China - Fourth Rural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY A;v 32 A/ . g ' 2~ ~4 Report No. P-5356-CHA MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$75 MILLION AND A PROPOSED CREDIT OF SDR 143.7 MILLION (US$200 MILLION EQUIVALENT) TO THE PEOPLE'S REPUBLIC OF CHINA FOR A FOURTH RURAL CREDIT PROJECT OCTOBER 9, 1990 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENT (Effective December 15, 1989) Yuan (Y) 1.00 - US$ 0.21 Y 4.72 - US$ 1.00 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer - 0.62 miles 1 hectare (ha) = 2.47 acres = 15 mu 1 kilogram (kg) = 2.2 pounds (lbs) = 2 jin 1 ton (t) = 1,000 kg = 2,205 pounds (lbs) ABBREVIATIONS AND ACRONYMS USED ABC - Agricultural Bank of China IFAD - International Fund for Agricultural Development 4OF - Ministry of Finance PBC - People's Bank of China PMCs - Project Management Committees SAA - State Audit Agency RCCs - Rural Credit Cooperatives SMCs - Supply & Marketing Cooperatives  FOR OFFICUIL USE ONLY (i) CHINA FOURTH RURAL CREDIT PROJECT Loan/Credit and Project Summary Borrower: People's Republic of China Beneficiary: Agricultural Bank of China (ABC) Amount: IBRD Loan: US$75 million equivalent; IDA Credit: SDR 143.7 million (US$200 million equivalent) Terms: IBRD Loan: 20 years including five years of grace, at the Bank's standard variable rate; IDA Credit: Standard, with 35 years maturity Onlending Terms: From government to ABC: 15 years, including five years of grace. On Bank Group funds onlent to ABC in foreign exchange, government to charge interest at the prevailing IBRD rate or such other market-based rate acceptable to the Bank Group; and on Bank Croup funds onlent in local currency, government to charge interest at a non-subsidized rate which shall be based on ABC's weighted average interest cost of long term domestic funds. Commitment fee on IBRD Loan and IDA Credit (if any) to be borne by ABC. From ABC to subborrowers: Interest at ABC's/RCCs' prevailing rates; interest spreads for ABC/RCCs on project lending of at least 2.5Z p.a. (after payment of income and adjustment taxes); interest rates on subloans to remain positive in real terms; Exchange risk: On proceeds of Bank Group assistance onlent to ABC in foreign exchange, ABC to bear exchange risk; on subloans disbursed by ABC in foreign exchange, subborrowers to bear exchange risk; Financing Plan: IBRD US$ 75.0 million IDA US$ 200.0 million ABC/RCCs US$ 110.9 million Subborrowers US$ 164.1 million Total US$ 550.0 million Economic Rate of Return: 27% Staff Appraisal Report: Report No. 8387-CHA Maps: IBRD 22151, 21792, 21793, 22129 This document has a restricted distribution and may be used by recipients only ir. the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF CHINA FOR A FOURTH RURAL CREDIT PROJECT 1. I submit for approval the following memorandum and recommendation on a proposed loan of US$75 million equivalent and an IDA credit of SDR 143.7 million (US$200 million equivalent) to the People's Republic of ChiPa to help finance a Fourth Rural Credit Project. The loan would have a term of 20 years including five years of grace, with a standard variable interest rate, and the credit would be on standard IDA terms with 35 years maturity. 2. Background. During the past decade, China's rural economy witnessed remarkable growth and structural change as a result of economic reforms including the introduction of the production responsibility system (PRS), increased producer prices and the enlarged role of the mprket. Recent government strategies in agriculture have focussed on stabilizing grain production, mainly through irrigation expansion and rehabilitation, and developing remaining underutilized land, and making uplands, natural pastures, and water surfaces more productive for expanding production of nonstaple foods, forestry and commercial crops. The Bank Group lending to China's agricultural sector has generally supported the above noted strategies. To date, 26 operations amounting to $2.6 billion, cover the full spectrum of geographic areas and subsectors, with a focus on: land development, irrigation, and drainage; upgrading support services such as research, education, credit, and seeds improvement; developing specialized subsectors including forestry, rubber, fruit, livestock and fisheries; and supporting area development including soil conservation and settlement. Implementation of the ongoing Bank Group-assisted projects in the agricultural sector is satisfactory with disbursements, by and large, outpacing those in other countries and sectors. 