Progress Report on Tranche Release Program Number: 33173 Loan Number: 1877/78 June 2007

Pakistan: Agriculture Sector Program Loan II

CURRENCY EQUIVALENTS (as of 31 May 2007)

Currency Unit = Pakistan rupee(s) (PRe/PRs)

PRs1.00 = $0.0165 $1.00 = PRs60.72

ABBREVIATIONS ADB – Asian Development Bank API – Agricultural Policy Institute ASPL – Agriculture Sector Program Loan GDP – gross domestic product GMP – guaranteed minimum price GVA – gross value added M&E – monitoring and evaluation MINFAL – Ministry of Food, Agriculture, and Livestock NGO – nongovernment organization NWFP – North West Frontier Province PARC – Pakistan Agricultural Research Council PASSCO – Pakistan Agriculture Storage and Supplies Corporation PIU – project implementation unit PCSIR – Pakistan Council for Scientific and Industrial Research SDR – special drawing rights SPA – senior policy adviser SSC – Sindh Seed Corporation TA – technical assistance

NOTE

In this report, “$” refers to US dollars.

Vice President L. Jin, Operations Group 1 Director General J. Miranda, Central and West Asia Department Director K. Matsunami, Agriculture, Environment, and Natural Resources Division Team leader L. Adriano, Senior Rural Development Economist, Agriculture,

Environment, and Natural Resources Division Team members S. Zaidansyah, Counsel, Office of the General Counsel

M. A. Deguito, Project Implementation Officer, Agriculture, Environment, and Natural Resources Division

CONTENTS

Page I.

INTRODUCTION 1

II.

DEVELOPMENTS IN THE AGRICULTURE SECTOR 2

III.

ASPL II: EXPECTED OUTCOMES, CONSTRAINTS, AND ACHIEVEMENTS

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IV.

STATUS OF DEFERRED SECOND TRANCHE CONDITIONS

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V.

STATUS OF THE THIRD TRANCHE CONDITIONS 13

VI.

PROGRESS OF THE TECHNICAL ASSISTANCE PROGRAM 19

VII.

USE OF ASPL II COUNTERPART FUNDS, PROGRAM IMPLEMENTATION, MONITORING AND EVALUATION

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VIII. CONCLUSION AND FOLLOW-UP PROGRAM OF THE GOVERNMENT

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IX. THE PRESIDENT’S RECOMMENDATION 23 APPENDIXES

1. Status of the Agriculture Sector Program Loan II (ASPL II) under the Deferred Second Tranche

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2. Status of the Agriculture Sector Program Loan II (ASPL II) under the Third Tranche and Follow-Up Actions

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3. Use of ASPL II Funds for Capacity Building, Enterprise Restructuring, and Agriculture Development Projects

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I. INTRODUCTION

1. The Second Agriculture Sector Program Loan (ASPL II) to Pakistan, approved by the Asian Development Bank (ADB) on 13 December 2001, comprises three loans totaling the equivalent of $350 million from the Asian Development Fund (ADF) and ordinary capital resources (OCR).1 The Loan Agreement was signed on 1 April 2002 and took effect on 24 September 2002 with the release of the first tranche equivalent to SDR39,121,000 from the ADF and ¥9,154,500,000 from the OCR. The second tranche equivalent to SDR39,121,000 and ¥6,103,000,000 was released on 25 August 2006. The release of the third and final tranche equivalent to SDR17,996,000 and ¥12,206,000,000 is scheduled for the third quarter of 2007, but the loan is set to close on 30 June 2007.2 Additionally, SDR1,565,000 is being provided until 31 August 2007 for technical assistance (TA) to facilitate the implementation of the Agriculture Sector Program (the Program). 2. With the primary objective of promoting growth through increased agricultural productivity and profitability, the Program was designed to assist the Government in removing policy distortions and supporting institutional restructuring. Its specific reform measures are aimed at: (i) promoting efficient markets for major agricultural commodities, including wheat, cotton, rice, and sugarcane, to encourage market-based incentives for small farmers; (ii) liberalizing markets for agricultural inputs, particularly fertilizers and seeds; and (iii) strengthening support for small-farmer extension, training, and research services, as well as regulatory functions that improve input quality control. Pakistan’s Ministry of Finance is the Executing Agency for the Program, while the Ministry of Food, Agriculture, and Livestock (MINFAL) has day-to-day responsibility for implementation and monitoring, in coordination with other federal ministries and the provincial governments. 3. The release of the loan tranches is subject to the fulfillment of policy and institutional reforms required under the Program. This progress report discusses the ASPL II achievements in the context of recent developments in agriculture, and the socioeconomic-political factors that have influenced the nature, form, and extent of progress made under the Program. It then evaluates the status of compliance with the 11 policy conditions set for the release of the third tranche. These include the 4 deferred second tranche conditions, and the 7 third tranche conditions. The report also discusses the performance of the TA loan and the use of counterpart funds under the Program.

1 The loan total comprises the following: Loan Nos. 1877-PAK(SF) for SDR96,238,000 ($123 million) from ADB’s

Special Fund resources; 1878-PAK for ¥27,463500,000 ($225 million at $1.00 = ¥122.06 as of 12 November 2001); and 1879-PAK(SF), a technical assistance loan of SDR1,565,000 ($2 million) from ADB’s Special Fund resources (ADB. 2001. Report and Recommendation of the President to the Board of Directors on Proposed Loans to the Islamic Republic of Pakistan for the Agriculture Sector Loan Program II. Manila).

2 According to the report and recommendation of the President for ASPL II, the third tranche was to be released within 60 months of loan effectiveness (by the end of third quarter of 2007). But the loan closing date specified in the Loan Agreement is 3 months before that. This progress report on the third tranche should be assessed in this context, and in view of the significant headway made by the Government in meeting the policy conditions for the release of the third tranche, as highlighted in this report.

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II. DEVELOPMENTS IN THE AGRICULTURE SECTOR

4. Agriculture Performance. Pakistan’s economy is undergoing structural transformation from an agriculture-based to an industrial- or knowledge-based economy.3 Agriculture, once the mainstay of the country’s commodity-producing sector,4 has waned in importance, albeit gradually. Its contribution to gross domestic product (GDP) has decreased, from 50% in the 1950s down to 22% in 2000–2006, with an accelerated decline from 2000 to 2006. The share of the sector in export earnings and in imports has also showed a downtrend. The labor force employed in agriculture was reduced from 68% in the 1950s to 44% in 2005, and the proportion of the agriculture population in the total population from 73% to 49% in the same period. 5. Until recent years, annual growth in agriculture was on a downward trend. Growth averaged 4.4% in the 1990s, compared with 5.4% in the previous decade, then went into marked decline in the first two years of the new millennium, to below 2% a year, after a severe drought. Although the rate fluctuated somewhat during the Program years (2002–2006), it was much better on average than in 2000–2002. Agriculture growth picked up in 2003, to 4.1%, but again dropped to 2.4% in 2004 because of water stress. In 2005, the record high production of cotton pushed the growth rate to 6.7%. The following year, overall growth in crop production declined, as production returned to normal. Among the agriculture subsectors, livestock did very well in 2006, growing by 2.5% overall. The prospects this year look good: the sector is expected to grow by 4.5%, according to preliminary estimates.

6. Important structural changes are under way in agriculture, and in the rural economy in general. First, gross value added (GVA) in the sector has diversified to comprise not only the major crops (cotton, rice, sugarcane, and wheat), which contributed 35% of the GVA of agriculture from 2000 to 2006, but also minor crops (chillies, garlic, onions, potatoes, pulses, etc.), with a share of 12% of agriculture’s GVA, and livestock, which accounted for almost half of the sector’s GVA. Second, nonfarm rural households (52%) now outnumber farm households (48%). Rural households in general rely less on agriculture as their main source of income. In 2004–2005, only 37% of rural incomes came from agriculture-related activities (25% from crops, 8% from livestock, and 4% from agriculture wage labor), nonfarm income (40%), remittances (9%), and other sources (15%) made up the bulk. Even among farm households, crop-based income was just 49% of rural income. Third, the nature of rural poverty is changing. While most of the poor—about 4.38 million—still live in the countryside, the incidence of rural income–based poverty declined from 39.3% in 2001–2002 to 28.1% in 2004–2005. Rural nonfarm households constitute the great majority of the rural poor, at 57%; farmers compose 35%, and agriculture labor households, the remaining 8%. 7. For Pakistan to accelerate and sustain the high-growth and poverty-reducing economic development experienced in recent years, agriculture growth remains an important ingredient. Agriculture is still a major source of income and jobs for about half of the country’s households; is vital in keeping inflation stable and low; and has strategic links with the flourishing manufacturing sector (principally food and textiles), wholesale and retail trade, and the export sector (65% of export earnings come from the textile industry). The productivity of the agriculture subsectors must increase if the sector is to have a greater share in the country’s

3 The Government’s vision for 2030 is “a developed, Industrialized, just and prosperous Pakistan through rapid and

sustainable development in a resource constrained economy by deploying knowledge inputs.” 4 The Government divides its economic sectors into two: the commodity-producing and service sectors. The

commodity-producing sectors are agriculture, mining and quarrying, manufacturing, construction, and electricity and gas distribution. The services sector includes transport, storage and communication, wholesale and retail trade, finance and insurance, ownership and dwellings, and public administration and defense.

