Costa Rica - Agricultural Credit Project

RESTRICTED Report No. P-601 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE BANCO CENTRAL DE COSTA RICA May Z3, 1968  LITERIIATE)IIAL B FOR RCOMSThUCTIOIJ AID DEELOP?I'IT REPORT A1TD RECOKAWDATIOU1 OF THS PR3SIDST TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOA1 TO THE BAiCO CSMRAL DE COSTA RICA 1. I submit the following report and recommendation on a proposed agricultural credit loan in an amount in various currencies equivalent to US$3.0 million to the Banco Central de Costa Rica. PART I - HISTORICAL 2. In July 1964, the Government of Costa Rica made a preliminary request for Bank assistance in financing a credit proGram to expand and diversify agricultural production. A Bank mission w.as sent to Costa Rica in September 1964 to identify and help prepare a project for possible financing. Following the receipt in iay 1965 of the project study, prepared by the Banco Central and the Oficina de Planificaci6n, the Bank sent an appraisal mission to Costa Rica in August 1965. 3. Negotiations were conducted in tashington in late June 1966. The Costa Rican delegation t:as composed of iIr. Eduardo Lizano, Aember of the Board of the Banco Central and Head of the Delegation, ;Ir. Claudio Volio, representative of the Commercial Banks, ir. Ariosto Garcia, Representative of the A1inistry of Agriculture and ilr. * ario Ugalde, Representative of the Central Bank. Representing the Government of Costa Rica were His Excellency Mr. Fernando Ortufio, Ambassador to Washington and ',Jr. Guido Fernandez, the Erbassy1s Counselor for Economic Affairs. 4. There are two reasons for the long delays between appraisal, negotiation and submission of the following recommendation. At the time of the 1965 appraisal mission, a Bank economic mission also visited Costa Rica to review Costa Rica's public investment program for 1965-68 and the problems of financing this program. Fiscal problems, of a dimen- sion that affected Costa Rica's creditworthiness and ability to proceed wsith a sizeable investment program, had been identified by previous economic missions. The mission concluded that a sizeable effort at increasing revenues and considerable restraint on growth of current expend- itures wias needed to avoid serious deterioration in Costa Rica's finances. Howiever, Presidential elections during the first half of 1966, and the subsequent change of administration resulted in an extended delay in con- fronting the fiscal issue ':ith the result that the ex^ected financial deterioration did, in fact, occur. During this period, changes tvere made in Costa Rica's agricultural credit progranm and, therefore, in the design oif the oroject, .ahich also contributed to the del.r.  - 2 - 5. As pointed out in Part V of this report some improvement has taken place in the fiscal situation inrecentmonths, althDugh a number of important issues have still to be resolved before the country will have an adequate fiscal base for proceeding with the expanded public in- vestment program proposed., In these circumstances the Bank would appear to be justified in proceeding with the loan under consideration. 6. The proposed loan would be the eighth made in Costa Rica and it wzould increase the total of Bank loans in Costa Rica to $50.7 million (net of cancellations). IDA has made one credit of $4.5 million (net of cancellations) to Costa Rica. The following is a sumnary statement of Bank loans and IDA credits as of April 30, 1968. US$ Hillion Loan or Undis- Credit Year Borrower Purpose Bank IDA bursed .umber 147 1956 Banco Central Agriculture and ind. 3.0 nil 219 1959 Banco Central Agriculture and ind. 3.5 nil .51 1960 Banco Central Industry 2.0 nil 276 1961 ICE Power (Rio Miacho) 8.8 nil 296 1961 Banco Central Lndustry 2.9 nil 299 1961 Government Roads 5.5 nil 10 1961 Government Roads 4.5 nil 3h6 1963 ICE Power (Cachi) and Telecommunications 22.0 0.1 Total (less cancellations) 47.7 4.5 of which has been repaid to Bank and others 11.8 Total now outstanding 35.9 Amount sold 3.5 of which has been repaid 3.2 .3 Total now held by Bank and IDA 35.6 4.5 Total undisbursed 0.1 nil 0.1 7. As of April 30, 1968, IFC has one active investment in Costa Rica of $276,042 (loan outstanding and equity) in a company manufacturing concrete products (Productos de Concreto, S.A.). 8. New projects in the fields of power, telecommunications, and highway and port construction are under consideration but are still in an early stage of preparation.  - 3 - PART II - DESCRIPTION OF TIE PROPOSE) LOA1N 9. Borrouer: Banco Central de Costa Rica. Guarantor: Republic of Costa Rica. Amount: The equivalent in various currencies of US$3.0 million. Purpose: To assist in financing a three-year lending prograin of the borrowrer, to be carried out through Comercial Banks, for increasing the production of beef-cattle, tananas, cotton and pineapples. Amortization: 20 years including 5 years of grace; principal repayments semi-annually from August 1, 1973, through August 1, 1988. Interest Rate: 6-1/ percent per annum. Commitment Charge: 3/4 of 1 percent per annum. PART III - THE PROJ-CT 10. An appraisal report entitled "Agricultural Credit Project - Costa Rica" (TO-515c)on the proposed project is attached. 