3. A key feature of China's economic reforms has been the decentralization of investment decision-making and separation of the government's economic functions from administrative functions. As a part of this reform process, the role of the government budget in financing commercial investments in agriculture and agroindustry (among others) is rapidly decreasing, with financial institutions assuming an important role in resource mobilization and allocation. In support, the government befan in 1979 but more concertedly since 1985, to reform the banking system. I In this effort, the Bank Group has been assisting China, through economic and sector work and lending operations, in developing a coherent strategy for financial sector development. 4. The Agricultural Bank of China (ABC), which has been the beneficiary of the previous three IDA-assisted rural credit projects, and would be beneficiary of the proposed (fourth) project, is a government-owned I/ The World Bank, 'China: Finance and Investment" and "Financial Sector Review: Financial Policies and Institutional Reforms", Reports Nos. 6445 dated June 11, 1987 and 8415-CHA dated June 29, 1990.  2 specialized bank. ABC undertakes mainly commercial banking functions for China's rural sector and manages state funds allocated for agriculture and grain and non-grain commodity procurement. Through its nationwide network of branches and affiliate township-level rural credit cooperatives (RCCs) -- financial institutions collectively owned by farmers--, ABC has the capability of reaching deep into rural areas for resource mobilization and real sector development. Using this unique status, ABC is in the process of increasing its medium-and long term lending for bankable investments in rural areas. Starting from the ongoing Rural Credit III project (Cr. 1871-CHA), ABC has begun to use RCCs, on a pilot basis, for onlending project funds for investments by households. For the proposed project also, ABC would use RCCs as a channel for lending to smaller subproj cts undertaken by households, wherever feasible. In addition, ABC would use a network of Supply & Marketing Cooperatives (SMCs) which traditionally distribute farm inputs and provide marketing services to farmers, for subloan collections on an agency basis. Recent PCRs on IDA-assisted Rural Credit I Project in Guangxi Zhuang Autonomous Region (Cr. 1462-CHA) and the IFAD-assisted Rural Credit project in Hubei province have indicated that the implementation of the two projects has been satisfactory with considerable impact on real sector development objectives, increases in per capita incomes and rural employment, and upgrading of ABC's institutional capabilities for investment appraisal and portfolio management. Implementation of the ongoing Rural Credit II and III projects is also satisfactory. 5. Recent Bank Group Review of China's Financial Sector. A recent Bank review of China's financial sector indicated that the steps taken during 1978-89 have indeed contributed to the emergence of a broader financial market and provided alternative financing sources for government, enterprises, households, and financial institutions. The government response to the Bank's financial sector review recommendations has been quite positive (para. 3). The Ministry of Finance (MOF) and the People's Bank of China (PBC), the main agencies responsible for financial sector development, have begun preparation of a technical assistance project for Bank Group assistance, which would focus on reforms in six specific areas including the payments system, bank supervision, accounting for financial institutions, legal framework for banks, and strengthening of PBC's research department and its fiscal agency and market regulation role. 6. The government has also agreed that as a part of the proposed Fourth Rural Credit Project, it would carry out with the Bank Group a mid-term review of the progress made in implementing overall financial sector reform, including credit and interest rate policies, rationalization of the interest rate structure, and upgrading of banking regulation and supervision arrangements; and of the progress made in carrying out the proposed project including the institutional development program for the Agricultural Bank of China (ABC). Starting with the proposed project, subsidies on onlending of Bank Group funds to ABC are being eliminated. The government has also agreed to carry out with the Bank Group a review of rural investment and finance focussing on, among other aspects, the role and functions of the nationwide rural credit cooperative system, and on legal, operational and supervisory framework for the expanding network of non-governmental financial associations in the rural sector. The proposed operation would thus be placed in the  3 context of this broader sector dialogue with the government, while advancing several of the most sustainable development programs in agriculture. 