Romania - Private Farmer and Enterprise Support Project

JAA 5 7e b - 14 Documot of The World Bank FOR OmFAL USE ONLY MICROFICHE COPY Report No. P- 5747-RO Type: (PM) RIPutNo6 P-5747-RO LUCCA, F. / X32642 / H5 067/ ECIAG MEMORANDUM AND RECOMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$100.0 MILLION TO ROMANIA FOR A PRIVATE FARMER AND ENTERPRISE SUPPORT PROJECT MAY 18, 1992 V~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ This document has a restricted distibtion and may be used by recipiets oy In the perfonnrace of dteir offcial dubies ts contns may not othewwise be disclosed widtout World Bank authoriaton.  CURRENCY EOUIVALENTS Currency Unit - Leu (plural Lei) US$1 Lei 200 Leu 1 = US$0.0050 Lei Per US Dollar Official Rate Market Rate 1990 November 20 35 1991 April 60 200 (Interbank)1 1991 November 180 300 1992 March 200 350 ABBREVIATIONS AND ACRONYMS AB - Agricultural Bank DB - Romanian Development Bank FESAL - Financial and Enterprise Sector Adjustment Loan FI - Financial Intermediaries AB and DB GOR - Government of Romania IMF - International Monetary Fund MEF - Ministry of Economy and Finance NBR - National Bank of Romania SAL - Structural Adjustment Loan OMPANIA - FISCAL YEAR January 1 - December 31 1 The interbank rate applies to other foreign exchange transactions. The interbank market for foreign exchange was established in April 1991.  FOR OmCIAL USE ONLY ROMANIA PRIVATE FARNER AND ENTERPRISE SUPPORT PROJECT LOAN AN4 PROJECT SJMMARY Bgorroert Romania BegeicgarieJs Private farmers, food processing and marketing enterprises Amount: US$100 million equivalent To =-at Seventeen years, including five years grace, at the standard variable interest rate. Releudina Terms: (i) From the Government tc the financial intermediaries (FP) in either domestic currency (lei) at the then- prevailing National Bank of Romania (NBR) discount rate, or in dollars at LIBOR plus a margin to be determined by the Ministry of Economy and Finance (MEF). (ii) From the FIs to the beneficiaries in either lei at the NBR discount rate (variable) plus a spread to be decided by the FIs, or in dollars at LIBOR plus the MEF margin and the PI spread. Proiect O-bectives: The project will support private sector agricultural development. It would raise agricultural oatput, increase efficiency of production and value-added, generate employment, and improve living standards. It would begin strengthening the rural banking system. The project will finance private agricultural processing and marketing enterprises and investments in primary production. Financino Plan: (US$ million) IBRD 100.0 Financial Intermediaries 20.0 Subborrowers 44_7 Total 164.7 Staff Anoraisal Resorts Report No. 10458-RO dated May 18, _992 Mao: IBRD No. 23664 - Romania This document has a resticted distribution and may be used by recipients only In the peformnoe of their officila dulies. ft contents may not otherwise be disclosed witho World Bank authoriaon.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ROMANIA FOR A PRIVATE FARMER AND ENTERPRISE SUPPORT PROJECT 1. I submit the following memorandum and recommendation on a proposed loan to Romania for US$100 million equivalent for approval. The proposed loan would be on standard IBRD terms with 17 years maturity including five years grace and would help finance a private farmer and enterprise support project. 2. Iagkrouud. Romania has a land area of 237,000 km2 of which 43% is cultivated and 20% is meadows and pastures. It has a population of 23.4 million including a work force of 11.7 million, 35% of which is employed in agriculture. Agriculture, including agroindustry, accounts for 20% of GDP and until the late 1980. accounted for 23% of total exports, 50% of which were to the EC. At the time of the 1989 revolution the state presence was pervasive in agriculture. Of the ha 10 million of arable land, 88% was operated by state farms and production _ooperatives. The bulk of the food processing and distribution system was operated by inefficient state enterprises. Since the revolution the Government has embarked on an ambitious program of system reforms to liberalize the economy. The princlpal elements of these reforms applying to the agricultural sector lnclude redistributlon of land to the private sector (ha 8 million), agricultural price liberalization and promulgation of a new banking law based on competitive banking principles. These initiatives, which are still in the process of belng implemented, have set the scene for addressing many sectoral issues. The main issues in the process of being addressed ares (a) restructuring of agricultural support institutions including those providing inputs, extension servlces, marketing information, and credit; (b) institutLonal strengthening of the banking system to upgrade the operating performance of most commercial banks providing rural credit; (c) setting interest rates at positive levels in real terms; (d) elimination of de facto state monopolies in processing and distribution; and (e) completion of the price liberalization process. 