Tunisia - National Rural Finance Project

Document of The World Bank Report No. 13922-TUN STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT APRIL 25, 1995 Middle East and North Africa Region Maghred and Iran Department  CURRENCY EQUIVALENTS Currency Unit = Tunisian Dinar (TD) TD LOO = US$1.00 (As of March 1995) FISCAI YEAR Januar's I to December 31 WEIGHTS AND NIEASURES ha = hectare (2.47 acres) mt = metric ton (2,204 pounds) GLOSSARY OF ABBREVIATIONS ADB African Developmenit Bank (Banque Africaine de D6veloppement) ANPE Agence Nationale de Protection de l'Environnement APB Association Professionnelle des Banques (Professional Bankers' Association) APIA Agricultural Investmenit Promotion Agency (Agence de Promotion des Investissements Agricoles) ASAL Agricultural Sector Adjustment Loan (Pret Sectoriel d'Ajustement Agricole) ASIL Agricultural Sector Investment l oan (Pret Sectoriel d'Investissement Agricole) BC]' Central Bank of TIunisia (Banque Cenitrale de Tunisie) BNA National Agricultural Bank (Banque Nationale Agricole) CAS Country Assistance Strategy CFD Caisse Francaise cle D6veloppement CLCM Local Mutual Credit Fund (Caisse Locale de Credit Mutuel) CNEA Centre National des Etudes Agricoles (National Center for Agricultural Studies) CRDA Regional Agricultuiral Developimient Commission (Commissariat Regional de D6veloppenient Agricole) CTAMA Compagnie Tunisienne d'Assurances Mutuielles Agricoles EFRSL Economic and Financial Reforms Support Loan FNG National Guarantee Fund/Drought Risk Fund (Fonds National de Garantie) GOT Governmient of Tunisia (Gouvernement de Tunisie) IFAD International Fund for Agricultural Development (Fonds International pour le D6veloppernent Agricole) KfW Kreditanstalt fiir Wiederautbau of Germany MFF Ministere de la Femme et de la Famille (Woman and Family Ministry) MOA Ministry of Agriculture (Ministere de l'Agriculture) MMR Money Market Rate (Taux du March6 Monetaire) MTASAP Medium-lTerm Agricultural Sector Adjustinent Program OC National Cereal Board (Office National des C6r6ales) ONH National Olive Oil Board (Office National de l'Huile) PDRI Programme de Developpement Rural Int6gre (Rural Poverty Alleviation Program) PICP Private Investment Credit Project (Projet de Credit a l'lnvestissement Prive) SCMA Agricultural Mutual Guarantee Society (Societe de Caution Mutuelle Agricole) UTAP Tunisian Association for Agriculture and Fisheries (Union Tunisienne de l'Agriculture et de la Peche)  STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT Loan and Project Summary Borrower: Banque Nationale Agricole (BNA) Guarantor: Republic of Tunisia Amount: US$65 million equivalent Terms: 17 years, including five years of grace, at the Bank's standard variable interest rate, plus commitment fee of 0.75% less any waiver. Onlending by BNA would be at market conditions. Project Description: Consistent with the Government's priorities, the primary objectives of the project are to assist Tunisia and BNA in promoting viable private investment in rural areas and in strengthening, on a sustainable basis, the financial viability and institutional reform process of BNA in order to improve its development impact on the country's rural sector. Bank involvement would help develop a sound rural finance system well-integrated into an increasingly liberalized financial sector. The project would fulfill fundamental economic and social needs in Tunisia for progress in rural development, greater efficiency in rural financial intermediation, and private sector growth. In this context, the project will be integral to the Country Assistance Strategy (GAS) articulated in April 1993. The Government has already made operational a drought risk management scheme that is expected to reduce risk for farmers and for BNA and other banks in the future. The project also include a study on group lending and elements of targeted interventions to, and in support of the rural poor in particular through the promotion of financially viable credit and savings schemes. Agriculture is a key sector in Tunisia, and provision of credit has been one of the main factors in developing the agricultural and rural sectors. Implementation, Beneficiaries: Specifically the project would fund over a four-year implementation period: (a) medium- and long-term credit to private farmers and investors to finance a wide range of investments including irrigation development with water conservation measures, livestock and forage development, tree crop plantations, forestry development, farm equipment, storage facilities, greenhouses, agro-processing plants, coastal fisheries, rural housing, and rural non-farm investments, and (b) project-related training, consulting services for the strengthening of BNA management, planning, computerization, rural outreach, and internal controls. A mid-term review will assess progress made during implementation. Risk: Since the Government of Tunisia reemphasized the role of BNA in the development of the country's rural sector and the need to make BNA a financially viable and strongly autonomous institution, and ensuring that the viability of the first deposit bank of the country is sustainable, BNA has the highest political support for its reforms. Thus, the risk outside the control of BNA of slower progress in BNA's financial reengineering is considered reduced. Tunisia, however, is vulnerable to droughts, and these have an immediate adverse impact on farm credit recoveries and rural savings mobilization. In addition, poor repayment discipline in the past in Tunisia has had a negative impact on BNA and other banks. The quality of BNA new management, improved credit policies and client selection, and the adoption of enhanced prudential banking regulations for loan classification, loan loss provisions and capital adequacy in Tunisia, as part of the ongoing financial sector reforms are important positive developments which are minimizing risks. On the basis of past experience and current progress, IBRD funds are not expected to be at more than normal risk, in a country like Tunisia, if the Government is committed to further improving its ability to manage droughts. The Government would assume the foreign exchange risk against a fee charged to BNA, as for any other bank in Tunisia.  - Hl - Local Foreign Total ---------------US$ Million------------ Estimated Cost BNA Credit Operations (Medium- and Long-Term) 194.2 217.8 412.0 Institutional Development (Training, Consultants, MIS, 2.8 5.2 8.0 Office Technology, Software) Total Project Cost 197.0 " 223.0 420.0'/ Proposed Financing Plan - IBRD - 65.0 65.0 - CFD - 35.0 35.0 - KfW - 25.0 25.0 - BNA 79.0 98.0 177.0 - Sub-Bqrrowers 82.5 - 82.5 - Government /b 35.5 - 35.5 Total 197.0 223.0 420.0 Estimated Disbursements: Bank FY 1995 1996 1997 1998 1999 ---------------------------------US$ Million------------------------------- Annual 5 16 16 16 12 Cumulative 5 21 37 53 65 Environmental Category: B Poverty Category: Program of targeted interventions: the project contains some elements of targeted interventions (up to 25% of loan amount) to respond to the credit demand for investment at market conditions of small farmers, small fishermen, rural women, artisans, service cooperatives supporting small farms, and for rural housing. /a Includes US$62 million of taxes and duties /b In accordance with the 1993 Unified Investment Code  (iii) STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT CONTENTS Page No. I. INTRODUCTION ............ .................................... I II. THE AGRICULTURAL AND RURAL SECTORS ........................... I A. Economic Outlook . .......................................... I B. Place of Agriculture in the Economy ............................... 2 C. Agriculture Sector Performance and Government Strategy ................. 2 D. Bank Role in the Agriculture Sector ............................... 2 III. THE FINANCIAL SECTOR.. 3 A. The Banking System. 3 B. Financial Sector Reforms. 3 C. Agricultural Credit. 5 D. Main Instruments and Institutions in the Rural Financial Sector. 6 IV. THE BANQUE NATIONALE AGRICOLE .. 9 A. Organization and Staffing. 9 B. Agricultural Lending Operations .13 C. Financial Situation and Performance (1989-1994) .13 D. BNA Projected Financial Situation .16 V. THE PROJECT ..17 A. Rationale for Bank Involvement and Project Objectives ..... ............. 17 B. Summary Project Description . ................................. 17 C. Detailed Features ........................................ 18 D. Project Costs and Financing . ................................... 20 E. Procurement ......................................... 22 F. Disbursements ......................................... 23 VI. PROJECT IMPLEMENTATION ..24 A. Credit Operations ........... 24 B. Women's Participation and Environmental Aspects ...... ............... 25 C. Institutional Development .................................... 25 D. Monitoring and Evaluation .................................... 28 E. Supervision, Mid-Term Review and Reporting ........ ................ 28 F. Accounts and Audit ..................................... 28 VII. BENEFITS, JUSTIFICATION AND RISKS ..29 A. Benefits and Justification .29 B. Project Risks ........ 29  (iv) Page No. ANNEXES Annex 1. Structure of Farm Holdings and Categories of Agricultural Credit Borrowers ... .... 31 Annex 2. BNA Staffing and Staff Training . .................................. 34 Annex 3. BNA's Action Plan ........................................... 38 Annex 4. Informal Rural Finance and Group Lending Schemes: Terms of Reference ... ..... 53 Annex 5. Project Implementation and Bank Supervision ........................... 58 Annex 6. Conceptual Approach on a Rainfall-Based Insurance System ................. 60 Annex 7. BNA's On-Lending Procedures, and Appraisal and Approval Methods ... ........ 63 Annex 8. Agricultural Sector Performance, Challenges, and Bank's Role in the Sector ... . ... 66 Annex 9. BNA Supervised Credit Program for Small Farmers, and Financial Impact ... ...... 69 Annex 10. Selected Documents and Data in the Project File ......................... 74 IN-TEXT TABLES Table I: Interest Rates in Tunisia 1987 - 1994 ............................... 7 Table 2: BNA Training Activities ........ . . .. . . . . . . . . . . . . . . . . . .. . . . . . . 11 Table 3: BNA & GOT Breakdown of Lending and Arrears (1992) ...... . . . . . . . . . . . 14 Table 4: BNA & GOT Agricultural Operations Financial Summary ..... . . . . . . . . . . . 15 Table 5: BNA's Projected Financial Indicators 1995-98 ...... . . . . . . . . . . . . . . . . . . 16 Table 6: Breakdown of Project Costs ......... . . . . . . . . . .. . . . . . . . . . . . .. . . 21 Table 7: Project Financing Plan .......... . .. . . .. . .. . . .. . .. . . .. . .. . . .. . 21 Table 8: Summary of Proposed Procurement Arrangements ...... . . . . . . . . . . . . . . . 22 Table 9: Estimated Disbursements ........ .. . . . . . . . . .. . . . . . . . . . . . .. . . . . 23 Table 10: Disbursement Procedures ........ .. . . . . . . . . .. . . . . . . . . . . . . .. . . . 23 SUPPORTING TABLES Table I1: BNA and Deposit Banks Commitments (Total and Agricultural) .. ....... . . . . 76 Table 12: BNA's Project-related Subloans Commitments and Disbursements . ....... . . . 77 Table 13: BNA Financial Position: Summary of Balance Sheets (1988-1994) . ....... . . . 78 Table 14: BNA Income and Expenditure Statements (1988-1994) .... . ......... . . . . . 79 Table 15: BNA Sources and Applications of Funds (1988-1994) ... . .......... . . . . . 80 Table 16: Basic Assumptions for BNA's Financial Projections (Parts I to 4) ... ...... 81-84 Table 17: BNA, Summary of Projected Balance Sheets (1994-1998) ...... .. ......... 85 Table 18: BNA, Projected Income and Expense Statements (1994-1998) .............. 86 Table 19: BNA, Projected Sources and Applications of Funds (1994-1998) ... ......... 87 Table 20: Reimbursement and Arrears Situation of All Ag-Credit Lines Combined (1987-1994) 88 Table 21: Recovery Rate by Line of Credit (1987-1994) ........................ 89 Table 22: Reimbursement and Arrears Situation of BNA and GOT Credit Operations ... ... 90 Table 23: Estimated Schedule of Disbursements of Bank Loan .................... 91 Table 24: Development Impact Indicators ................................. 92 CHART: BNA's Organization Structure ................................ 93-94 This report, updated in April 1995, is based on the findings of a Bank appraisal mission that visited Tunisia in December 1994 following preparation and pre-appraisal missions in December 1993 and in April 1994. The team was composed of Mr. B. Dussert (Task Manager); Messrs. P. Beuzelin, P. Goffin (Bank Consultants); Mr. R. Hartel and Mr. R. Siller (KfW Representatives) and Messrs. Y. Grouitch and F. Mahe (CFD Representatives). Messrs. C. Bartoli, J. Tillier (KfW funded Consultants) and Mr. L. L'Aot (CFD Representative) participated in pre-appraisal missions; Mr. A. Tlili (Tunisian Expert) participated in the preparation and revision of financial projections. Messrs. 0. Sacay (FSD) and W. Dick (Consultant) participated in a follow-up mission on drought management and crop insurance in May 1994. Lead Advisor/Peer Reviewer are Mr. M. Long and Ms. D. McNaughton (FSD). The Acting Division Chief is Mr. T. Sinha (MN1NE), the Department Director is Mr. D. Ritchie (MN1) and the Regional Vice-President is Mr. C. Koch-Weser (MENA). Office technology assistance was provided by Ms. S. Creger (MNINE).  STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT I. INTRODUCTION 1.01 Within the context of the Eighth Economic Development Plan of Tunisia (1992-1996), the Government of Tunisia (GOT) and the National Agricultural Bank (BNA) have requested Bank assistance to finance, with other cofinanciers, a line of credit for the rural sector. The Eighth Plan envisages an increased role for private sector investment within a more liberalized and outward-oriented economy.' Consistent with the Country Assistance Strategy (CAS of 1993), the National Rural Finance Project will promote private sector investment and sustainable financial intermediation in rural areas. It has two interdependent objectives, a development and an institutional objective. The development objective is to promote and finance viable private investment in rural areas and to help alleviate rural poverty. The institutional objective is to strengthen, on a sustainable basis, the financial viability and institutional reform process of a major multiservice bank--the BNA-- which is the key bank for agriculture in Tunisia. These objectives have the highest priority in Tunisia. 1.02 The Project would be essentially implemented by BNA, which is a client in good standing with the Bank. The project would finance on-farm investments undertaken by private farmers; and investments for the establishment or expansion of agro-industries (including working capital and technical assistance), of private coastal fisheries, of artisans (men and women), and of rural non-farm enterprises; for reforestation and environmental protection; and for rural housing investments. The Project would also finance training/technical assistance to strengthen BNA's organizational and regional structure, and improve the planning and control process, including BNA's decentralized Management Information System (MIS), and support, on a pilot basis, Tunisia's climatic risk insurance mechanism, and support the preparation of a study on informal rural finance and group lending. The Project would be implemented over a four-year period (1995-1999). 1.03 The total cost of the Project is estimated at US$420 million, of which US$223 million (53%) is foreign exchange. A Bank loan to BNA would finance part of BNA's medium- and long-term lending, and part of its institutional development cost during the Project period. BNA's own resources, sub-borrowers' contributions, and loans from the Kreditanstalt fur Wiederaujbau (KfW) of Germany and the Caisse Franfaise de D&veloppement (CFD) would provide most of the remaining investment resources. II. THE AGRICULTURAL AND RURAL SECTORS A. Economic Outlook 2.01 Background on the Tunisian economy, past economic performance, recent economic trends and the Government's adjustment effort as well as current economic, financial and social priorities are fully described in the Country Assistance Strategy (CAS) for Tunisia, attached to the memorandum of the President of April 16, 1993 on a Second Forestry Development Project of the Republic of Tunisia (Report No. P-6006-TUN). 2.02 . The Bank and the IMF have supported the economic adjustment process in Tunisia to foster sustainable and equitable growth. Tunisia has made significant progress in macro-economic stabilization during the last ten years. The present project would help the Government in its effort to promote the private sector, to develop the agricultural sector in poor rural areas and thereby create employment, to facilitate export promotion and domestic resource mobilization while reducing pressure for public expenditure. I A Private Sector Assessment is available for Tunisia: World Bank Report No. 12945-TUN of November 1994.  - 2 - B. Place of Agriculture in the Economy 2.03 Agriculture plays an essential role in Tunisia's economy. It generates 16% of GDP, employs almost one out of every three workers in the labor force, and contributes about 11 % to total export earnings (Annex 8). 2.04 Out of a total land area of 16.4 million hectares (ha) in Tunisia, only 8.4 million are suitable for agriculture and grazing. Cultivable land amounts to 5.3 million ha, of which 25% are devoted to cereals, 35% to crop trees, 10% to forage crops, fruits and vegetables, grain legumes and industrial crops, and 20% left fallow. Animal husbandry is a major activity, with the majority of the national herd's 624 thousand heads of cattle and 6.5 million small ruminants raised on small farms. 