Madagascar - Cotton Development Project

DocumntM of The World Bank FOR OFFCIAL USE ONLY C R. 14133 R C> Ra1t Ne. P-3655-4AG .5 REPORT AND M dADION OF THE PECSIDENT OF THE TIorIOL DEVELOPMENT ASSOCIATION TO TM E-EcUTIvE DIRECMORS ppOSED IDA CREDIT FOR SDR 7.5 MILLION (US$7.9 MILLION SJIVALENT) M A PROPOSED IDA SPECIAL FUND CREDIT FOR SDR 9.4 MILLION (US*9.9 MLION EQUIVALENT) TO THE DEDOCRNTIC REPUBIC OF N R FOR A COTTAO DEVELOPMET PROJEC December 1, 1983 | This d t ha* a icd b be by r y i e P Of tbrgIngd lb casf uynot dtew be didwio Wwi m uwiaoi .I  Currency Eauivalents Currency Unit = xalazasy Franc (FMG) USS1 = FMG 475 FMG 1,000 = USS2.105 FMG 1,000,000 = USS2,105 WEIGETS AND MEASURES (metric System) 1 hectare (ha) 2.47 acres 1 kilometer 0.62 mile 1 square kilometer (km2) = 0.39 square mile 1 kilogram (ks) 2.20 pounds 1 liter (1) 0.26 US Lallon 0.22 Imperial zallon 1 metric ton (r/ton) = 2,204 pounds ABBREVIATIONS AND GLOSSARY BTM Agricultural Credit Bank CCCE Caisse Centrale de Cooperatiou Economique (French development fund) CFDT Compaenie Frangaise pour le DWveloppement des Fibres Textiles CSPC Caisse de Stabilisation du Prix de Coton FOFIFA Center for Agrictltural and Rural Development Research HASYMA Hasy- Nalagasy (Government Cotton Company) MI Ministgre de l'Industrie (Ministry of Industry) ?EPAEF Ministere de Production Animale et des Eaux et Forets (Ministry of Animal Production, Fisheries and Forests) MPARA Ministere de la Production Azricole et de la REforme Azraire (Ministry of Az ricultural Production and Agrarian Reform) MTP Minist4re des Travaux Publics (Ministry of Public Works) GOVERNMENT AIO(INISTRAIIN (Fokonolona Territorial Divisions Fokontany g zroup of villazes Firaisam-pokontany (or Firaisana) = group of fokontany (former canton) Fivondronam-pok'ontany (or Fivondronana) = group of Firaisana (former sub-prefecture) Faritany = group of Fivondronana (former province) FISCAL YEAR Government January 1 - December 31 HASYMA April 1 - March 31  FOR OMCIAL USE ONLY - i - MADAGASCAR Cotton Development Project Credit and Project Summary Borrower: Democratic Republic of Madagascar Beneficiary: Hasy Malagasy (HASYMA). a parastatal responsible for cotton processing and marketing, input supply, extension, coordination and planning. Amount: IDA SDR 7.5 million (US$7.9 million) IDA Special Fund: SDR 9.4 million (USS9.9 million) Terms: Standard IDA terms. Onlendinz terms: For investment costs of HASYMA. two years grace, nine years repayment. 14 percent p.a. interest rate;for monitoring and evaluation, training and technical assistance, grant basis; for equipment and inputs provided to farmers, prevailing commercial terms. Project Description: Objectives Theproposed project would expand Madazascar's cotton production from 26,000 tons to 45,000 tons over a four year period thereby saving foreign exchange expenditures on cotton fiber import and increasing per capita cash income of producers, including some 20,000 smallholders. Production increases would be achieved by increasing yields on existing cultivated lands and by expanding cultivation through the development of 8,000 ha. of new land. Components (a) Purchase and distribution of equipment, vehicles and farm inputs to maintain and improve producti- vity; (b) rehabilitation of cotton roads and tracks to improve communication for input supply and crop marketing; (c) adaptive research; and (d) technical assistance to cotton parastatals and farmers. Benefits: By relieving production and marketing constraints, the project would result in production increases equivalent to an estimated US$11.0 million per annum This docnuent bas a resricted distbutio and may be used by repents only i the perfonmance or eir offici duties. Its contents may not otherwise be discowd without World Dank authoriatin  - ii - in foreign exchange savings. Although a substantial part of this project will benefit 43 large farms in the north, it will also increase by about 50% the per capita cash income of about 20,000 smallholders, largely in the south, and provide additional employment on 43 large production estates. It will also increase the supply of edible oil and cattle feed, which are byproducts of cotton ginning. Risks: Producer prices set at appropriate levels and the allocation of sufficient foreign exchange to the sub-sector are critical to the success of the project. The availability of foreign exchange after the completion of the project will of course depend on the prevailing economic situation. Assurance on pricinz and foreign exchange was received at nigotiations and pricing issues and foreign exchanze allocation will continue to be at the forefront of the continuing dialogue between the Bank and the Malazasy authorities. Other risks are the incidence of dry years and insect pests, which have been taken into consideration in evaluatinz the project's rate of return. estimated at 30X. Estimated Project Costs: Z of (USS Million) % of Total For. Base Local For. Total Exch. Costs Agricultural Equipment - Large Farms 1.01 9.10 10.11 90 33 - HASYMA 0.10 0.88 0.98 90 3 - Smallholders 0.04 0.36 0.40 90 5 Workshops and Stores 0.34 0.53 0.87 61 3 Cotton Track Rehabilitation 1.04 1.78 2.82 63 9 Agricultural Inputs 1.23 11.01 12.24 91 33 Research and Development 0.05 0.48 0.53 90 2 Technical Assistance 0.21 1.80 2.01 89 9 Monitoring and Evaluation 0.06 0.30 0.36 83 1 Training - 0.21 0.21 99 1 Studies 0.07 0.27 0.34 79 1 Total BASELINE COSTS 4.15 26.72 30.87 87 100 Physical Contingencies 0.23 0.75 0.98 77 3 Special Contingencies (Track Component)0.34 0.51 0.85 61 3 Price Contingencies 0.58 1.09 1.67 65 5 TOTAL PROJECT COSTS 5.30 29.07 34.37 85 111  - iii - Financinz Plan IDA Special IDA Fund CCCE HASYMA/Farmers Total USS (Millions) 7.9 9.9 11.3 5.3 34.4 Percentage 23.0 28.0 33.0 16.0 100.0 Estimated Disbursements: SDR milliont Fiscal Year Annual Cumulative 1985 4.4 4.4 1986 4.2 8.6 1987 4.0 12.6 1988 2.9 15.5 1989 1.4 16.9 Economic Rate of Return: 30 percent. Staff Appraisal Report: No. 4514-MAG Map: IBRD 15921  - INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A COTTON DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed Development Credit to the Democratic Republic of Madagascar for SDR 7.5 million (USS7.9 million equivalent) and an IDA Special Fund credit for SDR 9.4 million (US$9.9 equivalent) to help finance a Cotton Development Project. The French Caisse Centrale de Cooperation Economique (CCCE) has agreed to cofinance this project with two loans in an aggregate amount of FF 86.3 million (USS11.3 million equivalent) at an interest rate of 4.5% and repayment over 10 years after a grace period of 5 years. PART I - THE ECONOMY 2. A report entitled 'Madazascar - Economic Memorandum dated November 3, 1981 was distributed to the Executive Directors. An economic updating mission visited Madazascar in November/December 1982, and its Report MAG (83-4) entitled -Current Economic Situation and Prospects- dated March 20, 1983, was distributed to participants of the Madazascar Consulta- tative Group Meeting of April 27-29, 1983. This report incorporates the findings of that mission. Country data sheets are provided in Annex I to this report. 3. Madagascar, with a population of 8.7 million and a GNP per capita of about US$315 in 1982, is among the poorest countries in the world. It is a sparsely populated country (about 15 persons per square kilometer) with less than 20 percent of the population living in urban areas. Although generally well endowed with natural resources and a variety of soils, there are considerable rezional variations in ecology and climate. The central plateau, the most economically advanced region, has a subtropical to temperate climate, the South is the poorest region with an arid climate and infertile soils, the eastern rezion has a tropical climate and althouagh rich azriculturally, crops are frequently devastated by cyclones. Agriculture accounts for about 35 percent of GDP; about 85 percent of the population lives in rural areas, and azricultural products account for about 80 percent of the country's export earnings. 4. Over the longer term Madagascar's development has been very sluagish and erratic. For the period 1970-1982 there was, on average, virtually no growth in real GDP, and with an average population growth of about 2.8 percent per annum; per capita real income in 1982 was about 25 percent below its 1970 level. 5. This very slow development was true for all sectors of the economy. Agricultural output lagged conspicuously, and yields tended to stagnate or decline; the country became increasingly dependent on imports, especially of rice, to meet food requirements, and the volume of agricul- tural exports virtually stagnated. Manufacturing output showed a very modest expansion; the sector remained heavily dependent on imported inputs and operated at low levels of capacity utilization. There was very little  -2- expansion in the country's transport network and indeed the existing transport facilities (road and rail) were subject to increasingly serious deterioration. 6. Most of the decade of the 1970s was also marked by the vigorous pursuit of official policies which sought to reduce foreign involvement in the economy, and through nationalizations and various economic controls, to greatly extend the Government's role in economic activity. 