7. Project Objectives and Description. The main objectives of the proposed project would be as follows: (a) to stimulate growth and diversification of agriculture by financing profitable investments by farmers, collectives, state farms and enterprises, and (b) to promote efficiency of rural financial intermediation through introduction of sound, market-oriented policies, and development of the main institutions concerned with rural savings mobilization and lending. The project, which would be carried out over a period of five years, would provide funds to ABC and RCCs for medium- and long-term credit programs in crops, livestock, fisheries, and establishing agroprocessing and marketing facilities, and for technical assistance in continuing its institutional development programs. The total cost of the project is estimated at US$550 million with a foreign exchange component of US$120.2 million. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and of disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in China are given in Schedules C and D, respectively. Maps are also attached. The Staff Appraisal Report No. 8387-CHA dated October 9, 1990 is also being distributed separately. 8. Credit Component. To implement the project's credit component, ABC has developed an indicative investment program (FY1991-95) in crops, livestock, aquaculture, and agroprocessing and marketing facilities, with a focus on increasing the productivity of natural pastures, underutilized uplands and water surfaces based on recognized local comparat`7e advantage. The proposed investment program would be flexible so that ABC could make modifications in its lending strategies based on subloan appraisals, including market and credit risk analysis. Subborrowers woula include individuals and specialized households, collectives, cooperatives, township and village enterprises, state farms, SMCs and enterprises set up by state farms, local governments and SMCs. ABC has established satisfactory subloan appraisal criteria and organizational arrangements to carry out such appraisals. Retroactive financing of SDR 17.96 million ($25 million equivalent) is being recommended for subloans/expenditures made/incurred after January 1, 1990 but before Loan and Credit signing and consistent with the project terms and conditions. Expenditure eligible for retroactive financing relates mainly to subprojects for which an early startup was considered essential for mobilizing local resources especially by using underemployed labor available in project areas during winter months, and for maintaining the momentum of project preparation and implementation. 9. The credit program would be implemented mainly in the Autonomous Region of Inner Mongolia, five provinces including Shaanxi in the northwest, Liaoning and Jilin in the northeast, Jiangxi and Guangdong in central and south China, and Beijing municipality. The program in these areas has been substantially appraised by the Bank Group, since these regions/provinces would be first time beneficiaries of a Bank Group-assisted project with ABC. Given the line of credit nature of the proposed project, ABC could also use a part of the project funds for financing investments in other regions/provinces,  4 mainly those covered by previous IDA-assisted Rural Credit Projects including Guangxi Zhuang Autonomous Region (Cr. 1462-CHA), Fujian and Hunan (Cr. 1642- CHA) and Hubei (Cr. 1871-CHA). ABC branches in these jurisdictions have demonstrated their capabilities to appraise and implement longer term lending programs by applying internationally accepted techniques of financial and economic appraisal and technical standards (para. 4). Lending in other areas would require prior consultations with the Bank Group which would take account of the economic rationale of the activities proposed to be financed and institutional capabilities of ABC's local branches to implement the lending program. 