2.05 While Tunisian agriculture is predominantly rainfed, a majority of Tunisian farmers work small holdings with low income. According to the 1989 agricultural survey (see Annex 1), out of the estimated total of 387,100 holdings engaged in some form of agricultural production, 330,000 are small. Thus, 85 % of farmers own farms of sizes no larger than 20 ha, which constitute 39% of a total agricultural land surface area of 5.3 million ha. The average farm size is 15 ha, broken up into four parcels, each averaging 3.7 ha. Only 36% of irrigated acreage belongs to small farmers. On these meager land resources, sources of household income are diversified between crop and livestock and between farm and off-farm. The results of a consumption survey and data on rural household income are in Annex 8 para. 2. Based on the 1984 population census, updated in 1989, 120,000 heads of households consider farm activity their principal activity. C. Agriculture Sector Performance and Government Strategy 2.06 Past Performance. Between 1980 and 1988, the agricultural GDP has been highly variable, exhibiting a coefficient of variation (c.v.) of 0.13, with estimates of c.v. for durum wheat at 0.44, for bread wheat at 0.55 and for barley at 0.58.2 Vulnerability to severe droughts is a chronic problem. In the eighties, agriculture suffered from severe droughts in 1982-83, 1985-86, 1987-88, and again in 1988-89. 2.07 Government strategy in the Eighth Plan. The central objective remains food security. The main policy shift initiated under the previous plan period, 1987 - 1991, continues to be increased emphasis on efficiency rather than on self-sufficiency at all costs; on export promotion and outward orientation rather than import substitution; on reliance on private sector rather than public sector; and on decentralized market mechanisms rather than on centralized public controls. Specifically, the GOT has implemented a program of structural adjustments to achieve the following: (i) improve the pricing and marketing framework; (ii) reform parastatals and privatize them; (iii) redemarcate activities for valid public sector intervention; (iv) reorient public expenditures to strengthening these activities; and (v) improve the monitoring and evaluation capabilities of the Ministry of Agriculture. Current challenges on the Agricultural Sector are in Annex 8 para. 4. D. Bank Role in the Agriculture Sector 2.08 Bank group lending to Tunisia began in 1967. To date, 105 loans and credits have been made, supported by US$4.6 billion Bank and IDA funds, net of cancellations. In agriculture, 17 projects have been completed and six are being implemented, totalling US$720.9 million of Bank group lending. (See details by project in Annex 8 para. 6). Performance of Bank-financed projects in agriculture has generally been satisfactory. The implementation of the Bank's portfolio in Tunisia is currently satisfactory. 2 Tunisia: Small Farmers--Potential and Prospects, a Technical Study, World Bank Report No. 9323-TUN, 1991, para. 1. 1. a coefficient of variation is a statistical measure of variability and is defined as the ratio of the standard deviation to the mean.  -3 - 2.09 Lessons Learned from Past Agricultural Credit Projects. Performance of the Agricultural Credit Projects has been good compared to agreed objectives at the time, and trend improving. In contrast to the First Credit Project, the Second Credit Project provided investment credit to small/medium farmers who, up to 1976, had limited access to institutional credit. The Project Completion Reports (PCRs) of the First Three Credit Projects note that disbursements were affected by competition with Government credit schemes offering loans at lower subsidized interest rates and by a lack of profitability of agricultural operations. The OED Performance Audit Report of June 1993 on the Fourth Credit Project underscores the need to continue institutional and financial improvements at the National Agricultural Bank (BNA) through adjustment towards market orientation, phasing out of Government-subsidized credit schemes, recovery discipline, BNA reorganization on a decentralized basis to allow it to reach a larger number of farmers, and its gradual assumption of full responsibility for all credit decisions without Government interference. III. THE FINANCIAL SECTOR A. The Banking System 3.01 Institutional Setting. Tunisia's banking system, which is well developed, consists of the Banque Centrale de Tunisie or Central Bank (BCT), twelve deposit (commercial) banks, eight investment (development) banks, one specialized savings institution, and eight off-shore banks. The Government holds a majority share in four of the five larger commercial banks; two private commercial banks are subsidiaries of foreign banks, and several other private commercial banks have significant portions of their capital held by foreign interests. GOT holds a 50% share in many of the development banks, and foreign governments (Kuwait, Qatar, Saudi Arabia, United Arab Emirates) hold the other 50%. 3.02 As of 1992, the commercial banks represented about 82% of total assets of the banking system. At that time, there were two financial leasing companies, with total assets totalling TD 64 million, or less than I % of the total assets of the banking system. Other financial institutions included a number of insurance companies, a postal checking center, several mutual funds, and investment firms. The capital market is just starting and the stock market is small, with only twelve companies listed permanently, of which nine are banks. Furthermore, new financial institutions, such as factoring companies and investment firms, as well as financial instruments are continually being created in response to emerging opportunities. B. Financial Sector Reforms 3.03 The highly regulated financial sector has been gradually undergoing substantial reforms since 1986. The reforms seek to: (i) increase market-orientation; (ii) deepen financial intermediation; (iii) liberalize interest rates; (iv) reduce Government directed credit; and (v) strengthen the regulatory and supervisory framework. 3.04 Increasing market orientation. The shift has been from centralized control through quantitative credit guidelines to decentralized management through freeing selected interest rates and through modifying the global ratio which imposed portfolio requirements on banks.3 Most deposit rates were freed except those on convertible Dinar accounts of Tunisians working abroad and on site deposits. Most lending rates of commercial banks were also freed except those for priority activities, (agricultural production, exports, small- and medium-scale enterprises in industry and commerce, and energy saving industries). The portfolio requirement that commercial banks lend at least 18% of their deposits to priority activities was reduced to at 3 Republic of Tunisia: Country Economic Memorandum--The Road to an Outward-Oriented Economy, Annex 2 on the Tunisian Financial System in Support of Investment, March 1990, pp. 6-13. The CEM is being updated (Towards the 21st Century, YC Report No. 14375-TUN of April 1995). The global ratio refers to required allocation of bank deposits. Banks were required to allocate up to 43% of their deposits to the following: 10 year Treasury Bonds (20%); housing saving funds bonds (5%); medium- and long-term lending (18%).  least 10% at regulated rates in 1989. Prior authorization requirement from the Central Bank for private investment was abolished except for those investments benefitting from special advantages. 3.05 Deepening financial intermediation. GOT broadened the participation in the money market in three ways: (i) banks were allowed to issue a wider range of certificates of deposits (CDs); (ii) non-bank enterprises were allowed to lend directly by purchasing CDs; and (iii) non-bank enterprises with a minimum capital of TD I million were allowed to borrow by issuing a new commercial paper, billets de trisorerie. To inject or withdraw liquidity, the Central Bank has been undertaking weekly auctions in the money market to buy or sell its securities. Within the Economic and Financial Reforms Support Loan (EFRSL, FY92), the GOT is committed (1992-1996) to reforming the Treasury's borrowing practices which tend to crowd out private sector investment and to removing fiscal distortions which inhibit resale of bonds and shares. The GOT would be redeeming its bons d'Fquipement which represent a tax on financial intermediation and banks would be allowed to hold 20% of their portfolio in any Treasury security. The unification of the six sectoral investment codes and the reform of the system of rediscounted preferential credits should increase the supply of shares and their appeal to the public as financial investments. 3.06 Interest Rate Liberalization. Until 1987, the BCT closely regulated a detailed structure of interest rates for deposits: by term, by corporate vs. individual deposits, and by size. It regulated a similarly detailed structure of interest rates for lending: by sector, by purpose, by size of loan, and by whether the loan was rediscountable. Because real rates were largely negative, credit was rationed administratively. BCT required prior authorization on loans and refinancing, involving cumbersome procedures and long delays. Among other requirements on the use of their funds, commercial banks were required to allocate at least 18% of their deposits to medium and long-term lending, of which 2% to small and medium scale enterprises. 3.07 In 1988, rates on deposit were completely deregulated, and, notwithstanding attempts by commercial banks to agree on ceilings on deposit rates, competition for deposits is strong. Prior authorization on loans and rediscounts was abolished in 1988, thereby introducing greater accountability and the need for stronger appraisal capacity in the banks. Furthermore, lending rates for deposit banks were liberalized, subject to a ceiling of 3% over the money market rate. Under the Economic and Financial Reforms Support Loan (EFRSL, approved in FY92), as a transitional measure, lending rates were further liberalized to allow for each bank's lending rates being an average spread of 3 % over the money market rate. With the removal of this last administrative constraint in June 1994, lending rates for deposit banks were fully liberalized, following which the third tranche of the EFRSL was released in September 1994. For the financing of priority activities, which represented about 7% of the banking sector commitments in 1994 and 8% of BNA's loans, (2.6% is for agriculture, i.e., TD53 million out of which 90% are short-term credits), rates are still regulated4 for all banks as follows: (i) 10% on short-term and some medium-term lending for agricultural production; (ii) 11 % for investments and production short-term and credit to small- and medium-sized enterprises; (iii) 10% for investments in energy saving industries; and (iv) 11 % in export-oriented industries and 10.25% on short-term export prefinancing.5 The initial objective on these regulated rates was to reach money market rates. In fact, they are now exceeding them (8.8%). Interest rates are strongly positive, with most lending rates at 12.5 - 14%, and inflation rates for 1992 and 1993 of 5.7% and 5.4% respectively (and about 5.1% in 1994). In response to these measures, commercial banks in particular have developed departments specialized in analyzing credit risks and are beginning to differentiate their risks through the interest rates charged on loans. 3.08 Directed credit reduction. Prior to 1987, directed credit was an important feature of the controlled financial sector; preferential rediscounts at the BCT and subsidized loans available to investors through the banking system (funded by the GOT and external sources) accounted for 40% of total lending in the system. Investments in tourism were the major beneficiaries of subsidized lending, with total subsidies 4 Central Bank's circular no. 92/15 to all banks, June 29, 1992. All banks using their own resources to finance priority activities are compensated by a supplemental margin of 1.8 to 2.8% according to the type of credit made and based on the prevailing MMR.  amounting to about 27% of the investment cost (including benefits in the form of tax holidays). Since 1987, these programs have decreased in importance to about 24% of total credit to the economy in 1992 of which 40% was from external resources. Rediscount rates at BCT are positive in real terms (6% to 9.5%, depending on the activity). As part of current financial reforms, the recourse to rediscounting at the Central Bank to finance the banking sector has been eliminated. The new unified investment code does not provide for subsidized interest rates and replaces subsidized lending for investments with fiscal benefits and capital subsidies on selected investments; in particular, it allows capital subsidies for investments by farmers in rainfed areas, micro-enterprises, and other small groups of beneficiaries, which together account for a maximum of 5% of total lending to the economy. This compares well with many other developing countries. 3.09 Strengthening the supervisory and regulatory framework. The GOT is committed to a four- pronged approach to minimizing the likelihood of a financial crisis as the sector is being liberalized. First. prudential regulations on provisioning and capital adequacy (Cooke ratio of equity to risk-weighted assets with a minimum requirement of 5%) have been strengthened. Second, the BCT is emphasizing on-site inspection of asset quality and adherence to more rigorous accounting rules. This includes loan classification rules with five asset classes, from class zero to class four according to increasing potential risk, and based on aging of arrears (90, 180, and 360 days) linked to strict provisioning rules (20% of loan amounts in class two, 50% in class three, and 100% in class four). Third, the existing banking law was amended to increase BCT's powers to enforce sound prudential practices and impose financial discipline on banks, including limits on risk concentration.6 Fourth and finally, the BCT has implemented a program for auditing and inspecting banks, based on accounting principles following international norms. The transition for full compliance by all banks with these regulations, which are strictly enforced, is expected to be up to five years for some banks. 3.10 In September 1994, the following conditions for the release of the third tranche of the EFRSL were met: (i) the individual financial position of each audited or inspected bank operating in Tunisia had been jointly reviewed by the Tunisian authorities and the Bank, based on internationally accepted banking and audit standards previously agreed with the Bank; (ii) satisfactory action plans for all reviewed banks had been adopted by their respective boards and are being implemented; (iii) the Central Bank had adopted a program. acceptable to the Bank, for auditing and examining the overall viability of all remaining Tunisian banks. These banks have launched audits, most of which--and this includes BNA--have been completed. C. Agricultural Credit 3.11 GOT Approach to Agricultural Credit and Institutions. GOT has, since the early sixties, been directly involved in agricultural credit; it considers agricultural credit as an important tool to assist all farm households, large and small. This latter category, including subsistence and noncreditworthy small farms. represents about two thirds of the farm population. The financial effort has been substantial; it involved subsidized interest rates to agriculture and linked credit programs with grants to all categories of farmers, including those who were not creditworthy. In times of adverse climatic conditions, it intervened through postponement or forgiveness of interest and principal repayments. 3.12 On the institutional side, to allocate and deliver credit, it created in 1959 (para. 4.01) a national agricultural credit bank, expanded into a multipurpose commercial bank in 1969, which developed a country- wide branch network to make credit accessible, including to small- and medium- size farms. This bank conducted credit operations on its own resources, but also administered direct GOT credit lines aimed principally at small farmers. GOT also attempted to promote and develop farmers' associations, at the village level, which would handle the credit for their members; the members, in turn, would assume mutual responsibility for repayment of the loans. In 1963, these took the form of "Caisses Locales de Credit Mutuel" (CLCM) and, in 1973, of "Societes de Caution Mutuelle Agricole' (SCMA). Both CLCM and SCMA played a minor role in lending to small farmers; these were saddled with arrears which GOT had to assume. GOT 6 Central Bank's circular No. 91/24 to all banks, December 17, 1991.  - 6 - in its desire and concern to reach small farmers maintained an interventionist policy in agricultural operations but, over time, allowed market rates in lending to larger farmers. 3.13 Reorientation in GOT Agricultural Credit. In the mid-eighties, GOT altered the orientation of its economic policy and undertook broad reforms to build a more efficient, market-oriented and outward- looking economy. In agricultural credit, it introduced major policy reforms to gradually eliminate the interest rate differential between agricultural and market rates and to disengage GOT from direct involvement in credit operations. There has been progress in implementing these changes but they need to be pursued further. Most interest rates including in agriculture are now free, and rates which remain regulated by the Central Bank (at 10% to 11 % for the so-called priority activities) are above market rates (8.8% since November 1993), but in view of the high risks involved (drought), agricultural lending remains financially unattractive to most banks. Over the last four years (1990-93), despite good progress in the policy environment, the legacy of the past appeared in the form of high accumulated arrears on Government-sponsored credit programs. After restructuring in 1994, the number of these programs was reduced from 48 to four with full implementation effect in March 1995, and volumes have sharply decreased but the past situation has weakened the agricultural credit system at a time when it is expected that the banking sector will assume an increasing role in the rural credit delivery system. 