11. The proposed loan would be the third loan to be made to Costa Rica to assist in developing a Ikey sector of the economy, agriculture. Agriculture in Costa Rica is the most important sector of activity, both in terms of employraent, and of its contribution to Gi!P and to exports. In recent years, coffee has accounted for almost half of Costa Rica's export earnings. With relatively large accessible areas of land still to be developed, Costa Rica has good prospects for egpanding the produc- tion of a more diversified range of agricultural export products with a proven market. An encouraging beginning has already been made in the cattle industry, and Costa Rica should be able once more to be a major exporter of bananas. 12. The Danco Central de Costa Rica will be responsible for the coordination of the project and wrould execute the lending program through four government-owned banks, Banco Nacional de Costa Rica, Banco de Costa Rica, Banco Anglo-Costarricense and Banco de Cr6dito Agricola de Cartago, referred to hereafter as "Commercial Banks". The Banco Central, created in 1953, is a Government institution and the Bank's past experience wJith loans made to it and channeled through the Commercial Banks has been  - 4 - satisfactory. The Board of Directors of each of the Commercial Banks are appointed by the Central Government Cabinet for four-ysar t-rms. The Cormercial Bank's are autonomous public iastitutions and ha-e complebe inelependence with respect to admni,.rtration and management. They have adequate offices distributed throughout the country, staffed with tech- nically prepared and experienced administrators. They are experienced in making agricultural credits and with some specialized technical assistance are capable of handling the volume of buisiness envisaged. 13. The project proposed for Bank financing consists of a lending program designed to increase the production of beef-cattle, bananas, cotton and pineapple. Under this lending program loans will be granted for land preparation; pasture improvement, fencing, water and handling facilities; selected breeding stock and semen; machinery and equipment; fertilizer, insecticides, fungicides, and herbicides for pre-production purposes; buildings, wells and ginneries; tecbnical services, related equipment, training and studies. 14. The project also contemplates the provision of technical specialists from abroad for agricultural credit administration, pasture improvement and livestock management, entomology and horticulture. The training of more agriculturists and agents and the further training of existing ones in financial analysis of projects would also be conducted to assure a more thorough evaluation of loans in the future. 15. The proposed loan of $3.0 million would be used to cover 60 per- cent of the amounts lent by the Commercial Barks under the program1i, the remaining 40 percent coming from the Commercial Banks' own resources. This 60 percent represents the estimated cost of the imported materials, equipment and services purchased by the farmers with their loans. Loans made by the Commercial Banks to farmers would cover on an average some 80 percent of the farmers' investments, the farmers themselves providing on an average some 20 percent. Loans to any individual farmer wrould not exceed in the aggregate 700,000 Colones without the Bank's approval, except for loans for banana production, which Teould require the approval of the Banco Central if their amount were between 700,000 Colones and 1,500,000 Colones and the approval of the Bank also if they exceeded 1,500,000 Colones. The Banco Central de Costa Rica would relend the proceeds of the loan to the Commercial Banks on the same terms as it received them from the Bank, except that the relending would be in Colones, with the Banco Central bearing the exchange risk. The Com- mercial Banks would relend to the farmers, also in Colones, at an interest rate of 8 percent per anmnum and a service charge of up to one per cent per annum. The loans to the farmers would hav-e periods of grace of from 2 to 5 years and would be amortized over periods of from 5 to 10 years, according to the items financed. The Commercial Banks could relend repayments made by farmers to the extent that they were not requ_i:ed to meet their contractural repayment obligations to the Banco Central. 16. Financing of the four above-mentioned products, i.e., beef- cattle, bananas, cotton and pineapple, would greatly assist in obtaining significant increases in production and exports in a relatively short  period of time, thus helping the balance of payments situation of the country. The credit program would sustain the expansion of production by private planters of banana varieties resistant to the Panama disease, mainly in the Atlantic region, one of the most suitable and most con- veniently located areas for banana production in Latin America. MIeat production, which has grown very rapidly in the last few years, would open new opportunities for export, mainly to the US market, Costa Rica being free of foot-and-mouth disease. Part of the expanded cotton production, of relatively high quality fiber, would supply the growing domestic textile industry. Pineapple cultivation in two areas in the Pacific region would be undertaken largely as a pilot project. 