7. The poor growth and development performance and the extensive institutional changes which were being effected were nevertheless accompanied by continued cautious policies in balance of Payments, public finances and external debt. The external resource gap was kept at low levels (about 3 percent of GDP from 1970-78), the overall Government budzet deficit fluctuated slightly around 2.5 percent of GDP and recourse to external borrowing was strictly limited. Total external public debt (outstanding and disbursed) at end 1977 was equivalent to about 13 percent of GDP, compared to an average of about 22 percent for low income developing countries, and the ratio of debt service payments to export earnings at end 197' was only about 3 percent. 8. In 1978 the present Government adopted a significant new economic policy orientation in undertaking a large expansion in public sector investment with greatly increased reliance on external sources for its financing. Investment outlays increased in volume terms by about 13 percent per annum between 1978-80 and the share of investment in GDP, which had been about 14 percent since the early 1970s rose to around 21 percent in 1979 and 1980. The increased investment resulted in increased imports and coincided with virtually stagnant export earnings and a deterioration in the terms of trade, so that Madagascar's balance of payments deteriorated very sharply in 1979 and 1980 and the resource gap reached almost 17 percent of GDP. External payments began to run into difficulties in 1980 and foreign exchange shortages grew increasingly severe through 1981 and 1982. This was to a considerable extent due to rapidly growing claims of external debt services. 9. With the rapid expansion in external borrowing -ad a hardening of average terms Madagascar's public external debt service obligations increased dramatically from about USS19 million in 1978 (equivalent to about 4 percent of receipts from exports of goods and non-factor services in that year) to about US$265 million in 1982 (equivalent to about 72 percent of exports of goods and NFS). In 1981 and again in 1982 Madagascar sought and obtained a rescheduling of a part of debt service obligations due. These reschedulings reduced payments due in 1981 and 1982 by over 50 percent so that service payments on external public debt actually made in 1982 were equivalent to about 35 percent of export receipts. 10. The performance of the agricultural sector from '979 on was less disappointing than in the immediately preceding vears, but nevertheless unsatisfactory. Output zrew by 7 percent in 1979 and except for a drop of 1.5 percent in 1981 continued to grow by 2.5 percent p.a. Since 1979 the weather has been poor and there have been shortages of inputs such as fertilizers, pesticides and improved varieties of seeds. The production of rice, the staple of the Malagasy diet, varied little between 1979 and 1982,  - 3 - with slight declines in 1981 and 1982, in 1982 due to an important extent to the effects of the severe cyclones. There were considerable differences amongst other crops. Most export crops had somewhat higher outputs in 1982 than in 1979. In the case of coffee the increase was only about 2.5 percent, but output reached the highest level so far obtained. Cloves went through a peak of the clove cycle, beginning at the trough in 1979, almost tripling in 1980 and declining slightly thereafter. Vanilla also picked up from a very low level in 1979 and almost doubled by 1982. These three crops accounted for over 70 percent of merchandise exports. 11. Since 1979 the drop in industrial production, including mininz, has been especially sharp. Production at end 1982 had dropped to 70 percent of the level in 1979, lower than in any year of the 1970s. Output in every branch of production was lower in 1982 than in 1979, with the exception of petroleum products, which reached a peak in 1980. A particularly serious aspect was that the output of some basic consumption items (soap, shoes, matches, batteries) had dropped by well over one half since 1979. 12. The central government's finances in 1978-82 clearly reflect the investment boom and the subsequent efforts to restore equilibrium. Total expenditures more than doubled between 1978 and 1980 and declined slightly in 1981 and 1982, when the inflation rate was much higher. The overall deficit swung from 4 percent of GDP in 1978 to a peak of 18 percent in 1981 and then down to 9 percent in 1982. The recurrent budget contributed little to the swings since expenditures and revenues moved roughly in line. The main cause was the capital budget, which more than quadrupled between 1978 and 1980 and declined by 57 percent from 1980 to 1982. However, other government expenditures, mostly Treasury on-lendinz and general government expenditures from the export crop stabilisation funds, have grown continuously and in 1982 exceeded capital expenditure. Despite considerable growth in nominal terms, both revenues and recurrent expenditures generally declined in real terms, after 1980. The growth of revenues has been greatly slowed by the deterioration of the economic situation, although a number of measures were taken to increase taxation in 1982. 13. The investment boom and the ensuing stabilization policies are also reflected in the money and credit figures for the years 1978-82. The net foreign asset position of the monetary system deteriorated rapidly in 1979 and 1980 and more slowly in the next two years. Net domestic credit expansion was overwhelmingly in net government borrowing from the central bank; at end 1982 it was 58 percent of total net domestic credit, as compared to 31 percent at end 1978. 14. Available price information indicates accelerating inflation over the last year or two. The official cost of living index for Antananarivo, which is likely to understate the actual price rises, showed an 18 percent increase in 1980 and about 31 percent in 1981 and 1982. The implicit GDP deflator shows a parallel development with a 15 percent increase in 1980, a 25 percent increase in 1981, and a 34 Percent increase in 1982.  -4- 15. The balance of payments has also been affected by the investment spending of 1978-80, but the sluggishness of exports and the difficulties in reducing imports have made restoration of external equilibrium especially difficult. The current account deficit began to rise rapidly from less than 2 percent of GDP in 1978 to over 18 percent. Transictions with the rest of the world had been financed by a total exhaustion of reserves, an unprecedented degree of foreign borrowing, and by incurring substantial arrears on external payments obligations. The Government began to take stron2 measures to restore equilibrium in 1981 and 1982, notably by tightly restricting imports and by negotiating arrangements with the IMF and the Paris Club. It succeeded in reducing the overall deficit to FMC 31.4 billion (US$90 million) in 1982, thanks to the agreements reached with the IMF and the Paris Club as well as some exceptional balance of payments financing, but it failed to improve siznificantly the current account, whose deficit in 1982 was still US$350 million. 16. The main reason for the failure to improve the current account was that capital goods imports, which were tied to the existing financing arranaements and on-going projects, continued at very high levels through 1981 and 1982. The total volume of imports grew by 33 percent in this period, but price increases were also substantial, increasing at roughly the same rate. The foreign exchange shortages that beean in 1980 and grew much worse in 1981-82 obliged the Government to restrict imports where it could. The categories of raw materials and spare parts and of non-food consumer goods suffered most, though the Government ensured that energy imports covered essential needs. Food imports increased because bad weather, including serious floods, reduced the rice harvests. The slu,sish export performance aggravated difficulties. During 1978-1982 the volume of exports stagnated. Coffee, the main export, was seriously affected by the international market situation, first by a drop in prices in 1981 and then by the ICO quota restrictions. 