3.14 GOT policies have shaped the present agricultural credit system in which the lead bank for agriculture, BNA (a major commercial bank in Tunisia, renamed after the merger in 1989 of the National Bank of Tunisia--BNT created in 1969, and of a small bank, the National Agricultural Development Bank--BNDA created in 1983), dominates formal lending to agriculture and the rural sector. BNA's share capital (40% private) is priced at the stock exchange of Tunis. Other commercial banks have concentrated on financing commercial and industrial activities, including short-term financing of agro-industry and of imports of cereals, and prefinancing of exports. Because of the high risks and entry costs into rural finance, other banks have been reluctant to lend for agricultural investment and input supply, especially for small-and medium-scale farmers. D. Main Instruments and Institutions in the Rural Financial Sector 3.15 The main instruments and institutions influencing rural finance are: (i) the BCT instruments for regulating the financing of priority activities (para. 3.07); (ii) the GOT credit lines; (iii) the Fonds National de Garantie (FNG); (iv) the private sector insurance agencies; and (v) the Agricultural Investment Promotion Agency (APIA). 3.16 BCT Regulating of Priority Activities Lending. BCT's principal instruments of control include setting some of the interest rates banks can charge small farmers. The latter is used mainly to finance short-term credit for production as well as for marketing operations (para. 3.07). Besides this tool, BCT has also introduced since 1987 a credit/deposit ratio for the financing by commercial banks of priority activities (agricultural production, exports, small scale enterprises, and energy-saving activities). Each bank is required to have at least 10% of its core deposits loaned out to these priority activities (BCT 's circular No. 89-16 of May 17, 1989). 3.17 With the gradual liberalization of prices to farmers and the liberalization of the financial markets, interest rates to agriculture have been gradually adjusted upwards over the last five years. Table I shows the progress made since 1987:  Table 1: Interest rates in Tunisia 1987-1994 (% p.a.) 1987 1988 1989 1990 1991 1992 1993 1994 Money Market Rates (MMR) 10.5 8.7 9.5 11.4 11.7 11.8 10.7 8.8 Inflation Rates 8.2 7.2 7.7 6.5 7.8 5.7 5.4 5.4 Savings Rates -------------------------------------MMR less 2 % lb Agricultural Nominal Rates (priority Activities"crates) (See para. 3.07) Short-Term 6.75 7 7 8 9 10 10 10 Medium-Term 7 7.5 7.5 8 9 lo,' MMR +3% Long-Term 7 8 8 8.5 9.5 MMR +3% Free /a For all agro-industries and integrated type investment loans, rates are free since June 1994 lb BNA is launching in 1994 savings/credit products (including rural savings) with credit at MMR +3% and savings at MMR -1% leaving a net margin of 4%. Long-term savings are available at about MMR - 0.5% /c Priority activities loans in agriculture account for 2.6% of BNA's commitments in 1994. 3.18 The successive adjustments slowed down in 1988 and 1989, in agreement with the Bank, following droughts that severely affected the agricultural sector. In view of these circumstances, progress has been commendable. Interest rates paid by farmers are, since 1990, positive in real terms and have now reached no less than 10%, and are above the MMR. For the remaining regulated rates (para. 3.07) the banks' margin is 4%. It allows BNA to cover its operating costs and provisions for credit risk as soon as a substantial improvement is made in recovery rates (paras. 6.10 and 6.11). This implies maintaining operational the climatic risk mechanism (para. 3.23) to allow the banks and the farming community to better manage risks. 3.19 GOT Credit Lines. These credit schemes, which began in the sixties, aimed at helping potentially creditworthy subsistence farmers and small farmers who had no access to formal credit. The rationale was that small farmers could not increase their production/income because of credit shortage, and that different organizations were needed to allocate credit as the delivery system of the ex-BNT gave limited access to credit by many farmers. The number of schemes, small in the sixties and seventies, had grown to some 48 funds and accounts. These were funded through budgetary appropriations and donor funds (loans and grants). They were managed by project authorities, regional offices (CRDAs) of the Ministry of Agriculture (MOA), the Governorates, and, in some cases, BNT. The CRDAs identified and prepared subprojects for financing as part of their extension activities. They were also monitoring farm investments after the loans and subsidies had been approved. BNT's role was mainly to disburse and collect loans and to keep the accounts against a fee varying from 1.5 to 3% of loan amount. Competing lines of credit at low interest rates and diverse procedures had not only complicated the management of these lines but had also created confusion for the borrower between credit and income transfers. These credit lines, when used without other development measures, had a limited impact on farm development. Recovery under this system over the years has been below 55%. In 1992 it was 53%. Under the Fourth Agricultural Credit Project (1988-1991), GOT had accepted the principle of the fungibility of funds, agreed to harmonize the terms and conditions of these various lines, and accepted to gradually transfer the credit risk to the banking sector. 3.20 In 1993, GOT opted to disengage itself from countrywide direct agricultural credit operations and BNA established a "Supervised Credit Unit" responsible for developing and promoting credit operations to potentially creditworthy farmers previously beneficiaries of GOT credit lines. Under this supervised credit program, BNA appraises and approves the loans and receives the support from MOA's extension services in identifying and selecting the beneficiaries and in providing technical assistance to the farmers during supervision  (See part A of Annex 9). GOT has refocused its credit assistance to the households living in the poorest rural areas by integrating its remaining credit programs with other actions such as irrigation, reforestation, land conservation and other rural works, and/or by supporting the development of specific action programs such as olive production. 3.21 To achieve these poverty-oriented programs/projects GOT has maintained four funds out of a total of 48, i.e., FOSDA, FODERI, PAAF, and F.S.Oleicole.7 Interest rates under these restructured funds are similar to those applied by the banking sector for priority activities except for FODERI where a rate of 6% will be applied. With regard to the 44 phased-out funds having a total of outstanding loans of TD 133 million to fall due over the period 1994-2012, Parliament approved, February 8, 1994, a law (Law No. 94-30 of February 21, 1994) to gradually transfer the amounts due to BNA into a quasi-equity fund (fonds de dotation non remboursable) open in BNA's accounts in 1994. 3.22 These are critical policy changes within the framework of restructuring and shifting credit operations from GOT to the banking system. The implementation details are spelled out in two agreements between GOT and BNA signed in March 1995: (a) One agreement on the transfer of amounts due (for a total of TD 133 million) under GOT restructured credit lines, and on the implementation modalities of the guarantee on the shortfalls; period for transfer is established at a maximum of 20 years: BNA will collect, each year, the recoverable portion (total estimated at about 50%) of farmers' dues on these lines, and the unpaid portion is guaranteed by the GOT through annual budget allocations until BNA has reached its financial equilibrium; and (b) One agreement on the precise role and responsibilities (disbursement on behalf of GOT within budget limits, and bookkeeping with separate, off-balance sheet accounts), and remuneration of BNA for managing on behalf of GOT the remaining funds (FOSDA, FODERI, PAAF, and F. S. Oleicole) to cover 100% of administrative and management cost plus incentives on recovery performance. 3.23 The National Guarantee Fund (FNG). In 1981, GOT established the FNG (Fonds National de Garantie), which guarantees loans made by commercial banks to small- and medium-scale enterprises for all sectors, including agriculture. The FNG is capitalized through automatic premium payments made by beneficiaries through banking operations, plus reserves. At the end of 1994, total accumulated resources amounted to TD 48 million. The FNG, however, which is operational since 1984 in its initial form (and was managed by BCT until 1993), was not conceived to protect farmers against climatic risk. The GOT amended the implementation decree of the FNG, November 22, 1993, to cover drought risk, and the FNG, since 1994, is administered by an insurance company (Tunis-Re). The GOT confirmed in March 1995 that this new drought risk management scheme has been made fully operational. Eligibility criteria to the modified FNG were spelled out in July 1994, and implementation modalities in March 1995 (para. 6.12). 3.24 Agricultural Insurance. The Compagnie Tunisienne d'Assurances Mutuelles Agricoles (CTAMA), a farmers' mutual since 1912, insures against fire and hail damage to crops, livestock and greenhouses, among other things, for commercial agriculture. BNA requires its borrowers to purchase hail and fire insurance. However, drought is not covered by private insurers ( Annex 6). FOSDA: Special Fund for Agricultural Development; FODERI: Special Fund for Rural Integrated Development; PAAF: Citrus and other Fruit-tree Program (new plantations); F.S. Oleicole: Special Olive-tree Fund.  -9- 3.25 The Agricultural Investment Promotion Agency (APIA). Through its new Unified Investment Code8 (law No. 93-120 of December 27, 1993), GOT promotes and encourages investments in the agricultural-- fisheries sector, to improve productivity, efficiency and employment. The law provides for fiscal advantages, such as tax deductions, duty free imports of livestock and seeds, and/or direct financial support through grants ranging from 10% for investments in equipment to 25% for water conservation actions. APIA, under the direction of MOA, is responsible for approving the agricultural investments eligible for benefits (API is responsible for industrial investments). For those investments eligible under the code, the beneficiary bank loan is reduced by the amount of the contribution/grant. BNA works closely with APIA. 3.26 Rural Poverty9 Alleviation Program. Subsistence farmers not eligible for bank credit amount to about 267,000 (Annex 1). Some of them are potentially creditworthy. To help these poor rural families, the GOT has developed a poverty alleviation program (Programme de Developpement Rural Integre--PDRI). The objectives of the PDRI are to improve living conditions, increase production and income (farm and off-farm), and improve employment. Budget resources allocated to the PDRI finance the development of rural infrastructure, including sanitation, rural electrification and drinking water (TD 350 million in five years). The FODERI (about 2,000 beneficiaries and TD 8 million per year) is the rural credit instrument of this program (24% recovered). Another small fund (OPEC) provides credit to micro-enterprises (petits metiers) with a 30% recovery rate. Decisions are made by the regional Governorates. The PDRI has laudable goals but a joint GOT- FAO evaluation conducted in April 1993 (Working Document No.22) shows that the program got mixed results and needs to be revamped (not part of this project). IV. THE BANQUE NATIONALE AGRICOLE A. Organization and Staffing Background 4.01 In 1959, the GOT established a Banque Nationale Agricole (BNA) as a specialized agricultural credit institution and, for the following ten years, its activities were concentrated mainly in that sector. In 1969, the GOT decided to transform this bank into a multipurpose commercial bank (BNT). The decision to diversify the institution's operations and to maintain its viability as a financial institution was complemented by GOT entrusting to BNT the management of numerous special subsidized agricultural credit programs, including the important Special Fund for Agricultural Development (FOSDA). In October 1989, BNT was merged with BNDA which was created in 1983 to provide financing to large farmers and to agricultural enterprises. The new BNT was renamed the Banque Nationale Agricole (BNA). 4.02 BNA currently occupies a unique position in the Tunisian banking system as it provides most of the financing extended to the agricultural sector while also being one of the two largest commercial banks in Tunisia, with an extensive network of regional and branch offices, further explained below. 4.03 Until 1993, only part of agricultural credit operations were carried out under the responsibility and risk assumption of ex-BNT and BNA (66% of total in 1992), while the other part (34%) was carried out by GOT but managed by the bank, on behalf of GOT, for a fee. (Reforms were completed in March 1995 to phase out most GOT's credit programs, paras 3.20 to 3.22). Code d'incitations aux Investissements A Poverty Assessment for Tunisia is available: "Poverty Alleviation: Preserving Progress while Preparing for the Future" (GC Report No. 13993-TUIN, April 1995).  - 10 - Organization 4.04 In March 1993, BNA put in place a new organizational structure at its headquarters (see Chart at end of Supporting Tables) which eliminates duplications and regroups various departments under the authority of eight central directorates. These directorates correspond to the various functions that BNA is fulfilling in its role of multipurpose bank (Agricultural Lending Operations, Commercial and Industrial Lending Operations, International Operations) as well as its own needs as a financial institution (Organization and Data Processing, Financial Affairs and Treasury, Branch Network Management, Human Resources and Administrative Services, Legal). 4.05 The departments within each central directorate are responsible for the various phases of the activities of the directorate. For instance, the Central Directorate for Agricultural Lending Operations includes four departments, two of which are in charge of appraising loans, one in charge of implementation and supervision and one responsible for loan collection. 4.06 The new structure is adequate to allow BNA to fulfill its role of multipurpose bank. However, within the context of a necessary improvement of the automated management tools and of a greater decentralization of operational responsibilities toward the regional offices, some adjustments will need to be made to the structure. 4.07 BNA's field organization at the end of 1994 includes 15 regional offices and 140 branch offices. Four regional offices (Bizerte, Sfax, Sousse and Gabes) are decentralized, which means that they have some decision-making powers regarding their operations that the non-decentralized regional offices do not have (e.g. credit decisions on new loans up to specified ceilings, roll over of existing loans, short-term overdrafts, and personnel/legal matters). BNA's management is committed in its action plan (para.4.18) to strengthen the institution, and to pursue the delegation of operational authority to the branch network by giving the decentralized status to three additional regional offices per year. BNA is currently considering the possibility of also giving them more decision-making authority for loan approvals and collection of arrears. BNA's decentralization of operations will be feasible only to the extent that, in parallel, it implements a modern management information system, an effective internal audit and strengthens the inspection function. Management 4.08 BNA is administered by a Board of Directors and a President Director General (PDG) who is the Chairman of the Board and the Chief Executive Officer (CEO). The Board includes representatives from the Prime Minister's Office and from the ministries of Finance, Economic Development, and Agriculture, from the National Cereals Board (OC), the National Olive Oil Board (ONH), the Trade Board of Tunisia, and from the private sector (40% of BNA's capital) including the Tunisian Agricultural Mutual Insurance Company (CTAMA). A financial controller is appointed by the Ministry of Finance to monitor and report on BNA's compliance with pertinent laws. BNA's financial statements are audited annually by an independent auditor. 4.09 A new PDG/CEO was nominated in mid-1992. After consultation with the senior staff of the institution, he proceeded with the preparation of broad strategic orientations for the bank (1992-2000) which includes a general policy statement (Working File No 16). BNA's Board of Directors approved these new policy orientations and strategic agenda December 11, 1992. In parallel, he proceeded with the restructuring of the headquarters as described in paragraphs 4.04 to 4.07, in line with the new strategic orientations. He is also decentralizing operational decision-making authority to the regional offices in a gradual manner and introducing more efficient and client-oriented business practices and processes. New policies are also designed to shift BNA's own culture towards a more consistent emphasis on the management of operations and risks. Furthermore, he is developing a strong training program in line with BNA's new policies. There are clear indications that the new President is determined to set the institution on a sound financial footing and to improve  - 11 - significantly its effectiveness as a multi-purpose commercial bank. BNA's top management is experienced and competent. Staffing 4.10 While on December 31, 1987, BNA's total staff numbered 2,136, seven years later at the end of 1994, it totalled 2,981 persons, an increase of 40%. During the period 1989-1992, the staff increased at a faster rate than in preceding years, mainly because of the merger of BNT and BNDA into BNA in 1989. However, to contain costs, the number of staff hired every year is decreasing since 1992 (from 185 new positions in 1992 to 145 in 1993 and 129 in 1994). Priority for recruitment is given to functions understaffed. 4.11 Between 1987 and 1993, the proportion of staff in management positions has increased from 6 to 8.7%, while the proportion of professionals has risen significantly from 18 to 31 %. During the same period the proportion of support staff has declined from 76 to 60% of total staff. 