3. Rationale for Bank Involvement. Because of its favorable resource endowment, agriculture ln Romania has considerable potential for growth and most products can be produced competitively. The historical bias ln favor of state farms and the lack of resources in recent years has caused the private agricultural sector which now controls 80% of the arable land to be starved of capital resources. Consequently, private agriculture ie a subsector which is likely to respond rapidly to investment and institutional support. The Bank's lending strategy in agriculture is to support the government effort to establish a stable macroeconomic environment conducive to a gradual development of a market-driven private agriculture. The Bank's role in agriculture is especially aimed at providing support for the emerging class of private farmers and rural entrepreneurs to stimulate a rapid supply-side response to increasing market esgnals. This strategy is conceived withln the objectlves of the IMF stand-by arrangements and supports the aims of the structural adjustment loan (SAL). SAL addresses policy and Lnstitutional issues particularly relevant to the privatization and transformation of agriculture into a market based sector. The Bank is currently preparing a  -2- Financial and Enterprise Sector Adjustment Loan (FESAL) which is expected to substantially improve the efficiency of the financial intermediation system and provide a basis for the reform of the Agricultural Bank (AS) and the Romanian Development Bank (DB), the financial intermediaries (FIs) to be used and strengthened under this project. Significant distortions of pr.ces in the agriculture sector persist notwithstanding the liberalization of agriculture prices on all but a few essential cummodities. There are a number of reasons for this, in particular, a distribution system that is dominated by a few large inefficient enterprises, a ban on the export of key commodities and an overvalued exchange rate. Notwithstanding these distortions, we are proceeding with the proposed project in tandem with our policy die gue to address and remove these price distortions in a reasonable time-frame. The macro-policy dialogue, including the implementation of the SAL, as well as key sector tasks, beginning with a broad review of agriculture sector strategy, will be the vehicles through which all these issues are addressed. At the same time, support to the agriculture sector, which is a central part of the Government's reform program, is needed quickly. The proposed project is therefore designed to meet these needs, while minimizing the risks associated with price distortions, by limiting its support to selected investments that are clearly economically viable. Experience gained through the project and project-related sector studies under preparation may provide the basis for other Bank operations to support further development of the market economy in the agricultural sector. 4. Project Obiectives. The objective of the project is to support private sector development in rural areas and thereby raise agricultural output, increase efficiency of production, generate employment and impro, standards of living. The project aims to achieve this through financing credit to private farmers and other private businesses for (a) the improvement of input supply, food processing, marketing and distribution services, and (b) on-farm investment in order to increase production and productivity. 5. Project DescriAtion. The loan would finance private investment in viable agricultural and other rural businesses. It is intended to be wide- ranging but to exclude those ineligible subsectors assessed not to be economically viable. It would cover both investment items and incremental working capital. Funds would be made available to partially finance investment by private individuals, farmer associations or private companies in the following categories: (a) marketina and trade of aoricultural Droducts, especially for transport, wholesaling and retailing of both agricultural outputs and inputs; (b) Drocessina of aaricultural groducts, particularly small- and medium-scale investment to increase value-added in the rural areas; (c) aaricultural production including livestock; and (d) other rural business. 6. The loan would support an aggregate investment of about US$165 million. Of this, about US$74 million is expected to be for marketing, distribution, services and other rural businesses, US$58 million for agroprocessing, and US$33 million for on-farm investment. The loan would be used primarily for marketing, distribution and agro-processing (at least 80%) where the needs are greater, as well as some selected on-farm investments which can be shown to be economically viable, notwithstanding existing price distortions. The maximum amount onlent to any single beneficiary would be US$5 million. The loan would cover only a small part of the country's total  - 3 - agricultural investment needs, estimated at over US$1 billlon during the project period. 7. Procurement under subloans financed through the project would be through direct contracting by private borrowers for contracts of up to US$25,000, local shopping with at least three quotations for contracts of US$25,000 to US$200,000, international shopping with at least three quotations and two countries for contracts of US$200,000 to US$1 million, and limited international bidding (LIB) over US$1 million. S. Disbursements would be against subloan expenditures on the basis of certified Statements of Expenditures. A Special Account would be established covering about four months' expenditures. The loan closing date is December 31, 1997. A breakdown of costs and the financing plan are shown in Schedule h. The procurement method, with amounts, and disbursements are shown in Schegdle B. A timetable of key project processing events and the status of Bank Group operations in Romania are given in Schedules C and D, respectively. The Staff Appraisal Report No. 10458-RO, dated May 18, 1992, is being distributed separately. 