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GDP. Although the sector has generally improved in recent years, it is still performing below its potential. From a long-term standpoint, the performance has been mediocre, with real GDP growth per capita averaging 1.04% from 1990 to 2005, and low total factor productivity relative to that of comparable countries. Low productivity and profitability have been the core problems in the crop and livestock subsectors, while neglect has constrained the non-crop subsector from realizing its full potential. In the crop subsector, resource constraints and policy and institutional bottlenecks have seriously impeded investments. 8. To improve the performance of the agriculture sector, the policy and institutional environment must encourage efficient production and greater private sector participation in agriculture-related activities in the upstream and downstream. However, although government policies in recent years have reduced public sector involvement in agriculture and moved the sector toward a more market-led economy, policies affecting the commodity and inputs market still thwarted the development of a level playing field for private sector involvement. Among these were the provision of commodity and input subsidies particularly for the four major crops, and the existence of state-owned enterprises or public agencies that engaged in market activities. Additionally, the regulatory and legal frameworks for agriculture-related activities were outdated. Lastly, rural service delivery, particularly the public sector-dominated agriculture research and extension programs, was largely ineffective, had overlapping functions, and did not fully serve the small farmers. These core reform areas were covered by ASPL II.

III. ASPL II: EXPECTED OUTCOMES, CONSTRAINTS, AND ACHIEVEMENTS 9. ASPL II: Expected Outcome and Outputs. Overall, the Program was expected to improve the productivity and profitability of agriculture, especially of small farmers. The resultant higher incomes would reduce the incidence of poverty and spur sustainable agro-industrialization. To this end, ASPL II was designed to address the key policy and institutional constraints that resulted in: (i) inefficiencies and distortions in the markets for major commodities (cotton, rice, sugarcane, and wheat) and key inputs (fertilizers, pesticides, and seeds); (ii) poor delivery of research and extension services to farmers; and (iii) lack of effective quality control for inputs and commodities. The Program would have two outcomes: more efficient commodity markets, and stronger support services. The first outcome was to be achieved through (i) the removal of restrictions on the movement of agricultural commodities, (ii) the rationalization of public management of the strategic wheat reserve, (iii) the phaseout of commodity price supports and subsidies, and (iv) the closure or restructuring and divestiture of state-owned enterprises or public agencies competing with the private sector. The Program would make the second outcome possible by (i) accelerating the provision of agriculture support services, (ii) strengthening and coordinating agriculture support services, and (iii) improving quality control and regulation of agriculture inputs. The outputs for each outcome were the 32 policy conditions that the Government committed to fulfill under ASPL II, in three time-bound phases. The 32 policy conditions were grouped into seven modes of intervention, as shown in the table. Of these conditions, 11 were met under the first tranche. Under the second tranche, 8 of the 14 conditions and 1 sub-condition were fully complied with, 3 conditions were substantially complied with, 1 condition was partially complied with, and 1 condition and 1 sub-condition were waived. The status of compliance with the 7 policy conditions under the third tranche is discussed below. Progress in meeting the policy conditions that were only partially or substantially complied with under the second tranche is also assessed.

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Outcomes and Outputs of ASPL II Output

Outcome

Tranche 1 Policy Measures (identification number;

tranche released in September 2002)

Tranche 2 Policy Measures (identification number; period covered

2002 to August 2006)

Tranche 3 Policy Measures (identification number; tranche to be released in June 2007)

A. Improve the Efficiency of Commodity Markets by: • Removal of

market restrictions

A1.1. Internal movement of agricultural commodities

A1.2. Policy allowing import and export of agricultural products, subject to International Monetary Fund and World Trade Organization tariffs and antidumping rules

A1.3. Production, marketing, and export of brown sugar (gur) and molasses

A1.4. Cotton Standardization Ordinance A1.5.De-zoning of sugarcane areas A1.6. Access to breeder seed

A1.7. Grading and standardization of cotton

• Public management of strategic wheat reserves

A2.1. Policy on procurement and management of wheat and closure of directorates of food in Sindh, NWFP, and Balochistan over 5 years

A2.2. Changes to PASSCO’s Memorandum and Articles of Association

• Phase out of commodity price supports and subsidies

A3.1. No new subsidies on wheat imports, public seed production and marketing, or fertilizer production imports and marketing

A3.2. Small Farmers Plan.

A3.3. Market-based sales price for wheat

A3.4. Market-based price for procurement of wheat

A3.5. Implementation of Small Farmers Plan

• Accelerating divestiture and restructuring of state-owned enterprises

A4.1. Closure of Sindh Agricultural Supplies Organization and the Agricultural Development Authority, NWFP and start the process of divestiture A4.2. PASSCO’s procurement and storage costs to be borne by the provinces, and losses from exports to be borne by Government A4.3 Termination of all budgetary support, subsidies, and preferential credit for Trading Corporation of Pakistan (TCP), except for year-end losses in its wheat, cotton, rice, edible oil, and seed operations

A4.4. Closure of Federal Fertilizer Import Department and the Food Directorate, and timetable for closing the Sindh Seed Corporation

A4.5. Restructuring of PASSCO and the provincial food departments, operation along market lines, and competing on equal footing with the private sector

A4.6. Retirement of, or provide severance package to, redundant staff

A4.7. TCP on equal footing with private enterprises

A4.8. Complete implementation of restructuring plans for PASSCO and provincial food departments; closure of directorates of food in provincial food departments of Sindh, NWFP, and Balochistan as well as Sindh Seed Corporation; and commence divestiture; and end budgetary support, subsidies, and preferential credit for PASSCO, except for costs of managing wheat strategic reserve

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Output

Outcome

Tranche 1 Policy Measures (identification number;

tranche released in September 2002)

Tranche 2 Policy Measures (identification number; period covered

2002 to August 2006)

Tranche 3 Policy Measures (identification number; tranche to be released in June 2007)

B. Strengthen Support Services by: • Accelerating

provision of agriculture support services

B1.1. Onlending to provincial governments (PGs) on the same terms as ASPL II

B1.2. Financing requirements for support services through reform programs, provincial trust funds, and private associations’ endowment funds B1.3. Sindh Rural Support Program

B1.4. PGs to commence financing new initiatives in agricultural research, extension, and higher education, using some of the local currency funds in the provincial trust funds

• Accelerating the strengthening and coordination of agriculture support services

B2.1. Provincial agricultural research and extension services (research institute plans) B.2.2. Agricultural support plans and research

B2.3. Implementation of research institute plans

• Better quality control and regulation measures

B3.1. Draft amendment for fertilizer regulation; regulation and control of agricultural chemicals; and revision of Environmental Protection Act

B3.2. Certification of nutrient content at point of entry and certification of quality at retail level by private third party laboratories B3.3. Fertilizer and pesticide regulations

Total Number of Policy Measures

11 14 7

ASPL = Agriculture Sector Program Loan, NWFP = North West Frontier Province, PASSCO = Pakistan Agricultural Services Supply Corporation, PG = provincial government, TCP = Trading Corporation of Pakistan. Source: Loans 1877-PAK(SF) and 1878-PAK: Agriculture Sector Program Loan II 10. Constraints. Sociopolitical factors influenced the nature, form, and extent of compliance of the Program with the policy conditions. The interplay of these factors explains in large measure why the release of the second tranche took much longer than originally scheduled, and compliance with some of the policy conditions under the third tranche was a challenging task. First, program implementation coincided with a major political change in the country. The assumption of power by a military regime in 1999 resulted, among other things, in the decentralization of government operations, especially the delivery of extension services to local governments. Moreover, policies and regulations on agriculture-related matters have mainly been a constitutional mandate of the provincial governments. Even the Rules of Business of the Federal Government, which give MINFAL authority in agriculture policy and regulatory measures, are continually being refined, and these formerly federal roles are being transferred to the provincial governments. In fact, some policy conditions under ASPL II were within the formal jurisdiction of the provincial governments or were handled by them in practice even before ASPL II. 11. At the start of the Program, policymakers in the provincial governments, who were affected by many of the policy conditions under ASPL II, did not have a sense of ownership of the Program, as they had not been fully involved in its design. Only the federal Government

