Malawi - Agricultural Marketing and Estate Development Project

Document of The World Bank FOR OFFICIAL USE ONLY R,pVort No. 7401-MAI STAFF APPRAISAL REPORT AGRICULTURAL MARKETING AND ESTATE DEVELOPMENT PROJECT MALAWI October 31, 1988 Southern Africa Department Agriculture Operations This document has a restricted distdbution and may be used by redpients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Malawian Kwacha (MK) US$ 1.00 MK 2.50 MK 1.00 US$ 0.40 SDR 1.00 MK 3.40 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 miles 1 square kilometer (km2) = 0.39 square miles 1 hectare (ha) 2 2.47 acres 1 metric ton (ton) = 2,204 lb FINANCALK YEAR Government of Malawi: April 1 - March 31 INDEBANK: January 1- December 31 National Bank of Malawi: January 1- December 31 Commercial Bank of Malawi: July 1 - June 30 SEDOM: April 1 - March 31  FOR OFFICIAL USE ONLY ABBREVIATIONS ADD Agricultural Development Divisions ADMARC Agricultural Development and Marketing Corporation AfDB African Development Bank CDC Commonwealth Development Corporation CBM Commercial Bank of Malawi DEG Deutsche Entwicklungsgesellschaft (German Finance Company for Investments in Developing Countries) DEMATT Development of Malawi Traders Trust EAC Estates and Agro-industries Committee EEC European Economic Community EP&D Department of Economic Planning and Development FAO/CP Food and Agriculture Organization/Cooperative Program FMO Nederlandse Financierings Maatschappi Vor-Outwickeling Sladen (Netherlands Finance Company for Developing Countries) FRG Federal Republic of Germany KFW Kreditanstalt Fuer Wiederaufbau GOM Government of Malawi ICB International Competitive Bidding IDA International Development Association IFAD International Fund for Agricultural Development IFC International Finance Corporation INDEBANK Investment and Development Bank of Malawi INDEFUND Investment and Development Fund LCB Local Competitive Bidding LFB Local Fund Board MBS Malawi Bureau of Standards MC Marketing Committee MOA Ministry of Agriculture MOF Ministry of Finance MOLG Ministry of Local Government MSU Marketing Support Unit MTIT Ministry of Trade, Industry and Tourism NBM National Bank of Malawi NRDP National Rural Development Program ODA Overseas Development Administration OPC Office of the President and Cabinet RBM The Reserve Bank of Malawi SACA Smallholder Agricultural Credit Administration SAL Structural Adjustment Loan SEDOM Small Enterprise Development Organization TRA Tobacco Research Authority TRF Tea Research Foundation UK United Ri ngdom USAID United States Agency for International Development 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.  MALAWI AGRICULTURAL MARKETING AND ESTATE DEVELOPMENT PROJECT Table of Contents Credit and Project Summary .......................... ... .i-iii I. BACKGROUND ... ........................................ 1 A. Project Background ............. . . ... 1 B. Salient Economic Features .1 C. The Agricultural Sector .............................. 3 The Smallholder Subsector .3 The Estate Subsector........ . 4 Main Constraints........... . .... 4 D. Government Objectives for Agriculture 4 E. Bank and Other Donor's Strategy and Assistance 5 II. SECTORAL BACKGROUND ...... ......7 A. Agricultural Marketing ....*..... 7 The Marketing System for Smallholder Produce 7 Processing............. 8 The Private Trade............. 8 The Marketing Liberalization Program. 8 Constraints to Private Sector Participation 9 B. The Estate Subsector . ............ . 11 Constraints to Estate Development 11 C. The Financial System. 13 The Reserve Bank of Malawi. 13 The Commercial Banks .............................. 14 Development Finance Institutions ..15 III. THE PROJECT .................. . 17 A. Project Objectives and Design ..... ................... 17 Project Objectives ....... .......................... 17 Project Design ..................................... 17 B. Project Summary and Description ...................... 17 C. Detailed Features .. . ................................ 18 Credit Component ....... ............................ 18 Institutional Development Component ........... I .... 20 Market Infrastructure Component .................. .. 23 D. Project Costs ........ ................................ 23 E. Financing ......... ................................... 25 F. Procurement ........ .................................. 26 G. Disbursement ......................................... 28 IV. PROJECT IMPLEMENTATION ....... ............................. 29 A. Organization and Management ............. ............. 29 Project Coordination ............ ................... 29 Marketing Policy and Support Services .............. 30  - 2 - Training ............................................ 31 Export Quality Control .31 Regulation of the Private Trade .32 Market Infrastructure Development .33 Estate Development, Agro-industries and Rural Traders 33 Credit Terms and Conditions ..33 B. Aceounts and Audit ..39 Accounts and Audits. 39 C. Monitoring and Evaluation ..39 D. Environmental Safeguards ..40 E. Role of Woomen. 40 F. Status of Project Implementation . .40 V. PROJECT BENEFITS AND RISKS .41 A. Project Benefits ..41 B. Project Risks. 42 VI. ASSURANCES AND RECOMMENDATIONS . . .43 Annex 1 Marketing and Pricing Section Organizational Charts .47 Annex 2 Detailed Cost Tables and Summary Tables .49 Annex 3 Indicative Project Lending Program . .55 Appendix 1 - Indicative Program of Subprojects 57 Appendix 2 - Summary of Lending Activities Under the Industrial and Agricultural Credit Project (Loan 2646-MI) .59 Appendix 3 - Estate Sector Lending Models .60 Appendix 4 - Marketing Models for Pilot Credit to Rural Traders 74 Appendix 5 - Proposal for Negotiable Warehouse Certificates 77 Annex 4 Draft Lending Terms for Agricultural Marketing and Estate Development . .80 Annex 5 Schedule A - Estate Development Subproject Feasibility Study .83 Schedule B - Agroprocessing Subproject Feasibility Study .85 Schedule C - Criteria for Appraisal of Subprojects 86 Schedule D - Subproject Reporting Forms .90 Annex 6 Draft Terms of Reference - Marketing Services Advisor .93 Annex 7 Performance Indicators for Participating Banks .94 Annex 8 Marketing Policy, Information and Monitoring and Evaluation ..97 Annex 9 Estate Policy Development .103 MAP: IBRD NO. 21033 ............................................ 105  MAIAWI AGRICULTURAL MARKETING AND ESTATE DEVELOPME-? CREDIT AND PROJECT SUMMARY Borrowers The Republic of Malawi Executing Agencies: Ministry of Agriculture, Ministry of Local Government, Malawi Bureau of Standards, Investment and Development bank of I4alawi (INDEBANK), National Bank of Malawi (NBM), Commercial Bank of Malawi (CBM), Smill Enterprise Development Agency of Malawi (SEDOM). Amount: SDR 14.2 million (US$18.3 million equivalent). Terms: Standard, with 40 years maturity. Proiect Description: The proposed project is designed to improve the marketing of smallholder crops by supporting the Government's efforts to develop a multi-channel marketing system. The project aims to strengthen Government market support, policy analysis and regulatory functions and to develop mechanisms for financing private marketing and processing of smallholder crops. Another aim of the project is to improve resource utilization and productivity in the estate sub-sector by providing medium-term credit for sub-projects aimed at intensifying and diversifying production, particularly for smaller estates that have limited access to commercial financing. The Project would include funds for: (a) credit to be channeled thrnugh the commercial banks, INDEBANK, and the Small Enterprise Development Organization of Malawi (SEDOM) in support of estate development and agricultural marketing subprojects, including a pilot credit for rural assemblers; (b) support to the Government, including technical assistance, training, and equipment to improve its market information, quality control and regulatory systems; and (c) improvement of rural marketing infrastructure. Benefits and Risks: A broad spectrum of smallholder and estate farmers throughout the country would benefit from the improved marketing and processing services and the bett r farm practices made possible through the use of the proposed credit lines. Improved marketing and processing services would yield benefits from better quality products and lower marketing margins which would be passed on to both producers and consumers. Better cultivation practices, improved grading and handling facilities, and expanded land utilization financed under the proposed credit line for estates would result in higher incomes for Malawian estate  - ii - owners through increased yields and higher quality output. Moreover the project would create a viable a-ld sustainable institutional framework for Government market support and regulatory services. The potential risks include the ability of Government to implement its market reform program effectively. So far the Government has demonstrated firm resolve in implementing its market liberalization program but it is concerned about the impact of the program, particularly on vulnerable groups. The institutional component addresses this concern by improving Government's capacity to monitor market developments, and implement appropriate measures. For the estates, a potential uncertainty is future price levels for estate exports. Bank forecasts show prices for Malawi's export crops as holding steady in the medium term. Also the subprojects financed by the credit are expected to make the estates more productive and better able to withstand price declines. Estimated Cost Local Foreign Total ----_______(US$ 000)- Technical Assistance - 668.0 668.0 Civil Works 235.7 353.5 589.2 Vehicles and Equipment - 174.4 174.4 Office Supplies 6.2 24.6 30.8 Oversees Training - 116.0 116.0 Local Training 185.6 0 185.6 Information, Monitoring, and Evaluation 120.0 120.0 240.0 Studies 35.9 554.1 590.0 Estate Development 7,360.0 11,040.0 18,400.0 Agro-industries 1,617.0 3,003.0 4,620.0 Pilot Credit for Rural Traders 1,400.0 600.0 2,000.0 Recurrent costs 242.4 174.0 416.4 Total Baseline 11,202.8 16,827.6 28,030.4 Physical Contingencies 35.4 53.0 88.4 Price Continqencies 80.9 109.7 190.6 Total Project Costs 11,319.1 16,990.3 28,309.4  - iii - Financing Plan Local Foreign Total Z ------------- US $ million ---------------- IDA 1.3 17.0 18.3 64 Participating Banks 3.2 - 3.2 12 Sub-Borrower 6.3 - 6.3 22 Government 0.5 - 0.5 2 Total 11.3 17.0 28.3 100 Estimated Disbursements of IDA Credit FY89 FY90 FY91 FY92 FY93 FY94 FY95 --------------- US$ million------------------------------ Annual 3.3 2.7 2.8 2.5 2.4 2.3 2.3 Cumulative 3.3 6.0 8.8 11.3 13.7 16.0 18.3 Map IBRD No. 21033  MALAWI AGRICULTURAL MARKETING AND ESTATE DEVELOPMENT PROJECT I. BACKGROUND A. Project Background 1.01 The Project, for which an IDA credit of US$18.3 million is proposed, aims at improving the marketing system for smallholder crops in support of the market liberalization program initiated under the Government's structural adjustment program. It is also designed to assist Government efforts to increase estate productivity and exports. These goals would be achieved through the development of a multi-channel marketing system for agricultural produce and by improving the access of small estates to medium-term credit. The marketing element of the proposed Project was identified during negotiations of the IDA-financed supplement to SAL III. The support for estate development was included during Project preparation based on identification work undertaken by FAO/CP and the rapid commitment of credit funds for estate agriculture under the US$4.5 million pilot component of the Industrial and Agricultural Credit Project (Ln. 2646-MAI), Following a request from the Goveznment for IDA assistance, a mission visited Malawi in November 1986 to initiate preparation. A follow- up mission during January/February 1988 finalized the preparation. The appraisal took place in May 1988. B. Salient Economic Features 1.02 Malawi is characterized by a limited resource base, poorly developed social and physical infrastructure and low per capita incomes. Despite these limitations, the country achieved impressive economic growth during the fifteen years following independence in 1964. GDP more than doubled during this period, resulting in sustained real per capita growth of 3.OZ per year. This growth was largely fueled by a steady expansion of agriculture. However, beginning in the mid-1970's, Malawi's economic performance weakened as a result of external shocks, delayed policy responses and intensification of structural imbalances. On the external front, falling world prices for exports, soaring oil prices, and the gradual disruption of transport routes through Mozambique led to a 28% decline in the terms of trade between 1978 and 1981. On the domestic front, the Government resorted to deficit spending to maintain aggregate demand. As a result the fiscal deficit, financed to a large extent by external borrowing on commercial terms, rose to 15? of GDP in 1981/82. Several underlying weaknesses in the economy were revealed by the deteriorating economic situation, includ'ng the lack of export diversification, slow growth in smallholder agriculture, and import dependence in the industrial and energy sectors. Problems also emerged with inadequate agricultural price incentives, reliance on industrial price controls, weaknesses in key parastatals and poor budgetary planning and implementation. As a result of these domestic and external factors, GDP did not grow at all in 1980 and contracted by 5.22 in 1981.  1.03 In 1981 the Government introduced a structural adjustment program to restore macro-economic stability and economic growth. This program has been supported by three SALs and successive stand-by operations and an e2ctended facility from the IMF. The adjustment package includes: (a) price refotm, including agricultural price adjustments to bring domestic producer prices in line with international prices, decontrol cf most industrial prices, and the gradual reduction in fertilizer subsidies; (b) improved public sector resource management; (c) external sector reforms, including exchange rate management and development of export promotion programs; and (d) parastatal reforms including restructuring of ADMARC. 1.04 The adjustment package yielded immediate results. Good progress was made in reducing financial imbalances and restoring economic growth with the economy growing at an annual rate of 4.1Z between 1982 and 1985. But the recovery was short lived as Malawi's strong macro-economic performance was reversed in 1986 by new external events that derailed the Government's adjustment efforts. Renewed fiscal imbalances resulted from increased transport costs, large military expenditures associated with regional political tensions, and the costs incurred in providing assistance to displaced persons from Mozambique. In addition, continued declines in agricultural terms of trade, and problems in 1986-87 with administered resource allocations and expansionary fiscal programs undermined the incentive structure and efficiency in the productive sector. Finally, the growing population and the influx of displaced persons from Mozambique have strained social services and created severe land pressures that adversely affected agricultural productivity and per capita food consumption. All of these factors have weakened Malawi's economy and contributed to a decline in real output of 0.2Z in 1987. The government has respon,ud to the growing difficulties with further adjustment measures designed to curb public sector consumption and restore domestic and external balances. However, the resumption of sustained economic growth requires that Malawi not only continue these adjustment efforts but also implement a new development strategy that addresses the structural and policy constraints that have dimmed Malawi's growth prospects. 1.05 In recognition of the continuing macro-economic imbalances and stagnating growth, the Government recently reviewed its adjustment program and prepared a new medium-term development strategy. This program is outlined in the Government's "Statement of Development Policies", 1987-96 (DEVPOL), a comprehensive strategy statement for each sector of the economy for the next decade, and the "Policy Framework Paper, 1988/89-1990/91" (PFP), a review of the three-year development program prepared jointly with the World Bank and the IMF. The major economic and social objectives of Malawi's medium-term development program are: (i) reduction of poverty, ignorance and disease through sustained growth, (ii) improvement in income distribution, and (iii) stabilization in the growth of the economy. 