Mexico - First and Second Agricultural Sector Adjustment Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15794 PERFORMANCE AUDIT REPORT MEXICO AGRICULTURAL SECTOR ADJUSTMENT PROJECTS I and II (LOANS 2918-ME and 3357-ME) June 26, 1996 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance. of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents, New Pesos per US$ (annual averages) 1988 2.28 1992 3.12 1989 2.64 1993 3.30 1990 2.95 1994 3.41 1991 3.07 1995 7.40 Abbreviations and Acronyms AGSAL I Agricultural Sector Adjustment Loan I AGSAL II Agricultural Sector Adjustment Loan II ASERCA Apoyos y Servicios a la Comercializacion Agricola (Services for Commercialization of Agriculture) BoP Balance of Payments BTOR Back to Office Report CONASUPO Compania Nacional de Subsistencias Populares (National Commission forDistribution of Basic Foods) DICCONSA Distribuidora CONASUPO (Agency in charge of CONASUPO's retail outlets) EAS Economic Advisory Staff ED Executive Director ESW Economic and Sector Work GA Guarantee Agreement GATT General Agreement on Trade and Tariffs GDP Gross Domestic Product GOM Government of Mexico FAO Food and Agriculture Organization FOB Free on Board IDB Inter-American Development Bank IM Initiating Memorandum MES Monitoring and Evaluation System NAFIN Nacional Financiara, S.N.C. NAFTA North American Free Trade Agreement NPC Nominal Protection Coefficient NTB Non-Tariff Barrier PCR I Project Completion Report of AGSAL I PCR II Project Completion Report of AGSAL II PNyS Programa de Nutricion y Salud (Nutrition and Health Program) PR President's Report PROCAMPO Programa Nacional de Modernizacion del Campo (National Agricultural Modernization Program) PRONASE Productora Nacional de Semillas (National Seed Production Company) QR Quantitative Restriction SAL Structural Adjustment Loan SARH Secretaria de Agricultura y Recursos Hidraulicos (Ministry of Agriculture and Water Resources) SDR Special Drawing Rights SECOFI Secretaria de Comercio y Fomento Industrial (Ministry of Trade and Industrial Development SEDESOL Secretaria de Desarrollo Social (Ministry of Social Development) SHCP Secretaria de Hacienda y Credito Publico (Ministry of Finance and Public Credit) SPP Secretaria de Progamacion y Prepuesto (Ministry of Budget and Planning) TAL Technical Assistance Loan TOR Terms of References TRICONSA Trigo Industrializado CONASUPO (CONASUPO's Processing Wheat) Fiscal Year: January I - December 31 FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.S.A. Office of the Director-General Operations Evaluation June 26, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: MEXICO-First Agricultural Sector Adjustment Project (Ln. 2918-ME) Second Agricultural Sector Adjustment Project (Ln. 3357-ME) Performance Audit Report Attached is the Performance Audit Report on two agricultural adjustment projects in Mexico (AGSAL-I and AGSAL-II) prepared by the Operations Evaluation Department. AGSAL-I was supported by a loan for US$300 million equivalent approved in FY88 and AGSAL-II by a loan for US$400 million equivalent approved in FY91. AGSAL-1 was closed in FY91, seventeen months behind schedule, and AGSAL-II was closed in FY94, ten months behind schedule. Both loans were fully disbursed. AGSAL-1 was designed to help shape and accelerate the structural adjustment of Mexico's agriculture. At the time, Mexico had perhaps the most thoroughly state-controlled agricultural trade and marketing policy in Latin America, with major interventions in production, credit, inputs, storage and processing. The AGSAL-I program, some of which was implemented before the loan took effect, was designed to: * reduce government intervention in agricultural markets, including replacing fixed producer prices with a price band based on world market prices for some key commodities; * abolish quantitative restrictions on many agricultural imports; * reduce the role of agricultural parastatals, including selling and closing some enterprises and limiting the government's coverage of parastatal operating losses; * liberalize domestic agricultural trade; * eliminate subsidies on farm inputs; * increase the efficiency and volume of pubic investment in agriculture; and * establish a targeted food subsidy program with adequate funding. AGSAL-1 was successful. The parastatals were divested on schedule. The reform of quantitative restrictions on output and exports went further than loan conditions required. The untargeted general food subsidy was reduced, and a program of food rationing was introduced to safeguard the food consumption of some of the urban poor. AGSAL-II continued the process of agricultural adjustment through: This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. 2 * trade and other policy reforms to reduce further the government's role in producing, marketing and processing agricultural products and inputs while encouraging more competition from the private sector; * better targeting of consumer food subsidies; * changing the Ministry of Agriculture's role from putative planning and control of production to policy formulation and regulatory functions. During the disbursement period the Government also developed an agricultural protection plan (PROCAMPO) that would avoid distortions in resource allocation in that farmers would receive subsidies based not on the volume of production but on the amount of land sown to specified crops in the past. AGSAL-II was successfully implemented. Export restrictions on key food commodities were eliminated as was the Ministry of Agriculture's system of imposing crop production targets. The production and marketing of seeds, pesticides and other inputs was liberalized. Prices of important food commodities were freed. The public investment budget for agriculture was increased. A pilot program of food assistance to the poor was introduced in selected rural areas. The outcome of both projects is rated as satisfactory and sustainability as likely. Bank performance for both projects was satisfactory. These ratings are identical to those in the Project Completion Reports. The cumulative institutional development resulting from the policy changes the projects supported will be substantial. Wide-ranging privatization of production and commerce stimulates the development of new production and market institutions. Opening up export markets leads to institutional change as farmers and other producers respond by learning about new markets, developing new business relationships and applying new technology. Two lessons can be drawn from this experience. First, the Mexican AGSALs demonstrate a fruitful interaction of policy-reform with food-security issues. The attention to food-security improved the overall reform program. Most Bank operations dealing primarily with agricultural policy reforms would do well to build in similar attention to food security. Second PROCAMPO-the producer subsidy scheme is now operational-paying subsidies to farmers based on past production patterns, and thus not affecting current production choices. This is a better outcome than can be achieved by most other subsidy schemes which usually lead to excess production that requires sale at values far below economic and social costs. Attachment FOR OFFICIAL USE ONLY Contents Preface ........ ..................................................... 3 Basic Data Sheet ...................................................... 5 Evaluation Summary ......................................... .......... 9 1. Introduction ........................................ .......... 17 The Economy .....................7........ ....................17 The Agricultural Sector ...................................... ..... 18 Agricultural Policies and Government Objectives prior to AGSAL I ...... ..... 19 2. Preparation, Implementation and Outcome of AGSAL I................. 22 Objectives and Preparation ........................................ 22 From Appraisal to Approval ....................................... 27 Effectiveness through Closing ...................................... 32 Performance in Achieving Loan Objectives ............................... 35 3. Preparation, Implementation And Outcome of AGSAL II ...... .......... 37 Objectives and Preparation ........................................ 37 From Appraisal to Approval ................................. ...... 42 Effectiveness through Closing ...................................... 44 Performance in Achieving Loan Objectives ....................... ..... 48 4. Findings, Ratings and Lessons ............................... ..... 50 Findings ........................................... .......... 50 Ratings ................... . ......................... ....... 54 Lessons ...................................................... 57 Tables 1.1 Summary Statistics for Mexican Agriculture ............................ 19 1.2 Producer Prices in Constant 1992 US$ and Nominal Protection Coefficients for Maize, Wheat, Sorghum, Barley, Rice, Soybeans, Coffee, and Cocoa ...... 21 4.1 Mexico - Selected Growth Rates .................................... 54 This report was prepared by John Baffes and Jacob Meerman; the audit mission took place in November/December 1994. Helen Claverie and Pilar Barquero provided administrative assistance. The report was issued by the Agriculture and Human Development Division (Roger Slade, Chief) of the Operations Evaluation Department (Francisco Aguirre-Sacasa, Director). This document has a restricted distribution and may be used by recipients only in the performance of their oflicial duties. Its contents may not otherwise be disclosed wiLout World Bank authorization. 2 Annexes 1: Chronology of AGSAL I .......................................... 59 2: Agricultural Sector Objectives of the Mexican Government, 1987-88 ................. 60 3: Policy Matrix of AGSAL I .......................6.... ............61 4: Chronology of AGSAL II ................................ ......... 64 5: Policy Letter from the Mexican Government on Agriculture and Food Consumption Policy ....................................... 65 6: Policy Matrix of AGSAL II.................................. ...... 73 7: GOM's Comments on the Tortilla Subsidy Program .................. ..... 80 3 Preface This is the Performance Audit Report (PAR) of the First and Second Agricultural Adjustment Loans for Mexico (AGSAL I and II) in the amount of US$300 and US$400 million equivalent, respectively. AGSAL I was approved on March 15, 1988 and became effective on March 16, 1988. The original loan closing date was March 31, 1989; the loan closed on March 15, 1990, almost one year behind schedule. AGSAL II was approved on June 25, 1991 and became effective on December 20, 1991. The original loan closing date for AGSAL II was February 28, 1993; the loan closed on December 31, 1993. This PAR is based on the Project Completion Reports (PCRs), the President's Reports (PRs), the Loan and Guarantee Agreements (GAs), the Board Discussions, review of files, study of Bank and Mexican reports, and interviews with Bank staff involved in the operations. An OED mission visited Mexico in November 1994 and discussed the loan with officials from the Ministries of Agriculture, Finance, and Industry. Both PCRs are evaluations of good quality, comprehensive, and analytical. The Audit confirms the accuracy of their account and validity of their conclusions. The PAR goes beyond the PCRs by providing a background description of Mexican agriculture within the context of the two operations, information on the evolution of the sector after implementation of AGSAL II, and lessons that provide feedback that may be useful for future operations. The draft PAR was sent to the Borrower for comments but none were received.  5 Basic Data Sheets AGRICULTURAL SECTOR ADJUSTMENT LOAN (LOAN 2918-ME) Estimated and Actual Disbursements FY88 FY89 FY90 FY91 Appraisal estimate (US$M) 100 200 - - Actual (US$M) 10.7 98.1 176.9 14.3 Actual as % of appraisal 10.7 49.1 - - Date of final disbursement: 04/01/90 Project Dates Original Actual Initiating memorandum 03/23/87 03/23/87 Negotiations - 1st phase 12/14/87 12/14/87 Negotiations - 2nd phase 02/16/88 Letter of Development Policy 02/26/88 Board approval 02/22/88 02/22/88 Loan Agreement 03/15/88 03/15/88 Effectiveness 03/16/88 03/16/88 Loan Closing 06/30/89 11/15/90 Actual Completion 11/15/90 Staff Inputs (staff weeks) FY86 FY87 FY88 FY89 FY90 FY91 Total Through Effectiveness 1.1 88.0 89.1 Supervision 20.0 20.5 20.8 10.1 0.6 72.0 Total 1.1 108.0 20.5 20.8 10.1 0.6 161.1 6 Mission Data Date (month/year) No. ofpersons Days infield First preparation 07/86 7 11 Second preparation 09/86 2 10 First preappraisal 10/86 7 na Second preappraisal 11/86 7 14 Third preappraisal 12/86 2 5 First appraisal 04/87 3 10 Second appraisal 05/87 7 na Third appraisal 07/87 4 12 Prenegotiations 09/87 3 5 First supervision 05/88 2 na Second supervision 09/88 2 5 Third supervision 02/89 1 5 Fourth supervision 09/89 10 18 Other Project Data Borrower/Executing Agency: Nacional Financiera, S.N.C. FOLLOW-ON OPERATIONS Operation Loan No. Amount (US$ million) FY Export Development I 2331 350 83 Trade Policy I 2745 500 87 Export Develoment II 2777 250 87 Trade Policy II 2882 500 87 Agricultural Sector Adjustment I 2918 300 88 Fertilizer Sector Adjustment 2919 265 88 Financial Sector Adjustment 3085 500 89 Industrial Sector Policy 3087 500 89 Road Transport & Telecommunications 3207 300 90 Agricultural Sector Adjustment II 3357 400 91 7 SECOND AGRICULTURAL SECTOR ADJUSTMENT LOAN (LOAN 3357-ME) Estimated and Actual Disbursements FY92 FY93 FY94 Appraisal estimate (US$M) 200 200 Actual (US$M) 200 0 200 Actual as % of appraisal 100 0 - Date of final disbursement: 03/31/94 Project Dates Original Actual Initiating memorandum 12/11/90 Preparation 03/31/90 Appraisal Mission 01/15/91 Post Appraisal Updating Mission 03/18/91 Negotiations 05/24/91 05/31/91 Board Approval 06/19/91 Loan Signature 06/25/91 Effectiveness 07/91 20/12/91 Loan Closing 02/28/93 12/31/93 Disbursement-First Tranche 01/22/92 Disbursement-Second Tranche 08/92 12/20/93 Staff Inputs (staff weeks) FY90 FY91 FY92 FY93 FY94 Total Through appraisal 80.0 80.0 Appraisal through approval 23.0 23.0 Approval through effectiveness 56.0 56.0 Supervision 35.0 23.9 54.6 13.9 127.4 Total 103.0 91.0 23.9 54.6 13.9 286.4 8 Mission Data Date No. of Days in Specializations represented (month/year) persons field First preparation 09/89 10 18 ti, e, ae, ca(4), idb(3) Second preparation 11/89 10 20 tM, e, ae, ca(l), idb(6) Preappraisal 03/90 6 10 tm, dc, ca, ce, idb(2) Appraisal 01/91 3 3 tm, dc, idb Partial supervision 03/91 1 1 dc Partial supervision 09/91 1 3 tm Full supervision 11/91 2 2 tm, e Partial supervision 06/92 2 3 tm, e Full supervision 12/92 3 4 tm, e, ae Full supervision 11/93 3 3 tm, dc, ae The numbers in parentheses indicate the number of representatives from the particular specialization. e economist; ae = agricultural economist; ca = economist (commodity analyst); tm = task manager; dc division chief; ce = chief economist; idb = 1DB staff. Source: PCR II. Other Project Data Borrower/Executing Agency: Nacional Financiera, S.N.C. FOLLOW-oN OPERATIONS Operation Loan No. Amount (US$ million) FY Export Development I 2331 350 83 Trade Policy I 2745 500 87 Export Develoment II 2777 250 87 Trade Policy II 2882 500 87 Agricultural Sector Adjustment I 2918 300 88 Fertilizer Sector Adjustment 2919 265 88 Financial Sector Adjustment 3085 500 89 Industrial Sector Policy 3087 500 89 Road Transport & Telecommunications 3207 300 90 Agricultural Sector Adjustment II 3357 400 91 9 Evaluation Summary Introduction 1. Although committed to structural reform, for political reasons the Government of Mexico (GOM) did not want a Structural Adjustment Loan (SAL). Instead, the GOM and the Bank agreed that long-term structural issues would be addressed through sectoral adjustment operations that would include all elements of a SAL program. The first and second agricultural sector adjustment loans (AGSAL I and II) addressed structural issues in the agricultural and food sectors of Mexico. 2. Prior to AGSAL I, Mexico's agricultural policies were characterized by administered "guarantee" prices on major agricultural commodities, heavy involvement of parastatals in production, processing and marketing, comprehensive planning of agricultural production by the agricultural authorities, and expensive general food subsidies to urban consumers. Objectives and Preparation of AGSAL I 3. AGSAL I had the following policy objectives: (i) reduction of general food subsidies and targeting food subsidies to the poor; (ii) reduction of government intervention in agricultural markets, including movement from guarantee prices to a price band, based on world-market prices, for setting prices for wheat, barley, rice, sorghum, soybean, sesame, sunflower, safflower, seed cotton and copra; (iii) abolition of quantitative restrictions (QRs) on the production of some agricultural commodities; (iv) reduction of the role of agricultural parastatals; (v) liberalization of domestic agricultural trade; (vi) elimination of input subsidies; (vii) increase in the efficiency and volume of public investment in agriculture; and (viii) decentralization and reduction of staff of the agricultural ministry. 4. In Bank files, AGSAL I is first mentioned in July 1985, and the first preparation mission took place in July 1986. Initially, AGSAL I was thought of as a quick, one-tranche operation to be approved before Mexican elections. Hence the staff were to prepare the loan by October 1986 and have the package ready for Board presentation in early 1987. It was also understood that a more demanding operation would follow. The complexity of Mexico's agricultural economy and the food distribution system plus the Bank's lack of information on them, led to an enormous amount of preparation (two preparation, three pre-appraisal, three appraisal, and one pre- negotiation mission) and delayed appraisal until September 1987. 5. The main reforms supported by AGSAL I, as reflected in the loan conditions are listed below: * Food Assistance Program. Introduction of eligibility criteria to ensure that food assistance was targeted to low-income people and introduction of a pilot program of food assistance to low-income populations in rural areas. Subsidized food prices did not extend to the rural areas. * Parastatal. Limiting operating losses to CONASUPO, the marketing parastatal responsible for guarantee prices and subsidized consumer food prices by closing, or relocating to low-income areas, 500 retail food outlets operated by CONASUPO's 10 retailing affiliate; liquidation of CONASUPO's wheat processing affiliate; selling or closing 15 parastatal enterprises in the agricultural sector; and selling or closing six sugar mills. * Studies of the following. A possible nutrition program; guarantee price system; sugar pricing policy; irrigation water-user charges. * Guarantee Prices and Quantitative Restrictions. Monthly adjustment of guarantee prices of agricultural crops to offset inflation; elimination of QRs on selected agricultural imports; elimination of CONASUPO's import monopoly for powdered milk. * Investment Budget. The FY89 budget for agriculture to exceed that of FY88 by the equivalent of US$200 million. 6. The yellow-cover meeting of the President's Report (PR) took place on October 7, 1987. With the exception of Economic Advisory Staff (EAS), all concerned parties endorsed the loan. The EAS advisers, however, raised three issues: (a) the macro-economic case for a US$500 million operation had not been made; (b) the GOM did not have a medium-term vision concerning the reforms outlined in the PR; and (c) no serious ESW had been done prior to AGSAL I, and the PR should not have been viewed as a piece of ESW. At the meeting it was decided: (a) to reduce the loan amount from US$500 to US$400 million; (b) to include a US$10 million technical assistance loan (which was later dropped); (c) to drop the condition to eliminate CONASUPO's legal monopoly in the market for imported milk powder. 7. Negotiations started on December 14, 1987. Because of differences in opinions in four key areas they were suspended on December 18, 1987. Following the suspension, the new management of the Agriculture Division expanded the loan in several ways. Negotiations were resumed on February 16, 1988 after each delegation had consulted with its authorities. The following changes were made in the loan package: (a) for the food security program, government would provide sufficient funding to meet the needs of the low income population (US$250 million equivalent); (b) limit budget transfers to CONASUPO to US$85 million in 1988; (c) remove export restrictions on high quality cuts of beef and high quality rice; and (d) the guarantee price system would be maintained at least at the 1987 levels in real terms in 1988 and the guarantee prices of all crops (except beans and corn) would be set within a band of 90 percent to 125 percent of world prices. Finally, it was agreed to further reduce the loan from US$400 to US$300 million. Implementation and Outcomes of AGSAL I 8. AGSAL I disbursed in two tranches (US$100 and US$200 million, respectively). The first tranche disbursed in two parts. US$25 million upon effectiveness and US$75 million after agreeing on the TORs of studies that would establish the basis for further trade and price reform. The first tranche was completely disbursed in November 1988 while the second tranche was fully disbursed in March 1990. 9. Most of the conditions set forth in the Loan Agreement were met. The food assistance program exceeded targets. The parastatals were divested on schedule. The studies for sugar pricing policy, water-user charges, and the nutrition program were completed satisfactorily. Quantitative restrictions were reduced more than tranche conditions required. 11 10. The prices of soybeans, barley, and wheat were not maintained within the band of 90 percent to 125 percent of import parity prices. Second tranche release conditions also required that the proposed 1989 budget exceed the 1988 budget by US$200 million. The 1989 budget exceeded that of 1988 by only US$82 million because of the economic stabilization program then underway which the Bank agreed took precedence over the AGSAL I covenant. In 1990, however, the GOM exceeded the conditionality of the previous year as it increased the budget allocated to agriculture by US$315 million. 11. Overall, AGSAL I was a successful operation. It achieved its main objective of improving economic efficiency by replacing existing non-market mechanisms by market ones. It assisted reforms in prices, trade, public investment, poverty alleviation, fiscal transfers, and the role of parastatals. The impact on the poor was softened through the targeted food subsidies. The agricultural economy moved closer to a market-pricing system. Arbitrary and costly trade restrictions were reduced. Objectives and Preparation of AGSAL II 12. AGSAL II was described in the President's Report as a program of Bank support to the Government's objective of increasing the rate of growth of agriculture by raising resource productivity and otherwise improving the efficiency of the agricultural sector by helping output and input markets to work better. It would also alleviate the poverty of the most vulnerable population groups through targeted food programs. These objectives were to be achieved through: (i) implementation of trade and other policy reforms to reduce further the Government's role in the production, planning, marketing, storage, and processing of agricultural products and inputs and to encourage more competition from the private sector; (ii) reducing generalized consumer food subsidies and substituting targeted assistance and nutrition programs; and (iii) changing the role of the Ministry of Agriculture to emphasize policy formulation and basic regulatory functions. 13. Early preparation of AGSAL II overlapped AGSAL I implementation. Preparation of AGSAL II was expected to be much shorter than AGSAL I. However, Mexico's negotiations to join the North American Free Trade Agreement (NAFTA) delayed both preparation and implementation of the second operation. An issues paper, circulated in July 1989, later became the IM which was first reviewed in November 1989. Following two preparation and three pre- appraisal missions the loan was finally appraised in January 1991. 14. The reforms included both effectiveness and tranche conditions. Effectiveness required elimination of the export tax for raw cotton and cotton fiber, study of Government-set production targets, and elimination of export permits for a number of commodities. The main reforms supported by AGSAL II as described in the final IM-which later became loan conditions-are listed below: * Prices. Liberalization of the prices of tobacco, cookies, pasta, edible oils, cigarettes, dairy products, eggs, and beef. Free determination of pesticide prices. No increase in nominal import protection of wheat, maize, and barley. * Studies of the following. Bean market, sugar sector, plant protection and animal health, and CONASUPO's monopoly on dry milk. 12 * Market Liberalization. Remove the following: nationwide crop production targets; CONASUPO's monopoly of powdered milk; export restrictions for milk; restrictions that prevent competition with the National Seed Production Company; the government monopoly on holding germplasm; restrictions on plant breeding. * Nutrition Program. An evaluation of the pilot Health and Nutrition Program and an action plan for each department participating in its implementation. The fact that liberalization of maize, wheat, and sugar production were quite limited, triggered discussion at the vice-presidential level. The Bank finally accepted GOM's pcsition that these sectors were vital elements in the negotiation of NAFTA and that any additional conditionality would undermine GOM's negotiating position. Implementation and Outcomes of AGSAL II 15. AGSAL II had two tranches of US$200 million each, plus cofinancing of an additional US$200 million from IDB. The first tranche was released upon completion of the effectiveness conditions in June 1991. The second tranche was released in December 1993. 16. Implementation of AGSAL II ran into some problems. On at least three occasions and despite earlier price liberalization, the GOM gave producers marketing support through the precios de concertacion scheme (i.e. agreed prices between producers, consumers and the Government). Along with the delays caused by NAFTA negotiations, this marketing support, which was at odds with the reform program, delayed second tranche release. The Bank finally accepted GOM's position that the new subsidies were a transitory "measure" which would eventually be replaced by a new income support scheme, PROCAMPO. 17. PROCAMPO is an income support scheme that is to eventually replace both guarantee and agreed prices. Rather than pay a subsidy to farmers based on what they produced, PROCAMPO pays farmers subsidies based on the amount of land that they had cultivated for specific crops. PROCAMPO is consistent with NAFTA requirements concerning protection of commodities. The Bank helped the GOM prepare PROCAMPO, mainly through work shops and ESW. PROCAMPO has now become effective. 18. There were also some problems with the evaluation of the Health and Nutrition program. The ministry of Budget and Planning that was charged with guiding the Health and Nutrition component of AGSAL II was dismantled in 1992. The lengthy disputes among the Ministry of Health, the Ministry of Finance and the Ministry of Social Development as to who would take over this component slowed down the evaluation of the program and hence the preparation of the required action plans. 19. The GOM liberalized the prices of cookies, pastas, vegetable oils, cigarettes, eggs, dairy products, beef and tobacco. The prices of sugar, maize, and barley remained within the limits stipulated in the guarantee agreement of the loan package. The prices of pesticides were allowed to be freely determined by the market. Although agreed prices for soybeans, sorghum, rice, wheat and other crops was backtracking on an already achieved goal, this was accepted as a transitory measure until PROCAMPO fully materialized. 20. The beans study concluded that Mexican bean prices were well above world levels. It also found that imports would grow under free trade and some growers would be competitive at 13 world prices. The study on plant and animal health protection was delivered to the Bank in October 1992. It led to an action plan which defined new regulations for pesticide use and animal health and inspection that were consistent with NAFTA. Instead of a study on the sugar sector, in December 1993 the GOM submitted a letter outlining the major steps taken to restructure the sector since privatization of the sugar mills in 1989. 