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was committed to implementing the policy reforms under ASPL II. After meeting the policy conditions under the first tranche, MINFAL invested in ensuring a shared understanding of the ASPL II’s impact, outcomes, and deliverables with the provincial governments through consultation meetings, dialogue, and workshops. The provision of counterpart funds for the development projects of provincial governments also facilitated their implementation of the policy conditions under ASPL II. Once the provincial policymakers gave their full support and commitment to ASPL II, progress speeded up, and it became possible—though still challenging—to complete some unfinished tasks under the second tranche and to meet substantially most of the seven policy conditions of the third tranche within the stipulated time. 12. Second, the policy and institutional reforms under ASPL II had an impact on the interests of politically and economically powerful groups, which had benefited from the status quo. Because of the traditional hierarchical structure of Pakistan’s society, with its entrenched interest groups, the threat of policy reversal is high, especially at the local levels. Thus, efforts to incorporate the reforms into legal instruments and enforce them were met with resistance from the groups that would lose advantage under these reform measures. Some political measures called for political savvy and a great deal of communication and advocacy work before they could be instituted. Often, the politically workable reform measures were compromise agreements, which required longer implementation before the expected output could be achieved but nevertheless laid the groundwork for private sector participation and leveled the playing field. 13. Lastly, policy and institutional reform in ASPL II was a daunting task, not only because of the complexity of the 4 deferred second tranche conditions and the 7 third tranche conditions; but also due to the weak technical capacity in the country for policy analysis and advocacy. Each of the 21 policy conditions for the second and third tranches had several sub-conditions, all of which were difficult and time-consuming. Some policy conditions also required coordinating a number of federal and provincial government agencies to ensure compliance. More importantly, policy analytical skills were deficient in both the federal and provincial governments. There was a need to train policy makers and implementers especially in the local governments, as they had limited experience in formulating and implementing market-friendly policies for the agriculture sector. Additionally, policy reforms require institutional changes, which in turn need investments in institutional/capacity building for the reformed institutions. 14. ASPL II Achievements. A complete review of the status of compliance has to look at the big picture (how ASPL II progressed toward its goals), the record of sustaining compliance with the conditions for the release of the previous (first and second) tranches, and the specific progress and compliance with unfinished tasks for the second tranche release conditions and with the third tranche release conditions. Progress in achieving goals is best assessed by reviewing the conditions before ASPL II and at the end of the Program. At the time ASPL II was launched, agriculture faced two kinds of constraints—resource constraints and policy distortions. ASPL II attempted to address both of these constraints. Resources were made available in the form of counterpart funds, and policy distortions were addressed through technical advisory support for the technical fulfillment of the policy conditions. With counterpart funds from ASPL II, the provinces were able to develop a robust investment portfolio. Overall progress in using counterpart funds was substantial, considering the problems faced at the start, when there was confusion or lack of shared understanding about the kinds of expenditure that were eligible for counterpart funding under ASPL II. As discussed in Section VII, the provinces have been undertaking innovative and productive projects with ASPL II counterpart funds. The portfolio they have developed is making agriculture in Pakistan more profitable and productive.

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15. Before ASPL II, the Government heavily intervened in the agricultural markets. Wheat import subsidies, duty and periodic restrictions on cotton exports, and protection of sugarcane distorted incentives. Nominal protection coefficients revealed a persistent policy bias against cotton and wheat and in favor of sugarcane. Indirect intervention, through protection of industry, penalized agriculture through the impact on relative sectoral prices. Government policy also affected vital inputs (fertilizers and seeds) and the credit market. The composition of public expenditure in agriculture was also distorted. Spending was dominated by subsidies that did not help farmers, either because they led to rent seeking and inefficiencies or because the subsidies were designed to help consumers at the expense of producers. 16. Because of some of the fundamental reforms initiated under ASPL II and other structural adjustment programs initiated by the federal Government at the macro level, Pakistan’s agriculture sector today is more liberalized with reduced government interference compared to the agriculture sectors of other countries in South Asia. The rice market is fully liberalized and there is no intervention from the public sector. The cotton market also works with less government interference—the occasional price support to growers at times of bumper crop has been done through open-market operations. Steps have been taken to free the sugar subsector from distortions. Most importantly, a market-friendly wheat policy was adopted in 2005 under the ASPL II, as explained further in the next paragraph. The fertilizer market has been almost totally liberalized; occasionally the public sector augments the total supply by providing a facility for imports. Measures have also been taken to liberalize the seed market and to limit the public sector’s role in addressing market failures. 17. The most significant and effective reform has taken place in the wheat market, which was the subject of several conditionalities of ASPL II. Public sector intervention in the wheat market before ASPL II was most pervasive, creating disincentives for wheat growers and traders. This explains why 12 of the 32 conditions for the release of tranches under ASPL II were related either to wheat policy or to the restructuring of public sector agencies dealing with wheat. Considerable progress has already been made in reforming wheat policy as a result of a consultative approach adopted under ASPL II. The key ingredients of the new phased wheat policy—as outlined in government papers—are as follows:

(i) Government will not, in any circumstances, reverse the liberalization of the wheat trade. No restriction will be imposed on the movement of wheat at any level within the country, and private traders will buy and trade wheat without any restriction.

(ii) A clear distinction will be made, during stock buildup by the public sector,

between the guaranteed minimum price (GMP; fixed and announced before the sowing season) and the procurement price (variable and dependent on market conditions), which the Government will use in building up stock if the targeted amount is not bought at the guaranteed price. Producers of wheat will be free to sell their wheat either to the Government or to the private sector.

(iii) A strategic reserve (the size of 1 million tons initially suggested under ASPL II will

be reviewed by the Government) will be maintained and it will be distinguished from the operational stock (which was used to stabilize price within the year but will now be reduced in size over time to the extent needed for the targeted food subsidy program). The strategic reserve will be managed optimally and cost-effectively to influence the domestic wheat price, if necessary.

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(iv) The Government, through a body of experts, will set a price band for wheat procurement and marketing, with the GMP at the lower end, to provide incentives to growers, and a predetermined ceiling to serve the interest of the consumers.

(v) The import and export of wheat will be open to the private sector, and the

Government will continue its policy of liberalizing wheat imports and exports. (vi) The general subsidy program will end, and will be replaced by the targeted food

subsidy programs for the underprivileged to reach the poorest of the poor. 18. These policy reforms are irreversible because the benefits that they have brought about and the considerable pressure groups (constituencies) that have been created in the process will make it impossible to retract these reforms. The wheat policy reform, for example, has produced private importers and exporters of wheat, who will now be a vocal group in support of the liberalization of the wheat trade. Similarly, the wheat policy reform has forced public food agencies (such as the provincial food departments and the Pakistan Agriculture Storage and Supplies Corporation [PASSCO]) to face competition from the private sector. In the last three procurement seasons, the Government has been purchasing from the market at the announced minimum price, in open competition with the private sector, which has operated in the market without any restriction. Consequently, the growers have been receiving a good price for wheat, generally higher than the GMP. Particularly in 2005, the food departments in both the Punjab and Sindh could not procure the targeted wheat amount because the prevailing market price was higher than the announced or issue price (the price at which the Government sells its stock to flour millers). Later that year, the lifting of public stock by flour millers was slow because liberalized imports made the price in the open market lower than the issue price. There is burgeoning competitive market in wheat, which all public sector agencies such as the provincial food departments have to face. 19. The impact of the wheat policy reform has thus already created internal pressure for structural adjustment as public agencies face competition from the private sector. The restructuring of these public sector agencies (required under ASPL II conditions) should now be possible, but may take longer because it needs to be done through broad-based consultation with stakeholders. The momentum created through the wheat policy reform and the results of the restructuring studies done in close consultation with relevant policy makers and officials of the food departments will carry the reform program even beyond the period of ASPL II. The latest initiative of the Government to follow up on ASPL II confirms this.5 20. Good progress was also made toward the second objective of ASPL II—strengthening support services. Strong momentum for the reorganization of agriculture research has been created. A good deal of reorganization has begun. Agricultural research councils have been set up, and measures to ensure independence and improve the incentives for the research staff are under way. The various projects funded by ASPL II for the reorganization and strengthening of agriculture research will carry the momentum further. Some provinces and the Pakistan Agricultural Research Council (PARC) have initiated much more ambitious reform programs

5 During the deliberations on reports on the restructuring of the provincial food departments and directorates at the

11 April 2007 meeting of MINFAL officials with the secretaries of the provincial departments of agriculture, MINFAL and the provincial government officials agreed on the next phases of the wheat policy program after ASPL II. These include: (i) the phaseout of operational reserves; (ii) a systematic approach to a wider price band; (iii) free movement of wheat within the country and private sector involvement in the import and export of wheat; and (iv) more market-enabling roles for MINFAL and the restructured food departments in the provinces.

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than those aimed for under ASPL II. The Punjab, for example, is setting up research organizations for five crops on a trial basis. 21. The progress of ASPL II in other aspects has also been quite impressive. As noted earlier, some provinces—notably the Punjab—raised strong opposition to the ASPL II reform package at the start. Other provinces gave lukewarm support at best, and no one wholeheartedly bought into the program. Provincial officials had no shared understanding of the content and rationale of ASPL II. Many were only partially informed about the program, and often the information they had was distorted and the context was hardly known or understood. From that initial position, there was remarkable progress in the acceptance of and commitment to the reform program in the later years of ASPL II. 22. A sign of the commitment to reforms is support for the reforms in general and sustained compliance with the tranche conditions in particular. The progress made in meeting the first tranche conditions toward establishing a market-based system has been retained. A quick review of the 11 first tranche conditions indicates that they fall into three groups by expected output. 23. The first group was aimed at removing market distortions. Compliance with all the conditionalities in this group was sustained, except for the critical condition of unrestricted movement of agricultural commodities. The Punjab violated this by reimposing restrictions on the movement of wheat within and between provinces. The infringement was later corrected through federal and interprovincial discussions resulting in a comprehensive and phased reform of the wheat policy based on consensus. 24. The second group of first tranche conditions was aimed at encouraging private sector participation, and the third group at redefining the role of the Government by restructuring its agencies. Compliance with these two groups of conditions was fully sustained. This record of sustained compliance with 10 out of 11 first tranche conditions is encouraging. Even the solitary violation of the policy condition on the movement of wheat triggered a process of internal debate and discussion leading to far-reaching and sustainable reforms in the wheat policy, which was endorsed by the federal Economic Coordination Committee of the Cabinet and the provincial governments. The salient features of the new wheat policy have already been noted (see para. 17). The new wheat policy has already generated pressure for the institutional reforms required under ASPL II. 25. To sum up, although it is too early to gauge the full impact of the policy reforms begun under ASPL II, it can be safely argued that the reforms have so far led to more extensive private sector involvement in the agriculture sector and the operation of more competitive markets. Most significant has been the development of a phased market-friendly wheat policy, which has already generated momentum for further progress, especially in the restructuring of public sector food agencies. The structured reform begun by ASPL II for the reorganization of research is also substantial. There was, unfortunately, a long delay of more than 2 years in the release of the second tranche. The delay was caused by a host of factors, as outlined earlier, but it was not time totally lost for the overall progress of ASPL II. During the interval, the Government went ahead with several reform programs that now make it possible for ADB to consider releasing the third tranche less than a year after the release of the second tranche.

