i TuRng' TOFILE CO PYUS

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION

Not For Public Use

Report No. P-1130

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED LOAN

TO

FEDERATIVE REPUBLIC OF BRAZIL

FOR AN

INTERIM SECOND LIVESTOCK DEVELOPMENT PROJECT

December 6, 1972

This report was prepared for official use only by the Bank Group. It may not be published, quor cited without Bank Group authorization. The Bank Group does not accept responsibility fbor theaccuracy or completeness of the report.

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CURRENCY EQUIVALENTS

Currency Unit Cruzeiro (Cr$)

US$1.00 - Cr$6.165 -

Cr$1 v US$0.162

Cr$1 million US$162,000

1/ Selling rate effective November 22, 1972. Appraisal estimates basedon US$1 = Cr$5. 8 5.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

REPORT AND RECO1IENDATION OF THE PRESIDENTTO THE EXECUTIVE DIRECTORS ON A PROPOSED

LOAN TO THE FEDERATIVE REPUELIC OF BRAZILFOR AN INTERIM SECOND LIVESTOCK DEVELOPMENT PROJECT

i. I submit the following report and recommendation on a proposedloan to the Federative Republic of Brazil for the equivalent of US$26million to help finance a project for livestock development. The loanwould have a term of 17 years, including five years of grace, withinterest at 7¼ percent per annum.

PART I - THE ECONOMY

2. An 'economic report entitled "Current Economic Position andProspects of Brazil" (WH-210a), dated November 30, 1971, was distributedto the Executive Directors on December 2, 1971. A country data sheet isattached as Annex I. A new economic report is now being prepared, basedon the three Bank economic missions which were sent to Brazil this yearto review, respectively, the Government's programs for developing theNortheast and Amazon regions, prospects for development of agriculturaland industrial activity elsewhere in Brazil, and Brazil's macro-economicperformance.

3. After having grown by about 9 percent annually during 1968-70,Brazil's national product increased by an estimated 11 percent in 1971.Indications are that growth will be even greater in 1972. Industrialproduction during the first six months of 1972 was almost 15 percentgreater in real terms than during the equivalent period in 1971 which, inturn, was 11 percent larger than during the first semester of 1970. Outputof Brazil's principal crops excluding coffee is expected to increase byabout 10 percent in 1972 compared to about 2 percent in 1971. Simultaneously,the Government appears to be succeeding in its effort to reduce the annualrate of inflation from 20 to 15 percent. Reflecting good weather and sharpincreases in crop yields, food supplies have been abundant and food priceshave risen by only 10 percent over the first eight months of the year comparedto 21 percent last year.

4. Export growth and diversification continues to be strong. After-slowing down from 19 percent in 1970 to 5 percent in 1971 on account of adrop in coffee prices, export growth is expected to amount to 27 percent in1972. Manufactured exports are increasing this year at a 46 percent pacecompared to 34 percent last year. However, rapid economic developmentcontinues to provoke massive import increases; imports are up by about 27percent in 1972, and a current account deficit in the balance of payments

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of some US$1.5 billion appears to be in prospect fcr the year. TheGovernment, is taking several importent measures designed to reduce theexternal gap in the future. Besides continuing its system of incentivesfor manufactured exports, the Government is implementing an "exportucorridors" program designed to increase non-traditior.al agriculturalexports such as corn. soya and beef, and is moving to expand productioncapacity in areas such as ferrous and -non-ferrous imetals and petrochemicalswhere substitutes for imports may be produced economically in Brazil.

5. However, as inLdicated in the last economic report, the externalconstraint clearly remains the dominant one on Brazilian growth, so thatsubstantial capital inflows continued to be required to sustain rapid devel-opment. The private international financial oomx4=ity *ees Brazil i an

attractive outlet for international financial investment. Nore than US$hbillion in gross loan capital is expected to flow into Brazil in 1972, ofwhlich at least US$3 billion in the form of financial credits. By the endof 1572 Brazil's total external debt is likely to amount to about US$9billion of which about US$5 billion would be in financial credits, In orderto prevent this accumulation of debt from causing eventual liquidity problemaBrazil has been inplementing two important policies: first, comprehensivecontrols on debt maturities which have pushed out the average term of newfinancial credits from about 2 years in 1971 to about 4 years this year;and second, management of aggregate demand in such a way that about ti4o-thirds of the financial credit buildup has been offset by accunulatior ofnet foreign reserves. Thus, even though its oretall debt service ratio,amounts to about 5% percent this year, the UI$3.5 billion in resetves whichBrazil has accumulated would give it a substantial margin of time for balanceof payments adjustment in the event that its presently favurable internationalpayments position were to deteriorate. This debt service ratio refers to bothpublic and private debt including all financial credits, information on whichis not usually available for member countries. IWhile the ratio of service ofthe public debt is not available in Brazil, it wouad be very luch less thanthe preceding figure. Service on total debt excluding financial credits (thebulk of which is owed by private borrowers) is arouand 15 percent in 1972.

6. The need to offset the bulk of financial ctedit with reserve accu-mlation means that mobilization of official long-term loar capital still iscrucially important for Brazil despite the ready availability of fifancialcredit. The Government's sound policies with respect to the zianageiment ofoverall demand and of external lebt augurs well for BrazilTs creditworthinessfor large scale official lending. While the official loan capital needed tosupport Brazil t s economic growth targets is substantial, the direct importneeds of most public investment projects are relatively low, reflecting --inter alia -- the ability of Brasil's highly developed capital goods industryto compete successfully under international competitive bidding. Rence3 anappreciable part of official external financing mast continue to be availableto cover domestic expenditures.

PART IT - BANK GROUP OPERATIONS IN BRAIL

7. By October 31, 1972, Brazil had received 4i loans from the Bankamaournting to US$1,520.3 million. Annex II gives a sumary statement of loansas of October 313 1972. Of the loans declared effective, 25 have not been

3

fully disbursed, and of those, disbursement of 12 was behind schedule atthe end of 1971. However, the pace of disbursements has accelerated.During FY65 to FY69 disbursements averaged only US$10 million per year,increasing to US$66 million in FY70, US$75 million in FY71, and US$137million in FY72. IDisbursements should continue to increase during thenext few years. Comments on the implementation of individual projectsare contained in Annex II.

8. IFC has conmitted more financial resources to Brazil than toany other country. Since 1957, IFO has made 20 commitments in Brazil,totalling Us$96.4 million, of which US$5.7 million has been repaid andUS$35.7 million sold. Of the balance of US$55.0 million, US$37.8 millionrepresents loans and US$17.2 )million equity. A summary of IFC's invest-ments is also given in Annex II.