17. The proposed employment of specialists by the Banco Central and the assignment of technicians and extension officers to the project by the Commercial Banks, the Ministry of Agriculture, and the National Production Council, the greater decentralization of commercial bank operations and the improvements in appraisal and supervision methods suggested by the Bank should assure prompt implementation of the project and the realization of the above benefits. 18. Procurement of all items financed would be through normal commercial channels. Costa Rica has a well established network of private importers and dealers in farm machinery and equipment, fertilizer, her- bicides and insecticides. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 19. The draft Loan Agreement between the Bank and Banco Central de Costa Rica, the draft Guarantee Agreement between Republic of Costa Rica and the Bank and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement are being distributed to the Executive Directors separately. These draft agreements are in the usual form. PART V - THE ECONOMY 20. Costa Rica's basic problem in recent years has been one of persistent financial difficulties in an otherwise very satisfactorily growing economy. Highly trained manpower, the efficient agricultural sector and a rapidly growing market for industrial products within a framework of political stability, were the main sources of successful development. However, persistently widening fiscal deficits throughout the 1960's have exerted mounting pressures on the balance of payments. Given the openness of the economy and, in the short run, relatively rigid domestic supplies, excess public demand spilled over into imports rather than raising the domestic price level. The resulting losses in inter- national reserves reached a critical stage at the end of 1966, when gross reserves merely covered one month of imports while net reserves were negative by $11L2 million. To safeguard the balance of payments while the underlying causes for the extemnal disequilibrium were to be eliminated, a dual exchange system was introduced in early 1967.  -6- 21. The last Bank report on Costa Rica (MH-170a dated June 5, 1967) clearly identified these issues wihen it concluded that, although the Costa Rican economy had favorable growth potential, the creditworthiness of the economy for additional external public borrowing was dependent upon? a very substantial improvement in the fiscal situation of the Central Gov- ernment. Such improvement would permit not only the generation of sufficient savings to carry out important infrastructure projects, but also enable the authorities to maintain monetary and financial policies consistent with an orderly exchange system. 22. During 1967, the fiscal situation further deteriorated despite the introduction of a substantial package of additional taxes. Revenues- from import duties declined again, while both current and capital expend- itures continued their rapid growth. The resulting record deficit wqas on a net basis entirely financed from domestic sources, including substantial borrowing from the Central Bank. Although net international reserves apparently increased in 1967 by some $25.0 million, the real balance of payments situation deteriorated slightly further. Payments arrears, due to delays in the processing of exchange requests in the official market, increased by some $28.0 million. Thus, the external disequilibrium con- tinued despite a 14 percent depreciation of the free market rate between January - December 1967, at which rate about half of all transactions were made. 23. The major underlying causes of the fiscal difficulties are clearly identifiable as: (a) the excessive growth of current expenditures to meet the rising demands for health, education and other public services as a result of rapid population growth and (b) a limited tax base which has been increasingly eroded by tariff exemptions on imports from within the Central American Common Narket (CACM) and the competitive pressure within the region to grant fiscal incentives to industry. 24. For 1968 prospects are for a substantial improvement in the fiscal situation. The tax action taken in 1967 now effective on a full year basis plus economy measures introduced early in the current year will com- - bine in reducing the Central Government's budget deficit after external dis- bursements and rollover of domestic debt to about 40 million. While such a deficit is still considered too large from a balance of payments point of view, it nevertheless represents a substantial improvement over the 1967 performance (comparable deficit of 0116 million). With exports, mainly of bananas and coffee, expected to increase markedly and imports expected to stay put as a result of the contemplated tight credit policy of the Central Bank, the balance of payments should also slightly improve during 1968. 