1.06 To achieve the growth objective, the Government has identified a series of policy reforms and new investments designed to reduce structural constraints in key productive sectors. Growth is expected primarily from increased productivity in smallholder and estate agriculture, higher capacity utilization and new investment in industry, and reduction in external transport costs. While Government services will  - 3 - continue to play an important role in economic development, Malawi's growth strategy emphasizes private sector control of economic production and reduction in the scope of Government regulatic- To achieve the equity objective and provide the basis for sustained long-term growth, the Go;ernment has identified measures to strengthen development of human resources and expand rural social infrastructure. These include expansion of primary school enrollment, promotion of small-scale enterprises and increased expenditures on social services, particularly primary health care, rural water supplies and low-cost housing. Finally, to achieve the stability objective, the Government hae developed a macro-economic stabilization program designed to restore domestic and external balance. Reduced fiscal deficits, strict monetary and credit policies and continuation of active exchange rate management will play a key role in redressing the external shocks that slowed growth in the 1980s. C. The Agricultural Sector 1.07 Malawi is heavily dependent on agriculture, which supports about 85% of the population (7.6 million people) on 94,300 sq. km and in 1986 contributed 37X of the GDP and 91% of all exports. Major agricultural exports include tobacco (54% of total exports), tea (162) and sugar (9%). Major food crops include maize, pulses, cassava and groundnuts. Agriculture in Malawi is characterized by two distinct subsectors that are defined by the tenure system. Smallholders cultivate traditional tenured or customary land while estate cultivation takes place on freehold or leasehold lands. Farmers in each subsector differ in the types of crops they grow and in their access to markets, credit, and extension services. The Smallholder Subsector 1.08 About 1.3 million smallholder families cultivate customary lands in Malawi and produce about 852 of the country's food supply. The majority of these smallholders are near-subsistence cultivators with limited access to land and very low income levels. The average farm size is about 1.1 ha with about 552 of the holdings in the country less than one hectare. The average income of a smallholder farm family in 1984/85 was estimated at less than MK300 (US$120), of which about 80Z was from crops and livestock and 20X from off-farm employment. For many smallholders chronic food insecurity is a pervasive and growing problem. Due to small farm size, and the lack of access to adequate plant nutrients, the productivity of many smallholder homes is inadequate to meet basic household food needs. Consequently, most smallholders are net buyers of food, though off-farm incomes are often insufficient to purchase adequate calories. The result is widespread rural malnutrition and high child mortality rates. 1.09 Maize is the dominant smallholder crop and is cultivated on three-quarters of the cropped land, mostly for home consumption. Other smallholder food crops include cassava, pulses and groundnuts which are grown both for home consumption and the market. In addition to food crops, the larger smallholders often market some tobacco or cotton. Smallholder production is derived almost entirely from family labor, and despite small farm size, seasonal labor shortages often arise. Technology is rudimentary and land management is generally poor. Erosion and declining soil fertility are becoming serious problems in densely populated areas.  - 4- The Estate Subsector 1.10 Estate agriculture is defined to include farming on freehold and leasehold land. Since the early 1900s when European settlers started to grow tea, tobacco, cotton and coffee, the orientation has always been on the production of crops for vxport. It is the only legal producer of flue- cured and burley tobacco, the only commercial producer of sugarcane, the major producer of tea and a minor producer of cereals and seed cotton. It generates about 40Z of the total wage employment in the economy and accounts for about 8O0 of the country's foreign exchange earnings through exports of tobacco, sugar, tea, coffee and macademia. With few exceptions, estates are owned by private individuals or by companies. There are now about 4,000 estates with total land holdings estimated at about 600,0000 ha. The number of estates increased rapidly during the 1970's and early 1980's, spurred largely by the growth in burley tobacco production. Since 1980 the total area devoted to burley production has doubled. 1.11 Major estate crops include tobacco, sugar, tea, and coffee. Traditionally individual estates grow only one export crop. Diversification into non-traditional crops such as macademia has started only recently. Of the total estate area harvested about half is still under flue-cured and burley tobacco. Tea and sugarcane cover over a third with the balance made up mostly of coffee, nuts, and cotton. Main Constraints 1.12 A number of constraints prevail in both the smallholder and estate subsectors which must be overcome before agriculture can reach its full potential. The most pressing constraint for smallholder agriculture is growing land pressure. Rapid population growth rates (in excess of 3.52 per year) mean that the current average holding size of about three quarters of a hectare will decline to less than one-half hectare by the year 2000. As a consequence, traditional patterns of shifting cultivation have given way to continuous mono-cropping of maize that has led, in the absence of fertilizers, to depleted soil fertility and declining yields. Given such land constraints, most future increases in the production of food and export crops must come from more intensive and productive use of land. However, a variety of related factors have caused smallholder productivity to remain stagnant for a number of years despite considerable Government investment. These factors include: (a) inappropriate smallholder technology, especially for maize; (b) weaknesses in extension and research services; (c) uneven access to production credit; (d) Government pricing and subsidy policy; and (e) growing marketing problems for smallholder crops. Constraints in the estate subsector include poor manage)ient and a lack of access to credit and extension services. These problems are particularly severe for the smaller estates recently established under Malawian ownership and management. D. Government Objectives for ARriculture 1.13 The resumption of growth in agriculture is central to the Government's medium-term development plan. The main objectives for agriculture are to increase both domestic and export production, ensure food security, improve the distribution of rural incomes, and reverse the deterioration of the natural resource base. For smallholders, the aim is to raise agricultural productivity both for farmers with small plots to ensure that they are self-sufficient in food production and for larger farmers to enable them to diversify into cash crops. Despite years of effort, adoption rates of existing high yielding maize varieties have been  - 5 - low. As part of the Government's agricultural strategy, the National agricultural Research System is being reorganized under the Agricultural Research project (Cr. 1549-MAI) so that research priorities can be formulated and viable technological packages developed for the smallholder subsector. At the same time the Government is strengthening the extension service and improving Ministry of Agriculture's policy analysis capabilities through the Agricultural Extension and Planning Support project (Cr. 1626-MAI). It is also expanding the scope of the smallholder credit system through the recently approved Smallholder Credit project (Cr. 1851-MAI). For the estate sector, the Government aims to restore growth in export crop production and to diversify the crop mix in an effort to lessen Malawi's dependence on tobacco exports. To help accomplish these objectives, the Government is seeking to improve the access of estate owners to medium-term investment funds and to establish an estate extension and management training service, which is expected to begin operations in 1989. To ensure equitable and efficient allocation of land between estates and smallholders, the Government is undertaking a review of the land tenure system and will continue to freeze estate expansion in densely populated areas. 1.14 The Government will continue to use pricing policy to maintain adequate producer incentives for smallholders. Producer output and input prices will be reviewed annually in light of production and marketing costs, border prices, the level of domestic supply, and Government food security goals. Moreover, after the maize shortages in 1987/88, the Government gives high priority to developing a comprehensive food security program. A food security monitoring and reporting unit that was set up in 1987 is expected to be fully operational in 1988 and a study will soon be undertaken to review the optimal size and operation of the strategic grain reserve. The Government also intends to rebuild the reserve in 1989-90 as domestic production and external financing permit. In addition, the Government is committed to improving food security at the household level and is reviewing options to raise nutrition levels, including off-farm employment opportunities, special food and fertilizer for work programs for food deficit farmers, expansion of smallholder credit and extension programs to encompass a much larger proportion of the smallholder population, and development of appropriate high-yielding crop packages. It is also examining the feasibility of relaxing existing restrictions on smallholder production of burley tobacco. In view of the growing population of displaced persons from Mozambique, the Government will continue to mobilize emergency food relief from the donor community and private relief agencies. 1.15 Reform of agricultural marketing remains an important element in Mala'wi's agricultural strategy. The Government will continue efforts to improve smallholder agricultural marketing and restructure ADMARC. After encouraging private trading in smallholder marketing in 1987, the Government will revipw the appropriate role of ADMARC in stabilizing market prices and in providing marketing services in areas not covered by private traders. Government also intends to develop an effective multi-channel marketing system by strengthening marketing services and infrastructure in support of the private trade and to developing effective market intelligence, regulatory and quality control functions. E. Bank and other Donor's Strategy and Assistance 1.16 Malawi's Agriculture is heavily supported by other donors besides the Bank. The USAID, EEC, FRG, ODA, AfDB, and IFAD provide  - 6 - significant support to NRDP and national level institutions and services. In addition the UK, USAID, FRG, the Netherlands and Japan provide co- financing for the Government's Stuctural Adjustment Program. In the past, the Bank's and other Donor's assistance to agriculture has largely focused on the smallholder subsector and was channelled mainly through area development projects under the National Rural Development Program (NRDP). On balance the record of NRDP has been mixed with satisfactory physical implementation of investment and delivery of services but with a productive impact on a relatively small number of farmers. The Bank's and other Donor's present strategy continues to emphasize smallholder agriculture, however, the focus has shifted from area development projects to national projects designed to reach larger number of farmers through: (a) improving the Government's capacity for agricultural planning and policy analysis so as to develop and maintain a policy environment conducive to agricultural growth; (b) strengthening the implementation capabilities of the research, extension and credit delivery cervices of the MOA through institutional reforms, improved resource allocations, and human resource development; (c) supporting the Government's market reform efforts aimed at developing a multi-channel marketing system and improving ADMARC's operations; and (d) assisting in the development of special initiatives designed to give food deficit households access to farm inputs, improved maize packages, credit and extension services, and off-farm employment. The Bank is also supporting estate development in order to restore productivity and improve resource utilization in that subsector. The present project which concentrates on marketing and estate development forms part of the above strategy. 1.17 Since 1977, the Bank and IDA have undertaken 12 operations totalling US$173.3 million for agricultural development in Malawi. A total of US$121.2 million has been provided exclusively to support smallholder development, mostly through area development projects. The remaining US$52.1 million is being utilized to strengthen the planning and policy formulation capacity of the MOA and improve the extension and research services. It is also assisting in the development of forestry resources and institutions. Moreover, US$4.5 million has been made available for estate development under an industrial and agricultural credit project. In addition agricultural policy reforms have been a key element of the three SAL operations with the most recent focus being on agricultural marketing reform under the supplement to SAL III. Moreover, three IFC operations totaling US$17.9 million have assisted the development of agro-industries.  - 7 - II. SECTORAL BACKGROUND A. Agricultural Marketing The Marketing System for Smnallholder Produce 2.01 Until recently most smallholder produce was marketed through t:ie Agricultural Development and Marketing Corporation (ADMARC). This sL- tutory organization was established in 1971 to replace the Farmers Marketing Board that had been responsible for smallholder crop marketing until then. ADMARC was given a wider mandate than its predecessor. While Its primary objective is to provide an outlet for smallholder crops, it has also been assigned a broader developmental role. In performing this function, ADMARC has provided equity or credit assistance to other farming and industrial enterprises. It has also absorbed the costs of implementing the Goverrment's developmental objectives through pan-territorial pricing and maintaining market outlets in remote locations. 2.02 For the two major smallholder cash crops, tobacco and cotton, ADMARC has a legal monopsony. It buys these crops directly from farmers, assembles, stores and transports them to the auction floors in the case of tobacco or to the ginners and mills for cotton. The other main smallholder export, groundnut is also purchased, assembled and stored mainly by ADHARC. Considerable local private trade occurs in the main food crops, maize, rice, cassava and pulses, but ADMARC is an important outlet for these crops as well. ADMARC is obliged to buy all smallholder produce offered at its network of buying points which consist of 26 depots, 87 parent markets, 132 permanent markets and 1,090 seasonal markets. Until 1987 the number of seasonal markets, particularly in remote locations, had risen steadily in response to Government directives, with over 300 markets added between 1985 and 1987. 2.03 ADMARC was very profitable until 1978 with average profits of about 28Z of its sales for the period FY74-78. These surpluses were earned largely on smallholder exports such as tobacco and groundnuts by keeping their producer prices low relative to world prices. The profits cross- subsidized ADMARC's extensive system of rural markets, the expansion of its investment portfolio and consumer subsidies for food crops. Stagnant world prices for exports, higher transport costs and changes in Government pricing policy aimed at parity pricing for exports all contributed to a decline in ADMARC's profitability after 1978. Continued losses in the 1980s prompted Government action to address ADMARC's problems. These actions included a program to divest ADMARC's investment portfolio, close uneconomical markets, and improve management. ADMARC has also taken steps to reduce staffing levels, streamline its operations, and cut costs. 2.04 The trends in ADMARC's crop purchases since 1981 illustrate two points. First, its maize purchases rose dramatically during the early 1980s while purchases of tobacco and other crops fell due to relative price changes. This shift toward maize purchases changed ADMARC's regional buying and selling patterns as well as the bulkiness or its purchases thereby raising its storage, handling and transport costs. Consequently, the total value of its crop purchases also rose sharply in real terms.  - 8 - Second, the volume of ADMARC's purchases of maize, rice and pulses have fallen significantly in the last two marketing seasons (1986 and 1987). While these declines were due in part to lower production, the greater competition that ADMARC has faced from private traders and relief agencies purchasing maize for refugees, was also an important factor. Processing 2.05 Except maize and rice, the processing of smailholder crops is done mostly by urban-based processors. Even with maize, processing at the village level occurs only for the local varieties with hybrids and composites being milled almost entirely by urban processors. The principal maize processors in the organized sector are GRAMIL (a wholly owned subsidiary of ADMARC), and KK Millers. While some rice is hulled in village mills, the main processor is NOIL in which ADMARC has a 50% share holding. Tobacco is purchased by ADMARC and then regraded before being auctioned. All smallholder cotton is bought by ADMARC and transported to its subsidiary, Cotton Ginners Ltd., where it is ginned and the lint is baled and classified for a fee. The lint is then sold to David Whitehead and Sons, also owned partly by ADMARC, for milling. NOIL also crushes cotton seed for ADMARC for a fee and the products, are sold to Lever Brothers and GRAMIL. ADMARC purchases both confectionery and oil groundnuts unshelled from farmers and shells and grades these in house. The confectionery nuts are then exported while the oil nuts are sold to Lever Brothers for oil extraction. Pulses and coarse grains purchased by ADMARC are graded and then sold to urban processors or exported directly. The Private Trade 2.06 It is difficult to estimate the share of smallholders' marketed surplus that has been assembled and stored by private agents. However, for the reasons noted in paras 2.12 and 2.13, tht extent of such private trade in smallholder produce seems to have been limited in the past. It has also differed from the operations of ADMARC in that it consisted mainly of small-scale trade within rural areas and on the fringes of Blantyre and Lilongwe, the main urban centers. Moreover, most trade in the rural areas has been in the form of direct sales from producers to ultimate consumers or village-level assemblers. Food crops such as maize, rice, cassava and pulses are the main ones that enter the private trade. Apart from ADMARC facilities, most storage capacity in rural areas is provided by temporary structures on farms and village stores. Private traders and farmers also utilize the District Council Markets to sell and purchase agricultural produce. The Marketing Liberalization Program 2.07 As part of its Structural Adjustment Program, the Government acted at the beginning of the 1987/88 marketing season to encourage greater private sector participation in the marketing of smallholder produce. This market liberalization program aimed at encouraging crop assembly and transport by private traders and thereby develop a multi-channel marketing system that involves the private trade as well as ADMARC. The program covered all smallholder produce except cotton and tobacco for which ADMARC will continue to be the sole purchaser. It clarified the legality of private trade, introduced differential prices between ADMARC's seasonal  markets and its depots and reduced consumer subsidies on maize. It also contained measures, including closure of 190 seasonal markets, to improve ADMARC's operations and management. 