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IV. STATUS OF DEFERRED SECOND TRANCHE CONDITIONS 26. This section discusses the status of the deferred second tranche policy conditions (see Appendix 1 for the status of the deferred second tranche policy conditions), while Section V gives the status of the policy conditions under the third tranche. The nature and extent of the Government’s compliance with the conditions under the second and third tranches was evaluated not only for legal adherence to the reform measures but also according to the following criteria and indicators, and with the total picture in view: (i) the overall achievement of ASPL II—the extent to which it reached its overall goals of laying the foundation for private sector participation in agriculture and for the emergence of competitive markets, and the commitment of the Government to sustain the momentum of policy and institutional reform and investment; (ii) the political sensitivity of the reform measures and the political and economic feasibility of achieving them within a given period; and (iii) the time needed for policy dialogue, consultations, and other participatory measures to ensure consensus and ownership of the reform agenda, and the results obtained. 27. Item A4.4: The Fertilizer Import Department and the Directorate of Food shall have been closed by MINFAL and the process of divestiture commenced, and the Sindh Government shall have announced a time-bound action plan to close the Sindh Seed Corporation (SSC). From substantially complied with to complied with. This tranche condition was assessed as substantially complied with because SSC did not have an explicit timetable for its eventual closure although it has commenced its divestiture process and has involved the private sector in its management. The SSC was initially closed by the Government of Sindh in February 2001 and its operations were terminated by early 2002. However, because the private sector could not fill the role of the SSC, such that the crop’s productivity was adversely affected, the Government of Sindh revived the SSC as a lean, more efficient, and sustainable organization on 24 February 2004. The Sindh government prepared an action plan for the SSC in partnership with private sector, including private seed companies. The plan was approved in May 2005, and a management board with representation from the private sector was formed in November 2005. Steps are being taken to convert the SSC into a public limited company.6 Specifically, the Government of Sindh’s Agriculture Department has formulated the draft amendment to the Sindh Seed Act of 1976 to reflect the proposed status of SSC. Sindh’s Law and Parliamentary Department has approved the amendment and the Agriculture Department is currently awaiting the approval of the Chief Minister. Once this approval is obtained, the Department of Agriculture, Sindh will prepare the Articles of Association which will be submitted to the Securities Exchange Commission of Pakistan for the registration of the SSC as a public limited company. The registration is expected to be completed within the shortest possible time.7 28. On the basis of the proactive steps taken to reorganize the SSC into a public limited company with significant private sector representation in the board, this policy condition is deemed to have been complied with. 29. Item A4.5: MINFAL, in consultation with the Provincial Governments shall have submitted plans acceptable to ADB to restructure the PASSCO and the provincial Food Departments to operate on market-oriented lines and compete on equal terms with the private sector (the PASSCO and Provincial Food Departments, Restructuring Plans), and shall have begun implementation, including upgrading and leasing storage facilities. 6 When the SSC will be registered as a public limited company under the Companies Ordinance of 1984, its shares

become tradable on the stock exchange. 7 Based on Sindh Department of Agriculture Letter No. 14(52)SO(DEV)07, dated 5 June 2007.

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From partially complied with to substantially complied with. This tranche condition was assessed to have been partially complied with in the second progress report because (i) the present organizational structure of PASSCO needed to be clarified, and (ii) the restructuring plans for the provincial food departments had not been completed. PASSCO does not receive any subsidy or budgetary provision from the Government, obtains bank credit on the same terms and conditions as those offered to the private sector, and is thus a fully autonomous and self-financed agency that is operating commercially. It is managing the strategic reserve of wheat on a commercial and cost-effective basis. This was confirmed by the Ministry of Finance in a letter dated 11 February 2006 (Ref. No. Finance Division U.O. No. 123-AEAC/2006). MINFAL has given its assurance that this management role of PASSCO will be maintained within the purview of the market-friendly wheat policy program of the Government (as outlined in para. 17). With the planned phased reduction of the strategic and operational reserves, the role of PASSCO in the wheat market will be further streamlined even without a restructuring plan as the private sector plays a more visible role in the marketing and distribution of wheat. However, a formal restructuring plan for PASSCO (including the upgrading and leasing storage facilities) other than the organizational structure that is currently in operation, and the more focused role that it will play under a market-friendly wheat policy, may be politically challenging to achieve and unnecessary at this stage. As more market forces are allowed to operate in the marketing of wheat, PASSCO’s role will eventually be fine-tuned and influenced by the market operations. 30. On the other hand, the studies on the restructuring of the four provincial food departments of Balochistan, North West Frontier Province (NWFP), the Punjab, and Sindh have been completed. The draft studies have been discussed and reviewed by the provincial agriculture department officials at a meeting in MINFAL on 11 April 2007.8 The revised versions have been submitted to ADB in April 2007. A review by ADB of the proposed plans (April/May 2007) notes that the salient features of the comprehensive and phased market-based wheat policy as discussed in para. 17 have been incorporated in the plans, which vary only on the basis of the wheat-deficit or -surplus status of the province. The plans, which reduce markedly the role of the provincial departments in the wheat market and increase private sector involvement in the wheat sector (through the operation of the price band and competitive pricing within the band, the movement toward a targeted food subsidy, and continuation of the free movement of wheat), are being implemented. However, the administrative streamlining of the departments is still being discussed. 31. In this context, this policy condition is deemed to have been substantially complied with. 32. Item B1.2: The Ministry of Commerce and the provincial governments shall have determined and informed the Borrower and ADB regarding the financing requirements for (i) the reform programs, (ii) the provincial trust funds to be used for the joint nongovernment organization (NGO) and extension agent programs that focus on small farmers, and (iii) the private national associations’ endowment funds for export promotion and quality enhancement. From substantially complied with to complied with. 33. This policy condition was assessed to have been substantially complied with in the second tranche because sub-condition (ii) on the provincial trust funds required follow-up. In the Punjab, a proposal to set up a national agriculture foundation with NGO involvement in the provision and delivery of agriculture services and infrastructure was reassessed by the provincial governments. The Department of Agriculture, Punjab decided that the best way to 8 Minutes of meeting held on 11 April 2007 in MINFAL on Restructuring Study of Provincial Food Departments and

Future Plan of Action.

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meet this condition would be to rely on rural support programs. The Punjab rural support program, which already has about 16,000 community organizations (with mainly low-income individuals) as members, has established a sustainable income stream that does not rely on public funds, and more importantly is providing an array of agricultural and rural services and infrastructure to the rural constituents, from the improvement of watercourses to the vaccination of poultry birds and the pilot-testing of integrated pest management in communities. Similarly, the Departments of Agriculture of Balochistan, NWFP, and Sindh have been implementing for the last several years rural support programs that provide credit, improved seeds and other inputs, and agricultural machinery to the rural population particularly the farming community. Such investments help increase agricultural productivity and reduce rural poverty. The rural support programs are functioning continuously on a sustainable basis, with funds from various sources such as donors. The proposed trust fund would essentially overlap with the programs and activities of these rural support programs, and may not be sustainable, as it would compete for funds and other resources with fairly established rural support programs, which already have a track record and machinery for gaining access to financial, technical, and other resources. 34. Since this policy sub-condition (ii) has been completed, this policy condition can now be deemed complied with. 35. Item B3.2: The Borrower and the provincial governments shall have ensured that (i) suppliers of imported fertilizer certify the nutrient contents at the point of origin, and (ii) private third-party laboratories, certified by the Borrower, are also allowed to certify quality at the retail level for fertilizer and seed, subject to existing Borrower regulations. From substantially complied with to substantially complied with for sub-condition (i) and complied with for sub-condition (ii). Fertilizer legislation exists in the provinces of Punjab, Sindh, and NWFP.9 These regulations were legislated prior to ASPL II, and, with the exception of Punjab’s legislation, do not categorically specify that suppliers of imported fertilizers certify the nutrient contents at the point of origin. In the case of Balochistan, the Department of Agriculture follows the regulation of the Punjab Fertilizers (Control) Order 1973. In the Punjab, all fertilizer products other than standard fertilizers are registered in the province under the Fertilizer Control Order 1973 (amended in 2005). As required by the Department of Agriculture, a certificate of analysis accompanies the application for registration. The product sample is tested for field performance in a government laboratory before the registration certificate is issued by the Rapid Soil Fertility and Soil Testing Institute in Lahore. As provided in the Punjab Fertilizers (Control) Order 1973 (amended in 2005), soil and water testing laboratories also test fertilizer samples. 36. On the other hand, the private sector has established its own laboratories to test fertilizer contents at the factory level for quality control. In some cases, SGS, a reputable multinational company based in Karachi that certifies fertilizer contents, provides fertilizer analysis services to fertilizer importers of the Punjab and Sindh. Although SGS has not been appointed by the government to provide such services, private entities freely use its services since its certificate is recognized worldwide. In NWFP, the Department of Agriculture under the Fertilizer Act 2003 has authorized the testing laboratories of the Agricultural Research Institute, the NWFP Agriculture University, and the Pakistan Tobacco Board to analyze the fertilizer sold in the local market. The act provides for elaborate analysis techniques and reporting of results, with the scientist’s authorization. No private sector firm or agency in the province directly imports or sells fertilizers. All imported fertilizer in the province is marketed through the dealer’s 9 Punjab – Fertilizer Control Order 1973 (amended in 2005); Sindh – The Sindh Fertilizer (Control) Act, 1994; NWFP

– Fertilizer Act 2003.