9. Bank lending to Brazil was very active in FY72, and seven loanstotalling US$437 million were approved. So far, in FY73 three loans amount-ing to US$87.7 million have been approved covering an agricultural settlementproject in Northeast Brazil, the Fourth Highway Construction project, and aGrain Storage project. Now in the process of appraisal, is the investmentprogram of Light, S.A., the principal distributor of electric power in Riode Janeiro and Sao Paulo, with a view to a loan that would assist the companyto raise additional finance in the external capital market. We are alsoholding discussicns with the Brazilians on the Itumbiara Hydroelectricproject of Farnas S.A., a program of investment in processing facilitiesfor agricultural exports, an investment program in the port of Recife, anda water supply program in the state of Bahia, and hope to present theseprojects to the Ececutive Directors in the next nine months or so.

10. In lending to Brazil, the Bank is responding to Brazilts demon-strated ability to use increasing amounts of external capital to sustaina high rate of economic growth. In selecting sectors and projects forlending, the Bank seeks to fill important development needs. In thefirst place, the Bank can help Brazil to increase its total foreign capitalinflow by providing loans either to sectors where bilateral financing isnot available or to projects where the Bank's participation will help Brazilobtain additional bilateral financing. The proposed livestock loan -- whichhas a low import content (see paragraph 32), spread over several hundredinvestment proposals, and is therefore unlikely to attract support fromforeign bilateral financing agencies -- is an example of the former, whilethe Bank's recent and projected lending for steel and electric energy areexamples of the latter. In the second place, the Bank is hoping to directits lending towards areas in which it can support the Government's effortsto strengthen institutions and pursue sound economic policies. Such is thecase with regard to investment planning and finance in the power, water sup-ply and transport sectors. It is also the case in the proposed livestockloan which makes an extension of the use of real positive interest rates for

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agricultural lending in Brazil. Third, the Bank is stressing theselection of projects which will help Brazil overcome the most criticalconstraint on economic growth, namely, the balance of payments. Thismeans support of export-oriented investments, such as the MBR iron oreproject and the proposed livestock projects, or of import substitutingindustry where, as in the case of steel, Brazil has a significantcomparative advantage. Fourth, in selecting projects for financing, aconcerted effort is being made to identify projects that will foster thegrowth of the less developed parts of Brazil, particularly the Northeast,and reduce regional and other income disparities. The Alto Turi LandSettlement project, approved earlier in the year, is an example of this.

PART III - THE AGRICULTURAL SECTOR

11. The proposed livestock development loan would be the Bank'sfourth for the agricultural sector in Brazil. Previous loans include thefirst livestock development project (Loan 516-BR) in 1967, the Alto TuriLand Settlement project (Loan 853-BR) and the Grain Storage project (Loan857-BR) approved eaJlier this year. The agriculture sector was recentlyreviewed in the Report and Recommendation of the President (P-1115, datedAugust 22, 1972) for the recently approved Grain Storage project; relevantextracts with updated information, are attached in Annex I following theCountry Data Sheet.

Livestock Development

12. Despite Brazil's great;natural advantages for cattle raising thegrowth of the beef cattle sector has been barely sufficient to keep pacewith rising domestic demand. Until recently the sector was making littlecontribution to export earnings. Between 1966 and 1971, beef outputincreased at an annual rate of slightly below 2 percent, insufficient tomatch the increase in demand resulting from the growth of population andper capita incomes. Nevertheless, beef exports expanded impressively from30,000 metric tons in 1966 to 123,000 in 1971 (in value US$20 million andUS$1$0 million respectively). In 1972 the exports have been running 33percent higher than 1971. In order. to continue beef export growth withoutsacrificing domestic consumption, and at the same time provide stock for theexploitation of vast unused land resources, major increases in the productivityof existing livestock resources will be essential. The national herd will haveto produce breeding stock well in excess of its own replacement needs throughincreased weaning rates and decreased mortality rates.

13. Tne US$40 million Bank loan made for the first livestock project(Loan 516-BR) iY now approaching full commitment. Based on experiencegained during the first project, the Government is now preparing a morecomprehensive livestock program, but it will not be ready for Bank considera-tion until the middle of 1974. The Government has, therefore, proposed tocarry out now an interim second project of limited scope to avoid aninterruption of lending for commercial cattle development in the projectareas, to talce advantage of the technical services assembled during thefirst project and to complete some of the unfinished important features

of that project. The proposed interim second project would cover theforecast gap of about 18 months between full commitment of the firstlivestock project and possible Bank consideration of a loan for thelarger livestock program now being prepared.

PART IV - THE FIRST LIVESTOCK DEVELOPMENT PROJECT

14. The Bank's first livestock project in Brazil (Loan 516-BR ofAugust 1967) was directed at the improvement of herd productivity. TheBank loan of US$40 million is helping finance a US$80 million programof on-farm investments accompanied by technical assistance. At fulldevelopment, a total of US$74.6 million, including US$59.7 million inproject subloans, will have been invested in land clearing, pastureimprovement, fencing, watering and handling facilities, farm buildingand machinery and breeding cattle. About US$5.4 million will have beenutilized in technical services. The project has been conducted in threeregions with promising potential for productive livestock operations:(a) the state of Rio Grande do Sul and ecologically similar parts ofthe neighboring state of Santa Catarina; (b) the states of Mato Grosso,Sao Paulo and the adjacent northern part of the state of Parana; and(c) the states of Goias and Minas Gerais.

15. The first livestock project had a slow start caused mainly byorganizational problems and an unattractive interest rate policy. Thelatter was modified in 1970 and since then the project has progressedrapidly and project lending funds by now have been almost fully committed.Ranch development normally takes several years and it will be some fiveyears from now before the physical and economic impact of ranch investmentunder the first project will be known precisely. However, some of theindirect benefits of livestock investment in Brazil are already visible.As already noted, meat exports have increased substantially and after aserious shortage for domestic consumption (in 1970 imports had to bearranged on an emergency basis for meeting the requirements of Rio deJaneiro and Sao Paulo cities) the domestic supply position is now relativelyeasy. There are strong indications that in participating ranches theproductivity targets of the first project, namely, increasing weaning rates(from 50 percent to 67 percent) and decreasing mortality rates (by about50 percent), are in the course of attainment.

16. About 30 percent of the project funds were invested in breedingcattle and this practice caused other fixed investments in pasture establish-ment and related facilities to become productive earlier than would havebeen the case if incremental stocking would have been achieved completelythrough the slower method of cattle retention. This policy would becontinued in the Interim Second Livestock project.

17. The Borrower's submission of appropriate audited financial state-ments under the first project have not been satisfactory. It has beenagreed with the Borrower that in the future the Bank will receive suchstatements in a timely manner.

Subloan Terms

18. When the first livestock loan was made in 1967, some difficultproblems existed with respect to agricultural credit. On the one hand,

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there were banks and private lenders who lent for a very short period atexorbitant rates. On the other, the meager medium- and long-term fundsprovided through government institutions were lent at highly subsidizedrates. The relending terms of the first livestock project were designedto help meet these problems. The livestock producers received loans upto 80 percent of his investment with a term up to 12 years including agrace period of up to 4 years, at interest at the rate of 14 percent.l'he loans were indexed in order to protect the principal (and interest)from erosion by inflation.