2.08 The private sector hias responded enthusiastically to the liberalization of smallholder marketing. The program included a requirement that all traders be licensed by the Government and over three hundred trading licenses were issued in the first year. Due to the delay in beginning the licensing process it is likely that many traders were operating without licenses. 2.09 There appear to be four classes of licensees following the liberalization. The first group function primarily as assemblers and consists of store owners, maize millers and iarger farmers located in rural locations. Such assemblers, in turn, sell their crop purchases to other licensees, who operate from urban locations. The second class is made up of rural and urban institutions that purchase food, mainly maize, for the consumption needs of their employees or tenants. This group includes the estates, hospitals, military installations and other Government institutions. The third group of licensees are processors who have begun to purchase crops from farmers and rural assemblers in addition to buying from ADMARC. A last group of licensees are the urban merchants who buy produce from rural assemblers or farmers and sell it to urban retailers and consumers or to processors such as GRAMIL. Many of the licensees are women traders. 2.10 In the first year of the liberalization, most licensed private traders concentrated on the trade of maize, though some private trade also occurred in rice, pulses, and groundnuts. The maize trade is entered into by all four classes of traders identified above. Trade in other crops usually involves only processors such as NOIL for rice and Lever Brothers for groundnuts as well as urban merchants and transporters who sell their crop purchases to the processors or directly to urban consumers. Finally, the operations of most traders are self-financed with little or no reliance on outside sources of working capital credit. The only exceptions are the large processors who have access to the formal financial sector. Rural assemblers and urban merchants relied totally on savings and surpluses from their other activities to finance their working capital needs. 2.11 The Smallholder Agricultural Produce Marketing Regulations of 1987 which formalized the private trade included several regulations governing the activities of private trade. Among the regulations were the requirements that traders: (i) buy and sell at designated markets; (ii) not buy at prices below the official minimum price; and (iii) provide monthly returns on the volume of commodities. These regulations were approved well after the start of the last marketing season. As a result, the level of compliance was quite low. In particular, the reporting requirements were only partially effective due to a lack of understanding of the requirements and the absence of a credible mechanism to monitor compliance. Constraints to Private Sector Participation 2.12 From the experience with the first year of the liberalization, there appear to be three major constraints to the  - 10 - development of a genuine multi-channel marketing system for smallholder produce. The first constraint is posed by lack of adequate financing. As was noted, most private traders who responded to the Government's market liberalization program, have had to rely on their own financing. Existing financial intermediaries do not provide credit for many agricultural marketing functions. The organized financial system has failed to provide credit to the agricultural marketing system for two main reasons. First, these institutions lack the administrative capability to process and supervise the types of loans required to finance agricultural marketing functions, particularly in the smallholder sector. Since most of their lending has been to ADMARC, large estates and urban businesses, they lack the personnel and procedures necessary to identify creditworthy borrowers and viable projects in smallholder agriculture. Secondly, they have lacked the incentive to develop the capacity for such lending because of the relatively easy returns to credit extended to the Government and parastatals such as ADMARC. Such lending is risk free and involves low administrative costs unlike loans for marketing activities to traders, most of whom lack acceptable collateral. 2.13 A second constraint relates to the lack of marketing infrastructure and institutional support for marketing activities. Most indigenous Malawians currently lack entrepreneurial experience. The Asians accounted for most private trading activity until they were prohibited from trading in the rural areas in the 1970s and ADMARC has dominated the trade since then making it difficult for small-scale entrepreneurs to begin trading in smallholder crops. There is also a lack of training in basic business skills such as storage, handling, export regulations, bookkeeping, etc. Moreover, information about market opportunities and statistics on crop production, consumption and trade are unreliable and outdated. Existing public market facilities such as District Council markets that are used by the private trade are also inadequate in that they provide little or no storage space and often are not easily accessible on a year round basis. 2.14 Another constraint is the Government' ability to provide an appropriate regulatory environment for private trade activrities. The Government has concerns about its ability to collect marketing information, maintain quality and protect vulnerable groups from unfair trade practices. But such concerns need to be addressed in such away that does not preclude the private trade from engaging in profitable trading opportunities. Some of the regulations announced as part of the Government's liberalization appeared to be overly restrictive while poor enforcement of other regulations lead to a situation where they had a limited impact. 2.15 In addition, regulations governing the export of smallholder crops are overly cumbersome and ineffective. A private exporter is required to get an export license from the Ministry of Trade, Industry and Tourism and clearance from ADMARC before commodity can be exported. However, at no time is the crop actually inspected and certified for quality by either MTIT or ADMARC. Thus, there is a need to both simplify the licensing procedures and to ensure that some sort of quality control mechanism is enforced. This is particularly crucial for groundnuts which are subject to contamination by aflatoxin.  - .3 - 2.16 The proposed Project is designed to address the constraints to private marketing due to lack of financing, poor infrastructure, and weak institutional support. It would help develop appropriate credit mechanisms and help to improve the infrastructure and services available to the private trader. It would also enhance the Government's data collection and analysis, improve its regulatory function, and maintain the quality of agricultural exports. B. The Estate Subsector 2.17 After Independence in 1964, the amount of estate land was about 120,000 ha. However, beginning around 1970, the area under estate cultivation expanded rapidly when the Government encouraged Malawi citizens to take out estate leases and grow tobacco in response to the market opportunities arising from the Rhodesian tobacco embargo. Between 1970 and 1985 total estate land increased about four fold to an estimated 600,000 ha on about 4,000 estates, most of which grow tobacco. The majority of tobacco estates are small with about 70Z growing tobacco on less than 5 ha. 2.18 The rapid growth in the number of estates has led to uneven performance within the subsector. A small number of older, well- established estates are at one extreme. They are often held under freehold title and operated by expatriate owners. They have access to skilled management, technical expertise and financing, often from external sources. At the other extreme, are a large number of newer estates, many of which are still unregistered, that are operated by Malawian owners. These estates are often quite small and operate with low levels of managerial and technical skills and with limited access to support services and credit. As a consequence, many estates are under capitalized and poorly run. Moreover, much of the land held by such estates is under utilized, while smallholders in the same areas face growing land shortages. Constraints to Estate Development 2.19 Support services for the Estate subsector are limited and serve mainly the larger, long-established estates. Two institutions, The Tea Research Foundation (TRF) and the Tobacco Research Authority (TRA) conduct research on estate crops. These institutions are funded through producer levies to undertake basic research on tea and tobacco. In addition the TRA operates a limited extension service for tobacco growers. Moreover, the agricultural departments of the commercial banks (NBM and CBM) have a small cadre of technical staff who provide extension services and technical advice to their borrowers in the estate subsector. However, the scope of these services are limited and the Ministry of Agriculture's extension service is focussed exclusively upon the smallholder sector. As a result, the vast majority of estates have no access to technical advice and research results. 2.20 To address the lack of access to information on improved technology, the Government is developing plans for an autonomous estate extension and management training service. These plans are based on a feasibility study conducted as part of the Third Structural Adjustment Credit. The new service is to he established with the assistance of external donor support and would eventually become self-supporting through financial contributions from the estates. ODA of the UK has expressed a  - 12 - willingness to provide the initial financing for the service and the Government is currently completing procedures for establishing the service as a legal entity and financing its operations from contributions from the estates. It is expected that these arrangements would be completed in the near future and that the extension service would begin operations in 1989. 2.21 The Government's land policy also constrains efficient use of resources in the estate subsector. Ease of entry into estate production, low and uniform land rents and the inadequate enforcement of covenants in estate leases have all contributed to under utilization of estate lands. The Government in its recent Statement of Development Policy has indicated its intention to implement a series of measures to control future expansion of estate lands and to encourage better resource utilization in the sector. Future Bank policy-based operations are intended to support this important element of policy reform. 2.22 Another constraint to increased estate productivity is the lack of credit. The only source of credit for the estates is the commercial banking sector. Most estate credit is for seasonal crop financing that is secured through stop orders on the tobacco auction floors. Little medium-term financing is provided partly due to a lack of medium-term funds but also due to the poor experience with such lending during the rapid build up of tobacco production in the 1970s. During this period, the commercial banks were encouraged by Government to provide credit to new estates to help stimulate tobacco production. Despite limited experience with agricultural credit, the banks expanded lending to estates from about MK9 million in 1975 to above MK90 million in 1980. Most of these loans included medium-term financing and involved low borrower contributions and short repayment periods. High rates of default reportedly occurred when rising input costs, poor yields and falling international prices for tobacco created severe liquidity problems for many borrowers. Many loans were foreclosed and the management of some estates had to be taken over by the banks. 2.23 Although the banks suffered large losses, they have since recovered and in the process have built considerable expertise in agricultural lending. They have slowly rebuilt their agricultural portfolio with loans now going to over 1,300 estates or about 30? of the total number. However, the Bank's have focussed on seasonal financing and there are considerable number of estate subprojects for which medium-term credit is required. 2.24 To help meet the subsector's medium-term credit needs and to test mechanisms for channelling such credit through existing banking institutions, a pilot credit line of US$4.5 million was established under the Industrial and Agricultural Credit project (Ln. 2646-MAI) which was declared effective in July 1986. Three institutions were selected to participate in the pilot including the National Bank of Malawi, the Commercial Bank of Malawi and INDEBANK. The funds are available to either of the three institutions on a first come first serve basis at 10.5Z interest for on-lending to sub-borrowers for periods of between three and six years at interest rates of between 11.5 and 15Z p.a. (recently adjusted to 16X p.a.). The subloans are to be made to estate farmers with established rights to their land and competent management. All subprojects are to be technically and financially feasible and are to be for land  - 13 - improvement, the development of estate infrastructure and the purchase of machinery. Emphasis is to be given to intensification of tobacco production or diversification !nto other farm enterprises. Maximum size of the subloans is to be the kwacha equivalent of US$250,000 for projects not involving irrigation and US$500,000 for irrigation projects. 2.25 The experience with the first two years of the loan clearly demonstrates the demand for medium-term financing in the subsector. Twelve subloans have already been approved for almost US$4.0 million and projects in the pipeline and expected to be approved shortly are expected to account for the remaining credit line. Details of the loans are shown in Annex 3. Most are at or near the established maximum limit on loan size. Seven involve irrigation for expanded coffee and mixed crop production, three are for the purchase or rehabilitation of tractors, one is for rehabilitation of tea processing facilities, and another is for the construction of an estate-run cotton gin. Each of the loan proposals so far approved have been reviewed by the Bank. They have been well prepared and the approved investments promise to contribute significantly to the Project's objective of diversifying and intensifying estate production. However, the loans have benefited a few out of the 4,100 estates and have gone mostly to large corporate enterprises, many of which are owned by expatriates. Those failing to benefit from the Project are the smaller Malawian-owned estates. 2.26 The estate credit line in the proposed Project is intended to build on the experience with the pilot credit component under the Industrial and Agricultural Credit project. It would continue to offer medium-term credit in support of subprojects to diversify and intensify estate production. However, it would endeavor to broaden the impact of the credit line by making it available to a larger number of estates, with special emphasis on the smaller estates. C. The Financial System 2.27 The financial sector of Malawi includes the Reserve Bank of Malawi (RBM), and twelve institutions that provide a variety of financial services. All banking institutions are regulated in accordance with the provisions of the Banking Act. Six institutions provide financing to the agricultural sector. These include the two Commercial Banks, National Bank of Malawi and Commercial Bank of Malawi, and two development finance companies, the Investment and Development Bank (INDEBANK) and the Small Enterprise Development Organization (SEDOM). INDEFUND, a subsidiary of INDEBANK, also provides limited financing for agriculture. In addition both seasonal and medium-term credit to the smallholder agriculture is administered through the National Rural Development Program (NRDP) with overall coordination provided by the recently established Smallholder Agricultural Credit Administration (SACA). RBM 2.28 RBM acts as the central bank and regulates the banking system and implements national monetary and credit policies in close cooperation with the Ministry of Finance. RBM recently completed deregulation of all lending and savings rates. Monetary policy tools include the credit ceilings for the Government and private sector borrowings and the minimum liquidity requirement for the commercial banks. It also manages Malawi's  - 14 - international reserves and administers the foreign exchange control system in cooperation with the commercial banks. RBM can lend to the commercial banks, the Government, and also to any statutory board, subject to approval by the Ministry of Finance. 