Sri Lanka - Second Dairy Development Project

norump t of The World Bank FOR OMCIAL USE ONLY Repoi No. 12894 PROJECT COMPLETION NOTE SRI LANKA SECOND DAIRY DEVELOPMENT PROJECT (LOAN 2576-CE) MARCH 29, 1994 Agriculture Operations Division Country Department III South Asia Regional Office 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.   FOR OFFICLAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Offioe of Direatoi-Gar_al Opeiation Evaluation March 29, 1994 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT Subject: Project Completion Note on Sri Lanka Second Dairy Development Proiect (Ln. 2576-CE) Attached is the Project Completion Note on Sri Lanka - Second Dairy Development Project (Loan 2576-CE) prepared by the South Asia Regional Office. The loan, approved in 1985, was terminated in 1987 for failure to become effective, after five extensions to the effectiveness date. At the first supervision mission, the Bank and co-financiers agreed not to go on with the project until policy, technical and economic issues were solved. By the fourth extension, the Borrower was asked to make changes in pricing structure, raise consumer prices, obtain foreign technical support on management of dairy infrastructure, and propose a business plan for restructuring the dairy industry. The Bank terminated the Loan Agreement when the Borrower's response was found insufficient. The Note raises concerns on the quality of preparation and appraisal and on the commitment of the Borrower. Coordination between the Bank and the three co-financiers was consistent throughout the process. The narrative section of the PCN is satisfactory, but there are no basic data and loan summary. Attachment 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.   PROJECT COMPLETION NOTE SRI LANKA SECOND DAIRY DEVELOPMENT PROJECT (Loan 2576-CE) 1. In October 1985, the Bank made a loan of US$38.0 million (Ln. 2576-CE) for the Second Dairy Development Project to support the long-term development of dairying in Sri Lanka by assisting in the institutional restructuring and modernization of the dairy industry, including the provision of long-term incentives to farmers for milk production. The loan was to cover 34% of total project cost. The European Economic Community (EEC) and World Food Programme (WFP) were to provide commodity grants valued at US$56.9 million (51% of total cost), and the Netherlands a grant of DFl 24.5 million (US$7.5 million equivalent; 7% of total cost). The loan effectiveness date was January 10, 1986. 2. In January 1986, the Government of Sri Lanka (GOSL) requested an extension of the effectiveness date to April 10, 1986 (first extension). The conditions of effectiveness not yet fulfilled at that time concerned: (a) cofinancing arrangements with WFP and the Dutch Government; (b) secondary legal agreements with the beneficiary and key participants; and (c) certain organizational activities. The Bank granted the requested extension. 3. A principal objective of the March 1986 supervision mission was to find a way to obtain firm commitments for funding from the cofinanciers. During discussions with the cofinanciers, it became apparent that there were still important issues concerning the project design and the policy framework in which the project was to be implemented. All three cofinanciers now indicated that they would not commit their funds until these issues were resolved. To overcome these difficulties, it was decided that GOSL would address the issues raised and propose a reformulation of the project. To allow sufficient time for carrying out this plan of action, the mission proposed extension of the loan effectiveness date by nine months. 4. Bank management felt that some time was needed to formulate an appropriate approach to the questions raised about the project. Therefore, it was agreed to extend the effectiveness date by four weeks to May 8, 1986 (second extension), with the understanding that further extension would be needed at that time. 5. In a memorandum dated May 5, 1986, the Vice President, South Asia Region, recommended that following a proposed cofinanciers' meeting, the project should be reformulated to take account of major changes that had occurred since appraisal. He also recommended that the loan effectiveness date should be extended until shortly after the proposed cofinanciers' meeting, and indicated that a further extension would then be needed if the changes in project design required consideration by the Board. The memorandum explained that it would not be possible to obtain firm commitments for project financing from the three cofinanciers (which was a condition of effectiveness of the Bank loan) until their concerns were adequately addressed. These concerns centered around: (a) the appropriateness of the policy framework for the dairy sector in Sri Lanka, including tariff, subsidy and pricing policy, incentives for the use of imported commodities versus locally produced milk for reconstitution and subsequent  - 2 - processing, and coordination of processing and milk collection activities among project entities and other milk processors; (b) the appropriateness of the investments in collection and processing capacity envisaged for the project in the light of projected raw milk availability; and (c) the suitability of the planned product mix for the market conditions in Sri Lanka. The memorandum concluded that many of these concerns seemed well justified. 