19. Agricultural lending in Brazil is usually without monetarycorrection at rates, which with inflation of 20 percent or more, showan unpredictable and negative real rate of interest. The livestock proj-ect of 1967 was the first experiment with ex post monetary correction.During the course of project implementation several modifications in theindexing system were made with a view to make the system more simpleoperationally and more acceptable to the farmers. The original arrange-ments and the subsequent changes, culminating in the presen-t arrangementson which agreement was reached in July 1972, are described in Annex III.The original arrangements involved adjustment of the principal of subloanson the basis of a producer.price index compiled every June, with up to 10points of deductions for every year of grace; interest was charged at 14percent on unadjusted principal during the grace period and on adjustedamounts during the amortization period. In addition to the problems ofloan administration, with the declining rate of inflation in Brazil (28.4percent a year in 1967; 20.4 percent a year in 1971) the project loansbecame relatively unattractive compared to other agricultural loans. Thesystem now in effect, which would also apply to subloans made under theproposed interim second project, involve the annual correction of theprincipal of the subloans in proportion to the changes in the US dollarselling rate for Brazilian cruzeiros. Participating banks would chargeinterest on subloans at 71 percent, the same as the Bank's current lendingrate. They would continue to retain 3 percenc to cover their loan process-ing expenses and pass 4'-4 percent to the Central Bank. The latter wouldmake the full 7; percent interest payment to the Bank, thereby providinga subsidy to the project. Since it is the Government's policy to revaluethe cruzeiro frequently in accordance with domestic price increases (lessprice increases in Brazil's main international trading partners) the index-ing system should result at all times in real positive interest rates toranchers. That rate will, however, be less than 7;4 percent to the extentof price increases outside Brazil. While an indexing system based solelyon domestic price movements might be preferable, the Government does notat this time wish to apply such a system on programs financed with externalresources. In order to prevent a situation in which a change in theGovernment's foreign exchange rate policy could lead to negative real ratesof interest, it has been agreed with the Brazilians that the indexing systemwill be revised if the difference between price changes and changes in theexchange rate exceeds 7]4 percentage points. While this arrangement is notideal and still implies lending to ranchers at subsidized rates,, it repre-sents progress towards a system which would protect principal and interestfrom erosion by inflation.

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Beneficiaries

20. Although originally intended to reach 1,800 ranchers the projectwill have provided financing to about 800 ranchers, with subloans averagingabout US$80,000 against the projected US$33,000. It is estimated that about40 percent of the cost overruns are due to price increases. In addition,ranchers have tended to develop their entire ranch rather than only parts ofit, as envisaged when the loan was made. Because many eligible ranches inGoias and Mato Grosso are new "frontier" operations - contrary to traditionalranching in South Brazil - they are virtually undeveloped and require consid-erable investment for complete development. Fall on-ranch development hasalso been encouraged by the improved market outlook and the availability oflong-term project financing on reasonable terms.

21. In addition to the Bank assisted project, livestock developmentfunds are availeble in Brazil under projects financed by the Inter-AmericanDevelopment Bank and from Brazilian resources. The Government has in prac-tice channelled applications from larger farmers to the Bank-financed project,while financing smaller farmers from the other programs, whose lending termswere softer.

22. Bank staff members have discussed with the Government the importanceof assisting the smaller livestock farmers. At present the Government intendsto continue to rely on highly subsidized credit for meeting their requirements.However, the possibilities of Bank assistance to smaller farmers will be dis-cussed with the Brazilians during the preparation of the proposed expandedlivestock development project (see paragraph 13). In the meantime, under theSecond (Interim) Project, the trend established for the first project wouldcontinue.

Meat Marketing

23. Wihen the first livestock loan was made attention of the Governmentwas drawn to two problems in the marketing system: (i) deficiencies in themarketing infrastructure including inadequate cattle transport facilities,and outmoded processing plents and slaughter houses, and (ii) disincentivesto investment in beef production caused by Government policies that favoredthe urban consumer at the expense of the producers and the exporters.

24. Marketing infrastructure has improved significantly in recent years.Some 40,000 km of roads and 16 modern abattoirs were constructed between 1966and 1972; standard meat inspection norms have been introduced; and carcassgrading established. In addition the agricultural export industries programwhich the Bank is now examining (paragraph 9) would include substantial invest-ments for modernization of abattoirs, improvement of meat processing andconstruction of export facilities.

25. The Superintendencia Nacional do Abastecimiento (SUNAB), theGovernment supply agency, used to keep meat prices artificially low by oper-ating a complex system of quotas for cattle slaughter and by itself operating

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a number of strategically located slaughter houses. The Government under-mro-te the losses incurred by SUNAB as a result of supplying meat to theprincipal urban centers at artificially low prices. Early in 1970, theGovernment withdrew SUNAB from the cattle business, thus permitting priceincentives to operate for the expansion of livestock production.

26. However, this measure came at a time when there was a worldshortage of meat and beef prices were rising rapidly on the wiorld market.The Government had the dilemma of offering incentive to producers andincreasing export earning on the one hand and of keeping inflation undercheck (meat prices account for 5.2 percentage points in the Guanabara costof living index) on the other. At the end of 1970, Government thereforetook measures to limit price increases by: (a) suspending tax incentivesfor beef exports, and (b) prescribing export quotas from the main exportingregions. At that time, the Government assured the Bank that the exportcontrols would be temporary and relaxed as the situation permitted. Thequota system was made more flexible in 1972, and additional quotas offerecto exporters setting aside meat for storage during the high killing January-June season (1.5 tons and 5 tons of additional quota to exporters in Centraland South Brazil respectively for every ton stored). Since the export cuotaswere applied in terms of tonnage one of the results of the quotas has beer togive a strong impetus to exports of high value processed forms of meat, andtherefore to investment in processing facilities. The average unit price ofmeat exports has gone up from US$666 a ton in 1966 to US$1,219 a ton in 1971.In general, market conditions and facilities have substantially improvedsince 1967 and there is general optimism that no market constraint wouldaffect the progress of the interim project. At the same time, the exportcontrols have limited the increase in domestic meat prices which affectsthe protein intake of middle and low income urban families.

PART V - THE INTERIM SECOND PROJECT

27. A report entitled "Appraisal of the Interim Second LivestockDevelopment Project, Brazilt " dated November 28, 1972, is being circulatedseparately to the Executive Directors. A loan and project summary ispresented in Annex III.

28. The project was appraised by a Bank mission which visited Brazilin March-April 1972. Negotiations took place on lNovember 16 and 17, 1972.The Borrower, the Federative Republic of Brazil was represented by a teamheaded by Dr. Paulo Yokota, Director of the Central Bank.