2.29 The central government budget deficits are financed mainly by borrowings from the banking sector and from RBM. Central government notes, loans and advances from 80Z (MK543 million) of the total assets of RBM (MK676 million) as of December 31, 1986. The current budget deficit (1987/88) represents 8.92 of the GDP, and is expected to decline to 6.5% during the fiscal year 1988/89. The commercial banking sector deposits with RBM were MK184 million as of December 31, 1987. 2.30 Recent monetary policy measures include,the devaluation of the Kwacha by 15Z in January 1988. This measure was followed by the liberalization of the foreign exchange controls for imports of raw materials including farm inputs as well as spare parts. These items represent 25? of the total imports to Malawi. From the beginning of March 1988, RBM also ceased interest payments for the commercial bank' overnight deposits which exceed the 302 minimum liquidity requirements level. The Commercial Banks 2.31 The two commercial banks in Malawi are the National Bank of Malawi (NBM) and Commercial Bank of Malawi (CBM). Both banks were established about 17 years ago as joint ventures between Malawian and foreign investors. Over the years most of the foreign interests in both banks have been sold. NBM is currently owned by Press Holdings (47.4Z), ADMARC (32.6Z) and Standard Chartered Bank Africa (20Z). CBM is owned 402 by Press Holdings, and 30X each by the Government of Malawi and the Malawi Development Corporation (MDC). NBM is the larger of the two banks with nearly three times the financial resources and volume of operations of CMB. It has 14 branches and 63 agency locations throughout the country and about 1,200 employees. It is managed by Standard Chartered Bank under service agreement. There are seven expatriates and seven Malawian experts working in the Agricultural Department of NBM. Despite CMB's smaller operating base, it has a considerable geographic spread with 13 branches and over 80 agencies. 2.32 Both banks have had reasonably strong balance sheets in the last two years, continuing their recovery from the late 1970's when falling prices led to numerous defaults on loans to newly established tobacco estates. NBM's total assets grew by about 25% in 1986 to MK457 million while CBM's assets grew at a more modest rate (about 17Z) to MK131 million. Total loans by both banks reached MK232 million in 1986, rising by over MK39 million from the previous year's level (see Annex 7). Nevertheless, the balance sheets of the both commercial banks are characterized by a high proportion of investments .i GOM securities and deposits with RBM. Between 55 to 60% of both banks' assets were on deposit with RBM at the end of 1986 and this proportion rose in 1987. This high level of liquidity results from a good year for tobacco, import restrictions, and a Government ceilings on the growth of credit. However, it is expected that foreign  - 15 - exchange liberalization measures introduced recently should reduce the current level of liquidity. The banks' profits have also increased and they were able to pay dividends for a second year in row in 1986. 2.33 Both banks offer financing to the main sectors of the economy including agriculture, industry, construction, t;ansportation and trade. Most financing is for short-term working capital to established customers and is secured by assets and sound investment proposals. Potential borrowers are usually required to provide from 30 to 40Z of the Project cost from their own resources. Loans are regularly supervised by specialized staff in the branch offices and management is kept informed about the performance of each borrower through regular supervisions. The stringent and conservative loan procedures have helped to restore the banks' loan portfolio to good health. However, in the process, most Malawian entrepreneurs have found it difficult to secure commercial bank credit lines. Moreover, the administrative costs of the small loans required by the typical Malawian enterprise are making it highly unprofitable for the banks to service many of them. Development Finance Institutions 2.34 There are three development finance institutions in Malawi, each with distinct clientele. SEDOM is designed to service small businesses and offers loans up to MK75,000. INDEFUND is intended to service a clientele with slightly larger enterprises and offers a range of loans from MK30,000 to MK150,000. INDEBANK is the largest and concentrates on large projects, handling loans above MK150,000. SEDOM's portfolio emphasizes short and medium-term loans while the other two institutions focus on longer term investment projects. 2.35 Small Enterprise Development Organization of Malawi (SEDOM): SEDOM was established as a trust under the supervision of the Ministry of Trade, Industry, and Tourism in 1982, with the assistance of the European Economic Community. It is a development institution with the objective of assisting small entrepreneurs with technical advisory services, training and financial assistance. The training and advisory services are provided free of charge to clients and include business training, accounting and record keeping. On average 115 clients utilize these services each month. SEDOM's funds for on-lending as well as a major part of its operational costs have been provided in the form of grants from the Government, the European Development Fund (EEC) and the Kreditanstaff fur Wiederaufbau (KFW). In addition, SEDOM received a credit of ECU1.8 million, carrying an interest rate of 0.75Z, from KFW at the end of last fiscal year. 2.36 SEDOM had about 2,300 loans outstanding as of December 1987 with a total value of MK3,766,000. Of these loans, 327 were term loans with an average size of MK10,700 and a maturity of 24 months. The remaining loans were mostly seasonal "mini loans' which average MK1,500. About 25Z of the outstanding loans were for grain milling and food processing activities. Interest rates on SEDOM's loans are within the range of commercial banking rates. SEDOM has a staff of 130, up from 35 just three years ago. Its headquarters is located in Blantyre with branches in Lilongwe, and Mzuzu.  - 16 - 2.37 SEDOM has a strong loan portfolio with only 14Z of its outstanding loans over 30 days overdue and less than 4% over 90 days overdue. This good performance can be traced to stringent lending procedures, careful subproject supervision and support by the technical advisory services. Considerable effort is made to follow-up on delinquent borrowers and defaults. Despite its good lending record, SEDOM is a long way from being financially viable. Its revenue from lending only covers about 17 to 20T of its operating expenses despite the fact that the funds it receives for on-lending are or on highly concessional terms. This poor financial performance stems largely from the free training and advisory services SEDOM provides and its high cost of administering small loans. 2.38 SEDOM ultimately aims to cover its operational costs though it will require operating subsidies for some time to come. To this end, an agreement for a third phase development period covering 1988-1991 has just been signed by the Government, KFW, and EEC. The agreement provides for technical assistance and financial support for expanded lending activities. The agreement also calls for the funding of SEDOM's training and advisory services from sources other than internally generated revenues. This step along with strengthened internal cost controls should considerably improve SEDOM's financial viability. 2.39 Investment and Development Bank of Malawi - INDEBANK. INDEBANK was established in 1972 as a private limited liability company. Its basic objective is to promote economic development by providing medium and long-term loans and making equity investments mainly in industrial and agricultural projects sponsored by private or public investors. It emphasizes projects financed by Malawian interests and encourages foreign investors to find local partners. Its portfolio shows the following sectoral distribution: agriculture - 3.5%; agro-industry - 39.2z; industry - 26.3Z; property development - 12.3Z; hotels - 9.2Z; and finance, commerce and services - 9.5%. 2.40 INDEBANK is owned 24.82 by ADMARC, 8.6X by IFC and 22.22 each by the Commonwealth Development Corporation (CDC), the German Finance Company for Investments in Developing Countries (DEG) and Netherlands Finance Company for Developing Countries (FMO). Its authorized capital is MK7 million with paid up capital amounting to MK6.8 million. Moreover, MK15.25 million in additional resources have been provided by INDEBANK's shareholders in the form of Income Notes. These notes are unsecured, bear an interest rate of 8Z and are repayable by the year 2020. INDEBANK's Board of Directors consists of eight members including a representative of ADMARC who serves as chairman and two representatives each f.om CDC, DEG, and FMO. IFC has the eighth seat on the Board. 2.41 INDEFUND. This development finance institution is a subsidiary of INDEBANK with a paid-up share capital of MK1,670,000 of which 62Z is subscribed by INDEBANK and the remaining 38Z by EMO. It was set up in 1981 to finance projects between MK30,000 and MX150,000. It has funded its loan portfolio mainly from foreign sources including KFW (MK2.5 million), FMO (MK3.2 million) and a pledge from USAID fMK1.2 million). Its debt-equity ratio is presently about 6:1. Although it has an independent Board and management, the General Manager of INDEBANK plays an important role in its policy and investment decisions.  - 17 - 2.42 As of January 31, 1986, INDEFUND had approved 71 loans totalling MK2.8 million of which it had disbursed about MK1.8 million. The average loan size was about MK54,OuO. Most of its loans are for a term of five years, including the grace period of a year. It charges an interest rate of 16.52 p.a. on its loans. Over 60Z of the value of INDEFUND's loans has been to projects in manufacturing and agro-industries. Other projects financed have been in agriculture and trade. Since its inception, INDEFUND has made losses which have totalled almost MKl.O million by the end of FY87. These losses are attributable to a high rate of arrears on its loans and high loan supervision and other overhead costs. INDEFUND has had problems in controlling loan delinquencies and recovering loan principal from defaulters. New management has also been put in place recently to correct these deficiencies which should help strengthen INDEFUND's portfolio and income prospects in the future. III. THE PROJECT A. Project Obiectives and DesiRn Proiect Obiectives 3.01 The proposed Project would support two development objectives. First, it would aim to improve agricultural marketing and increase rural incomes by supporting Government efforts to develop a multi- channel marketing system. Second it would seek to improve resource utilization and productivity on estates by providing medium-term credit to intensify and diversify production. In achieving these aims, the Project would address the barriers to entry into agricultural trade faced by Malawian entrepreneurs and the factors that constrain the availability of credit to estates, particularly the smaller estates established since independence by Malawian owners. The Project would also assist the Government in carrying out its regulatory, promotional, and monitoring functions with regard to the private trade in smallholder crops. Project Design 3.02 The Project design is consistent with Government efforts to improve the existing system for rural credit delivery. The pilot component for estates under the Industrial and Agricultural Credit Project and the recent steps to strengthen the smallholder credit system under the Smallholder Credit Project were initial elements in a strategy to develop a low cost and reliable rural credit system by using existing financial institutions. This approach has been adopted in view of the high costs associated with establishing and operating a new institution focussed on rural credit. The proposed Project would build on these initiatives by expanding the scope of estate lending by existing institutions and promoting new credit lines aimed at the private trade in smallholder crops. The design also reflects the desire to minimize where possible the use of technical assistance personnel and to limit the impact of the Project on the Government's recurrent budget. B. Proiect Summary and Description 3.03 The Project, which would be implemented over a period of seven years, would comprise the following components:  - 18 - (a) estate development and agricultural marketing and processing involving: (i) subprojects to intensify and diversify estate production; (ii) investment in support of agricultural processing and marketing; and (iii) a pilot scheme to finance the short and medium-term credit requirements of rural traders specializing in the assembly, storage and transportation of smallholder crops. (b) institutional strengthening in the Ministry of Agriculture and the Malawi Bureau of Standards to imprc'e market policy analysis and develop market services, including market intelligence, regulatory and quality control systems; and (c) training of private merchants and construction and improvement of selected rural markets identified as potential growth centers for private trade in agricultural produce. C. Detailed Features Credit Component 3.04 The proposed Project would provide funds through RBM for subprojects in support of the Government's objectives of expanding and diversifying production in the estate subsector and developing a multi- channel marketing system for smallholder crops. The funds would help meet the demand in the estate subsector for medium-term credit and the credit needs emerging from the Government's liberalization of smallholder marketing. The funds would be provided as loans through existing financial institutions for subprojects that are technically and financially sound. The financial institutions expected to participate include NBM, CMB, and INDEBANK. These institutions would combine their own funds with IDA funds to support viable subprojects. A separate pilot credit scheme to be operated by SEDOM would address the credit needs of rural traders. The loans would be made by the participating institutions using loan procedures that have been agreed with IDA. 3.05 Estate Development. Estate development subprojects to be financed comprise: (a) establishment of new or expansion of existing estate crops, including overhead expenditures for staff, machinery and vehicle operation; (b) land improvements such as irrigation, drainage and establishment ot woodlotG;  - 19 - (c) development and rehabilitation of on-farm infrastructure such as curing barns, processing and grading facilities, boreholes and storage sheds; (d) purchase, rehabilitation and maintenance of farm equipment and machinery; and (e) purchase of livestock. Estates that are soundly managed, have evidence of clear title to land, and are engaged in financially viable productive activities would be eligible for financing under the Project. 3.06 The demand for this type of development is clearly evident from the rapid commitment of funds under the Industrial an Agricultural Credit Project, where the supply of credit funds was far outstripped by demand from large diversified estates. Moreover, in the last few years, the commercial banks have developed seasonal lend'.ng instruments for smaller estates and they see ample scope for medium-term credit to these borrowers as well. The proposed credit facility would be designed to reach these small estates as well as the larger and more diversified ones. To this end, two broad categories of estates have been identified. The first category would include estates whose annual turnover exceeds US$200,000. This group numbers about 500 and includes the estates that received credit under the Industrial and Agricultural Credit Project. They are well diversified and many are owned by expatriates. Loans in this category would concentrate on larger subprojects aimed at expanding tobacco production and diversifying into other crops such as coffee, cotton, wheat, macademia, etc., often through irrigation schemes. The second category would include estates with annual turnover of less than US$200,000. These estates were established after independence, are mostly Malawian owned and are currently devoted almost exclusively to tobacco. Loans in this category would, therefore, finance investments in buildings and equipment to expand and improve the quality of tobacco production although some diversification subprojects may emerge. The project-assisted lending program for estates would be determined by market forces and there will be no allocation of funds by crops or types of investments. An indicative lending program is shown in Annex 3 based on the experience with the Indu.trial and Agricultural Estate Credit Project for the large estates and representative models of some of the types of subprojects that are expected to emerge for smaller estates. 