (PEOs) are directly responsible for planning, construct- ing and maintaining the provincial highway system, with development guidance from the Ministry of Local Government and Community Development (MLGCD). In addition, both MPH and MLGCD have units handling barangay road assistance programs. The unit in MPH is large, with more than 100 employees at its headquarters in Manila. The unit in MLGCD is relatively new with fewer employees. Basic objectives of the two ministries are consistent but definitions of authority and responsibility differ. 42. The major objective of MLGCD is to assist local government agencies in developing their own capabilities, with the local roads program of MLGCD as a major step towards realizing this objective. The project includes a technical assistance program to improve the capability of MLGCD and the provinces so that they can effectively discharge their functions. 43. As part of the process of rationalizing the institutional respon- sibilities for rural roads construction and maintenance, several memoranda of agreement are being drawn up between MLGCD, MPH, the Ministry of Finance, the Ministry of the Budget and the Provinces. Under these agreements, MPH will be responsible for setting standards and, for a transitional period, will provide technical assistance to MLGCD and the provinces. MLGCD will monitor physical implementation and expenditures by the provinces and will provide technical assistance to the provinces. The provinces will have full authority to plan, program and execute the maintenance of all rural roads (except for city roads). The objective of this move is to gradually hand over to local agencies responsibilities for planning, construction and maintenance of all local roads, with MLGCD performing a coordinating and monitoring function. Agreement between the Borrower and the Bank on satisfactory Memoranda of Agreement between (a) MPH and MLGCD, defining responsibility for the  - 13 - construction and improvement of rural roads,I1 and (b) MLGCD, the Ministry of Finance and the Ministry of Budget, defining budgetary and administrative responsibility for local roads improvement, has been made a condition 'f effectiveness (Section 5.01 of the draft Loan Agreement). Assurances W obtained that the Memoranda of Agreement would be signed by December 31, 1980, and would be carried out in accordance with timetables and programs satisfactory to the Bank (Section 4.03 of the draft Loan Agreement). Cooperation With Other Aid Donors 44. During project preparation, extensive discussions took place w-th officials of USAID and ADB with a view towards coordinating the work of those lending agencies involved in rural roads in the Philippines. Although ADB's operations thus far have exclusively used MPH as the implementing agency, USAID has long been involved in developing local government capabilities through its Provincial Development Assistance Program (PDAP). Under this program USAID provides technical assistance to MLGCD and participating provinces and reimburses up to 75% of the capital costs for satisfactorily completed road projects. Design and construction are carri,:- out by force account or contract through local government engineering offic(- with coordination and monitoring by MLGCD. 45. The proposed project complements the work of USAID. Officials CA both USAID and ADB -xpressed an interest in following procedures similar r;^ those adopted for tie project on: (a) the project evaluatior. methodolp- (b) implementation of construction work by contract; and (c) the reimbuin- ment scheme designed to suit the varying fiscal capabilities of the provincaC rather than the uniform 75% reimbursement. In addition, ADB is considerig, an extension of the proposed technical assistance program to MLGCD under the same terms of reference when the two-year term of the advisors financed under the proposed project expires. This would take place under an ADB-financrcl technical assistance program of transport advisory services to be provided to a number of provinces. Bank Lending for the Highway Sector 46. The strategy of Bank lending for highways has been to: (a) in- crease the capacity of the existing infrastructure; (b) improve project preparation and implementation capabilities; and (c) develop an instituti->; framework to carry out proper maintenance. Continued assistance in attair.- ing these objectives will be needed, primarily focusing on maintenance and institutional development. A further objective of the Bank is to expand its participation in improving the capability of farm-to-market and feeder roads to accommodate motorized traffic and thus aid increased food production. Using rural roads planning and construction as a vehicle, the Bank will /1 Refers to provincial, municipal and barangay (village) roads. The Memoranda of Agreement concerning maintenance of these roads have already been concluded and signed and are satisfactory to the Bank.  - 14 - assist the Government in developing operational capability and improving financial management in the provinces. 47. The Bank has made four loans totalling $271 million /1 for the improvement of important sections of national highways and connecting secondary roads, and for a countrywide maintenance organization, including improvement of workshops and procurement of maintenance equipment, parts and workshop machinery. The four highway projects have also helped to develop the Philippine contracting industry and local consulting firms which gained valuable experience through their association with foreign consultants on the design of the project roads. The First Highway Project is fully dis- bursed, although the small portion deleted from the original construction contract due to civil disorders in the area has not yet been completed by the Government. The Second Highway Project is 99% complete. Problems in implementation, largely due to a shortage of local funds and unsatisfactory performance by some contractors, were overcome but resulted in a delay of about 3 years in project completion. The Third Highway Project is about 30% complete. There were some problems in implementation of its maintenance component, but the Government is now making satisfactory progress. Delays have also been experienced in construction of the project roads, mainly due to the use of unsatisfactory prequalification procedures. To avoid repe- tition of this problem, the Government has agreed to adopt improved prequalification procedures for this project similar to those being used for the Fourth Highway Proect (para. 69). Implementation of the Fourth Highway Project, using improved prequalification procedures, began slowly in the latter half of 1979 but there are no major problems. The Bank's future lending program for transport includes a fifth highway loan, the components of which will be defined on the basis of experience with ongoing projects. 48. The Project Performance Audit Report on the First Highway Project (Loan 731-PH) concluded that problems during implementation were largely caused by civil disturbances in the project area. Despite such problems, the project's re-estimated economic return was satisfactory. The transfer of responsibility for engineering and construction supervision from expatriate consultants to local firms and the rapid increase in local staff employed provided a good example of the possibilities in this field. PART IV - THE PROJECT Project Objectives 49. The objectives of the project are to improve high priority rural roads through reconstruction, restoration and improved maintenance; to upgrade procedures and operations of MLGCD; and to strengthen planning, /1 Loans 731-PH ($8.0 million), 950-PH ($68.0 million), 1353-PH ($95.0 mil- lion), and 1661-PH ($100.0 million).  - 15 - administrative, engineering and maintenance capabilities of provincial highway authorities. In formulating the project, high priority provincial roads were included for upgrading, since without this intermediary connective system, improvement of barangay (village) roads feeding into s.e provincial network would be meaningless. Also included are low-cost, lightly travelled provincial and barangay roads which provide the only access to market and administrative centers and the only means of moving agricultural inputs and outputs in many rural communities within the influence areas of the project roads. 50. The Bank has previously financed rural roads in the Philippines as a component of irrigation, multipurpose and rural development projects. Implementation of the road component of these projects has been carried out by the central government agencies, largely through MPH, whose major responsibility is construction and maintenance of national roads. This approach focused on the immediate need to improve physical facilities, but did not directly address the problem of strengthening local institutions to implement the Government's decentralization policy. 51. The proposed project represents the first Bank Group effort aimed at directly assisting the provincial governments in carrying out road improvement and maintenance programs under the overall guidance of MLGCD. This effort would support the Government's policy of expanding local government respon- sibility for the planning, construction and maintenance of all rural roads and improving the capability of MLGCD so that it can effectively monitor and supervise, in the near term, the work undertaken by the provinces as well as train provincial staff. Over the longer term, trained provincial staff would extend technical assistance to the municipalities and barangays to upgrade their planning and maintenance capability. Background 52. Six provinces, representing a cross section of the 73 provinces in the Philippines, were selected for inclusion in the project. These six provinces - Iloilo, Cebu, Quezon, Aklan, Camarines Norte and Ilocos Sur - represent differing conditions throughout the country and vary in their fiscal and implementation capability, with Iloilo and Cebu being relatively better off and further advanced than Quezon and Aklan, while Ilocos Sur and Camarines Norte are among the poorest and least developed provinces. A project in these provinces would provide useful experience that could be applied to all types of provinces in future rural road improvement programs. 