29. The proposed interim second livestock development project is in-tended to provide for a continuation of the credit and technical assistanceprograms established under the first project (Loan 516-BR) already discussedin Part IV and the project will cover the forecast gap of about 18 monthsbetween full commitment of Loan 516-BR and possible Bank consideration ofa loan for the larger livestock program now being prepared (see paragraph 13).

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30. As did the first project, the interim project would consistprimarily of a credit program, complemented with technical assistance,under which long-term loans would be extended to commercial livestockoperations to finance on-farm investments such as land clearing, pastureimprovement, fencing, watering and handling facilities, farm buildings andmachinery and breeding cattle, which, together with superior animal hus-bandry techniques, would result in better herd productivity and stock ex-pansion. Livestock would be grass fed, generally on ranches developed fromgrasslands unsuitable for crop production. About 700 ranches are expectedto be financed under the interim project on ranches or mixed farms rangingin size from about 500 to about 8,500 hectares, depending on the region.The interim loan would therefore be channelled to almost the same numberof ranches as in the case of the much larger first loan, with a concomitantreduction in the average size of the subloans.

31. The Bank loan would be repayable in 17 years, including fiveyears grace. This should be sufficient to cover the estimated four-yeardisbursement period, the maximum 12-year term of subloans, and one extrayear for delays. The proposed 17-year term is less than the 20-year termof the first livestock loan (because of the greatly reduced need to providefor delays).

32. Project costs -- the financial resources necessary to continuelending and technical assistance during the 18 months between full commit-ment of the first project loan and the expected date of Bank considerationof a third loan -- would total US$52 million. The foreign exchange componentis comparable to the first project, about 14 percent; consequently, about 75percent of the Bank loan (some US$19 million) would finance local currencyexpenditures, which is justified on country grounds (see paragraph 6). Theproject cost would be shared among the Bank, Government and ranchers in theratio of 50, 31 and 19.

Procurement and Disbursements

33. The Bank's loan would be disbursed against long-term subloans foreligible on-farm development refinanced by the Central Bank, and againsttechnical service costs. Investment proposals exceeding US$200,000 eachwould require prior approval of the Bank. Complementary short-term financingwould be provided by participating commercial banks.

34. Procurement from the proceeds of the Bank loan would be made throughnormal commercial channels. Bulk procurement and international competitivebidding would not be practicable in view of the varying requirements of theapproximately 700 individual farmers expected to participate in the projectand also in view of the need to procure machinery which can be serviced andrepaired locally. Most of the equipment required is manufactured inBrazil and sold at competitive prices. About US$7.3 million or 14 percentof total project costs is expected to represent either imported equipmentor the import component of locally manufactured equipment.

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Financial and Economic Benefits

35. To test the financial viability of proposed investments in live-stock development, seven models, which were prepared during the appraisalof the first project, were reviewed-on the basis of actual operations ex-perience gained during the execution of the first project. The financialrates of return for these models vary between 12 and 29 percent.

36. The project would result in improved livestock productivity rates,decrea'sed mortality, increased percentages of herds and flocks slaughteredannually, and intensified pasture use. This, in turn, would result in in-creases in prbdudtion of heifers and steers, resulting in an estimatedecohomic rate bf returni of about 23 percent for the project. The economicrate 6f retuirn calcuTlation does not take into account the substantial, butnot easily quantifiable, benefits such as the demonstrati6n eiffet of modernproduction techniques on project f&rms and the training of Brazilian person-nel in livestock development.

PART VI - LEAL INSTRUMENTS AND AUTHORITY

37. ' The draft L6an Agreement between the Federative Republic of Braziland the Bank, the draft Project Agieemnent betiieen Binco GCeitral do Braziland th' Banik, the Rep6ot bf the Coriidttee provided f6r in Article III, Sec-tion 4 (iii) of the Articles of Agreement and the draft Resolution approvingth proposed loan, are being distributed to tbhe Executive Directors separate-ly. The major features of these agreements have already been described in.this ireport.

38; I am satisfied that the pr6posed loan will comply with the Articlesof Agreement of the Bank.

PART VII - RECOMIUENDATION

39. I recommend that the Executive Directors approve the proposed loan.

Robert S. McNamaraPresident

Attachments

December 6, 19i2

ANNEX IPage 1 of 2

Fore No. 81.02 WORLD BANK GROUP(5-7 2)

COUNThY DATA

COUTNTRW, BRAZIL

AREA, 8,512,000 kce2

(3,286.000 sq. at.) POP1ULATION: 93.2 Bdillion (1970) DENSITY: 11.2 per Ice2Ra_te of _rrOwth 2.9CW (fran 1960 to 1970 )If 33.5 per km2 of arabla land

POP'ULATION CHARACTERISTICS: HEALTH:Crude Birth Rate (_per 1T,500) pa.opulation per physician 1432 (1960)crude Death Rate (per 1,000) 11.9 (1960) population per hoopital ked290 (1970)Infant Mortalit.y (per 1,000 live births) 170( 1960)

INOME DISTRIBUI1ON: DIISTRIBUTION OP LAND OWNERSHIP:o tin1incom, 1oweot quintile 3.5 39 7. of land owned by top 10% --er 45.0

7. of eatlosal higheat quietile 61.5 190 of land owned by seallset 107 ownrs 1.5

ACCESS TO POTABLE WATER 1% of population) ACCESS TO ELECTRICITY: (7. of populstioo)Uirhon 55.0 Urban n.4.Rural 2.5 Rural 0.0.

NUTRITION: ONP PER1 CAPITA: $411 (1970) EDUCATION:Caoloriea intake per day 32690 (1966) Adult Fliteracy rote (population aped 10 or -oe) 65% (1970)Per capita protein intake (graocme) 66.3 (1966) Primary school enrolmont (9) 64 (1960)

00011 NATIONAL PRODUCT (1970), ANNUAL RATE OP RONOT 9 osatpie)t~lein US ln.)79 b 10570 b'

GNP at market prices 367175 2 .00 4.5 7.3 9.4Gross Investament 6,624 18.3 4.5 7.1 13.3Gross Rational Savinge 6,343 17.5 Corront Account Balance -2801 0.8 FWporte of Goodsa, IFS 3,14 8.5 2.3 9.1 12.4Inporto of Goods, NFS -3,345 9.3 -7.5 18.2 20.3

O'UTPU 110 FORC AN'MUNIAflIN ( 970:

Value Added Labor F-rce Value Added Per donrker(US $ Million) 1 IlIoo 7. (US 5) %of notional overage

Agriculture 7,307 20.2 15.1 44.3 564 45.7Industry(i-c1. co-t-otli-) 12,665 34.7 5.0 16.9 2,533 205.3Services 16k483 45.1 11.5 39.8 1.433 116.1