4.12 In 1987, there was an almost equal number of staff at headquarters and in field offices. Every year thereafter, the proportion of field staff has increased and, at the end of 1994, 1,315 staff members (44% of the total) were working at headquarters while 1,666 (56%) were operating in field offices (regional offices and branch offices). This reflects BNA policy to strengthen its branch network through opening new offices. Forty-six new branches were opened in the last five years. 4.13 At the end of 1994, BNA's staff included 2,236 men (about 75% of the total) and 745 women (25%). In 1994, 80 women were hired out of the 129 new recruitments done. In 1987, the proportion of women in BNA's staff was about 21 %. While the proportion of women in support staff positions rose by 3 % (from 26 to 29%) between 1987 and 1994, the proportion of women in management positions rose from 6 to 10%, and that of women in the professional category increased 2.5 times to reach 22% of BNA's staff in that category. This indicates that BNA is implementing a more equal rights policy in its personnel recruitment and promotions. 4.14 Because of the nature of its operations as a universal bank, BNA employs specialists in various areas, e.g. financial analysts (211), economists (198), agronomists (24), and personnel specialists (8). In terms of level of education, 772 staff members have bachelor's degrees, 542 have a master's degree or a doctorate. Staff training 4.15 BNA's staff training activities in recent years are summarized in Table 2: Table 2: BNA Training Activities BNA Staff Trained Average Total Trainin Training Days Year Staff Days(j per Staff Trained 1989 2,294 889 39.0 1990 2,382 475 20.0 2,596 5.5 1991 2,522 947 37.5 3,520 3.7 1992 2,707 695 25.7 2,196 3.1 1993 2,852 1,363 47.8 7,307 5.4 1994 2,981 1,174 39.4 5,556 4.7  - 12 - 4.16 In recent years, BNA's training activities have fluctuated widely. The percentage of staff that received training in any given year exceeded 40% only once, in 1993; 40% is usually considered the desirable fraction to keep staff abreast of rapid changes in their professional fields. In summary, it appears that, until recently, although some attempt was made to develop training activities on a systematic basis by the preparation of a five-year training plan, BNA, in the past, did not actually give the training function the significance that it deserves (Annex 2). 4.17 Fortunately, this situation is in the process of changing as BNA's new management has clearly indicated that it gives a high priority to staff training. Much needs to be done to compensate for past deficiencies. In particular, the following actions are being taken: (a) BNA is defining the function of "trainer"; (b) BNA has prepared a four-year training plan as part of its action plan (para. 4.18 (f)), taking into account BNA's most urgent needs, and expected needs deriving from its new activities. BNA Institutional and Financial Development Plan 4. 18 From its broad institutional vision (para. 4.09) and strategic statement updated in September 1993 (a strong multilevel planning process will be formulated under the project, see paras. 5.12 b and 6.08 a), BNA's management had developed an action plan for 1994-1996 and has started its implementation. This action plan was extended to 1997 in December 1994 and updated in February 1995, and will be revised semi-annually. It is composed of measures addressing: financial restructuring, financial profitability, credit policies and institutional strengthening including training. The plan contains: (a) a development plan which integrates credit policies and all operational, financial and staffing aspects of BNA's activities; (b) the design of a strategic information system; (c) the implementation of a new accounting system that responds better to changing needs; (d) the implementation of an information system that will make it possible for management to monitor more effectively BNA's activities and risks; (e) the strengthening of the internal audit function and management control; (f) the strengthening of the capabilities of the training center and the preparation of a training program that responds to the strategic needs of the institution; (g) the implementation of a new recruitment policy based on BNA's projected staffing needs; and (h) the progressive decentralization of operations to a modernized branch network and its extension to geographic areas having a strategic and commercial interest. The BNA's Action Plan (updated to 1997 and with 1994 actuals) is presented in Annex 3. It includes financial and development impact indicators and intermediate indicators that will be used, during project implementation, to monitor the financial and managerial performance of BNA. BNA's Action Plan for the period 1995-1997 was adopted by its Board of Directors on February 28, 1995.  - 13 - B. Agricultural Lending Operations BNA's Share in Agricultural Credit 4.19 Although a multi-sectoral bank, the BNA is providing most of total banking investment rural credit in Tunisia (Table 11). Other commercial banks lend to agro-processors, a few large farmers and enterprises. BNA is the only bank servicing smaliholders, hence the focus on BNA in this project. C. Financial Situation and Performance 4.20 Financial Condition. BNA is the largest bank in Tunisia in terms of total resources (TD 2,962 million at the end of 1994), branch network (140 branches at the end of 1994), and lending to the economy and deposit/savings mobilization, which represent respectively about 31 % and 19% of total lending and total deposit mobilization by the banking sector in Tunisia. It is also the largest lender to the agricultural sector. BNA's commercial and industrial activities represented 73% of total operations and agricultural activities, including GOT operations, 27% end 1993. BNA's summary balance sheets for the period 1988-1994 are presented in Table 13. 4.21 Over the period 1989-1993, the total balance sheet has grown from TD 1,947 million to TD 3,129 (3,043 after deducting credit risk provisions from risk assets) on an average annual increase of about 12%. With respect to the use of resources, the relative importance of loans granted by BNA own resources has grown over the same period from 45% to 60%; while the GOT funded loans (special resources) remained at the 15% level. With respect to sources of funds, the financial structure (before recapitalization in 1994 to meet new prudential regulations on capital adequacy) remains weak due to a restated net worth as of 1992 to take account of provision shortfalls (para.4.22), and to a heavy reliance on short-term borrowing. BNA Action Plan for 1995-1997 is addressing this (Annex 3). 4.22 Overall Operating Results and Profitability. Table 14 shows BNA's audited income statements for 1988-1993 and 1994 results. The surplus earned by BNA on its commercial and industrial operations have, in the past, covered the losses on agricultural operations (Table 4) but left little room to build up larger provisions for credit risks. With the adoption of the new prudential regulations, the shortfall of provisions for restated credit risks is TD 201 million in 1994, down from TD 238 million in 1993 and from TD 249 million in 1992, out of which two clients (ONH and OC) counted for about 70% in 1992 and 1993. This shortfall is estimated to decrease to TD 180 million in 1995. As agreed with the international external auditors (and BCT), there is a five to six-year transition period to fully reflect this shortfall in operating results (Table 5). Profitability is therefore calculated accordingly. Should provision shortfalls be incorporated immediately without transition period, BNA would show no earnings from 1992 to 1997 or 1998. 4.23 Loan Portfolio Quality. Asset class four (high risk of loss) represented 10% of BNA's classified portfolio (nonperforming loans of ex-BNDA) in 1992 and 1993. ONH and OC (class two, and solutions are under way to reduce exposure--para. 4.27 (v)) represented 40%. BNA's financial results have been affected by: (i) financing an expanding portfolio, which more than doubled from 1988 to 1993, through short- term borrowing at high money market rates thereby increasing its average financial costs from 4.4% in 1988 to 7.9% in 1992 while average revenues increased only from 7.8% to 10.1 % over the same period; (ii) financing shortfalls in GOT budgetary resources, amounting to 56 MD at the end of 1993, for GOT credit lines without arrangements for compensation at the time (estimated interest at TD 6 million for 1993 and accumulated, since 1988, for over TD 25 million); and (iii) financing frozen assets in the form of arrears amounting to TD 395 million. Collection perfornance is poor, in particular on GOT credit schemes for which BNA does not assume the risk, and has deteriorated the past years. An analysis of the 1992 classified assets (adequate provisions are required for about 73% of risk assets in class two, three and four) led BNA, in 1993, to take strong remedial measures (see paras 4.27 and 6.10), to avoid further erosion of capital at BNA, and  - 14 - to rebuild credit discipline. The table below summarizes (at the end of 1992) the arrears situation in relation to lending activities: Table 3: Breakdown of BNA & GOT Lending and Arrears (1992) (TD million) Source of Funds Agriculture Commerce and Industnr Total BNA Risk GOT Risk BNA own resources 94 159 253 253 - Budgetary funds 123 5 128 - 128 External loans 14 14 -_14 Total arrears 231 164 395 253 142 BNA own resources 184 1,443 1,628 1,628 - Budgetary funds 271 116 519 - 519 External loans 132 132 100 32 Total lending 587 1,559 2,279 1,728 551 % of arrears to lending 39' 10.5 18 /a Arrears to loans ratio was 33% for BNA's agricultural portfolio at BNA's risk. On GOT risk schemes, the arrears/loans ratio was 45 %. Total arrears/total loans ratio for BNA was 15% in 1992. Trends on arrears in 1993 and 1994 are aggravated by a severe drought in 1993-94 (Tables 20 and 22). Financial Situation of Agricultural Activities 4.24 BNA's own resources were used principally to finance short-term loans; these credits are recovered at 90% on average. Medium- and long-term loans were principally financed with resources provided by GOT or obtained through external loans. The average recovery on these programs was below 50% on GOT programs and about 75% on external loans. 4.25 Agricultural arrears situation. The recovery rate"0 of agricultural loans, BNA and GOT operations combined, has declined from 79% in 1988 to 70% in 1994 (Tables 20 and 22). The total recovery rate on BNA loans, for which it assumes approval and full risk, was 90 % in 1988 and dropped to 83 % in 1994. In comparison, the recovery rate on GOT operations and external loans combined was 60% in 1988 and only 46% in 1994. Adverse climatic conditions explain the unsatisfactory results in certain years (1988-89 and 1993- 94), but even under normal climatic conditions the overall recovery performance is poor. In addition to drought and debt rescheduling, weak loan management of the various credit lines--combined to the transfer to BNT/BNA of the non-performing portfolio of the ex-BNDA representing 30% of current agricultural arrears--have contributed to poor repayment performance. As of December 31, 1993, total arrears in agriculture are TD 253 million. Aging (GOT and BNA combined) is as follows: 30% of arrears are less than 2 years; 48% are more than 2 years but less than 5 years; and 22% more than 5 years. 4.26 Financial Results. The consolidated results of the agricultural operations of BNA and the GOT are summarized in Table 4 (see also Tables 13 and 14 for BNA). IS Recovery rate at BNA is currently calculated on total collection at the end of the year on principal, after payment of interest due. In the future, BNA will also calculate rates on arrears collection and on current collection, interest plus principal. On short-term loans, interests due are prepaid at the time loans are disbursed.  - 15 - Table 4: BNA & GOT Agricultural Operations Financial Summary (TD '000) 1989 1990 1991 1992 1993 Expenditures financial 20,181 21,089 26,967 31,161 33,642 operating 10,272 10,382 10,723 12,311 12,100 other 3,686 3,271 389 584 50 TOTAL 34,139 34,742 38,079 44,056 45,792 Income interest & commissions 27,692 22,610 24,839 33,154 31,110 other 53 42 91 211 - loss 6,394 11,990 13,149 10,691 14,682- TOTAL 34,139 34,642 38,079 44,056 45,792 /a The ex-BNDA portfolio, taken over after the merger with BNT in 1989, led to a loss of TD 6 million in 1993 Besides the low recovery rate on GOT operations, there are other factors which have so far contributed to the negative profitability of the agricultural credit system. On the income side the revenues grew slowly because of delayed adjustments in interest rate (drought, see para. 3.18) and the insufficient commission paid by the GOT to BNA for administering its budgetary operations (1 .5% on the average outstanding balance while costs are at 2%--this 0.5% represents for 1992 and 1993 an annual loss of income of TD 1.4 million). On the expenditure side there are TD 6.4 million additional financial costs (interest expenses at MMR) for advances made by BNA on shortfalls of GOT budgetary resources. The BNA advances on GOT operations amounted to TD 55.9 million (plus interest due) at the end of 1993. These problems are being addressed by GOT and BNA but to restore profitability, a better level of debt collection must also be attained (paras. 6-10 and 6-11). BNA's Organizational and Financial Reform Achievements and Key Remaining Issues 4.27 To reverse past trends, BNA's management has started to take measures to strengthen its internal organization (para. 4.04) and to restructure its finances. With regard to the latter: (i) BNA's Board has decided to double its capital by two successive increases, one in March 1994, and one in December 1994; (ii) as decided by BCT for all banks, in mid-1992 BNA increased its interest rate on priority agricultural activities to 10% (lending to large farmers was already at MMR + 3% and are free since June 1994) and with the MMR dropping to 8.8% in November 1993 from 11 % the average cost of money is also decreasing; (iii) BNA borrowed US $60 million long-term from the ADB at 8.5% and is in the process of issuing long term bonds at 7.5% on the national market in order to reduce its dependency on short-term borrowing; (iv) BNA has prepared a recovery plan for both BNA and GOT arrears in March 1993 and implementation has started; and (v) GOT has taken important steps, first, to disengage itself from credit operations (paras. 3.19 and 3.20) thereby ending the confusion created between credit (reimbursable) and income transfers to farmers (government grants), second, to consolidate the amounts due from the phased out GOT credit lines in the form of a quasi- capital transfer (TD133 million), third, by deciding on March 24, 1995 to fully repay to BNA by end 1998 past advances made by BNA for past GOT credit operations (balance due of TD 54 million as of December 31, 1994, principal and interests); and fourth, by reducing BNA's overdraft exposure to large public enterprises as already done in 1994 for the National Olive Oil Board (ONH). Similar measures are expected to reduce BNA's exposure to the National Cereals Board (OC) and the Chemical Group (Groupe chimique) by June 30, 1996. 4.28 This package of measures and the agreements mentioned in para. 3.22 will strengthen BNA financially in the immediate future, and further adjustments may be needed once the results of the recovery plan are known; but in the next two years, one crucial factor to transform BNA into a strong autonomous financial organization  - 16 - will be to what extent BNA can ensure a level of collection over 95%. The proposed project, which arrives at this opportune and critical time when fundamental reforms to restructure the agricultural credit system are taking place, would strongly support the rehabilitation of BNA and GOT's objectives to create a more friendly environment for the banking system to serve all segments of the farm population, including small farmers. D. BNA's Projected Financial Situation 4.29 BNA's projected balance sheets and income statements, with key assumptions"l for the period 1995-1998 are presented in Tables 16 to 18. They have been prepared on the basis of the objectives established by BNA's management, as expressed in the institution's strategic plan. BNA's projected financial indicators, based on a low-case scenario (see assumptions in Table 16), are presented in the table below: Table 5: BNA's Projected Financial Indicators 1995-1998 1993 1994 1995 1996 1997 1998 -----------Actual-------- ------Projected------------- Net Worth / Total Assets ( Avg )( % ) n.c'- 3.2 4.0 6.0 6.9 8.0 P're-Tax Return on Equity ( Avg)( % ) 9.9 10.2 11.0 12.6 13.8 14.9 Net Return on Equity ( Avg ) ( % ) 8.2 8.2 8.6 9.3 10.0 10.6 Capital Adequacy Ratio ( % ) -5.0 3.7 4.3 6.4 7.2 8.1 Liquid Assets / Deposits ( %) 22 25 24 23 22 21 Total Deposits / Total Liabilities ( % ) 31 33 32 32 32 32 Loans / Deposits 2.04 1.97 2.00 1.98 1.95 1.89 Provisions as % of Classified Assets 3.8 4.5 4.9 5.7 6.5 7.4 Provisions ShortfaUs ( TD million ) 238 201 180 114 80 38"' Gross Financial Margin 19.1 25.2 28 33.2 36.6 39.5 Net Financial Intermediation Margin 2.9 3.0 3.4 3.8 4.1 4.4 /a n.c. not calculated. 1993 actuals are audited and 1994 unaudited. Net worth used is after deducting provision shortfalls. /h And no shortfall as of 1999. Provision shortfalls reflect the adoption of new prudential regulations calling for a transition period for full implementation by all Tunisian banks. The provision shortfalls will have a gradual impact on BNA's income statements. The above data show that BNA's financial situation is expected to improve significantly in coming years as a result of the measures already taken and in the process of being taken by GOT (paras. 