53. In addition to the rural roads, the project also includes about 150 km of national and provincial roads linking Mamburao and San Jose in Occidental Mindoro, to be executed by MPH. These roads were originally proposed for inclusion in a second integrated rural development project in Mindoro, but the Government and the Bank subsequently decided to finance the essential elements, irrigation and roads, in separate project loans. The  - 16 - irrigation component is being financed under Loan 1809-PH (Medium-Scale Irri- gation). The road component, which is essential for the success of the irrigation project, is proposed for inclusion in this project. 54. While the project constitutes only a beginning in terms of meeting the very large physical and institutional needs of the country, it would provide the foundation for the long-term development of an effective, locally based program for rural roads. This project is also one of a series now being developed by the Government and the Bank to increase the capacity of local governments to provide and maintain the basic infrastructure needed to encourage rural development in the Philippines. The project was prepared by MLGCD assisted by consultants and the Project and Program Development Office (PPDO) of MPH. Appraisal of the Project was completed in November 1979. Negotiations were held in Washington in April 1980 with a Government team led by His Excellency Eduardo Z. Romualdez, Philippine Ambassador to the United States. The Staff Appraisal Report (No. 2896-PH), dated April 30, 1980, is being circulated separately. Supplementary project data are contained in Annex III of this report. Project Description 55. The project would provide for: (a) construction and improvement of about 730 km of provincial and barangay roads in the provinces of Iloilo, Cebu, Aklan, Quezon, Camarines Norte and Ilocos Sur; (b) reconstruction and improvement of about 90 km of national and 60 km of provincial roads in the province of Occidental Mindoro; (c) construction and improvement of provincial workshops and quality control laboratories and provision of new facilities for the MPH Soils and Materials Quality Control Service (SMQCS); (d) procurement of road maintenance equipment for the six project provinces, including spare parts, tools, machinery and apparatus for provincial workshops and quality control laboratories; (e) procurement of tools, engineering, training and other equipment for MLGCD and the six project provinces; (f) technical assistance to: (i) MLGCD to improve contract adminis- tration and monitoring and to train officers who in turn would train provincial staff; (ii) the six project provinces to help improve engineering, quality control, construction supervision, and maintenance; and (iii) MLGCD and MPH for program and project preparation and financial management; (iv) MOTC/NEDA to assist in the continuation of transport advisory services; and  - 17 - (g) consulting services for detailed engineering and construction supervision of (a), (b), and (c) above, and for feasibility studies to prepare a future rural roads improvement project. Construction and Improvement of Roads 56. The project roads are impassable for part of the year with extremely rough and narrow surfaces. Inadequate drainage, poor original design and construction, and little or no maintenance have caused rapid deterioration of surfaces even under very light traffic. These roads would be restored or upgraded to all-weather, all-year standards, largely following existing alignments. Where necesary, bridges would be strengthened or replaced and embankments would be raised to reduce damage during floods. Some of the more heavily traveled sections would have bituminous stabilized surfaces. 