Total/Average .36,535 101.0 29.6 100.0 1,234 101.1

PUBLIC FINANCER ON (1970),All Goveer,oent fentra1/Fvderol oneernoect

(In olc noa tc A of rP -average (In 'illions 01 % of ISP averogocorrest Cr9) 9 Of GDP .last ,.roe yeAr.n corront Cr0) 9 of GOP lost three yours

Current Rce-ptrI 49,713 28.5 20.4 17,661 10.1 9.5Current E~xpenditures (mncl. transfers) 35,4121 20.3 20.8 11,629 6.7 6.7Current Iurplus/Oeficit -)14,282 18.2 9.6 n,032 3.5 2.9Capital Expcnditures 16,424 '9.4 8.7 6,770 3.9 3.6Extercol Assistance (net) 1,277 0.7 0.6 - -

PRICED AND CREDITend of year: General Price Index le3nk Crelit to Public Sector Bank Crndit to Privute Snct-or

indoc (1963-100) 7. hange I A T7i3WIl.li fl (nl -oiCrlioss oas f Cr0) 9el9nnBRyi%?1968 715 24.9 3,281 4r.2 Ys%f I 17,410 46.1 sP1969 860 20.2 2,953 -1.6 25,012 37.61970 1025 19.2 3,553 2.2 33,999 33.7

(De.). 1970 1025 19.2 3,553 2.2 33,999 33.7(De.. 31971 1328 19.8 . ... 48,800 43.1

BALANE OFPAYI47ITSIN 190. 16L±97 and1971 (mlin SIIERCHAN0DISE EXPOROTS (Average of the loot three years): 1)%

Exports of Goods, NES 2076 2379 3064 3174 Coffee 875 37.9Imports of Goods, NPS 2378 2630 3345 4028 B...a (842) (36.5)Resource Gal (deficit - )-302 51 281 -854 Soluble 3 33) (1.4)

Other agricolturol products 660 28.9Interest Payments (net) -144 -180 -232 -302 Cotton (160) (6.9)Workers' Remnittances - - - - Sugar (115) (5.0)Other Factor Paymenta (net) -04 -81 -119 -166 Otber (393) (17.0)Net. Transfers 22 31 10 14 Principal aineral 178 7.7Balance on Current Account -508 -281 -622 -1308 Monofant.ree 206 8.9

All other comoodities 303 16.6Direct Foreign Inveolstmt 61 124 85 124 Total 2,310 100.0Mediu.m and Long-tens Loans (set) 106 182 278 39

Disbursements (392 )(464 3(609 3 (817) E3CTERNAL DEBT ON DR2EMB21 31. 1971:Amer tisstion (-286 )(-282 3(-371 )(-425) (5 mln.)

Official Grants - - - Medium end Long-term Credits, Public 3,408Other Capital (net) 412 591 653 1164 Non-Guaranteed Private MILT 3,193Increase in Official Reserves -33 612 518 584

Total Outstanding and DisbursedAll other itmas -104 - 4 124 210660

a) Encluding fi.ancia1 credits 16.9Gossa Reserves 514.5 1,063.5 1,484.8 2062.3 DEBT SERVICE RATIO (1970): b) lncluding financ.Ial credits 46.1Net Reserves 342.2 954.6 1,472.6 2056.4

IBRD LENDI1NG, DOEEMBED 31. 1971 (, cal.)IBRD

Outstanding and Disbursed 345.8Undisburoed 433.7

Outstanding ian]l. Undisbarsed 779.5

Bate of Exchange, US0 $1.00 -6.165 Nov-ber 22. 1972(Effective Novenher 22, 10721 Cr5 1.00 U 010.160

Latin A,serico ned the Caribbeao

ANNEX IPage 2 of 2

THE AGRICULTURE SECTOR IN ERAZIL

1. The agriculture sector has been receiving much attention fromthe Government in recent years and the Bank organized a sector survey in1969-70 (Report PA-52a of August 19, 1970). Review of the agriculturesector has been an integral part of the Bank's annual country economicreviews and this sector -- including the rural agricultural economy ofthe Northeast -- is being specially studied in the current year.

2. Agriculture is a mainstay of the Brazilian economy, despitethe country's recent rapid industrial growth. In 1971 agricultureaccounted for 20 percent of Gross Domestic Product, employed 44 percentof the labor force and farm products made up about 70 percent of totalexports. Over the past decade, growth of agricultural output averaged4.5 percent a year and the Government in its plan for 1972-74 expectsgrowth to accelerate to 7 percent.

3. Brazil is attempting to recover from the unusually low coffeecrop of 1970-71 (11 million bags) to an annual production of 26-28 mil-lion bags. The mid-1960's coffee diversification program reduced toomuch Brazil's coffee production capacity. Frost and rust brought thecoffee crop to dangerously low levels. Brazil has now embarked upon awide ranging program to promote planting of new trees and provide addi-tional fertilization and coffee rust and broca treatment.

4. There is intense activity aimed at accelerating growth inBrazil's agricultural sector. Besides coffee, the greatest gains inagricultural output are expected in grain, soybean and beef productionin the South and Center, both for domestic consumption and for export.In support of this objective, the Government is operating a generalagricultural minimum price support program which covers grains otherthan wheat and assures minimum support prices, near world market levels,announced in advance of grain cultivation seasons. It has provided astrong incentive to production. The Government also operates a wheatprice support program which was initially designed to promote importsubstitution and producer prices were substantially subsidized for thispurpose. As domestic production responded strongly (production increasedfrom below one million tons in 1968, to around 2.25 million tons in 1972)the subsidy paid to producers was reduced by one-third and the supportprice is now at the level of 140 percent of the CIF price of import andat 110 percent of production cost.

5. Intensive efforts are also underway to promote livestock pro-duction -- through investment credits, introduction of improved technology,pricing policy and marketing improvements. Finally, the Government isattempting through its "export corridor" program to increase several foldearnings from exports of coarse grains, animal feeds, meat and frozenjuices; the program consists of improvement of production, storage, mar-keting and transportation of these goods.