17. The IMF Board approved its first Stand-by arrangement with Madagascar in June 1980, but, since the Government failed to limit its expenditures sufficiently, the program was suspended, though some of the other measures in the program had been implemented e.g. increasing revenues. A second Stand-by agreement was concluded in April 1982 providing for drawings of SDR 109 million (USS130 million) by June 1982. This agreement too had to be suspended because unanticipated shortfalls in export earnings and smaller inflows of capital from commercial banks than expected made it impossible for the Government to abide by the program for more than part of the period. A third Stand-by agreement, for the period to June 1983, was approved by the IMF Board in July 1982. This arrangement made available SDR 51 million (US$57 million) in addition to SDR 22 million (USS24.6 million) under the CFF. 18. A first meeting of the Consultative Group for Madagascar took place in April 1983 (following a Donors Conference in June 1982). One of the objectives of the meeting was to secure additional external assistance commitments sufficient to cover the country's external resource gap for calendar year 1983, a requirement which the IMF had made a condition for Madasascar's continued access to Fund resources under the Third stand-bv arrangement. The meeting was successful in securing commitments to cover  the estimated gap requirement. However, by June 1983 it had become evident that Madagascar would not be able to comply with IMF stand-by performance criteria for the reduction of external payments arrears. This was in large part due to unanticiapted delays in concluding clove export contract agreements with Indonesia which occasioned a significant shortfall in anticipated export receipts. The extent of Madagascar's non-compliance with the reduction in payments arrears was such as to require suspension of the third stand-by agreement and prevent Madagascar making the final drawing due in June 1983. However, negotiations began immediately between the IMF and the Malagasy authorities on a fourth Stand-by arrangement. In addition to establishing performance targets for external borrowing, domestic credit, reduction in external arrears, and maintenance of appropriate exchange rate adjustments the new Government program requires increases in prices for major agricultural products, further measures to liberalize the marketing of agricultural prnducts, and progress towards a market determined system for interest rates. The letter of intent for the fourth Stand-by was signed in October and the new agreement is scheduled to be presented to the IMF Board in mid-December. A further meeting of the Paris Club to reschedule debt service falling due in 1984-85 is expected to take place early in 1984. 19. The economic crisis and the greater dependence on external donors have prompted the Government to question many of its policies and to appreciate that a sustained improvement in the economy's performance requires considerable policy reform and a more systematic approach to the balance of payments and public investment. Of the weaknesses underlying the economy the most harmful has been the persistent low productivity of agriculture, the result-;of many and complex factors among which are:the lack of price incentives, inefficient state marketing, and shortages of inputs. In industry, commerce and transport price controls and shortages of inputs have posed equally serious problems. One especially grave feature of government policy has been inadequate resources for maintenance, and hence a deterioration of infrastructure, particularly of roads. On most of these points the Government has either begun to take action or is working out new policies. A major step has been the preparation of a public investment program for 1983-85. This program, apart from bringing government investments in line with projected resource availabilities and ensuring a degree of coordination between ministries and agencies that has been lacking in the past, emphasizes rehabilitation and maintenance rather than new investments. 20. Over the last couple of years the Government has shown a willing- ness to take a number of difficult policy measures. At the Consultative Group Meeting, Government announced its intentions to free the marketing of rice. As a first step it was decided to liberalize price controls by allowing free movement between minimum producer price and maximum consumer price, and to permit the private sector to trade rice except in the regions of Lac Alaotra and Fifabe. Transport tariffs have been increased in -une 1983 as agreed during the negotiations of the Sixth Highway Project. A 10.5% de facto devaluation took effect on October 3, 1983 as part of an exchange rate adjustment. Government has also engaged in a reassessment of its public investment program and is considering abandoning certain proj^cts which could not be rehabilitated. A major cabinet reshuffle in  July 1983 has reinforced the economic management team by giving prominence to technicians who are taking a pragmatic approach. Cosu recovery is now at the forefront of government policy and emphasis has been put on relaxing administrative controls. Some liberalization measures are also expected in the industrial sector and we expect to support the Government program with an operation in industry to be appraised in the near future. 21. Increased external financing on a concessionary basis will be required to support the Government's economic restructuring and development efforts and to ensure a continued capacity to service external debt. Given Madagascar's poverty and current resource constraints, IDA should continue to contribute to local cost financing. PART II - BANK GROUP OPERATIONS IN MADAGASCAR 22. IDA credits to Madagascar amount to US$388.89 million, and Bank loans total US$32.58 million. Since 1975, about 44 percent of Bank Group lending has been for transport, 26 percent for agriculture, 16 percent for electric power and petroleum, 6 percent for industry and water, 4 percent for technical assistance and 4 percent for education. IFC's first investment was in 1977 for the expansion of the SOTEMA textile mill. In 1980 IFC made a US$1.25 million loan for the Bata shoe manufacturing company in Antananarivo and in 1983 an investment of US$7.44 million for the Pacheries de Nossi-Be was approved; other projects are under preparation. Annex II contains a summary statement of Bank loans, IDA credits and t-FC investments as of September 30, 1983. 23. Bank Group assistance to Madaaascar has been concentrated on the key areas of infrastructure (including urban and social infrastructure), azriculture and energy. In infrastructure, four projects have provided for the construction of all-weather highway links between the island's different regions and three projects for road maintenance. There have been projects to improve Madagascar's main port of Toamasina, and to support the railway's modernization efforts. Urban infrastructure development has benefitted from a water supply and sanitation project for the capital city of Antananarivo for which a US$20.5 million credit was signed in May 1980. In the social sectors, education has been tle major recipient of Bank assistance with two credits totaling US$18.8 million. In addition, studies for urban development financed by the UNDP with the Bank as Executing Agency have led to preparation of a project for urban development. We began lending to the industrial sector with a first US$5 million DFC credit to the Industrial Development Bank of Madagascar (BNI) in May 1980. In addition, a credit of SDR 9.4 million for an accounting and audit project was sianed in June 1981. 24. Bank Group lending for agriculture consists of three livestock development projects, three irrigation projects, two forestry projects, an agricultural credit project and a rice intensification project. In addition, a US$2.3 million technical assistance credit to examine possibi- lities for flood protection in the Plain of Antananarivo area was signed in  January, 1981, and a US$5.7 million technical assistance credit for an Agriculture Institutions project was signed in June 1982. We expect agriculture to continue to absorb a large share of Bank Group lending, in line with Government strategy to expand agricultural production. Further rural development and crop production projects are being prepared. 25. Energy projects have also received growing Bank Group attention; IDA participated with several co-lenders in the financing of the large Andekaleka hydroelectric project, which was successfully completed in June 1982. A US$12.5 million credit for petroleum exploration promotion is supporting the Government's efforts to develop a domestic supply of hydrocarbons and to improve planning in the energy sector. In addition, a heavy oil exploration credit (Tsimiroro), in the amount of SUR 10.7 million was approved by the Executive Directors on November 16, 1982. Both projects are proceeding well. 26. In the past, problems have arisen in the execution of several projects. The main problems encountered included delays, cost overruns, deficiencies in management and inadequate financial performance of project agencies. Recent problems have centered on difficulties linked to the country's economic crisis, notably, acute shortage of foreign exchange and budget funds and institutional problems related above all to the parastatal system. The road construction component and maintenance studies of the Fourth Highway project are nearly completed. Construction under the Fifth Highway project has begun and $13.0 million out of $24.0 million are expected to be disbursed by June 1984. Disbursements under the Second Railway Project are almost completed. However, disbursement of the railway credit wds suspended on June 25, 1982 pending government action to correct major deficiencies affecting the railway's operations. They were resumed in December 1982, after the Government had implemented a satisfactory financial recovery program. 27. Experience with project implementation in agriculture has been mixed, reflecting the difficult experience of the agriculture sector in general over the last few years. The Bank Group's involvement in two irrigation projects involving rice and cotton production provides striking illustrations of the impact of policy and the general economic environment on project implementation. Both the Morondava and the Mangoky projects were designed to increase production through extension of cultivable land under irrigation. Both experienced substantial cost ove ans which necessitated reductions in the irrigated area under development. Production too has slumped on both schemes. The Morondava project, approved in 1972 and closed in 1981, was a serious problem project. Even after incurring cost overruns of 70 percent over appraisal estimates, only 60 percent of planned land development was carried out and azricultural production fell far below appraisal estimates. The rate of return is likely to prove negative. 