3.07 Agro-industrial Subproiects. The Project would provide medium-term credit for the development or rehabilitation of agro-industrial facilities (maize mills, cotton ginneries, rice mills and cassava and oil prccessing plants, etc) the construction or rehabilitation of storage, handling and grading facilities and/or the purchase of transport equipment and spare parts. To qualify for loans, marketing enterprises must have valid licenses and permits where required, should be engaged in financially viable activities and display adequate management capacity. Much of the demand for this credit would come from existing agro-industrial enterprises and would include financing for the rehabilitation and expansion of existing operations or the development of new activities. Included in this category are the large processing firms currently owned by ADMARC and scheduled for divestment. Once they are divested, rehabilitation of their plant and equipment would become eligible for financing under the Project.  - 20 - 3.08 Aside from medium-term credit, a need ekists for short-term working capital to help private marketing enterprises assume some of the buying functions currently being handled by ADMARC. Although adequate short-term funds exist in the banking sector to finance working capital, the provision of loans for working capital is often constrained by the lack of adequate security. To provide such se.,urity, the Project would promote the establishment of warehousing facilities where crops would be held as collateral for working capital loans. ADMARC has agreed to operate such a system. Merchants seeking working capital financing would be required to store commodities at selected ADMARC facilities on a fee basis. They would be given warehouse receipts that specify the quality and quantity of the commodities in store. These receipts would be held by the participating financial institutions as collateral for working capital loans. The marketing advisor to be provided under the Project (para 3.11) would assist in developing the legal framework and operating procedures for such a facility acceptable to the commercial banks, ADMARC and the Government. Annex 3 describes such a system and the criteria for its operations. 3.09 Pilot Credit Scheme for Rural Merchants. A crucial element of the Government's efforts to liberalize smallholder trade is the development of Malawian traders who operate in the rural markets purchasing crops from smallholders. Such merchants operate on a small scale, have little collateral and have limited access to formal credit markets. Thus, their ability to assume some of the responsibility for primary marketing currently being handled by ADMARC is constrained by the lack of suitable financing. To test mechanisms for delivering credit in a cost effective manner to such merchants, a pilot scheme would be implemented by SEDOM to channel funds to rural traders who have limited ability to provide security and contribute to the costs of subprojects. The pilot scheme would finance both short-term credit for working capital and medium-term credit to finance investments in storage, processing and transport. Annex 3 contains models of the types of borrowers projected to participate in the scheme and their likely credit requirement. SEDOM was chosen as the intermediary for the pilot because of its experience with lending to rural enterprises, its effective lending appraisal and supervision procedures and its ability to provide essential advisory services. Because of the pilot nature of the scheme, implementation would be overseen by the Pricing and Marketing Section of the Planning Division in MOA which would be responsible ror reviewing SEDOM's lending program to ensure that it is targeted to the credit needs of emerging rural merchants, including women traders. The rural financial specialist to be provided under the project (para 3.11) would oversee implementation of the pilot. Institutional Development Component 3.10 The Marketing and Pricing Section (MPS). The development of effective agricultural marketing channels comprised of both ADMAPRC and private enterprises, calls for the expanded responsibilities in the MOA. With private traders playing an increasing role in smallholder trade an important responsibility for MOA, would be the analysis and formulation of agricultural marketing policies. In addition, the Ministry would be responsible for providing market intelligence, promotion, and regulatory services. These responsibilities would be undertaken by the existing Marketing and Pricing Section (MPS) in the Planning Division of the MOA (Annex 1). The MPS consists of the Marketing and Policy Unit (MPPU), which would be responsible for market and pricing policy and the Marketing Services Unit (MSU), which would be responsible for market intelligence,  - 21 - training, extension, promotion and other support services. To assist the MPS in fulfilling its policy formulation and market support functions, the Project would provide resources for technical assistance, vehicles and spare parts, office supplies, equipment and rent for housing and office space. In addition, funds for special surveys and studies would be provided. 3.11 Technical assistance to be provided under the Project would include an internationally-recruited marketing services advisor who would be funded for the first three years of Project implementation and a rural financial specialist who would be funded for two years. The marketing services advisor would advise and assist the Chief and other MPS staff in strengthening and maintaining marketing support services including: standards and export quality control; storage and bonded warehousing, credit for marketing, market intelligence, and marketing extension and training. Guidelines for the terms of reference for this individual are given in Annex 6. During negotiations, assurances were obtained that a marketing advisor would be recruited by March 31, 1989. The rural financial specialist would assist MOA und SEDOM in the implementation and monitoring of the pilot credit scheme. Assurances were obtained at negotiations that terms of reference and work program for the specialist would be submitted to IDA for review and comment prior to March 31, 1989. Assistance for the marketing policy function is already being provided by an internationally recruited Price Policy Advisor, funded under the Bank- financed Agricultural Extension and Planning Project (Credit Number 1626). 3.12 The operation of MPS hinges critically on the effective functioning of the Planning Unit of MOA and closer collaboration with the ADDs' staff. The number of staff positions currently allocated to the Planning Division in MOA is adequate to carry-out the additional responsibility under the project with the exception of statistical clerks to help with the additional data collection and dissemination responsibilities of MPS. Therefore, while no incremental professional staff would be financed under the Project, funds would be made available for two statistical clerks. However, while the number of positions is adequate in the Planning Division, many of these have been vacant for over a year. These vacancies have affected the Division's ability to handle its existing work load and, if not filled, would make it impossible for it to handle the additional responsibilities envisaged in this Project. Thus, assurances were obtained at negotiations that four economist posts currently vacant in the Planning Division would be filled by March 31, 1989. For most of the field work, MPS would utilize the credit/marketing officers located in the ADDs for its data collection and market intelligence activities to be undertaken in the field. These officers are already involved in smallholder marketing and credit operations. 3.13 The Project would also allocate funds to the Planning Division for data collection and analysis in the estate sector. The data collected would be useful for policy formulation and would help the Project's Estates and Agro-industries Coordinating Committee (para 4.02) to manage implementation of the estate credit component. Annex 9 provides some of the data collection and policy issues that would be considered by MOA.  - 22 - 3.14 Trainin. Given the current lack of marketing skills among indigenous Malawians, the proposed Project would provide training programs for traders. Such training would focus on subjects such as handling and storage of crops, bookkeeping, business procedures, marketing management, and credit operations. Particular attention would be given to training in the safe handling and storage of pesticides used in fumigating crops (para 4.05). The organization of training for private traders is often complicated by varying levels of prior knowledge of the subject matter, skepticism on the part of traders as to the practical value of the training, and reluctance to give time to training since it might conflict with ongoing business responsibilities. A training program to be financed under the proposed Project would be designed to minimize these conflicts. In this regard, a pilot training program for traders, financed under the PPF was undertaken in Malawi to ascertain the above concerns. During the pilot training period, an evaluation was carried out by the Training and M&E Units of MOA. The one day training, which was well attended, was determined to be a success. Based on this evaluation, MOA has decided that the program should be geographically expanded, and be conducted in each ADD. The proposed Project would finance this training program. Initially, three-day courses twice a year would be conducted, but would be reduced to once a year in the fourth year of the Project. 3.15 The proposed Project would also finance training for MPS staff and the credit and marketing field officers. Specifically, funds would be provided for overseas training of three marketing officers for period of two years each. In-service training would also be provided for 32 field credit and marketing officers who would undergo training, lasting five days at a time, twice a year. These field officers, located in the ADDs would be trained to be effective in providing advice to individual traders to meet their specific needs, including assistance in storage and handling of crops, record keeping, and obtaining credit. Funds would also be provided for suitably qualified local trainers who would be employed on a temporary basis to provide specialized training services. 3.16 Export Quality Control. Given the importance of agricultural exports to Malawi, it is critical that suitable quality standards be maintained. Currently the procedures for maintaining quality control and institutional responsibility for enforcing it are ambiguous (para 2.15). Under the proposed Project, the Government has agreed that Malawi Bureau of Standards (MBS), of the Ministry of Trade, Industry, and Tourism (MTIT) would carry out this responsibility. MBS, which is currently responsible for quality certification of tobacco, would extend this responsibility to all agricultural products. MBS would be responsible for developing procedures and testing for the quality of export consignments. MTIT would continue with is responsibility of granting export licenses. The proposed Project would finance the initial costs of MBS's activities. Specifically, the proposed Project would finance salaries and wages of: one scientific officer and one technical assistant; two inspection and sampling field officers; external study tours, and two vehicles and equipment. A short- term technical expert (9 man-months) in export quality control, would also be funded.  - 23 - Market Infrastructure Component 3.17 The Ministry of Local Government recently formulated a National Development Physical Plan, one feature of which is the identification of rural markets whose expansion ot improvement should be supported by the Government. While these markets do not have adequate facilities, they are being used extensively by farmers and traders for trade of agriculture produce. The Project would assist the Government's efforts by financing the construction and/or rehabilitation of 16 district markets. The improvements would be designed to provide better market access, improved facilities for the display and handling of commodities, and the provision of market storage. Improved sanitation facilities would also be provided. The provisional sites for these infrastructural investments are those identified in the Plan. These markets are Chilumba and Ifumbo in Karonga ADD; Ntangatanga and Chintheche in Mzuzu ADD; Ntchisi and Mvela in Kasungu ADD; Chimbiya and Lizulu in Lilongwe ADD; Nkhotakota and Chipoka in Salima ADD; Namwera and Mayaka in Liwonde ADD; Kungu and Nkado in Blantyre ADD; and Ngabu and Nsanje in Ngabu ADD (Map No. IBRD 21003). These markets have been chosen because of their accessibility to farmers, assemblers and transporters, the volume of produce currently handled and their potential for developing into wholesale and storage centers. The market facilities will be rented out to farmers and traders. D. Proiect Costs 3.18 Total costs of the proposed Project, including physical and price contingencies, are estimated at about MK70.8 million (US$28.3 million), of which US$17.0 million or 602, represents the foreign exchange costs. Project costs by expenditure category are summarized in Table 1 below, and details are provided in Annex 2.  - 24 - Table 1 - Project Cost Summary by Components (Kwacha '000) (US 1000) X Total Local Foreign Total Local Foreign Total X Base FE Costs Marketing & Estate Credit Estate Development 18,400.0 27,800.0 46,000.0 7,360.0 11,040.0 18,400.0 so 68 Agro-Industries 4,042.6 7,607.6 11,650.0 1,617.0 3,003.0 4,620.0 65 17 Pilot Marketing Scheme 3,500.0 1,500.0 5,000.0 1,400.0 600.0 2,000.0 30 7 Sub-Total Credit 25,942.6 36,607.6 82,550.0 10,377.0 14,643.0 26,020.0 69 90 InstituWtonal Strangthening Pricing A Marketing Unit Technical Assistance - 1,580.0 1,580.0 - 832.0 632.0 100 1 Office Equipment 16.4 81.6 77.0 6.2 24.8 30.8 80 0 Training 464.1 208.0 872.1 186.8 83.2 288.8 81 1 Vehicles - 200.0 200.0 - 80.0 80.0 100 0 Information, MAE 300.0 300.0 600.0 120.0 120.0 240.0 so 1 Studies 89.8 1,386.3 1,476.0 35.9 664.1 690.0 94 2 Incremental Salaries e Operating Expenses 240.5 275.5 518.0 98.2 110.2 208.4 53 1 Sub-Total Pricing and Mar. 1,109.8 4,010.4 6,120.1 443.9 1,604.1 2,048.0 76 7 Bureau of Standards Technical Assistance - 90.0 90.0 - 38.0 38.0 100 0 Training - 82.0 82.0 - 32.8 32.8 100 0 Vehicles and Equipment - 236.0 236.0 - 94.4 94.4 100 0 Incremental Salaries A Operating Expenses 365.4 169.8 626.0 146.2 63.8 210.0 80 0 Sub-Total Bureau of Stand. 386.4 657.8 933.0 146.2 227.0 373.2 e1 1 Marketing Infrastructure Civil Works 689.2 883.8 1,473.0 235.7 353.6 689.2 80 2 Sub-Total Infrastructure 689.2 883.8 1,473.0 236.7 353.5 589.2 80 2 Total Baseline Costs 28,008.9 41,689.3 89,678.1 11,202.8 16,627.6 27,830.4 60 100 Physical contingencies 88.4 132.6 221.0 36.4 63.0 88.4 e8 0 Price contingencies 202.2 274.2 478.4 80.9 109.7 O.6 S8 I Total Project Costs 28,297.5 42,478.0 70,773.4 11,319.0 16,990.4 28,309.43 60 101  - 25 - 3.19 Project base costs have been estimated at March 1988 prices updated to January 1989 prices. Physical contingencies have been included at a rate of 15Z on civil works. Price contingencies estimates assume, for both foreign and local currency costs, price escalation of 3Z for 1988-1990 and 4Z per year thereafter. Price contingencies have been calculated on the assumption that differences between domestic and international inflation rates would be offset by the exchange rate adjustments. E. Financing 3.20 The proposed financing plan for the Project would be as follows: Table 2 - Financing Plan by Summary Accounts (USS '000) Participating Government IDA Banks Borrowers of Malawi Total Amount % Amount X Amount X Amount X Amount % Technical Assistance 689.1 100.0 - - - - - - 689.1 1.7 Civil Works 867.0 90.0 - - - - 73.0 10.0 730.0 2.6 Office Equipment 84.1 100.0 - - - - - - 34.1 0.1 Vehicles & Equipment 186.1 100.0 - - - - - - 185.1 0.8 Local Training - - - - - - 210.1 100.0 210.1 0.7 Overseas Training 126.2 100.0 - - - - - - 126.2 0.4 Information, MAE 248.0 100.0 - - - - - - 248.0 0.9 Studies 698.9 100.0 - - - - - - 698.9 2.1 Credit Large Estate 5,520.0 60.0 1,380.0 16.0 2,300.0 25.0 - - 9,200.0 32.7 Small Estato 5,520.0 60.0 1,380.0 16.0 2,300.0 26.0 - - 9,200.0 32.7 Agro-industries 8,003.0 65.0 462.6 10.0 1,164.5 26.0 - - 4,620.0 16.4 Pilot Marketing 1.499.9 75.0 - - 600.1 26.0 0.0 0.0 2.000.0 7.1 Sub-total Credit 15,542.9 62.1 8,222.6 12.9 8,254.6 26.0 0.0 0.0 26,020.0 89.0 Incremental Salaries & Operating expenses 198.3 41.8 - - - - 273.6 68.2 469.9 1.7 Total Disbursement 18,276.6 84.3 3,222.5 11.5 6,264.6 22.3 66f.7 2.0 28,309.4 100.0 3.21 The proposed IDA Credit of US$18.3 million would be on standard IDA terms. The Credit would cover all the foreign exchange costs of the Project (US$17.0 million) and llZ of the local costs, or about 642 of total Project costs, net of taxes and duties. Participating banks, final borrowers, and the Government would finance the remaining 12?, 222, and 2? of the Project costs, respectively. It is expected that  - 26 - participating borrowers would, overall, contribute about 25X of the costs for the estate development, agro-industrial and marketing subprojects. Participating credit institutions would, overall, contribute about 132 towards the costs of the subprojects. The Government would not contribute towards the credit funds. The Government's contribution (2Z of total Project cost or 92 excluding the credit fund), would finance part of the Project's recurrent local costs amounting to about US$0.5 million in 7 years. 