ANNEX IIPage l of 6

THE STATUS OF BANK GROUP OPEiATIONS IN BRAZIL

A. SUMKMAY STATEMENT OF LOANS(as of October 31, 1972)

Loan Amount LessNo. Year Borrower Purpose Cancellations Undisbursea

(US$ million)

Loans fuJlly disbursed 288.9

403 1965 Centrais Eletricas deFurnas - Estreito I Power 57.0 0.7

404 1965 Centrais Eletricas deSao Paulo - Xavantes Power 19.8 2.1

442 1966 Centrais Eletricas deMinas Gerais - Jaguara Power 49.0 9.6

474 1966 Centrais Eletricas deFurnas - Estreito II Power 39.0 7.1

475 1966 Cia. Brasileira deEnergia Eletrica Power 6.2 0.6

476 1966 Cia. Forca e Luz do Parana Power 8.1 0.5

477 1966 Cia. Paulista de Forca e Luz Power 41.0 5.0

478 1966 Cia. Forca e Luz deMinas Gerais Power 6.3 0.1

516 1967 Brazil Livestock 40.0 17.8

565 1968 Centrais Eletricas deFurnas - Porto Colombia Power 22.3 9.3

566 1968 Centrais Eletricas de MinasGerais - Volta Grande Power 26.6 17.7

567 1968 Brazil Roads 26.0 4.5

656 1970 Banco do Nordeste do Brasil Industry 25.0 16.5

676 1970 Brazil Roads 100.0 46.5

677 1970 Centrais Eletricas de Furnas- Marimbondo Power 80.0 60.i

728 1971 Centrais Eletricas do Sul doBrasil - Salto Osorio Power 70.0 66.1

ANNEX IIPage 2-of 6

Loan Amount LessNo. Year Borrower Purpose Cancellations Undisbursed

755 1971 Brazil Education 8.4 8.0

756 1971 Brazil Ports 45.0 43.1

757 1971 Superintendencia de Agua e WaterEsgotos da Capital Supply 22.0 22.0

758 1971 Companhia Metropolitana de PollutionSaneamento de Sao Paulo Control 15.0 14.8

786 1971 Rede Ferroviaria Federal Railways 46-.0 46.0

787 1971 Mineracoes BrasileirasReunidas Industry 50.0 37.7

797 1972 Companhia SiderurgicaNacional Industry 64.5 64.5

812 1972 Usinas Siderurgicas deMinas Gerais Industry 63.0 62.8

813 1972 Brazil Roads 89.0. 89.01/

828 1972 Companhia SiderurgicaPaulista Industry 64.5 64.5

829 1972 Centrais Eletricas de MinasGerais, S.A. - Sao Simao Power 60.0 60.0

853 1972 Brazil Agriculture 6.7 6.71/

854 1972 Brazil Roads 51.0 51.OV

857 1972 Banco do Brasil, S.A. Agriculture 30.0 30.01/

Total 1,520.3 864-3

of which has been repaidto Bank and others: 201.3

Total now outstanding 1,319.0

Amount sold 21.2of which hasbeen repaid 9.9 11.3

Total now held by Bank 1,307.7

Total undisbursed 864.3

No IDA credits have been made to 1Brazil.1/ Not yet effective.

ANNEX IIPage 3 of 6

B. SUMb4ARY STATEMENT OF IFr INVESTNENTS(as of October 31, 1972)

Amount LessYear Borrower Pu-pose Cancellations Undisbursed

(US$ thousand)

Loans Equity

Investments no longer held 9,911 -

1966,1968and 1972 Acos Villares, S.A. Steel 8,000 1,627 2,333

1966 and1969 Papel e Celulose Pulp and

Catarinense, S.A. Paper 3,984 3,133

1967 and1972 Ultrafertil, S.A. Fertilizer 8,224 3,025

1969 Petroquimica Uniao, S.A. Petrochemicals 5,500 2,880

1970 Poliolefinas, S.A. Petrochemicals 5,500 2,877 142

1971 Oxiteno, S.A. Petrochemicals 4,600 1,440 3,356

1971 Industrial de CeluloseBorregaard, S.A. Pulp 4,900 -

1972 Compar-hia de CimentoNacional de Minas, S.A. Cement 18,610 3,200 8,200

1972 Cosigua, S.A. Steel 7.000 2,000 1,215

Total 76,229 20,182 15,246

Less: Aepaid to IFC 5.679

70,550 20,182

Less: Sold 32,795 2,942

Held by IFC 37,755 17,240

Total undisbursed 10,000 5,246 15,246

ANNEX IIPage 4 of 6

C. PROJECTS IN EXECUTION

As of December 1, 1972 there were 25 effective Bank loans underdisbursement:

Loan No.

h03/47L 3streito Hydroelectric Project: US$57 and US$39 million loans ofFebruary 26, 1965 and December 19, 1966. The project is proceedingon schedule. Eauipment costs were substantially below estimates,so that disbursements have been less than forecast.

404 Xavantes Hydroelectric Project: US$22.5 million loan of February27, 1965. The project was completed in early 1971 (after a delayof about eighteen months) except for the installation of equipmentfor an associated transmission line. Ordering of this equipmentwas delayed, and the loan is now expected to be fully disbursed byDecember 31, 1973, four years after the initial closing date.

442 Jaguara Hydroelectric Project: US$49 million loan of March 15,196. All the four generators were commissioned during 1971 andthe project has been,completed. Disbursements will extend up tomid-1973.

475/476/477/478 Power Distribution Projects: US$6.2, US$8.1, US$41, and US$6.3

million loans of December'19. 1966. These four power distribu-tion projects had a slow s'tart but after administrative reorganiza-tion in 1970 they gained momentum. Proc'urement'for the projectshas been completed but some equipment may not be delivered by theDecember 31, 1972 closing date. Most of the overhead distributionsystem has been completed; construction work'on transmission lines,substations and underground distribution systems will extend into1973.

516 Livestock Project: US$ho million loan of September 23, 1967.After initial delays due to marketing and organizational difficul-ties, the livestock credit program has been proceeding at asatisfactory rate. Some problems arose in early 1972 with respectto the calculation of interest on indexed principal amounts duringthe grace period but these have now been settled. About US$35million out of the US$ho million loan has been committed and thebalance is expected to be committed by December 1972. Disburse-ments are expected to be completed by the closing date, December31, 1973.

565 Porto Colombia Hydroelectric Project: US$22.3 million loan ofOctober 23, 1965. Changes in the project layout and design haveincreased substantially the local cost, which will be covered by-ELetrobras. Construction work is well advanced and the projectis likely to be completed on schedule.

ANNEX IIPage 5 of 6

Loan No.

566 Volta Grande Hydroelectric Project: US$26.6 million loan ofOctober 23, 196d. The project was delayed six months by spillwayfoundation difficulties and is now scheduled to be completed byOctober 1974.

567 First Ilighway Construction Project: US$26 million loan ofOctober 23, 1968. The First Highway Construction project isvirtually completed at a cost slightly below estimates.

656 Industry: US$25 million loan of February 16, 1970. Disburse-ments to Banco do Nordeste do Brasil (BNB). The date for commit-ment of the loan by BNB originally set for June 30, 1972, has beenpostponed by one year to reflect lower than expected demand forfunds. One obstacle to more rapid utilization of the loan hasbeen the Bank's requirement that entrepreneurs normally put up aminimum of 25 percent of total project cost from their own fundsin order to have access to the Bank loan. As long as subsidizedlocal currency resources were plentiful, entrepreneurs chose touse them to the utmost and to finance import costs from their ownresources or through suppliers' credits. The situation changedsignificantly in 1972. SUDENE has made it more difficult for pros-pective investors to have access to subsidized resources, by re-quiring them to increase their financial stake in projects and themonetary authorities have extended ex post indexation to all termindustrial lending by Federal credit institutions. Utilization ofthe Bank's loan should therefore accelerate.