28. At Mangoky, yields of seed cotton, the most important crop grown on the network, plummeted from about 3 tons per ha in the early 1970s to less than one ton per ha and the area cultivated decreased. The deterioration of agricultural and land development performance had a direct impact on the financial situation of SAMANGOKY which has accumulated debts of more than FMG 1.5 billion (US$3.3 million). An additional effect of the  - 8 - company's difficulties has been a loss of part of the cultivated area due to floodinz and salinity and increasing detcrioration of the state of the irrigation network. Key factors in the performance of these two projects were: Ci) the weakness of the parastatal manazing institutions; (ii) the incentive structure, both at scheme level and in the official pricing systems; (iii) inadequate arrangements for maintenance and cost recovery on the schemes; and (iv) the macroeconomic environment, particularly the availability of foreign exchange. The hard-learned lessons of these two projects are beinz applied to the Mangoky project, Which has recently been restructured to reflect implementation experience and Government's recovery policy. The accent in the restructured project is on gettinz the incentives right so that both producers and parastatal find production attractive, and on making the best use of existinz investments without undertaking further expansion. 29. In contrast to this experience, after initial delays, the executing agency for the First and Second Village Livestock Projects, FAFIFAM&, developed into a satisfactory institution with technically competent and dedicated management. Similarly, the project agency for the First and Second Mangoro Forestry Projects. FANALAIMANGA, established a strong record, with execution of components ahead of schedule and in line with appraisal cost estimates. However, technical problems over tree growth have led to a cutback in the planting program. ln general, most projects are now being adversely affected by the worsening economic conditions and particularly by shortages of foreign exchange. 30. IFC has three investments in Madagascar in textiles, footwear and fisheries. The first investment was made in 1977 when IFC participated in financing the SOTEMA textiles mill. Recentlv SOTEMA encountered problems in obtaining a sufficient cotton allocation, in transferinz payments on its loan to IFC. and was threatened with conversion to a Socialist Enterprise. All of these problems appear to have been satisfactorily resolved and this year IFC made its third investment in the Nossi-Be fisheries project. 31. Since the start of our program in Madagascar, four projects, have been completed and audited by the Operations Evaluation Department. The Audit Report No. 1622 of December 1976 on the first Lac Alaotra project concluded that work had been successfully implemented bit that the benefit pattern was not yet clear. However, the Impact Evaluation Report No. 3600 of August 1981 concluded that a decline in the efficiency of management, technical probleis with production and the deteriorating economic and policy environment had contributed to a decline in the project's prospects, and that the actual economic rate of return was probably negative. The Audit Report No. 1559 of April 1977 on the Beef Cattle Development Project concluded that the Project had contributed little to Madagascar. The Audit Report No. 2143 of July 1978 concluded that the Third Hizhway project was well justified and had a good rate of return despite substantial cost overruns. Report No. 2299 of December 1978 concluded that the physical objectives of the Tamatave Port Project were satisfactorily achieved but pointed out that the institutional objective was not accomplished during project implementation because of inadequacies in the staffing of the port authority.  - 9 - 32. In fiscal years 1980-82, disbursements for Madagascar totalled about USS70 million compared to new commitments of USS96.5 million. In the same period, the average annual disbursement rate (rate of disburseoent to undisbursed balance) was 20 percent. This is about averaze for countries of the Eastern Africa Rezion. Disbursement performance in general is satisfactory. III - THE COTTON SECTOR General 33. Cotton production and the textile industry form one of the most important economic activities in Madagascar. About 20,000 families are involved in cultivation of cotton. Five textile factories and a score of large earment manufacturers employ another 10,000 persons. The textile industry is one of the country's largest industries, contributing about 332 of the value added in the manufacturing and extracting industries. Cotton seed is similarly an important raw material of the vezetable oil industry, satisfyinz 15-20% of the local demand for cooking oil. Cotton Production 34. Cotton production in Madazascar started in 1958 on about 300 na and spread rapidly. Until 1968 cotton remained a plantation crop, being grown on large farmos in the north-west owned by companies or individuals. In 1968 smallholder production started and has developed very fast. Cotton production reached a peak in 1977; thereafter poor price incentives and technical difficulties largely due to foreiga exchange shortages have contributed to a decline from these peak levels. Producti,n figures have been as follows: tons of Year ha. Seed Cotton 1965 3905 5809 1970 10313 18714 1977 20403 37081 1980 16985 23210 1981 1972'- 27962 1982 17500 25900 35. Cotton production is concentrated almost exclusively on the west coast. There are two well-defined production areas: the northern zone which is dominated by large, private farms using highly-mechanized techniques on the flood recession system of production and the southern zone which is predominantly smallholder production under irrigated or rainfed conditions. In spite of serious difficulties in procuring equipment and spare parts, the large farms have succeeded in maintaining high yields. Smallholder production on the other hand has been erratic with area cultivated sensitive to prices, and yields more subject to climatic vagaries.  - 10 - Marketinz and Ginning 36. HASYMA (Hasy Malagasv, a zovernment parastatal) has a monopoly on marketina and ginning cotton, although in some areas it has delezated responsibility for buying seed cotton to other parastatals. HASYMA buys eitter at its own buying centers or at the large private farms, and oraanizes transport, by both private and by parastatal transporters. With the deterioration of the rural road network, shortage of spare parts and problems in the replacement of worn-out trucks, transportation of seed cotton has become increasingly difficult. HASYMA gins the cotton in the eight zinneries which it owns. Ginning capacity is presently a nominal 39,000 tons per year but much of the new area that has come into cotton production in recent years is situated at an uneconomic distance from existing ginneries. HASYMA has therefore undertaken an expansion program with a loan from the French Caisse Centrale de Cooperation Economique that will add 35,000 tons of new annual capacity, most of which is at Port-Berg6 and Toliara. With these new installations, ginnery capacity will be adequate to process forecast production. Oil Extraction 37. Cotton seeds are an important raw material for Madagascar's vegetable oil industry. There are about 13 plants equipped to extract oil from cotton seed and groundnuts with a total capacity of 60,000 tons, far above the availability of raw material. Almost all these companies are privately owned. Yields in cotton seed oil are low, larzely because the extraction plants are old and inefficient. Cotton seed production in 1981 of 16,000 tons yielded around 1,500 tons of oil, 60% of total production of vezetable oils. There is high unsatisfied demand far oils and fats estimated at up to 20,000 tons a year. Possible rehabilitation of edible oil plants is being examined by the Government in the context of an industrial sector investment program. The Textile Industry 38. Cotton fiber is the principal raw material of Madagascar's textile industry which transforms it into yarns, fabrics and garments. The two largest factories are majority owned by Government and represent over 85% of total installed capacity. The production of the textile industry was fairly stable during the period 1974-82 at 80-90 million meters of fabric per year. The drop in domestic fiber production in 1979-82 together with the shortage of foreign exchanze for the import of fiber and chemicals is threatening to constrain production. However, the mills have so far managed to maintain and even expand production to a record 92 million meters in 1982 by reducing fiber content and recycling chemicals. Utilization of spinning and weaving capacity in 1982 was about 84 per cent. 39. Domestic fiber productior has long supplied the domestic textile industry. In the 1970s small surpluses were available for export, but the expansion of the textile industry during the decade led to mounting demand that could not be satisfied by domestic production. Total consumption of fiber by the textile industry averaged 15,000 tons annually between 1979 and 1982, equivalent to 40,000 tons of seed cotton. Domestic cotton fiber production during the same period averaged only about 11,000 tons per year  - 11 - and the gap had to be made up by imported fiber, which has placed a heavy burden on Madaaascar's slim foreign exchange resources. The shortaze of local fiber supplies has resulted in temporary difficulties in fiber distribution between processing plants with problems over the administra- tion of a quota system based on installed factory capacity. To remedy the situation, the Government has azreed to establish a committee responsible for development policy and overall coordination of the cotton sector including the distribution of fiber to the textile industry (Section 3.07, draft Credit Agreements)'/. The actual setting up of this committee is a condition for Credit effectiveness (Section 5.01 (d) of draft Credit Agreements). 