21. Export restrictions on wheat, sorghum, livestock feed, soybean, barley, copra, cartamo, cartamo oil, cottonseed, tobacco, eggs, and fluid milk were eliminated as was the Ministry of Agriculture's system of imposing crop production targets. The GOM abolished the state germplasm monopoly as well as restrictions on plant breeding by the private sector. As indicated in the PCR, although CONASUPO's milk-import monopoly was allegedly eliminated and thereafter GOM permitted import through competitive auction of import licenses to the private sector, the PAR mission found that only 0.5 percent of powdered milk was imported through the private sector. 22. Despite its short duration, the pilot Health and Nutrition program significantly improved the nutritional status of children under the age of 5 at one of the two sites. It had more effect on the nutrition of girls than boys. There was a marked reduction in diarrhea among children in one site. The program had limited effects on pregnant and lactating women. The program became a model for a larger rural nutrition program which is now underway. 23. The evaluation of the tortilla coupon program found that the program reached a significant fraction of the nutritionally at-risk population at an acceptable cost. Findings, Ratings and Lessons 24. Food Security. By 1994, Mexico's targeted food security program had evolved into a targeted tortilla and milk subsidy program operating in more than 200 cities. This program requires verification of the socioeconomic status of the beneficiaries and uses modem electronic scanning and registration technology (identification cards for beneficiaries). In the Government's words, the program has "laid the groundwork for the possible liberalization of prices in the final tortilla market without placing the most economically vulnerable families at risk." The Bank contributed to this because of the heavy emphasis it put on food-security issues during the preparation and implementation of both AGSALs. Recently the GOM introduced a new pilot nutrition program in the states of Campeche and Hildago. Nevertheless the GOM also continues to subsidize general maize marketing in an effort to stabilize consumer maize prices on the low side. 25. PROCAMPO. Mexico is exceptional in moving towards a system of agricultural subsidies that do not distort resource allocation. If achieved this will be a considerable improvement over the usual agricultural subsidy programs tied to the production of specific agricultural commodities, leading to substantial overproduction of protected commodities and use of labor and capital. Although initially expensive, PROCAMPO payments are planned to decrease and then cease after some years. PROCAMPO, which is now in operation, would facilitate the liberalization of prices and marketing of beans and maize. Both are still subject to administered pricing, but the payments to producers under PROCAMPO would compensate farmers for any reduction in income attendant on liberalizing producer prices. 26. Supply Response. One of the main objectives of AGSAL II was "increasing the rate of growth of agriculture" by eliminating policy and institutional distortions in Mexico's agriculture. 14 This aim was based on the assumption that on balance Mexico's agriculture was taxed in the period preceding the reforms, say 1984-87. By 1991 most of the reform program was in place so that for the period 1991-94 the expectation was some increase in output above that of 1984-87. But, as indicated in Table 3, agricultural GDP during 1991-94 grew at an annual average of 0.7 percent close to the 1984-87 average of 0.8 percent. Over the same time periods agricultural exports grew at 2.7 percent and 1.8 percent annually. The average growth of total GDP, however, increased from 0.2 percent in 1984-87 to 2.2 percent in 1991-94. 27. This outcome loses its paradoxical quality when the consequences of the reforms are considered more closely. As discussed in Chapter 4, on balance the reforms were accompanied by decreasing real producer prices for crops while input prices rose because of the elimination of input subsidies and exchange rate appreciation. The output-input price squeeze that resulted made agriculture less profitable and explains the weak supply response. 28. Bank's Performance. Project design was relevant. Both preparation and supervision were comprehensive, careful and adequate. The Bank was innovative in using the break in negotiations to introduce new reforms as well as in dividing the initial tranche release into two parts. The Bank was impressive in the care and tenacity it used in dealing with food security issues, as at the outset of AGSAL I, the Government was reluctant to make food security a prominent element in the projects. The redefinition of the Government's role in agriculture by eliminating the policy of programming agricultural production is a significant achievement, attributable in part to the work of World Bank staff. 29. There were also shortcomings. First, with the wisdom of hindsight, the most serious appears to be the failure to address the persistent appreciation of the exchange rate during the supervision of AGSAL II. One of the conditions for second-tranche release was "[p]rovision to the Bank of evidence that the macroeconomic policy framework is consistent with the objectives of the program." Exchange rate appreciation probably reduced agricultural exports and put increased pressure on the authorities to continue to subsidize producer prices for the basic grains in an ad hoc fashion rather than to move to autonomous markets and price liberalization. Second, although Bank performance was good in "catching up" on the hiatus resulting from a past neglect of sector work, the emphasis on executing and digesting new analytical work may have reduced the effectiveness of the Bank and Borrower in finding the best ways to reduce and eliminate policy constraints. Third, the Bank was content to push for rationalized prices in AGSAL I, which would be administered at close to world market prices. But as long as prices are administered they can be easily changed to undesirable levels. A better approach is to press for full price liberalization at border values. Fourth, to some degree the Bank saw financing from the loan as both reward and inducement for undertaking reforms. Both reward and inducement rationales for financing are out of line with Operational Directive 8.60 which states that the rationale for financing structural adjustment operations is the uncovered balance-of-payments gap and additional external financing needs that result from the adjustment process itself. 30. On balance the performance of the Bank is considered satisfactory, compared to what was considered good practice at the time. The main weakness is the Bank's failure to grapple with the exchange rate issue. It is difficult, however, to show that this was imprudent behavior since ex ante it was not obvious that the high value of the Mexican peso was unsustainable. 31. Borrower Performance. The Borrower's performance was satisfactory basically because of its decided ownership of a demanding program that grew out of the strong commitment to structural adjustment after the elections late in 1988. This commitment helped the long, in-depth 15 and frank discussion between Bank staff and the authorities during both preparation and implementation. On the Government side, those responsible for implementation also had the authority and capacity needed to carry out the program. The Government also mostly lived up to its obligations with respect to the reforms stipulated in the tranche release conditions. 32. Borrower performance also had shortcomings. The Government essentially replaced a number of guarantee prices with the precios de concertaci6n for grains which led to a Government system to establish producer floor prices. Defacto CONASUPO's powdered milk monopoly continued, at least through 1995. Once implemented, PROCAMPO was to have compensated producers according to the amount of land that they tilled. The Government would in turn then liberalize the producer prices for maize and beans which had been maintained far above c.i.f. values through CONASUPO's pricing policies. But implementation of the PROCAMPO program has not occurred and Government has continued to maintain floor prices for maize and beans. 33. Sustainability. As long as Mexico's governing party stays in power, sustainability of the agricultural reforms achieved under these projects is highly probable since economic liberalization is an important plank in the party platform. Even if the governing party in Mexico changes it is not clear that the successor would reject the economic liberalization platform. Sustainability of both AGSALs is rated as likely. 34. Institutional Development. The cumulative institutional development resulting from the policy changes supported by the AGSALs will be enormous. Wide-ranging privatization of production and commerce brings in train the development of new production and market institutions. Opening up export markets leads to large institutional change as farmers and other producers respond by learning about new markets, developing new business relationships, and applying new technology. In the public sector, there is now a new role for the agricultural authorities while new organizations and rules for supporting the poor have been developed. Institutional development is rated as substantial. 35. PCRs. Both are satisfactory. The PAR confirmed the relevance and validity of their analysis and conclusions in the PCRs. PCR II provides a useful background chapter that facilitates understanding of the objectives pursued and how the proposed policy reforms would contribute to those objectives. The information in PCR II on recent developments in the agricultural economy is also useful in facilitating judgments concerning outcomes. Part II of PCR II, the Borrower's Perspective, is largely consistent with the PCR. It also provides valuable and detailed information on the implementation of the program that complements the content of the PCR. 36. Outcome Rating. The outcome rating is satisfactory for both AGSALs. The objectives were relevant. The major objectives were achieved and are likely to yield substantial development results without major shortcomings. 37. Lessons. The evolution of the Mexican AGSALs presents a convincing demonstration of a fruitful interaction of policy-reform issues with food-security concerns. Most Bank operations dealing primarily with agricultural policy reforms would do well to build in similar, substantial attention to food security. 38. The experience with PROCAMPO can also be viewed as an important lesson. At a certain stage in their economic development, nearly all countries swing over to protecting and 16 subsidizing agriculture usually by means that are economically wasteful. From this perspective, PROCAMPO appears to be an important approach that could be tried elsewhere. 39. AGSAL II, as most AGSALs, had as its fundamental objective increasing the rate of growth of agriculture. But through 1994 at least, Mexico's agricultural adjustment did not lead to expanded output. Clearly, agricultural adjustment can lead to contraction in output as liberalization and other policy reforms reduce the profitability of agriculture. It is important to be clear at the outset on whether to expect more rapid agricultural growth or the contrary as a result of the reform program. In the Mexican case, the failure to induce supply response has caused confusion and may have reduced support for the reform program. 40. The failure to do the analytical work underpinning the agricultural reforms ahead of time meant that a lot of resources had to be dedicated to catching up in the form of quick studies. Knowledge about consequences of policy changes was slow in coming. The Mexican reform program probably suffered as a consequence. 41. A better way to proceed is to carry out analysis of policy and institutional issues in advance and as a collaborative undertaking with the Borrower. Agricultural policy reform, like structural adjustment in general, is a time consuming process involving substantial learning. It is preferable to begin the process with sector analysis that informs the process of policy reform rather than attempting to provide the knowledge base and the reform actions almost simultaneously. This is particularly important where the operators on the Borrower side have a set of beliefs about economic development and the way the economy functions that diverge radically from those that are implicit in structural adjustment programs. In the latter case upstream policy-oriented sector work can make a contribution in increasing comprehension of the rationale for the adjustment program. Presumably this would also increase Borrower commitment to the reform program. 17 1. Introduction The Economy 1.1 Overall Performance. Between 1960 and 1982 Mexico's GDP grew at an annual rate of 6.5 percent. Conservative fiscal policies were able to keep inflation at single-digit levels until 1972. When economic policy became more expansionist they led to double-digit inflation and eventually to the collapse of the exchange rate in 1976. Thereafter, expanded borrowing, high world interest rates, and the decline in oil prices led to the debt crisis in 1982. Economic performance following the debt crisis was poor. Average GDP growth during 1982-92 was 1.2 percent, far below the growth of population. In some years inflation reached three digits. But by the mid-I 980s, Mexico began to reform its economic policies. The key reforms involved fiscal adjustment (para. 1.2), trade liberalization (para. 1.3), and deregulation (para. 1.4). By the mid- 1980s Mexico was also redefining its basic economic strategy and growth policies, a process that was much accelerated by the Salinas administration which was elected in 1988. By the early 1990s, Mexico had cast off the highly dirigiste, public-production-and control model of the 1970s for a market-oriented strategy that stresses integration into the world economy. 1.2 Fiscal Adjustment. Excluding interest payments, public expenditures declined from 35 percent of GDP in 1981 to 20.5 percent in 1992. Government capital expenditures were cut in half over the same period in large degree by eliminating most of the "white elephants" of the late 1970s. But O&M for infrastructure and social sector spending were also reduced sharply. Interest payments, which represented an important expenditure component, were reduced sharply by 1991-92 with the reduction of the debt burden. On the revenue side, the efficiency of the tax system has been substantially improved by an expanded tax base, simplified tax system, increased compliance in part because of reduced rates, and modernized tax administration. 1.3 Trade and Enterprise Liberalization. Until the mid- 1 980s, quantitative import restrictions were used as the main vehicle of protection. In addition, the Government typically applied tariffs plus high surcharges to provide "temporary" protection to the few industries subject to tariffication. The official shift to trade liberalization took place in 1985 when the de la Madrid administration announced that Mexico would seek membership in the GATT. After the reforms of December 1987, tariffs were reduced to a maximum of 20 percent. The share of domestic production that continued to be protected by restrictive import licensing was reduced to 20 percent in 1988. 1.4 Deregulation. In 1982 the national telephone system was privatized. The cumbersome transport licensing system has also been streamlined and the sector opened to competition. Electricity generating plants can now be privately owned. Foreign participation in the petrochemical sector is being extended as the list of petrochemicals reserved for the public sector has been very significantly narrowed. 1.5 Exchange Rate. Mexico's exchange rate collapsed in 1976. Thereafter, because of inflation and the government', volatile policy credibility, the exchange rate was devalued nominally on a daily basis. After 1988, on average, the daily nominal devaluations were less than inflation, and the real exchange rate appreciated. In October 1992, exchange rate policy was adjusted to raise the rate of nominal devaluation by widening the band of possible daily 18 devaluations. In its economic analysis, the Bank argued that widening the band was appropriate because it allowed a larger role for market forces in determining the rate, eased fears of abrupt large devaluations and gave better incentives to producers of tradable goods.' Nevertheless, an extreme devaluation took place in December 1994 (see para. 4.15). The Agricultural Sector 1.6 Mexico's agriculture is dualistic. Commercial farmers use modem technology, achieve high yields, compete in international markets, and earn high incomes. The majority of small- scale farmers produce mainly rainfed crops whose yields are well below those with irrigation; they do not generally compete in international markets, and earn subsistence incomes, frequently supplemented by work as seasonal laborers on commercial farms. 1.7 Land tenure in Mexico has been one of the most difficult aspects of farm policy. In addition to private farms, there is a class of communal farms, the ejidos. Created under the Constitution of 1917 through expropriations of large landholdings, the ejido system guaranteed all Mexicans land rights. The ejido holders have rights to use land and water; but sale or rental of ejido land was prohibited. The ejidos account for about half of all arable land but only 20 percent is cultivated. Most of it is of low quality, contributes little to farmers' income, and is fallow, consisting of pasture and forest. Very little ejido land is irrigated. Although the Bank has never been involved in Mexico's land reform efforts except in informal policy discussion, it has proposed broad options for improving productivity in ejido areas.2 In 1992 a change in the Constitution (Article 27) gave ejido holders the right to rent and sell land to outsiders with the approval of a majority of ejido members. Ejido land can now also be pledged as collateral. Individual land registration, however, has been slow. Up to early 1995, only 20 percent of ejidos had distributed certificates of ejido rights. 1.8 During the period 1989-92 agriculture employed almost 28 percent of the total labor force, but it contributed less than 8 percent to total GDP (Table 1.1). Between 1965-70 the share of agricultural GDP was 12.3 percent while the share of agricultural labor was 42 percent. Throughout the past three decades the ratio of these shares has remained virtually unchanged, implying that agricultural labor productivity, although very low, is growing no faster than that of the entire economy, notwithstanding rapid emigration to other sectors. The rate of emigration, however, has been lower than the growth rate of population so that the population active in agriculture is still growing. 1.9 For more than 30 years, growth of agricultural GDP has been less for than that of total GDP. Between 1961 and the debt crisis of 1982 while non-agricultural GDP was growing at an 1. "Recent Developments in Mexico's Exchange Rate Policy" Report No. 11911, June 1, 1993. 2. "Enhancing the Contribution of the Land Reform Sector to Mexican Agricultural Development", Report No. 8310- ME, March 30, 1990. 3. de Janvry, A., E. Sadoulet, B. Davis, and G. Gordillo de Anda (1995). "Ejido Sector Reform: From Land Reform to Rural Development". Paper presented at the Conference on Mexican Agrarian Reform, Columbia University, April 6-7, 1995. 19 average annual rate of 6.47 percent, agricultural GDP grew at 3.24 percent. In the period 1989- 92 the corresponding rates are 1.19 percent and 0.74 percent (Table 1.1). Table 1.1: Summary Statistics for Mexican Agriculture Period Share of ag. in Share ofag. in Growth of ag. GDP Growth of total GDP GDP labor (% p.a.) (% p.a.) (percent) (percent) 1965-70 12.30 41.96 2.14 6.04 1971-76 10.19 31.80 2.62 5.78 1977-82 8.69 27.87 3.67 6.30 1983-88 8.40 27.65 0.52 0.15 1989-92 7.55 27.61 0.84 3.68 1961-82 11.17 36.82 3.24 6.47 1982-92 8.10 27.47 0.74 1.19 Notes: The average annual growth rates for the first five periods have been calculated using the beginning-to-end logarithmic changes. With the exception of 1989-92, the time periods correspond to the six-year periods of Mexico's presidential term of office. The growth rates for the two periods reported in the final two rows have been calculated by least squares. Source: Mexico: Agricultural Sector Memorandum Report No. 13425-ME, September 16, 1994. 1.10 Crops account for about 60 percent of Mexico's agricultural output. Livestock provides about one-third, forestry and fisheries the remainder. In 1992 within the crop sub-sector, cereals accounted for 48 percent, oilseeds for 5 percent, fruits, vegetables and legumes (including beans) for 28 percent, sugarcane for 5 percent, fibers for 4 percent, and coffee and cocoa for 6 percent. Agricultural Policies and Government Objectives prior to AGSAL I 1.11 A key player in agricultural policy was the National Basic Foods Company (CONASUPO) a parastatal under the Ministry of Trade and Industry (SECOFI). CONASUPO's responsibilities included: (i) provision of consumer and food subsidies (except sugar), (ii) marketing and storage of food grains, (iii) distribution of retail services in urban and rural areas, and (v) production of processed foods. CONASUPO's subsidy mechanism took either the form of selling products it had purchased at loss to processors (who themselves were subject to controlled prices on outputs) or reimbursing processors directly for costs not covered by sales revenue. 1.12 Prior to the reforms which started with the first agricultural sector adjustment operation, the main characteristics of agricultural policies were as follows. 4. The growth rates were calculated by regressing the logarithm of GDP on a linear time trend and by allowing a kink in 1982. The hypothesis that the pre- and post-1982 growth rates were equal was tested and rejected for both agricultural and non-agricultural GDP. The kinked growth model is taken from J. Boyce (1986), "Kinked Exponential Models with Growth Rate Estimation", Oxford Bulletin of Economics and Statistics, Vol. 48, pp. 385-391. 20 * The Government guaranteed pan-territorial producer prices for 12 crops (maize, beans, wheat, barley, rice, sorghum, safflower, seed cotton, copra, sunflower, and sesame). The guarantee prices were pegged by CONASUPO which purchased between 15 percent to 50 percent of the crops. * Parastatals were involved in the production, processing, and marketing of cotton, tobacco, coffee, livestock feeds, tropical fruits, seeds, and cocoa. Quantitative restrictions (QRs) on exports and imports were the rule. Import permits were restricted to a few individuals. * The Ministry of Agriculture (SARH) attempted to plan agricultural production by nationwide production targets that dictated what farmers should produce and their corresponding use of inputs. * In an effort to raise output, the GOM supported investments in land clearing and input subsidies, especially by providing credit for purchasing machinery and fertilizer (in earlier years). * Consumer prices of key industrial inputs and basic foods were fixed through price regulations, trade controls, and direct subsidies to private and parastatal processors. Consumer price controls covered about half of agricultural production. * CONASUPO administered general food subsidies. * Double digit inflation was the rule throughout the 1980s and early 1990s. This greatly complicated Government policies to stabilize basic food prices as well as producer prices. 1.13 As a , zsult of these policies, price distortions away from border prices have been high. Between 1989 and 1992, the unadjusted average NPC (nominal protection coefficient) for maize ranged from 1.41 to a maximum of 1.93. For barley it ranged from 1.24 to 1.62. During the same time period, the NPC for rice was 0.52 while that of coffee was 0.81. Overall, grains (except rice) and oilseeds have been protected while rice, sugar, coffee and cocoa have been taxed (Table 1.2). 1.14 To summarize, the GOM's policies were motivated by the desire to increase agricultural production by protecting the major food crops and cotton through high guarantee prices but simultaneously keep urban consumer prices low through heavy subsidies and various types of 6 market regulations. Since the guarantee prices were pan-territorial, producers close to production centers received lower subsidies than distant producers. Furthermore, consumers in urban centers paid much lower food prices than their rural counterparts, as consumer subsidies targeted the cities only. 5. The degree of protection implied by the farmgate NPC can be misleading. If downstream costs (processing, transport, marketing) are excessive, the incidence of excess burden is analogous to a tax that may in part be borne by the "protected" commodity. 6. In some instances, the Government imposed restrictions on interstate comerce to limit the activities of the private sector (Mexico - Policy Notes on Agriculture, Food and Rural Development, Report No. 8144-ME, February 1, 1990). 21 Table 1.2: Producer Prices in Constant 1992 US$ per Ton and Nominal Protection Coefficients for Maize, Wheat, Sorghum, Barley, Rice, Soybeans, Coffee, and Cocoa Maize Wheat Sorghum Barley SPk NPC ELce NC ELL NPC Ea NEC 1983 238 1.11 165 0.97 143 0.74 201 0.95 1984 281 1.31 203 0.99 195 1.08 248 1.17 1985 267 1.53 189 1.04 173 1.11 245 1.28 1986 190 1.44 130 0.86 171 1.34 150 0.88 1987 209 1.87 125 0.91 137 1.30 123 0.83 1983-87 1.45 0.95 1.11 1.02 1988 204 1.41 164 0.96 173 1.29 183 1.01 1989 181 1.41 145 0.96 153 1.21 162 1.24 1990 233 1.70 194 1.27 130 1.02 215 1.39 1991 241 1.82 200 1.33 147 1.18 217 1.58 1992 246 1.93 199 1.19 141 1.19 225 1.62 1988-92 1.65 1.14 1.18 1.37 Rice Soybeans Coffee Cocoa Year Price NPC Price NPC Price NPC Price NPC 1983 246 0.46 385 0.97 1,772 0.40 1,553 0.60 1984 301 0.59 470 1.23 1,484 0.33 1,812 0.58 1985 298 0.60 437 1.49 3,201 0.75 2,098 0.77 1986 208 0.47 342 1.28 3,398 0.52 628 0.24 1987 196 0.49 415 1.56 2,364 0.81 312 0.14 1983-87 0.52 1.31 0.56 0.47 1988 179 0.35 405 1.13 932 0.30 1,334 0.70 1989 134 0.29 359 1.15 883 0.36 1,258 0.90 1990 208 0.50 312 1.18 940 0.47 1,246 1.08 1991 208 0.48 433 1.75 312 0.19 1,113 1.03 1992 183 0.45 330 1.40 330 0.15 921 0.93 1988-92 0.41 1.32 0.30 0.93 Notes: The underlying world-market prices are US Gulf-port prices for U.S. exports. In the case of crops they are unadjusted for the costs of entering the Mexican market, that is c.i.f. costs plus transborder costs into Mexico. In the case of exports such as coffee, cocoa, and rice, they are unadjusted for the costs of transport to the U.S. market, which would bring their values down to the fo.b. level, plus a further reduction for the costs of getting them off the farm to the port. Source: PCR II (p. 6) 22 2. Preparation, Implementation and Outcome of AGSAL I Objectives and Preparation 2.1 Although committed to structural reform, for political reasons the GOM did not want a Structural Adjustment Loan (SAL). Instead, the GOM and the Bank agreed that long-term structural issues would be addressed through sectoral adjustment operations that would include all elements of a SAL program. Two Export Development Loans were the first such operations (FY83 and FY87 for US$350 and US$250 million each). They were followed by two Trade Policy Loans (FY87 and FY88 for US$500 million each); a hybrid adjustment loan in the fertilizer sector (FY88, US$265 million); Agricultural Sector I and II (FY88 and FY91, US$300 million and US$400 million); Steel Sector (FY88, US$400 million); Financial Sector (FY89, US$500 million); Industrial Sector (FY89, US$500 million); Public Enterprise Reform (FY89, US$500 million); and Road Transport and Telecommunications (FY90, US$380 million). Together with the Fertilizer and Steel Sector Adjustment Loans, Agricultural Sector Loan I (AGSAL I) was part of the set of loans that financed Mexico's first debt reduction program . 2.2 Since 1982, the IMF has supported Mexico with an extended arrangement for SDR 3.4 billion, a special emergency drawing for SDR 291 million following the 1985 earthquake, a stand-by agreement for SDR 1.4 billion in 1986, a drawing of SDR 453 million in 1989 under the compensatory facility, and a further extended arrangement of SDR 2.8 billion. 