676 Second Highway Construction Broject: US$100 million loan ofMay 25, 1970. The Second Highway Construction project is about70 percent completed. Although disbursements are now slightlybehind schedule, the project is expected to be completed withoutdelay and within cost estimates.

677 Yarimbondo Hydroelectric Project: US$80 million loan of Pay 15,1970. Construction work started in early 1972 as scheduled. Aproposed increase in the length of the transmission system, togetherwith substantially higher than estimated equipment costs, are expec-ted to raise the project's cost by US$20 million over the originalforecast. This increase does not affect the project's economicjustification.

728 Salto Osorio Hydroelectric Project: US$70 million loan of April 5,1971. The project is proceeding according to schedule. The cost ofthe civil works so far contracted is in accordance with the estimates.

755 Education Project: US$8.4 million loan of June 21, 1971. Inaccordance with a revised schedule agreed upon between the Bank andthe Project unit, construction is expected to be six months behindthe initial estimate. No need to postpone the closing date is foreseen.

ANNEX IIPage 6 of 6

Loan No.

756 Santos Port Project: US$45 million loan of June 21, 1971. Theproject is proceeding satisfactorily. Preliminary engineeringhas been completed, though invitation of tenders is slightlybehind schedule. The Bank has agreed to an increase in grainsilo capacity and is reviewing several other works revisions.

757 Sao Paulo rWater Supply Project: US$22 million loan of June 211971. The state Government is somewhat behind schedule in raisingresources according to the financial plan for the project. SAEC,the Borrower, has made significant progress in reorganizing itsstructure and in improving operations. The water and sewagetariffs have been revised in fulfillment of the undertaking i-nthe loan documents.

758 Sao Paulo Pollution Control Project: US$37 million loan of June21, 1971. The state Government is behind schedule in raisingresources according to the financial plan for the project. Theproblem is under active review with the Government.

786 Railway Project - MER: US$46 million loan of -Auapt,,25-J,1_7A delay of about 6 months occurred in awarding the contracts fbrconstructing the new railway link for the MMBR iron ore mine dueto engineering problems encountered and inadequate project manage-ment by the Federal Railways. Work has now commenced on site andmuch of the lost time is being regained.

787 MR iron Ore Project: US$50 million loan of August 25.,, 1971.. Theestimated cost of the project has increased due to major designchanges for the port terminal and several investment additions tothe project. A new financing plan is under discussion with theBorrower and target completion dates at the mine and terminalshould be met. The project remains profitable despite the increasein capital costs.

797 CS; Steel Expansion Project: $64.5 million loan of Februaar &, 1972.The loan became effective on August 31, 1972 and the project is pro-ceeding according to schedule.

812 Usininas Steel Ecpansion Project: US$63 millibn loan of April 11,1772. The loan became effective on July 25, 1272 and the projectis proceeding according to schedule.

828 COSTIA Steel Expansion Project: US$64.5 million loan of,June 14,1972. The loan became effective on October 5.% 1972 and the projectis proceeding according to schedule.

ANNEX IIIPage 1 of 7

BRAZIL

LOAN AND PROJECT SUMMARY

I. LOAN SUMMARY

Borrower: Federative Republic of Brazil.

Beneficiaries: About 700 ranchers.

Amount: US$26 million equivalent.

Terms: Payable in 17 years including 5 years of grace and71 percent interest.

RelendingTerms: Subloans to ranchers will cover 80 percent of ranch invest-

ment costs (62.5 percent of the subloan being drawn fromthe Bank loan) repayable in nine to twelve years, includingthree to four years of grace; interest rate 71¼ percent;outstanding balances of subloans will be corrected inproportion to the changes in the US dollar selling rate inBrazilian cruzeiros. Of the 71¼ percent interest paid byranchers the participating commercial banks will retain3 percent.

II. PROJECT SUMMARY

ProjectDescription: The project is a continuation of the First Livestock

Development Project (Loan 516-BR) and involves a creditprogram operated by Banco Central do Brasil (the Central Bankof the country) through participating commercial banks in thefollowing three Regional Project Areas:

Regional Project I - The state of Rio Grande do Sul andthe Campos de Lajes and Curitibanosregions in the state of Santa Catarina.

Regional Project II - The states of Mato Grosso, Sao Pauloand Parana (northern part).

Regional Project III - The states of Goias and Minas Gerais.Credit will be available to eligibleranchers (about 700 are expected toparticipate) to finance on-farm

ANNEX IIIPage 2 of 7

investments such as land clearing,pasture improvement, fencing, water-ing and handling facilities, farmbuildings and machinery, and breedingcattle. Technical assistance forlivestock development will also beextended and the project would resultin better herd productivity and stockexpansion.

EstimatedCost and_inancingPan:

Bank Government Ranchers Total

US$ % of US$ % of US$ % of US$Category Million Total Million Total Million Total Million %

On-RanchDevelopmentCosts 25.0 50 15.0 30 10.0 20 50.0 100

TechnicalServicesCosts 1.0 50 1.0 50 --- 0 2.0 100

.Total 26.0 50 16.0 31 10.0 19 52.0 100

ANNEX IIIPage 3 of 7

EstimatedDisbursements: Disbursement

(US$ Thousands)

FY Annually Cumulative

1973 2,100 2,100

1974 10,500 12,600

1975 7,400 20,000

1976 4,000 24,ooo

1977 2,000 26,000

Procurement: Procurement would be made through normal commercial channels.

Rate of Return: The economic rate of return is 23 percent.

Appraisal Report: No. lOa-BR of November 28, 1972.

ANNEX IIIPage 4 of 7

Relending Terms for the Fir-st Livestock Development Project (516-ER)

Background Information on Inflation

1. In terms of annual average differences, the rate of priceincrease measured by the General Price Index / accelerated from 29.2percent in 1960/59 to a peak level of 88.9 percent in 1964/63. In 1967the general price level rose by 28.4 percent compared to the previousyear and.in 1971 by 20.4 percent compared to 1970.

AVERAGE ANNUAL PRICE LEVEL CHANGES

General Wholesale Guanabara Cost ConstructionYear Price_Index. Price Index of Living Index ,,Cost Index

1960 29.2 31.3 29.3 17.41961 37.0 40.5 33.2 43.61962 51.6 50.2 51.5 42.31963 75.4 76.0 70.8 88.31964 -88.9 81.3 91.4 82.31965 56.8 53.6 65.9 69.71966 37.9 41.1 41.3 36.61967 28.4 26.7 30.5 41.41968 24.2 2'2.7 22.3 31.91969 20.8 19.1 22.0 18.01970 19.8 19.3 22.7 16.71971 20.4 21.5 20.2 15.1

Relending Terms Prescribed in 1967

2. The relending formula originally agreed in 1967 had the followingfeatures:

(a) Loan duration: nine to twelve years, including three tofour years of grace for amortization of principal;

(b) Interest rate: 14 percent over the life of the loan,calculated on outstanding loan principal adjusted;

(c) Rediscount rate changed by Central Bank to participatingbanks: 7 percent (equal to the rate of the Bank's loan).

