Mexico - Ninth Agricultural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-4582-ME MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN WITH THE GUARANTEE OF THE UNITED MEXICAN STATES IN AN AMOUNT EQUIVALENT TO uS$400 MILLION TO NACIONAL FINANCIERA, S.N.C. FOR A NINTH AGRICULTURAL CREDIT PROJECT May 29, 1987 This _1-o ha a dW ron sand may be usdby recipients only in the performance of tdrk 1k d lls centeots may n ot denei be diselosed withoot Worldl Bank authorization.  Currency Unit - Peso (Mex$) On May 12, 198.', the exchange rate in the controlled market was US$1 Mex$ 1,218.30; the free market exchange rate stood at US$1 = Mex$ 1,214.00. FISCAL YEAR January 1 to December 31 UNITS AND MEASURES 1 hectare (ha) : 10,000 m2 = 2.47 acres 1 kilometer (km) 0.62 milee 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. - 1 metric ton = 0.98 long ton ABBREVIATIONS ACF - Index of Average Cost of Funds to Multipurpose Banks BANRURAL - National Rural Credit Bank BANXICO - Bank of Mexico FEFA - Special Agricultural Credit Trust Fund FEGA - Technical Assistance and Loan Guarantee Trust Fund FICART - Trust Fund for Credit in Irrigated and Rainfed Areas FIRA - Agricultural Trust Funds in Bank of Mexico FONDO - Trust Fund for Crop, Livestock and Poultry Credit GIRA - General Interest Rate Agreement ICB - International Competitive Bidding IDB - Inter-American Development Bank NAFIN - Nacional Financiera, S.N.C. PRONADRI - National Program for Integrated Rural Development SAM - Mexican Food Program SARH - Secretariat of Agriculture and Water Resources SHCP - Secretariat of Finance and Public Credit SOE - Statement of Expenditure  FOR OFFICIAL USE ONLY MEXICO NINTH AGRICULTURAL CREDIT PROJECT LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.N.C. Beneficiaries: Agricultural Trust Funds in the Bank of Mexico (FIRA), mainly for on-lending by comaercial banks, and the Trust Fund for Credit in Irrigated and Rainfed Areas (FICART), for on-lending by BANRURAL, Mexico's largest agricultural credit lender. Amount: US$400 million equivalent Terms: Repayment in 15 years, including 3 years of grace, at the standard variable interest rate. Financing Plan: Beneficiaries: US$ 141 million Participating Banks: US$ 141 million FIRA/FICART: US$ 318 million World Bank: US$ 400 million Total US$1,000 million Economic Rate of Return: Not Applicable Staff Appraisal Report: Report No. 6802-ME This document has a restricted distribution and may be used by recipients only in the of their official duties. Its contents may not otherwise be disclosed without World Bank  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A NINTH AGRICULTURAL CREDIT PROJECT 1. The following report on a proposed loan to Nacional Financiera, S.N.C. (NAFIN) for US$400 million equivalent is submitted for approval. The proposed loan would be repaid over 15 years, including three years of grace, at the standard variable interest rate. 2. Background. Mexico's agricultural sector accounts for ab3ut 9% of GDP, employs about 25% of the labor force, and contributes about 26% to the country's non-oil exports. kirnl incomes are low with 78% of rural households earning incomes less than 30% of the national average. Because of agriculture's large share of employment, its political importance and the extent of poverty in many rural areas, the Government considers the revitalization of agriculture to be an important economic and social element in the structural recovery of Mexico. 3. Before 1970, Mexico produced sufficient food to feed its population and export substantial surpluses. By the end of the 1970s, however, it had become a major importer of basic foodstuffs. In March 1980, the Government resorted to major action to reverse agriculture's decline by using the growing revenues from oil. It raised support prices, and increased subsidies on agricultural inputs and on credit. These interventions, coinciding with favorable weather, led to substantial increases in agricultural production of 6% p.a. in 1980 and 1981. However, because of the burden they placed on the budget, these market interventions were not sustainable and fell early victim to Mexico's economic crisis. In 1982, when farmgate prices fell in real terms with high inflation, agricultural production declined by 1%. Production recovered moderately from 1983 to 1985 and gre-w about 2.5% p.a. primarily because of a supportive exchange rate and favorable weather. In 1986, however, agricultural production fell by 4.2% due to poor weather and contractior. in domestic demand. Declines in domestic consumption and a favarable exchange rate, however, permitted increased exports, producing the first agricultural trade surplus since 1979, estimated at aborut US',~ billion. 4. The Government continues to seek remedies to Mexico's rural problerds. Fiscal constraints prevent it from reverting to the kinds of costly subsidy policies used in the early 1980s. Instead, it has made its main objectives reducing subsidies while improving the effectiveness of remaining subsidies including those directed at agricultural credit, raising returns to public investments, and reducing its intervention in the market. 5. Agricultural credit, delivered mainly through the FIRA/Commercial Banks and the FICART/Public Development Bank Credit Systems, is an important instrument for meeting these objectives. However, due to the continuing  -2- eaonomic crisis and lack of financial resources, agricultural credit is declining in real terms. Projections through 1991, however, indicate a rapid increase in the demand for agricultural credit along with a general recovery of the Mexican economy. 6. Consistent with its overall policy to reduce subsidies, the Government has taken important steps in reducing credit subsidies. In the past, interest rates have been negative in real terms and accelerating inflation in recent years has heightened this tendency. To deal with this issue, the Government and the Bank entered into a General Interest Rate Agreement (GIRA) in 1984. As a result of GIRA and its amendments, the interest rate regime has improved and credit subsidies have been significantly reduced. All interest rates have been linked to an index of deposits rates (the average cost of funds or ACF) and made variable. Nevertheless, aggregate credit subsidies to all sectors remain large (at about 3.8% of GDP in 1986). To address this problem, the Government and the Bank have been discussing a possible revision of GIRA. A new agreement is being developed to provide for the introduction of an administrative framework for systematic credit subsidy budgeting and control, along with progressive further reductions in the amount of credit subsidies. Until such time as a new agreement has been concluded, the present GIRA remains effective. 