2.3 AGSAL I had the following policy objectives: (a) remove general food subsidies and target remaining food subsidies to the poor; (b) reduce government intervention in agricultural markets, including movement from guarantee prices to a price band around world market prices for wheat, barley, rice, sorghum, soybean, sesame, sunflower, safflower, seed cotton and copra; (c) abolish quantitative restrictions of some agricultural commodities; (d) reduce the role of agricultural parastatals; (e) liberalize domestic agricultural trade; (f) cut input subsidies; (g) improve the efficiency of public investment in agriculture and raise it in real terms; and (h) decentralize and reduce staff of the agricultural ministry.9 2.4 Undertaking AGSAL I was first considered in July 1985 in a letter from a divisional economist to the Division Chief that included a list of possible reforms: * gradual elimination of QRs on agricultural imports and replacement by tariffs of 10 to 15 percent, * gradual deregulation of 18 agricultural commodity prices, leaving a "strategic" subset of 3 to 4 prices (e.g., maize, beans, sorghum), 7. PCR I, para 11. 8. The general objective of AGSAL I was not in terms of increased growth in the agricultural sector but in terms of greater allocative efficiency and equity. 9. PR 1, para 34. 23 * gradual elimination of input subsidies, * agribusiness export development, and * reform SARH's budget by reducing excess staff and increasing the number and salaries of extension agents and by better balance between current and capital expenditure cuts.10 2.5 The first preparation mission ran from July 10 to July 25, 1986 and had 7 staff members. It found that there had already been substantial reforms of agricultural and food policy. At its conclusion, in addition to the reform program, which was close in content to the list of possible reforms suggested in July 1985, the mission proposed that the AGSAL finance the following components:I * imported agricultural inputs (fertilizer, chemicals, pesticides, seeds machinery, agro-industrial * inputs, storage and transport equipment), * studies to improve the efficiency of CONASUPO and its affiliates, * studies of small investments in rehabilitation and maintenance of irrigation systems, * sector studies and generation of data and statistics pertinent to the agricultural sector, and * monitoring and evaluation studies of agricultural policy reforms.12 The mission was expected to return to Mexico in October 1986 to appraise the loan. In the interim (between August and October 1986), an Initiating Memorandum (IM) was to be prepared. The loan was to be ready for Board presentation in early 1987. 2.6 Whether AGSAL I would deal with the agricultural sector in a comprehensive manner or be limited to some key issues was yet to be determined. An internal Bank memo mentioned that while trade liberalization in agriculture was indeed a GOM objective, it had to be coordinated with removal of other policy distortions in the sector (producer subsidies, input subsidies, 10. Letter from senior economist, LCIMX to Chief, LClMX, July 24, 1985. In addition some staff thought that AGSAL I could respond to two key Mexican concerns: (a) the loan could be used to finance small-scale projects in place of big full-scale investment projects and (b) avoid loan cancellation because of slow disbursement for non- project reasons. In March 1986, the GOM asked the Bank to draft a 6-7 page note on what the Bank considered as the issues in agriculture that might be addressed in future lending operations (Letter from Acting Chief. LC IMX to Chief, LCPAC, March 3, 1986). No "6-7 page note" was in the files. I 1. BTOR, "Agricultural Sector Reconnaissance Mission", August 4, 1986. Before this mission, an informal discussion between the Chief, LCPAC and the GOM took place as part of "Mexico and Peru: Pipeline Discussion", TOR from Assistant Director, LCP to Chief, LCPAC, March 3, 1986. No BTOR in the files. 12. The heavy emphasis on studies reflects the Bank's weak base in agricultural sector work on Mexico at this time. 24 consumer subsidies, price controls, marketing distortions, credit controls, etc.). It was also recognized that the AGSAL would have a major role to play in the overall country strategy. Nevertheless, it was suggested that AGSAL I need not address the broader question of reaching an agreement with the GOM on how to address the major issues in Mexican agriculture. The memo also stated that "[t]here will be plenty of money to lend to Mexico over the next three years, but we will be under great pressure to lend big and at the same time show really meaningful contributions to basic policy reform."14 Since 1988 was an election year and the GOM would be unwilling to undertake major reforms, the idea (as can be inferred from the letter) was: (1) to go ahead with a quick undemanding operation (to be approved before Mexican elections took place) and (2) later set up a more demanding operation which would include marketing deregulation, price decontrol, trade liberalization, and other subsidy reductions. 2.7 The second preparation mission arrived in Mexico on September 21, 1986 (two staff members, two weeks) primarily to review the GOM's statement of agricultural policy and strategy that would be submitted to the Bank in support of the AGSAL and to review the proposed 1987 budget for SARH.15 2.8 A pre-appraisal mission followed in October 1986 (7 staff members). A second pre- appraisal mission followed a month later (November 5 to 21, 1986, 7 staff members, including one who concentrated exclusively on the sugar sub-sector.)17 Besides discussing the data base for the sector analysis and assessing the reforms already underway, the second mission was to help complete preparation cf the GOM's agricultural policy statement. The statement was to cover wide areas of policy reform including food subsidies, trade liberalization and inter- ministerial coordination. The mission recognized that little progress had been made on the content of the policy statement. SARH informed the mission that the policy letter had yet to go to the President and the Cabinet. The TM noted that "Although I have no direct evidence of problems as yet, the process of timely loan preparation and appraisal is already at risk." 2.9 A month later a third pre-appraisal mission took place (December 12 to 17, 1986, two staff members) primarily to review the draft agricultural policy statement and to continue to seek common ground on the conditions of the proposed loan. The tranching issue was also discussed. As the BTOR stated: "Given the additions to the conditionality and the political considerations because of the coming elections, a single loan of two tranches is more feasible. In this case the loan amount should be increased to US$500 million." The mission again found that little progress had been made in the policy statement. The preliminary draft furnished to the Bank 13. Memo from senior economist, LC IMX to senior agricultural economist, LCPAC, September 12, 1986. This letter was in response to a memorandum (circulated on August 6, 1986) regarding AGSAL I preparation. The memorandum was not in the files. 14. The pressure for lending to Mexico was also confirmed by a staff member who stated that: "There was a target lending volume for Mexico, which had to be made." Another staff member noted: "There had been agreed lending targets between top Bank management and GOM officials. Yes, I guess there was pressure to lend, but I didn't feel it." Interviews, November 9, 1994. 15. TOR, "Mexico - Preparation of Agricultural Sector Loan and Discussion on Public Investment Budget in Agriculture", September 12, 1986. No BTOR was found in the files. 16. No BTOR of this pre-appraisal mission was in the files. 17. BTOR, "Agricultural Sector Loan, Pre-Appraisal", December 4, 1986. 18. BTOR, "Mexico - Agricultural Sector Loan", December 24, 1986. 25 was very general and without specific timetables. Although the GOM had devised a reform program for the sugar industry, it was reluctant to share the details of the program with the Bank. For trade liberalization, SARH proposed that it would remove import licenses for most agro- industrial products. But import of basic commodities (maize, oilseeds, sorghum, wheat, milk products, rice, and beans) would remain subject to administrative control. Although the mission and SARH discussed liberalizing the prices of 20 products by substituting a procedure whereby companies need only register price changes, the mission anticipated resistance to the proposed liberalization from the Ministry of Trade. The discussion on fertilizer subsidies was dropped as this was "best handled by the fertilizer missions."19 2.10 On January 27, 1987 a Bank meeting to discuss the draft of the IM took place. Most of the reform measures proposed in the IM later became part of the loan conditionality package These are described below along with the additional measures introduced during negotiations. For evaluation purposes implementation of this "negotiation package" is also considered the proiect objectives of AGSAL I.20 * Food Assistance Program. The GOM should implement a food assistance program which would include: (i) funding (about $250 million equivalent in real terms) sufficient to meet the needs of the low income population resulting from the reduction, during the period 1983 through 1986, of global food subsidies (added at negotiations, see paras. 2.21 and. 2.22(a)), (ii) eligibility criteria to ensure that such food assistance is targeted to low- income populations, (iii) plan of action for a nutritional monitoring program in both rural and urban areas, (iv) tortibono prices for tortillas to the price level of maize in order to maintain the subsidy per recipient in real terms at levels no higher than those existing as of the expected effective date of AGSAL (added at negotiations, see paras. 2.21 and 2.22(a)),21 and (v) a pilot program of food assistance to low-income populations in rural areas. 19. A Bank staff member said that the fertilizer loan was initially supposed to be part of AGSAL I (interview, November 9, 1994). This point, however, was never mentioned in the AGSAL I files. 20. In the case of Mexico, the legal structure of Bank lending is different from other countries. The Loan Agreement is signed between the International Bank for Reconstruction and Development (the Bank) and Nacional Financiera, S.N.C. (the Borrower). On the other hand, the Guarantee Agreement is signed between the Bank and the United Mexican States (the Guarantor). This is the reason why in most cases reference is made to Guarantee Agreement (GA) rather than Loan Agreement. 21. Tortibonos are coupons issued to consumers allowing them to purchase tortillas (maize cakes) at subsidized prices. In November 1990, the tortibono program was replaced by the tortivalles program. This program along with the LICONSA one, i.e. the social supply of milk, were for the urban poor. In 1988, the LICONSA and tortibono programs were reaching 2 and I million families (or 50 percent and 25 percent of the number of urban families with income below two minimum wages). The families could save, respectively, US$90 and US$105 per year (PR of AGSAL II, Annex 6). 26 * Parastatals. The GOM should reduce the role of parastatal enterprises in the agricultural and agro-industrial sectors by: (i) limiting transfers to CONASUPO for operating losses during FY88 to less than US$85 million excluding transfers for food assistance programs to low- income populations, investment, and debt service (added at negotiations, see paras. 2.21 and 2.22(b)), (ii) submitting a budget for FY89 to limit transfers for operating losses to CONASUPO to no more than USS85 million, (iii) making CONASUPO and its affiliates responsible for all food subsidy programs, (iv) closing, or relocating to low-income areas, 500 retail food outlets operated by DICCONSA (the retailing affiliate of CONASUPO), (v) liquidation of TRICONSA (the wheat processing affiliate of CONASUPO), (vi) selling or closing 15 parastatal enterprises in the agricultural sector, and (vii) selling or closing six sugar mills. * Studies. The GOM should carry out studies on: (i) expansion of the nutritional program to buffer the impact on low-income populations of the GOM's macroeconomic adjustment program and of nutritional monitoring in both rural and urban areas, (ii) the guarantee price system in Mexico, including pan-territorial and pan- seasonal pricing, and use of variable tariffs to promote price stability, (iii) sugar pricing policy, including cane, f.o.b. mill and consumer prices, so as to reduce subsidies and promote greater efficiency in the agricultural sector, (iv) a system of water charges for irrigation designed to cover operation and maintenance costs. * Guarantee Prices and Quantitative Restrictions. The GOM would also: (i) adjust, monthly during 1988 and in accordance with the terms of Pacto de Solidaridad Econ6mica (PSE), the guarantee prices for agricultural crops, in order to maintain such prices in real terms, at the prices prevailing on March 1, 1988,22 22. The Economic Solidarity Pact (PSE) was an agreement among businesses, labor, and government that called for accelerated structural reform, further tightening of fiscal and monetary policy, a freeze on minimum wages and basic public and private sector prices, and on the nominal exchange rate against the U.S. dollar. The PSE was renewed in 1988 and then again in 1991 under the names PACTO and PECE. 27 (ii) after December 31, 1988, make adjustments in the guarantee prices for wheat, rice, sorghum, soybeans, sunflower, seeds, cotton seed, sesame seed, copra and barley to hold their prices between 10 percent below and 25 percent above of their international prices (modified at negotiations, see paras 2.21 and 2.22(d)), (iii) avoid export controls and other QRs on fruits and vegetables, except for hygienic or health reasons, (iv) eliminate QRs on imports of agro-industrial products corresponding to 5 percent of total national production as calculated on November 30, 1986, (v) eliminate CONASUPO's monopoly for imported milk powder (this condition was dropped at the final PR review meeting, see para 2.20). Agricultural Investment Budget. The GOM would: (i) establish procedures to simplify the disbursement of loans in support of agricultural investments from international agencies, (ii) submit to its Congress a FY89 budget for agriculture which exceeded the FY88 agricultural budget by the equivalent of US$200 million in real terms. The IM proposed two tranches: US$300 and US$200 million and the loan was to be ready for Board presentation in early FY87. The loan amount, however, was reduced twice: at the first PR meeting (to US$400 million, because of the improved foreign exchange position of Mexico, see para. 2.20) and at negotiations (to US$300 million because the GOM did not accept the Bank's position on guarantee prices see para. 2.22). 2.11 Following review, on March 27, 1987 the Loan Committee approved the IM (subject to some minor revisions).23 In the approval memo, it was recognized that, although the GOM had demonstrated commitment to reforms by actions already taken, the operation entailed the risks that the Bank would not be able to successfully negotiate all of the complex and politically sensitive reforms covered in the IM. The memo also recognized that the agreed reforms required the support and cooperation of five government ministries and of several parastatals. It concluded that the Bank must be ready for compromises. From Appraisal to Approval 2.12 The first appraisal mission (April 6 to 15, 1987, three staff members) concentrated on: (a) completing the agreements on policy reforms proposed in the IM; (b) revising the agricultural policy statement drafted by the GOM to make it compatible with the with the agreements; and (c) drafting TORs for several studies required by the proposed loan.24 23. "Minutes of the Loan Committee", April 3, 1987. 24. TOR, "Mexico - Agricultural Sector Adjustment Loan", April 4, 1987 and Interim BTOR, "Mexico - Sectoral Sector Adjustment Loan", April 23, 1987. 28 2.13 The intramural Mexican reaction to the program was mixed. DICCONSA (a subsidiary of CONASUPO responsible for the food retail outlets) as well as SARH agreed to support the freeing of price controls in the rural stores in exchange for a well targeted food coupon program, although TRICONSA, the wheat processing subsidiary of CONASUPO and most of DICCONSA's stores would be closed. The Ministry of Trade and Industry (SECOFI) was against it because of high political costs. SECOFI was also very reluctant to substitute tariffs on basic commodities for QRs. Finally, while there was agreement on the policy statement, elimination of consumer price controls appeared to be a difficult issue. It is noteworthy that, throughout appraisal, SARH was supporting the reforms, while SECOFI was resisting them. An explanation for this may have been the fact that under AGSAL I funds going to SARH would increase while funds going to SECOFI were to decline. 2.14 The three-week second appraisal mission (May/June 1987, 7 staff members) covered the entire program. But it concentrated on (a) the proposed food coupon program and nutrition monitoring system to "determine the Government's willingness to implement a targeted, socially acceptable, and well administered food coupon or other targeted nutrition intervention and to coordinate it with a reduction in consumer price controls" and (b) in conjunction with the fertilizer appraisal mission, the effects of raising fertilizer prices on fertilizer use and yields. Upon return the mission was to prepare the President's Report (PR). 2.15 After the mission, two difficulties resulting from the forthcoming elections remained: (a) eliminating consumer price controls and (b) closing sugar mills. The government was reluctant to lift consumer price controls and did not want to publicize the number of mills to be closed (at the outset, six sugar mills were closed). There were also delays in completing the policy letter because of the difficulties in coordinating the views of five ministries. The GOM promised that they would finish the policy letter, send it to the Bank for comments and get approval by the Ministries and perhaps by the President.25 2.16 Progress at this stage was slow because the Bank's 1987 reorganization left the Agriculture Operations Division without an economist and one of the two task managers (TMs) of AGSAL I transferred elsewhere in the Bank. To compensate, the staff who had originally participated in the preparation of AGSAL I came back for short assignments while the new TM, an economist, became acquainted with the operation and the Mexican economy (PCR I, para 59). 2.17 A third two-week appraisal mission (July 12 to 24, 1987, 3 staff members; the new Division Chief joined the mission during the second week) concentrated on the policy letter and 26 the TORs of the technical studies. The mission agreed with the GOM that instead of a lengthy policy paper, which would delay further processing of the loan, a one- or two-page letter that would set out the GOM's intention in several key areas would be more appropriate. This letter was to be supplemented by a matrix setting out specific actions the GOM would take to achieve its objective. Upon return to Washington, the mission recommended that the Bank proceed with processing of the loan. 25. BTOR, "Mexico - Agricultural Sector Adjustment Loan", May 20, 1987. 26. TOR, Chief, LCPAC to mission members, LCPAK, June 19, 1987 and TOR, Director, LA2 to Chief, LA2AG, July 16, 1987. Also BTOR, "Mexico - Proposed Agricultural Sector Adjustment Loan Appraisal Mission", August 5, 1987; attached is an Aide Memoire with a modified conditionality timetable for AGSAL I. 29 2.18 The final pre-negotiations mission went to Mexico in September (September 20 to 25, 1987, 3 staff members) to reach agreement on the second tranche release conditions, including steps to monitor the legal agreements.27 Nevertheless, complete agreement on the policy statement was still not achieved. 2.19 Although discussions with the GOM regarding the policy statement were still under way, it was decided to review the yellow cover draft of the PR at a meeting on October, 7, 1987. The Agriculture Division Chief of the Technical Department endorsed the loan, but was concerned that the loan did not address land tenure constraints (para. 1.7). The meeting noted that this loan was only the first step in what was to be a long-term effort to reform the sector.28 The Economic Advisory Staff (EAS), however, raised a number of questions:29 The macro-economic case for a $500 million adjustment loan at this time has not been made (the reference to the medium-term balance of payments prospects in Annex 6 [of the PR] is not sufficient); the sectoral case is also unclear. The main issues are: Has the Mexican Government really undertaken far-reaching reforms? Does it really have a medium-term vision that deals with what we think is necessary? Are the second Tranche conditionalities meaningful (or should the most important ones be conditions for Board presentation, given the political risks)? We would add: Do we really know what Mexican policies have been and how they have worked? No serious sector work has been produced on Mexican agriculture for a long time (at least five years); a document like this SAR [sic] is not the most convenient one for in-depth presentation and review of the analysis of sector issues.30 These objections had little impact. 2.20 The main decisions reached at the PR meeting were:31 * Reduction of the loan from US$500 to US$400 million (because of the improved foreign exchange position of Mexico). * Inclusion of a freestanding US$10 million Technical Assistance Loan (TAL) to support the policy reforms supported by AGSAL I (it was later dropped). * Given Mexico's high rate of inflation, a condition was added to link the nominal price of tortilla food stamps (tortibonos) to the nominal price of tortillas; revise the criteria for eligibility of this program in line with recommendations of the appraisal mission; expand the targeted food assistance program on a pilot basis to rural areas; study expansion of targeted programs, other than food stamps. 27. TOR, "Mexico: Agricultural Sector Adjustment Loan", September 21, 1987. No BTOR found in the files. 28. Office Memorandum, Chief, LATAG to Chief, LA2AG, September 30, 1987 29. Office Memorandum, Advisers, EAS to Chief, LA2AG, October 6, 1987. 30. It appears that these objections did not affect on loan processing or content. 31. Office Memorandum, Acting Vice President, LAC to Senior Vice President, SVPOP, November 12, 1987 and Office Memorandum, Acting Director, LA2 to Acting Vice President, LAC, November 23, 1987. 30 * The condition to eliminate CONASUPO's legal monopoly in the market for imported milk owder was dropped due to Mexico's dominance in world trade in dried milk. 2 Removal of export controls were retained for meat but dropped for basic grains which would remain under guarantee prices. 2.21 Negotiations started on December 14, 1987. Differences in four key areas (food assistance program, role of parastatals, export controls, and price controls) between the GOM delegation and the Bank could not be resolved and they were suspended on December 18, 1987. Following the suspension, the new management of the Agriculture Division expanded the loan in several important ways. In a memo that circulated between the first and second phase of negotiations, the Division insisted that the Bank should continue to emphasize that the historical 33 urban bias in pricing policies must be removed to restore efficiency in the agricultural sector. Later the Division added two conditions to the package: (a) farmgate prices of the five major commodities must be raised to offset inflation and maintained at parity with international prices34 and (b) export controls on beef must be removed. Furthermore, the following conditions were modified: * General food subsidies should not be allowed to increase. * Export controls must not be expanded to agricultural or agroindustrial products not currently covered by existing programs. * Other food subsidy programs must be well targeted. * Studies on pricing policies must be carried out under appropriate TORs. * The loan amount should be reduced to US$300 million, with US$100 million in the first tranche and US$200 million in the second tranche, which could be made available in January 1989. This tranching was to provide leverage throughout the election year of 1988 to ensure that the conditions were met and sustained. 2.22 Negotiations resumed on February 16, 1988 and agreement was reached on all outstanding points. (a) Food Assistance Program. The Mexican delegation had stated earlier that the GOM could not make commitments to fund a food assistance program, perhaps because of budget constraints from the macroeconomic stabilization program. Furthermore, the GOM could not agree to link tortibono values to market prices of tortillas as such linkage would have been "impractical" at this point in time. The delegations now agreed that the funding for "well-targeted food subsidies" 32. Mexico is a large importer of powder milk and has monopsonistic power in the world market. CONASUPO, being the only legal importer for Mexico, is able to exercise such monopsonistic power and "get better deals" as a CONASUPO official noted. 33. Office Memorandum, Chief, LA2AG to Director, LA2, December 31, 1987. 34. Given that (a) 1987-88 had been a high inflation period and (b) guarantee prices were adjusted only once a year, a commodity whose producer price appears to have been close to border price on average (Table 1) may in fact have been highly taxed in certain months. 31 would exceed US$250 million. It was also agreed that tortibono prices for tortillas would be linked to the price of maize. (b) Role of Parastatals. Initially, the Mexican delegation had stated that the GOM could not agree to limit the transfers to CONASUPO to cover operating losses to any specific figure, since it did not know in advance how much intervention would be required to fulfill CONASUPO's role as regulator of the market. At the second phase, the two sides agreed on a formula to calculate the transfers. The operating losses of CONASUPO were calculated as US$173.8 million in 1986, US$215.1 million in 1987 and projected at US$84.9 million in 1988. The cap for 1988 was, therefore, set at US$85 million. (c) Export controls. At negotiations in December 1987, the Mexican delegation had stated that the GOM could not agree to remove export controls on meat, since this issue was being discussed in Mexico. In the second phase the GOM agreed to remove export restrictions on high quality cuts of beef and high quality rice as well. (d) Price controls. Earlier, the Mexican delegation insisted that the GOM could not agree to any reduction or elimination of the strict price controls on basic consumer commodities since protecting the consumption levels of lower income groups was an important part of Government policy. In the second phase it was agreed that the guarantee price system would be maintained at least at 1987 levels in real terms in 1988, while in 1989, the prices of all guarantee crops except corn and beans would be set within a band of 90 percent to 125 percent of world prices adjusted for processing, transportation costs and quality differences. Finally, it was agreed to reduce the loan from US$400 to US$300 million.35 It was also understood that a larger loan would follow AGSAL I to help maintain the momentum of reforms in the sector. The reduction of US$100 was made in the first tranche of the loan. 2.23 Before Board presentation, an economic mission of the Country Operations Division had examined Mexico's macroeconomic framework and concluded that it was sound and should not delay the effectiveness of the loan.36 The Board approved the loan on March 15, 1988. The 11 Executive Directors (EDs) who spoke all supported the loan and praised the food security component and in particular the targeted food subsidies. Two EDs indicated that the retroactive financing of US$60 million was inconsistent with the spirit of adjustment as it looked more like straight balance of payments support. Management responded that retroactive financing was within the permissible norms as it covered expenses incurred after the appraisal mission. Furthermore, the GOM had taken several steps in support of the loan objectives before appraisal. One ED thought that the 90 percent-I 25 percent price band was too wide. Management responded that the price band would stabilize prices by offsetting the extreme price fluctuations in world markets. The loan was approved unanimously. 