Mexico - Eighth Agricultural Credit Project

Documr.ent of The World Bank FOR OFFICIAL USE ONLY Report No. 5014b-ME STAFF APPRAISAL REPORT MEXICO EIGHTR AGRICULTURAL CREDIT PROJECT June 4, 1984 Projects Department Latin America and the Caribbean Regional Office This document is a restricted distribution ad my be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank antherizato.  CURRENCY EQUIVALENTS 1983 US$1 Mex$ 160 Mex$ I = US$0.0062 Mex$ 1 million US$6,250 1982 US$1 Mex$ 70 1981 US$1 Mex$ 24.5 1980 US$1 Mex$ 12.5 WEIGHTS AND MEASURES Metric System 1 hectare (ha) 10,000 m2 = 2.47 acres 1 kilometer (km2) 2 0.62 miles I square kilometer (km2) - 0.39 sq. miles = 100 ha 1 kilogram (kg) 2.20 pounds 1 liter (1) 0.26 gallons 1 cubic meter (m3) 35 cubic feet 1,000 kg = I metric ton 0.93 long ton AMBREVIATIONS ACF - Index of Average Cost of Funds to Multi--Purpose Banks BANRURAL - National Rural Credit Bank CONASUPO - National Marketing Corporation FEFA - Special Agricultural Credit Trust Fund FEGA - Technical Assistance and Loan Guarantee Trust Fund FIRA - Agricultural Trust Funds in the Bank of Mexico FONDO - Trust Fund for Crop, Livestock and Poultry Credit IDB - Inter-American Development Bank NAFINSA - Nacional Financiera, S.A. SARH - Ministry of Agriculture and Water Resources FIDEC - Trust Fund for Marketing Development SOE - Statement of Expenditure GOVERNMENT OF MEXICO FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT EIGHTH AGRICULTURAL CREDIT PROJECT MEXICO Table of Contents Page No. LOAN AND PROJECT SUMMARY ..................................D6 6 iii I. THE AGRICULTURAL SECTOR ....................... ............ 1 Agriculture in the Economy ........... ................ 1 Production, Trends and Past Agricultural Policy .... ....... 1 Present Government Agricultural Strategy .................. 2 Agricultural Credit ............................... 3 Previous Bank Projects ................ ****** ............. 6 II. THE PROJECT ... *w.* ................................... 8 A. Introduction ....................*66**60**60600**6**0606066 8 B. Project Objectives and Description ........ ............. 8 C. Detailed Features D................... * ................. 9 F. Project Costs ........................................... 13 E. Financing .......................................... 13 F. Procurement oo........................................ 15 G. Disbursements ************************.*.**............. 17 III. PROJECT IMPLEMENTATION ............... ..................... 19 A. Project Execution ...................................... 19 B. Sublending Procedures DODD ............ 0*6600 6060666 19 C. Accounts and Auditing *..........*....................... 22 IV. PROJECT BENEFITS AND RISKS .... ........... 23 A. Illustrative Investment Plans ..... ..................... 23 B. Project Benefits ....................................... 23 C. Project Risks * .........................* ............... 26 V. SUMMARY OF AGREEMENTS REACHED AND RECOMMENDATION .......... 26 This report is based on the findings of an appraisal mission which visited Mexico during November 1983. The mission consisted of Messrs. G. Russell, M. Wilson, E. Brook (Bank), and P. Stroh (Consultant). 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.  Table of Contents (continued) Page No. TABLES IN TEXT 2.1 Total Investment Program ..... .......................... 14 2.2 Financing Plan ......................................... 16 2.3 Estimated Disbursement Schedule ........................ 18 3.1 Structure and Adjustment of On-lending Interest Rates by Category of Producers ... 21 4.1 Summary of Financial and Economic Results of Investment Plans 24 4.2 Estimated Impact of Subloan Inivestments on Yields of Key Products 25 ANNEXES Annex 1 - Imports and Exports of Selected Agricultural Products - (1975-1983) ..................................... 28 Annex 2 - Production Trends of Key Agricultural Commoditiese - (1975-1982) ............................................... 29 Annex 3 - Loan Portfolio for Agriculture through the Banking System by Type of Financial Institution ........... 30 Annex 4 - Agricultural Trust Funds (FIRA) ..... ................ 31 Tl. Principal Indicators of FIRA's Operations (1977-1983) .. 33 T2. Comparative Statement of FIRA's Consolidated Financial Statements (1977-1983) ..................... 34 T3. FIRA Lending (1976-1983) and Projections (1984-1988) .... 35 T4. Comparative Statement of FIRA's Profit and Loss Statements (1979-1983) .*.... ........ .... ... 36 T5. FIRA Discounts by Category of Producers (1977-1983) C... 37 T6. FIRA Projected Cash Flow (1984-1988) ..... .............. 38 T7. FIRA Projected Balance Sheet (1984-1988) .... 6........... 39 Annex 5 - Illustrative Investment Plans ..... .................. 40 Tl. Rainfed Annual Crops Farm .............................. 44 T2. Irrigated Annual Crops Farm ............................ 45 T3. Beef Ranch ..................*..*.....*..............* 46 T4. Dual-Purpose Cattle Farm .. ............................. 47 T5. Egg Production Unit .................... ........ ..... 