Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 17038

IMPLEMENTATION COMPLETION REPORT

CHINA

FOURTH RURAL CREDIT PROJECT

(LOAN 3265-CHA/CREDIT 2182-CHA)

August 26, 1997

Rural Development and Natural Resources Sector UnitEast Asia and Pacific Regional Office

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Yuan (Y)

1990 $1=Y4.781991 $1 = Y 5.321992 $1 = Y 5.421993 $1 = Y 5.731994 $1 = Y 8.501995 $1=Y8.401996 $1 = Y 8.30

FISCAL YEAR

January 1 - December 31

WEIGHTS AND MEASURES

1 meter (m) = 3.28 feet (ft)1 kilometer (km) = 0.62 mile (mi)

1 hectare (ha) = 2.47 acres (ac) 15 mu1 kilogram (kg) = 2.2 pounds (lb)

ABBREVIATIONS AND ACRONYMS

ABC - Agricultural Bank of ChinaADB - Asian Development BankADBC - Agricultural Development Bank of ChinaBOC - Bank of ChinaEDI - Economic Development InstituteERR - Economic Rate of ReturnFIL - Financial Intermediary LoanFRR - Financial Rate of ReturnFSTAP - Financial Sector Technical Assistance ProjectIBRD - International Bank for Reconstruction and DevelopmentICB - International Competitive BiddingICR - Implementation Completion ReportIDA - International Development AssociationIFAD - International Fund for Agricultural DevelopmentLIB - Limited International BiddingMOA - Ministry of AgricultureMOF - Ministry of FinanceNCB - National Competitive BiddingNGO - Nongovernmental OrganizationPBC - People's Bank of ChinaRCC - Rural Credit CooperativeRC I - Rural Credit I Project (CR 1462-CHA)RC II - Rural Credit II Project (CR 1642-CHA)RC III - Rural Credit III Project (CR 1871-CHA)RC IV -. Rural Credit IV Project (LN 3265/CR 2182-CHA)SAR - Staff Appraisal ReportTA - Technical AssistanceTEG - Technical Expert Group

Vice President Jean-Michel Severino, EAPManager Geoffrey Fox, EASRDStaff Member Ramesh Deshpande, Principal Financial Operations Officer, ECSPF

FOR OFFICIAL USE ONLY

CONTENTS

PREFACE .......................................................................................

EVALUATION SUMMARY ........................................................ v

PART I: PROJECT IMPLEMENTATION ASSESSMENT ................................. 1A. Project Background .........................................................B. Achievement of Project Objectives ...................................................... 2C. Implementation Record and Major Factors Affecting the Project ... 13D. Project Sustainability ....................................................... 16E. Bank Performance ................................................... 16F. Borrower (MOF) and Beneficiary (ABC) Performance .. 16G. Assessment of Outcome ....................................................... 17H. Future Operation ....................................................... 18I. Key Lessons Learned ....................................................... 19

PART II: STATISTICAL TABLES ....................................................... 21Table 1: Summary of Assessments ....................................................... 21Table 2: Related Bank Loans/Credits ....................................................... 22Table 3: Project Timetable ....................................................... 22Table 4: Loan/Credit Disbursement: Cumulative Estimate and Actual ......... 23Table 5: Key Indicators for Project Implementation ...................................... 24Table 6: Key Indicators For Project Operations ............................................. 25Table 7: Studies Included in Project ....................................................... 25Table 8a: Project Costs ....................................................... 26Table 8b: Project Costs ....................................................... 26Table 8c: Project Financing ....................................................... 27Table 9: Economic Costs and BenefitsZa ....................................................... 27Table 10: Status of Legal Covenants ....................................................... 28Table 11: Compliance with Operational Manual Statements ......................... 32Table 12: Bank Resources: Staff Inputs ....................................................... 32Table 13: Bank Resources: Missions ....................................................... 33

ANNEX A: BORROWER'S CONTRIBUTION TO THE ICR ........................... 35

ANNEX B: ICR MISSION'S AIDE MEMOIRE ....................................... 45

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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IMPLEMENTATION COMPLETION REPORT

CHINA

FOURTH RURAL CREDIT PROJECT

(LOAN 3265-CHA/CREDIT 2182-CHA)

PREFACE

This is the Implementation Completion Report (ICR) for the Fourth Rural CreditProject in China, for which Loan 3265-CHA in the amount of $75 million equivalent andCredit 2182-CHA in the amount of SDR 143.7 million ($200 million equivalent) wereapproved on October 30, 1990 and made effective on March 22, 1991. The loan andcredit were closed on December 31, 1996. These were fully disbursed; and the lastdisbursement took place on February 5, 1997.

The ICR was prepared by Ramesh Deshpande, Principal Financial OperationsOfficer, Agriculture, Industry and Finance Division, Country Department III, Europe andCentral Asia Region, with the assistance of Kay Hill and Weiguo Zhou (Consultants), andreviewed by Messrs. Joseph Goldberg, Chief, EA2RS and Yo Kimura, Project Advisor,EA2DR. The borrower provided comments that are included as an annex to the ICR.

Preparation of this ICR, which began during the Bank's final supervision missionin May 1996, was completed by an ICR mission that visited ABC headquarters andselected provincial branches during March 1997. The ICR is based on materials in theproject file. The borrower contributed to the preparation of the ICR by providing viewsreflected in the mission's aide-memoire, preparing its own evaluation of the project'sexecution and initial preparation, and commenting on the draft ICR.

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CHINA

FOURTH RURAL CREDIT PROJECT

(LOAN 3265-CHA/CREDIT 2182-CHA)

EVALUATION SUMMARY

Introduction

1. The Fourth Rural Credit Project (RCIV) was one of the first few operations,Bankwide, which the Bank processed using guidelines contained in Operational Directive8.30. The project was designed in the context of the Bank's ongoing dialogue onfinancial sector issues, and on the understanding that the Chinese authorities would beprepared to implement various policy reforms and institutional changes supported by theproject. At the time of RCIV's appraisal, there was considerable uncertainty over thepace and direction of China's financial sector reforms. The financial sector, as others,was caught in a problematic situation, where it was given substantial responsibility forallocation of China's investible resources but its decisions had continued to be subject toheavy intervention by government at all levels. The Bank Group's financial sectorreview,' which was then under discussion with the government, had recommended theintroduction of a range of reforms to enable banks to become full financial intermediaries,including enactment of a comprehensive banking law; strengthening of bankmanagement; competition among and a mix of financial intermediaries; and furtherrationalization of monetary, credit and interest rate policies.

Project Objectives

2. Against this background, RCIV's main objectives were to:

(a) stimulate growth and diversification of agriculture by financing profitableinvestments by farmers, collectives, state farms, and enterprises; and

(b) promote efficiency of rural financial intermediation through introductionof sound, market-oriented, policies and development of main institutionsconcerned with rural savings mobilization and lending.

3. The Agricultural Bank of China (ABC) used the Bank Group funds along with itsown funds to provide subloans to expand production and improve productivity ofcommercial agriculture including crops, livestock, fisheries, agroprocessing, and

The World Bank, "China: Financial Sector Review: Financial Policy and Institutional Reforms,"Report No. 8415-CHA dated June 29, 1990.

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marketing facilities in seven regional clusters, including Inner Mongolia, five provincesof Shaanxi in the northwest; Jilin and Liaoning in the northeast, Jiangxi and Guangdongin central and south China, and Beijing municipality. ABC also used a part of the BankGroup assistance in Guangxi Zhuang Autonomous Region and three provinces of Fujian,Hunan and Hubei, which were covered by earlier IDA-assisted credit projects. Given theline-of-credit nature of the project, ABC had the flexibility of adjusting the lendingprogram in response to a changing macroeconomic environment and subprojectappraisals including market and credit risk analysis.

Implementation Experience and Results

4. Achievement of Project Objectives. The project's first objective of stimulatinggrowth and diversification of agriculture was substantially achieved through provision ofcredit (investment funds and incremental working capital) for commercially viableproduction and productivity improvements in agriculture and agroprocessing, withemphasis on environmental protection and poverty alleviation. Most of the subprojectsare expected to achieve their production targets, but a small number (6 percent), accountingfor 16 percent of subloans disbursed, are considered problem projects and have the potentialto threaten the viability of the project, if not corrected. The project's second objective ofpromoting efficiency of rural financial intermediation was, however, only partiallyachieved because some of the core features of the project designed to accelerate ABC'scommercialization were either not implemented or only partially implemented. Theseincluded elimination of subsidies on onlending of Bank/IDA funds from MOF to ABCand ensuring minimum interest spreads to ABC and the Rural Credit Cooperatives(RCC). In retrospect, the financial sector objective of the project may have been tooambitious, as it did not fit with the government's phased approach to sector reform andmany of the proposed activities were outside the control of ABC.

5. Banking Reforms. During the course of RCIV's implementation, as part ofbroader financial sector reforms, the government took important steps toward theproject's objective of promoting efficiency of rural financial intermediation andintroduced important policy and institutional changes. In 1993, ABC was split into twoinstitutions: (a) the existing ABC retaining its commercial banking functions; and (b) thenewly established "policy" bank, the Agricultural Development Bank of China (ADBC)assuming government business including subsidized credits for grain procurement andpoverty alleviation. Subsequently, in 1996, the government also separated the grassrootsRCC system from ABC supervision, to function independently under a newly createdorganization which is currently under the State Council but is expected to become a RCCfederation. These initiatives were indeed consistent with the Bank's recommendationsfor financial sector reform and RCIV's objective of promoting efficiency of ruralfinancial intermediation.