35. Office Memorandum, Vice President, LAC to Acting Senior Vice President, SVPOP, February 22, 1988. 36. Office Memorandum, Senior Country Economist, LA2CO to Acting Chief, LA2CO, March 15, 1988. Attached is the BTOR of the economic mission (March 4, 1988) as well as questions and answers on economic issues raised at the Board Presentation meeting. 32 Effectiveness through Closing 2.24 The following day AGSAL I became effective (March 16, 1988). The first tranche was to be disbursed in two parts: US$25 million upon effectiveness and US$75 million after agreeing on the TORs of studies that would establish the basis for further trade and price reforms.37 2.25 To fulfill the requirements for the second part of the first tranche, the Mexican delegation submitted TORs for studies of the guarantee price system and the sugar industry. The Bank concluded that they were inadequate. They would recommend modifying the existing systems without significantly changing the basic pricing structure.38 An economist from the Bank's International Economics Department was sent to Mexico to help the GOM draft new TORs.39 Subsequently, the Bank helped the GOM identify the consultants who would carry out the sugar study. On August 4, 1988 GOM forwarded to Washington the TOR for the study of the guarantee price system. Review by the Bank indicated that the TOR did not cover specific issues in the GA. Hence, they were rejected again. 2.26 The second supervision mission (September II to 15, 1988, two staff members) discussed the TORs for both price studies.40 No agreement was reached in part because of lack of agreement within the Government on what to cover in the studies. Furthermore, the group that was responsible for drafting and negotiating the TORs lacked authority to make substantive decisions. 2.27 The mission found that monthly adjustments to guarantee prices to offset inflation as called for in the GA were not made because of price freezes required by the stabilization program. Moreover, selecting the right price index to use in maintaining real guarantee prices at the 1987 levels was problematic as each group within the administration selected the index that best promoted the interests of the administrative branch it represented. GOM's transfers to CONASUPO were within the agreed limits and thus in compliance with loan conditionality. Conditionality on remaining export controls was also met. On November 3, 1988, the GOM sent the TOR for the guarantee price study and on November 8, 1988 the GOM was notified that all first tranche release conditions had been completed. 2.28 The TOR of the third supervision mission (February 1 to 5, 1989, one staff member) assumed correctly that most second tranche conditions remained unfulfilled.41 The mission identified the following problems. 37. One peculiarity of AGSAL I was the spilt of the first tranche into two sub-tranches. The PR of AGSAL I (p. ii) noted: "The first US$25 million of the first tranche (US$100 million) would be available upon effectiveness, with first tranche disbursements thereafter contingent upon removal of export controls on exportable rice and quality cuts of beef and agreement on TORs for certain studies, discussion of which is a second tranche release condition." 38. Office Memorandum, Senior Economist, LA4AG to Portfolio Manager, LA2AG, April 14, 1988. 39. BTOR, "Report on Sugar Pricing Discussions and Drafting of TOR for Sugar Pricing Study with Mexican Officials", June 13, 1988. 40. TOR, "Agricultural Sector Loan September 9, 1988 and BTOR, "Agricultural Sector Loan - Supervision Mission", September 23, 1988. A subsequent Office Memorandum (October 5, 1988) attached Form 590. 41. TOR, "Tasks for Your Supervision Mission for AGSAL", January 30, 1989. Preliminary Supervision BTOR, "Mexico - Agricultural Sector Loan", February 8, 1989. Also Office Memorandum, TM to Acting Chief, LA2AG, March 3, 1989. 33 * The 90 percent- 125 percent price band had been exceeded for sorghum and rice while the 1988 prices of rice and soybeans were 50 percent-60 percent below international prices. * Guarantee prices were not adjusted monthly to keep up with inflation. * Preliminary data indicated that CONASUPO's budget transfer for FY88 was to be US$113 million, that is, US$38 million above the cap specified in the GA. * The studies of water-user charges, the guarantee price system, and the sugar sector had not started. Only the nutrition study had started. * The 1989 budget increase to SARH for agricultural investments was below the agreed US$200 million target. * No adjustment in tortibono values to tortilla prices had been made. * The pilot program of targeted food assistance had not yet been introduced. Following the mission, the TM had three key recommendations. (a) Since the discrepancy between the agreed and actual investment budget was very small, the Bank should consider this condition as fulfilled. (Later, the actual allocation fell far below the agreed target.) (b) The monthly adjustment of guarantee prices was to protect farmers against high inflation. Because inflation had been reduced enormously, the condition was considered fulfilled (provided prices remained within the 90 percent-125 percent c.i.f. band).42 (c) Further examination was needed as to why transfers to CONASUPO exceeded the amount agreed upon. Finally, it seemed likely that the GOM would ask for an extension beyond the March 31, 1989 deadline for completing the studies.43 2.29 On the positive side, the National Water Commission (CNA) was studying the possibility of increasing water-user charges to generate US$160.4 million annually of which US$150 million would be allocated to investment in agricultural projects. Under this scenario the requirement to increase the budget for agricultural investments would have been fulfilled. (This, however, never materialized). Most of the guarantee prices during 1988 were close to international ones. Fifteen parastatals of SARH had been closed. The nutrition study had been completed, while the studies on guarantee prices, sugar sector, and irrigation water-user charges had started.4 2.30 The Bank accepted that the following changes be made in the program of reforms. (a) Accept GOM's offer to concentrate the study of water-user charges in two states rather than in the entire country. (b) Make semi-annual adjustment of guarantee price changes instead of monthly 42. In 1987 the annual inflation was 159 percent while in 1989 it dropped to 20 percent. 43. The concerns regarding AGSAL I implementation were communicated from the Director, LA2 to the Minister of Finance (SHCP), May 3, 1989. 44. Guarantee prices (levels, band, and study) seemed to have been the main reason for the slow implementation of the operation. The GOM was very reluctant to deal with this issue in a straightforward manner. A mission was sent to Mexico in June 12-15, 1989 to discuss (again) the guarantee price system (i.e., comparison of domestic with international prices). 34 as agreed in the GA. (c) Accept the low increase in the agricultural investment budget.45 Modifications (b) and (c) were acceptable because of the requirements of the ongoing stabilization program. 2.31 On August 25, 1989, the studies on the sugar sector and guarantee prices were delivered to the Bank along with a promise to deliver the study on water user charges by the end of September. The Bank reviewed the guarantee price study and concluded that it did not fulfill the 46 TOR. The study was rejected and the GOM was asked to carry out a new one. 2.32 The final supervision mission took place in September 1989 (September 17 to October 7, seven Bank and four FAO staff members).47 Initially it reviewed progress on the second tranche release-conditions. The mission concluded that only the conditions regarding the guarantee price study, the 90 percent-125 percent price-band requirement and water-charges study remained unfulfilled. The nutrition study was accepted. The Ministry of Finance (SHCP) took over the guarantee price study. With respect to holding the guarantee prices within the c.i.f. band, the GOM proposed to replace them by precios de concertaci6n or "prices agreed between producers and industrial consumers with government acting as a broker". The Chief of LA2AG later expressed major reservation regarding the replacement of guarantee prices by precios de concertaci6n (letter of November 8, 1989). A new closing date of March 15, 1990 was recommended to permit completion of the unfulfilled conditions. The extension was granted; however, two conditions remained unfulfilled: (a) three commodities remained outside the 90 percent- 125 percent band and (b) the allocation of funds for agricultural investment for 1988 did not meet the US$200 million increase target. The Bank finally accepted the precios de concertafi6n as part of fulfilling condition (a) and because the 1989 budget exceeded the 1988 target the Bank accepted condition (b). 2.33 Second tranche release was approved on March 15, 1990, a year behind the original 48 schedule. At GOM's request, US$175 million of the $200 million released was reallocated by the Bank to support Mexico's debt reduction agreement with the commercial Banks. The loan was fully disbursed in August 1990. Performance in Achieving Loan Objectives 2.34 Food assistance program exceeded targets. Expenditure on the targeted food assistance programs reached US$456 in 1988 (the project goal was US$250 million), although the eligibility criteria of food assistance programs had been tightened to exclude high-income consumers. A pilot food assistance program in rural areas operated successfully. Linking the prices of tortibonos and tortillas was unnecessary as tortilla prices were not increased during the stabilization program. 45. Office Memorandum, Chief, LA2AG to Director, LA2, June 8, 1989. 46. Office Memorandum, Chief, LA2AG to Director, LA2, September 14, 1989. 47. TOR, "Travel to Mexico" September 14, 1989 and BTOR, "Mexico - Agricultural Sector Loan", October 25, 1989. 48. Office Memorandum, Director,,LA2 to Senior Vice President, OPNSV, March 8, 1990. 35 2.35 Parastatals divested on schedule. In 1988, the transfers for operating losses to CONASUPO were less than US$80 million. Furthermore, transfers for losses in 1989 were no more than those of 1988. Food subsidy programs were all administered by CONASUPO. The 500 DICCONSA retail outlets were either closed or relocated to poorer areas. TRICONSA was liquidated. Finally, the 15 agricultural parastatals and six sugar mills were closed. 2.36 Sugar, irrigation and nutrition studies completed satisfactorily. The Bank accepted the second draft of the sugar study in October 1989. After several delays, the GOM furnished the Bank a study that included an action plan for financing O&M irrigation costs by water users in two states, although the study was supposed to have covered water charges throughout Mexico. The nutrition study was accepted by the Bank in May 1989. (This study was the only one which was delivered without problems.) 2.37 Quantitative restrictions reduced more than the tranche condition required. The percentage of agricultural and agro-industrial output protected by QRs fell from 18.3 percent in 1986 to 13.2 percent in 1988. The percentage of GDP protected by QRs declined from 46 percent in 1986 to 20 percent in 1989. The export controls on high quality rice and beef were removed. QRs on exports of fruits and vegetables were not introduced. 2.38 Guarantee prices maintained near their average real level of 1987. During 1988, nominal producer guarantee prices were to be increased monthly so as to maintain their real levels at prices prevailing on March 1, 1988. Such adjustment was needed because Mexico's high inflation rate (almost 160 percent in 1987) was expected to persist in 1988 and later. This requirement was eliminated by the stabilization program. In the later stages of project implementation, annual inflation had dropped to about 20 percent, and the failure to adjust prices monthly implied a lower decrease in real value than would have been the case under "normal" inflation. Furthermore, if the GOM had adjusted guarantee prices in line with this condition, some producer prices would have moved out of the 90 percent-125 percent band because of the exchange-rate freeze during this period.49 2.39 Prices were not always maintained within a band of 90 percent-125 percent of import parity prices. Producer prices for the commodities for which import permits were eliminated by 1989 - sorghum, copra, sunflower, sesame, and seed cotton - remained within the band. Prices of the following three commodities exceeded the 125 percent ceiling. (a) Soybeans. Import permits for soybeans were not eliminated immediately. Their prices rose to about 60 percent above international prices by 1989. In mid-1990 the import permits for soybeans and soybean products were eliminated and the prices fell within the band. (b) Barley. While the price of barley stayed within the band in 1989, following second tranche release it reached twice the import parity price by the end of 1990, far above the maximum price of the band. The PCR notes that the failure to maintain this condition after compliance may have been partly due to the reluctance of the brewing industry (which established the precios de concertaci6n with the barley growers) to import at lower prices. 49. PCR I, para 31. 36 (c) Whcat. Prices of wheat stayed within the band in 1988 and 1989, despite QRs. But declining world prices during 1990 and the continued use of QRs led to prices above the band. A year after second tranche release, wheat prices were 40 percent above world prices.50 2.40 Price liberalization in lieu of the study ofguarantee prices. The main purpose of this study was to encourage discussions concerning the price system and trade regime. In August 1988, after several delays in formulating the TOR, the first draft of the TOR was rejected by the Bank. A draft of the study itself was rejected in August 1989 for not satisfying the agreed TOR. The Bank accepted elimination of guarantee prices and removal of many quantitative restrictions on foreign trade plus intensive discussions of the guarantee price system with Government in lieu of the study itself as having met the objectives of this condition. 2.41 Agricultural investment. Second tranche release conditions required that the proposed 1989 budget ex.;eed the 1988 budget by US$200 million. The 1989 budget only exceeded that of 1988 by US$82 million because of the stabilization program which the Bank agreed took precedence over the AGSAL I covenant. In 1990, however, the GOM exceeded the conditionality of the previous year as it increased the budget allocated to agriculture by US$315 million. 2.42 AGSAL I was a successful operation. It achieved its project objectives of supporting reforms in prices, trade, public investment, poverty alleviation, fiscal transfers, and the role of parastatals. Although the costs of reforms were borne mostly by consumers, the impact on the poor was softened through the targeted food subsidies. The agricultural economy moved close to a market-pricing system. Arbitrary and costly trade restrictions were abandoned. 50. Both barley and wheat prices were subject to AGSAL II conditionalities. 37 3. Preparation, Implementation, and Outcome of AGSAL II Objectives and Preparation 3.1 AGSAL II was part of a program of Bank support to the Government's objectives of (i) increasing the rate of growth of agriculture by improving the efficiency of the agricultural sector through better functioning output and input markets and (ii) alleviating the poverty of the most 51 vulnerable population groups through targeted food programs. 3.2 These objectives were to be achieved through: (a) implementation of trade and other policy reforms to reduce the Government's role in the production, planning, marketing, storage, and processing of agricultural products and inputs and to encourage more competition from the private sector, (b) revision of the allocation of government expenditure in consumer programs by eliminating generalized food subsidies and increase spending for targeted assistance and nutrition programs, (c) changing SARH's role in agriculture to emphasize policy formulation and basic regulatory functions.52 3.3 Early AGSAL II preparation coincided with AGSAL I implementation. Following an identification mission (May 31 to June 3, 1989, one staff member), an "Issues Paper for Agricultural Sector Loan II" was circulated in July 1989. 5 The paper drew on the aide memoire of the initial mission which, inter alia, provided a much needed clear and analytical description of the opcration of Mexico's food subsidy program, as suggested by this excerpt on food subsidies: Four categories of programs include more than 16 specific programs, but the tortibono program is the one with stronger ramifications to the rest of the economy because of its magnitude and the amount of interrelated subsidies in the maize industry. The tortibonos and maize-tortilla programs are really a set of programs that mix general and targeted subsidies, different target populations (corn producers and tortilla consumers), different target policy instruments (guarantee prices, maximum selling prices, fixed 51. The objective of "increasing the rate of growth of agriculture" received primary attention in the statement of objectives section of the Project Summary of PR II; however, it received less attention in the text (para 137): "AGSAL II is part of a program of Bank support to the Government's objectives of promoting efficient private sector development and increasing effectiveness of public sector institutions so as to enable the resumption of economic growth". The means of achieving the general objective of "increasing the rate of growth in agriculture" in this case are the policy reforms that received all the attention from loan signing to completion. At a lower level of abstraction these means become the specific objectives. 52. See statement of objectives in Program Summary, PR II, Report No. P-5520-ME, May 29, 1991. 53. TOR, "Mexico - Preparation of Agriculture Sector Loan II", May 12, 1989. No BTOR in the files. 38 prices and foodstamps) and differential subsidies by geographical area. ... The subsidy mechanism administered by CONASUPO is an extremely complex one. It sets a single national support price for corn, and then sets three different prices for CONASUPO's sales for corn (to flour and dough producers). The industrial producers in turn set two different prices each for dough and flour depending on the location. Finally the tortilla has three different prices. The issues paper became the basis for the draft IM that was discussed on September 15, 1989, six months before release of the second tranche of AGSAL I. The IM very tersely described both the problems surrounding agriculture and the food system and the complexities of Mexican agriculture in general. With the experience of slow implementation of AGSAL I, the TM noted that "... for this sector loan to take off, it is necessary to receive the full collaboration of the government agencies involved in the loan, particularly that of CONASUPO." The TM pursued this line in the first preparation mission (September 17 to October 7, 1989, seven Bank, three IDB, and four FAO staff members.) The mission was joint with the last supervision mission of AGSAL I (para. 2.32). 3.4 The Bank reviewed the IM on November 22, 1989. Few revisions were needed. The final version of the IM was also to discuss the environmental impact of the loan. There were to be no cross-conditionalities with other loans. careful attention was to be given to the phasing and sequencing of the targeted food subsidies. 3.5 A second preparation mission took place in December (November 27 to December 12, 1989, four Bank and six IDB staff members). The BTOR, and the Aide-Memoire, discussed the recent advances in policy reform the proposed reforms for AGSAL II, and steps to follow to preappraise the project. The BTOR stressed that there was no consensus on agricultural policy within the GOM. For this reason the Bank requested the Government to establish a clear policy position before the next mission. 3.6 The first pre-appraisal mission took place three months later (March 18 to 31, 1990, three Bank and two IDB staff members). The mission explained the link between the two parts of the reform program, i.e., agricultural growth and productivity and food consumption policy, and also suggested conditionality for each part.57 Agreement was reached concerning the growth and productivity component, but not on the food-consumption program. The GOM suggested breaking down the program into two operations: one dealing with growth and productivity, the other with food consumption. The mission, on the other hand, believed that the link between the two components should not be broken because: (a) the operation envisaged that the resources to finance the expansion of the targeted-food-consumption programs would come from the funds resulting from the elimination of general subsidies and (b) the impetus for reform would decline considerably if the components were separated. The mission further asked for a clear statement of Mexican food policy. It also anticipated presenting the loan to the Board by the end of 1990. The findings of this mission were conveyed to the Finance Minister. In a follow up communication to the Minister, the Bank again indicated its concerns about the food 54. Office Memorandum from TM to Acting Chief, LA2AG, July 26, 1989. 55. IDB co-financed AGSAL II with US$200 million. 56. BTOR, "Mexico - Agricultural Sector Loan II", December 19, 1989. 57. BTOR, "Mexico - Agricultural Sector Adjustment Loan 1l", April 13, 1990; also attached Aide-Memoire. 39 and nutrition component of the project in particular the substitution of targeted for eneral food subsidies and the uses of the budgetary resources that could be freed up as a result. 3.7 With the exception of price and trade policy for maize, beans, and sugar, broad agreement was reached on the productivity and growth component of the loan, in the second pre- appraisal mission (August 23 to 31, four Bank and three IDB staff members). For the first time, NAFTA formally came into the picture when it was agreed that elimination of import restrictions for agricultural products should be discussed within the NAFTA agreement. The food and nutrition component continued to meet resistance from the Ministry of Finance (SHCP), particularly since the Bank, sought an expensive program that would be implemented throughout Mexico. 3.8 In October 1990, the third pre-appraisal mission visited Mexico (October 2 to 17, two staff members).F Its objectives were to (a) participate in the preparation of the pilot nutrition and health project foreseen under AGSAL II; (b) reach agreement on the other outstanding issues of AGSAL II; and (c) help prepare a technical assistance loan (TAL) to support AGSAL II. It succeeded in achieving all of these objectives. The proposed TAL (US$27 million) would finance studies on plant protection, animal health, pesticide regulations, and would provide statistical information as well as the cost of a pilot nutrition project (except the cost of food supplements). The mission and the GOM developed a proposal for a pilot nutrition and health program to guide the expansion of the health sector's Programa de Nutrici6n y Salud (PNyS). The pilot program would involve 45,000 poor families and specifically target pregnant and lactating women as well as children under the age of 5. The average benefiting family would receive food equivalent in value to about US$140/year. The pilot was to be located in the states of San Luis de Potoci, Nueva Le6n, Tamaulipas, and Mexico.62 Although the mission and the GOM agreed on the details of the pilot program, the discussion that took place in the offices of the Director of the National Solidarity Program (PRONASOL) left the mission with doubts and several questions about the intentions of the Government in matters of food and nutrition policy. 3.9 The final IM review took place on November 13, 1990. Several participants thought that the reform program was too ambitious. Clarification was sought on the implications of Mexico's joining NAFTA. The Department explained that Mexico's trade liberalization under AGSAL II was consistent with NAFTA and Mexico "would be a more liberal regime than in most countries". In response to questions concerning the pilot nutrition project, the Department explained that "the GOM has designed an institutional and administrative mechanism which will 58. Letters from Director, LA2 to Minister of Finance, April 16 and June 18, 1990. 59. BTOR, Agricultural Sector Loan Il", September 17, 1990. The findings of this mission were also conveyed to the sub-secretary of SHCP, September 17, 1990. 60. The BTOR stated: "[T]hat before substantially expanding the nutrition and health program, [the GOM should] prepare and execute a pilot program to evaluate the procedures, operational viability and cost-effectiveness of the program. The pilot program would be designed before appraisal and be based on the operational capacity of the health system to implement it". 61. TOR, "Mexico - TAL for Pilot Nutrition Project and other AGSAL Studies Preparation Mission", September 28, 1990 and BTOR, "Mexico - AGSAL II: Pilot Nutrition and Health Project, Other Issues, and TAL", October 31, 1990. 62. There was some controversy regarding the location of the pilot nutrition project. A staff member noted: "We [the Bank] wanted to do the pilots in Chiapas and four Southern states and they wouldn't let us". Interview, November 9, 1994. 40 be tried first. If this is not effective, an alternative mechanism will have to be pursued." Finally, in responding to the suggestion to extend the disbursement period of AGSAL II in order to develop institutional capacity by including a third tranche, the Department explained that this would be better handled by an investment operation.63 3.10 The reform measures proposed in the final IM which supported AGSAL II's objectives (para. 3.2) later became part of the loan conditionality package as described in the Schedule of the Guarantee Agreement. The final conditions, whose achievement were also the prject Ojectives, are laid out below. A. Effectiveness Conditions * Issue a decree that improves present sugar cane payment arrangements. * Eliminate the export tax for raw cotton, cotton fiber, and breeding swine. * Eliminate the export permit for wheat, sorghum, livestock feed, soybean, barley, copra, cartamo, cartamo oil, seed cotton, tobacco and eggs. * Present a study which identifies the processes, legislation and regulations that give SARH and other Government entities the means and authority to establish, coordinate and enforce crop production targets. * B. Dated Covenants * Eliminate import permits for green coffee by September 30, 1991. * Based on the "production targets" study, present to the Bank, by September 30, 1991, a satisfactory plan of action to eliminate the processes, and regulations that enforce the system of crop production targets. * C. Second Tranche Release Conditions * Prices. (i) Allow the price of tobacco to be market determined; (ii) not increase the nominal protection of wheat above the level of May 1, 1991; (iii) liberalize the prices of cookies, pasta, edible oils, cigarettes, eggs, diary products, and beef, (iv) not increase the guarantee rice of maize above that of 1990/91 and not increase the domestic price of sugar above that of January 1, 1991; 63. Office Memorandum from Senior Operations Adviser, LAC to Files, November 15, 1990. 