48 T6. Feed Mill ...............................49 Annex 6 - Selected Documents and Data Available in Project File 50 MAP No. 11789R2 - Mexico - Eighth Agricultural-Credit Project-Distribution of FIRA Offices  - i - MEXICO EIGHTH AGRICULTURAL CREDIT PROJECT Loan and Project Summary Borrower: Nacional Financiera, S.A. (NAFINSA) Guarantor: United Mexican States Beneficiary: Agricultural Trust Funds in the Bank of Mexico (FIRA) Amount: US$300 million equivalent, including a capitalized front-end fee of US$748,130. Terms: Fifteen years, including three years of grace, at the standard variable interest rate. Relending Terms: Funds would be provided to FIRA in the form of equity. The proceeds would be relent by FIRA on terms and condi- tions that vary with the income level of the beneficiaries and purposes of the subloans, as specified in the General Interest Rate Agreement negotiated recently with Government. Project Description: The project is a credit program which would seek to in- crease agricultural productivity and production with a view to increasing exports and self-sufficiency in food and protecting real farm income. It would continue to develop FIRA's institutional framework for efficient allo- cation of financial resources and assist to improve agri- cultural policies through the reduction of interest rate subsidies. The low-income producers' component, would comprise about one-half of the total investment program. A program of training and demonstration would provide sup- port to credit operations. About 105,000 families or 580,000 beneficiaries would benefit from the project. Project Risks: Since FIRA is a reasonably efficient and mature insti- tution, the project presents no special risk in terms of the technical and financial soundness of various invest- ment opportunities that would be financed under the pro- gram. The main risk would be that political pressures would impede progress in eliminating interest rate subsi- dies, especially in the case of a resurgence of inflation causing a further deterioration of FIRA's financial posi- tion, a continued drain on Government budget resources, and a continued misallocation of production factors.  - ii - Estimated Cost: Local Foreign Total --US$ million -- I. Investment Program Crop Investments 103 129 232 Livestock Investments 120 39 159 Agroindustrial Investments 33 27 60 256 195 410 II. Working Capital 137 60 197 Subtotal 393 255 648 III. Productive Support 12 3 15 IV. Project Cost 405 258 663 V. Price Contingency 59 41 100 VI. Total Investment 464 299 763 VII. Front-end Fee on Bank Loan - 1 1 TOTAL 464 300 764 Financing Plan: Local Foreign Total =-- USS million Participating Banks 102 - 102 FIRA 260 - 260 Bank - 300 300 Beneficiaries 102 - 102 TOTAL 464 300 764 Estimated Disbursements: Bank FY 1985 1986 1987 1988 1989 US$ million Annual 80 75 80 60 5 Cumulative 80 155 235 295 300 Staff Appraisal Report: Report No. 5014b-ME dated June 4, 1984. Economic Rate of Return: Economic Rates of Return for subloan investments range from 19% to over 100%.  I. THE AGRICULTURAL SECTOR Agriculture in the Economy 1.01 Mexico's agricultural sector contributes about 10% of the gross domestic product, employs about one-third of the country's active labor force and contributes about 6% to the country's exports. Between 1945 and 1955, agricultural production growth rates annually averaged about 6%, but declined to about 4.4% between 1955 and 1965, and to less than 3% between 1965 and 1980. During the latter period, production increases from newly irrigated land slowed down and agricultural terms of trade gradually worsened. How- ever, agricultural production increased at an annual average rate of about 8.5% in 1981 and 1982. The increase was the combined result of favorable weather conditions, higher farmr-gate prices and large input subsidies under the Government-sponsored Mexican Food Program (SAM). 1.02 The reduced agricultural production growth before 1981, coupled with inu- .asing internal demand, resulted in increased food imports and dete- rioratio- in the agricultural trade balance. In 1979 the country experienced its firvt agricultural trade deficit, and in 1981 the deficit was over US$1 billizn. However, since 1982 the agricultural trade deficit has reversed primarily due to reduced imports influenced by substantial devaluations. Since 1970, corn, wheat, soybeans, sorghum and powdered milk have been the principal food imports, representing about 7.6% of total imports i:a 1980. During the same period, cotton, coffee, fruits and vegetab..es constituted the main exports (Annex 1). Production, Trends and Past Agricultural Policy 1.03 Mexico's basic crops, which include maize, beans, wheat, rice, sorghum, soybeans and sugarcane are produced on about 75% of the cultivated area (Annex 2). Production has varied strongly from year to year with a basic growth trend of 1.5% to 2.5% over the 1970s, i.e., well below the popu- lation growth rate. Government intervention in the price setting and marke- ting of these crops gradually grew stronger over the decade. With the pres- sure to protect the consumer against increased food prices during a period of gradually increasing inflation, the terms of trade worsened. As a result, imports of these crops increased strongly, i.e., maize imports increased from 736,000 tons in 1970 to 3.8 million tons in 1980 and sorghum imports from 10,900 tons in 1970 to 2.8 million tons in 1981. From 1980 to 1982, the Government attempted to reverse this trend, by substantially increasing farm-gate prices and introducing a range of input subsidies in the context of SAM. Farmers responded positively but, as consumer prices for the basic products were adjusted more slowly than producer prices, consumer subsidies also increased and the Government program became too costly to maintain after 1982.  - 2 - 1.04 The production of export crops (mainly coffee, fruits and vege- tables), which has remained relatively free from Government intervention in trade and prices, showed an annual average growth of about 12% between 1975 and 1979. In the ensuing three years, exports of these crops stagnated, mainly due to an increasing overvaluation of the Mexican currency. However, indications are that since 1982, growth has resumed. Regarding livestock activities, beef production grew at an annual rate of 7% between 1975 and 1982, and pork, poultry meat and egg production at even higher rates, between 10% and 12% annually over the same period. These growth rates were sufficient to cover increased domestic demand and Mexico's traditional beef exports were basically maintained. Milk, however, which is produced under controlled prices, grew at only about 1.8% per annum during this period. Milk imports in the ten years before 1982 rose at an annual rate of about 20%, and presently equal about 16% of total production in fluid equivalent. 