3.22 IDA funds and GOM contributions for the strengthening of MOA's Pricing and Marketing Section (US$2.0 million) would be channelled through MOA. IDA funds and GOM contribution for strengthening the Malawi Bureau of Standards would be channelled through the Ministry of Trade, Industry and Tourism. IDA funds and GOM contribution (US$0.73 million) for market infrastructure development would be channelled by GOM to Ministry of Local Government (MOLG) on a grant basis, to be administered by the Local Fund Board (LFB). These funds would then be on-lent to the local authorities at a 42 interest rate and 5 year grace period. IDA funds for special studies (US$0.6 million) have already been channelled to MOA under PPF financing. The credit component (US$15.55 million) would be channelled through RBM to participating banks, for on-lending to eligible borrowers, in accordance with terms and conditions of a subsidiary financing agreement, satisfactory to IDA, to be signed between the RBM and each of the participating banks. The proposed Project would increase the Government's budgetary allocation by only about US$0.5 million in 7 years. F. Procurement 3.23 Procurement under the proposed Project would be in accordance with Bank/IDA guidelines. Machinery, vehicles, irrigation equipment, materials, seedlings and other supplies required by estate growers under the credit lines would be procured by the farmers themselves from local dealers or through direct import. Given that the size of individual investments would be too small and bulking of contracts would not be possible because of their diversity and the wide dispersal of estates and traders in Malawi, neither international competitive bidding (ICB) nor local competitive bidding (LCB) would be feasible under this component. For civil work construction and land preparation/clearing, they would arrange for contractors of their own choice. Private contractors are available for construction of civil works on a competitive basis. Participating banks would ensure that che goods and services to be financed under the credit component are the most appropriate for the profitable operation of the subprojects and obtained at reasonable prices. 3.24 Orders for vehicles, spare parts, equipment and office supplies for the non-credit components (US$0.22 million) would be bulked as far as possible, and orders of US$200,000 or above would be subject to ICB procedures in accordance with IDA guidelines. Contracts below US$100,000 equivalent would be awarded through Local Competitive Bidding (LCB), according to Local Procedures which are acceptable to IDA, with contracts for less than US$50,000 equivalent up to an aggregate of US$100,000 being  - 27 - awarded on the basis of quotations from at least three suppliers. Local procurement would also be open to Bank-member countries. Civil work construction of the market infrastructure component would be too small and scattered to attract international interest. Procurement would, therefore, be by contracts awarded following locally advertised bidding subject to IDA approval. Foreign firms would be entitled to compete. If approved by IDA, works procurement could be by force account of the MOLG. The selection and employment of technical assistance personnel would be in accordance with IDA guidelines. Assurances were obtained during negotiations that the procurement procedures outlined above would be followed, and that all technical assistance personnel would be employed under terms and conditions of employment satisfactory to IDA. Procurement arrangements are summarized below, with the amount to be financed by IDA credit in parenthesis. Procurement Methiod (US$ million) ICB LCB Other Total Cost Technical Assistance - - .69 .69 = - (.69) (.69) Civil works - 0.73 - 0.73 (0.66) _ (0.66) Overseas training - - .13 .13 (.13) (.13) Local training - - 0.21 0.21 - - (0.00) (0.00) Studies (PPF financing) - - 0.60 0.60 - - (0.60) (0.60) Information, M&E - - 0.25 0.25 - - (.25) (.25) Vehicles, equipment and office supplies 0.22 - - 0.22 (0.22) - - (0.22) Credit - 25.0 25.0 - - (15.55) (15.55) Operating cost - - 0.47 0.47 - - (0.20) (0.20) Total 0.22 0.73 27.35 28.30 (0.22) (0.66) (17.42) (18.30)  - 28 - G. Disbursement 3.25 The total IDA financing (US$18.3) would be disbursed over a 7-year period. The rate of disbursement has been adjusted to reflect the Bank' standard disbursement profile for Malawi. It is also based on the experience with the Industrial and Agricultural Credit Project, which has generated loan approval at a faster rate than anticipated at appraisal. Disbursement would be made from IDA credit on the following basis. Amount US$ million IDA Proposed Disbursement Percentage Credit Estates 11.00 100Z of expenditures financed under subloans Agro-industries 2.90 1002 of expenditures financed under subloans Pilot Marketing (SEDOM) 1.40 1002 of expenditures financed under subloans Vehicles, equipment and office supplies 0.20 1002 of expenditures Technical assistance 0.80 1002 of expenditures & Overseas Training Operating costs C.20 422 of expenditures Information, M&E 0.20 1002 of expenditures Civil works 0.65 902 of expenditures Refinancing of PPF utilized 0.70 1002 expenditures Unallocated 0.25 1002 of expenditures Total 18.30 3.26 To facilitate disbursement of funds under the proposed Project, assurances were obtained at negotiations that the Government would establish two special accounts in financial institutions acceptable to IDA. Special account number one would be established in a commercial bank and administered by the RBM. This account would provide funds for expenditures incurred on subloans made by INDEBANK, CBM, NBM, and SEDOM relating to the estate development, agro-industrial and pilot marketing credit lines. Special account number two would be established in a commercial bank and administered by the MOA and would be used to finance expenditures by MOA, MBS, and MOLG relating to the institutional strengthening and market infrastructure components. IDA would, upon credit effectiveness and receipt of withdrawal applications, make an advance deposit of US$500,000 in the first special account and US$200,000 in the second special account. IDA would periodically replenish the accounts upon receipt and approval of  - 29 - the withdrawal applications, together with satisfactory evidence that the expenditures paid from the special account were eligible for financing from the Project. 3.27 Disbursements against the credit component would be on the basis of statement of expenditures (SOEs) and would cover 10OX of subloans. Disbursement for any civil work carried out by force account would be on the basis of certificate of expenditure signed by the PS and financial controller (Senior Accountant) of MOLG, chairman of LFB and the clerk (chief executive) of the respective District Councils. For the disbursements under force accounts, supporting documents would be retained for inspection by the supervision missions. Disbursement on operating and maintenance costs would be on the basis of certificates of expenditure, signed by the PS and the financial controller of MOA for MOA expenditures, and by General Manager and Chief Account of MBS for the expenditures by MBS. SOEs would be accepted for contracts of less than US$20,000 equivalent for vehicles, equipment, and office supplies; technical assistance and overseas training; operating costs; information, monitoring, and evaluation. All other disbursements would be made against full documentation. Full supporting documentation in respect to SOEs would be retained by the borrower and made available for inspection by IDA during normal Project supervision. Actual withdrawals would be made by suitably operating the special account. An indicative schedule of disbursement is shown in Annex 2. The completion date for this Project would be December 31, 1995, and the closing date would be six months after this date. IV. PROJECT IMPLEMENTATION A. Organization and Management Project Coordination 4.01 The overall responsibility for the execution of the proposed Project would rest with the MOA and RBM. Within the Ministry, the permanent Secretary would be responsible for efficient Project implementation and for insuring coordination among institutions participating in the proposed Project. The RBM would be responsible for administering the credit lines and operating the special account established for the credit component. To help focus the management of this Project, two coordinating committees would be established as follows: (a) a Marketing Committee (MC) to oversee the implementation of the institutional strengthening component, the pilot credit for rural traders and the market infrastructure component. This Committee, under the chairmanship of the Secretary for Agriculture, would include representatives from MOF, RBM, EP&D, MBS, MOLG, MTIT, SEDOM, ADMARC and representatives from the private traders. The Planning Division of the Ministry of Agriculture would provide the executive support for this committee; and  - 30 - (b) an Estates and Agro-industries Committee (EAC) to oversee the implementation of the credit lines through INDEBANK, CBM and NBM. This committee, under the chairmanship of the Secretary of the Ministry of Finance, would include representatives from RBM, MOA, EP&D, MTIT, NBM, CBM, INDEBANK, the Estate Extension Service, and Estate representatives. Executive support would be provided by the Planning Division of the Ministry of Agriculture. The committees, would meet ss necessary, but at least twice a year, to review Project progress ar; to make recommendations on any necessary changes in Project implemen.tation. Assurances were obtained at negotiations that these committees would be established before credit effectiveness. Marketing Policy and Support Services 4.02 The Planning Department of MOA would be strengthened to reorient the Government's role in analysis and formulation of marketing policies and in facilitating the operation of a private marketing system. The two units, the Market Services Unit (MSU) and the Marketing Policy and Pricing Unit (MPPU), within the Marketing and Pricing Section (MPS) would be reorganized to accommodate the added responsibilities for the Department. MSU's overall responsibility would be to promote agricultural marketing by providing marketing support services for smallholder agriculture and assisting in the formulation of appropriate marketing policies. In particular, MSU would be responsible for strengthening and maintaining, in collaboration with other relevant bodies, services with regard to: (a) monitoring of the smallholder marketing system, including development, collection, and dissemination of timely market intelligence and information or the impact of the market liberalization measures; (b) marketing extension, including organization and management of a continuing training program for private traders; (c) collaboration and review with participating financial institutions procedures for financing private marketing entrepreneurs; (d) assistance to MPPU in development and/or review of marketing policies, regulations, and procedures for an effective agricultural marketing system; (e) assistance to the Bureau of Standards to develop and implement standards of product quality and packaging and export quality control; (f) liaison with Food Security Committee in OPC to include monitoring of quantities marketed and prices and indicators of shortage;  - 31 - (g) organization of storage, including capacity requirements, standards, regulations, stock data, bonded warehouses, etc.; and (h) assistance to MOLG in development of market- infrastructure. 4.03 In addition to MPPU's ongoing price policy function, it would be responsible for undertaking market policy analysis including: (a) examination of the future role of ADMARC; (b) consideration of the marketing aspects of national food security and buffer stock operations; (c) analysis of the impact of the market liberalization; (d) individual commodity assessments; and (e) ongoing review of market regulations. 4.04 In carrying out its other responsibilities in the field, the MPS would draw oa the services of credit and marketing officers in the ADDs. Examples of the type of data that would be required by MPS in undertaking its market analysis and support functions are presented in Annex 8. Training 4.05 The training program under the proposed Project would be organized by the Planning Department. The Department would determine priority training needs of the marketing and credit staff and traders, and appoint candidates for overseas and local training. The general manager of MBS would determine the candidates for the export quality control study tours. In conducting the training program, the Planning Department would call upon qualified trainers from SEDOM, DEMATT, ADMARC, and other institutions able to provide suitably qualified people. ADMARC, in particular would be responsible for providing training on the proper use and safe handling of pesticides used in the storage of agricultural commodities. Such training would be undertaken in collaboration with the ADDs and the Planning Department would assure that women traders have sufficient access to training opportunities. The Marketing Services Adviser, to be recruited under the Project, would specifically be responsible for developing a practical program, organizing and overseeing a continuing training program for private traders as well as for staff. Assurances were obtained at negotiations that MPS would submit its annual training programs to IDA for review and comment by March 31 of each year. Export Quality Control 4.06 The General Manager of the MBS would be responsible for the establishment and implementation of an export quality control system for the agricultural products. An agreement was reached between the Government and the appraisal mission that the quality control responsibilities would  - 32 - be given to the Bureau. It is expected that the MBS would assume full responsibility for agricultural export control by October 31, 1989, and an assurance to this effect was obtained during negotiations. The Bureau of Standards' overall responsibilities would be to: (a) establish base facilities and infrastructure for the national agricultural export quality control system; (b) ensure that agricultural export products meet minimum quality requirements for Malawi and the importing country; (c) improve and raise the quality level of Malawi's agricultural exports; (d) assure exporters that their export agricultural products comply with Malawi standards and foreign standards and regulations; and (e) establish procedures for testing the quality of agricultural export consignment. 4.07 The Ministry of Trade Industries and Tourism (MTXT) would continue to be respensible for granting export licenses. Exporters would carry the obligation to obtain certification according to export quality criteria established by the MTIT. Exporters would be required to pay a fee for export quality certification as a contribution towards its cost. MBS would periodically evaluate its export quality control system as implemented to ensure that the criteria and procedures used are in line with current commercial requirements. Regulation of the Private Trade 4.08 The Marketing and Pricing Section in collaboration with other relevant institutions, is responsible for developing and reviewing marketing policies, regulations, and procedures to ensure effective operation of a private marketing system. In this context the appraisal mission reviewed the existing regulations and found them acceptable with one exception. Under existing market regulations, traders are required to operate at markets under the control ADMARC or District, Town, Municipal or city councils, they are not permitted to buy directly from farmers in the field. This regulation imposes unnecessary costs on farmers who must transport their produce to designated markets where traders are permitted to operate. Thus, assurances were obtained at negotiations that MOA would undertake an analysis of the impact of its market reform measures, including the effects of the regulations requiring traders to operate in designated markets. The results of this review would be reviewed with IDA and agreed changes would be implemented by March 31, 1990. Moreover, assurances were obtained that any subsequent proposals for changes in marketing regulations would be reviewed and agreed with IDA prior to their implementation.  - 33 - Market Infrastructure Development 4.09 MOLG would be responsible for approving and supervising the construction of market infrastructure under the proposed Project. MOLG would assist the district councils in selecting the market sites. The District Councils would construct these markets in accordance with MOLG's designs, which would be approved by IDA. Estate Development, Agro-industries and Rural Traders 4.10 The Project would provide financing to estate owners, agro- industries, transporters, and merchants for estate development, agro- industrial and marketing :.iubprojects. Financed institutions expected to participate in administering the proposed credit lines include the commercial banks (NCB and CBM), INDEBANK and SEDOM. The two commercial banks and INDEBANK would finance estate development and agro-industries subprojects. SEDOM would operate a pilot credit line in support of rural merchants. Credit Terms and Conditions 4.11 Funds for estate development, agro-industries and the pilot marketing scheme would be channeled through RBM to the pa:ticipating banks for subprojects on terms and conditions to be defined in subsidiary loan agreements acceptable to IDA. The execution of such a subsidiary loan agreement between RBM and a participating institution would be a condition of disbursement of the proceeds of the Credit to that institution. Draft terms and conditions of on-lending from RBM to participating banks and from participating bank to final borrowers are summarized in Annex 4. These conditions of lending would be agreed during negotiations and would be reflected in the subsidiary loan agreements. 