9. The Agricultural Bank (AS) and the D-erlopment (DB,, currently the most active banks in the agricultural sector with a total of about 270 branches and 360 agencies, would be the project FIs. They have initiated a structural reform program by undergoing independent external audits. These will provide the basis for the strategic plans to be prepared and adopted by each bank (para 10). 10. Actions Areed at eaotiations. At negotiations agreements were reached regarding: (a) adoption by the Flo no later than December 31, 1992 of strategic plans for institutional strengthening of Flo (including their capability to adequately appraise subprojects under the loan), based on the findings and recommendptions of independent external audlcs and satisfactory to the Bank, including a time-bound schedule for their implementationt (b) applying agriculture investment guidelines satisfactory to the Bank; (c) ensuring that Flo are adequately staffed to carry out subloan appraisal and supervision in accordance with the lending guidelines; (d) provide at least 80% of the Bank loan for high priority investments in marketing, distribution and agro-processing and no more than 20% for on-farm investments that are economically viable; (e) eligibility criteria for subborrowers, including demonstration of creditworthiness, financial and economic viability of investments to be funded and, in the case of lending to companies, adequate corporate financial ratios as well as submission of annual audited reports; (f) terms and conditions of financing subloans, including onlending either in lei, at a variable rate equal to the NBR rediscount rate plus spreads determined by FIs, or in US$ at a variable interest rate linked to the six- month London Interbank Offered Rate (LIBOR) plus a margin to be determined by the Ministry of Economy and Finance (MEF) and the Flo spread; (g) compliance with reporizing, accounting and auditing requirements acceptable to the Bank; and (h) compliance with laws and regulations of Romania related to environmental protection. Furthermore agreements were obtained on the following special conditions of effectiveness: ratification of the Project Agreements between the Bank, and AB and DB; execution of the subsidiary loan  agreements between QOR and the corresponding Pi, and adoption of agricultural credit guidelines by AB and DS. 11. Smofj&s. The main benefit of the project would be increased private rural sector business activity and improved rural institutions. The credit provided by the project would support primarily much needed private investment in input distribution, agricultural services and product marketing. Enhanced competition in the rural banking system and broader access to credit through the support of new business entrants would contribute to creating a competitive economic environment. The project would support the Government's economic reform program by creating additional employment and new sources of ineome in rural areas. Finally, because the project is expected to have a positive overall effect on agricultural production and efficiency it would make the country more competitive in international markets, resulting in a favorable impact on its balance of payments. 12. RiJks. The main project risk is that subloans would not be fully or promptly repaid. This could occur primarily because there is little experience with lending to private farmers and small businesses in a free market environment, entailing higher than usual financial risk for bor:rowers as well as financial intermediaries. To address this, the project provides for application by the FIe of sound lending criteria. Assistance in the preparation of the lending operations manual and associated training currently being provided by the Bank with Japanese Trust Fund financing will help implement this. The EC-PHAR$ program is also providing training to PIs. A second risk is that because businesses may be reluctant to borrow for goods which appear expensive on a historical basis, the drawdown of project funds could be slower than anticipated and the project period would need to be extended. This risk would be mitigated once the effects of macroeconomic reform are seen to be working, and borrowers understand the rationale of the new price relationships. 13. Unvixron_ental Issues. The proposed project has been reviewed and placed in environmental screening category B, consistent with the provisions of Operational Directive 4.00, Annex A, "Environmental Assessment." Therefore, the proposed project would not be subject to the preparation of an environmental assessment; however, a procedure for environmental screening of individual loans in compliance with both Romanian :equirements and those of the. Bank would be applied under the project. 14. Re _ntio. I am satisfied that the proposed loan would comply with the Articles of Agreement of the IBRD and recommend that the Executive Directors approve it. Lewis T. Preston President Attachment Washington, D.C. May 18, 1992