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Summary of Findings, Future Operations, and Key Lessons Learned

6. The project outcome is viewed as unsatisfactory on the basis that it at best onlypartially achieved its sector policy and institutional development objectives and its level ofachievement of the financial objectives was negligible. One could ask how an institutionthat had satisfactorily implemented three previous projects could perform poorly on thefourth. Also, it is unusual to rate a project with an estimated ERR of 24 percent asunsatisfactory. But RCIV had higher aims than the earlier projects, extending into theoverall operations of ABC and even into the government's financial sector developmentstrategy. The same project in today's financial sector environment would have a muchgreater chance of achieving its objectives.

7. A study of rural investment and finance, which had been intended to support sectordevelopment, was reduced in scope and intended consultations with the Bank on a generalinterest rate structure were not carried out as a result of the split of ABC and the overlapwith a subsequent Bank-assisted Financial Sector Technical Assistance Project (FSTAP),which focused on reforms applicable to all financial institutions. The financial objectivesthat the project had envisaged-elimination of subsidized credit, a more rational interestrate structure for the project and for ABC as a whole, and adjustment of the provision forbad debts to levels more realistic and in line with international practice-were notimplemented within the time frame of project implementation. It is unclear why MOFprovided subsidized credit to ABC, but the interest rate structure and provisioning are issuesstill unresolved for the sector and still being addressed by the Bank and government.

8. The main objectives of the institutional development programs were to upgradeABC's financial management. A financial management symposium, intended for ABC andPBC participation, to discuss ABC's long-range business planning, credit plan formulationand lending policies was not held because both ABC and the Bank decided this could bebetter handled by the FSTAP. Some studies were carried out and reviewed by the Bank, butnot pursued further in light of the impending hiving off of policy lending and RCCoversight.

9. The project's sustainability is uncertain; the real sector benefits are likely to besubstantial, but ABC's sustainability and its continued profitability will be somewhatcontingent on the financial reform process. The pace of commercialization of all theformerly specialized banks will to a large extent be influenced by state enterprise reforms,since the financial health of one affects the financial health of the other.

10. The Bank's performance was satisfactory, with the exception that it overestimatedthe scope for certain elements of the financial sector reform program during projectpreparation, ABC believes that the Bank did not effectively listen to its concerns duringappraisal and negotiations about the difficulty of implementing the financial sectorreform program, and the Bank did not give enough attention to the institutionaldevelopment and financial sector objectives during supervision. The Borrower (theMinistry of Finance, MOF) and the Beneficiary (ABC) did not comply with one of

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RCIV's core covenants, namely, the elimination of subsidized interest rates on BankGroup funds to ABC. Also, despite considerable technical assistance provided by theBank Group (RCI to IV) and other donors, ABC's loan portfolio managementperformance remained at a relatively low level. ABC, as a rule, should not administerforeign-funded project-type lending such as RCIV through international or othernoncredit departments but integrate such lending with its mainstream credit departmentsto improve the project's institutional development impact, efficiency of resourceplanning, portfolio management, and quality of financial services provided to clients.The Borrower (MOF) should have placed greater emphasis on introducing sustainablebanking practices in agricultural lending by allowing ABC to (a) retain minimum interestspreads on subloans assisted by the project, and (b) make adequate provisions fornonperforming subloans. These issues must be addressed by the government and thePeople's Bank of China (PBC) through ongoing banking reforms and possible futureBank-assisted operations with ABC and other financial institutions.

11. The major lessons learned are (1) there is a fairly narrow limit as to how far an FILfor one banking institution can go in achieving reform objectives for the whole financialsector; (2) when financial sector objectives are introduced into an FIL, all stakeholders mustbe explicitly involved and exhibit ownership of and commitment to the project objectives;(3) the Bank and Borrower should only develop projects for which there is a strongconsensus and common understanding about the main objective of the project, particularlyin a complex and sensitive policy area such as financial sector reform; and (4) projects mustbe kept simple enough that both Bank and implementing agency resources are not stretchedbeyond capacity to supervise implementation.

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CHINA

FOURTH RURAL CREDIT PROJECT

(LOAN 3265-CHA/CREDIT 2182-CHA)

PART I: PROJECT IMPLEMENTATION ASSESSMENT

A. PROJECT BACKGROUND

1. The Agricultural Bank of China (ABC) was reestablished in 1979 to take overrural banking functions of the People's Bank of China (PBC). This was the first majorinitiative the government took to begin restructuring of the country's monobank system,which was established in 1950 to serve specific needs of a centrally planned economy.Tlhe Bank Group started working with ABC in 1981. In 1990, when the Fourth RuralCredit Project (RCIV) was approved for Bank Group assistance, ABC had successfullyimplemented two IDA-assisted rural credit projects in three provinces (RCI, FY84, $50million; and RCII, FY86, $90 million), while the third project (RCIII, FY88, $170million) was under implementation. RCI to III were generally well implemented withpartial or substantial achievement of development objectives, satisfactory borrowerperformance, likely sustainability and satisfactory outcomes. However, they had focusednarrowly on strengthening ABC's capacity for investment appraisal and, considering theoverall pace of financial sector development, did not address its broader institutionalrequirements.

2. RCIV was one of the first few operations Bankwide, which the Bank processedusing guidelines contained in Operational Directive 8.30. The project was designed inthe context of the Bank's ongoing dialogue on financial sector issues, and on theunderstanding that the Chinese authorities would be prepared to implement various policyreforms and institutional changes supported by the project. At the time of RCIV'sappraisal, there was considerable uncertainty over the pace and direction of China'sfinancial sector reforms. The financial sector, as others, was caught in a problematicsituation, where it was given substantial responsibility for allocation of China's investibleresources but its decisions had continued to be subject to heavy intervention bygovernment at all levels. The Bank Group's financial sector review,' which was thenunder discussion with the government, had recommended the introduction of a range ofreforms to enable banks to become full financial intermediaries, including enactment of acomprehensive banking law; strengthening of bank management; competition among and

1 The World Bank, "China: Financial Sector Review: Financial Policy and Institutional Reforms,"Report No. 8415-CHA dated June 29, 1990.

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a mix of financial intermediaries; and further rationalization of monetary, credit andinterest rate policies.

3. The Bank processed RCIV on the basis that there must be an understanding withthe government on the financial sector development strategy, and that it (RCIV) shouldnot only address interest rate issues related to the project per se, but also to the reform ofthe overall interest rate structure (administered by PBC), which should, inter alia, providefor more automatic interest rate adjustment mechanisms.

4. In support of this approach, the Bank kept RCIV negotiations on hold for over sixmonths until after it received a positive response from the government to therecommendations of the Bank's financial sector review.2 During RCIV negotiations, thegovernment agreed to carry out RCIV's mid-terrn review, to enable the Bank to discusswith Chinese authorities the progress in implementing not only the project and ABC'sinstitutional development objective, but also overall financial sector reform. Specifically,RCIV required the government to take measures to:

3 eliminate subsidies on Bank Group funds onlent by the Ministry of Finance(MOF) to ABC;

* provide minimum interest rate spreads to ABC;* establish an appropriate recapitalization plan for ABC; and* strengthen ABC's financial management and credit policies.

B. ACHIEVEMENT OF PROJECT OBJECTIVES

Overview

5. The project's first objective of stimulating growth and diversification ofagriculture was substantially achieved through the provision of credit (investment fundsand incremental working capital) for commercially viable production and productivityimprovements in crops, livestock, aquaculture, and agroprocessing with emphasis onenvironmental protection, poverty alleviation, and market development. Most of thesubprojects are expected to achieve their production targets, but a small number (6percent), accounting for 16 percent of subloans disbursed, are considered problemprojects and have the potential to threaten the viability of the project, if not corrected.The project's second objective of promoting efficiency of rural financial intermediationwas, however, only partially achieved. In retrospect, the financial sector objective of theproject may have been too ambitious, as it did not fit with the government's phasedapproach to sector reform and many of the proposed activities were outside the control ofABC.

2 Ibid.

6. RCIV's performance with reference to key elements of the above two mainobjectives was as follows.

Agricultural Growth and Diversification

7. Subloans. During the project period (1991-96),3 ABC financed 1,780 subprojectsinvolving a total investment of about Y 4 billion ($648 million equivalent) and a lendingprogram of about Y 2.5 billion ($386.8 million equivalent), which in local currency washigher by about 53 percent than the appraisal estimate of Y 1.8 billion. The increase inthe lending program was mainly due to the cost escalation contributed by high rates ofinflation during 1993-96 and the devaluation of the yuan.4 Subborrowers' contributionturned out to be much higher than 30 percent of the project cost, at about $261 millioncompared to the appraisal estimate of $164 million. ABC provided about 17 percent ofthe total project cost from its own funds. The project supported term transformation ofABC's predominantly short-term resources. ABC could also roll over subloanrepayments to improve its profitability.

8. In most of the project provinces, RCIV-assisted loan portfolio was largely in linewith the appraisal estimates (Part II, Tables 8A and 8B.); however, overall, the proportionof agroprocessing investments was larger at 53 percent compared to 31 percent expectedat appraisal. ABC also financed construction and upgrading of 23 primary and wholesalemarkets, which activity was added to the project after the Bank Group appraisal. Giventhe line-of-credit nature of the project, such adjustments in the lending program wereexpected; in fact, ABC branches which did not adequately respond to the changingeconomic environment had a greater incidence of failed or problem subprojects. Byownership, about 42 percent of subloans went to state farms and state-owned enterprises(Y 1,057 million); 40 percent to collectives (Y 1,007 million); and 18 percent tospecialized households, individuals and joint ventures (Y 480 million). Lending inpoverty counties amounted to about 22 percent of total.