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network of importers from the Punjab and Sindh. In Balochistan, there is no private laboratory that can analyze and evaluate the nutrient contents of imported and local fertilizers. However, the Pakistan Council for Scientific and Industrial Research (PCSIR) laboratory, a federal government organization stationed in Quetta, evaluates and tests fertilizers, among others. Private or public organizations can send samples to PCSIR for analysis. 37. Based on the above, the policy sub-condition (i) is substantially complied with while sub-condition (ii) is deemed to have been complied with.

V. STATUS OF THE THIRD TRANCHE CONDITIONS 38. This section discusses progress in implementing the policy conditions and institutional measures under the third tranche. Appendix 2 summarizes the status of compliance. The following discussion groups the seven measures under the third tranche according to the overall direction of the outcome intended by the reform measures (see Appendix 2). A. Outcome 1: Improved Efficiency of Commodity Markets through (i) Removal of

Market Restrictions, (ii) Phaseout of Commodity Price Supports and Subsidies, and (iii) Acceleration of Divestiture and Restructuring of State-Owned Enterprises

39. The competitive environment for three food and cash crops (wheat, cotton and sugar) and three key inputs (breeder seeds, fertilizers, and pesticides) has been greatly enhanced to ensure a level playing field for the private sector, to set higher quality standards for the commodities, and to give farmers better access to essential inputs. The following five policy measures are aimed at achieving these objectives. 40. Item A1.7: The Borrower, through the Ministry of Commerce, shall have adopted legislation and the provincial governments shall have adopted implementing rules and regulations for the grading and standardization of cotton. Complied with. In October 2002, the Government of Pakistan issued the Cotton Standardization Ordinance, which is still the main policy for cotton grading and standardization. The ordinance established the Cotton Standards Institute to promote quality control of cotton. The Institute (i) introduces cotton grades and standards; (ii) devises quality control measures for the export of cotton, its domestic use, and related handling procedures; (iii) grades seed cotton; (iv) trains cotton growers, ginners, and others to grade and standardize cotton; and (v) assigns a classer to one or more ginning factories to supervise the standardization of cotton. 41. Cotton is mostly grown in the Punjab province (79% of total production), followed by Sindh (20%), Balochistan (0.8%), and NWFP (0.03%). As a follow-up to the Cotton Standardization Ordinance, the agriculture department of the Punjab has amended the Punjab Cotton Control Rules 1966 to ensure the mandatory marking of cotton grade and staple length on each cotton bale. The amendment will improve the standard and quality of cotton, with positive impact on the textile industry and exports of cotton and its value-added product. The amendment to the Rules has been approved by the Chief Minister on 15 May 2007. The Notification has been issued by the Department of Agriculture, Punjab on 7 June 2007. In the case of Sindh province, it issued an ordinance in May 2005 (The Sindh Cotton Control [Amendment] Ordinance, 2005. Sindh Ordinance No. IV of 2005) requiring each bale of cotton to be marked with the cotton grade and staple length. Balochistan has amended its cotton standardization ordinance through the Balochistan Cotton Control (Amendment) Act 2004. This Act provides for the grading and standardization of cotton. NWFP does not grow cotton on a commercial scale and needs no rules. These measures ensure the application of internationally

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recognized cotton grading standards in the ginneries. Additionally, MINFAL and the Punjab government have embarked on a “clean cotton” program to promote the sale of good-quality and standardized cotton both domestically and internationally. 42. From the above discussion, this policy condition may be deemed to have been complied with. 43. Item A3.3: The Borrower shall have eliminated the consumer subsidy for wheat by moving to a market-based sale price for wheat. Substantially complied with. In the past, the Government maintained a consumer subsidy by setting aside large amounts of strategic and operational reserves of wheat, and by fixing a Guaranteed Minimum Price (GMP) for wheat growers (usually below the import parity price) and an issue price for flour millers (equivalent to GMP plus a subsidized rate that does not fully cover the storage, distribution, and management costs of the Government but assures an affordable price to flour consumers). Through these methods, the Government provides a blanket type of consumer subsidy, meaning that all consumers technically benefit from the low prices of wheat and flour. 44. Under the new phased wheat policy, adopted o n 1 April 2005, the Government is moving toward eliminating the consumer subsidy in two ways. First, it is moving to reduce the size of the operational wheat reserve and to use the reserve for targeted distribution at a subsidized price to disadvantaged or vulnerable groups. Not only has the blanket subsidy proved to be expensive to the Government, it has also resulted in large leakages, as the vulnerable groups do not benefit. Several studies including the latest restructuring studies show that only a fraction of subsidies actually reaches the consumers—the bulk goes to intermediaries such as flour mill owners and public officials. Although leakages are still possible even in a targeted food subsidy, some schemes (like food stamps and food for education) have worked effectively and efficiently in other countries and can be tailored to the socioeconomic-political landscape in Pakistan. The restructuring studies suggest variations of these targeted subsidies and also provide detailed guidelines to make the directed subsidy program more effective, equitable, transparent, accountable, and efficient. Moreover, the phased wheat policy will reduce the need for operational reserves as market forces operate within the price band (discussed in the next paragraph), so that, effectively, only strategic reserves will have to be maintained. 45. The second evidence that the Government is moving toward a market-based sale price for wheat is its phased plan to develop a price band for wheat, a common food pricing policy applied by many developed and developing countries to balance the needs of food producers and consumers. The lower end of the band will be the GMP, which will provide incentives or insurance to wheat growers (by removing the risk of price collapse leading to an unprofitable price). In determining the GMP, border prices will be considered in the future to encourage wheat producers to become as competitive as their foreign counterparts. The GMP essentially triggers wheat purchases from the market by the Government to maintain a minimum price level. The upper band (ceiling price) is determined with the interest of consumers in mind but must also take into account the cost to the Government (GMP plus storage, distribution, management, and finance cost or market-based sale price) in making the wheat available to the flour millers (defined in Pakistan as the issue price). The upper band is essentially the trigger point for the release of stocks to the market to keep the price below the ceiling price. MINFAL expects to define the band somewhat widely; within the band, the private sector will operate without any market interference from the public sector except for a directed subsidy program. However, the Government would keep watch on wheat supply and price trends. So far, while the GMP is expected to move in the direction of the border parity price for wheat, the ceiling price (reflected until now in the issue price accorded to the flour millers) has yet to be

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determined. The issue price has fluctuated since 2001, coming close to the market price in some years and dropping below the latter in other years, implying that the Government sold the wheat to flour millers at a loss. 46. Although the full-scale implementation of the targeted food subsidy policy is still a work in progress, the combined effects of a phased implementation of the targeted food subsidy, the liberalization of wheat importation, greater mobility of wheat within the country, and the leeway given to the private sector to operate within a price band and to compete with the public sector have eased the need for the Government to implement a blanket type of consumer subsidy and facilitated the market provision of price incentives to farmers for their produce and affordable wheat and flour prices and timely delivery to millers and consumers. 47. From the above discussion, this policy condition may be deemed to have been substantially complied with. 48. Item A3.4: The Borrower shall have eliminated the producer subsidy for wheat by moving from a support price to a market-based price for the procurement of wheat, unless otherwise agreed between ADB and the Borrower (because of unforeseen external or internal factors), except for the losses that may accrue due to the minimum strategic reserve of wheat. Substantially complied with. The wheat pricing policy of the Government is not totally laissez-faire, but rather within a price band where the lower end (the GMP) is guided by the goal of providing some kind of insurance to wheat growers against price collapse, and the upper end is the consumer support price (guided by import price parity). Within the band, market forces are allowed to operate; the wider the band (as the Government intends it to be), the more the pricing options make it feasible for the private sector to operate, and vice versa. 49. The analysis of market price trends for wheat in relation to the GMP announced by MINFAL shows that market prices of wheat have been mostly higher than the GMP. This was particularly so during the Program period, meaning that farmers sold their produce at the market-determined price. There could, however, be a question about the incidence of the total subsidy for wheat from both federal and provincial governments. Most of the subsidy was intended for consumers (but did not reach them, as noted earlier). Government involvement in the market—to the extent of buying almost one quarter of the total production—has an effect on the wheat market. Here, two facts may be cited to support the contention that the Government has moved toward market-based pricing for the producers. First, the Government at the time of the procurement behaves like a player (albeit a big one) in the market by buying for its strategic and operational reserves at market prices. Also, the size of government purchases over the years has been declining. Second, GMP has been intentionally kept low over the years, to provide an insurance price to wheat growers. However, wheat farmers can sell their produce freely, either to the Government or to the private sector. As the price offered by the private sector was higher than the GMP in the past two seasons, majority of farmers opted to sell their produce to private traders. Most importantly, the total effect of that purchase and sale within the year is price stabilization (a narrowing price difference between the harvest and scarcity months), providing non-distortionary assistance to producers and not a subsidy to growers. The occasional export subsidy by the federal Government also ends up helping the trader of wheat because the exports take place at the end of year to ease the burden of cost of public storage of wheat. 50. From this discussion, this policy condition may be deemed to have been substantially complied with.