10. Technical Assistance Component. The proposed project would provide technical assistance to ABC and subborrowers for implementing the project's credit program and to ABC for its and RCCs' institutional development. Following upon the financial appraisal of overall ABC operations in two provinces during project preparation, and in-house system reform studies recently completed under Rural Credit III project, the proposed project would assist ABC to develop various aspects of its operations including long-range business planning; credit plan formulation and preparation; lending policies and procedures with regard to its major clients; monitoring of loan portfolio; assets and liabilities management; internal audit and controls; and financial management of the RCC system. It would also strengthen trainers' training programs at ABC's three national institutes and provincial staff training colleges. 11. Rationale for IDA support. Besides continuing the Bank Group's support to ABC for modernization and diversification of agricultural production, the project would make important contributions to environmental protection, poverty alleviation, and increasing employment potential for women. The project's technical assistance will assist ABC in upgrading its financial management, lending policies and procedures, management information system, and human resource development. As ABC is the national bank for the rural sector, the Bank Group support to increasing its operational efficiency would in effect contribute to overall financial sector development. The project would also serve as an important vehicle to continue the Bank Group's dialogue with the government on financial sector policies and institutions (paras. 3 and 6). 12. Agreed Actions. In addition to the agreements referred in para. 6 above, the project includes key financial covenants and understandings focussing on more efficient allocation of resources and ABC's continued profitability and financial viability. Specifically: the government would onlend project funds to ABC at market rates, i.e., for loans in foreign exchange, at the IBRD's standard variable rate, and for local currency loans at a non-subsidized rate based on ABC's weighted average interest cost of longer term domestic funds (currently at about 8X). Interest rates charged by ABC to subborrowers would permit ABC to retain an interest spread of at least 2.52 (after payment of 4ncome and adjustment taxes to MOP) or such other spread as may be agreed between the government and the Bank Group; interest spreads on ABC's total banking business would be sufficient to maintain ABC's overall financial viability and profitability; and interest rates charged by ABC would not be less than its interest rates for similar subloans for similar  5 purposes outside the project. Similar terms will apply to RCC subloans. The government and ABC have also agreed that ABC's ratio of equity to risk assets would not be less than 52 and that the government and ABC would develop, by December 31, 1991, a recapitalization plan for ABC indicating the mechanisms of replenishment of ABC's equity, on standards acceptable to the Bank Group. The goal would be to raise, in phases, ABC's risk-weighted capital adequacy ratio to 82 as per international standards. Agreements have also been reached on strengthening of ABC's project organization at headquarters; content and timing of institutional development initiatives; and technical guidelines for project implementation. For environmental protection, ABC and the government have agreed that each Project Management Committee (PMC) at the provincial and county levels would include a representative of the local Environment Protection Agency (EPA), that measures would be taken to protect the environment in specific subprojects reviewed during the Bank Group appraisal and that subproject activities would conform to appropriate guidelines on environmental control issued by provincial and national governments, and acceptable to the Bank Group. 