9. Realizing the problems with project implementation at the grassroots, withinabout a year from RCIV commencement (March 1991), ABC developed an action planand guidelines for subproject management and appraisal, including types of subloanseligible for financing, determination of loan repayment terms and interest rates, andoutlining corrective measures that must be taken for subloans that did not comply withthe project's procurement and environmental guidelines.

3 The project's closing date was extended by one year from December 31, 1995 to December 31, 1996to enable ABC subborrowers to complete outstanding procurement actions under approved subloans,and prepare pilot business plans in two provinces as part of the preparation of the proposed ABCCommercialization project.

4 The exchange rate at appraisal was at $1: Y 4.7, which changed as follows: 1991, Y 5.7; 1994, Y 8.7;and 1996, Y 8.3.

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10. RCIV introduced new initiatives to improve ABC's subloan approval processesby establishing a nongovernmental Technical Expert Group (TEG) at ABC headquarters,and private consultant rosters at provincial branches to advise subborrowers; and to assistABC in supervising compliance with technical aspects of the subprojects; developingtechnical guidelines for investment appraisal in major subsectors; and introducingenterprise appraisal as a criterion for subloan approval. These aspects have become animportant part of ABC's credit appraisal process, both in project and nonproject lending,and are being extended to provinces that did not have an opportunity to participate inBank Group-assisted projects. ABC recognizes this as one of RCIV's most importantelements in contributing to its ongoing commercialization.

11. Subproject Performance. The ICR mission briefly assessed virtually allsubprojects of which about 100 were reviewed in detail. This review indicates that withthe improvement in ABC's portfolio management capabilities through RCI to III, themajority of RCIV-assisted subprojects, about 94 percent, are performing satisfactorilyand are expected to reach their production and productivity improvement goalsanticipated at appraisal. These investments were of a commercial nature based onrecognized local competitive advantage, and were broadly consistent with sectorstrategies pursued by the government and assisted by the Bank Group.

12. Subloan Repayments. As per ABC calculations, as of December 31, 1996,subloans amounting to Y 217 million ($26 million equivalent) or 11 percent of the totaloutstanding subloans at Y 2.1 billion ($247.8 million) were overdue (or nonperforming),while interest due but remaining uncollected amounted to Y 54 million ($6.4 millionequivalent). Subloans amounting to Y 17.3 million ($2.1 million) were classified as"bad." The overdue subloans at the regional level range from 3 percent in Hubei to 21percent of outstanding subloans in Guangdong. Besides Guangdong, the other brancheswhich had high levels of overdues included Beijing (15 percent); Liaoning, Jiangxi (11percent) and Shaanxi (10 percent), reflecting the relatively high incidence of problemsubprojects in these regions. Repayment periods for subloans set by ABC branchesgenerally tended to be shorter than warranted by subprojects' cash flows, possiblybecause the branches hoped to accelerate the rollover of Bank Group funds, to enhancedevelopment impact of foreign funds and improve profitability on project operations. Inreality, however, ABC branches had to often extend grace periods for repayment ofprincipal, originally set at about one to two years, by a further two to three years due tosubborrowers' inability to repay their obligations on due dates. The branches alsoroutinely extended subloan grace periods to subborrowers even though they had thecapacity to repay, collecting only interest due for the year.

13. This implicit rescheduling of subloans seemed to have encouraged subborrowersto (a) possibly hide their financial problems for extended periods; and/or (b) userepayments due to ABC as working capital or investment funds to expand theirbusinesses, without necessarily subjecting themselves to ABC's reappraisal of theircontinued credit eligibility. For most of these subloans, ABC would be eventuallyrequired to extend originally-set subloan maturities. The branches' prevailing practice of

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extending subloan grace periods, besides significantly weakening portfolio management,has indeed exposed ABC to increased credit risks and potential problems with itsrepayment obligations to MOF under the project.

14. ABC's classification of subprojects by their likely outcome shows that theproportion of subloans involved in failed or problem subprojects in RCIV was significant,at about 16 percent of the total subloans disbursed or Y 380 million ($45 millionequivalent). This could have serious implications for ABC's future profitability onproject lending, as well as its total operations if their problems are not addressed.5

15. About 5.6 percent of the total investments (Y 221 million) in 27 subprojects(including a group of several small subloans for citrus development in Guangdong) havefailed mainly because of natural disasters such as widespread floods and diseasesaffecting shrimp, scallop and eel culture in Liaoning and Guangdong, and citrus plantingin Guangdong and Guangxi. A few (four) agroprocessing subprojects (Guangxi, Hunanand Jilin) have failed due to lack of markets, use of low or inappropriate technology, andpoor financial management. ABC has started developing financial workouts withsubborrowers, and enforcing guarantees for subloans against failed investments.

16. Besides failed investments, a number of subprojects (96) involving outstandingsubloans of about Y 246 million (a sizable 10 percent of the subloan disbursements), haveone or more problems-technical, financial, marketing and managerial-with potential todelay or reduce financial returns on related investments and possibly turn some of theproblem subloans into bad debts. In terms of outstanding subloans, the problemsubprojects relate predominantly to agroprocessing (54 percent), followed by livestock(27 percent), crops (8 percent), wholesale markets (6 percent) and aquaculture (5percent). It is possible that the number and the amount of problem subloans couldincrease as ABC branches' current reporting on problem subprojects is notcomprehensive and cover only those subprojects where the subborrowers have defaultedin payment of interest and principal.

17. Some of the subloans were clearly wrong decisions in terms of choice oftechnology, market prospects, and subborrowers' management capabilities. Additionally,some of the subprojects (mainly in the agroprocessing category) could not sustainanticipated profitability in a difficult macroeconomic environment that prevailed duringthe project period (1991-96), characterized by high rates of inflation and reduced accessto credit. Among factors that contributed to the subprojects' poor performance were, invarying degrees, the following: (a) low profitability due to changes in relative prices of

5 At appraisal, annual write-offs of bad loans under the project were expected at about 1 percent of theoutstanding loans; this may turn out to be a reality over the remaining life of the portfolio. Theproject had provided that ABC must receive a spread of at least 2.5 percent (after tax) so that it couldbuild up necessary provisions for bad debts (up to I percent of interest spread on project lending).ABC, however, received a spread of less than 2.5 percent (subject to tax) and its bad debtsprovisioning continued to be regulated by MOF as part of a sectorwide policy based on fiscalconsiderations rather than the viability of the banking system.

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inputs and outputs; (b) low capacity utilization; (c) lack of markets and marketingstrategies; and (d) inadequate crop extension services, especially in remote/poverty areas.While these problems fall mainly within the purview of subborrowers, ABC branches andlocal governments' technical bureaus (which had sponsored the subprojects) should haveassisted subborrowers to address these problems systematically, through effectiveextension services, supervision and monitoring and greater use of the TEG.

18. Problems faced by subprojects undertaken by state-owned enterprises are moreacute as they lacked flexibility, resilience, and incentives for efficient management ofrelated investments. As reform of the state-owned enterprises has become China'snational priority for 1997 and beyond, ABC (especially at the provincial level) must useits financial leverage to accelerate the reform of the state-owned enterprises that are itsclients, focusing first on those enterprises that have defaulted on the project-assistedsubloans. These enterprises have various options such as reorganization; mergers;corporatization (shareholding arrangements); leasing; contract operations; sell-offs; andbankruptcy. This process is critical if ABC is to reduce RCIV's potential subloan losses.

19. Lending Through Rural Credit Cooperatives (RCC)s. Traditionally, ABCprovided credit to state farms, collectives and specialized households. Individualhouseholds (peasant farms), which generally dealt with local RCCs for securing short-term production and farm improvement credit had practically no access to ABC. RCIV,therefore, extended the pilot started by RCIII of providing Bank Group funds (up to $10million) to eligible RCCs in six new project provinces to enable local branches to developoperational strategies for RCCs' institutional development for microcredit operations.After a slow start, ABC and participating RCCs successfully implemented thiscomponent and gained valuable experience, even though RCC credit went largely tospecialized households. With the separation of RCCs from ABC, follow-up on the pilotis expected to be continued by the new State Council organization for the RCC system.

20. Financial and Economic Rates of Return. A review of financial and economicanalysis of some 40 representative subprojects indicated that rates of return oninvestments in crops and aquaculture continue to be strong. Financial rates of return(FRRs) and economic rates of return (ERRs) for livestock and agroprocessing would belower due to changes in cost-benefit parameters and market prospects caused mainly byhigh rates of inflation during 1993-96 including adjustments introduced by thegovernment in basic construction material, energy and transportation prices. For theproject as whole, FRRs and ERRs would, however, be satisfactory at 22 and 24 percent,2-3 percentage points lower compared to the appraisal estimates of 24 and 27 percent,

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respectively. It is assumed that there would be no returns on failed investments.6 The netpresent value of the incremental production in crops, livestock and fisheries, togetherwith value added by agroprocessing and marketing services, amounted to approximately$3.0 billion, as against the appraisal estimate of about $1.9 billion. The FRRs projectedat completion for livestock and agroprocessing investments are estimated to be lower by8 and 9 percentage points relative to the appraisal estimate but still are at satisfactorylevels of 19 and 23 percent. The project benefits could, however, be enhanced if ABCand subborrowers rehabilitate and restructure the problem subprojects.