41 (v) not increase the price of barley through January 31, 1992 above 680,000 pesos per ton and not increase the price of barley for the following year above 714,000 pesos per ton; (vi) allow the prices of pesticides to be market determined. * Studies and Action Plans. The GOM should: (i) carry out a study on the beans market and agree on action plan recommending desirable price and trade policy; (ii) carry out a study on pesticide use in order to (a) describe current usage, (b) assess the legal and institutional framework, (c) recommend measures to promote competition between producers and distributors; and (d) establish guidelines for minimum standards of health, environmental safeguards, and quality control; (iii) carry out a study on the sugar sector and based on this study determine the policies to be applied to the sector (at negotiations it was agreed that the TOR were to be ready by Board presentation); (iv) carry out a study on the regulation, organization, and procedures for plant protection and for safeguarding animal health; (v) carry out a study on the best way to substitute competitive marketing for CONASUPO's monopoly on imports of dry milk products and its implementation. * Agricultural Budget. The GOM should submit an agricultural budget for FY92 "whose level and composition is consistent with GOM's macroeconomic policy framework and with efficient allocation of government resources at the sectoral level." * Market Liberalization. The GOM should eliminate: (i) crop production targets; (ii) CONASUPO's monopoly on imports of powdered milk and allocate import permits for powdered milk on a transparent and competitive basis; (iii) all export restrictions on fluid and powdered milk; (iv) all restrictions that prevent private-sector competition with the National Seed Production Company (PRONASE); (v) the monopoly of germplasm produced by the Agricultural Research Institute (INIFAP), (vi) restrictions on plant breeding by the private sector. 42 * Nutrition Program. The GOM should submit the following to the Bank: (i) an evaluation of the Pilot Food and Nutrition Program in accordance with a monitoring and evaluation (MES) Implementation Plan; (ii) an action plan for each department or agency participating in the implementation of the Food and Nutrition Program during 1993-94. From Appraisal to Approval 3.11 Bank and Government met in January 1991 to discuss the food and nutrition component. While the GOM was about to implement the pilot project for rural nutrition, it did not want to finance the costs of the program from a TAL as agreed earlier. It was also very reluctant to distribute low-cost food within Mexico's poorest states nor did it want a legal covenant requiring that a monitoring and evaluation system for all food consumption programs be established. It became clear from this meeting that the GOM was reluctant to go ahead with a nutrition program 65 that would cover the entire country but was willing to proceed with a pilot program. 3.12 Appraisal started in January 1991 (January 15 to 19, two Bank and one IDB staff member). The mission reached agreement on most of the program and its conditionality. The key issues to be resolved for the growth and productivity component were price and trade policy actions for maize, sugar, and wheat. There were also some problems identifying the executing agency of the food and nutrition component. Nevertheless, the mission expected the loan to be negotiated by April 1991. 3.13 The Gulf Crisis complicated matters. Oil prices went up sharply and Mexico's revenue increase from oil exports was expected to exceed the proposed AGSAL II loan of US$400 million. Since AGSAL II was no longer needed for balance of payments (BoP) support, the whole operation was in question. However, in recognition of the fact that the GOM had been engaged in a number of important reforms in the agricultural sector and that cancellation of the loan would undermine the continuity of the reforms, the Department decided that an "oil contingency repayment clause" should be added to the Loan Agreement. The contingency clause would accelerate repayment of the loan if oil revenues during the implementation period were such that BoP support could no longer justify an adjustment operation. This solution was favored over the alternative of canceling the second tranche which would have, allegedly, undermine the reform 67 effort. Before the loan was signed, however, world oil prices fell substantially and the clause was dropped from the Loan Agreement. 64. The TAL was later dropped from the package. 65. A staff member noted: "There is no adequate nutrition program for rural areas. In spite of all our pressure, we only got a pilot and an evaluation"; Interview, November 9, 1994. In another interview concerning both AGSALs (March 21, 1996), the same staff member commented "It was an uphill battle all the way ... AGSAL I was to open the door, AGSAL II was to make it [i.e. a national nutrition and health program] happen. We delayed it a long time and even had a cabinet meeting with the regional Vice President and all staff involved in the operation. The outcome was a pilot rural food and nutrition project." 66. BTOR, "Mexico - Agricultural Sector Adjustment Loan II", February 8, 1991. 67. Letter from Lead Economist, LA2C I to Chief LA2C 1, February 4, 1991. 43 3.14 Appraisal concluded in March 1991 (March 5 to 9, one staff member). The mission concentrated on the outstanding issues of maize, sugar, and wheat pricing policies plus the food consumption policy letter which had been sent to the Bank on February 21, 1991. Not much was achieved. The GOM argued that in view of ongoing GATT negotiations, the forthcoming negotiations of NAFTA, and the uncertain social impact of the agricultural sector reforms in the short term, Mexico could not commit to gradually phasing out the high protection levels of maize. The GOM could only agree to an upper limit to increases in guarantee prices. The sugar industry needed considerable protection to facilitate the heavy investment required for rehabilitation and modernization. The GOM, sugar cane growers, and sugar mill owners agreed on a domestic price policy rule leading to higher profits, since it guaranteed protection with producer prices at about 60 percent above world price levels. Because of the high cost of this rule, the GOM agreed to study the sector again to come up with a less costly support scheme. The GOM was to provide draft TOR of the study at the beginning of negotiations; final agreement on the TORs was to be reached prior to board presentation. Finally, the high rate of protection of wheat was considered by the GOM as an integral part of NAFTA discussions. The GOM presented several proposals to the Bank, including a variable levy with automatic phase-out mechanism that the Bank was willing to accept. 3.15 The yellow-cover PR review took place on April 3, 1991. It was first agreed that the loan was desirable in part as recognition of the policy reforms implemented during project preparation and second, the policy conditionality under the loan should not undermine Mexico's position in negotiating NAFTA. Hence, NAFTA negotiations would take priority over AGSAL II reform actions. 3.16 GOM's unwillingness to agree to major price reforms in the maize, sugar, and wheat sectors triggered the discussion at vice presidential level. In reviewing the green cover PR, the Senior Vice President for Operations commented: I am very concerned at the prospect of going ahead with a $400 million loan for the adjustment of the Agricultural Sector, leaving in place such large producer subsidies in three commodities without strong assurances that the current system will be modified or rationalized within a reasonable period of time. Therefore, I am reluctant to proceed with an approach which suggests that the Mexican Government has no intention, at least in the foreseeable future, of dismantling the subsidy system in these key agricultural crops. The Senior Vice President for Operations then recommended that the Bank should negotiate a position requiring that producer prices of maize decline in real terms, sugar protection be eliminated by 1992 and protection of wheat be eliminated within three years.69 3.17 The regional Vice President responded (by implicitly arguing) that the Department could do little to force compliance with the recommendations on maize and sugar.70 Maize policy was Mexico's most important NAFTA issue and GOM considered any conditionality regarding maize 68. TOR, "Mexico - Agricultural Sector Adjustment Loan 11", March 4, 1991. No BTOR in the files. The findings of the mission were illustrated in a letter from Chief, LA2AG to Distribution, March 25, 1991. 69. Letter from Senior Vice President, OPN to Vice President, LAC, April 30, 1991. 70. Letter from Vice President, LAC to Senior Vice President, OPN, May 2, 1991. 44 as undermining its bargaining position. It would be difficult for the Bank to even ask for a tariff reduction on sugar to 20 percent. Furthermore, the unprofitability of the new private sugar mills, raised the possibility that the GOM would partially or fully forgive the loans granted to the purchasers of the mills. This was a measure that the Bank would later suggest in the expectation that the industry's capitalization would be improved and there would be access to new financing which eventually would allow reduction of protection levels. But progress on wheat was possible. Protection of wheat, which was under the guarantee price system, had increased considerably due to the sharp reduction in world wheat prices. Moreover, there was little justification for protecting wheat farmers from world price fluctuations on a permanent basis as wheat was produced in the most prosperous agricultural regions of Mexico. The regional Vice President agreed that the Bank would press for a variable levy to be phased out over a 5- to 6- year period and concluded that "[s]hould such approaches to sugar and wheat policy along these lines not be acceptable to the Bank, it may be difficult to proceed further with the proposed Loan". 3.18 Negotiations were held between May 20 and 24, 1991. In contrast to AGSAL I (paras. 2.21 and 2.22), negotiations for AGSAL II went smoothly. As a second tranche release condition, it was agreed that nominal protection for wheat would not be increased above the levels of May 1, 1991 and January 1, 1991 for maize. 71 The Bank requested a gradual reduction over 5 years in the protection of sugar down to 20 percent. The Mexican delegation stated that while agreeing in principle that sugar protection should decrease, it could not commit itself to any specific timetable at the time of negotiations. It proposed that the period to reach the sugar policy objective would be based on the results of the sugar study. It was agreed that TOR for the sugar sector study would be ready by Board presentation. In sum, the Bank retreated and accepted the earlier Mexican position on wheat, sugar, and rice. 3.19 On June 25, 1991, AGSAL II was presented to the Board along with the Third Technical Training Loan (US$152 million) and the Mining Sector Restructuring Loan (US$200 million). All Executive Directors were supportive of AGSAL II. One was pleased to see adjustment come to an end because the Bank was overexposed in Mexico. Two Executive Directors questioned the fact that only limited conditionality was in place regarding sugar and maize. Management responded that maize was a vital part of NAFTA negotiations and the Bank did not want to undermine Mexico's negotiating position. With respect to sugar, management responded that a number of reforms had already taken place. Fifty sugar mills had been privatized while cane marketing and payments arrangements had been changed at tremendous political cost. In addition, before second-tranche release an action plan would be devised to bring protection down to 20 percent. The loan was approved unanimously. Effectiveness through Closing 3.20 The first supervision mission ran from September 22 to October 10, 1991 with four Bank and three IDB staff members.72 Its objectives were to advance compliance with effectiveness conditions and dated covenants and to review progress in the food and consumption policy part of the project as well as in the agricultural growth and productivity part. The mission found that 71. Office Memorandum from Director, LA2 to Vice President, LAC, May 29, 1991. Also attached were the Minutes of Negotiations. 72. BTOR, "Agricultural Sector Loan 11, Partial Supervision Mission", October 28, 1991; also form 590. 45 the GOM had met all but one effectiveness condition, namely initiation of the study to identify the regulatory framework of SARH's production targets and an action plan to eliminate them. Several steps had been taken towards fulfillment of second tranche release conditions. The execution of the pilot project was advancing. The evaluation process of the tortilla program and LICONSA's supply of milk program had been started. SARH had selected the firms to carry out the remaining studies, while the Mexican Congress had approved a new seeds law. 3.21 Another supervision mission followed in November 1991 (November 10 to 22, four staff members).73 It found that the only remaining effectiveness condition was the presentation of an action plan to end SARH's production targets. This was sent to the Bank by the GOM on December 5, 1991 and AGSAL II became effective on December 20, 1991, seven months after negotiations. 3.22 The two-member supervision mission from August 3 to 6, 1992 concentrated on the problems in completing the evaluation of the Pilot Food and Nutrition Program.74 The main problem was the lack of a control population that made it impossible to compare the findings to a "without project" scenario. The results of the evaluation were supposed to be presented to the Bank during the next supervision mission. The mission also found that the evaluation of the milk and tortibono programs, although less complex than the nutrition evaluation, were likely to be delazed. The Bank's concern with the completion of the studies was communicated to the GOM. Questions were also raised with respect to support for the producers of rice, soybeans, and sorghum through the precios de concertaci6n. 3.23 By December, the GOM had completed the following second tranche release conditions: (a) took action to abolish SARH 's production targets; (b) as part of the increased budget for investment in agriculture, the GOM allocated an additional 300 billion pesos (equivalent to US$100 million) to be invested in irrigation; (c) completed the Health and Nutrition Pilot Program and began its evaluation; (d) began the evaluation of the tortilla and LICONSA's social milk programs; (e) comnleted the studies of milk, sugar, and the processes and regulations for plant protection, animal health, and pesticides use; and (f) liberalized the prices of cookies, pastas, vegetable oils, cigarettes, eggs, milk products, and beef. 3.24 The last full supervision mission took place in December 1992 (December 7 to 15, four Bank and four IDB staff members).76 Its purpose was to advance completion of second tranche release conditions. The mission emphasized four unresolved issues: (a) elimination of CONASUPO's monopoly on powdered milk imports; (b) definition of sugar price policy; (c) approval of an action plan based on the study of price and trade policy for edible beans; and (d) the precios de concertaci6n were not acceptable to the Bank as fulfilling second-tranche-release condition.77 The discussion below indicates how these four issues were finally resolved. 73. TOR, "Agricultural Sector Loan 11, Partial Supervision Mission", November 8, 1991 and BTOR, "Agricultural Sector Loan 11", December 4, 1991. 74. BTOR, "AGSAL II, Nutrition Pilot Project Evaluation", August 10, 1992. A partial supervision mission took place in June 3, 1992; however, no BTOR was in the files. 75. Letter, Acting Chief, LA2AG to SHCP, August 20, 1992. 76. Supervision Report, "Second Agricultural Adjustment Loan", January 25, 1993. 77. Letter, Chief, LA2AG to SHCP, October 15, 1993. 46 3.25 CONASUPO's Monopoly. On December 6, 1993, SHCP sent a letter to the Bank which stated that CONASUPO's monopoly of powdered milk had been eliminated and that further import licenses would be awarded through auction to the private sector. 3.26 Sugar Sector. Rather than doing a study, the GOM sent a detailed policy letter to the Bank describing actions regarding the sugar sector. These included: (a) a new Decree which allowed flexible price determination between cane growers and mills and individual price determination beginning with the 1994/95 harvest season; (b) reforming the social-security system of the cane-sugar industry to put it on a sound and equitable basis; (c) creating a spot market in sugar to provide more accurate and current information to producers; (d) closing unprofitable sugar mills; and (e) restructuring the debt of viable sugar mills. While these reforms had been proposed to the Mexican Congress, not all had been approved. Nevertheless, the Bank accepted the draft decree as meeting the condition. 3.27 Beans Study. In lieu of an action plan based on the study of price and trade policy for edible beans (which was completed in November 1991), the Bank accepted GOM's implementation of PROCAMPO (discussed below) which would support farmer's income and permit bean prices to be liberalized. 3.28 Precios de Concertaci6n. During disbursement of AGSAL I, GOM eliminated guarantee prices, that is fixed producer prices, for ten crops. GOM later initiated the use of precios de concertaci6n for some of these crops. Ideally, these were prices on farm commodities that were agreed on between producers and consumers, without active intervention of government. But before second tranche release, on at least three occasions, the Government's precios de concertaci6n involved a cash subsidy, so called marketing support via traders, to benefit producers per unit sold to supplement the market price that they received. In the cases involving sorghum and rice production, the subsidy was designed to make producer revenues equivalent to the imputed c.i.f. price for their output. In the case of soybeans, the subsidy was designed to facilitate competition with soybean imports from the U.S. that were subsidized by the U.S. Government. 3.29 There was long debate between the Bank and the Borrower regarding the precios de concertaci6n. The prices of the commodities in question were not subject to any second-tranche conditionality. They were supposed to have been liberalized as they were included in the already achieved list of the PR which states:79 "The guarantee price system has been abolished for wheat, sorghum, soybean, rice, barley, cotton seed, cartamo, sunflower, copra and sesame. Maize and some qualities of beans still remain in the guarantee price system." The issue of these prices was also brought up at negotiations where it was agreed that:80 In relation to the condition which establishes that prices of paddy rice, sorghum, soybeans and tobacco be freely determined by the market, the parties understand that it requires that the government does not intervene in the markets with the purpose of determining product prices. However, government actions to resolve specific marketing 78. PCR II, Part II - Project Review from the Borrower's Perspective, paras 2.27-2.32. 79. Policy Matrix of PR II, Annex 4, p. 1 80. Minutes of Negotiations, para 2. 47 and transport problems at the local level, provide market and price information, and provide market infrastructure does not constitute violation of this condition. Therefore, in our interpretation, implementation of precios de concertaci6n was backtracking with respect to an already achieved goal which was also reconfirmed in negotiations and hence a case of failure to achieve "satisfactory progress" in carrying out the program. This caused some legal problems which almost led to cancellation of the second tranche altogether. The Bank finally accepted GOM's position that the precios de concertaci6n were a "transitory" measure which would eventually be replaced by PROCAMPO as explained below.8' 3.30 PROCAMPO. During 1993, the GOM was very eager to get the NAFTA passed and AGSAL II had to take a back seat to it. Consistent with NAFTA requirements for gradually liberalizing agricultural pricing and marketing, GOM introduced PROCAMPO as an income support scheme which would replace both guarantee and agreed prices. Rather than subsidy payments to farmers based on what they produced, PROCAMPO would pay farmers subsidies based on the amount of land that they had cultivated for specific crops. The rationale of PROCAMPO is stated in GOM's contribution to the PCR II: PROCAMPO is a new support program for Mexican farmers who are currently devoted to the production of certain grains and oilseeds.84 The traditional support scheme to the agricultural sector, which PROCAMPO will replace, operated basically through high guarantee prices. This scheme led to an inefficient allocation of resources in the rural sector, shifting resources towards those crops with the highest degree of relative protection. The poorest of all peasants, which devote their production to self- consumption, did not benefit from a scheme of support based on market price since they do not have any marketable production. PROCAMPO does not support production of specific commodities, but farmers' income. The program grants payments to producers based on land ownership; it is completely decoupled from prices, production levels or any other requirement of performance, therefore, the effect will be neutral on production and trade. PROCAMPO supports proportionally more low income producers, and proportionally less high income producers. 3.31 The Bank played some role in helping the GOM prepare for NAFTA as well as design 85 PROCAMPO. As a staff member put it, "AGSAL I (and later AGSAL II) helped Mexicans begin the road to NAFTA; it sugared some bitter pills and helped them develop technical negotiation 81. Letter, Director General (SHCP) to Vice President, LAC, December 6, 1993. 82. PROCAMPO payments were supposed to be granted on a per hectare basis and were to be calculated as the average of areas planted between December 1989 and December 1992. The income support was roughly US$113 (i.e., N$350) per hectare (at the pre-1994 exchange rate). With the current exchange rate (March 1996) the income support would be about US$50 per hectare. 83. PCR 11, paras 2.24 and 2.25. More details on PROCAMPO, as initially designed, can be found in "PROCAMPO: Vamos al grano para progresar", Secretaria de Agricultura y Recurson Hidraulicos (no date). 84. The PROCAMPO crops (as stated in the original PROCAMPO document) are: maize, soybeans, dry beans, sorghum, wheat, rice, cotton, barley, safflower. 85. This role was of informal nature (e.g. workshops and ESW). 48 capacity." At the time, both NAFTA and PROCAMPO issues were also vital elements in the economic and sector work of the agriculture division.87 3.32 Pilot Health and Nutrition Program. There also were some problems with the evaluation of the Health and Nutrition program. The Ministry of Budget and Planning (SPP), the executing agency of the Health and Nutrition component of AGSAL II, was dismantled in 1992. While SHCP was the formal successor of SPP, in reality no institution to supervise this component of the project had been designated. The lengthy disputes among SHCP, the Ministry of Social Development, (SEDESOL), and the Ministry of Health as to who would take over this component slowed down the evaluation of the program and hence the preparation of the required action plans.t8 Even after the second tranche was released the responsibilities for the various parts of the Health and Nutrition program as well as its content remained unclear. 3.33 The advancement of NAFTA and PROCAMPO convinced the Bank that the GOM was serious in proceeding with trade and price reforms. The second tranche was released in December 20, 1993, two years after effectiveness and one and a half years after the loan was signed. Completion of AGSAL tt at the end of 1993 was coincident with completion of the Bank's active role in supporting Mexico's adjustment process not only for agriculture but for the entire economy. Performance in Achieving Loan Objectives 3.34 Prices. The GOM liberalized the prices of cookies, pastas, vegetable oils, cigarettes, eggs, diary products, beef and tobacco. The prices of sugar, maize, and barley remained within the limits stipulated in the GA. The prices of pesticides were allowed to be freely determined by the market. Although agreed prices for soybeans, sorghum, rice, wheat and other crops was backtracking on an already achieved goal - but not one that had been part of the conditionality of AGSAL I - this was accepted as a transitory measure until PROCAMPO fully materialized (para. 3.30). 3.35 Studies. Because ofPROCAMPO, the bean study was no longer needed to define an action plan for improving bean marketing. Nevertheless it concluded that Mexican bean prices were well above world levels and that imports would grow under free trade but some growers would be competitive at world prices. The study on plant and animal health protection was delivered to the Bank in October 1992. It led to an action plan which defined new regulations for pesticide use and animal health and inspection that were consistent with NAFTA. Instead of a 86. Interview, November 9, 1994. 87. There were serious concerns within the Bank that PROCAMPO was too expensive. The Bank repeatedly advised the GOM to reduce its costs. For example, the Agricultural Sector Memorandum stated: "PROCAMPO will add significantly to the GOM's food and agriculture budget and it is therefore essential to consider ways to make it cheaper." (para 2.73, "Mexico: Agricultural Sector Memorandum, September 16, 1994, Report No. 13425-ME). PROCAMPO was also discussed with the GOM ima mission to Mexico ("Mexico - AGSAL It: Review of Proposed Agricultural Support Program", March 11, 1993). A report attached to the BTOR clearly outlined the costs of the proposed support scheme. 88. PCR II, para 1.82 89. Because of the plethora of bean varieties there is no standard world bean price, so comparison had to be made on the "approximation principle", subject to a number of assumptions; furthermore, Mexico produces substantial quantities of beans, thus influencing the world price for some varieties. 49 study on the sugar sector, in December 1993 the GOM submitted a letter outlining the major steps taken to restructure the sector since the privatization of the sugar mills in 1989. 3.36 Agricultural Budget. The equivalent of US$100 million dollars (300 billion pesos) was allocated in 1992 to irrigation development as part of the increased budget to agriculture. 3.37 Market Regulations: Export restrictions on wheat, sorghum, livestock feed, soybean, barley, copra, cartamo, cartamo oil, cottonseed, tobacco, eggs, and fluid milk were eliminated. SARH's system of imposing crop production targets was eliminated.90 The GOM eliminated the monopoly of germplasm by INIFAP as well as restrictions on plant breeding by the private sector. As indicated in the PCR II although CONASUPO's milk-import monopoly was allegedly eliminated and thereafter GOM permitted import through competitive auction of import licenses to the private sector, the PAR mission found that only 0.5 percent of powdered milk was imported through the private sector. 3.38 Nutrition Program. Despite its short duration, the pilot Health and Nutrition program significantly improved the nutritional status of children under the age of five at one of the two sites. It had more effect on the nutrition of girls than boys. There was a marked reduction in diarrhea among children in one site. It had limited effect on pregnant and lactating women. The evaluation of the tortibono program found that the program reached a significant fraction of the nutritionally at-risk population at an acceptable cost. The completion of the evaluation and the action plan for replicating the nutrition program was not done since no executing agency was assigned after the disappearance of SPP. 90. However, field visits during a supervision mission found that in some cases local extension officers were unaware of the change (PCR II, para 1.68). 50 4. Findings, Ratings and Lessons Findings 4.1 Food Security. Before AGSAL I, Mexico's food and nutrition policy consisted mainly of maintaining low retail prices on basic foods by use of general subsidies that were untargeted, expensive, and limited to urban centers. Much of the subsidy did not benefit the poorest while the affluent benefited disproportionately. Little was done for the rural areas where the poorest were found. 4.2 The reforms undertaken under the two AGSALs led Mexico to establish a program of targeted food subsidies. The program initially provided for (a) food coupons targeted to the urban poor; (b) the nominal redemption value of food coupons to increase so as to keep pace with inflation; (c) an aggregate subsidy of approximately US$250 million annually; and (d) a pilot program for selected rural areas that inter alia provided information on the effects of the various food-security programs. The number of poor families reached by public food programs grew from roughly 4.4 million in 1983 to 10.7 million in 1988. 