1.05 Growth in related sectors has been mixed: (a) the agroindustries subsector grew rapidly through the decade of the 1970s (10 per annum), and in 1979 accounted for about 18% of the industrial sector's output; (b) the forestry sector which comprises about 21 million ha of commercial wood is underexploited, producing only about 9 million m3 of wood products in 1981; and (c) the fisheries subsector has shown significant growth in recent years, rising from an annual catch of about 0.25 million tons in 1970 to about 2 million tons in 1982. Approximately 30% of the value went into exports (mainly shrimp) and about 50% of the total catch into fish meal. Present Government Agricultural Strategy 1.06 At the end of 1982, when the new Government took office, there was an urgent need to reassess and reorient agricultural development policies. After substantial devaluations, domestic farm-gate prices had deteriorated in real terms. Strong price increases, especially for the basic commodities, were required if farmers were to maintain and increase production levels. On the other hand, in order to lower high inflation levels, there was a need to contain increased food prices. Also, in view of high public sector deficits, the Government's agricultural subsidy policy needed to be overhauled. 1.07 The Government's strategy, as outlined in the National Development Plan for 1983-1988, aims at accelerated agricultural growth. The policy emphasizes the importance of agriculture in increasing Mexican exports and production of import substitutes. The stated policy over the medium-term is to guarantee farm prices which are consistent with international prices. However, in the short-term, emphasis is being placed on adequate compensation for the increased cost of production and a reasonable profit margin to produ- cers to determine price levels. Prices for basic crops (i.e., mostly the controlled sector) increased about 120% in nominal terms during 1983 and further increases, averaging about 35%, have been made in 1984. The basic staples, such as maize and wheat, are now priced at current international levels. Input subsidies have been strongly reduced. Subsidized prices for key inputs (i.e., fertilizer and seeds) are now only available to  - 3 - rainfed-maize production to small farmers holding less than 20 ha each. Interest rates on agricultural subloans, which until now were fixed and gene- rally negative in real terms, will be made variable and are to approach positive levels gradually, in accordance with a timetable that fo,-ms part of the General Interest Rate Agreement between the Government and the Bank. The movement in rates will be referenced to the latest average cost of funds to multipurpose banks (ACF)1/. Irrigation water rates were increased on an average of about 200% during 1983, which implied an increase in real terms at the time, and further adjustments are expected to be made towards the stated goal of achieving operationL and maintenance costs recovery, under a gek'eral strategy to improve the use and management of Mexico's water and soil resources. Improvement and rehabilitation projects would be undertaken in existing irr'gation areas, and new investments would be decided on selectively, stressing small and medium-scale irrigation projects in region., with a lesser degree of development. The Government is also taking steps to decencralize planning, programming and implementation of rural development projects to state and local levels and to improve interagency coordination. Agricultural policy dialogue between the Government and the Bank has been intense in the recent past, and both have agreed to a continuous policy dialogue in the future. Agricultural Credit 1.08 Within the context of its agricultural development policies, the Government has used credit as an important instrument for achieving growth and equity objectives. First, it has encouraged growth in agricultural lend- ing by making public funds available (through the Bank of Mexico or from the budget) to various financing agencies, such as the Agricultural Trust Funds (FIRA), to discount subloans made by Mexican banks. Second, it has signifi- cantly promoted credit to low-income producers by (a) financing operating subsidies of the state-owned National Rural Credit Bank (BANRURAL para. 1.16); (b) providing technical assistance and loan recovery guarantees to commercial banks that lend to low-income producers (para. 1.17); (c) obliging such banks to hold part of their legal deposits in the Bank of Mexico in low-income producer loans (para. 1.17); and (d) since 1976, increa- singly, financing subsidized interest rates on loans to such farmers. The result has been a dramatic growth in outstanding agricultural credit from the commercial and public banks from Mex$ 17.7 billion in 1970 to Mex$ 218.5 billion in 1981-an average annual increase of 10.4% in real terms. Low-income producers accounted for about 50% of the total loan portfolio in 1981. 1.09 While agricultural credit grew continuously up to 1981, growth came to an abrupt end in 1982, when institutional credit to agriculture fell nationwide by about 28% in real terms; again in 1983 it fell by about 25%. 1/ The weighted average of interest rates paid by financial institutions on bonds, notes, and certificates of deposit, excluding checking and savings accounts. This rate is published monthly by the Bank of Mexico.  - 4 - The decline occurred because (a) as a result of high inflation, recuperations on the existing loan portfolio were inadequate to cover the demand for funds; and (b) the Government was unable to finance the large subsidy required to bridge this gap. In addition, because of strong devaluations, many traditional US sources of short-term financing outside the domestic banking system disappeared. It was estimated that in 1983, the banking system satisfied significantly less than the agricultural credit demand. 