57. About 200 km of barangay roads in Iloilo are included in the project to support the Rainfed Agriculture (Iloilo) Project (Ln. 1815-PH). Of this total, approximately 50 km would be identified for improvement using barangay labor, a minimum of equipment and a labor-intensive construction system. Labor-intensive methods are also expected to be applied in carrying out maintenance operations: clearing ditches, controlling vegetation, and transporting and spreading materials. In order to help improve efficiency and identify new areas where improved labor-based methods could be applied, the provinces would be assisted by technical assistance advisors. The Bank is expected to prov;de additional assistance during project supervision in determining means, methods, and practices of increasing the labor/capital ratio wherever appropriate in road construction and maintenance works. Institutional Objectives (i) Technical Assistance to NLGCD 58. IMLGCD has the major responsibility for providing guidance and for monitoring development activities undertaken by the local authorities. With the increasing emphasis placed on the Government's decentralization policy, MLGCD could emerge as the key institution to help implement this objective in the field of rural road improvement and maintenance. Presently, MLGCD lacks the resources and the capability to properly coordinate, supervise or monitor an expanded rural roads program due to inadequate facilities and ai shortage of competent staff. MLGCD needs staff in the various disciplines necessary to undertake contract administration, monitor construction and maintenance activities of local governments, prepare a national local road improvement program, advise on financial management and train provincial staff. The technical assistance component of the project was thus tailored tr the needs of MLGCD to enable its various units to assume greater responsibility.  - 18 - 59. Although major improvements in MLGCD are required, a beginning has been made with a change in organizational structure consolidating functions to avoid duplication. It now has the skeleton of the staff necessary to expand, organize and improve its operations. The experts to be financed under the project would initially assist the Ministry staff in performing their duties, gradually taking a less active role so that the Ministry staff would carry on their operations independently, with the experts performing only an advisory role. Assurances were obtained that the Government would carry out organizational and management changes in MLGCD and the provinces in accordance with a program satisfactory to the Bank (Section 4.04 of the draft Loan Agreement). (ii) Technical Assistance to Six Provinces 60. While MLGCD would provide supervisory and monitoring functions, the actual work would be carried out by the provinces. The six project provinces, however, generally lack the ability to plan and maintain roads properly and to manage financial resources. The proposed technical assist- ance program was designed to upgrade the provincial capabilities to design, improve and maintain roads on the basis of local knowledge of area resources and needs. 61. The long-term objective of the Government is to consolidate the various local road improvement programs operated by the national government agencies and incorporate them into local programs administered by the provincial governments. In order to achieve this objective, it will be necessary for the Government to make an increased annual allocation of resources to the provincial governments to provide them with a regular flow of funds for improving and maintaining low-cost, low-standard roads. Efforts are also being made to increase the local tax base to enable provincial governments to contribute a larger share of the cost of rural road improve- ment programs. Expanded local government responsibility for the construc- tion and maintenance of rural roads is a positive step towards increasing local participation in rural development programs, the dominant theme of decentralization. (iii) Technical Assistance for Training 62. Technical Assistance for training, extended to MLGCD and the provinces, would further promote the institution-building objective of the project. A training unit would be set up within MLGCD (Section 4.05 of the draft Loan Agreement), and technical assistance advisors appointed to develop a training program utilizing and adapting systems and materials already developed by MPH for the national road program. Training would be carried out at the provincial level by the Provincial Engineers Offices (PEOs), and MLGCD's training unit would train the PEO teachers. A training evaluation system would be instituted, in consultation with the Bank, in MLGCD's training unit, to appraise and monitor the effectiveness of the  - 19 - manpower development and training programs on a continuous basis (Section 4.05 of the draft Loan Agreement). The project also includes advanced technical training and study tours for selected permanent staff of the provinces and MLGCD. Project Execution 63. MLGCD and the provinces, assisted by qualified consultants, will be the implementing agencies for all project components associated with rural roads. MPH, assisted by qualified consultants, will be the executing agency for the construction and improvement of the roads in Occidental Mindoro and the provision of a new MPH Central Soils and Materials Laboratory. The technical assistance for transport advisory services will be the responsibility of MOTC and NEDA. 64. The project includes 48 man-months of local and 556 man-months of expatriate technical assistance advisory services. The estimated cost of expatriate consultants' services including all expenses is $8,700 per man- month. The estimated cost per man-month for local consultant's services is about $2,700 equivalent. Assurances were obtained from the Government that the qualifications, terms of reference and work programs of the consultants and technical assistance experts would be satisfactory to the Bank (Section 3.02 of the draft Loan Agreement). 