40. Domestic consumption of fabric rose steadily to reach 72 million meters in 1980. Thereafter a combination of factors has reduced slightly both per capita and agareeate domestic consumption: a drop in real incomes, difficulties in the distribution system, particularly in rural areas and poor market appeal of the product. In addition, textile firms have been encourazed by Government to export, reducing availability on the domestic market. 41. Future trends in the domestic market indicate steady growth as population expands and the economic situation improves. Prospects for the export market are also favorable if profitable product lines can be developed. Government policy is to export production in excess of domestic demand up to present mill capacity, and to allow textile firms to make up for possible losses on exports through higher prices on domestic sales. From small beginnings in the early 1970s, fabric exports averased 25-30 million meters ini 1975-78, dropped off in 1979-81 and picked up again to 25 million meters in 1982. Cotton Feeder Tracks 42. The road network in the cotton producing areas is in poor condition due to inadequate maintenance arisinz from the weakness of rural institutions and from lack of funds. The main roads are maintained by the Ministry of Public Works (OTP) and the access roads by the local authorities. The rehabilitation of the main roads in the north-west and the Toliary to Tanandava and Toliary to Ihosy trunk roads in the south-west is provided for under present Government plans for rehabilitation of the .economic network. However, there is no plan for rehabilitation or feeder tracks which play a vital role in the supply of inputs, transport of seed-cotton and the opening-up of new production areas. In the north, where many roads pass through the flood plain, access to areas of very hiah production potential has dwindled as feeder tracks have deteriorated; transport costs have risen and some areas risk becoming inaccessible with consequent impact on production. In the south, feeder tracks have also deteriorated from lack of maintenance. In both zones, rehabilitation and subsequent maintenance of cotton feeder tracks is thus essential if cotton production is to be maintained and expanded; therefore a component for the 1/ By the term draft Credit Agreements, we refer to the draft Development Credit Agreement and the draft IDA Special Fund Credit Agreement.  - 12 - rehabilitation of the cotton track network has been included in the project (paras 54 and 56 below). Government Policy 43. In the late 1970s the absence of an explicit development strategy for cotton became evident through the relative decline of producer and fiber prices, which contributed to a production slump. Insufficient allocations of foreign exchange to cotton parastatals and to the large cotton producers for the import of urgentlv-needed machinery and spare parts also contributed to the decline in cotton production. The rapidly deteriorating state of rural roads has hampered input supplv, access by extension services and collection of seed cotton. Break-down of the national agricultural research system has resulted in virtually no technical improvement of the subsector for many years. 44. The slump in production and the increasing burden of fiber imports has led to real efforts to redefine government's policy towards the cotton sector. As a first step, Government has addressed producer incentives, has taken measures to improve smallholder access to credit and has shifted to a policy of active support to the large farmers. However, a number of key issues will have an impact on the success of this program; these issues are discussed below. 45. For years the large private farms, particularly those owned by non-Malagasy nationals, have operated in a climate of uncertainty. In the cotton subsector the technical strength and efficiency of the large farmers did win them some protection as the backbone of cotton production, but even they have suffered from official neglect and, most recently, from foreign exchange shortages. Government has recently taken steps to reassure these farmers of their key role in cotton production and development. 46. The present scarcity of foreign exchange affecting all sectors of the Malagasy economy has had a severe impact on the cotton subsector, which is a high consumer of imported inputs. Until 1981, HASYMA, which is responsible for input supply for all cotton producers, had no difficulty in obtaining sufficient foreign exchange but thereafter allocations of foreizn exchange throuzh normal channels have been inadequate and HASYMA could only procure its requirements under bilateral aid programs. The large planters, who account for 60% of total cotton production and are dependent upon the use of mechanical equipment, have also been unable to obtain foreign exchange for spares and equipment renewal. Most of their equipment pool is past its useful life and the likelihood of disruption to this production system is increasing. Smallholder production has already been disrupted as plows for animal traction have become scarce, as a result of a lack of foreign exchange for the purchase of raw materials by the local manufac- turers of agricultural equipment. It is essential for the future of the cotton subsector that adequate and timely foreign exchange is made avail- able. Foreign exchange allocation procedures are under review by the Government. It has set up a special allocation committee and is working on a set of criteria to allocate foreign exchange. The annual work program to be submitted by HASYMA should include a forecast of the foreign exchange  - 13 - allocation required (Schedule 2 (IV) of the Draft Project Agreement) and Government will make available, annually, sufficient foreign exchange (draft Credit Aareements, Section 3.01(e)). 47. Until 1983, the price structure of seed cotton was complex and the official seed cotton price was only one element of the final price received by the producer. The final producer price consisted of three elements: (a) an official price announced by Government decree; (b) a bonus paid to the producer by the textile factories; (c) a subsidy on chemical inputs used. 48. Although official producer prices have risen in nominal terms each year, the price of cotton remained low in relation to the import parity price until the end of the 1970s. Unattractive prices were a major factor contributing to the fall of cotton production during 1972-78. In 1981, and again in 1982 and 1983, official prices were substantially increased. Present final seed-cotton prices (including the bonus and subsidy) are attractive in relation to production costs and returns for other crops, and are close to the import parity price at the official exchange rate. 49. Government indicated, following appraisal, that a new policy for future price reviews would Drovide for a single seed cotton price to include the elements currently paid as bonus and subsidy. The present subsidy:on farm inputs will be eliminated (Section-2.10 of Project Agreement). The Government has confirmed at negotiations that before the start of the planting season producer price for seed cotton winl be set in relation to the import parity price to maintain at least the present level of producer incentives. Specific proposals would be included for the first time in HASYMA's 1984 work program and budget to be agreed by IDA and Government no later than December 31, 1983. This is a condition of Credit effectiveness (Section 5.01 (b) of draft Credit Agreements). IV - THE PROJECT 50. The Project was appraised in November 1982. A staff appraisal report entitled Madagascar Cotton Development- Project (No.4514-MAG) dated November 18, 1983 is being distributed separately. Negotiations were held in Washington D.C. from November 9 through November 15, 1983. The Malagasy delegation was led by H.E. Leon Rajaobelina, Madagascar's Ambassador Designate to the United States. Project objectives 51. The proposed project would support Government's cotton development program aimed at expanding seed cotton production over a four year period from 1982 levels of around 26,000 tons to about 45,000 tons, thereby saving foreign exchange for imports of cotton fiber; 26 percent of this increase in production would be achieved by increasing yields on  - 14 - e6istinz areas and 74 percent by extending cultivation through the development of 8000 ha. of new lands. Project area 52. The Project area comprises a number of scattered production areas in two broad zones to the north and south of the Tsiribihina River, totallina about 131,200 km2. The northern zone, where production is on the -flood-recession" system, consists basically of two areas, the region around Ambilobe in the Faritany of Antsirinana and the triansle around Xaevatanana, Ambato-Boeni, and Port Berge, in the Faritany of Mahajanga. The area is mostly flat and is dominated by many wide rivers; severe floods occur in the rainy season. The southern zone, where production is rainfed or irrigated, stretches from the coast at Toliara and reaches inland with increasing altitude up to Ihosy. The landscape varies, flat at lower altitudes but more undulating inland. 