3.22 and 4.27 (v)) and BNA (para 4.27 (i)). BNA's management has also taken measures to improve the quality of its portfolio by applying stricter lending criteria and provisioning rules. In full compliance with BCT's new prudential regulations, BNA's capital adequacy (Cooke ratio) which was negative in 1993 (-5%) improved to 2% in March 1994 (audited) and, with the strengthening of BNA internal organization and financial structure, is expected to reach 5% as of June 30, 1996. BNA management's objective is to reach about 8% in 1998. Liquidity, defined as the ratio of loans (including overdrafts) to deposits would improve to a more acceptable level by 1998. Net financial intermediation margin (see definition in para. 6.08(c) footnote), is expected to be maintained above a minimum acceptable of 2%. BNA's financial indicators, in particular the liquidity, profitability, and capital adequacy ratio as well as collection rates and financial intermediation margin will have to be closely monitored during Project implementation and the mid-term review in order for BNA to prevent or correct any deteriorating trends. Estimates have been revised after negotiations in the light of decisions on (i) the settlement of BNA advances to GOT; (ii) implementation of the GOT's law on the TD 133 million quasi-capital transfer; and (iii) projected settlement of OC and Chemnical Group overdrafts to reduce risk exposure by end June 1996.  - 17 - V. THE PROJECT A. Rationale for Bank Involvement and Project Objectives 5.01 Rationale for Bank Involvement. The Bank's involvement in the rural financial sector of Tunisia will be integral to the Country Assistance Strategy (CAS) articulated in April 1993 by supporting government efforts to develop the rural private sector and to alleviate rural poverty. Within this framework, the strengthening of the rural financial sector plays a leading role. The financing of agriculture, where smallholders predominate and are geographically scattered, is a risky business. Bank involvement through the proposed project would help Tunisia in: (i.) broadening and improving the accessibility of agricultural credit by developing the sustainable foundations of a sound rural finance system well-integrated into an increasingly liberalized financial sector; (ii.) promoting the financial viability of rural lending by separating normal credit risk from climatic risk and from income transfers; and (iii.) strengthening the operational capacity of the lead bank for agriculture, the BNA. The proposed project is thus a key complement to the on-going macro and financial reforms to transform Tunisia into a market driven, private sector economy. 5.02 Main Focus of the Project and Actions already taken. The project is focussing on key institutional changes at the level of the BNA and the GOT. At the level of the BNA, the focus is on an action plan with measures needed to improve credit risk management and collection performance so as to develop a financially viable bank and sound agricultural portfolio, and to reorganize the bank (Annex 3). These actions and measures are consistent with a general action plan of financial sector restructuring within the EFRSL. At the level of the GOT, upfront actions have been taken on (i) restructuring and phasing out 44 GOT funded credit lines and on the role of BNA for managing at GOT's risk the four remaining GOT lines (para.3.22); and (ii) modifying the FNG to protect credit beneficiaries against drought (para. 3.23). 5.03 Project Objectives: Institutional and Development Agenda. Consistent with the Government's priorities, the primary objectives of the project are to assist Tunisia in promoting creditworthy private investment in rural areas and in strengthening, on a sustainable basis, the financial viability and institutional reform process of BNA in order to improve its development impact on the country's rural sector. Specifically, the project would assist in the following: (a) supporting the implementation of a sound action plan to recapitalize BNA, deal with the arrears problem, and improve BNA's overall profitability; (b) developing an effective strategic planning process, decentralized organizational plan and internal controls for BNA to implement improved lending policies, risk analysis and client selection. provide credit to all creditworthy farmers (including small farmers), and expand financial intermediation (credit and savings) in rural areas; and (c) developing a pilot program for the establishment of group lending schemes at village level. B. Summary Project Description 5.04 The proposed project would support the following activities over a four-year implementation period (1995-1999). (a) BNA's Credit Program: (i) on-farm processing and marketing investments by creditworthy farmers (small, medium and large, including women farmers), cooperatives and enterprises in crops and livestock; (ii) fisheries; iii) other rural investments (farm and off-farm), including for rural services enterprises and rural women's activities; and (iv) rural housing; (b) BNA's Institutional Development: (i) implementation of a strong strategic and organizational plan that aims at strengthening BNA's strategic process, organization structure, its management effectiveness by improving its management tools such as the information systems, and facilitating the effective decentralization of its operations. This would result into more efficient banking functions; the strengthening of BNA's branch offices for intensification of rural outreach, loan management for improved identification, supervision and recovery of loans and  - 18 - agricultural staff training for effective rural outreach and loan management; (ii) implementation of an action plan to absorb BNA's arrears and strengthen its financial situation; and (iii) improvement of the transparency of its resources and activities by separating GOT-funded credit lines from its regular operations and by establishing a cost accounting system for its branch network; and (c) Informal Rural Finance and Group Lending Schemes: developing and carrying out with BNA-GOT, by March 31, 1996, a study to assess the feasibility of group lending at village level, covering two parts: (i) informal rural markets and the operation of group lending to better understand its riskiness, terms, conditions and recovery; and (ii) the institutional framework (legal and regulatory) to better understand how best to promote mutual guarantee credit groups and credit unions at the village level. By joining together, smallholders can reduce costs of borrowing, keep collection rates high and improve access to credit. Based on study recommendations, pilot implementation would start by November 1, 1996. C. Detailed Features BNA Credit Program 5.05 Investment Lending to small and medium private farmers. This component will finance all types of productive agricultural investments for a broad range of small-and medium-size farms. Medium- and long-term lending, either for a single operation or a combination of operations, would be in response to market demand, which is expected to include a broad spectrum of investments in irrigation development, livestock sheds, cattle, sheep, forestry and forage development, agricultural mechanization, tree crop plantations and water and soil conservation works. Small and medium farmers would be defined as those who propose to carry out a category "A" or "B" investment under the investment code. Their pre-investment net return would generally be not more than TD 3,600, based on 1993 prices. The number of beneficiaries is expected to be about 23,200, of which 9,400 under the supervised credit program (para. 3.20). The average unit cost per single operation would vary from TD 5,000 to TD 10,000 and up to TD 20,000 per integrated or combined operation. 5.06 Investment Lending to Large Farmers. This component would provide medium- and long- term credit for all types of productions investments in response to market demand for commercial farmers defined as those who propose to carry out a category "C" investment under the investment code. Their pre- investment net farm return exceeds TD 3,600 based on 1993 prices. The expected investments include on-farm silos in addition to others cited in para. 5.05. The number of beneficiaries is estimated at 2,715. The average unit cost per single operation would vary from TD 15,000 to 40,000 and for the integrated or combined operations from TD 20,000 to TD 50,000. 5.07 Investment Lending to Fishermen. Lending to fishermen will cover (a) the supply of engines, equipment and fishing gear; (b) small boats for coastal fishing; (c) aquaculture; and (d) the modernization of large boats for high-sea fishing. In view of the past poor record of loan recovery, lending under this component would be highly selective: particular attention will be given to good records of fishing performance and satisfactory recovery rates for credit decisions. The number of coastal fishermen (category "A" and "B" investment under the investment code) is expected to be 500 (of which 300 under the supervised credit program) and the number of larger fishermen 29 (category "C" investment). The average cost for coastal fishermen would vary from TD 30,000 for a single investment to TD 60,000 for a combination of investments, and for the modernization of larger and high-sea vessels and aquaculture from TD 200,000 up to TD 650,000. 5.08 Lending to Service Cooperatives and Medium-Size Enterprises. Under this component, subborrowers would mainly be service cooperatives providing on-farm and off-farm in rural areas, individual entrepreneurs and tnedium-size enterprises including agro-investors defined as those proposing to carry out an  - 19 - investment the cost of which does not exceed TD I million. Subloans would finance civil works, equipment and minimum working capital requirements of investments designed to create jobs in rural areas, provide outlets for agricultural products, develop new sub-sectors and fill unsaturated market segments in traditional subsectors, such as cereal storage, where the private sector is gradually taking over following divestiture in the public sector. Most projected investments would be for cold storage facilities, fish, vegetable and fruit (including date) processing/packaging plants for both new facilities and upgrading of existing facilities. Service cooperatives for small- and medium-size farms would aim at providing on-farm contract works (land preparation, harvesting) and marketing services for the supply of farm inputs and the commercialization of farm outputs. The number of investors under this component is estimated at 70 with an average unit cost of TD 500,000 per operation. In the cereal storage subsector the number of investors would be 60 with a per unit cost averaging TD 400,000. 5.09 Lending to Agricultural Development Enterprises. This component would provide medium- and long-term credit to agro-investors, entrepreneurs and/or medium-size enterprises, in particular those which qualify to obtain public land (e.g., long-term lease), previously poorly operated by production cooperatives or state farms. Already 45,800 ha have been leased (or sold) to 83 investors and, in accordance with land still available, an additional 81 investor-entrepreneurs will start developing some 70,000 - 90,000 ha at an average unit cost of TD 750,000 . 5.10 Lending to Artisans' and Rural Women's Enterprises. The main objective of this component is to help artisans and women closely linked to rural activities to start and develop their own entrepreneurial activities in handicraft, cottage industries and other productive activities. This component is expected to finance about 2,500 beneficiaries at an average unit cost of TD 4,000, and would represent 2.4% of total investment under the project. 5.11 Lending for Construction of Rural Housing. The main objective of this component is to provide credit to construct, expand and rehabilitate rural dwellings for farm families, agricultural laborers, rural women, and other rural families, so as to improve their living conditions in rural areas. This small component would finance about 500 loans varying from TD 5,000 to TD 15,000, mainly for low- and medium-income rural families, and would represent about 1.2% of total investment under the project. The Indicative project lending program is summarized in Table 16, Part 3. Institutional Development 5.12 Improvement of BNA's Management Systems and Procedures, Financial Performance, Planning Process and MIS. The Project would provide for: (a) strengthening BNA's personnel management systems and facilitating the decentralization of operations and authority towards the regional offices; (b) helping BNA to formulate and implement a multilevel strategic planning process; and (c) further improving BNA's MIS and accounting and expansion of computerization. The project would finance: (i) The process of formulating a strong strategic development plan (Schnma Directeur Strategique), MIS software, data processing and office technology maintenance during a three year period at BNA's headquarters and branches; and (ii) related training needs (para. 5.13) and consulting services as necessary. 5.13 Training Program. The Project would fund training by BNA's Training Center with the assistance of consultants. The emphasis of the training program will be towards enhancing the managerial capabilities of BNA's staff in order to facilitate the decentralization of operations and the use of modern techniques in the various areas of BNA's operations. Training will also include courses in investment project appraisal and supervision, environmental planning and assessments, and portfolio management for credit staff;  - 20 - accounting for middle level and operational staff; planning, programming, MIS, management control, and communications skills for senior staff; electronic data processing for computer staff and computer users; banking services for branch managers and selected support staff; and risk management. The project would also finance small equipment, professional visits overseas for senior managers, and the recruitment of appropriate training specialists as necessary. 5.14 Technical Assistance. Technical assistance would help considerably in facilitating BNA's institutional strengthening particularly in the planning process, personnel management and the computerization of operations. The Project would finance the expertise necessary to support project implementation and training, up to a total of 30 person-months of consultants, estimated at US$ 1.0 million. Co-financing funds (CFD and KfW) will also be available. 5.15 Project's Relation to Drought Management. Although not financed under the Project as it is not part of project description, drought management is an important feature in relation to this operation, and it will have an impact on project performance by reducing risks for farmers and banks. GOT's commitment on drought risk management is spelled out in para. 6.12. D. Project Costs and Financing 5.16 Estimated Costs. The total project cost is estimated at US$420 million equivalent, including US$223 million (or about 53%) in foreign exchange and US$62 million equivalent in related taxes arid duties. Baseline estimates are expressed in March 1995 prices. The credit component is based on financial projections that take into account past lending and BNA's development objectives and strategy as well as the priorities outlined in the Eighth Development Plan. Physical contingencies are only calculated on storage and agro- processing facilities but price contingencies have been calculated for the whole lending program."2 Cost estimates are presented in Table 6: 12 Projected price increases (% p.a.): 1995 1996 1997 1998 Domestic 5 5 5 5 International 3 3 3 3  - 21 - Table 6: Breakdown of Project Costs Cost (fD or USS million)' % Foreign % Total Local Foreign Total Exchange Cost 1. Agricultural Development Enterprises 36.5 24.5 61.0 40 15 2. Small- and Medium-scale Farmers 83.0 92.0 175.0 42 irrigation 25.0 25.0 50.0 50 livestock 18.4 27.6 46.0 60 plantation 31.4 7.6 39.0 20 equipment 8.2 31.8 40.0 80 3. Large-scale Farmers 33.6 40.4 74.0 18 irrigation 10.0 10.0 20.0 50 livestock 6.4 9.6 16.0 60 plantation 12.8 3.2 16.0 20 equipment 4.4 17.6 22.0 80 4. Fishermen 6.9 16.1 23.0 5 small 4.8 11.2 16.0 70 large 2.1 4.9 7.0 70 5. Service Co-ops and Medium Enterprises 25.6 38.4 64.0 15 Cereal storage 10.4 15.6 26.0 60 Cold storage/processing 15.2 22.8 38.0 60 6. Rural Housing 3.0 2.0 5.0 40 1 7. Artisans' & Rural Women's Enterprises 5.2 4.8 10.0 48 2 8. Institutional Development 2.8 5.2 8.0 65 2 Total Project Cost 197.0 223.0 420.0 53 100 Total Base Costs 183.0 205.0 388.0 Contingencies 14.0 18.0 32.0 /a TDI = US$S 5.17 Financing Plan. Financing of the Project would be as follows: Table 7: Project Financing Plan (US$ Million) Subborrower's BNA's GOT' IBRD KIfW CFD Total All Equity olwn Contribution Loan Sources Funds 1. Agricultural Development Enterprises 15.3 18.7 3.0 15.0 4.0 5.0 61.0 2. Small- & Medium-scale Farmers 25.0 87.8 24.7 10.5 10.0 17.0 175.0 3. Large-scale Farmers 21.0 31.0 3.0 15.0 4.0 - 74.0 4. Fishermen 3.5 10.7 2.3 3.0 - 3.5 23.0 5. Service Co-ops & Medium Enterprises 15.7 21.3 1.5 19.0 3.5 3.0 64.0 6. Rural Housing 1.0 3.0 - 1.0 - - 5.0 7. Artisans' and Rural Women's Enterprises 1.0 2.5 1.0 1.0 1.0 3.5 10.0 8. Institutional Development - 2.0 - O.5 2.5 3.0 8.0 Total All Activities 82.5 177.0 35.5 65.0 25.0 35.0 420.0 X 20 42 8.5 15.5 6 8 100 /a in accordance with the 1993 Unified Investment Code.  - 22 - 5.18 The proposed Bank loan of US$65 million would finance less than 16% of the project costs and 30% of the foreign exchange requirements. The Government would guarantee repayment. It would also assume the foreign exchange risk against a fee (para. 5.20) as for any other bank in Tunisia. 5.19 The Bank loan would be for 17 years, including five years of grace, at the standard variable interest rate (plus commitment fee). Repayments of subloans not needed to service the Bank loan would be recycled by BNA for additional agricultural and rural loans. Conclusion of the CFD and KfW loan agreements would be required before June 30, 1996. 5.20 Treatment of Foreign Exchange Risk. The Republic of Tunisia would assume the foreign exchange risk on the loan based on a cost sharing arrangement with BNA. As for the PICP loans, BNA would cover exchange risk against a fee equal to "the MMR plus 0.5% and minus the Bank's standard variable interest rate". E. Procurement 5.21 Procurement arrangements under the Project are summarized in Table 8 and described in paras. 