Efficiency of Rural Financial Intermediation

21. Financial Sector Development. As part of a broader financial sector reform,7 thegovernment took steps toward the project's objective to promote efficiency of ruralfinancial intermediation and introduced important policy and institutional changes withregard to the rural financial system. ABC was split into two institutions: (a) the existingABC retaining its commercial banking functions; and (b) the newly established "policy"bank, the Agricultural Development Bank of China (ADBC) assuming governmentbusiness including subsidized credits for grain procurement and poverty alleviation. In1996, the government also separated the RCC system, which was then operating underABC's supervision, to function under a newly constituted organization under the StateCouncil, operating directly under the general supervision of PBC (the central bank).Government initiatives to separate policy lending from ABC's commercial bankingactivity and RCCs from ABC's oversight were indeed consistent with the Bank'srecommendations for financial sector reform, and RCIV's objective of promotingefficiency of rural financial intermediation.

22. As a result of these government decisions and the overlap with the Bank'ssubsequent Financial Sector Technical Assistance Project (FSTAP, Cr. 2423-CHA) someof the RCIV activities intended to support rural financial market development andbroader financial sector development were considerably reduced in scope. For example,RCIV's mid-term review, which was intended to assess project implementation and the

6 The project's financial and economic rates of return at completion are based on recalculation of 40representative investment models for principal subcomponents of crops, livestock, acquaculture,agroprocessing, and markets. The weighted average of the relative rates of return, by category ofinvestments, were applied to the total investment cost of the project (including the cost of failedinvestments at 6 percent of the total on which no benefits have been assumed). The project FRR andERR were lower compared to the appraisal estimate due to: (a) higher real prices of inputs and lowerreal prices of some of the outputs; (b) reduced yields on some investments; (c) changes in the relativeshares of subcomponents in the investment program; and (d) increase in the standard conversionfactor from 0.86 to I following the adjustment of the exchange rate.

7 Significant legislation was passed in 1995-the Central Bank Law, the Commercial Banking Law, theNegotiable Bills Law, the Insurance Law, and the Guarantee Law. The Central Bank Law providesPBC with the powers to regulate and supervise the banking system; the Commercial Banking Lawstipulates capital adequacy, legal lending limits and insider trading, asset/liability management, andprovides for compensation to financial institutions for losses that may result from loans to specialprojects at the behest of Government.

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progress in financial sector development, was confined to only those aspects specificallyaffecting ABC and the financial sector review was left to be covered by the Bank Group'sgeneral financial sector dialogue with the government in the context of the FSTAP.Similarly, RCIV had proposed, a rural investment and finance study, under the leadershipof MOF, focusing on further market orientation of credit and interest rate policies andintroducing a competitive institutional base for rural finance, but the scope of this studywas necessarily reduced to focus mainly on ABC's difficulties in raising longer-termresources for rural lending. Broad-based policy work in rural finance contemplated byRCIV was not carried out pending emergence of a new institutional set up contemplatedfor the financial sector. ABC, the newly established ADBC, and the State Council'sCoordinating Group for Rural Reform (which is now responsible for RCC development)consider that the rationale for a broader rural financial sector review is now stronger thanbefore, and that the Bank and government should find ways to continue their support forthis activity.

23. ABC's Financial Management. While RCIV was being prepared, the Bank'sfinancial sector operations including agricultural credit, had come under criticism: oneobjection was that traditional credit projects provided credit for production objectivesrather than encouraging intermediation between savers and investors as an objective in itsown right. The other objections included the traditional credit project's indifference todeposit mobilization, widespread use of subsidies, targeting without effect, and the use ofspecialized and protected agencies. The use of low interest rates in many such projectswas seen as ineffective in reaching production and equity objectives and destructive in itsimpact on financial systems. The situation in China was not different, exacerbated byconsiderable uncertainty within China and within the Bank over the pace and direction ofthe financial sector reforms. The Bank was, therefore, exploring what kind of processcredit operations in China should be trying to assist.

24. RCIV attempted to address the objective of upgrading ABC's financialmanagement. However, some of the core features of the project that were explicitlydesigned to accelerate ABC's commercialization were either not implemented or onlypartially implemented. These included elimination of subsidies on onlending ofIDA/Bank funds from MOF to ABC; ensuring minimum interest spreads to ABC andRCCs; and establishment of a recapitalization plan for ABC. However, the progress inthis regard suffered a great deal as some of the core covenants under RCIV were eithernot implemented or the pace of implementation has been rather slow to have anysignificant impact. The Bank's Financial Sector Review8 had noted that it was then notfeasible for China to replace the prevailing system of controlled interest rates by a systembased on market forces mainly because the government still continued to use credit plansas a tool to influence the banking system's resource allocation across sectors and by typesof subborrowers, including the level and pattern of investments in the economy. Interest

8 The World Bank, "China: Financial Sector Review: Financial Policy and Institutional Reforms,"Report No. 8415-CHA dated June 29, 1990.

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rate liberalization per se would not have made much sense at the time unless thegovernment was prepared to rapidly reduce its role in credit planning and increase the useof the interest rate as a tool in managing aggregate demand. This was expected to happengradually as financial reforms were adopted.

25. Still within the bounds set by the Government's financial sector policy, RCIVattempted to introduce a comprehensive framework for interest rates and interest spreadsthat would have no element of subsidy and would help to ensure that ABC would remaina profitable and viable institution. However, the impact of various financial covenants, asthey related to ABC, turned out to be far less than that expected at appraisal.

(a) MOF Onlending to ABC. RCIV provided that (a) the MOF interest rateon Bank Group funds onlent to ABC in local currency should not be lowerthan the rate charged by PBC on ordinary long-term loans to otherspecialized banks, so that no subsidies were provided to ABC in relation toother specialized banks or sectors; and (b) the MOF rate on both IDA andIBRD funds onlent to ABC in foreign currency should not be lower thanthe rates charged by the Bank to the government on IBRD loans. Thiscovenant, which was intended to eliminate subsidies to ABC andaccelerate its commercialization, however, was not complied with. MOFonlent Bank Group funds entirely in foreign exchange at 5.4 percent, theweighted average cost of the IBRD/IDA blend. These funds should havecarried an interest rate equivalent to that charged on IBRD loans (in therange of 7.2 to 7.5 percent); instead, ABC received an unintended subsidyof about 2 percent on the amount of $275 million disbursed over a periodof six years. Surprisingly, the Government and ABC never sought Bankconcurrence to use lower-than-market rates for project-assisted subloans.

(b) Interest Spread on Project Lending: RCIV provided that ABC'sinterest spread on project lending should not be less than 2.5 percent (afterpayment of income and adjustment taxes to MOF) or such higher spreadas may be agreed between the government and the Bank in order to enableABC to fully cover its transaction costs and provide for possible bad debtsannually up to 1 percent of the outstanding subloans under the project.ABC could have approached PBC to permit it to use flexible interest rates,which was possible both under PBC's policy for foreign-funded loans andproject covenants; however, ABC did not do so as it feared that it wouldface client resistance to charging interest rates higher than those prescribedby PBC.

Throughout project implementation, as ABC applied PBC-prescribed ratesto project subloans, it was generally unable to earn the minimum spread of2.5 percent (after tax). According to present calculations, ABC received aspread of less than 2.5 percent (before tax) during 1991-94 and 1996; in

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1995, however the spread was higher at about 3.23 percent.9 On subloansexpressed in US dollars, which accounted for a very small part of theRCIV's loan portfolio, ABC received a spread of about 2.2 percent (beforetax). ABC's view was that as it borrowed Bank Group funds entirely inforeign exchange (US dollars) and used these funds to expand its foreignexchange business, it earned profits that were sufficient to make good theshortfall in interest spreads on local currency subloans under the project.

Perhaps, overall, ABC did earn additional margins that were sufficient tomake good the shortfall in interest spreads on project subloans. However,if ABC had paid market rates on Bank Group funds borrowed in foreignexchange, the potential for cross-subsidization of local currency subloanswould have been negligible. Moreover, RCIV had not contemplatedcross-subsidization of local currency subloans, given that ABC's foreignexchange business had its own costs and risks, and that such cross-subsidization would not have been helpful to establish a sustainablelending program in the rural sector.

(c) Positive Interest Rates on Project Lending. RCIV provided that ABCshould onlend project funds to subborrowers at least at the same interestrates that it charges on subloans for similar purposes with similarmaturities outside the project; and that taking into account inflation in theeconomy, interest rates paid by final beneficiaries on project subloanswould remain positive in real terms. However, during 1993-95, interestrates especially on subloans with maturities up to five years prescribed byPBC were generally negative. Since ABC was using PBC-prescribedinterest rates, the needed adjustment in interest rates was not made.

(d) Interest Spread on ABC's Total Banking Business. RCIV hadstipulated that ABC's interest spread on total banking business (includingcommercial and policy-based lending), should be adequate (after paymentof taxes) to maintain its overall financial viability and profitability, and toenable ABC to make provisions for bad debts on the basis of criteriaacceptable to the Bank Group. During the project period, PBC continuedto administer interest rates that regulated ABC's interest spreads. ABCremained profitable (according to its income statement based on Chineseauditing principles) during the project period; however, its profitscontinued to be subject to tax, and its bad debt provisioning was stillregulated by MOF guidelines.

(e) ABC's Recapitalization. For ensuring ABC's overall financial viability,RCIV included the following covenants: (a) ABC's equity should not be

9 The interest spreads were as follows: 1.35 percent in 1991; 2.19 percent in 1992; 1.75 percent in1993; 2.36 percent in 1994; 3.23 percent in 1995; and 1.88 percent in 1996.

initially less than 5 percent of the risk assets; and (b) MOF and ABCshould develop a recapitalization plan for ABC, indicating the likelymechanisms of equity replenishment. The goal was to raise in phasesABC's risk-weighted capital adequacy ratio to 8 percent as perinternational standards (Basle Committee recommendations). As ABCwas in the process of being split up and PBC began to pursue this aspectfor the banking system as a whole, ABC did not prepare therecapitalization plan under RCIV. However, since July 1994, allcommercial banks including ABC are required to provide to PBC forreview the information on capital adequacy ratio. Furthermore, both theIMF and the Bank are of the view that recapitalization without firstaddressing more fundamental issues is not a good strategy.