53. The population in the Project area numbers about 800,000. Althouzh population densities are low, availability of labor is not a constraint for the larze farms in the northern zone as there is sianificant seasonal migration of casual labor, and permanent labor has been provided by spontaneous settlement around the large cotton farms. In the southern zone, which is dominated by smallholders, most agricultural activities are carried out by family labor and there is little demand for hired labor. Project Description 54. The proposed project would include: (a) provision of equipment and vehicles to replace and expand existing pools, and so improve yields and extend areas planted to cotton; (b) rehabilitation and maintenance of rural tracks to improve communications for input supply and marketing; (c) provision of farm inputs to maintain and improve productivity; (d) construction of workshops and stores to maintain equipment and vehicles and ensure input supply; (e) adaptive cotton research and pre-production trials aimed at boosting yields and improving production techniques; (f) technical assistance to HASYMA (project agency) and SAMANGOKY (cotton parastatal), training of their personnel and strengthening of the data processing system of HASYMA, the Project agency;  - 15 - (2) monitoring and evaluation of Project activities; and (h) studies. 55. Equipment and Vehicles: F--,uipment and vehicles would be provided for sale to cotton producers. Bulldozers, tractors with accessories such as harrows. ploughs, ridzers, seed drills, sprayers and rotary slashers and trucks and cars would be made available to the participating larze farmers. Smallholders' equipment would comprise animal traction equipment, and HASYMA would receive equipment for its demonstration farms and seed production centers. HASYMA would also receive trucks, cars, motorcycles and bicycles for its extension service and the transport of inputs. A radio communication system would be provided to improve pest control programs. An airplane would be provided to HASYMA to facilitate staff access to widely scattered production locations. Acquisition of this 4-6 seater single enzine plane is expected to reduce transport costs significantly by eliminating costly charters and to improve management and staff contact with the field, both in the north where most farms are cut off by flooding for several months and in the south where the rugged terrain makes access difficult year round. Most cotton farms and areas have landing strips and for a number of years HASYMA operated its own aircraft effectively. The proceeds of the sale of equipment will be deposited with BTM in a special account to increase credit availability to farmers (Section 5.01 (e) of draft Credit Agreements and Section 2.12, draft Project Azreement). BTM is expected to continue with its present lending practices of charging interest rates between 14 and 18 percent depending upon terms and conditions. 56. Feeder road and cotton track rehabilitation: Difficult transportation conditions resulting from a deterioration of the rural road network are serious constraints to the maintenance and development of cotton production. The rehabilitation of the main roads in the project area is already provided for under the present government plan for the rehabilitation of the economic road network. Financing is provided under the Sixth Hizhway Project recently approved. However, there are no plans for the rehabilitation of the cotton tracks which play a vital role in the supply of inputs and the transport of seed cotton. The project would therefore Provide for rehabilitation and subsequent maintenance of about 500 km of feeder tracks. This involves, in the south, the building of structures to alleviate bottlenecks, together with simple maintenance; in the north more elaborate structures are required together with new align- ments on high ground for approximately 50 km of tracks presently inundated and the supply of 4 ferries, together with track maintenance at least cost. Quantities are estimated from the results of field reconnaissance priced in line with recently let contracts and form an acceptable basis for the cost estimates within normal tolerances except for new alignments where quantities have not been the subject of detailed survey. Because of the comparatively high uncertainties for the rehabilitation component in the north a special contingency of 60 percent on these works has been built in to project costs. Detailed engineering will be available by early 1984.  - 16 - 57. Provision of Farm Inputs: Owing to the foreign exchanae crisis, HASYMA has been finding it increasingly difficult to obtain the necessary chemical inputs to supply the cotton producers. Under the Project, fertilizers, insecticides and herbicides would be imported for sale to producers, with Project finance of 100% in the first and second year of the Project, declining to 60% in the third year, 20% in the fourth year and being eliminated in the last year. The inputs will be sold at a price determined to cover the full cost to HASYMA. (Section 2.10, draft Project Agreement.) The Project would also provide for the reinforcement of ongoing seed production programs. 58. Workshops and Stores: HASYMA's workshop, office accommodation and storage facilities would all be modestly expanded. Two workshops, one at Mahajunga and one at Toliara would be constructed and four combined office/storage facilities of 200 m2 each would be constructed. 59. Research and Trials. An adaptive cotton research program would be undertaken by the national research agency (FOFIFA) with the assistance of IRCT, the French research agency, as part of Project activities. Work would be undertaken to introduce and test improved seed varieties, to multiply seeds, to study soil moisture and fertility, nutrient requirements and fertilizer, and to test new insecticides and herbicides. A detailed research program to be acceptable to IDA will be finalized by September 1984 (Section 2.01(c), draft Project Agreement). 60. Technical Assistance, Traininz and Data Processing. Two agricultural managers, a ginnery specialist, a financial management specialist and an agriculturalist would be recruited to provide assis.cance to HASYMA. (Section 2.02 of draft Project Agreement). Technical assistance for SAMANGOKY, the development and production azency for the lower Mangoky valley, would be provided through the services of a cotton aeronomist, an irrigation engineer and a mechanical engineer (Section 3.03 of draft Credit Agreements). The services of these experts will be financed for the first year under the Mangoky project (Cr. 881-MAG), and for two years subsequently under this project. In addition, external experts in the design and monitoring of research and pest control programs would make short periodic missions to the Project area. Terms of reference and conditions of employment for these posts were discussed during negotiations. 61. Short practical training courses for its own staff and staff of other agencies involved in cotton production and on-the-job training would be organized by HASYMA. Training would be in the hands of the technical assistants or subject matter specialists recruited for short-term assignments as required. On-the-job training and study tours would be made available to management staff. A training coordinator would be appointed by June 30, 1984 to assist HASYMA's General Manager with the implementation of the training program (Section 2.07, draft Project Agreement). 62. Monitoring, Evaluation and Reporting. HASYMA's research unit would be responsible for monitoring progress of Project activities. The functions of the unit would be to: (i) provide management information for decision taking; (ii) coordinate monitoring of technical aspects of  - 17 - HASYMA's program; (iii) provide data for continuous ex post evaluation of Project costs and benefits in relation to progress. In addition to ann.al work plans, semi-monthly reports would be prepared and submitted to IDA for comment. No later than six months after the closing date, HASYMA and MPARA would prepare a Project Completion Report to summarize Project performance, evaluate its achievements and draw lessons for the future design and imple- mentation of similar projects (Section 3.06, draft Credit Agreements and Section 2.05(d), draft Project Agreement). 