5.22 to 5.24. Table 8: Summary of Proposed Procurement Arrangements (US$ million equivalent)/ Procurement Method Total Cost ICB LCB Other,' NBF' 1. Farm Machinery, farm and non-farm equipment and implements, livestock, fishing gear, civil works and working - - 412.0 - 412.0 capital under subloans' (64.5) (64.5) 2. Consultants /d - - 0.2 0.8 1.0 (0.2) (0.2) 3. Software, computer maintenance, - - 0.3 0.7 1.0 training programs (0.3) (0.3) 4. Data processing - - - 6.0 6.0 TOTAL - - 412.5 7.5 420.0 (65.0) (65.0) /a Figures in parentheses represent Bank loan financing; /b See aras. 5.22, 5.23 & 5.24; /c NBF: Non Bank-financed; financed by KtW, CFD and BNA; /d Includes training specialists; /e jointly fnanced with KfW, CFD, BNA and beneficiaries (see para. 5. 17). 5.22 The goods to be financed by BNA credits to farmers, cooperatives and fishermen are not suitable for bulk procurement because of their variety, the small size of individual investments and the wide dispersion of contracts both in location and time (paras. 5.05 to 5.11). Since there are sufficient suppliers ensuring competition, machinery and equipment would be bought by the subborrowers through established commercial channels, acceptable to the Bank, from both local and foreign firms operating in Tunisia. Agroindustrial investors will use, under BNA supervision, competitive procurement procedures from eligible private sources, i.e , obtain quotations from eligible competing companies and make their choice based on quality, know-how, price and after sale service. This procedure worked satisfactorily under previous projects; competition is keen and prices competitive. 5.23 Consultants. Consultants and training specialists totalling 10 person-months (US$200,000) would be appointed in accordance with Bank Guidelines for the Use of Consultants of August 1981.  - 23 - 5.24 Other Procedures. MIS software, computer maintenance, and goods for training programs (US$300,000) would be procured through national shopping involving quotations from at least three suppliers, in accordance with Bank Guidelines for Procurement of January 1995. With a maximum value of a contract of US$100,000, these procedures are appropriate for the specialized nature of the goods and services involved. Review of the procurement made under the project will be carried out as part of the supervision by the Bank. F. Disbursements 5.25 Disbursement Schedule. The proposed Bank Loan of US$65 million would be disbursed over a period of five Bank fiscal years (1995-1999). Previous agricultural credit projects in Tunisia were also disbursed in about four to five years. A schedule of estimated disbursements under the proposed Bank Loan is summarized below and detailed in Table 23. Table 9: Estimated Disbursements Bank FY 1995 1996 1997 1998 1999 Annual 5 16 16 16 12 Cumulative 5 21 37 53 65 5.26 Disbursement Procedures. As the actual financing of subloans would be demand driven, the allocation categories are only indicative for financial planning and cofinancing allocations. With this provision, disbursement categories and the share of expenditures to be financed would be as shown in Table 10: Table 10: Disbursement Procedures Category Amount of the Loan Allocated % of Expenditures (US$ Million) to be financed I. Subloans to Agricultural Development Enterprises 15.0 50% of amounts paid by BNA 2. Subloans to Small- & Medium-size farmers 10.5 50% of amounts paid by BNA 3. Subloans to Large Farmers 15.0 50% of amounts paid by BNA 4. Subloans to Fishermen 3.0 50% of amounts paid by BNA 5. Subloans to Service Co-ops and Medium-Size 19.0 50% of amounts paid by BNA Enterprises 6. Subloans for Rural Housing 1.0 60% of amounts paid by BNA 7. Subloans to Artisans' & Women's Enterprises 1.0 60% of amounts paid by BNA 8. Goods and Computer Services 0.3 100% of foreign expenditures and 80% of local expenditures 9. Training and Consultants 0.2 100% of total expenditures Total: 65.0 5.27 Bank Approvals of BNA subloans. Subloans to agro-processing and fishery investors and to agricultural development enterprises above US$1 Million equivalent (TDI Million) would require Bank approval before financing. 5.28 The Revolving Fund. To facilitate the efficient and timely implementation of the project, the Bank would authorize a maximum allocation of US$6.5 million (about four months' estimated disbursements by BNA) to set up a revolving fund in accordance with Bank guidelines. After loan effectiveness and at BNA's request, an initial deposit of up to US$6.5 million would be made in US$ dollars into a special account at BNA  - 24 - to finance eligible subloans and expenditures. BNA would normally request replenishment by the Bank when 33% or preferably 50% of the revolving fund has been disbursed to replenish the special account up to the maximum authorized allocation of US$6.5 million. The minimum size of replenishment applications would be US$500,000. Any ineligible payments made by BNA out of the special account must be reimbursed promptly to the account, or if the Bank so requests, refunded to the Bank. Any amount outstanding in the special account at loan closure not required to cover further payments for eligible subloans and expenditures would be refunded to the Bank. 5.29 Statements of Expenditures (SOEs) and Retroactive Financing. All disbursements would be against certified SOEs except for subloans above TDI Million (para. 5.27). The minimum size of withdrawal applications would be US$200,000. Full Documentation for SOEs would be retained by BNA for review by Bank supervision missions and would be reviewed and checked by the external auditors (para. 6.16). To ease the prompt execution of the project, Retroactive financing up to US$6.5 million (10% of loan amount) is recommended for payments made for eligible subloans approved by BNA after January 1, 1995 (signing date is expected by end May 1995). Retroactive financing will help BNA by permitting some contracting for eligible subloans during the FY95 agricultural season. The loan closing date is expected September 30, 1999. VI. PROJECT IMPLEMENTATION 6.01 BNA will be responsible for the implementation of the project, and the GOT will provide its full support to BNA and be accountable for maintaining operational the drought risk coverage mechanism of the Fonds National de Garantie--FNG; and for launching the study on informal rural finance and on group lending. BNA is in the process of delegating an increasing amount of decision-making authority to the regions and giving greater autonomy to the regional and branch offices. The goal is to make regional and local managers more responsible for operational decisions. BNA will assume the full credit risk on subloans. A. Credit Operations 6.02 Credit Risk Management. In response to its greater responsibility for managing risk in agriculture, BNA has begun to develop credit risk management by implementing improved credit policies, client selection, procedures, and supervision and collection capabilities. These continued efforts are part of BNA's strategic statement (para.4.09) and action plan for 1994-1997 (Annex 3). These policies are acceptable to the Bank. Under the project, BNA will assume 100% of the credit risk on subloans. Climatic risk will be handled separately (FNG). Lending Procedures and Terms 6.03 Credit Guidelines. Purpose of BNA subloans, subloan size and terms, interest and spreads, sub-borrower's contribution, appraisal and approval methods, delegation of loan approval, credit limits, disbursement and supervision of subloans, and collateral and measures to increase loan collections are contained in a BNA manual of procedures used by BNA's branch network staff. Details are in Annex 7. 6.04 Manual of Procedures. To address credit policy issues in response to changes in the Tunisian financial system and market (chap. ITI), BNA needs to recast its manual of procedures to reflect evolving conditions and BNA strategy. BNA action plan includes the distribution in 1995 to all credit officers, of revised directives for loan approval and supervision, together with the prevailing BNA's terms and conditions. BNA is reviewing, in consultation with the Bank the upgrading of existing procedures as well as the writing of new procedures. The manual will regroup all operating guidelines specifying lending terms and conditions, including subloan size, subborrower contribution, collateral requirements, repayment terms, current interest rates to be applied, and procedures to appraise, approve, disburse, supervise and recover subloans. This manual will have to evolve as the reforms proposed under the project take place.  - 25 - 6.05 Subborrowers Eligibility. Only subprojects in agriculture, agriculture-cum-processing, rural and cooperative enterprises, fisheries wherein the potential for increased production or increased efficiency in related marketing and processing are clearly established will be eligible for project financing. Rural housing, artisans and rural women's enterprises are also eligible. Subloan appraisal and approval would be the responsibility of BNA. Where useful and practicable, BNA would also rely on the advice and existing expertise of the Ministry of Agriculture staff to firm up the appraisal of the technical aspects of investments proposed by farmers. The initiative for these periodic consultations between BNA and MOA would come either from BNA headquarters and field staff, or from the MOA. B. Women's Participation and Environmental Aspects 6.06 Women's Participation in Credit Activities. The banking system in Tunisia lends to women without prejudice provided it can recover its money, and employs women on an equal footing with men. Traditional family attitudes in rural areas, however, are still a strong limiting factor for women's access to credit. Under the project, action to promote rural savings tied to credit eligibility is an area where efforts would be made to help the very few existing women farm holders. Women seem to be most active in livestock and vegetable activities and off-farm activities where they can take some lead in the family. The line of credit will be open to both men and women in all categories of eligible activities. The study on informal group lending will include measures to develop credit/savings pilot actions for women. 6.07 Environmental Aspects. Regulations for environmental protection exist in Tunisia and are well-supported by GOT in the area of water and soil conservation. For agro-industries to be financed under the Project, there are no special environment concerns given (a) the nature of the products to be processed (mainly fruits and vegetables where use of agro-chemicals is not significant), and (b) the minimum amount of water to be used in the processing so that there is no water pollution problem. Subloan proposals, however, will include an environmental analysis satisfactory to BNA in accordance with the requirements of the National Agency for the Protection of the Environment (ANPE) as needed. The scope and detail of this analysis would be appropriate to the size and nature of the investment proposed. For livestock, there are no major environment concerns either, since animal health services are being improved by encouraging veterinarians to enter private practice. With regard to herbicides only 20% of farmers apply weed-killers; most smallholders have their fields hand weeded using family labor as weeds have value as animal feed. Pesticide imports, transport, storage and use are well-controlled and pose no problem. On fisheries, subloans will not encourage the expansion of new activities, but the consolidation of the existing ones so as not to increase excessively the fishing efforts in the Gulf of Gabes which has limited resources. The state of exploitation of the Gulf will be monitored by BNA in cooperation with the Tunisian Fisheries Research Institute. C. Institutional Development 6.08 BNA Institutional Strengthening and Financial Performance. The following set of actions and measures have been taken and others would be taken under the Project to make it possible for BNA to become a financially sounder and stronger institution. (al Implementation of Strategic Plan. To enhance its performance, BNA will have to carry out improvements in several aspects of its evolving policies and operations. Because of the multiplicity of actions, BNA needs to formulate, by December 31, 1995, a strong multilevel strategic planning process (sche'ma directeur strat6gique), with a view to improving strategic and tactical plans, and translating more efficiently goals, strategies and tasks into financial and operating targets (systeme de pilotage de management). This will make it possible for BNA, by December 31, 1996, to better implement changes within its vision of the future of the bank in a gradually open market (Annex 3 pages 49,53,54).  - 26 - (b) Decentralization of Operations. BNA's operations are still too centralized. Most regional directorates and local branches must refer to headquarters for a large number of operational decisions such as small overdraft of commercial credits or agreements with clients on payment of past due loan amounts. BNA has started to delegate an increasing amount of decision making authority to the regions; because of the cost involved and the staff qualifications required to succeed in this effort, it is proceeding with great care. Without immediately increasing the number of decentralized regional offices, BNA will give greater autonomy to the regional and to the local branch offices in order to responsibilize their managers, speed up decision making in the field, and improve the quality of service to customers. Accordingly, a decentralized cost accounting system to determine results per sector and regional/local branch has been initiated and would be made operational as of June 30, 1996. Within that context, headquarters will increasingly play a role of a posteriori control. (c) Financial Performance. BNA has provided with its adopted action plan for 1995-97, a financial performance development letter, satisfactory to the Bank, with monitorable indicators aiming at maintaining minimum standards of financial performance. On the basis of these indicators and those summarized in Table 5, BNA is expected to achieve the following financial results: (i) BNA's capital adequacy as measured by the ratio of equity to risk-weighted assets increased to 3,7% end December 1994, and is expected to reach 5% by June 30, 1996 (Central Bank requirement). BNA's objective is to reach a higher level of capital adequacy in 1997 and 1998. Current projections show that BNA could reach the 8% international standard by Project completion; (ii) BNA's liquidity as measured by the ratio of loans to deposits would be reduced from above 2.0 in 1994 to a more acceptable international standard of about 1.8 in 1998; (iii) BNA's would maintain, annually, a pre-tax return on equity of 10% in average; (iv) BNA's gross financial margin (excess of interests received over interest paid as a percentage of interest received) is expected to increase from 25.2 in 1994 to 39.4 in 1998 which would be good. Recoveries on credit operations from 1995 onwards are expected to be not less than 90% on average. BNA would also: (v) monitor onlending interest rates and spreads on an annual basis so that they cover average financial cost, operating cost, and credit risk; and (vi) verify that its net financial intermediation margin'3 remains at no less than 2%. (d) Definition of Decision Making Authority. The functions of the main units (central directorates, directorates and divisions) are clearly defined in BNA's organization manual. The decision making authority of the managers at various sub-levels in the organization still needs to be clearly defined, and BNA has decided to remedy this weakness by end 1995. (e) Derinition of Functions. Because of its activities as a multi-purpose bank, BNA's staff works in a wide variety of operational activities such as financial and economic analysis of investment projects, accounting, commercial banking operations, data processing, personnel management, control and other functions. In 1994, neither the specific tasks nor the qualifications required from those fulfilling these various functions were defined in writing. The result is a lack of objective criteria to evaluate staff performance and difficulty determining staff training needs clearly. BNA will define in writing the tasks and qualifications required for each of the functions performed by the staff by end 1996 (project analyst, accountant, personnel officer, credit officer and others). (f) Improvement of the Data Processing System. The data processing system currently used by BNA does not correspond to its needs. It does not provide managers at different levels with the timely information required to make decisions, nor with statistics regarding some key elements of BNA's activities. Furthermore, many operational activities are still carried out 13 Interest income as a percentage of average portfolio outstanding minus interest expenses as a percentage of average borrowing outstanding and deposits.  - 27 - manually, which mobilize a considerable amount of BNA's human resources, while urgent needs, such as loan collections and contact with customers, do not receive all the attention that they deserve. BNA will devote all the resources in staff and materials needed to start developing, as of December 1995, a modern and efficient data management system. 6.09 Project-Related Training. BNA would be responsible for project-related training, and would use its own facilities, those of the training institute of APB and/or any other good facilities needed to hold seminars in Tunis or in other cities of the country. The objective is to train around 40% of about 3,000 BNA staff each year. BNA will continue using members of its staff to provide in-house training. However, to ease the task of the staff doing the training and optimize its effectiveness, BNA will create the position of "trainer". Furthermore, to stimulate the interest of qualified staff in doing this type of work, the function will be given high visibility, will be motivating and will part of a career development plan. BNA would prepare, by November 30 of each year, an annual training program. 