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51. Item A3.5: Subject to the results of the feasibility study, the Borrower shall have commenced implementation of the agreed Small Farmers Plan.10 Complied with. Consistent with the small farmers plan endorsed by the provincial governments, various projects began implementation in 2006. The programs and projects provide extension services, soil testing services, credit services, and training in crops and livestock to small farmers to reduce rural poverty and build skills in rural communities. These small farmer programs and projects receive government funding and counterpart funding from ASPL II. In the Punjab, projects worth more than Rs50 billion are being implemented, and most of these will continue until 2009. In Sindh province more than Rs1 billion is being provided. Programs and projects worth Rs0.7 billion are ongoing in NWFP, and Rs1.2 billion is being spent in Balochistan. 52. In the Punjab, the projects for small-scale farmers fall into seven categories: (i) provision of house and garden plots to the rural landless poor in four low-income districts, as well as livestock to augment their income; (ii) credit facilities for smallholders (a “one window” operation) including agricultural credit in association with a commercial bank, microfinance, and revolving funds for farmers in 49 villages of six union councils; (iii) control of soil erosion in rain-fed areas; (iv) scaled-up activities of the rural support programs (including community integrated pest management, and rehabilitation of waterlogged and salt-affected land in three districts); (v) agriculture diversification through the production of fruits, vegetables, and fodder (e.g., cutflower production and technology dissemination, organic production of vegetable crops, seed production of fodder), and livestock-related projects (e.g., establishment of quality control laboratories to test food and animal origins, as well as semen quality control and the strengthening of foot-and-mouth disease research centers); (vi) public-private partnerships serving small farmers (introduction of high-yielding fodder varieties and seed production, extension and input supply services in an “agrimall,” etc.); and (vii) restructuring of agriculture extension services through such means as the introduction of adaptive research farms and participatory approaches linking research and extension. In Sindh province, small-scale farmer projects that are under way include the upgrading of soil and water laboratories, the introduction of a market information network for farmers, the establishment of 29 veterinary mobile units, and the construction of nine fruit and vegetable markets. In NWFP, at least seven projects for small farmers have been started, such as the installation of tube wells on a cost-sharing basis in rain-fed areas, the establishment of a germplasm unit for fruit and vegetable farm growers, the provision of mobile veterinary services, and breed improvement programs. In Balochistan, farmer field schools have been established; the formation of water users associations and village organizations are being promoted; the rural-based poultry development for women was initiated; and other productivity enhancement projects have been developed. 53. From the above discussion, this policy condition may be deemed to have been complied with. 54. Item A4.8: The Borrower shall have caused the Provincial Governments to (i) complete the implementation of the agreed PASSCO and Provincial Food Departments Restructuring Plans; (ii) close the Directorates of Food in the provincial Food Departments of Sindh, NWFP, and Balochistan, and as well as the Sindh Seed Corporation and commence the process of divestiture; and (iii) end budgetary support, subsidies, and exclusive preferential credit for PASSCO except for the costs of managing the wheat Strategic Reserve. Waiver for sub-conditions (i) and (ii) and complied with for sub-condition (iii). There are three interrelated measures under these 10 A study of the feasibility to replace untargeted commodity subsidies with targeted programs for small farmers.

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conditions. On the first sub-condition, considerable progress has already been made in reforming wheat policy—such as by liberalizing imports and exports, and promoting greater private sector participation in the wheat market. This policy reform has forced public food agencies (such as the provincial food departments and PASSCO) to face competition from the private sector. In the past two procurement seasons, the Government purchased from the market at the announced minimum price in open competition with the private sector, and it operated in the market without any restriction. Consequently, the growers received a good price for wheat, generally higher than the GMP. Particularly in 2005, both the Punjab and Sindh food departments could not procure the targeted amount because the prevailing market price was higher than the announced price. Later that year, the lifting of public stock by flour mills was slow because liberalized imports made the price in the open market lower than the issue price. This was clearly a competitive market situation that the provincial food departments had to face and a recurrence would force them to behave like any other player in the market. Thus, a key objective of ASPL II—to ensure a competitive wheat market—is already being attained substantially by the reform of wheat policy.

55. Although wheat policy reform is already creating internal pressure for structural adjustments in public sector agencies to enable them to compete in the marketplace, accompanying reforms of the agencies are still desirable to consolidate the reform progress so far. However, the structural reforms require broad-based consultation with stakeholders and the whole process requires a good deal of time—much longer than the period originally stipulated under ASPL II. As clearly illustrated earlier, the successful design and implementation of wheat policy reform was made possible through a series of internal meetings, which created broad consensus on and support for the key reform steps. Similarly, meaningful and lasting institutional reform is possible only through an elaborate process of consultation with various stakeholders in designing and implementing the structural reforms. The momentum already created through the wheat policy reform and the results of the restructuring studies carried out in close consultation with relevant policy makers and officials of the food department will carry the reform program even beyond the formal closing date of ASPL II. By now, MINFAL and the provinces have become fully committed to the restructuring goals. The time-bound action plans that are being prepared or have been prepared on the basis of the restructuring studies indicate the commitment of policy makers to implement the reform program. Given the need for time to restructure the provincial food departments, the implementation of the restructuring studies cannot be completed within the stipulated time; a waiver is therefore sought for sub-condition (i). Similarly, PASSCO, as noted earlier (para. 29), is now a self-financed agency operating commercially and without budgetary support from the Government or preferential access to credit (ref: MOF letter dated 11 February 2006, Finance Division U.O. No. 123-AEAC/2006). However, completing the restructuring of PASSCO is a politically challenging and unrealistic condition at this stage. 56. On the second sub-condition, it is now recognized that abolishing three provincial food directorates (leaving out the Punjab food directorate) would not be politically feasible. As discussed in the recently-completed provincial food restructuring studies for the food growers, some food distribution functions (food subsidy directed to the poor) and quality control functions will have to continue and the food directorate will have to carry out these functions. Most importantly, the provincial food department (which is the policy making body on food-related matter) cannot work without its implementing arm, the food directorate. Hence, a waiver will also be sought for sub-condition (ii). 57. The third sub-condition has been complied with as reflected in the penultimate sentence of para. 55.

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58. In view of the considerable progress already made in reforming wheat policy, the strong pressure built by reform in wheat policy for the completion of the restructuring process, the clear commitment and initiative shown by the Government to continue with reforms after ASPL II, and the impracticability and undesirability of abolishing the food directorates in the three provinces, a waiver will be sought for sub-conditions (i) and (ii) under this tranche condition and indicate compliance for sub-condition (iii). B. Outcome 2: Strengthened Support Services to be Achieved by: (i) Accelerating the Provision of Agriculture Support Services, (ii) Accelerating the Strengthening and Coordination of Agricultural Support Services, and (iii) Implementing Better Quality Control and Regulation Measures 59. Item B1.4: Provincial Governments shall have each commenced implementation of their Financing Determination including financing new initiatives in agricultural research, extension, and higher education, through using some of the local currency funds in the provincial trust funds. Complied with. The provincial governments have initiated development projects in agriculture research and extension, as well as technical training and laboratory improvements (consistent with World Trade Organization policies on quality control of inputs and agriculture commodities) in key university research institutes, with counterpart funds from ASPL II. In all, more than 10 development projects are now being implemented in the four provinces. These projects are aimed at improving agriculture research and extension services to the farming community, consistent with the financing determination plans. 60. Apart from using counterpart funds from ASPL II, the provincial governments are implementing rural support programs serving the rural community including the farming community, in close coordination with NGOs. Large funds are spent each year to reduce poverty and increase agricultural productivity through innovative public-private partnership schemes for the provision of improved crop management practices and high-yielding varieties, market information, provision of timely extension and veterinary services, and access to market infrastructure. For the rural support program in the Punjab, the projects include integrated pest management for cotton and wheat crops, extension and health services for livestock farmers, and the establishment of milk processing plants and milk collection centers. In Sindh province, trainers have been trained in crop improvement, on-farm water management, and livestock development. In NWFP, farm service centers are being promoted as one-stop shops for the timely provision and delivery of crop inputs, medicine for livestock, agriculture machinery, soil testing laboratory facilities, and other technical advisory services related to good farming practices. Another important project involves the promotion of high-value crops for floriculture and for fruit and vegetable farming, in close coordination with research centers. In Balochistan, farmer field schools are being established to improve the access of small farm holders to good-quality crop and livestock practices and technologies. Emphasis is also placed on the development of water users associations and village organizations. 61. In view of the above, this policy condition is deemed to have been complied with. 62. Item B2.3: The Borrower and Provincial Governments shall, subject to the results of the relevant study, and their joint agreement, have commenced implementation of: (i) the Research Institute Plans,11 (ii) the Agricultural Support Service Plans;12 and (iii) 11 Feasibility of allowing greater administrative and financial autonomy to provincial research institutes. 12 Right-sizing and strengthening the delivery and coordination of agricultural research, extension, and higher

education services.