7. Current bank lending supports the Government's objectives in increasing the efficiency of production and reducing subsidies. A proposed Agricultural Sector Adjustment Loan to aid structural reform in the sector is under appraisal and projects to increase efficiency in extension and research, irrigation, dairying and forestry have been or are about to be appraised. The proposed project, the ninth of a series of successful credit operations involving FIRA, would finance agricultural credit to improve the sector's productivity while supporting further reductions in interest rate subsidies to farmers. 8. Project Objectives. The proposed project is designed to: (a) increase agricultural productivity, exports, farm incomes, and rural employment; (b) improve agricultural sector policies by reducing interest rate subsidies and by carrying out a study of rural credit issues so as to facilitate addressing these in the future; and (c) improve the institutional capability of FIRA and FICART while assisting in maintaining their capital structure.  -3- 9. Project Description. The proposed project would: (a) finance short-term and investment credit for crops, livestock, agroindustries and other activities (e.g. aquaculture and horticulture); (b) provide training, technical assistance and consultants' services, as well as civil works for the construction of demonstration centers, to support FIRA and FICART's technical assistance programs to farmers; and (c) include a rural credit study to identify further areas to improve the rural financial system and resource mobilization. 10. Total projeet cost is estimated at US$1,000 million, which represents about 15% of the overall program of FIRA and FICART. The foreign exchange cost i8 about 40%. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key processing events and the status of Bank Group Operations in Mexico are given in Schedules C and D, respectively. Staff Appraisal Report No. 6802-ME dated May 29, 1987 is also attached. 11. Rationale for Bank Involvement. The provision of credit is a key element of the Government's strategy to increase agricultural output and to raise living conditions in the countryside, where most of Mexico's poor live. In recognition of this, support to private farmers, ranchers and agroindustries has accounted for a major share of Bank lending to Mexico. Past Bank-financed rural credit operations to FIRA show that funds are utilized appropriately with significant production, institutional, social and economic gains. The proposed project--the first in which FICART/BANRURAL (Mexico's largest source of term lending for agriculture) would participate directly--would extend the Bank's institutional development assistance to FICART/BANRURAL. Without the proposed loan, FIRA and FICART would have to curtail their lending programs. The proposed project would also lead to reductions in interest rate subsidies and thus contribute to the important policy objectives of phasing out subsidies and allocating resources more efficiently. 12. Agreed Actions. During negotiations, the Government of Mexico agreed that: (a) The obligations under the General -terest Rate Agreement would be applicable under this loan; (b) the agricultural financial subsector study would be completed by January 31, 1988 under terms of reference agreed with the Bank and thereafter there would be an exchange of views with the Bank on the conclusions and recommendations of such study. Beginning March 31, 1988 the study's recommendations would be implemented within a time period acceptable to the Bank;  -4- (c) all necessary actions would be taken to ensure that adequate funds would be budgeted annually to FIRA and FICART to prevent any material capital erosion, in real terms, which FIRA or FICART may have incurred during the immedliately preceding year on account of all their lending operations after January 1, 1986; and (d) participating banks would have their eligibility suspended whenever the arrears under loans made by any such participating bank and discounted by FIRA or FICART exceed fifteen percent of the aggregate outstanding amount of such loans. 13. This loan supports the Government's medium-term structural policy reform program and is part of the 1986-87 external financing plan of assistance to Mexico supported by the Bank and other donors. Release of the third tranche of the commercial bank package to Mexico is linked to effectiveness of the proposed loan. 14. Justification. The project would benefit about 100,000 families, a total of about 550,000 beneficiaries, and would generate an additional 240,000 jobs. Evaluation of model investment plans indicates that subprojects are expected to have financial and economic rates of return in the range of 22% to over 50%. The project would also have an important institutional strengthening effect, particularly for FICART/BANRURAL--Mexico's largest agricultural credit lender. Furthermore, the financial subsector review should lead to improved efficiency and self-sustainability of the rural financial system. 15. Risks. The main risk is that political pressures could reverse the progress achieved in reducing interest rate subsidies. However, this is unlikely to occur. The Government is committed to the gradual elimination of distortions and has a close dialogue with the Bank on interest rates --including those charged to farmers--within the context of GIRA. As an indication of Government's continuing cormitment to the gradual elimination of interest rate subsidies, interest rates to small farmers were increased from 70% of ACF to 75% of ACF as of May 1, 1987. 16. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. May 29, 1987  Schedule A ESTIMATE OF PROJECT COSTS AND FINANCING PLAN July 1987 - June 1991 Estimated Cust: Local Foreign Total ------ US$ million I. Investments A. Low-income producers Crops 140 95 235 Livestock 106 70 176 Agroindustries 25 16 41 Subtotal 271 181 B. Other producers Crops 132 89 221 Livestock 114 76 190 Agroindustries 25 16 41 Subtotal 271 YU 45 Total 542 362 904 =_.-se_ - II. Working Capital A. Low-income producers 24 16 40 B. Other producers 24 16 40 Subtotal 48 32 80 III. Productive Support 10 6 16 Total Project Cost 600 400 1,000 _-_ _ Financing Plan: Local Foreign Total US$ million -- -- Beneficiaries 141 - 141 Participating banks 141 - 141 FIRA/FICART 318 - 318 Bank -- 400 400 Total 600 400 1