1.10 FIRA. The Bank of Mexico is the trustee for the three agricultural trust funds, which are integrated for management and accounting purposes and administered as FIRA: (a) the Trust Fund for Crop, Livestock and Poultry Credit (FONDO), which dJscounts to participating commercial and public banks short-term subloans for crops, livestock and agroindustry; (b) the Special Agricultural Trust Fund (FEFA), which discounts medium- and long-term sub- loans for crops, livestock and agroindustry; and (c) the Technical Assistance and Loan Guarantee Trust Fund (FEGA), which defrays to participating banks part of the cost of subloan evaluation and technical assistance for low-income producers, and guarantees the commercial banks' contribution to these subloans. 1.11 FIRA and the Bank have a long and good relationship, having satis- factorily completed six projects with the ongoing Seventh Agricultural Credit Project (providing a total financing of USS925 million), substantially on schedule. In addition to being one of the main providers of financial resources to the Mexican agricultural sector, FIRA provides significant tech- nical assistance to commercial banks and to farmers, through its training programs and demonstration centers. Throughout the years, FIRA has earned a good reputation, and its management is experienced and of high quality. How- ever, some fine tuning of its operations will be needed, especially in the field of FIRA's medium-term planning, in order to optimize use of scarse resources. Moreover, FIRA's technical assistance program needs to be expanded, to promote producers' adoption of new and improved technology and to strengthen its monitoring and evaluation procedures. FIRA's organization and management, and its planning and programming, training and demonstration, monitoring and evaluation functions are described in Annex 4. 1.12 FIRA has been a relatively sound financial institution. Its conso- lidated financial statements at end-December 1983 showed assets amounting to about Mex$ 146 billion (US$912 million) (Annex 4, Table 2). These assets were financed mainly by the Bank of Mexico, by external loans for which the Government absorbed the foreign exchange risk, and by equity. FIRA's loan portfolio at the end of 1983 amounting to Mex$ 137 billion (US$856 million) represents about 95% of its total assets. During the five-year period 1977-1981, FIRA increased its lending to agriculture at ar. annual average rate of over 20% in real terms. However, lending in 1983 of about Mex$ 123 billion (US$767 million) was about 23% below the 1981 level in real terms (Annex 4, Table 3). All subloan repayments are recuperated on due dates from participating banks through the Bank of Mexico's current accounts; as a  result, FIRA suffers no arrears. Arrears to participating commercial banks on subloans discounted by FIRA are estimated to be about 22. 1.13 FIRA has consistently earned annual profits in nominal terms (Annex 4, Table 4). In 1983, FIRA's average interest Income was 20.7%, and its cost of funds 18.5%, providing a net financial income of 2.2%. However, this net financial income was lower than the previous three years' average of 4.1X, reflecting an increased cost of funds without a corresponding increase in on-lending rates. FIRA's operating costs before recoveries, comprising technical assistance, demonstration centers and administration was a low 2.72 of average loan portfolio in 1983. Recoveries derived from production income of demonstration centers and from Government compensation to FIRA for technical assistance reduced operating costs in 1983 to 1.32 of average loan portfolio. 1.14 Until end-1981, FIRA's annual operating profits were sufficient to avoid decapitalization of its equity. This position was reversed when infla- tion rose to 99% in 1982 and 81% in 1983, while interest rates on subloans were fixed. In addition, prevailing rates for current lending were not raised sufficiently to adjust to the high inflation levels of the period. However, the decapitalization of the loan portfolio was largely absorbed by the Government through (a) Bank of Mexico rediscounts of about 602 of FIRA's discounts at varying rates of interest, allowing FIRA a fixed margin of 32 to 3.5%; and (b) Government guarantees which absorb exchange losses on almost all foreign indebtedness. At end-1983, the accumulated losses (1981 to 1983) on existing FIRA foreign indebtedness to be absorbed by the Government amounted to about Mex$ 70 billion (US$437 million). After deducting the Government subsidy, FIRA suffered decapitalization at an average of about 302 per year during 1982 and 1983. 1.15 For the next four-year period (mid-1984 to mid-1988), FIRA has adopted an overall lending target of about US$3,556 million (Annex 4, Table 3). This would allow it to increase its level of lending by 52 per annum in real terms. Targeted lending for short-term, and for medium- and long-term investments would amount to about 62X and 38%, respictively, of the total investment which is in line with its ongoing program. FIRA's Invest- ment program is reasonable, inasmuch as it reflects the Government's prio- rities to promote agricultural growth and focus on diversification of produc- tion, export expansion and efficient Import substitution and is well within its capacity and that of the participating banks to carry out. However, to sustain such a lending program, FIRA would have to mobilize substantial addi- tional internal and external financial resources. FIRA's proposed lending prcgram would be financed partly by Bank of Mexico financing, equivalent to about 402 of its total lending. The remaining balance would be generated from FIRA's own resources and through external borrowings. During the period 1984-1988, FIRA's financial gap, after allowing for the repayment of USS442 million of foreign indebtedness becoming due, would be USS790 million. The Bank's proposed loan of US$300 million would allow FIRA to reduce thls gap to US$490 million (Annex 4, Table 6).  