(f) Portfolio Review. As part of RCIV preparation, ABC carried out acomprehensive internal loan portfolio review and had agreed to update thisinformation annually for ABC as a whole and for the project provinces forpurposes of assessing ABC's overall subloan collection performance andadequacy of interest spreads, bad debt provisions and capital. ABC'sinitial proposals were that the responsibility for writing-off of accumulatedbad debts arising in respect of loans disbursed prior to the end of 1988should be undertaken by the government, and for bad debts against loansdisbursed after that date by ABC. This approach was not pursued.Instead, ABC continued to follow prevailing MOF rules by which ABCanmually made incremental provisions for bad debts at the prescribed rateof 0.08 percent of the outstanding loan amount. Clearly, this amount isvery low relative to the large volume of ABC's (or any other bank's)nonperforming loans. MOF's bad debt provisioning rules are notconsistent with international standards and are primarily governed byfiscal considerations.

(g) General Interest Rate Structure. While the level of interest rates,especially of the lending rates, is gradually becoming an important tool formanaging aggregate demand, in recent years low and often negative ratesof interests have, inter alia, affected the efficiency of financialintermediation, and encouraged relatively capital-intensive production inenterprises that have access to credit. During RCIV negotiations, the Bankhad reached an understanding with the government (which alsorepresented PBC) and ABC that while the loan/credit agreements shouldaim to rationalize onlending terms and conditions for the project, thegovernment, ABC and the Bank Group should seek ways to rationalize thegeneral interest rate structure for rural households, collectives, state farmsand township and village enterprises (TVEs) by purpose and subloanmaturities. This was proposed to be done during the course of projectsupervision, while related policy issues were to be considered by theproposed study of rural finance and investment and the project's mid-term

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review. However, since the latter activity was moved to another BankGroup-assisted operation, namely the FSTAP, the issue of rationalizing thegeneral interest rate structure was not effectively pursued during projectsupervision.

26. In retrospect, the project agenda seems to have been too ambitious, consideringChina's record of gradualism in the area of financial reform. The Minutes of Negotiationrecorded that while the Chinese delegation agreed with the onlending terms proposed onthe project, they "noted that, in order to achieve these onlending rates, considerabledifficulties had to be overcome." This is not to say that ABC languished in the controlsand constraints imposed on a financial sector that was emerging from its role as statefiscal agent into conmmercial banking organizations. ABC is ranked by asset size asamong the top 100 banks in the world (Institutional Investor, August 1995). Probably themost significant event affecting ABC (and the other specialized banks) was the ThirdPlenum of the Fourteenth Party Central Committee in November 1993 which issued its"Decision on Issues concerning the Establishment of a Socialist Market EconomicStructure." This document outlined a 50-point agenda for economic reform, including along-term strategy to stimulate rapid transformation of the Chinese financial system andto gradually transform the specialized banks into commercial banks. Only then couldABC truly embark on a route toward commercialization, and its progress is outlined inBox 1.

Human Resource Development

27. RCIV focused on core activities in ABC's very large training program that isfunded from its own resources including: (a) training of trainers at three national trainingcolleges (Tianjin, Wuhan and Changchun) and 147 regional/vocational training schools;(b) conduct of special courses for project/credit staff in project appraisal, supervision andmonitoring; and (c) purchase of equipment for ABC headquarters, project provinces andthe three national training colleges. Overall, during 1991-96, some 24,750 officials(including 500 trainers) received training under the project-assisted programs. About 350officials (including 20 trainers from three national training colleges) were trained abroad,focusing on financial management, risk analysis, internal audit, foreign exchangebusiness; foreign languages; and information technology. Domestic and overseas trainingfor a large number of managerial staff has significantly enhanced ABC's institutionalcapabilities for rapid commercialization. ABC's three national training colleges have,over the years, developed comprehensive training material in collaboration with theBank's Economic Development Institute (EDI). By investing about $650 millionequivalent from its own resources since its reestablishment in 1979, ABC has developedinfrastructure that is capable of training annually about 200,000 staff in differentprograms. With its ongoing commercialization, ABC is in the process of reorientingsome of its trainers and training programs, and twinning with universities and bankinginstitutes abroad, in Europe and the United States, to effectively address skillrequirements of its new mandate.

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C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT

28. The main factors that had affected the achievement of RCIV's objectives asenvisaged at appraisal were the following:

Factors Subject to Government Control

29. Macroeconomic Environment. RCIV started in a relatively stablemacroeconomic environment (with inflation rates ranging between 3 percent in 1991 and5.4 percent in 1992) but faced high rates of inflation in the following two years, at 13percent in 1993 and 21.4 percent in 1994. Though later years saw the inflationdecelerating as a result of the government's successful implementation of stabilizationpolicies, the inflation rates were still high at 15 percent in 1995 and about 10 percent in1996. The inflation was driven mostly by increases in administrative prices for food,petroleum, coal and steel (and accommodated by excessive monetary expansiongenerated in part from sharp increases in foreign exchange reserves). On the one hand,this slowed down the completion of several subprojects, as ABC and subborrowers facedthe constraint of raising counterpart funds; and on the other, subprojects that werecompleted during 1991-93 faced a severe shortage of working capital in the wake ofPBC's tightened controls on bank credit.

30. The changes in relative prices of inputs and outputs reduced the profitability ofsome investments. The fallout was that several of ABC's subborrowers defaulted insubloan repayments, affecting the quality of RCIV's loan portfolio. As ABC had madethe bulk (close to 80 percent) of the total subloan commitments proposed under theproject by the end of 1992, the project could not effectively respond to economicstabilization measures by reducing the level of new lending and making subprojectappraisal more rigorous, so that the project-financed portfolio would still be viable in aninflationary environment. Demand for project funds was also exacerbated by the fact thatduring the periods of high inflation (1993 and 1994), PBC-administered rates werenegative in real terms.

31. Financial Sector Policy. During the early years of project implementation, thecredit plan was the centerpiece of monetary management and guided the bulk of alllending activity. By setting limits on prices (interest rates) and quantities (creditceilings), PBC tried, often unsuccessfully, to accomplish the dual objectives of directingcredit while maintaining macroeconomic stability. Aware of the increasing inconsistencybetween China's highly decentralized and largely market-driven economy and a centrallyplamned credit allocation, the authorities began to reduce the scope of the credit plan untilby 1995, it was only applied to the four specialized banks and the policy banks, withother banks' lending controlled through asset/liability management ratios. Thespecialized banks are allowed to extend additional credit only if deposits exceed targets.The government's stated position is to continue to gradually phase out the credit plan,while pressing ahead with the development of indirect instruments.

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Box 1: ABC's PROGRESS IN COMMERCIALIZATION

* Establishment of ADBC Completed. The separation of ABC's "policy" business into ADBC, whichstarted in 1994, was completed in 1996. ADBC, which used ABC's agency services for the past twoyears, now operates through its own branch network.

* Separation of RCCs Completed. By end-1996, ABC had fully entrusted the administration of theRCC system to the Rural Finance Reform Office, set up under the jurisdiction of the State Council.

* New Charter Prepared. Following the requirements of the new Law on Commercial Banks (1995),ABC has introduced a new charter and important initiatives in following key areas: Assets andLiability Ratios Management; Accounting and Audit; Personnel Management; Branch NetworkAssessment; Resource Planning and Adjustment; Capital Operations; Deposit Mobilization; LoanPortfolio Management; Noncredit Business; and Financial Management.

* Pilot Programs Introduced. Several provincial and lower-level branches have piloted newmanagement practices and improved credit risk management; profitability norms, organizationalefficiency and quality of services provided to clients.

* Large-Scale Readjustment and Relocation of Grassroots Offices Under Way. Over the past years,about 7 percent of the total number of offices (about 50,000) have been closed and/or relocated, usingbusiness potential and efficiency criteria. This process will continue over the next several years, withemphasis on closing down of unprofitable branches in rural areas and opening of new branches in urbanareas.

* Business Development. Much progress has been made in improving the quality of banking andfinancial services to clients. Besides traditional banking, ABC has introduced international bankingservices; credit card business; trade bills settlement; and other kinds of agency and noncredit services.Over 90 percent of the branches in large- and medium-size cities have computerized their operationsand electronic banking including ATM stations. Some 6,000 offices are connected to electronicpayments/ remittance systems.

* Review of Financial Management Practices. In conjunction with RCIV and using the AsianDevelopment Bank's technical assistance, ABC completed four major reviews as follows: ProjectLending Review; Risk Management Policies and Procedures; Accounting Systems Review; andAccounting Systems Improvement. While the Financial Management symposium planned under RCIVfor March 1991 was not held (as the Bank and ABC thought that this activity could be better handledby the Bank-assisted FSTAP), ABC carried out other activities provided by RCIV including the reviewsof its medium- and long-term lending strategies and lending policies concerning its major client groupsincluding TVEs, state farms, and the beneficiaries of poverty alleviation programs. The Bank reviewsnoted that the content of these studies were not analytical enough; moreover, in view of the change inABC's business mandate, these studies would have to be redone or updated involving ADBC andRCCs.

* Development of Business Plans. ABC carried out an activity that was not contemplated by RCIVappraisal, namely the development of business plans, on a pilot basis, for two provincial branches(Henan and Fujian) in conjunction with the preparation of the proposed ABC CommercializationProject for possible Bank assistance. These business plans focused on issues such as strategic analysis,financial analysis, portfolio analysis, and development of action plans that would accelerate ABC'scommercialization. ABC proposes to field-test a suitable methodology and framework for thepreparation of business plans, for purposes of replication in other provinces.