4.3 By 1994, the food security program had evolved into a targeted tortilla and milk subsidy program operating in more than 200 cities. This involves verification of the socioeconomic status of the beneficiaries and uses modem electronic scanning and registration technology (identification cards for beneficiaries). In the Government's words, the existence of the program has "laid the groundwork for the possible liberalization of prices on the final tortilla market without placing the most economically vulnerable families at risk."91 (Annex 7 provides GOM's description of the Mexican food security program as it existed in 1995.) 4.4 The Bank contributed to this because of the heavy emphasis it put on food-security issues during the preparation and implementation of both AGSALs. This was unusual. Over 85 percent of all AGSALs have completely ignored food security, notwithstanding their strong bearing on agricultural policy reforms.92 Recently, the GOM introduced a new pilot nutrition program in the states of Campeche and Hildago. It has also consolidated the responsibilities of LICONSA, DICCONSA, and Tortibonos under the Ministry of Social Development. Nevertheless the GOM also continued to subsidize general maize marketing in an effort to stabilize consumer maize prices on the low side. 4.5 PROCAMPO. Mexico is exceptional in moving towards a system of agricultural subsidization that is allocatively neutral. This is a considerable improvement over the usual agricultural subsidy programs such as those of the OECD countries. In these countries subsidies are usually tied to production of specific agricultural commodities which leads to substantial overproduction of protected commodities and excessive use of labor and capital in protected subsectors. The fiscal costs of the PROCAMPO system are large, but their economic impact should avoid such allocative waste (para. 3.30). PROCAMPO payments are to decrease and then 91. PCR II, para 2.80. 92. OED draft, Reforming Agriculture: The World Bank Goes to Market, 1996, chapter 6. 51 cease after some years so that the fiscal costs will also be eliminated. PROCAMPO should also facilitate the liberalization of prices and marketing for beans and maize as well as the commodities subject to agreed pricing. Because of this expectation of price liberalization for beans, once PROCAMPO was in place, the Bank agreed that this was tantamount to the bean- policy action plan and therefore fulfilled the corresponding condition of second tranche release of AGSAL II. Implementation of the PROCAMPO program was also seen as the key to Mexican liberalization of the price of maize. The payments to producers under PROCAMPO were to be compensation for the reduction in income attendant on letting the producer price of maize decrease to its CIF value. 4.6 Despite GOM's initial projections that PROCAMPO's implementation would take place by April 1, 1995, PROCAMPO was then still in the transition stage. Two factors contributed to the delay: (a) Because of GOM's poor preparation, the registries of eligible producers and their cultivated-land base are still not complete. (b) The GOM was undecided as to whether it should proceed with the program as originally designed or with a revised, less costly version. It was projected that PROCAMPO would absorb more than 50 percent of SARH's budget in 1995. After the devaluation of the peso in December 1994, the reduction in the prices of the major commodities (especially maize and beans) which would have followed their liberalization is unlikely because food crops are no longer protected.93 4.7 OED's PAR mission (November, 1994) found widespread confusion concerning the terms of PROCAMPO payments. Many eligible farmers believed that they had to continue to produce the same grains as those that qualified them for PROCAMPO payments. This has been also confirmed by ongoing ESW.94 Several factors contribute to the confusion: (a) farmer's unawareness of the program; (b) poor instructions from government officers; and (c) the registries of eligible producers have not yet been finalized. Hence, farmers produce the same crops (and possibly allocate to them a greater area than in the recent past) in an attempt to qualify for larger acreage on which to base PROCAMPO payments - a typical moral hazard 93. For example, in June of 1995 the NPCs for wheat, soybeans, and sorghum ranged between 0.60 and 0.65 while that of maize was 0.80. Thus, PROCAMPO can no longer be justified as compensating farmers for the loss of income that would result from the removal of protection by liberalizing imports. 94. It has been reported that in 1994 PROCAMPO payments were made on the basis of current acreage allocations and not historic cropping patterns as originally announced. Field reports for 1995 suggested that many farmers intended to remain in maize and other PROCAMPO crops to ensure their maximum eligibility for PROCAMPO payments ("Mexico - Issues in Agriculture, Natural Resources, and Rural Poverty", Report No. 14926-ME, Green cover, November 8, 1995). 52 case.95 Contributing to the confusion is the lack of clarity within the Government on the basis for payments. GOM officials responsible for PROCAMPO have asserted that the cultivated land on which PROCAMPO payments should be based must be cropped for specific grains (but they anticipated liberalization soon). SHCP officials, on the other hand, claimed that the use of land was unrestricted. 9 (As of mid-1996, PROCAMPO was in operation.) 4.8 Subsidies. Some subsidies are still in place. Electricity and water charges are still below cost. In 1995, after the devaluation, a fertilizer subsidy was introduced. The Government also introduced a subsidy for the purchase of machinery to offset the effects of devaluation. In 1996, the new subsidies are expected to absorb between N$1-2 billion (the entire budget for the ministry of agriculture was N$12 billion in 1995 and programmed for N$16 billion in 1996). PROCAMPO is estimated to have absorbed about N$7 billion in 1995, equivalent to almost US$1 billion.98 4.9 Supply Response. One of the main loan objectives of AGSAL II was to increase the rate of growth of agriculture by eliminating policy and institutional distortions. The expectation was based on the assumption that on balance Mexico's agriculture was taxed in the period preceding the reforms, say 1984-87. By 1991 most of the reform program was in place so that for the period 1991-94 the expectation was some increase in output above that of 1984-87. Actual performance has not been consistent with this expectation. As indicated in Table 4.1 agricultural GDP during 1991-94 grew at an annual average of 0.71 percent close to the 1984-87 average of 0.82 percent. Over the same time periods agricultural exports grew at 2.71 percent and 1.82 percent annually, a small increase. The average growth of total GDP, however, increased from 0.19 percent in 1984-87 to 2.18 percent in 1991-94. 4.10 This outcome loses its paradoxical quality when the implications of the reforms are considered more closely. One analyst estimates that "[f]or Mexico's 14 most important commodities in aggregate, policy transfers to agriculture fell from 21 percent of the value of output in 1984 to 8 percent in 1992."99 It is not surprising that supply response has not been positive through 1994. To show this is the case it is important to analyze producer price and 95. The preparation of registries has been a very complicated process. As a recent paper reports, "[i]n actual practice, however, due to the fact that many areas were first under-reported (due to fear of Government taxation), then over- reported compared with known aggregate areas from the agricultural censuses, the final determination of eligible area has not yet occurred. In many instances, eligible areas are "negotiated" at the community level, and thus only bear loose resemblance to the objective three-year record. The process is further complicated by the complexity of the on- going land titling program, which gives ejidatarios legal title to the land they cultivate." (Salinger, Metzel, Arndt, and Ferrel, AIRD, May 1995. Report prepared for the Mexican Ministry of Agriculture and the World Bank.) But, LASLG (the Bank's Division for Mexico's agriculture) stresses that according to the GOM, functioning of PROCAMPO is based on historical cultivation patterns. 96. The agency handling PROCAMPO is ASERCA (Support Services for Agricultural Marketing). In addition to handling PROCAMPO, ASERCA also assists farmers in price discovery through dissemination of information and at a latter stage the creation of spot and forward markets. 97. LASLG (the Bank's operational Division that work's on Mexican agriculture) stresses that according to the GOM the basis for payments by PROCAMPO is historical cultivation. 98. Interview, March 11, 1996. 99. Valdes, Constanza, "Mexico," in US Department of Agriculture, "Estimates of Producer and Consumer Subsidy Equivalents, 1982-92," Statistical Bulletin of the Economic Research Service, Number 913, December 1994. 53 input prices. If the ratio of output to input prices decreased over the two periods, the expectation would be negative rather than positive supply response. 4.11 As concerns output prices, the data do not show large increases in real terms in the second period compared to the first. Throughout the periods under consideration, the two main crops, maize and beans, accounting for more than one half of the aggregate value of crop production, were heavily protected by limiting imports through quantitative restrictions. They were essentially left out of the reforms. At first glance, ceteris paribus conditions largely apply to these two crops over the entire pre- and post-adjustment periods. Production of wheat, an important grain crop, was also protected throughout the periods in question. One would not have expected a dramatic increase in the production of these three crops because of price effects. The data are consistent with this conclusion. Moreover, throughout the period 1991-94 the Mexican peso was appreciating in real terms, a factor which should have held down the value of export crops in the second period compared to the first. World market price trends for Mexican agricultural commodities were also falling throughout the years in question (1984-94). Insofar as they affected Mexican agricultural prices their effect would have been one of reducing supply response in the second period relative to the first. This conclusion is supported by a recent paper which shows that agricultural prices for Mexico's major crops (maize, beans, wheat, sugar cane, beef, rice and coffee) decreased by 24 percent in real terms in the post-reform period of five years compared to the pre-reform period of five years.ioo 4.12 The impact of the agricultural adjustment program was probably also on balance negative with respect to input prices. In general terms, total input subsidies decreased substantially from the earlier to the later period. In 1988 they are estimated to have amounted to US$2.1 billion.101 During the same year the value-added in agriculture is estimated to have been about US$22 billion. Hence, input and credit subsidies were a significant portion of total agricultural production. Most of these subsidies (credit, seed, power, fertilizers) were eliminated during the period 1991-94, which would have led to reduced profitability of agricultural production.02 4.13 The combined effect of these factors was to substantially reduce the profitability of agriculture and therefore supply response as well.103 The elimination of input subsidies should have caused farm input prices to rise. And the structural adjustment program did little to increase 100. Bruce Gardner, "Policy Reform in Agriculture: An Assessment of the Results in Eight Countries", Mimeo, (University of Maryland, December 1995), p. 22. 101. PCR I, para 1.69. In 1984, CONASUPO subsidies accounted for 0.95 percent of GDP (PR 1). 102. An econometric study found that the structural reforms had an overall negative effect on the profitability of the crop sub-sector . It also found that the reduction in profitability was a result of both revenue reduction and cost increase (John Baffes, "Structural Reforms and Price Liberalization in Mexican Agriculture", Mimeo, World Bank, January 26, 1996). 103. Reduction in sectoral profitability following structural adjustment should not be surprising. Clearly, many reforms have involved movements away from agricultural subsidization or trade protection. "These reforms (for example in the case of New Zealand) are expected to have different consequences than the removal of policies that discriminate against agriculture." (Bruce Gardner, "Policy Reform in Agriculture: An Assessment of the Results in Eight Countries", Mimeo, University of Maryland, December 1995). Jenkins reported that the impact of trade liberalization has been negative for many sectors in the Bolivian economy ("Does Trade Liberalization Lead to Productivity Increases?", Journal of International Development, 7(1995):578-597.) 54 farm output prices. On balance, the average output/input price ratio probably fell between 1984- 87 and 1991-94.104 Table 4.1: Mexico - Selected Growth Rates (Annual Averages) Year(s) 84-87 1988 1989 1990 1991 1992 1993 1994 91-94 GDP 0.19 1.30 3.24 4.42 3.57 2.72 -0.11 3.94 2.18 Agricultural GDP 0.82 -3.21 -2.80 6.49 1.20 -1.44 0.24 3.33 0.71 Exports 1.82 7.91 4.91 20.91 9.93 -11.65 17.07 na 2.71 Notes: The growth rates are annual changes from the previous to current year (e.g., the 1988 growth rate refers to 1987/88 change); they are calculated as logarithmic changes as in Table 1. Source: Original data from "Mexico - Country Economic Memorandum: Fostering Private Sector Development in the 1990s", Volume II, Statistical Annex. Report No. I1823-ME, May 16, 1994. Ratings 4.14 Bank Performance. The far-reaching discussion with Mexican decision makers contributed to the development of an intellectual consensus on the Mexican side concerning the wisdom of moving agriculture from administrative to market allocation of resources and production. Although at the beginning of AGSAL I, the Bank had limited knowledge of those Mexican institutions most important for policy-reform it managed to "catch up" by means of a number of studies undertaken for the most part while the AGSALs were already in preparation or under disbursement.5 Design was innovative. The attention to and success in liberalizing marketing in agricultural chemicals and seeds has been rare in AGSALs. The two AGSALs were successful, and unusual, in supporting a number of key reforms to improve food security. After initial resistance because of the heavy fiscal cost required for this new kind of subsidy, the Bank wisely supported the PROCAMPO undertaking as a way to facilitate commodity price liberalization and to deal with the political need to support agriculture while minimizing the negative allocative effects. The monitoring of outcomes and identification of shortfalls in expected results was better than in many other AGSALs.106 During the first operation, the 104. Uncertainty over land tenure may also have contributed somewhat to the lack of supply response. In 1994, Mexican officials repeatedly stressed reduced investments at the farm-level because of uncertainty over land property rights after the recent amendment to Article 27 ofthe Constitution. 105. A staff member said regarding ESW: "We used AGSAL I information for the sector report". Interview, November 19, 1994. 106. For example, there was Bank follow-up on the impact liberalizing seed production (PCR II, para 1.61), on the intervention in what were supposed to be liberalized markets for wheat, barley, sorghum and rice markets (PCR II, paras 1.52-53), on the impact of elimination of the production targets in the rural development districts (PCR II, para 1.68). 55 success in introducing important new material during negotiations and the addition of a quasi tranche to facilitate the preparation of back-up studies are also noteworthy.107 4.15 There were also several shortcomings. With the wisdom of hindsight, the most serious was the failure to consider the appreciation of the exchange rate as an issue needing discussion during AGSAL II supervision. In 1989, the exchange rate had received substantial attention when the Bank supported a number of consultants who advised the Government to control capital inflows.08 But later, the appreciating exchange rate led to little Bank/Government discussion at least in the context of AGSAL II. Yet one of the conditions for second-tranche release was "[p]rovision to the Bank of evidence that the macroeconomic policy framework is consistent with the objectives of the program." Nevertheless, after 1988, the exchange rate continually appreciated until 1994, which probably contributed to the decline in agricultural exports during the period as well as put increased pressure on the agricultural authorities to continue to subsidize producer prices for the basic grains in ad hoc fashion rather than to move to autonomous markets and price liberalization. Note that during 1992-93, other than the fertilizer operation, the only adjustment operation still disbursing was AGSAL II. 4.16 The dearth of sector work addressing policy constraints in the years just prior to AGSAL I forced the Bank to scramble in fomenting the production of a number of studies to provide the information and analysis needed for developing the reform program. A good deal of the resources dedicated to the agricultural reform program of both Bank and Government concentrated on executing and digesting the results of this analytical work, possibly to the detriment of work on the best ways to reduce and eliminate the policy constraints.109 For example, as PCR I exhorted, the Bank could have "... better elaborated and explained up-front a long-term strategy for Mexican agriculture, especially regarding assistance to small farmers and marginal areas during structural adjustment."1'o 4.17 In both AGSALs, notwithstanding conditionality that addressed public expenditure to support agricultural development, little attention was given to improving such expenditure. By the end of AGSAL II, there had been a decline in public investment in research and irrigation. There is no indication whether this was a desirable outcome or not. Nor is there consideration of other aspects of the PEP (Public Expenditure Program), such as the quality of public investments 107. It is illuminating to contrast the implementation experience of Mexico's AGSAL II with Morocco's AGSAL II. As in the case of Mexico, the Moroccan operation was very demanding and aimed at widegoing liberalization of markets, prices and industries. The Moroccan operation was less successful than Mexico's AGSAL II in achieving its objectives primarily because the Government of Morocco was less committed to the reform program. Nevertheless, in contrast to the Mexican case, the failure to open several agroindustries to competition and integration with world markets may have been related in some degree to the failure of Bank staff carrying out the project to build good working relationships with those parts of the Moroccan bureaucracy directly responsible for actions that would have led to the desired liberalization. Unlike Mexico, the food security program put in place as part of the Moroccan operation was not supervised, and disappeared after the loan was closed. See PAR, Morocco Second Agricultural Sector Adjustment Loan, Report No. 14588, June 12, 1995, pp. 39-41, passim. 108. Interview with Bank manager (November 19, 1994). 109. In 1987 after a long period without sector work, the Bank produced a paper entitled Mexico: Policy Notes on Agriculture, Food and Rural Development. These summarized the main issues affecting the sector's performance and made specific recommendations concerning them. Initially they lacked the detailed legal and institutional aspects that must be addressed in actual reform actions. The Notes did, however, guide the discussions with the Government during the preparation of AGSAL 1. 110. PCR I, para. 64b. 56 and cost recovery issues. In other words, assuming a radical decrease in public expenditure in agriculture, were the "surviving" expenditures those with the highest returns? 4.18 Second tranche release conditions on guarantee prices assumed that they would persist as highly administered prices. In AGSAL I, guarantee prices were to remain within a band of 90 percent-125 percent of international prices. In 1991, price rationalization rather than liberalization was still common practice in AGSALs. This is no longer the case. As long as prices are administered they can be easily changed to undesirable levels. A better approach to pricing in AGSAL I would have been to press for full price liberalization at border values. Implicitly, this became the Bank's position in AGSAL II when it took issue with the establishment of the precios de concertaci6n. 4.19 As indicated in the detailed review of the preparation and implementation of the two operations, to some degree the Bank saw financing from the loan as an inducement for undertaking reforms. Financial-inducement rationales for adjustment lending are incompatible with Operational Directive 8.60 which states that the rationale for financing structural adjustment operations is the uncovered ex ante balance-of-payments gap and additional external financing needs (if any) that result from the adjustment process itself. 4.20 On balance the performance of the Bank is considered satisfactory. The objection to this conclusion could be the Bank's failure to address the exchange rate issue. It is difficult, however, to show that this was imprudent behavior since ex ante it may not have been obvious that the high value of the Mexican peso was not sustainable. 4.21 Borrower Performance. The Borrower's performance was satisfactory because of its decided ownership of a demanding program growing out of the strong commitment to structural adjustment per se after the elections late in 1988. This facilitated the long, in-depth and frank discussion between the Bank staff and the authorities during both preparation and implementation. On the Government side, those responsible for implementation also had the authority and capacity needed for carrying out the program. 11 The Government also largely lived up its contractual obligations with respect to the reforms stipulated in the tranche release conditions and therefore its performance is rated as satisfactory. 4.22 Borrower performance also had shortcomings. The Government essentially replaced a number of guarantee prices with the precios de concertaci6n for grains which led to a Government system to establish producer floor prices that were made effective through 112 ASERCA. Apparently, defacto the CONASUPO's powdered milk monopoly continues. 4.23 Once implemented, PROCAMPO was to have compensated producers according to the amount of land that they tilled. The Government would in turn then liberalize the producer prices for maize and beans which had been maintained far above c.i.f. values through CONASUPO's pricing policies. Although PROCAMPO is now in operation, the Government has 111. Five of the 34 completed AGSALs were much diminished in effectiveness because the implementation authority of the government group charged with carrying out the adjustment program was insufficient. See Reforming Agriculture: The World Bank Goes to Market, chapter 3. 112. The GOM has removed the precios de concertacion for wheat, sorghum, rice, and soybeans. Currently, the Government's involvement is limited to the maize chain. 57 continued to mantain prices for maize (precios de concertacion, however, have been abolished).113 4.24 Sustainability. As long as Mexico's governing party stays in power, sustainability of the achieved agricultural reforms is highly probable since economic liberalization is a basic plank in the party platform. Persistence of the political status quo also guarantees Mexico's continued membership in the World Trade Organization and the NAFTA and membership in these two organizations promotes a decentralized market-orientation to economic policy. Even if Mexico changes its governing party is not clear that the successor would reject the economic liberalization platform. Therefore, sustainability of both AGSALs is rated as likely. 4.25 Institutional Development. As is customary in adjustment operations, the AGSALs did not include explicit institutional-development objectives. Nevertheless the cumulative institutional development resulting from the policy changes supported by the AGSALs will eventually become enormous. Wide-ranging privatization of production and commerce brings in train the development of new production and market institutions. Opening up export markets leads to large institutional change as farmers and other producers respond by learning about new markets, e.g., for fruits and vegetables north of the Rio Grande, developing new business relationships, and applying new technology. In the government sector, there is now an entirely new role for the agricultural authorities while new organizations and rules for supporting the poor have been developing. Therefore, institutional development is rated as substantial. 4.26 PCRs. Both are satisfactory. The PAR confirmed the relevance and validity of their analysis and conclusions. PCR II provides a useful background chapter that facilitates understanding of the objectives pursued and how the proposed policy reforms would contribute to those objectives. The information in PCR II on recent developments in the agricultural economy is also useful in facilitating judgments concerning outcomes. Part II of PCR II, the Borrower's Perspective is largely consistent with the PCR. It also provides valuable and detailed information on the implementation of the program that complements that of the PCR. 4.27 Outcome Rating. The outcome rating is satisfactory for both AGSALs. They achieved their major objectives and are likely to achieve substantial development results without major shortcomings. Lessons 4.28 The evolution of the Mexican AGSALs presents a convincing demonstration of a fruitful interaction of policy-reform issues with food-security concerns. If the design of the Mexican AGSALs had been similar to that of most AGSALs, they would have ignored food security, at least explicitly, and would have been less effective operations as a result, both in terms of impact on poverty and long-run development impact. Bank performance on this dimension is impressive in that in the initial period of design of AGSAL I, the Government's response to the Bank's suggestions that food security be considered as part of the reform program was negative. Most Bank operations dealing primarily with agricultural policy reforms would do well to build in substantial attention to food security. 113. Interview with Bank staff, March 12, 1996. 58 4.29 The experience with PROCAMPO can also be viewed as an important lesson. At a certain stage in their economic development, nearly all countries swing over to protecting and subsidizing agriculture by means that are economically wasteful. From this perspective, PROCAMPO appears to be an important approach that could be tried elsewhere. Experience with it should be closely followed. 4.30 AGSAL II, as most AGSALs, had as its fundamental objective increasing the rate of growth of agriculture.114 But as discussed above, through 1994 at least, Mexico's agricultural adjustment in the context of an increasingly overvalued exchange rate did not lead to expanded output. Agricultural adjustment in a situation of protection through subsidies and trade restrictions can lead to contraction in output as liberalization and other policy reforms reduce the profitability of agriculture. The impact of exchange rate policy must also be taken into consideration. In Mexico, exchange rate appreciation led to substantial disprotection of agriculture during the reform period. It is important to be clear at the outset on whether to expect more rapid agricultural growth or the contrary as a result of the reform program. In the Mexican case, the failure to get supply response has caused confusion and may have reduced support for the reform program. 