63. HASYMA would carry out certain studies as part of the Project activities. At negotiations draft terms of reference were discussed for two priority studies. First, an institutional study of HASYMA, both internal (manaaement audit) and external (role in the subsector vis a vis other institutions, local communities, etc.). A team of CCCE (cofinan- ciers) was in the field in late 1983 carrying out a preliminary review of HASYMA and terms of reference for the proposed study will be further elaborated once the results of the preliminary review are available in 1984. A second study for HASYMA would review prospects for future develop- ment of cotton production and assess the feasibility of a further stage in Government's cotton development program. Project Organization and Management 64. HASYMA. The Project would be implemented mainly by HASYMA, a Socift6 anonyme, which is owned 702 by Government and 30% by the "Compagnie Francaise pour le Developpement des Fibres Textiles- (CFDT). It is governed by a Board of Directors (seven Government representatives and three from CFDT), but day- to-day operations are largely entrusted to a General Manager appointed by the Board subject to approval of MPARA. The Company has enjoyed substantial autonomy in its efforts to develop the cotton sector but it maintains close and frequent contact with MPARA and MI, the two ministries responsible for its supervision. HASYMA has retained much of the professionalism of its CFDT forerunner and is considered to be one of the more dynamic and well-managed of Madagascar's Darastatuls. 65. HASYMA's financial performance has been generally good but has deteriorated in 1982 because of inadequate margins set by the Government and a sharp increase in interest charges related to the Company's increased reliance or- short and medium term debt to supplement working capital and finance the expansion of zinning capacity. The financial viability of HASYMA in the future depends on adequate margins and an increase in equity capital. Proposals on the margins, which are linked to seed cotton and fiber prices, would be included in the annual work prozrams (Schedule 2, draft Project Agreement). No profit will be distributed as long as the debt equity ratio remains at or below 70:30 and during the period of amortization of Project loans, the profits distributed in any given year will not exceed 25% of net income after taxes (Section 4.03, draft Project Agreement). Furthermore the government will make a contribution to HASYMA's working capital so that current assets of HASYMA will be equal to or exceed twice the current liabilities of HASYMA as at end 1983. This is a condition for Credit effectiveness (Section 5.01 (f) of the draft Credit Agreements).  - 18 - 66. Annual Work Programs. HASYMA would prepare annual work programs which would serve three purposes: (i) to facilitate a full annual review of Project progress; (ii) to make adjustments possible as experience is gained; and (iii) to serve as a planning, implementation and monitoring tool. The annual work program would also specify the foreign exchange allocation required by HASYMA to carry out the program, and spell out producer fiber pricing proposals. Assurances were received at negotiations that the annual work programs would be submitted to IDA for comments no later than April 15 of the year preceding the year of the program (Section 2.08 and Schedule 2, draft Project Agreement). Final programs agreed by IDA and the Government would be prepared no later than December 31 of each year at which time the Government investment budget would normally have been voted by the National Assembly. IDA's approval of annual work programs would be a condition of disbursement for the activities to be undertaken durinz the year (Schedule 1, draft Credit Agreements). The approval by IDA of the finalized program for the calendar year 1984 would be a condition of Credit effectiveness (Section 5.01 (b), of draft Credit Agreements). 67. HASYHA would be responsible for the recruitment of technical assistants: job descriptions and proposals for recruitment were agreed at negotiations. The research component would be implemented by the national research institution, FOFIFA, with support of IRCT, a French research agency. 68. HASYNA would implement the component for the rehabilitation of cotton tracks. It would be responsible for the preparation of bidding documents for rehabilitation work in the north and building of minor structures in the south. With the Ministry of Public Works (MTP) and consultant assistance, HASYMA will be responsible for the execution of the works and maintenance of the tracks through two maintenance brigades. MTP would be responsible for major maintenance works beyond the capacity of -LASYMA's brigades (Section 3.02, draft Credit Agreements). The value of inputs financed by the project (with the exception of the first year of the project) will be retained by HASYMA in a separate account to finance the rehabilitation and maintenance of cotton tracks or for other purposes (Section 2.11 draft Project Agreement). 69. A small part of the technical assistance component (SDR 280,000) will be executed by SAMANGOKY, the government agency responsible for the development of the Lower Mangoky Valley; as indicated in para. 60, the Special IDA Fund Credit will finance the services of the experts after the funds for the Mangoky project (Credit No. 881-MAG) have been exhausted. Project Costs and Financing 70. Total Project costs are estimated at about FMG 16.3 billion (USS34.4 million) of which some 85 percent would be in foreign exchange. These costs include only negligible amounts of taxes in the form of a sales tax on goods locally produced. Government has not yet decided whether  - 19 - goods imported for the Project would be subject to taxes and duties: if they are, then the Government and/or HASYMA would provide the funds necessary tn pay for them, about FMG 1.2 billion (US$2.5 million equivalent). 71. The cost estimates were made on the basis of prices prevailing in January 1983 and adjusted for inflation to late 1983 levels. A phvsical contingency of 5 percent was applied to the cost of inputs; and of 10 to 20 percent on civil works and track maintenance. A special contingency of 60% over the estimated base cost was applied to the northern tracks rehabi- litation sub-component. This sub-component represents about 5 percent of project base cost and the special contingency is thus equal to about 3 percent of project base cost (see para 56). No physical contingency was applied to technical assistance, monitoring and evaluation, training or studies. Price contingencies were calculated on a cumulative basis: 12% for domestic inflation per annum through 1987 and 7.5% for international inflation in 1983 and 1984, 7.0% in 1985, 6.0% in 1986 and 1987. 72. The financing of Project costs would be shared by IDA, the IDA Special Fund, French Caisse Centrale de Cooperation Economique (CCCE), and HASYMA. The proposed IDA Credit of SDR 7.5 (US$7.9 million) and the IDA Special Fund Credit of SDR 9.4 (USS9.9 million) would be to the Government of Madagascar on standard terms and conditions. The Credit would finance imports of vehicles and equipment and aaricultural inputs (starting in the second year) and the costs of consulting services up to USS100,000. The proposed IDA Special Fund Credit would finance the second and subsequent years of imports of vehicles and equipment up to US$1.0 million and of agricultural inputs up to US$3.0 million. The IDA Special Fund Credit would also finance the foreign exchange costs of civil works for the track rehabilitation, and of technical assistance monitoring andevaluation, training and studies. Should the special contingency for the northern track component prove too high after detailed engineering, the corresponding Credit funds would be used for financing a small part of local costs for track maintenance. Financing of chemical inputs would be on a declining share basis. 73. The Credit funds provided to HASYMA would be in the form of a loan for capital expenditures; and in the case of monitoring and evalua- tion, traininz and technical assistance, they would be a grant. Lending terms of government to HASYMA would be 14% interest repayable over nine years wi.h two years grace. Signature of a subsidiary loan agreement between Government and HASYMA is a condition of Credit effectiveness (Section 5.01 (a) of draft Credit Agreements). It is expected that the CCCE loans of FF86.3 million would be repayable over ten years at an interest rate of 41% with five years grace. The effectiveness of the CCCE agreement would be a condition of Credit effectiveness (Section 5.01 (c) of draft Credit Agreements). 