. ABC's Management Information System. Based on the studies carried out as part of appraisal, RCIVhad provided for a review of ABC's management information system (MIS) and relatedcomputerization programs. Using a long-tenn consultant to study this topic, ABC's managementreviewed a medium- to long-term strategic plan for ABC's computerization and the development of anMIS. Some of the key elements of this work have been included in ABC's Ninth Five-Year Plan.ABC's MIS is still in a formative stage and needs much strengthening.

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Factors Subject to ABC Control

32. Project Implementation. Generally, RCIV relied excessively on governmentagencies for technical support, which are becoming increasingly out-of-date on broadertechnology and subsector issues. The use of TEG and local consultants helped toimprove subproject designs and layouts to some extent, but as demonstrated by theincidence of problem projects, these arrangements were not adequately used by ABCbranches, with a possible consequence that technical experience gained in one provincehas not benefited other areas. At the provincial level, ABC's supervision oversubprojects, despite considerable improvement over RCI to III, was still less thanoptimal, especially in terms of ensuring compliance with technical standards, addressingsubproject performance problems, and ensuring timely repayment of subloans.

33. Subprojects financed by RCIV generally followed local environmentalregulations; however, for a good number of agroprocessing subloans, the Banksupervision missions pointed out deficient wastewater treatments. ABC promptly askedsubborrowers to rectify environmental problems, stopping subloan disbursements whereneeded. ABC has now established a joint agreement with the National EnvironmentProtection Agency for technical collaboration.

34. During the initial years of the project (1991-92), ABC's compliance with BankGroup procurement guidelines was a problem area as the provincial branches used localguidelines for national competitive bidding (NCB) and limited international bidding(LIB) procurement and shopping (both domestic and international) seemed to be the mostfrequently used procurement method. However, during project implementation, ABCrevised local guidelines; provided necessary orientation and training to project staff andsubborrowers; and brought about significant efficiency in procurement of goods andservices.

Factors Subject to Subborrower Control

35. Problems faced by several subprojects could be attributed to the lack of marketorientation and management capabilities at the level of subborrowers. In severalsubprojects, subborrowers have not scrupulously followed technical standardsrecommended by the project; used traditional (and costly) designs and layouts, did notadequately explore marketing strategies, and ignored efficient financial management.Examples include: (a) failure to follow breeding and nursery guidelines to produce virus-free planting material for oranges which resulted in substantial losses in Guangdong andGuangxi; (b) financing investments in cotton and silk processing in Hunan, withoutadequate profitability and market analysis; and (c) poor technical and financialmanagement of poultry breeding in Beijing and shrimp and eel production in Liaoningand Guangdong. Clearly, ABC and the governments' technical bureaus should haveassisted clients more systematically to address these problems through necessaryorientation programs and effective subloan supervision.

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D. PROJECT SUSTAINABILITY

36. The project's sustainability is uncertain. The real sector benefits are likely to besubstantial, including increased production and productivity in a regime of diversifiedagriculture, incremental employment, enlarged product markets, enterprise efficiency,substantial use of improved technologies and environmental awareness. ABC'ssustainability and its continued profitability will be somewhat contingent on the financialreform process. The existence of strong linkages between the fiscal, banking and enterprisesectors, and organizational changes needed to transform the existing institutions withdifferent mindsets, culture and traditions into market-based institutions will take time. Thepace of commercialization of ABC and the other formerly specialized banks will to a largeextent be influenced by state enterprise reforms, since the financial health of one affects thefinancial health of the other.

E. BANK PERFORMANCE

37. The Bank's approach, during project identification, preparation and appraisal, toachieve broader financial sector objectives (such as sectorwide interest rate reforms)through a single FIL such as RCIV, seems in retrospect too ambitious. The project hadfour different task managers over the six-year implementation period. Because of this andthe fact that substantial organizational changes (split off of policy lending and then RCCs)were either impending or occurring during the course of implementation, supervisionmissions concentrated on tracking progress of the subprojects, and the eleven provincialbranches' performances in subloan administration, instead of the overall institutionaldevelopment of ABC and the financial sector objectives of RCIV. In retrospect,supervision did not place adequate emphasis on the institutional and sectoral objectives ofthe project and, therefore, is rated as deficient.

F. BORROWER (MOF) AND BENEFICIARY (ABC) PERFORMANCE

38. The borrower (MOF) was not expected to have a direct role in RCIVimplementation except for two sectoral activities, namely, the project's mid-term reviewand the rural finance and investment study. However, since the scope of these activitieswas reduced in the wake of ongoing financial sector reforms, ABC was asked to completethese studies focusing on its operations. It is unclear why MOF did not use market-basedrates (or IBRD rates) for onlending Bank Group funds to ABC as required under theLoan/Credit agreements and why it did not seek the Bank's prior concurrence to uselower-than-market/IBRD rates. This left one important objective of the project, namelyelimination of subsidies to ABC lending, unachieved. The ICR mission was informedthat all future Bank Group loans/credits to financial intermediaries will carry market-based interest rates.

39. ABC on its part made best efforts to implement the project efficiently in spite ofvarious systemic problems and the lack of adequate skilled manpower. In implementingRCIV, after initial difficulties concerning compliance with the Bank's procurement andenvironment guidelines (largely discovered through Bank supervisions), ABC made

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major strides in rectifying the problems, improving subproject appraisal and supervision,and enforcing Bank procurement and environment protection guidelines. ABC did not,however, integrate project lending with its mainstream credit departments to improve theproject's institutional development impact, efficiency of resource planning, portfoliomanagement, and quality of financial services provided to clients. Because of this lack ofintegration, RCIV could make only a limited impact on improving the quality of ABC'slending and portfolio management.

G. ASSESSMENT OF OUTCOME

40. The project outcome is viewed as unsatisfactory on the basis that it at best onlypartially achieved its sector policy and institutional development objectives and its levelof achievement of the financial objectives was negligible. One could ask how aninstitution that had satisfactorily implemented three previous projects could performpoorly on the fourth. Also, it is unusual to rate a project with an estimated final ERR of24 percent as unsatisfactory. But RCIV had higher aims than the earlier projects,extending into the overall operations of ABC and even into the government's financialsector development strategy. The same project in today's financial sector environmentwould have a much greater chance of achieving its objectives.

41. Sector Policies (Partial Achievement). The financial sector policies that had thegreatest effect on ABC during project implementation-separation of policy lending(including grain procurement and poverty alleviation) from ABC into a newly establishedfinancial intermediary and separation of the rural credit cooperative system from ABC'soversight-were not the result of the project, but were definitely within the overallobjectives of the financial sector reform recommended by the Bank and intended to besupported by the project. The RCIV activities intended to support rural financial marketdevelopment and broader financial sector development-a study of rural investment andfinance and ongoing consultations with the Bank on a general interest rate structure (thiswas an understanding reached at negotiations, but not covenanted)-were, in the case of theforrner, reduced in scope as a result of the split of ABC and by the overlap with asubsequent FSTAP, which focused on reforms applicable to all financial institutions and forthe latter, not pursued.

42. Financial Objectives (Negligible). The financial objectives that the project hadenvisaged-elimination of subsidized credit, a more rational interest rate structure for theproject and for ABC as a whole, and adjustment of the provision for bad debts to levelsmore realistic and in line with international practice-were not implemented within the timeframe of project implementation. It is unclear why MOF provided subsidized credit toABC, but the interest rate structure and provisioning are issues still unresolved for thesector and still being addressed by the Bank on a project-by-project basis. The Bank is nowof the view that deregulated interest rates are an important objective, which can best be fullyattained only in the final stages of the financial reform process after a number of conditions,such as macroeconomic stability, contestable financial markets, healthy financial

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institutions and real sector enterprises, trained bank staff and bank supervisors, and modemaccounting and auditing systems, have been put into place.

43. Institutional Development (Partial Achievement). The main objectives of theinstitutional development programs were to upgrade ABC's financial management (with asymposium in Beijing, which ABC and the Bank decided could be better handled by theFSTAP). Some studies were carried out and reviewed by the Bank, but not pursued furtherin light of the impending split of policy lending and RCC oversight. ABC's recapitalizationplan was not prepared, but there is a view in the Bank that this recapitalization without firstaddressing the more fundamental issues is not a good strategy. ABC did not provide theupdated portfolio review annually to the Bank.

44. Physical Objectives (Substantial Achievement). About 94 percent of thesubprojects are performing satisfactorily and are expected to reach their production andproductivity improvement goals. The remaining 6 percent of the subprojects, accountingfor 16 percent of the subloan amounts disbursed, are rated as failed or problem projects withthe potential to further increase the proportion of overdue/nonperforming loans, theestimated FRR and ERR are 22 percent and 24 percent, respectively.

45. Poverty Reduction (Partial Achievement). Lending in poverty counties amountsto about 22 percent of the total subloan amount.

H. FUTURE OPERATION

46. ABC would take steps, in conjunction with its clients, to improve performance ofproblem subprojects; spearhead the reform of state-owned enterprises that have borrowedproject funds; and improve portfolio management to reduce overdue subloans. ABCshould also continue various institutional development activities started by RCIV,including trainers' training and staff training programs in investment appraisal, projectmonitoring, and financial management. ABC should use its three national trainingcolleges and several regional training institutes to disseminate skills and experience inproject lending gained through RCI to RCIV.