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the Research Councils’ Plan.13 Complied with. All four provinces have already started to implement the plan to grant autonomy to the research institutes and improve the incentive structure for researchers. Of the four provinces, the Punjab is the most advanced in the implementation of the research institute plans and has initiated quite innovative measures. On 28 February 2007, the Chief Minister of the province approved the incorporation of the five research institutes for sugarcane, cotton, rice, wheat, orange, and mango. This is in line with the revitalization of research and education services as envisaged in the Punjab Economic Vision 2020. This strategy provides, among other things, for administrative and financial autonomy and flexibility for research institutes, a change in the service structure of research scientists, and the laboratory and farm requirements of agriculture research. Steps are also under way for the retrenchment of several research stations, substations, and several posts of different grades, as well as the introduction of a competitive grant system. In Sindh and Balochistan, initiatives toward the implementation of research institute plans include the preparation of PC-1s on the restructuring of the agriculture research systems toward more financial and administrative autonomy and improved incentive structure to researches. In the case of Balochistan, the organizational set up of its agriculture research has already been restructured to ensure more autonomy and appropriate incentive schemes for its researches are underway. 63. The four provincial Departments of Agriculture have commenced the implementation of their respective agriculture support services plans. In Punjab province, a project on crop productivity enhancement through the restructuring and strengthening of its agriculture extension services, as well as improved support services for livestock producers as part of the four model districts in low-income areas are being implemented. In Sindh, there is the Support Services for Livestock Farmers; in NWFP province, there are two projects, (a) the strengthening of research and extension through establishment of Farmers’ Field Schools, and (b) promotion of agriculture extension education through publicity programs. In Balochistan, it has disseminated modern agriculture technology and agronomic practices through Electronic Media. 64. On the third sub-condition, PARC, an apex agriculture research body at the federal level, is already implementing a reorganization plan. The Government has approved a restructuring program for PARC on 25 August 2006. The restructured PARC would have a board of governors with full powers in all administrative and financial matters, a modernized financial management system, and a performance-based service structure with special pay scales. The changes would improve the functioning of the PARC and reorient it to demand-driven research. 65. In view of the above, this policy condition may be deemed to have been complied with.

VI. PROGRESS OF THE TECHNICAL ASSISTANCE PROGRAM 66. At appraisal, the Government requested ADB to take responsibility for recruiting the TA consultants, and it was expected that all consultants would be recruited in one package through a firm or organization. After ASPL II was approved, MINFAL requested changes in these implementation arrangements, and ADB agreed to the changes. With guidance from ADB, MINFAL took the lead in recruiting the consultants, starting with the senior policy adviser, who was fielded in October 2003, 14 months after loan effectiveness. Also by agreement with MINFAL, the remaining consultants were to be recruited in two packages, with the first package

13 Substantially reorganizing and downsizing Pakistan and National Agricultural Research Councils.

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(package A) mainly comprising specialists needed for the release of the second tranche. Ten domestic consultants were recruited and have completed their assignments. 67. The ten consultants in package A consisted of: (i) four agricultural research and extension reorganization experts (6 person-months), (ii) a social safety net expert (6 person-months), (iii) an institutional finance specialist (4 person-months), (iv) a legal expert (8 person-months), (v) a project planning and performance monitoring expert (12 person-months), (vi) a restructuring specialist (4 person-months), and (vii) a monitoring specialist (7 person-months). After these consultants, local consultants in package B worked for 58 person-months on the reorganization of PARC, the restructuring of the provincial food departments, and the further deepening of agriculture research and extension reforms in the provinces. 68. Two important lessons were learned and acted on during the implementation of the TA program. First, package B was originally envisaged as the residual program after the urgency of hiring the package A consultants to help meet the policy conditions for the second tranche. Later on this view changed. A special administration mission stressed the need to revise package B and to make it a follow-up package, whose focus and composition was to be largely driven by demand from the provinces and by the following factors: (i) the key objectives of the overall TA program, the achievements so far, and the critical objectives that still had to be attained; (ii) the lessons and results obtained from the work of the package A consultants, the gaps that remained, and ways in which future work could build on the work done so far, including filling the gaps identified; and (iii) the emerging circumstances and developments since the start of ASPL II and since the time package B was conceived. These considerations led to a drastic revision in the composition of package B, which then became fully responsive to the emerging TA needs identified by the participating agencies especially the provinces. 69. The other key lesson learned was that a senior policy adviser (SPA)–cum–team leader (international consultant) was needed to provide timely analytical support to key policy makers in the federal and provincial governments. The SPA also facilitated the dialogue and consultations with key stakeholders on the ASPL II reform agenda, especially in the formulation of a comprehensive and phased wheat policy as well as the restructuring of the research system. As noted in previous sections, the consultations were instrumental in ensuring a shared understanding of the ASPL II reform agenda, and in hastening compliance with the policy conditions under the Program. 70. However, relying on the SPA and short-term experts was not a sustainable approach to addressing policy bottlenecks and ensuring responsive policy reforms and advocacy work. Policy analysis skills first had to be developed in both the federal Government and the provinces. With the assistance of the SPA, the Agriculture Price Commission was transformed into the Agricultural Policy Institute (API). In the future, much-needed analytical input to the agriculture ministry will come from this institute. With some TA assistance at the start, the API could provide the internal driving force and sustained support for policy and structural reforms in agriculture and rural economic development. Similar institutions that may or may not be public sector-led should be encouraged to develop in the provinces, where policy analysis and advocacy work is required more.

71. Besides the SPA who was engaged for 33 months (international), the TA program used 111 person-months of national consulting expertise in agriculture research and extension, finance, law, social safety nets, enterprise restructuring, and program monitoring and evaluation. The performance of the national consultants was generally satisfactory. The main

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problem was delay in their hiring, because of the cumbersome government review and approval of the terms of reference and contracts, complicated further by the need to consult closely with all the provincial governments and assist them in preparing restructuring plans for state-owned enterprises and agencies. 72. At the close of the TA, the consultancy requirement of 144 person-months was distributed as follows: 90 person-months (33 international and 57 domestic) for the project implementation unit (PIU) of ASPL II; 13 person-months for PARC; and 41 person-months for the provincial governments (Balochistan 8, NWFP 10, the Punjab 11, and Sindh 12).

VII. USE OF ASPL II COUNTERPART FUNDS, PROGRAM IMPLEMENTATION,

MONITORING AND EVALUATION 73. Agriculture in Pakistan has largely been devolved to the provinces, which bear nearly all the costs of the reforms. The federal Government thus agreed to provide a major part of the counterpart funds to the provinces on the same terms and conditions as stipulated in the ADB Loan Agreement, with the federal Government bearing the foreign exchange risk. In compliance with condition B1.2, the federal Government in December 2004 approved counterpart funds of Rs10.3 billion (about one half of the ASPL loan amount) to cover the costs of the reforms under ASPL II and to meet the investment costs of agriculture sector projects at the federal and provincial levels (item B1.2). The allocation of federally administered loan proceeds to the provinces was, at the time of ASPL II approval, the first such arrangement under a program loan. Another innovative feature of ASPL II is the significant share of ADB loan funds allocated directly to the agriculture sector, rather than simply providing general budgetary support. Besides assisting in implementing ASPL II conditions (particularly those that entailed the early retirement of redundant staff), this feature has provided a major incentive to the provinces to participate actively in the policy reforms. The funds earmarked for agriculture sector development projects under ASPL II were divided 80:20 between the provinces and the federal Government (including federally administered territories). The provincial share was based on population. 74. The provincial and federal agencies (e.g., PARC) submitted proposals to MINFAL for the use of ASPL II funds. Each proposal was evaluated according to the criteria laid down in the Loan Agreement, i.e., each project proposal had to (i) be consistent with the ASPL II objectives, (ii) meet the objective of increasing agricultural productivity, (iii) meet the cost of reforms undertaken under ASPL II, and (iv) meet the severance package of the affected staff of closed state-owned enterprises (SOEs). On the basis of these criteria, top priority was accorded to defraying the severance packages of SOEs and public agencies that were scheduled for closure or restructuring under ASPL II. Second priority was given to reforms in agriculture research and extension that focused on small farmers. Project proposals aimed at increasing the productivity and profitability of agriculture had last priority. To date, MINFAL has disbursed Rs7.9 billion in ASPL II funds to the provinces and Rs1.3 billion to the federal Government for ongoing projects. A total of 107 projects at a total cost of Rs8.2 billion are ongoing (Appendix 3) while a few projects await approval and the start of implementation. By 30 June 2008, ASPL II will close disbursements from the budget of Rs10.3 billion. 75. Of the 107 ongoing projects, 31 belong to the federal Government, 20 to NWFP, 17 each to Balochistan and the Punjab, 11 to Sindh, 5 to AJK, 4 to the Federally Administered Northern Area (FANA), and 2 to the Federally Administered Tribal Areas (FATA). From a quick review of these projects, two categories—high-value activities such as livestock and horticulture, and strengthened research and extension services—figure most prominently.

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Many of these projects are innovative, breaking new ground, providing the technology-based infrastructure (e.g., improvement of laboratories for quality control, and development of high-yield varieties) essential for global competition, and contributing significantly to making agriculture productive and profitable. 76. Program Monitoring and Evaluation. According to the Loan Agreement, MINFAL was required—but failed—to collect baseline data at the start of the Program and continuously monitor and assess the Program’s impact. MINFAL recruited three consultants to develop a framework for monitoring and evaluation (M&E) and for impact assessment. The consultants submitted their reports and provided the format and design for the monitoring of projects being implemented under ASPL II. Since no baseline data were collected, it was difficult to design a framework for assessing the impact of the Program’s policy conditions on the agriculture sector, as a whole, as well as on poverty reduction and the economy. The baseline scenario was constructed from secondary sources, and a draft M&E paper was prepared. Despite efforts to develop the baseline data and the appropriate M&E system, there was lack of appreciation of the usefulness of the methodology among federal and provincial policy makers. In the future, the M&E must be established under the API. 77. Reporting. The Loan Agreement also required the submission of half-yearly reports on the progress of, and issues related to, policy implementation. The PIU at the federal level has been providing frequent progress reports on the implementation of the Program as well as the documents relating to the compliance status of the policy conditions. It also submitted a complete and up-to-date report on the implementation of the TA program. ADB has received a comprehensive final report from the SPA. After the TA program ends on 30 June 2007, the PIU plans to prepare a PC IV report (project completion report) for the Planning Commission of Pakistan. A copy of the report will be available to ADB in July 2007.