25. To further reduce the remaining 1968 fiscal deficit but, even more importantly, to lay the basis for a continuation of the fiscal improvement through 1969 and subsequent years, the early introduction of the contemplated regional tax measures will be of crucial importance. These measures, the final content of which is still subject to discussions presently taking place among the CACM1 partners, are expected to include a 40 percent surtax on extraregional imports and an agreement regarding the discontinuation of competitive and indiscriminate,-granting of fiscal - incentives. While the increased protection may lead to additional -un- economic import substitution, the fiscal needs are paramount in the present  situation. If, in addition, action is taken to continue the income/pro- perty tax surcharges (temporary measures which are due to lapse at the end of 1968) or equivalent measures are adopted, and if the restraints imposed on current expenditures in the 1968 budget are extended for another year, the financing of the ambitious 1969 Central Government investment program (about 50 percent higher than in 1968) would seem to be feasible without recourse to the Central Bank. Such a fiscal effort, which has still to obtain the support of Congress in Costa Rica, would represent a major achievement and bring Central Government savings from a negative figure in 1967 to financing 40 percent of an increased level of public investment in the period 1968-71, when total public investment is programmed at 01,o5o milliont as against 0780 million in the preceding four years. Savings of the rest of the public sector, as at present projected, would finance 30 percent of this investment. The public investment program is concentrating on providing infrastructure, both in transport and power, to support further diversification of the economv. On the assumptions made above about public savings, and with a moderate allowance for domestic borrowing, such an investment level would call for a total gross capital inflow of $90 million (0600 million), half of which is already committed to ongoing projects. 26. While in the short and medium term revenue measures may reduce the fiscal problem to manageable proportions, there is also hope for improvement in the longer run on the expenditure side. There is now growing awareness by the general public and the authorities of a need for population control. A comprehensive family planning program, initiated recently, promises to cover a large segment of the population within the next two to three years. 27. Mainly as a result of the continuous fiscal deficits, which had been financed by substantial amounts of short term credit from abroad in addition to long term development loans, Costa Rica had acquired in recent years a heavy debt service burden amounting to almost 18 percent of export earnings in 1967 (Tables 1 anid 2 attached). Some of this short term debt has been repaid recently, and the Government has been able to extend the matur- ities on part of the remainder. As a result, by the end of 1968, the pro- portion of short and medium term debt will be reduced to 26 percent of the total, as against 36 percent at the beginning-of 1966. Assuming that the additional loans required to finance the 1968-71 investment program are obtained on conventional terms, debt service payments on the total debt would decrease to about 9 percent of projected export earnings by 1971. 28. While, therefore, the fiscal performance of Costa Rica cannot yet be judged fully satisfactory, there has been some improvement during the past year, and there is a reasonable prospect that additional corrective action will be taken in the coming months. Costa Rica can in these circumstances be regarded as creditworthy for the proposed loan. However, the Bank wants to see concrete evidence of further progress in dealing with the fiscal problem before going ahead with the substantial lending program under consideration for the next few years. PART VI - COPLIANCE WITH ARTICLES OF AGREEMNT 29. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 8 - PART VII - RECOM4MENDATICIT 30. I recommend that the Executive Directors adopt the following resolution: RESOLUTION NO, Approval of loan to Banco Central-ae Costa Rica in an amount equivalent to US$3,OO0os0OO to be guaranteed by Republic of Costa Rica RESOLVED: THAT the Bank shall grant a loan to Banco Central de Costa Rica to be guaranteed by Republic of Costa Rica, in an amount in various currencies equivalent to three million United States dollars (US$3,000,000), to mature on and prior to August 1, 1988, to bear interest at the rate of six and a quarter percent (6-l/1vO) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forthi in the form of Loan Agreement (Agricultural Credit Project) betwFeen the Bank and Banco Central de Costa Rica, and the form of Guarantee Agreement (Agricultural Credit Project) between Republic of Costa Rica and the Bank, which have been presented to this meeting. Robert S. McNamara Attachments President Washington, DIC. May 23, 1968