47. Competitive Banking Model. When RCIV was processed, it was ABC'sprimary mandate to support rural financial intermediation and real sector development(including poverty alleviation). However, since ABC is now in a transition to becominga full-fledged commercial bank, the Chinese authorities should focus on using a range ofinstitutions including all commercial banks (not just ABC), the RCC system, policybanks, and nonbank financial intermediaries in order to promote competition andefficiency in the provision of financial services to the rural sector. The government andPBC should launch a broad-based program to develop institutional capabilities within theRCC system, ADBC, as well as ABC to enhance achievement of objectives of RCIV andthe three earlier Bank-assisted rural credit projects.

48. Interest Rates and Recapitalization. In future, financial sector policies pursuedby PBC and the government should ensure that ABC and similar financial institutions

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receive adequate interest spreads on foreign-funded (as well as domestic) lending toenable them to (a) fully meet transaction costs (including realistic provisioning for baddebts) and (b) earn a reasonable profit (after tax) so that they could increase their equityand/or pay a reasonable dividend on equity. Over a period, allowing commercial banks toraise private capital is an issue that must be addressed by a broader financial sectordialogue between the Bank and the government, if the processes started by RCIV andother similar Bank-assisted financial sector operations are to be sustained. Meanwhile,subject to continuing review of ABC's capital adequacy ratio, MOF guidelines on baddebt provisioning need to be revised, as well as ABC's ability to increase its capital baseenhanced so that it could efficiently cope with problem loans, without jeopardizing itsstatus as a viable universal bank.

49. Greater Donor Coordination. Future financial sector and financial intermediaryoperations in China should ensure greater donor coordination (among the Bank, the AsianDevelopment Bank and the International Fund for Agricultural Development) to avoidwasteful overlap and duplication in technical assistance.

50. Technical Assistance: Design and Scope. RCIV relied for technical supportexcessively on government agencies that are becoming increasingly out-of-date onbroader technology and subsector issues. China's future rural finance programs shouldfacilitate subborrowers to engage technical experts competitively and irrespective ofwhether they work for the government or in the private sector. Future Bank Group andother donor-assisted credit operations should provide increased focus on strengtheningABC's portfolio management, institutional mechanisms for transferring new technologiesto subborrowers, and stricter compliance with environment protection regulations. Theproject design should also place increased emphasis on the quality of subprojectappraisals, which must adequately address product marketing issues and strategies foraccessing domestic and/or export markets.

51. At the grassroots level (especially in poverty areas), many ABC and RCC clientsstill regard bank credit as a grant from the government. If new rural credit programs areto be launched, this perception must be changed through client education, involvement ofself-help groups, accelerated introduction of new types of micro savings and creditprograms, and institutional development of grassroots-level financial institutionsincluding numerous types of rural credit cooperatives. The government should carry outa comprehensive rural finance and investment study that was contemplated by RCIV toaddress the above issues.

I. KEY LESSONS LEARNED

52. The key lessons learned from the project include the following:

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(a) Limit to Reform. There is a fairly narrow limit as to how far an FIL for onebanking institution can go in achieving reform objectives for the wholefinancial sector.

(b) Ownership. When financial sector objectives are introduced into an FIL, allstakeholders (in this case, specifically PBC) must be explicitly involved andexhibit ownership of and commitment to the project objectives.

(c) Consensus. The Bank and Borrower should only develop projects forwhich there is a strong consensus and common understanding about themain objective of the project, particularly in a complex and sensitive policyarea such as financial sector reform.

(d) Simplicity. Projects must be kept simple enough that both Bank andimplementing agency resources are not stretched beyond capacity tosupervise implementation.

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PART II: STATISTICAL TABLES

TABLE 1: SUMMARY OF ASSESSMENTS

Achievement of Objectives Substantial Partial Negligible Not Applicable

Macroeconomic policies xSector policies XFinancial objectives XInstitutional development XPhysical objectives XPoverty reduction XGender issues xOther social objectives XEnvironmental objectives XPublic sector management XPrivate sector development X

Project Sustainability Likely Unlikely Uncertain

x

Rank Performance Highly Satisfactory Satisfactory Deficient

Identification XPreparation assistance XAppraisal XSupervision X

Borrower Performance Highly Satisfactory Satisfactory Deficient

Preparation XImplementation XCovenant compliance XOperation (if applicable) X

Assessment of Outcome Highly Satisfactory Unsatisfactory HighlySatisfactory Unsatisfactory

x

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TABLE 2: RELATED BANK LOANS/CREDITS

Year ofLoan/Credit Title Purpose Approval Status

Rural Credit I (Cr. 1462-CHA) Provision of medium- and long-term loans in FY84 CompletedGuangxi for investment in aquaculture,orchards, agroprocessing, livestock and TA.

Rural Credit II (Cr. 1 642-CHA) Provision of medium- and long-term loans in FY86 CompletedFujian and Hunan for investment in aquacul-ture, orchards, agroprocessing, livestock andTA.

Rural Credit III (Cr. 1871 -CHA) Provision of medium- and long-term loans in FY88 CompletedAnhui, Henan and Hubei to stimulate growthand diversification of agriculture andincrease the operational efficiency of ABC.

Financial Sector Technical Support to govemment for continued FY93 OngoingAssistance Project financial sector refonn(Cr. 2423-CHA)

Agricultural Bank of China ABC's capacity building as a commercial Under preparationCommercialization Project bank.

TABLE 3: PROJECT TIMETABLE

Steps in project cycle Date planned Date actual

Identification 04/88 10/03/88Preappraisal - 08/08/89Appraisal 11/89 12/11/89Negotiations 04/90 09/10/90Board presentation - 10/30/90Signing - 12/10/90Effectiveness 12/90 03/22/91Project completion 06/30/95 12/31/96Loan closing 12/31/95 12/31/96

- 23 -

TABLE 4: LoAN/CREDIT DISBURSEMENT: CUMULATIVE ESTIMATE AND ACTUAL($ million)

FY91 FY92 FY93 FY94 FY95 FY96 FY97

Appraisal estimate 30.0 80.0 150.0 220.0 275.0Actual 31.4 112.3 172.5 220.8 259.2 268.8 274.6Actual as % of adjusted estimate 104.8 140.4 115.0 100.4 94.3Date of final disbursement February 5, 1997

- 24 -

TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION

Key implementation indicators in SAR Unit Estimated Actual La

Incremental Production at Full Development:

CropsFruit ton 360,000 490,280Vegetable and other specialty crops ton 170,000 163,420Bamboo ton 1,000,000 117,500Tea ton 40,000 12,280Mulberry and cocoon ton 180,000 13,210

LivestockCattle head 200,000 110,840Sheep/Goat head 450,000 65,600Poultry bird 21,000,000 13,304,000Pig head - 165450

FisheryFreshwater fish ton 13,000 28,670Shrimp ton 1,800 84Scallop ton 6,000 2,490Fingerling n/a adequate adequate

AgroprocessingFruit processing ton - 11,870Fruit storage ton - 24,470Livestock product ton - 12,610Animal feed ton - 223,560Tea processing ton - 5,600Chinese medicine ton - 20,340Cold storage ton - 97,620

Market each - 20

Incremental production value $ million 600 826

Incremental employment generation person/year 108,000 655,900

Training person - 24,750

La Figures are rounded.

- 25 -

TABLE 6: KEY INDICATORS FOR PROJECT OPERATIONS

(Not Applicable)

TABLE 7: STUDIES INCLUDED IN PROJECT

Study Purpose as defined at Status Impact of StudyAppraisal/Redefined

Study of rural invest- Review of rural financial Partially done focusing on Limited as ABC now in transi-ment and fnance institutions and credit ABC's constraints to raising tion to become a universal bank;

and interest rate policies long-term funds for rural rural lending being moved tolending ADBC and RCCs

Development of ABC's Review of status of lend- Completed Conclusions incorporated inlending policies for ing to TVEs, state farms ABC's lending policiesmajor client groups and poverty groups

- 26 -

TABLE 8A: PROJECT COSTS(Y million)

Appraisal Estimate Actual/Latest Estimate LaLocal Foreign Total Local Foreign Total

Crops 614.5 153.9 768.4 724.1 181.0 905.1Livestock 535.2 134.0 669.3 448.0 112.0 560.0Aquaculture 301.1 26.0 327.1 359.3 31.3 390.6Agroprocessing & Marketing 572.1 245.0 817.0 1,509.4 621.3 2,130.7Technical Assistance 5.7 8.5 14.2 6.3 8.6 14.9

Total 2,028.7 567.3 2,596.0 3,047.1 954.2 4,001.3

/a Source: ABC provincial branches.

TABLE 8B: PROJECT COSTS($ million)

Appraisal estimate Actual/latest estimate /aItem Local Foreign Total Local Foreign Total

Crops 130.2 32.6 162.8 125.3 31.3 156.6Livestock 113.4 28.4 141.8 73.0 18.2 91.2Aquaculture 63.8 5.5 69.3 60.3 5.3 65.6Agroprocessing & Marketing 121.2 51.9 173.1 235.2 97.1 332.3Technical Assistance 1.2 1.8 3.0 1.0 1.3 2.3

Total 429.8 120.2 550.0 494.8 153.2 648.0

/a Source: ABC provincial branches.

-27 -

TABLE 8c: PROJECT FINANCING($ million)

Appraisal Estimate Actual/Latest Estimate /aSource Local Foreign Total Local Foreign Total

IBRD 42.2 32.8 75.0 57.4 17.6 75.0IDA 112.6 87.4 200.0 152.3 47.3 199.6ABC/RCCs 110.9 0.0 110.9 85.4 26.8 112.2Subborrowers 164.1 0.0 164.1 199.7 61.5 261.2

Total 429.8 120.2 550.0 494.8 153.2 648.0

/a Increases in investment costs were financed mainly by the subborrowers.