1.16 BANRURAL. BANRURAL, a public entity and the largest bank in Mexico, incorporates 12 subsidiary regional banks with 630 branches and about 27,000 regular employees. Its lending operations, which increased from MexS 24 billion In 1970 to Mex$ 74 billion in 1981 and MexS 169 billion in 1983, consist mainly of short-term credit (822 of 1983 lending) primarily to low-income producers (about 90;; of total). Its short-term credit covered a cultivated area of 7.3 million ha In 1983, equivalent to 36.4% of all culti- vable lands ln Mexico compared to 232 in 1978. BANRURAL's operating costs are high (about 16X of loan portfolio) and a hlgh percentage of Its loans are In arrears or unrecoverable; as a result, the bank is heavily subsidized. In 1981, the Government allocated from Its budget about Mex$ 54 billion (US$2.2 billion), consisting of an equity contribution of Mex$ 14 billion and an operational subsidy of Mex$ 40 billion. The operational subsidy allowed the writing off of about 20X of its lending operation as unrecoverable and the coverage of operating costs In excess of revenue. While BANRURAL as a financial institution is considered too weak at this tim for direct Bank financing, it Is allowed to participate in FIRA's discounting system because FIRA exercises, through Its own control mechanism, sufficient selectivlty and supervision to obtain good performance. BANRURAL subloans discounted through FIRA generally perform well with only about 62 estimated to be In arrears. BANRURAL discounts are currently only about 122 of total FIRA discounts to participating banks. 1.17 Commercial Banks. The commercial banks, which were nationalized on September 1, 1982, continue to operate in a manner slailar 'to their previous role as private banks. Because of the support extended by FIRA in terms of funds, training of staff and other support services, many comercial banks have established agricultural credit departmnts with agricultural techni- cians, who are graded and authorized to evaluate and approve subloans at varying levels. Lending operations by comercial banks traditionally concen- trated on commercial producers and agroindustries. Consequently, the Bank of Mexico, In order to encourage lending to low-Incom producers, stipulated that 0.72 of total deposits of multipurpose banks and 22 of deposits In comerclal banks must be held in the form of agricultural loans to low-incone producers. In addition, FEGA provides guarantees (about 802 of subloans) and reimburses technical assistance for subloans to low-incom producers. Lending by commercial banks through FIRA to low-Income producers now averages about 282 of total subloans discounted as compared to about 10 In 1980. The commercial banks discounted about Max$ 109 billion (about US$680 million) of subloans wlth FIRA in 1983, representing 832 of FIRA's total discounts (over 952 of all FIRA short-term and over 602 of mediumterm discounts). This has resulted in FIRA financing about 532 of the agricultural loan portfolio of the comercial banks as of December 31, 1983, as compared to a range of 422 to 462 In the three previous years. Previous Bank Projects 1.18 In the past ten years (FY1974-1983), Bank participation in the agricultural sector mounted to USS2,523 million distributed among 19  projects, of which three were credit projects (FIRA V, VI and VII) with Bank financing totalling US$765 million. 1.19 In December 1982, the Bank issued a combined completion report on the Fifth and Sixth Credit Projects (Report No. 4240). The overall conclu- sions were as follcws: (a) FIRA's performance has been impressive and has had a strongly positive impact on agricultural production and institution building; (b) specific components set aside in Bank loans for low-income producers have helped to focus lending more on this farmer category. Also, lending, which was initially mainly for livestock, has become progressively more diversified; (c) FIRA, supported by the Bank, was in the process of developing a monitoring and evaluation system to measure lending impact, and has over the past three years effectively decentralized its lending operations, as a result of which most of its field offices have a reputation for excellence; Cd) the gap (since 1976) between FIRA's interest rates and commer- cial interest rates progressively widened as no provisions were made for periodic adjustments during implementation. This caused (i) an accelerating demand for credit; and (ii) a slow deterioration of FIRA's sound financial position; and Ce) FIRA's capabilities for sectoral analysis, planting and programming and internal control of subloans was inadequate in the face of strongly expanded demand. 1.20 The Seventh Project, which is expected to be completed in mid-1984, was designed taking into account the experiences and lessons gained through the previous projects. There is a significant improvement in quality control of subloans financed through FIRA (Annex 4, para. 3). An Operating Regulations and Procedures Manual and a data base system have been developed and a monitoring and evaluation system has been satisfactorily organized. FIRA's capabilities for in-depth sectoral analysis and medium-term planning and programming could, however, still be improved (para. 1.11). In addition, interest rate adjustments have not been sufficient to cover the gap between agricultural on-lending rates anid inflation. 1.21 Completion reports on two irrigation projects (Panuco, Loan 969-ME, and Sinaloa, Loan 970-ME) have been issued. The lessons learned from these projects, which have been confirmed by the audits are: (a) the evaluation of irrigation projects should consider the alternative of developing rainfed agriculture; (b) a strong extension service is necessary for the development  -8- of agriculture; (c) projected agricultural production targets should be based on tested models; (d) large civil works ccmponents require advanced preparation before appraisal; and (e) phasing should be considered for projects with long implementation periods. 