65. In order to ensure uniformity and because the provincial authorities have little experience in contract administration, all procurement, except that being undertaken by MPH and MOTC/NEDA, would be carried out by NLGCD with the help of the technical assistance advisors provided under the Project. This would include: (a) machinery and equipment; (b) civil works by contract; (c) consulting services and technical assistance; and (d) arrangements for overseas training and study tours. However, the project provinces would participate in the procurement process and in the design, contract adminis- tration and construction supervision of the project roads to an extent commensurate with their capability. As the provinces gain in competence, improve their organization and recruit sufficient qualified staff, their participation in undertaking the actual work would increase. It is antici- pated that by the time the project is completed, these provinces would be able to continue the development of their rural road networks independently, with only general guidance from MLGCD. 66. The project would be implemented over a four-year period and the road construction and workshop improvement components would require about three years to execute. An action program has been agreed between the Govern- ment and the Bank, with particular emphasis on staffing and institutional improvements for the implementation, by MLGCD and the provinces, of project components associated with rural roads (Section 3.07 of the draft Loan Agree- ment). Assurances were also obtained that the Government would: (a) arrange for timely acquisition of land for right-of-way for each road section and  - 20 - workshop site prior to awarding construction contracts (Section 3.05 of the draft Loan Agreement); and (b) cause MLGCD and the project provinces to implement a rural roads maintenance program in accordance with a timetable of physical targets, budgetary allocations and administrative improvements as agreed with the Bank (Section 4.06(b)(i) of the draft Loan Agreement). Project Cost and Financing 67. The total cost of the project, including land acquisition, is estimated at about $105 million equivalent, excluding duties and taxes for items to be procured directly by MLGCD. Physical contingencies of 10% on all items are included in the project cost and overall physical and price contingencies combined represent about 27% of the total cost. Inflation during the project implementation period has been assumed to be as follows: for local costs, 16% for 1980, 10% for 1981 and 7% p.a. thereafter; for foreign costs 10.5% for 1980, 9% for 1981, 8% for 1982 and 7% p.a. thereafter. 68. The proposed loan of $62 million would finance 59% of the total project cost, including $18.5 million of local costs. Justification for local cost financing is contained in para. 22 of this report. The national and provincial governments would finance the balance of the project costs of about $43 million equivalent. Except for the roads in Occidental Mindoro and the new MPH central laboratory facilities, which are entirely the national government's responsibility, the local costs of the rural road and provincial workshop improvements would be shared between the national and provincial governments, with the national government contributing varying amounts in accordance with the different fiscal capabilities of each participating province. During negotiations, the Government agreed to complete arrangements between MLGCD and the six provinces by December 31, 1980, for sharing the costs of project components associated with rural roads. (Sections 3.07 and 4.03 of the draft Loan Agreement). Retroactive financing of $108,000 is recommended to provide funds for project preparation work undertaken by consultants (Schedule 1, para. 4(a) of the draft Loan Agreement). Procurement 69. Civil works contracts for the construction and improvement of the national and provincial roads in Occidental Mindoro, amounting to about $17 million, would be awarded to prequalified contractors on the basis of international competitive bidding in accordance with the Bank Group's guidelines. Civil works contracts for the construction and improvement of rural roads, totalling about $29 million, and for the construction and extension of workshops and