74. Inputs and equipment for farmers would be sold on prevailing commercial terms (cash or credit) and the proceeds collected by HASYMA and BTM. Funds from the sale of inputs would be maintained in a separate account by HASYMA and used to finance local costs of the road rehabilita- tion component or for another purpose acceptable to the Association (Section 2.11 of draft Project Agreement). Funds from the sale of  - 20 - equipment would be placed in a special account with BTM, the Agricultural Development Bank, and would be used to provide credit to cotton farmers (Section 2.12 of draft Project Agreement). Signature of an agreement on these funds between BTM, HASYMA and MPARA is a condition of Credit effectiveness (Section 5.01 (e) of draft Credit Agreements). Amount Allocated (US$ million) IDA IDA Special Fund Plant, Vehicles & Equipment 3.3 1.0 Civil Works - 2.5 Agricultural Inputs 4.1 3.6 Technical Assistance - 1.6 Monitoring & Evaluation 0.2 Training - 0.2 Studies by HASYMA 0.1 0.2 Unallocated 0.4 0.6 7.9 9.9 Procurement and Disbursement 75. Equipment and vehicles (including the small aircraft) over a value of USS100,000 and agricultural inputs would be procured following international competitive bidding. Procurement under the IDA Special Fund will be subject to eligibility criteria applicable for the IDA Special Fund. In order to ensure that prices are competitive, orders will be bulked to the extent possible. In the case of certain items of equipment intended as complements to existing pools, appropriate weighting would be given to standardization in the bid evaluation. Ferries (about USS 200,000) would be constructed by local suppliers following local shopping procedures. In the case of pesticides, procurement may exceptionally be by direct purchase of formulated materials of proven effectivenes where there is only a single manufacturer. Rehabilitation of rural tracks in the north and buildings construction would be carried out by contractors selected in accordance with local competitive bidding in procedures satisfactory to the Association. International contractors are represented in Madagascar and are active in many projects. Others not already involved in the country would be eligible to participate but are not likely to be interested in these small contracts. Local competitive bidding procedures would be used for purchases of equipment and supplies for amounts between US$20,000 and USS100,000 while prudent shopping would be employed for purchases under US$20,000 (total procurement under US$100,000 about USS0.6 million). Under the project, HASYMA is responsible for procurement. Its procedures, as established by its Board of Directors, are in accordance with local laT.s and regulations and are acceptable to IDA. Technical assistants financed  - 21 - under the IDA Special Funds credit (US$1.9 million) would be recruited from IDA Special Fund countries accordinR to Bank/IDA auidelines for the use of consultants. Terms of reference and conditions of employment would have to be satisfactory to IDA. Invitations to bid, proposed awards and contracts would be subject to IDA's prior review for all contracts over US$100,000. Assurances on these procedures were obtained at negotiations. Procurement of items financed by the CCCE would be in accordance with CCCE and zovernment guidelines. 76. It is estimated that funds from the Credit account would be disbursed over four and a half years. This is faster than experience for similar projects in the country and region as the Project is a short (four year) project with the majority of investments made in the first two years. The Project is also relatively simple and represents a time-slice of a continuing program. Funds from IDA and the Special Fund Credits would be disbursed on the following basis: (i) for vehicles and equipment, agricultural inputs and civil works, 100 percent of foreign expenditures and B0 percent of local expenditures; and (ii) for consultants services, monitoring and evaluation, training and studies, 100 percent of foreign expenditures. Accounts and Audit 77. HASYMA's existing computerized financial management and accounting system is adequate to control and record expenditures under the Project with assistance from the technical assistance financial management specialist provided under the project. Assurances were obtained at negotiations that HASYMA would keep separate Project accounts, and have these and the accounts of the company as a whole, audited annually by auditors acceptable to IDA and submit the accounts to IDA no later than six months after the close of each financial year (Sections 4.01 and 4.02, draft Project Agreement). Project Benefits, Risks and Justification 78. The principal physical benefit expected to result from Project activities would be incremental production of seed cotton: at full development this should be of the order of 19,000 tons per annum worth about US$10.0 million. The decline in cotton production will be halted, thus preventing an estimated loss of 1,600 tons of seed cotton at full development, worth about USS0.9 million. Project beneficiaries fall into two categories: 43 large private farms and 20,000 smallholders. The rural population in the vicinities of the large farms would benefit from increased levels of economic activity there. Smallholder's per capita cash income is expected to rise from about FMG 25,000 (US$53) per year to around FMG 36,000 (US$76) per capita per year as a result of Project activities. 79. The rate of return of the Project is calculated at 30% over 20 years. For the purpose of analysis, foreign exchange was shadow priced at FMG600 to the dollar and project benefits were estimated on the basis of farm model estimates of increased production from improved yields and extension of area under cultivation. Project benefits were valued at  - 22 - import parity prices as Madagascar is a net importer of cotton. Costs of the development of new areas financed by farmers were taken into account in calculating Project costs. Provision was made for replacement of plant, equipment and vehicles five years from the time of purchase. Base cost estimutes for the southern tracks were increased by a physical continzency of 10 percent applied to civil works since these estimates are considered reasonably certain. The special continEency of 60 percent on the northern tracks rehabilitation sub-component (para 71) was treated as follows: for the base case economic evaluation, half the special continsency (30 percent) was added; for the sensitivity analysis the additional 30 percent was added, which reduced the overall rate of return by 2 percentage points. 80. The Project does not carry any unusual risk. The most likely risks are a lower than anticipated rate of adoption of new agricultural practices, greater than normal incidence of dry years and insect pests, and lack of foreizg exchange. The rate of adoption has been conservatively estimated but it is sensitive to the producer price of cotton. Government has undertaken to maintain this at adequate levels. The availability of foreign exchanze will depend on future improvements in the overall economic situation: issues of pricing and foreign exchange allocation are at the forefront of the continuing dialogue between the Bank Group and the Malagasy authorities and will be kept under constant review. 81. With these risks in mind, the rate of return was tested for sensitivity. If adoption were slower than anticipated by two years (consistent with a lag in raising the producer Prices), the rate of return might drop to 9 percent; the risk from greater than normal incidence of dry years or drought has been evaluated by assuming that incremental production in every fourth year, startinz in year 1 is only half of projected production. The rate of return to rainfed components, which attract a hizh rate of return of over 100 percent before sensitivity, from this analysis was still 52 percent. If in addition average be.iefits weme 20 percent lower the rate of return to these components would fall to a still satisfactory 26 percent; and if insect pest risks cannot be contained, benefits might drop by up to 10 percent, and the overall rate of return of the Project might be no more than 17 percent. If benefits went down 20 percent and costs down 10 percent (consistent with a foreign exchange shortaze) the rate of return might drop to 15 percent; if the costs of the track component in the north increased by another 30 percent over estimated base costs the overall rate of return would drop by two percentage points. 82. The Project presents no hazard to the environment or to human health. The use of pyrethrin-based insecticides instead of the DDT and organophosphates previously used has decreased the level of toxicity and frequency of sprayings needed. A pesticide monitoring program to monitor the effects of chemical use on man and the environment would be established. The proposals would form part of the monitoring and evaluation program to be submitted for IDA's approval.  - 23- PART V - LEGAL INSTRUMENTS AND AUTHORITY 83. The draft Development Credit Azreement between the Democratic Republic of Madagascar and the Association, the draft Special Fund Credit Agreement between the Democratic Republic of Madagascar and the Association as Administrator of the Special Fund and the Recommendation of the Committee provided for in Article V, Section 1 (d) of the Articles of Agreement of the Association are being distributed separately to the Executive Directors. 84. S-rcial conditions to the Credit are listed ir. Annex III of this report. Additional conditions of effectiveness of the proposed IDA and the Special Fund Credits are: Ci) Establishment of coordination mechanism for cotton/textile sector; (ii) Effectiveness of CCCE loan credit asreement; [ii) Signature of onlendinz agreement between Government and HASYMA; Civ) Signature of an agreement between HPARA, BTM, and HASYMA, concerning the use of the special reserve fund; [v) Government has made a contribution to HASYMArs workinLr capital; (vi) Approval of first year's annual annual work program; 85. 1 am satisfied that the proposed credit would comply with the Articles of Azreement of the Association and the proposed Special Fund Credit would comply with Resolution No. IDA 82-6. PART VI - RECOMMENDATION 86. I recommend that the Executive Directors approve the proposed credit. A. W. Clausen President by Ernest Stern Attachments December 1, 1983  BEST COPY AVAILABLE - 24 - ANNEX I ArgeLCa4 iwl of 5 SAaAGASC" - SOCIAL I.lQTORS uA.m Ssar nAUAGsNC: cumsacSin (u;fUa1nirm AvLRAGLS) Ia MOST fMfST E7 ESTIMATE) lb RFcTlb z.aI SGHE 5E1L8 izcOH 1ntk 170rb-