1.22 Implementation of ongoing projects is currently slow because of limited counterpart fund availability. In addition, disbursements have lagged substantially because of insufficient budget and because the Government's financial control and reimbursement procedures are cumbersome. The Government is reassessing some of the ongoing projects and, in cooperation with the Bank, is reviewing the financial control procedures for simplification. In 1982 and 1983, the higher devaluation rate over the inflation rate and stringent budget constraints further slowed down execution of ongoing projects and disbursements. The Bank is implementing a Special Action Program in which for 1983 through mid-1985 disbursement percentages for Bank financed projects have increased. This would accommodate some of the budgetary difficulties the Government experienced in maintaining its counterpart share in the investment programs and would accelerate disbursp'ents. II. THE PROJECT A. Introduction 2.01 The Government of Mexico has requested Bank assistance in financing the proposed Eighth Agricultural Credit Project to support the Government's National Development Plan (para. 1.07). The proposed project would provide much needed resources to assist the Government in maintaining and increasing short-term and investment lending to agriculture, which is crucial to sustain and promote increased agricultural production. The proposed project is further justified as (a) FIRA has developed a good reputation as a well-run institution with experienced management and a good tecbnical assistance program; and (b) the Government has agreed to introduce a variable interest rate system and significantly adjust upward ongoing interest rates for new subloans under ongoing credit projects so that most of them, over a determined period, will become positive (para. 3.04). This will arrest the recent deterioration in FIRA's financial position, provide a more efficient allocation of investment resources and ensure the availability of funds to meet future lending requirements. The preparation report for the proposed p-_ject was compiled by FIRA staff with Bank support. A list of studies and working papers relating to the project is given in Annex 6. B. Project Objectives and Description 2.02 In accordance with the Government's overall development plan of promoting agricultural growth and reducing fiscal deficits, the objectives of the proposed project would be to:  - 9 - (a) increase agricultural productivity and production with a view to (i) increasing exports, (ii) improving food self-sufficiency, and (iii) increasing farm income; (b) continue to strengthen FIRA's institutional framework for efficient allocation of financial resources; and (c) improve agricultural sector policies by reducing interest rate subsidies and restrict them to special target groups. 2.03 In order to achieve these objectives, the proposed project would provide: (a) investment credit and short-term loans to farmers for crops, livestock and agroindustries, representing a credit line of about 21% of FIRA's total lending program (the Bank loan would represent about 8% of the total lending program); (b) technical assistance to farmers to enable appropriate transfer and adoption of improved technology; (c) support services to continue the training of technical staff from FIRA and participating banks and strengthen FIRA's medium- and long-term development planning; and Cd) policy changes for (i) the introduction of a more realistic definition of subloan beneficiaries, and (ii) a gradual reduc- tion and eventual elimination of subsidized interest rates, except for low-income farmers. 2.04 The proposed project would be carried out over a four-year period, and most project requirements, including interest rates, subproject appraisal and supervision requirements, preparation of investment programs, and monitoring and evaluation would apply to FIRA's total lending program. About 50% of the proposed loan would be directed to low-income producers. Investment subloans to beneficiaries would, as in the past, be based on technically and economically sound development plans, and constitute approximately 70% of the total credit line. Because of the increased demand for working capital credit, incremental short-term financing would also be provided, constituting about 30% of the total credit line. About 52% of the investment portion of the credit line would be for annual and perennial crops, 35% for livestock and 13% for agroindustries. C. Detailed Features Crop Lending Program 2.05 Investment lending for crops would cover the complete range of pro- duction types from annual to perennial cropping under rainfed and irrigated  - 10 - conditions in the country. Crop investment subloans would include a wide diversity of loan size, type of borrower and ecological conditions. In rain- fed annual cropping areas, subloan beneficiaries would be mainly small pri- vate farmers or ejidatarios cultivating such crops as maize and beans. Sub- loans under irrigated annual cropping programs would encompass all produ- cers. Perennial-crop subloans in rainfed and irrigated areas would be diverse, including coffee, tropical fruits, apples, rehabilitation of coconut and cacao plantations, and production of table grapes and avocados. Based on initial estimates, it is unlikely that the project would significantly increase coffee production in Mexico. Investment items for the crop lending program would include, inter alia, land improvement, equipment and machinery purchases, civil works construction, including supporting infrastructure for irrigation