VIII. CONCLUSION AND FOLLOW-UP PROGRAM OF THE GOVERNMENT 78. To date, the Government has provided evidence to show that of the seven third tranche policy conditions, four have been fully complied with, two conditions are substantially complied with, and one policy condition with two sub-conditions for waiver and one sub-condition complied with. In the case of policy condition A4.8, the Government has sought a waiver for two sub-conditions relating to the complete implementation of PASSCO’s and the four provincial food departments’ restructuring plans, as well as the closure of the food directorate of the provincial food departments of Balochistan, NWFP, and Sindh, and the SSC. The reasons advanced for seeking a waiver are sufficient to establish that substantial work has been done to restructure the provincial food departments, the three food directorates, and SSC, and their closure at present is not advisable under the current sociopolitical situation in the country. For the four deferred second tranche policy conditions, two policy conditions and one sub-condition have been fully complied with; one policy condition and one sub-condition have been substantially complied with. Details of compliance status are provided for each of the seven third tranche and four second tranche policy conditions in the policy matrix (Appendixes 1 and 2). 79. The next steps to pursue are the follow-up actions with the Government to continue the reforms already undertaken under ASPL II to bring them to a logical conclusion and further build on the progress made. Already, the Government has initiated an internal process of reviewing the lessons learned and asking the provinces to let MINFAL know how they plan to follow up on ASPL II (particularly in the implementation of the wheat program and the restructuring of the research and extension institutions, as well as in the strengthening of the

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policy analytical and advocacy work of API and province-level public-private think tanks (e.g., chambers, farmers’ associations, etc.), as well as identify the ensuing policy areas that integrate the rural farm with the rural nonfarm economy. Federal policy makers have noted that while agriculture will still play a major role in the industrialization process, its contribution will need to be strengthened through closer integration of the commodity markets with their downstream and upstream activities. With a larger economic area (rural economy) as the focal point and the devolution of rural-based policies, there will need to be a redefinition of policy, institutional, and investment relations between federal and local governments, among federal agencies, and among the administrative hierarchies of the local government. The design of follow-up programs should take into account the lessons from ASPL II.

IX. THE PRESIDENT’S RECOMMENDATION 80. In view of the progress made in the implementation of the Agriculture Sector Program Loan II, as evidenced by the compliance with two deferred second tranche conditions, one deferred second tranche sub-condition, four third tranche conditions, and one third tranche sub-condition; and the substantial compliance with one deferred second tranche condition, one deferred second tranche sub-condition, and two third tranche conditions; the President hereby recommends that the Board approve, on a no objection basis: (i) the waiver of two third tranche sub-conditions for reasons set out in paragraphs 55 and 56; and (ii) the immediate release of the third tranche in the amount of equivalent to SDR17,996,000 and ¥12,206,000,000.

Appendix 1

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STATUS OF THE AGRICULTURE SECTOR PROGRAM LOAN II (ASPL II) UNDER THE DEFERRED SECOND TRANCHE

Policy Item Number/Policy Condition Status A4.4. The fertilizer import department and the directorate of food shall have

been closed by MINFAL and the process of divestiture commenced, and the Sindh government shall have announced a time-bound action plan for closing the Sindh Seed Corporation.

Complied with

A4.5 MINFAL in consultation with the provincial governments shall have submitted plans acceptable to ADB for restructuring Pakistan Agricultural Storage and Services Corporation (PASSCO) and for the provincial food departments to operate on market-oriented lines and compete on equal terms with the private sector, and shall have begun implementation, including the upgrading and leasing of storage facilities.

Substantially complied with (from partially complied with to waiver, for PASSCO’s restructuring; and complied with, for the restructuring plans of the provincial food departments)

B1.2. MOC and PGs shall have determined and informed the Borrower and ADB regarding the financing requirements for (i) the reform programs; (ii) the provincial trust funds to be used for the joint nongovernment organization (NGO) and extension agent programs focused on small farmers (the financing determination); and (iii) the private national associations’ endowment funds for export promotion and quality enhancement.

Complied with

B3.2. The Borrower and provincial governments shall have ensured that (i) suppliers of imported fertilizer certify the nutrient contents at the point of origin; and (ii) private third-party laboratories, certified by the Borrower, are also allowed to certify quality at the retail level for fertilizer and seed, subject to existing Borrower regulations.

Substantially complied with for (i) and complied with for (ii).

MINFAL = Ministry of Food, Agriculture, and Livestock, MOC = Ministry of Commerce, NGO = nongovernment organization, PASSCO = Pakistan Agricultural Storage and Services Corporation, PG = provincial government

Appendix 2 25

STATUS OF THE AGRICULTURE SECTOR PROGRAM LOAN II (ASPL II) UNDER THE THIRD TRANCHE AND FOLLOW-UP ACTIONS

Policy Item Number/Policy Condition Status Follow-Up Actions A1.7 The Borrower, through Ministry of Commerce, shall have

adopted legislation and the provincial governments shall have adopted implementing rules and regulations concerning the grading and standardization of cotton.

Complied with

A3.3 The Borrower shall have eliminated the consumer subsidy for wheat by moving to a market-based sale price for wheat.

Substantially complied with

The Government will ensure that the consumer wheat subsidy will be given only to vulnerable and poor households instead of a blanket subsidy for all wheat consumers. It will also develop a mechanism for ensuring that the issue price moves toward the guaranteed minimum price (GMP) plus storage, distribution, and management costs.

A3.4 The Borrower shall have eliminated the producer subsidy for wheat by moving from a support price to a market-based price for the procurement of wheat unless otherwise agreed between ADB and the Borrower (because of unforeseen external or internal factors), except for the losses that may accrue from the minimum strategic reserve of wheat.

Substantially complied with

The Government will implement the phased wheat policy, particularly the price band, the GMP based on the border parity price, and the directed food subsidy, to determine the strategic reserve and phase out the operational reserve.

A3.5 Subject to the results of the feasibility study, the Borrower shall have commenced implementation of the agreed small-farmers plan.

Complied with

A4.8 The Borrower shall have caused the provincial governments to (i) complete implementation of the agreed PASSCO and provincial food departments restructuring plans; (ii) close the directorates of food in the provincial food departments of Balochistan, NWFP, and Sindh, and the Sindh Seed Corporation, and commence the process of divestiture; and (iii) end budgetary support, subsidies, and exclusive preferential credit for PASSCO except for the costs of managing the strategic wheat reserve.

Waiver for (i) and (ii); complied with for (iii)

The Government will ensure that the recommendations of the restructuring plans for the provincial food departments are implemented over 2007–2009.

B1.4 The provincial governments shall each have commenced implementation of their financing determination, including financing new initiatives in agricultural research, extension, and higher education, by using some of the local-currency funds in the provincial trust funds.

Complied with

B2.3 The Borrower and provincial governments shall, subject to the results of the relevant study, and their joint agreement, have commenced implementation of: (i) the research institute plans, (ii) the agricultural support service plans, and (ii) the research councils plan.

Complied with

MOC = Ministry of Commerce, GMP = guaranteed minimum price, NWFP = North West Frontier Province, PASSCO = Pakistan Agricultural Storage and Services Corporation

26 Appendix 3

USE OF ASPL II FUNDS FOR CAPACITY BUILDING, ENTERPRISE RESTRUCTURING, AND AGRICULTURE DEVELOPMENT PROJECTS

(December 2003–June 2007)

(Number of projects, and budget in PRs million)

Capacity Building

Restructuring Research and

Extension Crop Production

Livestock, Fisheries, and

Forestry

Quality Control and Marketing

Soil and Water conservation Others Total

Item Projects Budget Projects Budget Projects Budget Projects Budget Projects Budget Projects Budget Projects Budget Projects Budget MINFAL 7 739.8 4 131.1 8 225.5 2 161.5 4 102.6 1 14.9 5 166.5 31 1541.9

FATA and FANA

0 0.0 1 98.7 3 133.7 0 0.0 0 0.0 0 0.0 2 206.8 6 439.2

AJK 1 32.1 1 60.2 1 38.2 1 89.0 0 0.0 1 20.6 0 0.0 5 240.0

Punjab 1 38.1 2 496.5 1 224.9 4 766.5 4 491.2 3 746.6 2 187.6 17 2,951.4

Sindh 3 206.8 1 151.6 1 448.3 3 383.8 2 157.4 1 140.0 0 0.0 11 1,487.9

NWFP 4 226.6 8 259.9 0 0.0 4 169.7 1 37.5 3 100.3 0 0.0 20 794.0

Balochistan 3 62.2 3 40.9 1 13.5 4 276.1 2 68.1 1 200.1 3 133.0 17 793.8

Total 19 1,305.6 20 1,238.8 15 1,084.1 18 1,846.5 13 856.8 10 1,222.4 12 693.9 107 8,248.2

AJK= Azad Jammu and Kashmir; FATA and FANA= Federally Administered Tribal Areas and Northern Areas; MINFAL = Ministry of Food, Agriculture, and Livestock; NWFP = North-West Frontier Province. Source: ASPL II Project Implementation Unit, MINFAL.