4.12 Estate Development. Funds in support of estate development would be made available through NBM, CBM and INDEBANK. This credit line has been designed to channel much of the proposed credit funds to subprojects on smaller estates. Assurances were obtained at negotiations that at least 50Z or US$5.5 million of the US$11.0 million in IDA funds earmarked for estate lending would be targeted for lending to small estates (para 3.06). 4.13 The funds for estate development would be available to the participating Banks on a first come first serve basis. It is recognized that the commercial banks, because of their extensive branch networks and experience with lending seasonal credit to smaller estates would likely handle most of the 5.5 million earmarked for small estate lending. Nevertheless, INDEBANK has indicated an interest in developing a pipeline of small estate subprojects.  - 34 - 4.14 Lending to small estates would be monitored by RBM and the Estates and Agro-industries Committee (EAC) to ensure that reasonable efforts are being made to achieve the target lending levels. The monitoring effort would be on the basis of quarterly compliance reports to be prepared by each participating bank (Annex 5). 4.15 To ensure that the benefits of the IDA credit for estates are spread as widely as possible lending limits will be imposed. For the smaller estates, assurances were obtained at negotiations that no individual estate would be able to take cumulative loans from this credit line of more than US$150,000. In addition the limits set for individual large loans in the Industrial and Agricultural Project of US$250,000 for rainfed projects, and US$500,000 for irrigated projects would be maintained in the proposed credit line. 4.16 Agro-Industries Subprojects. IDA resources totaling about US$3.5 million would be made available to CBM, NBM and INDEBANK on a first come basis in support of agricultural processing subprojects. Considerable demand for this type of credit has emerged in the past year. To satisfy this demand and to accelerate Project benefits, the Project would provide for the retroactive financing of up to US$1.5 million to finance eligible subprojects approved after July 1, 1988. 4.17 It is expected that the participating banks, in addition to supporting the traditional agro-industries, would also finance small-scale processing, transport, storage and handling of agricultural products in rural areas in support of the rural traders emerging as a result of the trade liberalization policy. There would be no limit on individual loan size for the agro-processing project. 4.18 Lending Terms for the Estate Development and Agro-industries Credit Line. Lending terms to the final borrowers would include a repayment period that is consistent with the useful life of the investment up to a maximum of 12 years. A grace period for repayment of principal of up to four years could be allowed, depending on the nature of the subproject. For estate development, those eligible for subloans would have to show evidence of clear title to land. They would also have to demonstrate competent management and their proposals would have to be technically and financially viable. For agro-industries, borrowing enterprises must have valid licenses and permits, where required, and should display adequate management skills. They should also be prepared to submit sound technical and financial proposals.  - 35 - 4.19 The participating banks would have the discretion to determine the interest rate charged to their borrowers, on a case-by-case basis, but they would offer rates that fall within prevailing market conditions. Lending rates recently have been deregulated in Malawi and are now market determined. Nevertheless, assurances were obtained at negotiations that the participating Banks would annually review and revise their lending rates to ensure that they are: (i) in line with the overall interest rate structure in the country; and (ii) adequate to obtain the project objectives. 4.20 The spreads between the Banks' interest rate to the final borrowers and the rates charged by RBM for IDA funds would be pegged at 5Z for large estate and agro-industries loans and 7Z for small estate loans. At the current lending rate of 16Z, the RBM lending rate would be liZ for large estates and agro-industries. The difference in large and small estate spreads is in recognition of the higher cost and risks associated with lending to smaller estates. To maintain these spreads, assurances were obtained at negotiations that the RBM would adjust the on-lending rate to the participating banks on a point-for-point basis when agricultural lending rates change. As in the Industrial and Agricultural Credit Project, the Government would bear the exchange rate risk on subloans to both the agricultural estates and agro-industrial enterprises. The difference between the IDA lending rate to the Government and the rate paid by the participating banks would go towards covering the foreign exchange risk. 4.21 Subproject Preparation and Appraisal. Each participating institution making loans for estate development and agro-indus;rial subprojects would have full autonomy to approve or reject subprojects financed under the projects. They would be responsible for all aspects of subproject v.dentification, preparation, appraisal and supervision. Subproject documentation or feasibility studies would be required of all prospective sub-borrowers. For the small estates, where loans would often be less than US$100,000, the preparation documents would be comprised of a simple letter of application that would provide relevant financial background and a description of how the loan proceeds would be utilized. The application would be evaluated and approved by participating bank staff in accordance with established practices and procedures that have been found to be adequate by IDA. More detailed subproject preparation and appraisal methods would be required for loans above US$100,000. Preparation reports for such loans would be the responsibility of the sub- borrower who would likely seek assistance from hired consultants when preparing subprojects. Proposals would contain a project description, an organizational and legal framework of the borrowing unit, a technical review, marketing and management analysis, project implementation schedule and production and financing plans. A detailed list of required subproject documentation is provided in Annex 5. Similar documentation requirements were utilized under the Industrial and Agricultural Credit project and were found satisfactory by IDA. 4.22 Each subproject would be subject to appraisal by the participating banks. Appraisal would include a detailed review of technical, organizational, managerial, and financial aspects. Draft criteria for appraisal are included in Annex 5. The technical analysis  - 36 - would include an analysis of the environmental impact of the Project and a description of measures to be taken to control any detrimental efcects on the environment or population (para 4.38 and 4.39). All the participating banks proposed for on-lending to the estates and larger marketing enterprises have already adopted appraisal methodology under the Industrial and Agricultural Credit Project that have been found acceptable by IDA. Nevertheless, assurances were obtained at negotiations that each participating bank would submit to IDA for its review and approval samples of appraisal documents for small estates subprojects, the large estates subprojects, and marketing enterprises subprojects. Thereafter, spot checks on subloan applications and appraisal would be undertaken during IDA's regular supervisions. Moreover, assurances were obtained at negotiations that financial rates of return would be calculated for all subloans above US$100,000 and that no subloans would be financed with FRR's of less than 12Z. 4.23 As these banks are holding the loan risk, there would be no loan approval required from either RBM or IDA. However, if it is fomnd that IDA on-lending proceeds were not being utilized for the purposes intended by this credit, all disbursements to the participating bank would be suspended and the bank would be obligated to immediate repayment to RBM for those loans found not to have been satisfactorily made. 4.24 Reporting on loans both to RBM and IDA, would be on the basis of the periodic withdrawal requests consisting of loan data summaries and a consolidated drawdown requests. In the case of the small estate sector these reports would be quarterly, while for the large estates and agro- processing subpro,ects, they would be prepared at the time of each drawdown request on a project by project basis. However, for IDA, the large estate drawdown reports would be held and submitted on a quarterly basis. 4.25 Revolving Fund and Replenishment. Loan repayments by the participating banks would take two forms: for the small estates - annual repayments of capital over 5 years on the basis of the quarterly reimbursement requests (i.e. repayments are not related to the repayment schedule by the borrowers); for the large estates - repayment matched to the schedule of and agroprocessing repayments of each borrower. subprojects In all cases the participating banks, having assumed the credit risk, would be required to repay the RBM on schedule irrespective of the borrowers' performance. 4.26 Government would consider placing capital repayments to RBM into a MK special account as a revolving fund for medium-term loans to the agriculture sector by the participating banks. The uses of these funds and the conditions for drawdown would be determined by the RBM in conjunction with the Ministries of Finance and Agriculture and the participating banks.  - 37 - 4.27 Pilot Marketing Scheme for Rural Traders. SEDOM would be provided funds through the RBM, for support of the emerging agricultural commodity trading sector. SEDOM's objective would be to support rural traders, including women traders, and to seek projects that woi'ld increase capital and marketing infrastructure investments in the rural areas. To ensure adequate management of this pilot credit, assurances were obtained at negotiations that SEDOM would appoint by March 31, 1989 a Project Manager from among their senior staff, who would take day to day responsibility for the administration and promotion of this pilot. SEDOM would prepare a program for the promotion of subprojects under this program, together with the criteria for the target groups to which this promotion would be directed. This program would be submitted for approval to the Planning Division of MOA, MTIT (para 4.01) and IDA. Such approval is a condition of disbursement of the pilot credit. 4.28 SEDOM would support the following activities: with short term credit lines - working capital for seasonal commodity trading; - working capital for rural multi-product trading based on purchase of commodities in the rural areas, and supply of consumer goods to the rural areas; and - working capital for the purchase of chemicals and fumigants, bags etc. for storage quality maintenance. with medium-term credit - purchase of small processing mills, drying, cleaning and grading equipment, weighing scales, moisture meters, and related civil works; - construction or rehabilitation of rural commodity storage facilities owned or rented to commodity traders; and - purchase of small trucks, suitable for rural road conditions. All seasonal loans would have a term to the borrower of between 3 and 12 months. Medium-term loans would have terms of between 3 and 5 years. 4.29 SEDOM would prepare an annual lending program, together with the criteria for selection of borrowers, to be agreed with the Planning Division of the Ministry of Agriculture and MTIT, before the commencement of each calender year's lending activities. The assessment of SEDOM's performance under these annual plans would be the function of the Marketing Committee. SEDOM would undertake to submit quarterly reports to this committee, that would include: - summary profiles of lending - summary profiles of borrowers  - 38 - _ geographic analysis of borrowers - loan portfolio and collection performance - promotion program implementation report. 4.30 On-lending rates for IDA funds to SEDOM from the Government would be set not less than 3.OZ, which is consistent with the cost of funds SEDOM receives from other sources and reflects the nature and cost of the technical assistance and training activities provided to its clients. SEDOM'S lending rate to its borrowers reflect market rates and are currently in the range of 16 to 18%. Assurances were obtained at negotiations that interest rates to the final borrowers would be reviewed annually by SEDOM, in conjunction with RBM, and set in accordance with market rates. As with the other credit lines in the proposed Project, the Government would bear the foreign exchange risk and SEDOM would bear the credit risk for IDA resources on-lent under the pilot. 4.31 All loans to SEDOM would have to be repaid in full to RBM on the following schedules: short-term credit - in full with accumulated interest in the 13th month; medium-term credit - equal annual payments of principal and interest over five years. For seasonal credit, the borrower would be required to pay interest on a fortnightly basis. No "automatic roll-over" by the borrower would be permitted. For medium-term credit, principal and interest would be payable on a monthly basis, on an equal payment basis for the duration of the loan. 4.32 Loan Appraisal. SEDOM's loan assessment capabilities were found to be adequate during appraisal. Nevertheless, assurances were obtained at negotiations that SEDOM would submit to IDA for examination a sample of loan assessments. On the basis of IDA's examination of this documentation it may require changes ir. SEDOM's loan assessment procedures. For replenishment claims to RBM, SEDOM would submit quarterly summaries of each project from which disbursement has been completed. 4.33 For seasonal credit to fund trading activities, the procedures to be adopted by SEDOM to ensure that loan proceeds are utilized as intended should be developed in conjunction with their auditors, and this set of loan monitoring procedures should be submitted to IDA for review and approval as a condition of disbursements under the pilot credit line. Similarly, examples of the loan summary sheets and reimbursement claim forms, that meet the auditors approval should be submitted by this date. 4.34 All repayments by SEDOM to the RBM would be placed into a separate revolving fund for further lending for marketing. Future use of the revolving fund would be at the discretion of the Ministry of Finance under terms and conditions to be agreed between it, the MOA, MTIT, RBM and SEDOM.  - 39 - B. Accounts and Audit Accounts and Audits 4.35 MOA, MBS, MLG, RBM, the participating banks and SEDOM would maintain separate accounts for the Project in accordance with sound accounting principles and would ensure that these accounts would be audited by qualified independent auditors acceptable to IDA. Audited annual accounts together with auditor's comments for each participating institution would be sent to IDA within nine months of the close of each fiscal year. Auditors would be requested to provide in their audits confirmation that the statements of expenditures submitted by the concerned project agency are properly prepared and that credit funds claimed have actually been spent and the goods and services procured are used for the purposes intended under the Project. MOA and RBM which would be responsible for operating the special accounts to be established for the project (para 3.26), would arrange for annual audits of the special accounts in accordance with IDA guidelines. Assurances to these effects were obtained at negotiations. C. Monitoring and Evaluation 4.36 The separate accounts to be maintained by CBM, NBM and INDEBANK for the estate and agro-industries credit lines (para. 4.35) would also form the basis of quarterly reports which would be submitted to the Estate and Agro-Industries Committee and IDA. These reports would include details of the subloans approved and committed, and a summary analysis of the implementation and performance of subprojects financed credit lines. For the estate credit lines, these reports would be used in monitoring compliance with the requirements for lending to small estates (para. 4.14). SEDOM4 would also prepare quarterly reports on the pilot credit for submission to the Marketing Committee and IDA. The other implementing agency, i.e., MOA, MLOG, and MBS, would also monitor the progress of the part of Project for which they are responsible. Each of these entities would report semi-annually to the Marketing Committee and IDA, providing data on Project activities, on completion of physical and institutional targets, and on circumstances or problems that are critical to the effective implementation of the Project. Assurances on these points were obtained during negotiations. 4.37 Evaluation would be carried out by the Planning Division and specifically by the Monitoring and Evaluation Unit of MOA, at the end of Year 3 of the Project implementation and after completion of the Project. The three year evaluation report would form the basis of mid-term Project implementation review. Assurances were obtained at negotiations that MOA would prepare an evaluation report by June 30, 1992, which would be submitted to IDA for comment and review. Changes in Project activities that have been agreed with IDA as a result of the evaluation would be implemented promptly. MSU would prepare a Project Completion Report within six months after completion of the Project. An assurance to this effect was obtained at negotiations.  - 40 - D. Environmental Safeguards 4.38 The production of the estate crops which would be financed under the Project (tobacco, coffee, tea, macademia, etc.) involves the application of agro-chemicals with potentially adverse environmental and health risks if handled improperly. Similarly, subprojects financing crop marketing and processing activities possibly could be the source of polluting agents resulting either from fumigation, discharge of effluents, dust or smoke. To limit the risk of environmental damage, subprojects financed under the Project would incorporate appropriate environmental safeguards. In the preparation and appraisal of large estate and agro-industrial subprojects, the technical evaluation would include analysis of the environmental impact of the su1-project and the steps to be taken to control polluting agents in accordance with IDA guidelines which would be provided to the participating banks. In addition, the participating banks during the course of their normal supervision would ensure that the subprojects operate according to environmentally sound practices. For the pilot credit line for rural traders, potential borrowers would be required to take training to be financed under the Project in the storage and handling of agricultural commodities, including the use of pesticides and fumigants (para 3.14, 4.05). Potential borrowers would also need to demonstrate that they have appropriate facilities for pesticides storage and disposal. 4.39 Another environmental concern is the risk that the Project may finance the expansion of estate cultivation into protected lands or into areas currently occupied by smallholders. However, the requirement that prospective estate borrowers show clear evidence of title to the land they intend to utilize in a proposed subproject provides sufficient safeguard against such encroachment. The procedures utilized to obtain Government leases of estate land are designed to ensure that the lands in question are designated for agricultural use and are not currently occupied by smallholders under customary tenure arrangements. E. Role of Women 4.40 Women in Malawi, who constitute the majority of agricultural producers, are also heavily involved as petty traders in the marketing of grains (maize, rice, sorghum, millet), groundnuts, beans and fruits in both the urban and rural markets. Despite this, they generally have less access in their own right than men to credit, extension and marketing services, primarily due to traditional cultural patterns. The proposed project complements our activities under the ongoing Smallholder Agricultural Credit Project which through a group pilot lending scheme provides credit to women farmers and the Agricultural Services Initiative which has a special focus on women. The Project would seek to improve women's productivity and economic capabilities through the pilot scheme implemented by SEDOM which would channel credit to rural traders, the majority of whom are women (para 3.09). The credit would be used to buy bags for crop storage and transport, stalls, scales and other items needed for the marketing of produce. In addition, the Project would provide training to these traders in marketing skills such as handling and storage of crops, bookkeeping, marketing management and credit operations (para 3.14). To meet the particular needs of women who cannot be away from their families for extended periods, much of the training would be in carried out in short segments. F. Status of Project Implementation 4.41 IDA has approved a Project Preparation Facility (PPF) to ensure timely start-up of Project activity. The facility will also enable the Government to begin monitoring crop marketing activity for the upcoming marketing season. The PPF includes funding for crop specific marketing studies that would, among other things, identify a pipeline of potential marketing subprojects. Terms of reference for these studies have been finalized, consultants have been selected, and field work is currently getting underway. The PPF is also financing pilot training exercises for private traders and priority resources for improved data collection for production an pricing statistics. In addition, it is funding a study that seeks to establish an accounting system that differentiates the costs of ADMARC's commercial and developmental activities. Finally, the PPF is financing an examination of options for the distribution of fertilizer and other farm inputs.  - 41 - V. PROJECT BENEFITS AND RISKS A. Proiect Benefits 5.01 The Project would assist in the development of the agriculture in Malawi through the provision of credit, training, and technical assistance which would strengthen the agricultural marketing system and expand the production base in the estate subsector. The Project would contribute to increased agricultural production, employment and incomc generation through efficiency gains in agricultural marketing and increased productivity in estate agriculture. 5.02 Benefits of the Project would accrue to the borrowers of term credit and through them to the economy as a whole. For the marketing credit, the benefits to improved processing, transport, and storage would be in the form of improved quality and lower marketing margins which would be passed on to both producers and consumers. The pilot scheme for rural traders would assist in developing a multi-channel marketing system for smallholder agriculture which would give producers greater choice and flexibility in marketing their output. It would also help ADMARC in rationalizing its network of rural markets through financing private agents who would operate markets on ADMARC's behalf. 5.03 The credit provided for estate development would expand and diversify estate production. The credit is designed to benefit the small Malawian-owned estates which currently have limited access to term financing. The benefits to the borrowers would come in the form of higher income through increased yields, improved quality, and better utilization of land resources in the subsector. Additional benefits to the economy would result from increased employment on the estates and higher export revenues. 5.04 Tbase benefits cannot be quantified because they are the aggregate of benefits of subprojects which are only now being identified. Furthermore, benefits from investments in improved marketing infrastructure are difficuit to measure. However, the experience with lending to larger estates under the Industrial and Agricultural Credit Project provide some guidance on the level of returns to be expected from the estate credit lines. Preparation documents for the subloans under this Project show financial rates of return ranging from 23Z for mechanized tobacco cultivation to over 402 for irrigated coffee production. These rates are only moderately sensitive to changes in output prices and costs. Similar rates are anticipated for the prcposed large estate lending and the stringent loan appraisal requirements and supervision procedures would help to ensure that the FRRs are at acceptable minimum levels. Moreover, the requirement that all subloans above US$150.000, must have a minimum financial rate of return of 12Z will help ensure that the proposed investment are yielding satisfactory returns. 5.05 For the small e3tates, financial rates of return based on the five models have been calculated (Annex 3, Appendix 2). They range from about 18Z for small scale expansion of flue-cured tobacco to over 50Z for the small-scale burley model. Finally, rates of return for Agro-Industries  - 42 - subprojects are expected to be -n the range of 20 to 30Z based on calculations for a cotton ginnery and tea processing plant financed under the Industrial and Agricultural Credit Project. For all subprojects, the expected economic rates of return are at about the same level or higher than the FRR due to the limited number of subsidies and the distortions facing the estates sector and agro-processors. 5.06 The impact on employment and rural incomes of the proposed lending program are expected to be substantial. For example, full and part- time employment generated or saved from the 12 subprojects under the Industrial and Agricultural Credit Project, are estimated at about 7,500 with the value of total incremental production at about MK13 million a year. Similar orders of magnitude are expected for lending to large estate under the proposed Project. Employment generation estimated from the indicative small estate lending program is estimated in the range of 3,500 to 5,000 either as tenants or wage laborers. Value of expanded production from the tobacco and diversified cropping subprojects is expected to be in the range of MK10 to 12 million annually. 5.07 Benefits to the participating banks would accrue through expanded term lending to viable marketing and estate enterprises which would improve their asset structure and profitability. The technical assistance to be provided by the Project would also help develop the institutional capacity to promote private marketing enterprises. This enhanced institutional capacity for new lending will create new investment and employment opportunities fer Malawi citizens. 5.08 The institutional strengthening component will provide benefits in terms of improved data collection and analytical capabilities in the Government. The quality control improvement should ensure that the quality of Malawian exports is maintained, thereby helping to enhance ADMARC's production in position markets. Finally, the market infrastructure component will provide improved assembly, handling, and storage facilities in rural markets that would yield benefits in terms of lower marketing costs. B. Proiect Risks 5.09 The main risk associated with the pilot marketing program and agro-industries lending is the ability of the participating banks to promote, identify, and prepare viable subprojects. This risk has been covered in two ways. First, the rural trade credit line has been designed as a pilot exercise to test subprojects aimed at rural assemblers, traders, and transporters. SEDOM has built considerable experience in lending to such small scale rural enterprises and MSU will play an active role in helping to shape SEDOM's efforts to promote and implement the pilot program. Second, for the agro-industries subprojects, the work of the MSU is expected to identify marketing bottlenecks and potential subprojects to address these bottlenecks. ADMARC'S divestment of some of its agro- processing activities is also expected to generate demand for financing to rehabilitate and expand existing operations once they have changed ownership. 5.10 Another risk associated with the marketing aspect of the Project is the effectiveness of the Government's efforts to encourage private trade. The Government has demonstrated a firm resolve to implement  - 43 - its market liberalization program in face of the food shortages that have occurred in the last year. However, the Government's concern about the impact of the liberalization has caused it to place a great deal of emphasis on market regulations and control. There is a risk that this emphasis on regulations will unduly restrict the private trade and limit the impact of the liberalization measures. The Project would provide technical assistance to ensure that the Government's regulatory function is administered in a way that is conducive to the development of private trade channels. Moreover, the Project provides for IDA review of any proposed changes in market regulations. Finally, marketing and pricing are a major element of IDA's policy dialogue with the Government and future policy based operations will focus on maintaining favorable environment for private trade in agricultural commodicies. 5.11 The main risk associated with estate development is that the estate crops (especially tobacco) rre produced for the export market and a substantial drop in the international prices of these crops could result in liquidity problems for sub-borrowers and in defaults on loan repayments. Howfever, according to a Bank forecast, prices of Malawi's major export crops in constant US dollars are expected to remain relatively stable in the medium-term. Also, the term credit to be provided estate farmers will also help to make them more efficient, lower cost producers who will be better able to withstand price fluctuations. Finally, participating financial intermediaries are expected to review potential sub-borrowers to screen out those who are not good credit risks. VI. ASSURANCES AND RECO1413NDATIONS 6.01 Assurances were obtained at negotiations on the following: (a) the marketing advisor would be recruited in accordance with Bank guid2lines by March 31, 1989 (para 3.11); (b) terms of reference and a work program for the rural financial specialist to assist in the implementation of the pilot credit scheme would be submitted to IDA for review and comment prior to March 31, 1989 (para. 3.11)- (c) four of the economist posts currently vacant in the Planning Division would be filled by March 31, 1989 (para 3.12); (d) two special accounts would be established in financial institutions acceptable to IDA to ensure that funds for the proposed Project would be available when needed (para 3.26); (e) procedures satisfactory to IDA would be followed for procurement of civil works, vehicles spare parts, equipment and office supplies. Employment of technical personnel would also be under terms and conditions satisfactory to IDA (para 3.24); (f) MPS would submit its annual training programs to IDA for review and comment by March 31 of each year (para 4.05); (g) MBS would assume full responsibility of agricultural eyport quality control by October 31, 1989 (para 4.06);  - 44 - (h) MOA would undertake an analysis of the impact of its market reform measures, including the effects of the existing regulations requiring traders to operate form designated markets. The results of this analysis would be reviewed with IDA and agreed changes in the regulations would be implemented by March 31, 1990, (para. 4.08); (i) Any subsequent proposals to change market regulations would be reviewed and agreed with IDA prior to their implementations (para. 4.08); (j) at least 50Z of the credit proceeds earmarked for estate lending would be on-lent to estates in the smallest category (para 4.12); (k) NBM, and CBM would not make subloans to a single small estate in excess of US$150,000 on a cumulative basis. For large estate borrowers, INDEBANK, NBH, and CBM would not lend IDA resources in an amount exceeding US$500,000 for irrigated subprojects. For non-irrigated estate subprojects the upper limit would be US$250,000 (para 4.15); (1) RBM would annually review and revise, as appropriate, its on-lending rates to the participating banks to reflect changes in the agricultural lending rates (para 4.20); (m) the participating banks would annually review and revise as appropriate, their lending rates to the final borrower to ensure that they are: (i) consistent with the overall interest rate structure; and (ii) adequate to achieve project objectives (para 4.19); (n) each participating bank would submit samples of their lending documentation for each category of subproject to IDA for review and approval (para 4.22); (o) financial rates of return (FRR) would be calculated for subprojects above US$100,000 and no project would be financed that has an FRR of less than 12? (para 4.22); (p) SEDOM would appoint a project manager to administer pilot credit for rural traders by March 31, 1989. (para 4.27); (q) SEDOM, in conjunction with RBM, would annually review and revise as appropriate the lending rates to the final borrower to insure that they are consistent with overall interest rate status (para 4.30);  - 45 - (r) SEDOM would submit to IDA for examination samples of its loan assessment for subprojects it intends to finance under the pilot program (para 4.32); (s) audits would be conducted annually for each participating institution in the project and the audited accounts, together with the auditor's comments, would be sent to IDA within nine months of the close of each fiscal year. The auditor's comments would include confirmation that statement of expenses are properly prepared and that credit funds claimed have been used for the purpose stated under the Project (para 4.35); (t) each project implementing agency would monitor progress in the part of the project for which they are responsible and would submit progress reports to the relevant coordinating committee and IDA (para. 4.36); and (u) by January 30, 1992, the Planning Division of MOA would undertake a mid-term evaluation of the Project and changes in Project activities agreed with IDA as a result of the mid-term evaluation would be implemented promptly. It would also prepare a Project Completion Report within six months after completion of the Project (para 4.37). 6.02 Conditions of effectiveness are: (a) The Government would establish the two project management and coordination committees as described in para 4.01. 6.03 Conditions of disbursement are: (a) The execution of a subsidiary loan agreement with each participating financial institution would be condition of disbursement to that financial institution (para 4.11); (b) Approval of program of promotion for the pilot credit line for rural traders and criteria for selecting the target group by Planning Division of MOA, MTIT, and IDA would be a condition of disbursement of the pilot credit to SEDOM (para 4.27); and  - 46 - (c) Approval by IDA of loan monitoring procedures to be developed by SEDOM in conjunction with its auditors including loan summary sheets and recruitment claim forms (para 4.33); and 6.04 Subject to the above assurances and conditions, the Project would be suitable for an IDA credit of US$18.3 million on standard terms to the Government of Malawi.  -47- ANNEX I Chart 1 i