4.31 The failure to do the analytical work underpinning the agricultural reforms meant that a substantial amount of resources had to be dedicated to catching up in the form of quick studies. Much time was consumed in agreeing on terms of references and working through outputs. Knowledge about consequences of policy changes was slow in coming. The Mexican reform program probably suffered as a consequence. A better way to proceed is to carry out analysis of policy and institutional issues in advance as a collaborative undertaking with the Borrower. 4.32 Agricultural policy reform, like structural adjustment in general, is a time consuming process involving substantial learning. It is preferable to begin the process with sector analysis that informs the actual process of policy reform rather than essentially attempting to provide the knowledge basis and the reform actions almost simultaneously. This is particularly important where the operators on the Borrower side have a set of beliefs about economic development and the way the economy functions that diverge radically from those that are implicit in structural adjustment programs. In the latter case upstream policy-oriented sector work can make a contribution in increasing comprehension of the rationale for the adjustment program. Presumably this would also increase Borrower commitment of the reform program. 114. AGSAL I described its fundamental objective in the Loan Summary of the PR as promoting "greater efficiency and higher productivity in the agricultural and agro-industrial sectors." 59 Annex 1 Chronology of AGSAL I Event Date First memo mentioning AGSAL I July 24, 1985 Ist preparation mission July 10, 1986 2nd preparation mission September 21, 1986 1st pre-appraisal mission October 27, 1986 2nd pre-appraisal mission November 5, 1986 3rd pre-appraisal mission December 12, 1986 Discussion of first draft IM January 17, 1987 IM approval March 27, 1987 1st appraisal mission April 6, 1987 2nd appraisal mission May 27, 1987 Bank's reorganization July 1, 1987 3rd appraisal mission July 12, 1987 4th appraisal mission September 20, 1987 Yellow cover PR meeting October 7, 1987 Negotiations (1st phase) December 14, 1987 Negotiations (2nd phase) February 16, 1988 Approval March 15, 1988 Effectiveness March 16, 1988 First Tranche release November 8, 1988 New Mexican Administration assumed office December 1 ,1988 Closing date (original) March 31, 1989 Closing date (revised) November 15, 1989 Second tranche release March 12, 1990 Closing date (final) March 15, 1990 Full disbursement of Second Tranche August 15, 1990 PCR mission (by FAO) June 4, 1991 PCR submitted to OED June 16, 1993 Annex 2 60 Agricultural Sector Objectives of the Mexican Government, 1987 - 1988 1. The Mexican Government has assigned a high priority to rural areas. The Government Policy of Integrated Rural Development has as a fundamental purpose the improvement of social welfare of the rural population and increasing the levels of production, employment and income, through an increase in the efficiency of agricultural production, agroindustrial processing, and marketing. In addition, it established strengthening of food sovereignty of the country as one of the principle objectives. 2. To achieve this, the Mexican Government has enacted a group of actions oriented toward rationalizing the subsidies to food and agricultural inputs; toward liberalizing external trade for agriculture and agroindustry; toward rationalizing pricing policies for producers and consumers; and toward a selective participation of the public sector in the production, marketing, storage, and distribution of agriculture and livestock products. 3. During this year and the next, the Government intends to strengthen and consolidate the policy developed during the last years. In addition, it is proposed to maintain an adequate program of investment and to provide basic support services in an efficient and decentralized manner. Specifically, the program of the Government in this period is oriented toward achieving a solid program of public investments, based on economic and social criteria; toward making more efficient the basic services provided by government agencies, through their restructuring and decentralization so that a higher proportion of personnel will be in direct contact with farmers; increasing the efficiency of storage, processing, distribution, and marketing, considering if it is necessary to liquidate or privatize parastatal enterprises; giving a greater role to market mechanisms in the formation of agricultural product prices at the producer and consumer levels; expanding the opportunities of farmers to export their products and import inputs; giving the private sector better access to importing; diminishing the subsidies to agricultural inputs, such as water and fertilizer, and to interest rates for agricultural and livestock sector credit; and eliminating global consumer subsidies, maintaining selective subsidies for the population of lower income in rural and urban areas, with the purpose of protecting their purchasing power. 4. The Mexican Government has made important advances toward the achievement of the objectives indicated. What has been done to date and the actions that will be carried out in the rest of the current sexenio are presented in the attached table [i.e. Policy Matrix of PR 1]. MEXICO- Agricultural Sector Adjustment Loan I Policy Matrix Actions Prior to Board Presentation Conditions for Disbursement of Second Tranche Policy Objective Achieved (estimated date of disbursement March 31, 1989 Elimination of global subsidies and - Reduction of global food subsidies - Implementation in 19.. of a satisfactory targetted program of food stamps or establishment of a satisfactory targetted except for sugar. Global subsidies, other well-targetted food subsidy program at adequate levels of funding food subsidy program with adequate previously 1% of GDP, virtually sufficient to compensate poor for reduction of global food subsidies between funding. (paras. 32-36) eliminated in 1987 except sugar (0,05% 1983 and 1986, using mechanisms to minimize diversion of stamps from the of GDP). target population. About US$250 million or 0.1% of GDP would be considered an adequate level. Linkage of price of tortibonos to price of - Introduction of food stamps for tortillas tortillas by adjusting tortibono prices, taking into consideration the price of (about 0.02% of GDP in 1987). tortillas and the rate of inflation, so as not to increase the subsidy in real terms per recipient to levels greater than those existing as of the Effective Date of the loan. Pilot introduction of targetted food assistance in rural areas. Revision of criteria for eligibiliy. Study of expansion of nutritional programs to buffer impact of adjustment program. Presentation of a satisfactory action plan for expansion of nutritional monitoring program to rural and urban areas. Reduction of role of parastatals. - Agreement on reorganization and - Limitation of transferes for operating losses to CONASUPO in 1988 to (paras. 50-6 1 decentralization of CONASUPO and about US$85 million. affiliates. - No introduction of global food subsidies through institutions other than CONASUPO. - Defacto limitation of CONASUPO - Satisfactory progress on compliance with timetable for 500 DICONSA purchases to six commodities for outlets being closed or moved to poor neighborhoods. purposes of price support. - Liquidation of CONASUPO's wheat-processing affiliate, TRICONSA. - Satisfactory compliance with timetable for sale or closure of 15 parastatals - Closure of 31 defunct parastatals under in agricultural sector. SARH. - Submission to Congress of a 1989 budget with transfers for operating losses to CONASUPO at levels below or equal to those currently budgeted for the 1988 in real terms. - Agreement of sugar reforms. - Satisfactory compliance with timetable for closure or sale of six mills. - Discussion of results of a study on sugar pricing policy including cane, fob - Closure of two sugar mills. mill and consumer prices so as to reduce subsidies and to promote greater efficiency in the sector. MEXICO- Agricultural Sector Adjustment Loan I (continued) Policy Matrix Actions Prior to Board Presentation Conditions for Disbursement of Second Tranche Policy Objective Achieved (estimated date of disbursement March 31, 1989 Trade liberalization. - Removal of import licensing - Satisfactory completion ofa study of variable tariffs and discussion of its (paras. 62-69) requirements for agricultural and agro- results with the Bank. industrial products covering 2.8% of national production. - Removal of export controls on high quality rice and cuts of beef except as justified by hygienic or other nonprotectionist considerations as a condition - Reduction of tariffs on 66 categories of first tranche release. The Government shall not have imposed export and compliance with TPL timetables on controls on fruit and vegetables except for hygienic reasons and shall have removal of non-tariff barriers. encouraged farmer organizations to establish and control export quality standards for vegetables and fruits. The Government shall not have imposed - Elimination of monopoly import quantitative restrictions on exports for the purpose of controlling domestic position of CONASUPO for basic foods supply. except beans and milk powder. - Reduction of QR coverage of import licensing on agricultural and agro- - Removal of export controls on wheat industrial products by 5% of national production coverage. and some other agricultural commodities (about 0.8 % of national production). Liberalization of agricultural prices. Reduction of number of commodities - All guarantee producer, prices maintained at least at real 1987 levels in (paras. 37-49) under strict consumer price controls from 1968. Guarantee prices for all crops except corn and beans maintained in 121 in 1983 to 2 1. 1989 within a range of 90% to 125% of comparable international prices, adjusted for processing margins, transport costs and quality differentials according to an agreed upon methodology. (Upper limit of 125% may be revised pursuant to results of study described below if agreed by both parties.) - Review and discussion with the Bank of the results of a study on the guarantee price system, including issues of pan-territorial and pan-seasonal indutril_prducs_by5%_f_naionl_prducion_oveageprices. MEXICO- Agricultural Sector Adjustment Loan I (continued) Policy Matrix Actions Prior to Board Presentation Conditions for Disbursement of Second Tranche Policy Objective Achieved (estimated date of disbursement March 31, 1989 More rational input pricing policy and - Increase in fertilizer prices, interest - Provision of a plan of action satisfactory to the Bank to implement a system reduction of input subsidies. rates, water charges and power rates, but of charges for water used in agriculture that will achieve recovery of O&M (paras. 70-74). these remain highly subsidized. costs except under specific circumstances established by Mexican law. - Agreement to reduce subsidies to FERTIMEX, raise input prices to FERTIMEX, and privatize fertilizer distribution (conditions of proposed Fertilizer Sector Adjustment Loan). Sound Public Investment Budget. - Satisfactory 1988 public investment - Establish procedures to encourage and facilitate disbursement of loans from (paras. 75-79). program for SARH. international agencies in support of the investment budget of SARH. Submission of a 1989 budget request to Congress that increases investment budget of SARH by at least US$200 million in real terms. Bugettol funds will be made available to SARH as needed for timely implementation of agricultural investments. Rationalization of Ministry of - Decentralization of SARH by moving - Objectives achieved. Agriculture. staff from urban to rural areas. (paras. 80-82). Restructuring to improve responsiveness to farmers. Streamlining by staff reductions of about 20% . Annex 4 64 Chronology of AGSAL II Event Date Identification mission May 31, 1989 1st preparation mission September 17, 1989 1st IM draft discussion November 22, 1989 2nd preparation mission November 27, 1989 2nd IM draft discussion March 15, 1990 1st pre-appraisal mission March 18, 1990 2nd pre-appraisal mission August 23, 1990 3rd pre-appraisal mission October 2, 1990 3rd IM draft discussion October 22, 1990 IM approval November 15, 1990 1st appraisal mission January 15, 1991 2nd appraisal mission March 4, 1991 Yellow cover PR meeting March 27, 1991 Negotiations May 20, 1991 Approval June 25, 1991 Effectiveness December 20, 1991 Economic Solidarity Program renewal October 1992 NAFTA signed among US, Canada, and Mexico November 17, 1992 Closing date (original) February 28, 1993 Second tranche release memo December 20, 1993 Closing date (final) December 31, 1993 Effectiveness of NAFTA January 1, 1994 PCR submitted to OED June 29, 1994 65 Annex 5 Policy Letter from the Mexican Government on Agriculture and Food Consumption Policy A. Agricultural Growth and Productivity 1. As it is known, the Mexican Economy has experienced a profound transformation which is mainly characterized by reduction and control of inflation, reorganization of public finances, public sector restructuring, external debt renegotiation, trade liberalization for most products and the establishment of a maximum tariff of 20%, gradual substitution of import permits by tariffs, as well as the elimination of general subsidies. 2. At present, the set of macroeconomic and structural adjustment policies undertaken by the Mexican Government lay the basis for a more adequate economic environment leading to the development of the agricultural sector. 3. The main objectives of the agricultural modernization policy are: increase production and productivity of the agricultural sector, promote the development of adequate investment schemes, as well as raise the producers' welfare, mainly of those with low income. 4. The agricultural sector policy addresses a fundamental change in the role of public sector for the planning and regulation of agricultural markets. At present, the strategy is to promote a major participation of the social and private sectors, including the communities and associations of the rural producers. 5. The Mexican Government's strategy for the agricultural sector will be to support the process of structural adjustment through the following measures: shift public expenditures in favor of infrastructure rehabilitation and creation; eliminate institutional distortions and rigidities that restrain the production capacity of the sector; reduce and eliminate subsidies within the framework of a highly distorted international market; create and promote new production and marketing schemes within the context of an open economy; establish an adequate environment for larger investments; develop the effective linkage between the technological development and the producer through integrated extension schemes; develop a statistical, financial and market information system which provides adequate information to producers for a timely and effective decision-making in the allocation of their resources. 6. Several measures, without precedent at the international level, have been taken in order to meet these objectives. These measures have been oriented to eliminate excessive regulation in the production and marketing of most agricultural products, and to liberalize foreign trade (in spite of having to face an international environment characterized by high level of protection and government subsidies of agricultural products in most countries). At the same time, government intervention to set agricultural product prices for producers and consumers has been substantially reduced. The process of parastatals disincorporation and the elimination of general food subsidies, which are being replaced by targeted subsidies to the poor. 7. The main measures adopted by the administration to improve the productivity and efficiency of the agricultural sector are: Annex 5 66 1. The elimination of "Guarantee Prices" for the following products: rice, wheat, sorghum, barley, soybean, cottonseed, safflower (cartamo), sunflower, copra and sesame. This implies that the prices are determined by market forces and that the Government has no intervention in the marketing of these products. 2. Elimination of import permits for beef, pork, rice, sorghum, oat, soybean, oilseed and a considerable amount of agricultural inputs (seeds and new agricultural machinery). 3. Elimination of export permits for beef, cattle on the hoof, coffee and tobacco. 4. Elimination of barriers to entry to the wheat-tortilla industry. 5. Elimination of restrictive export practices which favor monopoly by some producers' associations. 6. In less than a year and through a difficult and complex agreement process, the Mexican authorities have made a considerable effort, to make the sugar industry productive and liberalize its market. Substantial changes have been achieved such as: elimination of the sales tax; elimination of AZUCAR S.A. monopoly which is practically no longer involved in the purchase and distribution of sugar, thus encouraging the establishment of private channels for its marketing; elimination of differential prices; liberalization of sugar imports by using a scheme of variable tariffs; and completion of the privatization of all sugar mills. 7. Another substantial change was the modification of sugarcane payment arrangements, which rationalizes trade relations between sugar workers and industrialists and establishes incentives for improving sugar production. The main changes introduced are: modification of the payments system according to sugar content or sugar extracted, the elimination of loans to producers which led to the development of excessive fragmentation of landholdings, the modernization of labor relations thus facilitating the development of new sources of employment in the sugar fields, thereby leading to improvements in the efficiency to the sugar industry. 8. Other actions taken were the liquidation or disincorporation of 17 parastatal enterprises from the agricultural sector: Tabaco Mexicanos, Comicion Nacional de Fruticultura, Productos Forestales Mexicanos, Alimentos Balanceados de Mexico, Centro Nacional de Investigaciones Agrarias, Fideicomiso para el Sostenimianto del Partimonio Indigena del Valle del Mezquital y la Huasteca Hicalguena, Aceitera Guerrero, Impulsora Guerrense de Cocotero, Complejo Fruticola Industrial de la Cuenca del Papaloapan Maderas industrializadas de Quintana Roo, Nutrimex, Servicios Ejidales, Servicion Forestales, Triplay de Palenque. Fideicomiso para Apoyo al Instituto Nacional de Investigaciones Forestales y Agropecuarias. 9. CONASUPO restructuring which includes: reduction in the purchase of grains and oilseeds under the "Guarantee Price" system; disincorporation of LICONSA; 67 Annex 5 approval for the disincorporation of LICONSA's industrial plants; access of the social and private sector to BORUCONSA's facilities; sale or relocation of DICCONSA urban stores as well as improvement of services in the rural stores. Additionally, the disincorporation of part of ANDSA's facilities was initiated. 10. Rationalization of government subsidies granted through credits and quotas for water or electricity consumption for irrigation purposes. Likewise, the crop insurance system has been reformed in order to make it more efficient. 8. It is important to underline that most of the measures taken have implied a change in the government's role in the agricultural sector, mainly in the marketing process. The non- intervention of the government in direct marketing activities has created a gap due to lack of marketing agents and calls for Government's attention and determination for the creation of such markets. 9. In spite of transition problems, the Mexican Government is committed to carry out the modernization of the agricultural sector in order to improve the welfare of the rural population. This is why it will continue with the application of policies which strengthen the measures adopted during the last years. 10. The strategy to be undertaken comprises guidelines and actions to be adopted with regard to foreign trade, prices, inputs, research and public investment. I. As regard to foreign trade, the government policy will continue supporting exports of agricultural and forestry products through the elimination of regulations limiting trade, and promoting and identifying new markets and financial alternatives. This is in order to integrate the national economy into the international trade. Also the liberalization process continues in concordance with bilateral and multilateral negotiations being carried out by the Mexican Government in the trade area. 12. With regard to the price policy of agricultural products, the intention is to continue reducing government intervention so that prices be determined according to market forces operating in an open economy. At present, most products have been excluded from the "Guarantee Price" system, with the exception of maize and beans. Prices for certain agricultural products are established through the "System of Agreement Prices" (precios de concertacion), which includes both producers and consumers, and which price levels are linked to international prices. The objective of this scheme is to facilitate the transition of the price liberalization process, since there were not corresponding markets. 13. However, due to the characteristics of the markets and the strategic situation of maize, wheat, sugar and barley, these will receive special treatment: i. Maize: A formula to calculate price increases will be established so that the dollar equivalent price will be constant in real terms, thus giving more certainty to producers. Annex 5 68 ii. Suagr: It is at present necessary to capitalize the sugar industry. To this effect, a constant real price in dollars will be maintained temporarily. At the same time, the Mexican Government's intention would be to reach, in a reasonable time, a protection level of 20%, compatible with Mexico's foreign trade policy. However, it should be noted that the international market for sugar is highly volatile with regard to price due to the serious distortions which result from the intervention of different countries with high subsidies for sugar exports and protection of their local markets. This situation makes it difficult to achieve this goal. For the above reason and in order to have the analytical elements to reduce protection, a study will be undertaken to evaluate and quantify the needs for capitalization of the sugar industry. Based on the diagnosis of the study, the time and timetable to implement a price stabilization system within a range of prices which protects both the producer and consumer from extreme price fluctuations will be determined. iii. Wheat: Due to its importance in the negotiations of the Free Trade Agreement with the United States and Canada, the Mexican Government's intention is to maintain its current level of protection. iv. Barley: Its current level will be maintained for the 1991-92 cycle. However, an increase not greater than 5% in nominal terms is expected during next year. 14. Moreover, an improvement in the linkage between research and extension services, as well as a better quality of zoo-sanitary and phytosanitary services, essential to achieve a better international integration, will be favored. At present, specific studies which will provide the necessary elements for the improvement of these services, are under preparation. 15. A study on Mexico's agricultural planning system is expected to be carried out in order to identify and eliminate the distortions that such system generates. 16. As one of its fundamental tasks, the strategy of agricultural modernization aims at facilitating producers' access to quality inputs at moderate prices. To this end, import permits for inputs will be abolished provided this is congruent with the country's general foreign trade policy. 17. With regard to seeds, the Federal Government decided to revise the current legislation and will soon submit a Bill on the Production, Protection, Certification and Trade of Seeds, to be considered by Congress. This bill calls for the elimination of excessive regulation and will promote private sector participation as well as free competition to PRONASE. 1 8. It is also considered necessary to create an integrated support and information system of agricultural markets, by which producers can make good decisions and efficiently diversify their production. 69 Annex 5 19. With regard to production infrastructure, public expenditures will be devoted to promote those activities which increase productivity, encouraging the participation of all sectors in the expansion and rehabilitation of infrastructure. Likewise, it is expected to facilitate and create an appropriate environment for investment in order to increase transportation and storage capacity. 20. The transformation of the agricultural sector proves to be a difficult challenge, mainly because of the many existing distortions in the international markets. However, we in the Mexican Government are certain that consolidating the progress so far achieved through the success of our future actions, presented in the annex to this letter, will raise the welfare of the agricultural sector and our country, as a whole. B. Food Consumption and Nutrition 21. The priority of the Mexican Government is to put an end to malnutrition, which is linked to poverty. The existing food programs have been improved so as to provide more benefits to the poor. The Mexican Government will continue developing these programs and will create those which are more adequate to protect segments of the population most exposed to potential problems due to a lack of nutrients. 22. The main strategy to protect the existing food programs has been a better targeting of the food subsidies. A scheme of general subsidies is being replaced by another scheme in which subsidies targeted to specific groups of the population are predominant. At present, subsidies are mostly directed to those who really need them, consequently the Federal Government saves on subsidies which previously reached the better off segments of the population. The improvement in targeting of subsidies has taken place both in rural and urban sectors. 23. In the urban sector, the generalized subsidy of tortillas has been replaced by a daily allowance equivalent to one kilogram of tortillas for households with incomes below two minimum wages - tortivales program. Likewise, CONASUPO Industrialized Milk distributes subsidized milk to poor households with children tinder the age of 12. 24. In the rural sector the DICCONSA chain of stores have been relocated in isolated communities without marketing systems or where they were not efficient. The population buys basic goods at better prices through an adequate supply in the rural sores. In particular, there is a special subsidy program for powdered milk, corn and flour. The expansion of the DICCONSA chain stores in the rural communities has been accompanied by the elimination of these stores in the urban areas where the non-poor population predominates. 25. The support program for the consumption of staple food by the poor population described in the last two paragraphs (Food programs in the context of this letter) will continue to be in effect, even though the modalities could vary so as to better direct subsidies to the targeted population. 26. While the Food Program is devoted to the poor, special attention should be given to that segment of the population which has been identified as potentially more vulnerable to the effects of an eventual nutritional deficiency. For operational purposes, this vulnerable population has been defined as the poor sector comprising pregnant or nursing women as well as children under the age of five. The Mexican Government has considered a special program for the segment of the Annex 5 70 population. This program consists in delivering a food supplement, which is linked to medical care (Food, Nutrition and Health Program, in the context of this letter). 27. However, due to the potential problems that would result from the introduction of the Food, Nutrition and Health Program at the national level and because of the risk of not reaching the desired nutritional objectives, a pilot project is being carried out. This project will provide a basic idea on the operational, institutional and financial viability of expanding the Food, Nutrition and Health Program at the national level, mainly to the rural areas. 