1/ A composite index made up of the following sub-indexes: wholesaleprice index (60%), Guanabara cost of living index (30%), and theconstruction cost index (10%).

ANNEX IIIPage 5 of 7

(d) Loan Adjustment:

(i) During grace period - interest calculated on the basisof unadjusted loan balancel/;

(ii) During amortization period - both principal repaymentand interest calculated on the basis of adjusted loanbalance;

(iii) Principal and interest payments made annually, on theanniversary date of loan commitmentsZ . Amounts duewould be calculated by applying the current loan adjust-ment index to the amounts which would be due had therebeen no adjustment. The loan adjustment index would berelated to the producer price index, measured from theyear each loan is made. For the base year, the producerprice index would be 100. The loan adjustment indexwould equal the producer price index during the sameyear, less the following amounts:

Year 1 - 10;Year 2 - 20;Year 3 - 30;Year 4 and ensuing years - 40.

In no case, however, would the adjusted loan balancebe less than the unadjusted balance during the sameyear. This means that the loan adjustment index couldnever fall below 100; and

(iv) Amounts derived from loan adjustment accruing to thecredit of the Government, to take care of the exchangerisk arising out of the Bank loan and to help defraythe cost of technical services.

3. The loan adjustment index would be defined and measured separatelyfor Central Brazil and Rio Grande do Sul. In the former region, where beefwould be the major output of Project farms, the index would be made up of fatcattle prices. In the latter region, the index would be composite, includingprices of both beef cattle and wool. Prices would be measured each year as

an average of prices obtained during the high-supply months. The GetulioVargas Foundation, an autonomous economic research agency of recognized in-tegrity and competence, would be entrusted with sampling, data collection and

1/ This implies no loan adjustment during the grace period insofar as debtservice is concerned. For prepayment purposes, loan balances would beadjusted from year to year, both during and after the grace period.

2/ A participating farmer would normally obtain four separate loans underthe Project, one for each year of farm plan execution. Interest wouldbe paid on June 30, and December 31, of every year.

ANNEX IIIPage 6 of 7

publishing the index. The index would be issued annually in July. Itwould be used for adjustments of amounts due in the 12-month period follov-ing publication of the index.l/

Changes in Relending Terms Introduced in May 1970

4. The above indexing mechanism was expected to yield a real interes,:,rate of at least 7 percent per annum, provided inflation did not rise abovethe 40-50 percent rate. These conditions proved to be unacceptable toranchers, particularly in view of the success of the stabilization progrnamin Brazil, and very few ranchers agreed to participate in the project.

5. In view of the lack of interest of ranchers the Government andthe Bank agreed in May 1970 on new interest rate terms. The participatingranchers were offered a choice of either of the following subloan terms:

(a) the same as in paragraph 2 but with a decrease in thenominal interest rate from 14 percent to 12 percent;

(b) nominal interest of 6 percent, the principal amount to b4fully indexed, including during the grace period, based oneither: (i) the cattle of cattle/wool price index, or(ii) the changes in the US dollar selling rate of theBanco do Brasil, S.A. from the one prevailing on the dateof the loan.

Ceiling on Adjustment Index Introduced in June 1971

6. In late 1970 and early 1971, following removal of meat pricecontrols, there occurred a substantial rise in cattle prices. It wasobserved that if the trend continued loans subject to adjustment in accord-ance with an index of cattle prices could be subject to extremely largeadjustments. The fact that these adjustments would be so much greater thanthe widely publicized inflation rates was operating as a serious disincentiveto rancher participation in the Project. A high percentage of farmers with-drew their loan applications. Consequently, in June 1971 the Bank and theGovernment again agreed to modified relendin- terms for loans to be committedfrom that time on. It was agreed that whatever adjustment was made in sub-loan principal would not exceed the extent of inflation as measured by thegeneral price index for the period.

1/ A linear interpolation would be made after publication of the index todetermine the amounts due during each month of the preceding year. Thiswould be used to adjust farmer's loan balances in case of partial ortotal prepayment of a loan.

ANNEX IIIPage 7 of 7

Present Relending Terms

7. A Bank mission reviewed the Project in March-April 1972 andnoticed that owing to misunderstandings there were several shortcomingsin the application of the monetary correction formula. Specificallythey found:

(a) that while monetary correction was being applied toprincipal during the four-year grace period (with theexception of an initial gap, see (b) and (c) below),interest during the grace period was being calculatedon the original nominal amount of the loan. Only afterthe end of the grace period was such interest calculatedon the corrected amount. This had the effect of reducingthe real interest rate paid by ranchers by one-half to onepercentage points per annum over the life of the averageloan;

(b) that on loans linked to the foreign exchange rate,monetary correction was not being charged during thefirst 12-18 months of the grace period despite the factthat the arrangements provided that it should be chargedfrom the beginning. This had the effect of reducing thereal interest rate paid over the life of the loan byabout 1.5 percentage points on the average;

(c) that on loans linked to the cattle price index, thecorrection was equally not applied in the first 12-18months. This reduced the average real interest rateby some 2 percentage points.

8. With a view to avoiding such mistakes in the future, the BancoCentral do Brasil, in consultation with the Bank, simplified the relendingterms beginning on July 1, 1972. The change provided that interest on allnew subloans would be 7 1/4 percent a year and the loan amount corrected inproportion to the changes in the US dollar selling rate for Braziliancruzeiros. Full adjustment of both interest and principal are to occurboth during the entire grace period and later. If at any time the increasein the general price index should exceed the rise in the US dollar/cruzeiroexchange rate by more than 7 1/4 percent, the Bank and the borrower will agreeon a new indexing system, and no new subloans will be committed until that newsystem has been agreed.

9. It is realized that the present system is not perfect and implieslending to ranchers at subsidized rates of interest. However, most agricul-tural lending in Brazil takes place at interest rates of up to about 15 per-cent without monetary correction. The system is sustained only with strongsupport of public funds. In this sector the Government made a beginning inex post correction with the first livestock loan and the system has now beenmade workable. It has been Government's policy to allow agricultural lendingrates to remain below industrial rates, partly as a compensation for the highprices of agricultural inputs caused by protection to the industrial sector.The Bank staff has a continuing dialogue with the Government about agriculturallending policies and the Government has been gradually extending the practiceof monetary correction.

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