6. A follow-up memorandum dated May 8, 1986, confirmed agreement that the date of effectiveness would be extended to December 31, 1986 (third extension). It also stated that "our continued participation in the project would depend on the sustained interest of the cofinanciers. Should they not support the project, either in its present form or as it may be reformulated, we will cancel our own participation". 7. In December 1986, the South Asia Region recommended a further extension of the effectiveness date to August 31, 1987 (fourth extension), on the following grounds. GOSL had shown strong commitment to the project and a number of effectiveness conditions had been met. The critical outstanding condition was obtaining firm commitments from the three cofinanciers. The consultant hired by GOSL to propose a reformulation of the project had submitted his report. Preparation for the cofinanciers' meeting, holding the meeting, and (possibly required) approval of the reformulated project by the Board might take until May 1987; and GOSL would probably need three months to meet conditions of the amended Loan Agreement. The recommendation was accepted and GOSL and the cofinanciers informed of the new effectiveness date. 8. Following his visit to Colombo, the Vice President, South Asia Region, wrote to the Minister of Rural Industrial Developmentl that the Bank would expect GOSL to take action in three areas before it could proceed with the project. First, make a commitment to a pricing and tariff structure in the dairy industry, at the producer and the consumer level, which provides adequate incentives for the development of local milk production and processing without burdening the national budget; as evidence of this commitment, raise consumer prices of dairy products so that margins to producers and processors fully cover costs of operations; in addition, undertake a review of the financial structure of MILCO2 operations and make recommendations on a price structure suitable to promote the development of a modern and profitable dairy industry. Second, make some contractual arrangement with a thoroughly knowledgeable external partner to ensure that MILCO's operations are managed efficiently -- without high quality management of milk collection and processing, and technical assistance to milk producers, MILCO, which had taken over from a public sector enterprise, was likely to lose money. Third, propose a satisfactory organizational and business plan for the development of a national dairy industry -- what had been lacking in studies already undertaken was a clear Sri Lankan position regarding the best means of restructuring the dairy industry to improve the efficiency of production, collection, transport and processing of milk and, thereby, to increase the income of dairy producers. 1 Letter of February 26, 1987. 2 The Milk Industries of Lanka Company Limited established on September 27, 1984, to lease and manage dairy plants and to invest in new milk plants and chilling centers.  - 3 - 9. The cofinanciers' meeting, chaired by the Bank, took place in the Hague on April 2, 1987. All three cofinanciers stated that they intended to continue their involvement but wished to await GOSL's response to the conditions outlined in the Bank's letter (para 8) before proceeding further. The Netherlands had already informed GOSL that they supported the Bank's position. 10. In August 1987, GOSL requested extension of the loan effectiveness date to December 1987, since with the signing of the Peace Accord relating to the disturbances in the North and East of Sri Lanka it had become necessary to redefine the project area and amend the Business Plan that had been prepared. The Bank agreed to establish December 31, 1987, as the new effectiveness date (fifth extension), but informed GOSL that in view of the long delay in meeting the conditions of effectiveness any further extension would not be possible. 11. A document containing GOSL's proposal for a reformulated project was given to the Bank's resident representative in Colombo on December 23 and received in Washington on December 29, 1987. A quick review showed that it only partially dealt with the points listed in the Bank's letter mentioned in para 8 above. Specifically, the Bank had not received evidence that GOSL had in fact raised consumer prices of dairy products to provide margins to producers and processors that fully cover costs of operations. Also, the mechanisms for adjusting the milk price structure and the tariff structure were sketchy, and adequate administrative procedures for making adjustments were not given. Further, GOSL had not responded to the Bank's suggestion that MILCO enter into a contract with a reputable dairy firm to ensure that MILCO's operations are managed efficiently. In any case, the date of receipt of the document did not allow time for adequate Bank review, exchange of views between the Bank and GOSL, action by the cofinanciers, Bank revision of the project and legal documents, and GOSL meeting outstanding loan effectiveness conditions by December 31, 1987. Therefore, the Bank notified GOSL that the Loan Agreement was terminated as of December 31, 1987, for failure to become effective.3 Considering the above, we see no need for a PCR on the Second Dairy Development Project. 3 Telex of January 4, 1988.