laboratories, including installation of workshop equipment, totalling about $3.3 million, would be awarded to prequalified con- tractors on the basis of competitive bidding advertised locally in accordance with government procedures which are acceptable to the Bank. In these cases, international competitive bidding would not be appropriate as the relatively small contracts involved would be scattered in six separate provinces and phased over a period of four years. However, foreign firms would be eligible  - 21 - to participate. All construction contracts would contain appropriate price escalation clauses to account for expected inflation. The Government has agreed to institute an improved system for careful evaluation of prequalificatUon applications, similar to the procedures adopted by MPH under the Fourth Highway Project (Loan 1661-PH) (Schedule 4, para. 3 of the draft Loan Agreement). Workshop equipment and machinery, soils and materials testing equipment, tools, and engineering and road maintenance equipment, with a total cost of about $9.0 million, would be procured on the basis of international competitive bidding in accordance with the Bank Group's guidelines. A preference limited to 15% of the c.i.f. price of imported goods, or the customs duty, whichever is lower, would be extended to local manufacturers in the evaluation of bids. Procurement of off-the-shelf items, each costing less than $10,000 equivalent, and procurement of hand tools for road maintenance would be conducted on the basis of normal government procurement procedures which are acceptable to the Bank; the total amount of such purchases would not exceed $300,000 equivalent. Disbursements 70. The loan would be disbursed against normal documentation over a five-year period on the basis of: (a) 55% of total construction and improvement costs for rural roads executed by MLGCD; (b) 50% of total construction costs for national and provincial roads in Occidental Mindoro; (c) 50% of total construction costs for provincial workshops and laboratories; (d) 60% of total construction costs for the MPH soils and materials labora- tory; (e) 100% of the c.i.f. cost of imported equipment, spare parts, tools, machinery and components, if procured directly abroad, or 65% if procured locally; (f) 100% of the ex-factory cost of equipment, spare parts, tools, and components produced locally; and (g) 100% of the cost of overseas training and consulting services, whether expatriate or local. Disbursements, up to an aggregate total of $108,000, may be made for project preparation costs incurred after July 1, 1979 and prior to loan signature. It was agreed with the Government that disbursements would not be made for rural road improvement contracts for each of the three years from January 1, 1981 to December 31, 1983, until the Bank has approved the size and scheduling of the annual rural road improvement program for the following year (Schedule 1, para. 4(b) of the draft Loan Agreement). Benefits and Economic Return 71. The major benefits of the project would result from the provision of more economical transportation in areas where an existing or potential transport demand has been identified. Project roads would serve areas which are predominantly agricultural, thus providing the local population with opportunities to market their products, to improve the quality and quantity of their yields through prompt, low-cost delivery of agricultural inputs, and thereby to intensify land use. Agricultural extension workers, through better access, would be able to assist more local farmers. Improvement of the national and provincial roads in Occidental Mindoro would give access to  - 22 - an area hitherto only reachable by sea. The population served by project roads generally have per capita incomes below the absolute poverty threshold for the Philippines. 72. By upgrading and improving the capacity and resources of provincial governments and organizations in the six provinces, the project would also assist in achieving the Government's objective of decentralizing responsi- bilities for the planning, construction and maintenance of the rural road network. The project would serve as a basis for extending such capabilities throughout the Philippines. Under Loan 1661-PH, preparations have already been completed to commence feasibility studies and develop rural road improvement programs in an additional 8 provinces. Additional funds have been included in the project to expand these studies to include a total of 20 provinces. 73. The quantified project benefits are based on: (a) the projected increase in the net value of animal and/or crop production, including better ex-farm prices of inputs and crops; and (b) the reduction in the transport costs of: (i) nonagricultural commodities, such as consumer goods and minerals; and (ii) passengers. Road user savings for these two types of traffic not directly related to agricultural production have been quantified to supplement the primary benefit component of the net value added on incremental output resulting from the road construction or from a combined road/agricultural investment (e.g. Iloilo). In general, these reduced transport costs comprise about 15-25% of total benefits. 