and storage, and establishment of fruit orchards and industrial crop plantations. Livestock Lending Program 2.06 Of the investment lending for livestock, about 55% would be for beef and dual-purpose production, 15%.for dairy production, and 30% for other livestock operations. As in the case of crop investment subloans, there would be a wide diversity of loan size, type of borrower and ecological conditions in livestock subloans. Lending for beef production would be allo- cated throughout the country, and investment items would include purchase of breeding stock, renovation and/or establishment of pastures, construction of buildings, fences and handling facilities and provision of water supplies. Dual-purpose livestock production would be supported on all types of farms, both in the humid tropics and in the temperate highlands. Intensive milk production would be promoted primarily on medium-size private family opera- tions in the central and northern regions. Swine subloans, primarily to small- and mediumrsize private operations, would continue to be for high technology breeding and fattening operations based on purchased feed located in the central plateau region. Poultry investments would be made largely in high technology operations in the northern and central plateau regions of the country. Agroindustries Lending Program 2.07 About 13% of FIRA's investment lending would be to the agro- industrial sector, particularly to small- and medium-scale producers. The portfolio of agroindustrial investments would continue to vary widely, inclu- ding sawmills, fisheries, feedmills, grain elevators, milk processing plants, and slaughterhouse facilities. However, the project would not finance marketing components of subprojects as these would be financed under the Marketing Project (Loan 2262-ME). Short-term Lending Program 2.08 Short-term subloans under the project would be provided for the entire range of crop, livestock and agroindustrial activities. Furthermore, as a large proportion of Mexico's low income producers are unable to take up  - 11 - investment loans, but do require working capital support to procure essential cash inputs, the project would provide at least 60% of project-financed short-term subloans to this group. The project would finance only incre- mental short-term lending, with incrementality defined as additional over FIRA's total short-term leading of the previous year. By end-November of each year, FIRA would provide the Bank with an estimate of its incremental short-term lending for the subsequent year, which would form the upper limit of the Bank's short-term loan reimbursements. Any deviations between actual and estimated short-term lending over the year would be taken into account in determining next year's disbursement limits. During negotiations, the borrower provided assurances that (a) the above procedures to determine incremental lending will be adhered to; and (b) at least 60% of project financed short-term loans will be allocated to low-income producers. Technical Assistance 2.09 FIRA's well-run technical assistance program would be expanded to promote the adoption of new and improved technology among farmers and to maximize the effectiveness of on-farm credit. During the project period, FIRA would develop intensive technical assistance packages to support all major areas of agricultural production. These packages are currently available for maize and milk, and would therefore be the products initially emphasized. Both these products have experienced significant increases in imports in recent years (paras. 1.03 and 1.04) but have good economic potential for increased production domestically. 2.10 In the case of milk, the program would emphasize support to low input, pasture-based systems on family holdings using technical packages generated at the demonstration centers. Over the four-year project period, about 40 groups of producers (10 farmers per group) would be identified in each of four geographic regions. Investment plans would be prepared for financing through credit. Administratively, technical assistance would be organized under four regional coordinators, each with a team of one veterinarian for each 20 groups, and one technician for every four groups. The program for family operations is conservatively estimated to raise calving percentages from 65% to 75%; raise cow culling rates from 11% to 15%; increase the lactation period from 270 to 300 days; and increase the milk yield from 2,800 liters to 3,500 liters per lactation on the central plateau. The full-development impact of this program is estimated to increase milk production by about 12 million liters/year. 2.11 The maize program would essentially follow a similar organizational pattern to the milk program with six regions being targeted. The groups of maize producers would be organized into units of 500-700 ha each. for adminis- tration by technical staff; the total number of beneficiaries is estimated at about 22,000. The full development impact of the complete program is esti- mated to increase average yields by one ton per ha and maize production by about 200,000 tons per year. The total technical assistance cost of the  - 12 - maize and milk targeting program is estimated at about US$7 million over four years. After investments are made, FIRA and participating banks would provide technical assistance on an intensive basis, the cost of which would be partly borne by the sub-borrower in the first three years of the program, and thereafter, totally financed by the sub-borrower. 