6.10 Loan Collection Measures. (a) Agriculture: as part of its strategy to improve loan collection, BNA's management has established in 1993, a special unit (in DCRA--see Chart) to develop and implement a recovery program. Its task is to reduce/clean, by the end of 1996, accumulated arrears (TD 213 million as of end 1992 plus TD 20 million under legal process) through collections, rescheduling, legal process and write- offs. BNA has carried out an analysis of its classified, subquality loans classifying individual amounts due by age, by crop, by region and BNA's branch. Based on this analysis, BNA has initiated an action program focusing, firt. on 7000 clients with debts over TD 10,000 who represent 60% of the portfolio affected by arrears. The non-performing portfolio of the ex-BNDA, with 100 clients represents half of these arrears (i.e., 30% of total arrears), and amounts that fell due in 1993 and 1994 as well as amounts falling due beyond 1994 add to existing arrears, and some write-offs will be needed. Second individual debts below TD 10,000-- representing 40% of the portfolio affected by arrears--are distributed over 153,000 clients. This latter category of clients, mainly funded under budgetary resources at GOT's risk, will be tackled in cooperation with MOA's regional offices, the CRDAs; (b) Industry and Commerce: a similar recovery plan, managed by a special unit (DRCE--see Chart) has started in 1994 for the industrial and commercial arrears (TD 164 million of which TD 39 million are in arrear and TD 125 million under legal process as of December 31, 1992). The number of clients with arrears is 2,960 of which 445 represent 60% of the portfolio affected by arrears. Action is targeted to this small group of clients. Since 1992, BNA complies with BCT new prudential regulations on risk assets classification (five asset classes according to portfolio performance--see para. 3.09). 6.11 The overall supervision process of the action program on recovery of arrears and on collection policy has been entrusted to the Deputy CEO (DGA--see Chart). Improved recovery rates are essential for the bank's viability and it is a top priority of BNA's management strategy not only to modify procedures in the short run but to fundamentally change BNA's culture and attitude towards lending. Staff, throughout BNA's branch network, have been sensitized to this critical issue and asked to devote time and effort to collections. Improved collection is linked to a better selection of viable clients and more regular visits to clients. BNA's management is closely monitoring the present recovery plan which is part of its action plan 1994-1997 (Annex 3). Assumptions on recovery rates used in financial projections are in Table 16 (Part 1). 6.12 Drought Risk Management Scheme: The GOT would ensure that the Fonds National de Garantie (FNG), now operational for covering the risk of default in interest payments from creditworthy farmers afflicted by drought is suitably maintained, including in particular: (i) the application of a sustainable level of drought insurance premium rates; (ii) the maintenance of well-defined management and financial procedures; (iii) the possibility to all banks that their clients who are farmers be covered against drought risk; (iv) a determination of drought-related losses through independent assessments of the degree of climatic damage in areas directly affected by drought; and (v) the availability of technical expertise in agricultural insurance. The MOA is responsible for coordinating the selection of drought-stricken areas using the necessary expertise to assess the severity of the drought and potential losses by farmers. BNA would conduct the analysis of its delinquent credit accounts on a case by case basis through its branch network. Details on the FNG are in working file No. 25.  - 28 - D. Monitoring and Evaluation 6.13 Monitoring is and would remain an integral part of day-to-day operational management of BNA's activities at Headquarters and branch levels. Under the Loan, BNA's monitoring and evaluation unit at Headquarters will: (i) collect and consolidate the data on commitments/disbursements under subloans, physical achievements under selected components/subprojects, and results of representative investment operations, (ii) monitor and evaluate BNA's results under its Action Plan, training programs and financial performance indicators including recovery performance, and (iii) monitor progress under the proposed pilot program on drought management (FNG) and informal group lending. E. Supervision, Mid-Term Review and Reporting 6.14 Bank strategy for the supervision of project implementation and performance is spelled out in Annex 5. As part of this strategy, the Government, BNA, and the Bank will carry out a joint Mid-Term Review of the project not later than April 30, 1997. The review will be a critical event in the implementation of the Project and its purpose and contents has been agreed upon during negotiations of the Loan. Its objectives are to: (i) monitor progress on implementation performance of agreed objectives, financial indicators, measures to clean past arrears, and compliance with legal covenants; (ii) examine the FNG operations in implementing the drought risk management mechanism, and progress made on developing pilot group lending; (iii) evaluate BNA's uses and sources of funding; (iv) assess BNA's strategy and the likely development impact and sustainability of the project at mid-term of its implementation; and (v) update as necessary BNA's action plan and the project's implementation program until completion. 6.15 Reporting. BNA will provide to the Bank the following semi-annual progress reports within three months of the end of each semester; these will include commitments, disbursements, subloan maturities and actual collections by category of beneficiaries, changes in lending policies and procedures, BNA's financial results and revised financial projections, progress being achieved in the implementation of the BNA's Action Plan and the drought insurance scheme. BNA will also provide summary statements on recoveries for all BNA's agricultural credit operations using an improved methodology to report on loan collections. The end of each calendar year evaluation report will include a detailed cost accounting of BNA's agricultural/rural operations, and of other operations and branch offices. In addition, BNA will prepare its part of an Implementation Completion Report (ICR) and its updated action plan for 2000-2002, to be submitted to the Bank within six months after the closing date of the loan. F. Accounts and Audit 6.16 BNA has a reliable basic accounting system involving (a) a centralized accounting system; (b) an internal audit unit; (c) a stable work force in terms of key financial staff; (d) defined procedures; and (e) timeliness in producing annual financial statements of satisfactory quality. During project implementation, BNA will further modernize its system by developing decentralized MIS applications, in particular for detailed cost accounting purposes at branch level. BNA accounts and financial statements have been since 1992 and would continue under the Project to be audited annually by independent auditors of international caliber"4 who are acceptable to the Bank. BNA will send to the Bank, within six months of the close of each fiscal year, a full audit report which will incorporate, in one document with the auditors' opinions, a long form report on BNA's overall-financial statements including project accounts, and on procedures including compliance with BCT prudential regulations, with three specific auditors' opinions on (i) project accounts, (ii) statements of expenditures (SOEs), and (iii) the revolving fund (Special Account). In addition, the auditors will certify, each fiscal year and as of June 30, 1996, the ratio of capital adequacy reached by BNA, and will verify if BNA's declared financial objectives are reached (BNA's financial performance development letter sent to the Bank with the approved Action Plan). BNA will send audit reports to the Bank and report contents will be discussed with BNA and the auditors during Bank supervision missions. 14 A private and international audit company.  - 29 - VII. BENEFITS, JUSTIFICATION AND RISKS A. Benefits and Justification 7.01 Benefits. The ultimate beneficiaries would be a wide range of private investors and in particular the small and medium-scale farmers who could benefit from an improved rural financial system and drought risk coverage mechanism. BNA, a critical bank in Tunisia not just because of its size but because of its involvement in the strategic sector, would be strengthened at a crucial stage in its institutional development. In addition, measures complementary to the project are already helping GOT reorient its rural credit policy which, over time, would make rural financial intermediation more attractive, hence more competitive. This reoriented approach separates credit from income transfer and addresses each of the three major sources of risk in financial intermediation separately, namely credit, moral and climatic. Instead of having to deal with the three types of risks, BNA will focus on credit risk. By separating GOT and BNA accounts, the GOT has taken a first step in lending the confusion between credit and income transfer, a confusion for lender and borrower alike, which has undermined credit discipline. With the focus on credit risk, BNA would place its agricultural and rural activities on a sounder financial and operational footing and benefit from lasting improvements in recovery. An increased number of creditworthy smallholders should benefit from BNA's strengthened rural outreach. 'To address climatic risk, the project is supporting the GOT's decision to use the FNG to help both farmers and credit institutions to better manage the effects of drought. The objective here is to provide a more efficient alternative to past GOT direct interventions which contributed to poor credit discipline. The GOT also intends to further promote private agricultural insurance. Over time, rural financial intermediation will expand and become more competitive as a clear demarcation is maintained between credit and income transfer, as interest rates become more attractive, and the risk of drought is better managed. 7.02 Financial Impact on the Beneficiaries. The projected impact of the Project on Farmer's and investors income would be substantial at full development. Under the best of conditions, financial rates of returns (FRRs) vary from 20% to 32% for the twelve investment models analyzed; eight farm models, one agro- industry, one large agricultural enterprise and two fishing investments. These FRRs are, however, very sensitive to decreasing benefits or increasing costs. Annex 9 describes: in part (A), BNA's Supervised Credit Program for Small Farmers; and, in part (B), the Project Impact on the Beneficiaries. 7.03 Economic Analysis of Selected Sub-Projects. Similarly, an economic rate of return (ERR) has also been calculated for each investment model. In most models the ERRs exceed the FRRs, mainly, because of the shadow pricing of labor and, to a lesser extent, because of taxation on some inputs. The results have not been aggregated into an overall ERR for the project as a whole, because the distribution of loans among these types of investment or among variations of the models will depend on changing relative prices, attractiveness of alternative investments, land use, and market forces (Annex 9). 7.04 Justification. The strengthening, financially and operationally, of BNA, the only bank for smallholder agriculture, is an important step in GOT's agricultural credit reform program. The Bank's support for agricultural credit in Tunisia is justified at a crucial stage in BNA's institutional development and at a time when the BNA is expected to play an increasing role in promoting private investment in rural areas, and agricultural growth. This, in turn, would impact favorably on Tunisia's economic and social goals. Satisfactory results on this reform program, would set the stage for further privatization of BNA in the future (e.g., withdraw of ONH and OC from capital ownership). B. Project Risks 7.05 Risks Outside the Control of BNA. The major risks outside the control of BNA are twofold: (i) weather-related and (ii) reform-related. To address weather-related calamities, the project is supporting the GOT's decision to make the FNG operational for drought management. This scheme should provide a more efficient alternative to GOT's political decision to write off repayment on loans after droughts. New droughts,  - 30 - GOT's decision to make the FNG operational for drought management. This scheme should provide a more efficient alternative to GOT's political decision to write off repayment on loans after droughts. New droughts, however, (as in 1993-1994) could undermine BNA's recovery performance although the drought risk scheme is fully operational. The project is taking measures to help BNA in recovery and in buffering the negative financial impact. The GOT realizes that it is essential to develop a sustainable rural credit system, one of its important development objectives. 7.06 Risks Within the Control of BNA. BNA is addressing the problem of poor repayment discipline by restructuring its rural operations in the following ways: (i) improving the creditworthiness of low income borrowers by grouping them; (ii) tightening eligibility criteria on creditworthiness; (iii) linking savings and past repayment record to new loans; and (iv) strengthening rural outreach.  - 31 - Annex 1 STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT Structure of Farm Holdings and Categories of Agricultural Credit Borrowers 1. Agricultural production in Tunisia is carried out under several types of tenancy and farm size arrangements. Broadly speaking, there are three categories of farmers, small, medium, and large. The first category can be further divided into subsistence and viable small farmers. There has been a long and lively debate in Tunisia regarding the definition of these farmers, their role in production, where they are located, and how to deal with these various categories from economic, political, and social points of view. 2. The structure of agricultural holdings. MOA has been concerned with production and productivity increases as well as with reducing poverty in agriculture. It has intervened very actively in agriculture to promote technological changes. In this pursuit it has, for operational reasons, established a definition of farmers based principally on size. Farm size is an important indicator to determine farm structure and to develop a strategy for production purposes; it is not sufficiently precise, however, to determine farmers' eligibility for bank credit or their ability to repay a loan. The census data (see table below) shows farm units by size but do not distinguish between non-cultivating owners and operators; as a result that they do not highlight tenancy as a widespread production arrangement, particularly among small farmers, and they thereby overstate the number of farms in the same category. Table 1: Land Distribution and Farm Sizes Farm size Total Area Of which irrigated (ha) Number offarms % (ha) % (71a) (number of farms) I - 5 175,000 45 453,700 8 105,000 45,100 5 - 10 85,800 22 673,900 13 70,800 14,700 10 - 20 72,900 19 1079,200 20 56,900 7,200 20 - 50 37,600 10 1219,500 23 32,400 2,700 50 - 100 10,300 3 733,000 14 2,000 200 > 100 4,700 1 1204,800 22 21,600 0 TOTAL 387,100 lo 5,364,100 100 288,700 69,900 Source: Enquete Agricole de base 1989, Minist6re de I'Agriculture.  - 32 - Annex 1 3. 86% of the farm holdings have less than 20 ha; these cover about 41 % of agricultural land. Most of these holdings are operated by subsistence farmers who have difficulty sustaining a family. The larger fatms above 50 ha represent only 4% of the farmers but operate about 34% of the land. In between these two categories are the small- and medium-size farms, between 20 and 50 ha, of which a larger group is viable depending on the agro-climatic zone in which they are located. The important agro-climatic variations with rainfall, decreasing from north to south, make it possible that some farms below 20 ha in the north are viable, while an 80 ha rainfed farm in the south may not be able to sustain a family; similarly, where irrigation water is available, a two ha vegetable plot may be a viable unit, or a 7 Tha rainfed plot in a marginal zone with one irrigated ha may also be a viable unit. These large agro- climatic variations make it difficult to clearly differentiate bankable or creditworthy farmers from subsistence ones on farm size alone. 4. The 1984 population census,' updated in 1989, indicates that 120,000 heads of households consider farm activity as their principal source of income; this represents 30% of the country's total farm units. Another 40% have declared themselves as part time farmers and off-farm activity to be their principal source of income. The remaining 30% have declared a part time and limited activity in agriculture together with other activities but without specifying the principal source of income. 5. Minimum viable farm size. The Tunisians, within the framework of IFAD loans, and a Bank loan (Ln. 2865-TUN) have made attempts to clarify and define viable small farmers to determine their creditworthiness and eligibility to banking credit. The Centre National des Etudes Agricoles (CNEA) conducted farm surveys in four governorates (le Kef, Siliana, Kairouan, and Sfax) in 1982 and 1987 and MOA, with the assistance of a consulting firm (SCET-Tunisie), carried out a minimum viable farm size study in 1987.2 The surveys and study were based on farm size in both rainfed and irrigated agriculture, potential of farm development, availability and access to inputs, and income prior to and after development. The analysis indicated that farms which could generate income at about TD 3,500 annually can afford to borrow at market interest rates; such income could be reached on farms with 20 ha in the agro-climatic zone with rainfall above 600 mm, or in zones with lesser rainfall when rainfed farming is combined with irrigation. However, for farmers with incomes between TD 1200 and 3,500, it was concluded that these could be potentially viable but are high risk for the lending agency. 