74. The economic rates of return (ERR) for the rural roads range from 17% to 55%, with an overall ERR of 31%. The returns on the national and provincial roads in Occidental Mindoro are 23% and 22%, respectively, with a weighted average of 23%. The overall ERR of all roads is 28%. These rates of return exclude investment in road maintenance equipment, workshops and related equipment and machinery, and technical assistance. The benefits of the maintenance components have not been quantified but experience in this type of investment elsewhere suggests high returns, giving this type of investment the highest priority in road development programs. Project Risks 75. The risks, in terms of potential economic benefits, are normally in the estimates of traffic and agricultural growth rates and savings in vehicle operating costs, which have been accounted for in the sensitivity analysis performed. Because of the new approach being taken by the project in decentralizing responsibility and authority, the main risks are associated with the performance of MLGCD and the provinces in implementing the various project components. While risks are not inconsiderable, the proposed approach provides the opportunity to promote the Government's decentralization policy. The lack of trained staff poses a problem but the substantial technical assistance and training, organizational changes, and agreed action programs, which are an essential part of the project, should minimize this risk.  - 23 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 76. The draft Loan Agreement between the Republic of the Philippines and the Bank and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank are being distri- buted to the Executive Directors separately. 77. Special conditions of the project are listed in Section III of Annex III. An additional condition of effectiveness would be agreement between the Borrower and the Bank on satisfactory Memoranda of Agreement between the Ministries of Finance, Budget, Public Highways and Local Govern- ment and Community Development defining responsibility for construction and improvement of national and local roads, and budgetary and administrative responsibility for such roads (Section 5.01 of the draft Loan Agreement). An additional condition of disbursement would be that disbursements would not be made for rural roads improvement contracts for each of the three years from January 1, 1981 to December 31, 1983 until the Bank has approved the size and scheduling of the annual rural road improvement program for the following year (Schedule 1, para. 4(b) of the draft Loan Agreement). 78. 1 am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 79. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments By Ernest Stern Washington, D.C. May 5, 198Q  - 24- ANNEX I SBLt 3A Page 1 of 5 PHILIPPINES - SOCIAL INDICATORS DATA SHEET IRUELNCE GROUPS (ADJUSTED AERtAGES LAO ARZA (THOUSAND SQ. DI.) QI - MOST RECENT EST1MATE) ' TOTAL 300.0 SAME SAME NEMl UIGCll ACRICULYDL6L 56. 7 m, mm =DCRAPHIC mcomi Dicoms 1960 A 1970 A ESTIMATE A RECION /e 0r8ou Ld GROUP C21 PER CAPITA (USS) 140.0 230.0 510.0 528.9 467.5 1097.7 Er ECT CONSUMPTION PER CAPITA (KILOGRAMS Or COAL EQUIVALENT) 147.0 3D1.0 329.0 371.1 262.1 730.7 POPUtLATION AN) VITAL STATISTICS POPULATION. fLD-YTA (MILLIONS) 27.4 36.9 4.5 UR1 POPULATION (PU1CRM OF TOTAL) 30.1 31.8 34.0 27.4 24.6 49.0 POPULATION PHOJHTIONS POPULATION IN TEAR 2000 (NLLIONS) 76.0 STATIONARY POPUI.ATION (KfLLIONS) 128.0 YEAR STATIONARY POPULATION IS RACHED 2075 POPULATION DESxiTY PER SQ. ]C. 91.0 123.0 148.0 154.8 45.3 44.6 PRr SQ. KM. AGRICULTURAL LAID 360.0 472.0 513.0 566.7 149.0 140.7 POPVLATION AGE STUCTURE (PECENT) 0-14 YRS. 44.7 45.5 46.0 41.3 45.2 41.3 15-64 YRS. 52.3 53.6 51.0 54.9 51.9 55.3 65 Ms. AD ABOVE 3.0 2.9 3.0 3.3 2.8 3.5 POPULATION GROWEH RArT (PERCENT) TOTAL 2.7 3.0 2.7 2.4 2.7 2.4 IIUUI 4.0 3.8 3.5 4.3' 4.3 4.5 CRUDE BIT RATE (PER THOUSAND) 45.0 43.0 35.0 30.2 39.4 31.1 CRUDE DEATH RATE (PER THOUSAND) 15.0 11.0 9.0 5.3 11.7 9.2 CROSS REPRODUCTION HATR 3.5f 3.3 2.4 2.1 2.7 2.2 FAMILY PLANNING ACCEPTORS. ANUL (THOUSANDS) *- 191.7 643.0 . USERS (PERCENT o0 2ARRIED WOM!g) .. 2.0 22.0 34.1 13.2 34.7 FOOD AND NUTRITION DIEX OF FOOD PRODU MION PER CAPITA (1969-71-100) 100.1 101.0 111.0 106.2 99.6 104.4 PER CAPITA SUPPLY TOF CALORIES (PERCENT OF REQUIREXITS) 63.0 86.0 87.0 104.1 9*.7 105.0 P1OTEINS (GRAMS PER DAY) 44.0 45.0 50.0 57.4 54.3 64.4 OF WHICH ANIMAL AND PULSE 19.0L& 22.0 19.2 16.9 17.4 23.5 CILD (AGES 1-4) MORTALITY RATE 16.0 10.0 7.0 4.8 11.4 8.6 HEALTH LIE