2.12 Direct training of farmers would focus primarily on the transfer of new technology through FIRA's demonstration centers and FIRA's and participating banks' technical staff visits. The number of demonstration centers would increase from 88 to 109 at full development. Those devoted to maize would increase from 40 to 54; those devoted to milk and livestock production from 15 to 22. Since the centers are the focal point for training farmers, the new centers would be established in strategic locations close to major production areas. Project financing to support the new centers would include civil works, land improvement and development, crop and forage establishment, agricultural machinery and equipment and livestock. Support Services 2.13 Training of Technical Staff. FIRA has a competent and successful training division, through which it would continue to maintain a strong training program under the project for its staff and technical personnel of the participating banks (Annex 4, para. 5). The project would expand the ongoing training programs by: (a) training of technical staff in the adoption of technological innovation by farmers; and (b) fellowships and overseas training, including two-year scholarships for post-graduate degrees where staff expertise requires strengthening. The primary focus of training would be to educate trainers through formal courses with effective follow-up to revise course content and teaching methodology. It is anticipated that 20% of the technical staff to be trained under the project would be from FIRA, 40% from participating banks and 40% from other sources including SARH. 2.14 Development of Planning and Programming. Until now, FIRA's investment planning has been limited to annual programs with only very broad multi-year targets, mainly based on expected overall increases in lending. In view of existing and predicted scarcities in lending resources, there is a need for more longer-term planning to efficiently allocate available monies within the framework of the Government's investment priorities and needs of the sector. Priorities for investments would be viewed in terms of products, producer groups and regions. There would be continuous dialogue with key Government agencies to determine the role of credit as an instrument in the agricultural development plan. From the dialogue above, FIRA would determine, on an ongoing basis, its growth objectives and the future focus of its lending program. At the Bank's request, FIRA prepared a position paper outlining (a) FIRA's background showing the linkage between current objectives and policies with the Government's agricultural priorities; and (b) FIRA's future direction as a development institution. This position  - 13 - paper, which indicates the direction of FIRA's longer term investment program, will serve as a basis for the elaboration of such a program. 2.15 Provision of Consultants. The project would provide a total of about seven staff-months of consultant support in monitoring and evaluation (four staff-months) and planning and programming (three staff-months). The monitoring consultant would be required to assist FIRA in simplifying the technique for gathering and computing information, making it more readily usable by the managers, and advising on related training procedures (Annex 4, para. 6). The planning and programming consultant would assist FIRA, including the training of its staff, in its in-house exercise to strengthen its capabilities in analyzing and developing medium- and long-term development plans. D. Project Costs 2.16 Project costs are estimated at US$763 million, including price contingencies (Table 2.1), representing US$520 million for medium- and long-term lending, US$227 million for short-term lending and US$16 million for productive support. About US$299 million, or 39% represents the esti- mated foreign exchange component. The proposed project would represent a credit line equal to about 21% of FIRA's overall lending program (US$3,556 million) for the project period; 46% of the medium- and long-term investment programs (US$1,139 million) and about 9% of the overall short-term program (US$2,417 million). 2.17 Project costs include no allowances for import duties, since the Government's policy exempts agricultural equipment and materials from import duties. Sales taxes are estimated at about 6% of project costs (US$46 million). Base cost estimates are evaluated at mid-1984 prices and incor- porate allowances for international inflation; current Government exchange rate policy is to compensate any excess of domestic inflation over international inflation by devaluations of the peso. The contingency for international inflation is estimated at 3.5%, 8%, 9%, 9% and 9% per annum for 1984, 1985, 1986, 1987 and 1988, respectively. E. Financing 2.18 The proposed Bank loan of US$300 million, amounting to about 39% of the project cost, would cover the entire foreign exchange cost. Financing provided by FIRA, participating banks, and the beneficiaries would amount to 34%, 14%, and 13%, respectively (Table 2.2). Participating banks would be required to finance from their own funds at least 10% of subloans to low-income producers, 15% to medium-income producers and 20% to commercial producers. Participating banks would, however, lose their eligibility for  TABLE 2.1:Total Investment Program ----------------------------------------------------------__-----------------__----------------------------------------- Local Foreign Total Local Foreign Total Foreign as Percent Mex$ million USS million . of Total of Bame Costs ------------------------------------------------------------------__---------__-----------_----------------------------- 1. Productive Investment A. Low-income producers Crops 9,120 11,360 20,480 57 71 129 55 19 Livestock 8,000 2,720 10,720 50 17 67 25 10 Agroindustries 1,600 1,260 2,860 10 8 16 44 3 Subtotal 18,720 15,360 34,060 117 96 213 45 32 B. Medium-income producers Crops 3,690 4,640 6,320 23 29 52 56 6 Livestock 5,600 1,760 7,360 35 Li 46 24 7 Agroindustries 1,920 1,600 3,520 12 10 22 45 3 Subtotal 11,200 6,000 19,200 70 50 120 42 19 C. Other producers Crop. 3,690 4,640 6,320. 23 29 52 56 9 Livestock 5,600 1,760 7,360 35 11 46 24 7 Agroindustries 1,760 1,440 3,200 11 9 20 45 3 Subtotal 11,040 7,840