6. On the basis of the above census figures and the indications from the surveys and study, it is estimated that the small farmers (subsistence and potentially viable) not eligible to bank credit amount to about 267,000 and the viable or bankable farmers about 120,000 - 130,000. Obviously, considering the ambiguities of the census data, these figures should be considered as an order of magnitude which indicates that the proportion of bankable to subsistence farmer is about one to three. BNA considers that its potential market is about 100,000 farmers, figure to be reduced, after screening to about 30,000 bankable farmers. 7. The Agricultural Credit System within the Farming Structure. Different sources of funds and different channels have shaped the agricultural credit system over the last 30 years to address these broadly categorized types of farm units. GOT has been mostly concerned with assisting the small, and particularly the subsistence farmers, through different credit lines (special funds). BNA is attempting to reach all bankable types of farmers and has interpreted the income guideline as the cutoff point of credit Institut National de la Statistique, Recensement de la Population et de l'Habitat. 2 Etude de la Superficie Minimum d'Exploitation Valable, Ministere de la Production Agricole et Agro- Alimentaire. Septembre 1987.  -33 - Annex 1 eligibility, flexibly based on individual appraisal (it is worthwhile noting that its list of agricultural clients at the end of 1991 numbered 109,680). 8. With regard to the other banks, they deal principally with short-term credit and focus on larger farmers (above 50 ha in the North) and on agro-industrial and development enterprises which have good collateral, for loans where fully liberalized interest rates apply. Reasons for the other banks' concentration in this latter category is that, besides financial consideration, these farmers or units are a better risk and are accessible without a large branch network. One of the principal obstacles to a broader participation of the banking system in lending to all categories of farmers has been the need to develop a costly outreach capacity, combined with the need for an effective insurance scheme to separate the normal credit risk from the climatic risk. BNA's share of the total credit channeled through the commercial banks for 1991-1992 is 30%, and BNA financed 75% of all agricultural credit, and this includes short-term credit for cereal marketing and export prefinancing. Strengths and weaknesses of the agricultural credit system 9. Substantial progress has been made on the agricultural credit policy level by closing the gap between the regulated or preferential interest rate and the money market rate. Since November 1993, all agricultural interest rates applied by BNA are above the money market rate. In June 1994 interest rate ceilings have been removed except a few rates for priority activities. These changes are important because they now allow BNA to obtain a surplus on its agriculture operations for the first time since its initial creation in 1959 and because they contribute to a better environment to induce other banks to become more active in agriculture. 10. This change in interest rate policy is part of GOT's broader commitment to reduce its involvement in direct credit distribution. The special funds aimed at the smaller farmers which amounted to 48 lines of credit have been reduced to four. Those funds that have been retained are part of integrated action programs aimed at poverty reduction. The small farmers under the previous credit lines which have a satisfactory recovery rate will, from now on, be eligible for BNA credit at BNA risk. At the same time BNA is developing, in cooperation with MOA, supervised credit schemes whose main focus and objective is to grant credit to these potentially creditworthy small farmers. These are located principally in the North and in areas where irrigation is available. MOA's extension services assist BNA staff to appraise the technical aspect of farmers investment, under BNA responsibility. The credit risk analysis and decision is BNA's responsibility. Extension services may provide technical advice to the farmers during supervision. 11. Since 1959, the authorities have largely approached the problem of building a credit delivery system from the top down. BNA was established and emerged as the principal bank to distribute credit under GOT's guidance, and developed a branch network to reach farmers on an individual basis, but little attention has been given to developing an approach from the grassroots or from the bottom up encouraging farmers to organize or participate in the system. There is presently no efficient farm organization at the primary or village level able to deal independently as a group with the banking system. Such a development will take time but initiatives in the form of studies and surveys on how to organize group lending schemes will be developed under the proposed project. 12. Substantial changes and fundamental reforms have taken place in the approach to agricultural credit in the last few years. This project should assist in deepening the institutional reform process to develop a financially sound rural finance system well integrated into a more competitive financial sector.  I  -34- Annex 2 STAFF APPRAISAL REPORT TUNISIA NATIONAL RURAL FINANCE PROJECT BNA Staffing and Staff Training I. Staffing Total staff evolution 1. While on December 31, 1987, BNA's total staff numbered 2,136, seven years later, at the end of 1994, it totalled 2,981 persons, an increase of about 40%. During that period, the staff increased at an annual average rate of 4.7%. 2. The annual increase of BNA's staff is presented in the table below: Table 1: BNA Employee Fluctuation Number of Employees Changefrom Previous Year Year (As of 12/31) (%) 1987 2,136 1988 2,245 109 5.1 1989 2,294 49 2.2 1990 2,382 88 3.8 1991 2,522 140 5.9 1992 2,707 185 7.3 1993 2,852 145 5.4 1994 (10/31) 2,981 129 4.5 3. The staff increases that took place in 1989 and 1990 were partly related to the merger of BNT and BNDA into BNA. In recent years, particularly in 1991 and 1992, the staff increased at a higher rate than experienced during the period overall.  - 35 - Annex 2 Staffing structure 4. Table 2 presents the staffing structure of BNA for selected years between 1987 and 1994. Table 2: BNA Staff Structure by Occupation Level 12/31/1987 12/31/1989 12/31/1991 10/31/1994 (#) (%) (#) (%) (#) (%) (#) (%) Management 124 6 135 6 208 8 260 9 Professionals 385 18 434 19 521 21 926 31 Support Staff 1,627 76 1,725 75 1,793 71 1,795 60 Total 2,136 100 2,294 100 2,522 100 2,981 100 5. Between 1987 and 1994 the proportion of staff in management positions has increased from 6 to 9%, while the proportion of professionals has risen significantly from 18 to 31%. During the same period the proportion of support staff has declined from 76 to 60% of total staff. BNA has recently put emphasis on developing its technical capabilities in the various areas of the banking sector in which it operates. Staff at Headquarters and the Field Ofrices 6. As of October 31, 1994, 1,315 staff members (44% of the total) were working at headquarters while 1,666 (56%) were operating in the field office (regional offices and branch offices). The changes that have taken place between 1987 and 1994 in terms of staffing location are presented in Table 3: Table 3: BNA Staff at Headquarters versus in Branch Offices Staff as of Staff as of Staff as of Staff as of 12/31/87 12/31/89 12/31/91 10/31/94 (#) (%) (#) (%) (#) (%) (#) (%) Headquarters 1,060 49 1,093 48 1,151 46 1,315 44 Branch Offices 1,076 50 1,201 52 1,371 54 1,666 56 Total 2,136 100 2,294 100 2,292 100 2,981 100 7. In 1987, there was an almost equal number of staff at headquarters and in the field offices. Every year thereafter, the proportion of field staff has been increasing, and, at the end of 1994, it was 44 : 56. This reflects BNA's policy to decentralize its operations and to have an increasing number of its staff working in the regional offices.  - 36 - Annex 2 Men vs. women staff 8. At the end of October 1994, BNA's staff included 2,236 men (about 75% of the total) and 745 women (25 % of the total). A breakdown of the staff between men and women and by occupational level at different dates is presented below. Table 4: BNA Staff by Sex and Occupational Level 12/31/87 12/31/90 10/31/94 Men Women Men Women Men Women (#) (%) (#) (9) (#) (%) (#) (%) (#) (%) (#) (%) Management 116 94 8 6 168 92 14 8 235 90 25 10 Professionals 352 91 33 9 419 88 55 12 722 78 204 22 Support Staff 1,210 74 417 26 1,280 74 446 26 1,279 71 516 29 Total 1,678 79 458 21 1,867 78 515 22 2,236 75 745 25 9. Between 1987 and 1994, the proportion of women in BNA's staff has increased by 4 percentage points. While the number of women in management positions rose by 4 percentage points, the number of women in the professional category increased 2.5 times. This indicates that BNA is favoring the recruitment of professional women, which is giving a more balanced sex distribution. Staff specializations 10. Because of the nature of its operations as a universal bank, BNA employs specialists in various areas, such as financial analysts (198), economists (187), agronomists (22), and personnel specialists (7). In terms of level of education, 764 staff members have bachelor's degrees, and 504 have a master's degree or a doctorate.  37 - Annex 2 II. Staff training 11. BNA's staff training activities in recent years are summarized in Table 5. Table 5: BNA Training Activities Total BNA Staff Trained Training Days Average Training Days Year Staff (#) (%) (#) per Staff (#) 1989 2,294 889 39.0 1990 2,382 475 20.0 2,596 5.5 1991 2,522 947 37.5 3,520 3.7 1992 2,707 695 25.7 2,196 3.1 1993 2,852 1,363 47.8 7,307 5.4 1994 2,981 1,174 39.4 5,556 4.7 12. BNA's training activities have fluctuated widely and, until recently, although some attempt was made to develop training activities on a systematic basis by the preparation of a five-year training plan, BNA has not actually given the training function the significance that it deserves. 13. Fortunately, this situation is in the process of changing as BNA's new management has clearly indicated that it gives a high priority to staff training. Much needs to be done to compensate for past deficiencies. In particular, the following actions are being taken: (a) BNA is defining the function of "trainer" with adequate incentives as an integral part of a career development plan to induce competent staff members to be interested in these activities. BNA would need to identify some individuals who might have such interest and the necessary qualifications to receive training as trainers. (b) BNA has prepared a five-year training program, taking into consideration BNA's most urgent needs, and also expected needs deriving from its new activities. In that respect, it would be worthwhile for all managers, at headquarters and in the field offices, to attend seminars to expose them to the most modern management methods and for the directors of regional offices and branch offices to be brought up to date on the developments that have taken place in the banking and financial sectors. As a second step or in parallel if possible, it would be worthwhile to organize seminars for the staff involved in project work to improve their performance in the preparation, appraisal and supervision of agricultural and industrial investments.  - 38 - Annex 3 Page 1 of 15 BNA's ACTION PLAN   - 39 - BNA - Analysis and Management Control Department BANQUE NATIONALE AGRICOLE SUMMARY OF ACTION PLANS 1994-1997 l  I., I  - 40 - Introduction The various centers of responsibility within the bank have conducted a strategic analysis of their activities in accordance with the broad objectives defined by the General Management as a result of the central strategic analysis that produced the "5 Year Strategic Plan" initiated in April, 1994. The "Action Plan 1994-1997" forms the connection between the Strategic Plan and the detailed action plans developed by the individual departments of the bank, with the " 5 Year Financial Projections" forrning a key component. * This document, which was developed by the Analysis and Management Control Department, provides a road map intended to facilitate oversight by the General Management. It summarizes by major areas - Financial Restructuring, Financial Performance and Institutional Issues - the main objectives to be achieved, the actions to be taken as well as the results expected. The entire management team of the Bank has been involved in its preparation. 3 The "Action Plan 1994-1997" was conceived as a tool to guide the transition from general principles on the strategic direction of the bank to the development of specific objectives and actions to be taken. Initially developed in September 1994, it will be updated periodically' with respect to: oversight of implementation - adapting to major internal or external events that could have a significant impact on the present or future financial condition of the bank, including the Restructuring Plan for the OC and for the Groupe Chimique. * The Action Plan is an analysis document. References to the information sources on which it is based are shown in the Comments column. The original Action Plan is in French - every effort has been made to translate the meaning into accurate English. The original French text is available on request. Source: BNA - Analysis and Management Control Department The attached, updated Action Plan was adopted by BNA Board on February 28, 1995.  BNA Analysis and Managrment Control Ospartmsnt ACTION PLAN 1994-1997 SECTION A. F-nacial rwtrueturing P 1/2 Cod Objedive Actions Tnkeno and to be Taken Resp. Results Expe ed Comments _________________ _ _____________________________ Drecription Dais ____________________________D_rip_o Date * Strengthening of capital (see Maintain a solvency ratio according to the Own funds = Paid in capital + reserves + general proviuions Capital adequacy objective A-2) following time line -shortfall in provisions A-i accordirng to BCT rules Ratio 3,7 Dec.94 (cirscular 91124) 0 Improvement in the cisssification of assets Ratio 4.0 jttte3 Capital adequacy ratio (see objective A-3) Ratio 4.4 Dci. 95 Capital = 5% risk weighted assets Ratio 5,0 ttttsg 96 _________________________ _ ________________________________________ Ratio = 5,3 Dee. 99 ____________ _ ______________________________Rtio 5 _ First increase in capital I * Capital raised to 75 M DT Decision to raise capital by two injections of * Capital raised to 100 M DT D6e. 094 25 M DT each through issuance of new shares Second increase in capital * Amount of share premium 8 M DT tsD ti4 for 22 5 M DT each and conversion of reserves of 2,5 M DT(AGO of 20/7/94) O Conversion of budgetary credit lin held ins A-2 Strengthening of trus to permanent, non-eanming capital Increase in own funds (capital and reserves) by Law 94-30 Capital an amount of: 133 M DT ,b9; * Devclopment of an agreement BNAIState Signing of the agreement and start to Draf agreement proposed by the BNA that defines how the provisions of Law z:::I:l- imnplementation of the State guarantees Pals 95 and reviewed by the State. 94-30 on the conversion will be applied -_ OMTI Receipt of guarantee would lead to an equivalent re-duction :: - reduition in exposufe by S5 M DT Ji - in the need for provisions. O Provision of State guarantees covering inceemi tal guarantees of 29 M DT i94 liabilities of the bank to certain public sector recovery of past due interest 7,7 M DT e. 94. --- -enterprises loans outstanding stabilized at: 219 M DT Jr 9 0 C Improvement in - Decision by the State determining the approach . The rehabilitation project for the OC i under A-3 net worth to rehabilitating the OC DV. 95' study within the Government which was < 123 M DT > Reduction or stabilization of credit outstanding Credit outstanding stabilized at 353 M DT Zrto 9 xs of 31 December 1993 to the public sector (of which 100 M DT guaranteed by treasury bills) . The rehabilitation project in process of implementation - Recovery of past due interest 5,3 MDT i 5 will impact the entire banking system .:: l:z GrDupe ChJmique Solutions that concern the BNA will therefore be Credit outstanding stabilized at 131 M DT Ci iAmplemented over time - - , * Improvement in net income sufficient to Additional guarantees received C M DT progressively absorb ihe shortfall in loan loss J Net position Shortfall in provisions . See 5 year forecast for financial performance provisions (see Section: B Financial performance) .- 105 M DT 208 M DT Di. S4 139 M DT 179 M DT i85 M DT 136 M DT fl0.9! i ______________ ';___-____________ _-_ _ 254 M DT 72 M DT _____________ ______________2M D7 M ote Capital is transated as Paid In Capital Fonds Propres is tranalatod as Capital, which is composed of Paid In Capital, Share Surplus and Unrestricted Reserves. DEcO-Wlch 1995  BNA Analysis mnd Mangsmeno Control Departmsnt ACTION PLAN 1994-1997 SECTION: A. Finaneial reructurlng P 2/2 Cod Objectovaa Actions Taken and to be Taken Reep. Re*is E-peo Cornnmots _ __________.__.___ D.ecrl _othrn D ate | _____________________________7_R s_in tm t - 1 Compliance starting in 1995 except for Riak concentrraton limits Adherence to risk ' Adherence wil be achieved through - OC, ONH, and Groupe Chimique for which - - Exposure to any client (or group) < 25% of capitol A4 concentrtion limitsr Increase in capita l - d.he BCT will waive compliance till 1996 - - Improved risk management and the State will alsist the BNA with their Tots] exposure to shareholders and mangement rehabilitation - who control more than 10%X of capitol -______________________________ _ - - <3 tim es capital t Issuance of notes as permitted Strengthening of permanent resources of the bank 0De6 9S Decision to float debt taken by AGO on 20/7/94 by market opportunities and the bank's Acquire longer term funds funding needs A-5 to achieve improved - BAD dubursement of 12 M DT I99 matching by onaturity disbursement of 20 M DT by end Dan. 94 disbursement of 25 M DT by end D