13. Benefits and Justification. The project's major benefits would be incremental production of a variety of commodities and increased rural incomes. At full development, the value of the project's incremental output of crops, livestock and fisheries and value-added benefits of agroprocessing and marketing facilities, would be about $600 million p.a. with significant potential for import substitution and export promotion. The project would enhance technical know-how of many processing facilities either by improving an existing technology or by Introducing a new one. The project would reduce seasonal unemployment and underemployment by generating the equivalent of 90,000 full-time jobs and contribute to poverty alleviation. In particular, additional employment would be created in remote mountainous and rangeland areas where alternative job opportunities are limited. About one-third of the 152 counties already identified for project implementation, are classified as poor counties by national and provincial standards, where relative income levels are extremely low and incremental income benefits would be substantial, contributing to narrowing of income disparities and reducing poverty. Another major social benefit resulting from the project would be improvement of women's position in their role as entrepreneurs and active participants in labor markets. Over 282 of ABC's total staff being women, many of which holding managerial and professional positions, the project would further strengthen their role within ABC through training components. The project will have a positive impact on environment through subprojects assisted, and with appropriate organizational arrangements instituted, it will ensure environmental assessment and protection. In particular, the project would introduce innovative new range management techniques to China's ecologically delicate northern grasslands (in Inner Mongolia and Jilin) as an integral part of livestock subproject formulation and approval. Financial rates of return (FRR) on representative subprojects are estimated to range between 142 and 35X and corresponding economic rates of return would vary from 24% to 41X. For the project as a whole, the FRR and ERR are estimated at 242 and 272 respectively. ABC would benefit from the project's institutional development in terms of increased efficiency of its overall operations including improved lending decisions and reduced subloan default risks.  6 14. Risks. The project faces no unusual technical, organizational or financial risks. Technologies to be adopted in agroprocessing are generally of standard designs, procurement requirements for machinery and equipment would provide technology choices to subborrowers, and training of factory workers and managers would ensure safe and optimal operations. ABC would introduce internationally accepted techniques for financial and economic appraisal of subprojects; establish a Technical Experts Group at ABC headquarters to assist in and oversee subproject implementation, reinforce field level arrangements for technical feasibility studies of subprojects, and supervise project lending. ABC would also appraise borrowing enterprises including an assessment of their overall financial condition and managerial capability. All this would help reduce subloan default risks. The project would provide adequate spread to ABC to cover its transaction costs on project lending including a reasonable provision for bad debts. The financial appraisal of ABC's overall operations indicates that ABC is a reasonably liquid and financially viable institution and suitable covenants have been introduced to ensure its continued profitability and viability. 15. Recommendation. I am satisfied that the proposed Loan and Credit would comply with the Articles of Agreement of the Bank and the Association and recommend that the Executive Directors approve the proposed Loan and Credit. Barber B. Conable President Attachments Washington, DC October 9, 1990  7 Schedule A CHINA FOURTH RURAL CREDIT PROJECT Estimated Costs and Project Financing Estimated Costs 2/ Local Foreign Total - ---------($ million)- A. Credit Program Crops 130.2 32.6 162.8 Livestock 113.4 28.4 141.8 Aquaculture 63.8 5.5 69.3 Agroprocessing & Mktg. 121.2 51.9 173.1 Subtotal 428.6 118.4 547.0 B. Technical Assistance Staff training 0.5 0.5 1.0 Consultant services 0.1 0.4 0.5 Equipment 0.4 0.7 1.1 Others 0.2 0.2 0.4 Subtotal 1.2 1.8 3.0 Total 429.8 120.2 550.0 Financing Plan: Local Foreign Total IBRD 42.2 32.8 75.0 IDA 112.6 87.4 200.0 ABC/RCCs 110.9 0.0 110.9 Subborrowers 164.1 0.0 164.1 Total 429.8 120.2 550.0 2/ Inclusive of related taxes and duties estimated at US$43.8 million.  