28. The Mexican Government will continue to provide food and nutritional support to the poor through different components under the Food and Nutrition Program. However, due to the importance of protecting the vulnerable population and in the absence of sufficient resources to cover all the poor, priority would be given to the most vulnerable segments of the population. 29. The different programs to eradicate malnutrition are complementary. The different instruments of the Food Program facilitate the improvement, in general terms, of the food, nutrition and socioeconomic conditions of the poor and, consequently, of the most vulnerable segment of the population which is considered to be a subset of the poor. On the other hand, the Ministry of Health, through the Health and Nutrition Program provides food support and nutritional orientation to the vulnerable population by using the infrastructure of the health services. The food supplements distributed through this program come from international donation only. The Health, Nutrition and Food Program, at present in the preliminary stage of a pilot project - as already indicated - differs from the Health and Nutrition Program in that the food component is financed by fiscal resources which are partially complemented with external credit. For the purposes of this letter, the set of programs to improve nutrition and eradicate malnutrition - including the Food Program as defined before - will be called the Food and Nutrition Program. 30. It is convenient to differentiate consumption subsidies from the price policy and the promotion of agricultural production to obtain a clearer picture in the programming and budgeting of the subsidies policy of the Mexican Government. This distinction is also important to ensure support of basic food consumption by vulnerable groups. Consequently, subsidies and support provided to the agricultural production will be independent from those given to the food and Nutrition Program for accounting purposes. 31. In the urban areas, the Mexican Government will compensate poor households (defined as targeted population for the Tortivales Program) for losses in their purchasing power which result from the effects that protection afforded to agricultural producers of food products have on consumer prices. This compensation will be effected through the Tortivales Program or another program of targeted subsidy adequately designed for that purpose. 32. In the rural areas, DICCONSA will continue to use corn and corn flour subsidies to lessen the impact that the support policy to producers has on rural consumers. However, as far as the coverage of the Food, Nutrition and Health Program is extended, this program could replace maize and maize flour subsidies; this would be subject to what is indicated in guideline No. 10. 71 Annex 5 33. Within this framework, and in order to carry out the National Food Program 1990-94, published in the Official Newspaper (Diario Oficial) on August 23, 1990, the Food and Nutrition Program for 1992-94 will include the following guidelines: 1. The Mexican Government believes that the Food and Nutrition Program is an important instrument to alleviate poverty and malnutrition in the rural and urban areas. 2. The implementation of the Food and Nutrition Program should be consistent with the execution of other priority programs of the Mexican Government and with the equilibrium of public finances. 3. Within the Food Program, it will be necessary to ensure that the vulnerable population of the urban areas be included among the beneficiaries, if they have not been included yet because of lack of information or other reasons. The participation of the Health System, through medical services provided to the vulnerable population, will be necessary to detect whether this part of the population is dully included in the list of beneficiaries, according to the mechanism agreed with CONASUPO. 4. The Ministry of Health is responsible for the execution of the pilot project for the Food, Nutrition and Health Program, and for its possible expansion. 5. The results of the pilot project, at present under implementation, will provide a preliminary diagnosis of the present administrative capacity of the health system for the implementation of the Food, Nutrition and Health Program. 6. Priority will be given, in the short run., to the design and implementation of the Food, Nutrition and Health Program in rural areas. At the same time, the application of the Food Program will continue to be improved so as to increase its cost-effectiveness. It will also be necessary to ensure that the most vulnerable segment of the population benefits from the Program, and to reach a reasonable balance in the distribution of benefits between the rural and urban areas. 7. In general terms means testing will serve to identify the beneficiaries of the Food, Nutrition and Health Programs, and of the Nutrition Program in the urban areas only. 8. The infrastructure of CONASUPO and its branches will serve as a primary channel for supplying and distributing food related to the Food, Nutrition and Health Program, and to the Food Program, in areas where better means of distribution are non-existent. However, in the case of Food, Nutrition and Health Program the social organizations or municipalities will carry out the secondary or final distribution in communities where CONASUPO does not have the infrastructure or where this is not appropriate. 9. According to the implementation capacity of the different institutions involved, and based on the results from the evaluation and monitoring systems described Annex 5 72 below, the government will make the budgetary provisions to continue with the application of the programs. 10. A program, under the consideration and responsibility of the Ministry of Programming and Budgeting, will be designed and implemented in order to follow-up, monitor and evaluate the pilot project and the Food and Nutrition Program. The results from the monitoring and evaluation program will determine the future of the Food and Nutrition Program. In sum: a) If the project is considered to be successful, it would be expanded depending on the implementation capacity of the health system. Measures will be taken to increase this capacity. b) If the pilot project fails due to the administrative reasons and deficiencies in the implementation, it would be redesigned and included in the medium-term action plan - whose elaboration will be considered by SPP - to be executed for an additional year. c) If the pilot project fails to achieve its nutritional objectives, it would be abandoned. d) The results obtained from the evaluation of the Food and Nutrition Program would serve as a basis to make its components congruent to the guidelines of the medium term program (1992-94). The parameter to evaluate all programs, with the exception of Tortivales, will be their nutritional benefit on the targeted population. The Tortivales program will be evaluated on the basis of its efficiency and effectiveness to support food consumption by the targeted population. e) The results from the evaluations would also be used to reallocate resources among the different components of the Food and Nutrition Program. 11. The Ministry of Programming and Budgeting will be in charge to ensure the existence of the necessary analytical capacity for SES implementation. 12. The action plans of the Food and Nutrition Program will include the proposals for budgetary resources to implement the program during 1993 and 1994. MEXICO - Agricultural Sector Adjustment Loan II Policy Matrix Suggested measures Policy issue Policy objective Already achieved Effectiveness and Second tranche dated covenants 1. General conditions A. Macroeconomic framework. Provision A. Macroeconomic framework Provision to to the Bank of evidence that the the Bank of evidence that the macroeconomic macroeconomic policy framework is policy framework is consistent with the consistent with the objectives of the objectives of the program. program. B. Maintaining progress. Maintain policy B. Maintain progress. Maintain policy reforms implemented up to Board reforms implemented up to this moment and presentation and documented under this documented under this project. project. II. Agricultural Growth Production policy and Productivity Problem: Low rate of growth, 1. Reduce direct policy inefficient resource use and interventions in output and input stagnating productivity. markets. 2. Improve allocation of public expenditure in agriculture. 3. Reduce government intervention in farmer's production decisions. fD MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Policy issue Policy objective Already achieved Suggested measures Effectiveness and Second tranche dated covenants A. Price, trade policy and market regulations (output and inputs) 1. Distort trade and resource 1. Output markets 1. Output markets 1. Output markets 1. Output market allocation in production and consumption. a. Liberalization of consumer and a. Price Dated covenant: a. Price and trade policy producer prices of agricultural 2. Large global subsidies to commodities and their industrial (1) The guarantee price system has been (1) Eliminate import (1) Implement action plan agreed upon; that inputs and producer prices derivatives, abolished for: wheat, sorghum, soybean, permits for green coffee no is: achieving modest results. rice, barley, cotton seed, cartamo, later than September 30, b. Reduction ofgeneral price sunflower, copra and sesame. Maize and 1991; (a) implement a system which will eliminate subsidies. some qualities of beans still remain in the CONASUPOs monopoly on imports of guarantee price system. (2) Issue the decree that powder milk, and allocate import permits in a c. Reduction of regulatory market modifies present cane transparent, competitive and efficient basis; barriers and promotion of private (2) Level of domestic producer prices for payment arrangements. (b) eliminate all export permits for fluid milk, sector competition. green coffee and cocoa determined by and powdered milk; international prices. (c) allow for prices of tobacco to be freely determined by the market; (3) Prices of roasted coffee, soluble coffee (d) not ncrease the nominal protection for flexibilized. wheat above its level existing on May , 199 1; (4) Prices of paddy rice, sorghum, and (e) flexibilize prices for cookies, pasta, edible soybeans freely determined by the market. oils, cigarettes, eggs, beef and dairy products; (f) not increase the guarantee price of maize (5) Differential domestic price of sugar to a level over its equivalent real US dollar according to user eliminated; one price value for the Autumn-Winter cycle of established for the same quality. 1990/1991;1 (g) not increase the domestic price of sugar (6) Terms of reference agreed for study to above its equivalent real US dollar value on design a system which will eliminate 01/01/91; CONASUPOs monopoly on imports of (h) not increase the nominal price of barley powder milk and will allocate import for the period June 1, 1991 to January 3 1, permits in a transparent, competitive and 1992 above the level of 680,000 pesos per efficient basis. ton, and set the nominal price of barley for the period 02/01/92 o01/31/93 at a level not (7) Terms of reference agreed for study to to exceed 714,000 pesos per ton; define price and trade policy for edible (i) discuss with the Bank the result of the beans. sugar study and based on such discussion approve a policy for the sugar sector; and (8) Terms of reference agreed to for study ) agree on action plan that follows from the to define sugar policy. edible beans market study. MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Suggested measures Policy issue Policy objective Already achieved Effectiveness and dated covenants Second tranche b. Trade, Effectiveness: (1) Export permits for coffee, rice, sesame, (1) Eliminate export tax for sunflower, ano vegetable oil -except raw cotton, cotton fiber, cartamo and cottonseed oil- lifted. and swine for breeding. (2) Export permits for beef and cattle on the (2) Eliminate export permit hoof lifted. for wheat sorghum, feedstuffs, soybean, barley, (3) A decree on cattle export that copra, cartamo, cartaro determines a gradual reduction of tariff on oil, cottonseed, tobacco exports of male animals, and elimination of and eggs. such a tariff by September 1992, issued. (4) Restrictive export practices for fruits and vegetables eliminated. (5) Import permits for sugar eliminated. Protection granted through a variable levy system. (6) Import permits for sorghum, copra, oilseeds and oilseeds oils lifted. c. Market regulations Restrictions that prevented entry into the com-tortilla industry abolished. 2. Input markets: 2. Input markets: 2. Input markets: a. Liberalize prices and trade and a. Price and trade policy a. Price and trade policy: eliminate regulations on the feedstuffs, seed, machinery and (1) Import licenses for new agricultural (1) For pesticides: maintain policy of pesticide markets. machinery abolished. allowing prices of pesticides to be freely b. Design and enforce a regulatory determined by the market; system for pesticide, plant (2) Tractor prices freely determined by the ar protection and animal health based market. strictly on quality control, health, phytosanitary, epidemiological and environmental protection grounds. MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Suggested measures Policy issue Policy objective Already achieved Effectiveness and Second tranche dated covenants b. Market regulations b. Market regulations: (1) For pesticides: agreement reached on (1) Agree on action plans to implement terms of reference for a study to diagnose recommendations of the studies on: (a) animal current use, assess present legal and health; (b) plant protection; and (c) quality institutional framework and streamline control of pesticides. Rules and regulations procedures to: (a) promote competition would be based strictly on quality control, between producers and distributors; (b) health, epidemiological, phytosanitary, and establish guidelines on minimum standards environmental protection grounds. to deal with health and environmental issues; and (c) enforce quality control. (2) For seeds: eliminate restrictions that impede private sector competition to (2) For animal health and plant protection: PRONASE, PRONASE's monopoly of agreement reached on terms of reference for germplasm produced by INIFAP and limits a study to: (a) assess the regulation, on plant breeding by the private sector. organization and procedures of the system of plant protection and animal health; (b) elaborate a proposal to modernize the system and streamline its procedures. (3) Government has initiated the process of submitting to Congress a draft seed law that will eliminate: restrictions that impede private sector competition with PRONASE, PRONASE's monopoly of germplasm produced by INIFAP, and limits on plant breeding by the private sector. MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Suggested measures Policy issue Policy objective Already achieved Effectiveness and Second tranche dated covenants B. Parastatals controlling B. Parastatals B. Parastatals production and marketing 1. Dismantle parastatal apparatus 1. Seventeen parastatals of SARH 1. Parastatals generated large for market intervention as price and liquidated in 1989 and 1990 (excludes losses and increased deficit of trade policy is rationalized. sugar mills). public sector. 2. Reduce waste in public sector 2. Distribution monopoly and the 2. Introduced large expenditures through agricultural acquisition right of purchase of sugar from inefficiencies into markets parastatals. mills taken away from AZUCAR. intervened by parastatals. 3. Elimination of the 50% tax precluding 3. Precluded competition and private sector transactions in sugar and discouraged private sector cocoa. investment. 4. Full divestiture of the 50 goverment- owned sugar mills. 5. Withdrawal of the parastatals for coffee (INMECAFE), tobacco (TABAMEX), and cocoa (CONADECA) from marketing coffee, tobacco and cocoa. 6. All plants of ALBAMEX but one sold' liquidation of company already authorized. 7. Decision to restructure CONASUPO and its affiliates; most important actions are: a. Divestiture of ICONSA; b. Process ofANDSA's divestiture has started; c. BORUCONSAs storage facilities open for commercial use by the social and private sectors; d. All 569 urban supermarkets closed; and e. Improved coverage of marginal areas by DICCONSAs rural stores. MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Suggested measures Policy issues Policy objective Already achieved Effectiveness and Second tranche t dated covenants C. Public expenditure C. Public expenditure C. Public expenditure C. Public expenditure 1 Large public expenditure to 1. Improve allocation and efficiency Government has provided satisfactory Provision of satisfactory evidence that the subsidize agricultural of public expenditure in agriculture. evidence that the level and composition of level and composition of budgeted producer prices and inputs budgeter agricultural expenditure presented agricultural expenditure presented to has been unproductive. 2. Increase public investment in to Congress in the 1991 budget are Congress in the 1992 budget is consistent infrastructure, research and consistent with the macroeconomic program with the macroeconomic program and with an 2. Low level of public extension. and with an efficient allocation of efficient allocation of government resources investment expenditure in Goverment resources at the sector level, at the sector level. agriculture particularly in for the fiscal year 1991. infrastructure, research and extension leading to deterioration of infrastructure and the sector's productive capacity. D. SARH's production D. SA RH's production targets D. SARH's Production targets D. SARH's production D. SARH's production targets oo targets targets Dismantle system. agreement on terms of reference for study Implement actions agreed upon to eliminate SARH and other agencies set to identify the process, legislation and Effectiveness and dismantle processes, and regulations that production goals guided by regulation that gives SARI and other enforce the system of crop production targets. some self-sufficiency criteria Government entities the power to establish, 1. Present study which unrelated to market coordinate and enforce production targets. identifies processes, conditions. This system is a legislation and regulations source of distortions in that give SARH and other resource allocation, Government entities the encourages resource waste at power to establish, the farm level and drains coordinate and enforce initiative and entrepreneurial crop production targets. ability from farmers. Dated Covenant: 2. Based on the study, present to the Bank, not later than September 30, 1991, a satisfactory plan of action to eliminate and dismantle processes, and regulations that enforce the system of crop production targets. MEXICO - Agricultural Sector Adjustment Loan II (continued) Policy Matrix Suggested measures Policy issue Policy objective Already achieved Effectiveness and Second tranche dated covenants III. Food Consumption and Nutrition Policy 1. Agricultural price and 1 Reduce incidence ofmalnution I increase of targeted and semitargeted 1. Present evalnation of food and nutrition marketing policy were in Mexico in the medium-tem. subsidies (torlibonos and milk programs, programs as agreed to in (lie implementation subordinated to consumer and DICCONSA stores) from 0.13% of plan for MES. price policy. 2. Improve effectiveness of GDP in 1989 to 0.26% of GDP in 1990. nutrition and primary health 2. Agree with the Banik on general and 2. Global consumer subsidies programs by fully exploiting 2. Agreement on central guidelines for a agencies action plais for 1993-1994. resulted in a high fiscal cost complemeitarily. medium-term food aid nutrition program. and waste of resources. 3. Eliminate consumer price control 3. Definition of the target population for the 3. Because of substantial as the main instrument for food and nutrition programs. leakages global subsidies implemeiting food consumption were not cosi-effective in policy. 4. Healh system designated as exectting attacking poverty and agent of the nutrition and health program. malnutrition 4. Free agricultural production and trade policy fromt its subordination 5. SPIP designated as the agency in charge 4 Targeted consumption to consumer price policy, of: (a) preparing central guidelines for the programs are mainly urban medium term program; and (b) coordinating while most of the poorest live tle. (i) budget allocation for the food and in rural areas. nutrition programs to the executing agencies, and (ii) monitoring, evaluation and research of the food and nutrition programs. 6. Agreement reached on: (a) terms of relcrence for tIme designm of a system to evaluate and motor food and nutrition programs (MES); and (b) a plan of action to iiplement such a system. 7. Agreement on a process for tsing the results oh tie s onitoritg and evaluatio systet (MS) to adjtst the guidelines and programs acording to the lessons learned aro experience. 8. Ipcmentation olagreed food, nutritiot amod health plot procr hs been started. Annex 7 80 GOM's Comments on the Tortilla Subsidy Program Background I1. The immediate precursor of the tortilla subsidy program was the tortibonos program in effect from April 1986 to October 1991. The tortibonos program formed part of the support that the federal government channeled to the maize tortilla chain, intended to strengthen the consumer stage. 2. The torlibonos program consisted of the sale of vouchers for one and two kilograms of tortillas at below market prices. The vouchers, known as tortibonos, were accepted by affiliated tortilla shops and were subsequently cashed by them for an amount equal to the market price. The subsidy, which was equal to the difference between the market price and the tortibono price, was paid by CONASUPO. 3. Tortihonos were distributed for sale to the general public by CONASUPO's retail food sale system (DICCONSA), and by certain social and labor organizations who sold them to their members. 4. Despite the channels set up for the distribution of tortibonos, the scheme had no instruments to monitor and follow up on the beneficiary population that would permit it to be classified as a targeted subsidy program. Tortilla Subsidy Program 5. The first list of families eligible for the tortilla subsidy program, which provided them with one kilogram of tortillas a day free of charge through affiliated establishments, was issued in November 1991. 6. When the tortilla subsidy program was set up, mechanisms were established to change the earlier scheme that involved a general subsidy to a targeted one, and to increase efficiency and transparency in the use of fiscal resources. Specifically: 7. A national list of beneficiaries selected though non-discretionary mechanisms was established and computerized. 8. Inclusion and exclusion criteria were defined, taking into account information on income, spending, housing conditions, and family possessions. The poverty line was defined as families with incomes of two inimmum wages or less, calculated for each family using indirect methods. 9. A planning system was established based on a mapping frame that identified marginal urban areas, target population, and population served. A geographic information system based on digitized maps has been in use since 1993. 81 Annex 7 10. A personal identification system was instituted, based on cards with bar codes for the beneficiaries and optical readers in the affiliated tortilla shops. In 1994, a new technology began to be introduced based on "intelligent" or "memory" cards. 1. An independent specialized agency was set up to pay the subsidy. under the administration of national credit institution (Banco Nacional de Comercio Interior) which worked on the basis of a fully automated system. Program Operating System 12. Program operation is based on the inclusion of families through household socioeconomic surveys, and subsequent data capture and evaluation using computer systems. Families that meet the eligibility criteria are given a personalized plastic card containing a unique bar code that identifies them as beneficiaries of the program. 13. Optical readers have been installed in the affiliated tortilla shops to read the bar codes. When the beneficiaries present their cards, provided they have not expired, an employee of the establishment gives them one kilogram of tortillas free of charge. 14. Subsequently, an employee from each shop takes the optical reader to an exchange center where the bar code information stored in it is downloaded through a computer linkup, and the shop is paid for the transactions at the official price per kilogram of tortillas. 15. As of December 1993, the tortilla subsidy program was operating in 202 Mexican cities, had 2.1 million beneficiary families, and 12,975 affiliated tortilla shops. 16. The program administration intends to continually monitor and update the list of beneficiaries, using a mechanism that verifies a random sample, whose results will be used to make statistical inferences on the reliability and accuracy of the list. The random verification will be carried out each quarter in each of the 202 participating cities. Shortcomings in the Tortilla Subsidy Program 17. The tortilla subsidy program only covers urban areas. It was designed in this way to complement the subsidized corn flour distribution program carried out in rural areas through DICCONSA. In urban areas, the idea was to accommodate the habits of city dwellers who prefer ready-made tortilla. 18. As of December 1993, the program covered 2.1 million families, which represented 60 percent of the target families, who number 3.5 million according to estimates based on CONASUPO's mapping study. 19. The list of beneficiaries of the tortilla subsidy program underwent a structural change when it was updated in 1992 and 1993. The updating involved verification of the socioeconomic situation of 70 percent of the families registered in the list. Forty percent of those verified failed to meet the eligibility criteria and they were removed from the list and replace with new beneficiaries. Annex 7 82 20. A consistent methodology for the inclusion and exclusion of beneficiary families has been used in the tortilla and milk subsidy programs since September 1993. At that time, the two institutions established a joint program to verify the whole list of milk subsidy beneficiaries, and to subsequently consolidate in CONASUPO the administration of a single list of beneficiaries of both social programs. This project will be concluded in October 1994 in the cities participating in the tortilla subsidy program, except for the metropolitan area of the Federal District. 21. The tortilla subsidy program is designed to transfer income (in kind) to poor families in Mexico's urban area through the provision of a staple food. Under the policies governing the program, the amount of the transfer is the relevant element, and not the nutritional content or contribution to the diet of the beneficiaries. The possible integration of the tortilla subsidy program into a program for nutritional support and the provision of educational and health services would be desirable and advisable from the institution's standpoint. Main Lessons Learned from the Tortilla Subsidy Program 22. The introduction of a targeted subsidy program to replace the earlier program of general transfers has led to better control over fiscal resources by eliminating the market distortions caused by the general approach. 23. Permanent updating of the list of the beneficiaries of the tortilla subsidy program and its coverage have laid the groundwork for the possible liberalization of prices on the final tortilla market without placing the most economically vulnerable families at risk. 24. The consolidation of methodologies, inclusion and exclusion criteria, and the merger of the lists of beneficiaries of the tortilla and milk programs will allow for expansion programs that are congruous with institutional criteria, economies of scale in the management of the two programs, and consistency in the policy of targeted subsidies administered b the CONASUPO system. 25. The use of leading-edge technologies in the planning (digitized mapping) and execution of the tortilla subsidy program (intelligent cards and bar codes), and of computer systems for managing lists and information have led to grater administrative and operational efficiency. Their use in CONASUPO's social programs has been highly relevant in attaining the desired objectives.  IMAGING Report No: 15794 Type: PPAR