8 Schedule B CHINA Page 1 FOURTH RURAL CREDIT PROJECT PROCUREMENT METHODS AND DISBURSEMENTS A. Procurement Methods (US$ million) --_---------------------------------------------------------------__---- Project Element ICB 1/ LIB LCB Others 2/ Total Machinery and equipment - 35 35 48 118 (35) (32) (37) (104) Civil works - - 68 28 96 (52) (19) (71) Agricultural inputs - - 32 301 333 (21) (77) (98) ABC staff training, and consultant services - - - 3 3 (2) (2) Total - 35 135 380 550 (35) (105) (135) (275) 1/ Farm households, collectives, state farms, and state-owned enterprises will purchase agricultural inputs including chemical fertilizers, seeds, and animal feeds from SMCs which have a network of branches throughout the country. Any bulk procurement of inputs, especially chemical fertilizers, would be made through national procurement agencies following procedures acceptable to the Bank Group. No single package is likely to exceed US$50,000 but if, in the unlikely event, any single procurement exceeds $5 million, such procurement would be made using ICB procedures. The Loan/Credit Agreements provide for this possibility. 2/ Includes shopping procedures and local procedures acceptable to the Bank Group. Note: Figures in parentheses are the respective amounts expected to be financed by the Bank Group.  9 Schedule B Page 2 B. Disbursements Category Amount of Credit Amount of Loan 2 of expenditure (SDR million) (US$ equivalent) to be financed (1) (a) ABC Subloans 132.92 75.0 71U of funds disbursed by ABC for ABC subloans (b) RCC Subloans 8.62 0.0 1002 of funds disbursed by ABC for RCC subloans (2) Machinery and equipment for ABC's institutional development 1.22 0.0 100Z of foreign expenditures and 1002 of local expenditures (ex- factory cost) and 75X of local expenditures for other items procured locally (3) Overseas fellowships, 0.94 0.0 1002 staff training, and consultant services Total 143.70 75.0 Estimated Disbursements: (In US$ million) IBRDIIDA FY 1991 1992 1993 1994 1995 Annual 30.0 50.0 70.0 70.0 55.0 Cumulative 30.0 80.0 150.0 220.0 275.0  10 Schedule C CHINA FOURTH RURAL CREDIT PROJECT Timetable for Key Project Processing Events Time taken to prepare: 18 months Prepared by: Agricultural Bank of China with assistance from technical bureaus of provincial and lower level governments, state farms, FAO/CP (for livestock component), and the Bank Group. First Bank Group mission: October 1988 Appraisal mission departure: November 1989 Negotiations: September 1990 Planned Date of Effectiveness: December 1990 List of Relevant PCRs: PCR dated May 31, 1990 on Rural Credit Project (Cr. 1462-CHA); and Final Supervision and Completion Report dated September 5, 1990 prepared by the Bank Group on IFAD-assisted Rural Credit Project.  Schedule D Page I of STATUS Of BANK GROUP OPERATIONS IN THE PEOPLE'S REPVBLIC OF CHINA A. STATEMENT Of BANK LOANS AND IDA CREDITS (As Ot June 30, 1990) Lca3o Amou t (usShTllins Cre le a~~~~or- tetotcneatns Number FY rower Purpose 8ank IDA tndlsb, (a Sxagloans and tne credits have been fully disbursed. 447.8 5Z3.9 _ 2967 1932 88 PRC Rural Sector Adj. Z00.0 100.0 - Z231 83 PRC Petroleum I (Daging) 162.4 _ 2.2 2252 83 PR Petroleum I (/T onr enlru) 100.8 _ 15.0 1411 84 PC Poltechnic TVzUniversity - 85.0 17.6 614 84 PRO Rubber Deve o ment - 100.0 3.5 2382 84 PRC Lub ge Hydroelectric 145.4 - 26.3 2396 84 PRC Raslwa 220.0 - 5.1 14 84 PRC Rural Health 6 Medical Educ. - 85.0 13.8 2426 84 PRC Peroleym1II (Karama9Z 6.4 243411491 84 PRCs Crelit tI'(I lIl 1 70.0 5.5 244461500 84 PRC Aricultural Educat on I 45.3 (23.5)fb) 7.0 1516 85 PRC A ricultural Research II - 2S.0 6.5 15i1 85 PRC Ulvers!.ty Development I1 - 145.0 31.7 2493 8 PRO Paer I' 117.0 - 17.7 2501 8 PRC Cha cur (Luan) Coal Mining 79.5 57.9 1577 8a PRO Seed 40.0 181 1578 8a PR Rura Uater Supply -. ao0.0 8.5 253911594 85 Hit 42.6 (30.0)(b) 11.2 2540 85 PRC Ra lway SS 235.0 - 144.0 2541 85 PRC FertilIzer Rehab. 6 97.0 - 0.8 Energy Savynm 16Q5 85 PRC Fore tr 0ev. loDment - 47.3 13.4 257911606 85 PRC PiShlHa ag-C hf. Area Dev. 17.0 75.0 14.4 2580 85 PRC Weiyuan Gas Fleld Technical 25.0 - 8.1 sstance 1642 86 PRO Rural Credit II - 90.0 1.1 2659 1663 86 PRO Industrial Credit III (0C1 III) 7S.0 25.0 10.7 1664 86 PRO Technical Cooyeration Credtt II - 20.0 19.3 1671 86 PRO Provincial UnIversities - 120.0 16.9 267811680 86 PRC Thir Railway 160.0 70.0 143.6 2689 86 PRC Tian in Port 130.0 - 90.5 1689 86 PRO Freslwater Fisheries - 60.0 1.9 2706 86 PRO Beilungan Th rmal Power 225.0 - 56.1 F77 86 PR Yann q re&etric 52.0 - 20.5 27 3 1713 86 PRO Rural H a th Preventive Med. 15.0 65.0 63.2 1713 87 PRO Red Soils - 40.0 1.8 2775 87 PO Sh3ikou Hidroelectric 140.0 - 62.5 278311763 87 PRO Industrial Crdigt IV (CIB IV) 250.0 50.0 90.4 27 4 87 PRO Shan ha Machn Too s 100.0 - 78.6 1764 87 PRO Xin an