TABLE 9: ECONOMIC COSTS AND BENEFITS /a

Appraisal Estimate Actual/Latest EstimateActivity FRR ERR NPV FRR ERR NPV

(N) (%) (Y million) (%) (%/0) (Y million)

Crops 31 36 837 30 34 1,334Livestock 27 28 386 19 27 260Aquaculture 27 26 198 25 28 223Agroprocessing 32 43 421 23 23 1,379Marketing /b - - - 14 14 46

Total Project 24 27 1,944 22 24 3,044

/a FRR and ERR represent weighted averages, based on 40 representative models for the fivesubcomponents and their relative shares in the total project-assisted lending program.

lb Marketing component was not separately listed at appraisal.

- 28 -

TABLE 10: STATUS OF LEGAL COVENANTS

Cove- Original RevisedAgree- nant Present fulfillment fulfillmentment Section type Status date date Description of covenant Comments

DCA Art. 1, 3 C Project entities defined asSection 1.02(a) Fujian, Guangdong, Hubei,

Hunan, Jiangxi, Jilin, Liaoning,Shaanxi, Inner Mongolia,Guangxi, Beijing

DCA Art, 3 3 NC MOF to onlend proceeds to MOF applied rate applicable toSection 3.01 (b) ABC at IBRD rate blend of IBRD and IDA funds

DCA Art. 3, 3 NC MOF to take measures to insure ABC continued to be bound bySection 3.02 that ABC has authority to PBC rates for subloans, which

increase subloan interest rates in some years were negative into achieve minimum spread of real terms.2.5% or such other rate agreedwith Bank/IDA and thatsubloan interest rates arepositive in real terms

DCA Art. 3, 12 CP 06/30/92 Govt/ABC to carny out studies The studies were partiallySection 3.07(a) under Part C (rural investment completed, partly due to simi-

and finance, rural financial lar work under the later FSTAPinstitutions, and credit and project and the implementationinterest rate policies) of new financial sector

reforms.

DCA Art. 3, 5 CP 12/31/92 Midterm review of financial The mid-term review wasSection. 3.09 sector reform, Project and restricted to project-related

ABC's institutional develop- matters. However, a generalment, including risk-assets ratio review of financial sectorand recapitalization reform program was held as

part of FSTAP project supervi-sion. Review of project imple-mentation issues conducted aspart of project supervision. Norecapitalization plan was pre-pared and reviewed.

DCA Sched. 4 5 NA Annual Calculation of interest rate from No onlending in yuan; all inMOF to ABC for onlending in foreign exchange. However,yuan MOF did not comply with

covenant, which requiredonlending at IBRD rate.

PA Art. 3, 3 NC Spread between cost of funds Interest rate spread on localSection. 3.02(a) and subloans to be 2.5% after currency subloans was general-

taxes ly less than 2.5 % (before tax)during 1991-94 and 1996.Interest spread was also lessthan 2.5% (before tax) on for-eign currency subloans. How-ever, ABC reported thatspreads on incremental foreignexchange business generatedby RCIV helped to make goodthe shortfall but details are notavailable. ABC did notapproach PBC to allowflexibility in interest ratesadmissible on foreign-fundedsubloans.

- 29 -

Cove- Original RevisedAgree- nant Present fulfillment fulfillmentment Section type Status date date Description of covenant Comments

PA Art. 3, 3 CP ABC to maintain financial ABC maintained itsSection 3.02(b) viability and profitability, profitability, but kept the bad

including provisioning for bad debt provision at the low ratedebts on the basis of criteria set by PBC.acceptable to IBRD/IDA

PA Art. 3, 3 CD ABC to maintain equity at level Recent audit indicated ABC'sSection 3.03 not less than 5% of its risk capital adequacy ratio at about

assets 8%.

Art. 3, 5 CD 12/31/91 ABC to provide recapitalizationSection 3.04 plan to Bank; discuss plan with

Bank; modify plan to ensurethat ABC's risk-weighted capi-tal adequacy ratio to be at least8%; carry out plan

PA Section 4.01 9 C 06/30 Auditing of Provincial Project Separate reports prepared forannually accounts; provide to Bank/IDA each province include project

certified copies of accounts and accounts and provincial branchfinancial statements, auditor's financial statements publishedreport, and financial statements in Annual Report. ABC'sof ABC's provincial and county global accounts audited by thebranches in project provinces State Audit Agency.and ABC's total operations.

PA Part A 5 C Procedures for appraisal andPara. I approval, including enterprise

appraisal for state farms andintermediary enterprises

PA Part A 3 C Free limit subloans defined asPara 2 subloang in an amount to be

financed out of loan/creditproceeds not to exceed $3million equivalent

PA Part A 3 C Request by ABC for authoriza-Para 3 tion to withdraw from Loan/

Credit account for a free-limitsubloan shall contain a sum-mary description of subborrow-er, subproject and terms andconditions of subloan; first twoirrigation subprojects to besubmitted to IDA for review.

PA Part B 3 CD Subborrower contribution to be After some initial problemsPara I at least 300/h of total invest- with subborrower contri-

ment; interest rate for subbor- butions and interest rates,rowers to be not lower than compliance was satisfactory.ABC's or RCC's prevailing Interests rates turned positiverate, positive in real terms and in real terms during 1995 andin compliance with interest rate after with the decline inspread covenant; amortization inflation.to be based on cash flow andnot to exceed 15 years;subloans to be withdrawn andrepaid in yuan or foreignexchange, with subborrower tobear foreign exchange risk.

- 30 -

Cove- Original RevisedAgree- nant Present fulfillment fulfillmentment Section type Status date date Description of covenant Comments

PA Part C 3 C RCC eligibility: satisfactoryPara 2 financial condition; equity

reserves not less than 15% oftotal loan portfolio, totalamount of past due loans not toexceed 20% of loans outstand-ing and past due loans in arrearsmore than 3 years not to exceed5% of total loans outstanding.

PA Part C 3 CD For RCC subloans, ABC to Several ABC subloansPara 3 onlend not more than 50% of exceeded 50% of subproject

subproject cost; require repay- cost, but these were adjusted.ment by RCC within sameamortization period as subloanand with same grace period;interest at ABC's prevailingrate for similar loans to RCCs.

PA Sched. 2 10 CD LIB procurement procedures to After considerable problemsSection 1, be used for items or groups of initially, usually in compli-Part C I items of machinery and equip- ance.

ment estimated to cost $50,000or more if used for producingexport products and $ 100,000for producing for domesticmarket.

PA Sched. 2 10 C NCB procurement proceduresSection 1, to be used for items/groupsPart C 3 estimated to cost between

$50,000 and $ 100,000 (exceptfor export production) and forcivil works under Part A.

PA Sched. 2 10 C Price quotations to be obtainedSection 1, for items/groups estimated toPart C 4 cost less than $50,000

PA Sched. 3 5 C Each project entity shall estab-Part A I lish and maintain a project

management committee,including a representative of theenvironmental protectionagency (EPA)

PA Sched. 3 5 C 12/31/91 ABC to maintain and strength- TEG and consultant rostersPart A 3 en its Technical Expert Group established at various levels

(TEG) at headquarters and byDec. 31, 1991, review progressof strengthening

PA Sched.3 5 CP Dec. 31 ABC to conduct assessment of Area livestock componentsPart B annually use of Area Management Plan- reduced due to lower profita-

ning techniques and review bility; AMP techniques satis-with Bank/IDA factorily implemented. ABC

will continue use of AMPtechniques in future lending.

Covenant Class: Status:I = Accounts/audits 8 = Indigenous people C = covenant complied with2 = Financial performance/revenue 9 = Monitoring, review, and reporting CD = complied with after delay

generation from beneficiaries 10 = Project implementation not CP = complied with partially

- 31 -

3 = Flow and utilization of project covered by categories 1-9 NA = not applicablefunds 11 = Sectoral or cross-sectoral NC = not complied

4 = Counterpart funding budgetary or other resources5 = Management aspects of the allocation

project or executing agency 12 = Sectoral or cross-sectoral policy/6 = Environmental covenants regulatory/institutional action7 = Involuntary resettlement 13 = Other

- 32 -

TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS

Operational Manual Statements were complied with.

TABLE 12: BANK RESOURCES: STAFF INPUTS

Planned Revised ActualStage of Project Cycle Weeks $'000 Weeks $'000 Weeks $'000

Preparation to Appraisal - - - - 175.5 488.3Appraisal-Board - - - - 70.8 209.4Negotiations through Board Approval - - - - 14.4 47.3Supervision - - - - 130.0 446.3Completion - - - - 22.5 75.0

TOTAL 413.2 1,271.3

- 33 -

TABLE 13: BANK RESOURCES: MISSIONS

Performance ratingNumber Imple- Devel-

Stage of Month/ of Days Specialized staff skills represented L/ mentation opment Type ofproject cycle year persons in field status Lb objectives problems

Identification 10/88 7 26 CS/EC/AQSILS/AGS/APSIFA

Preparation 04/89 4 32 CS/EC/APS/FA

Preappraisal 09/89 10 35 CS/FAIEC/APS/AQS/AGSIMS/HS/LS

Appraisal 12/89 8 30 CS/HS/FA/EC/APS/AGS/LS/IDS

Negotiation 09/90 4 CSIEC/LW/DS

Board approval 10190

Signing 12/90

Effective 03/91

Supervision 1 05/91 5 21 CSIEN/GD/APS/LS I I LC/PP

Supervision 2 04/92 4 17 EC/CS/APS/AQS 2 1 OS/LC/PP/SP

Supervision 3 09/92 9 23 EC/CS/APS/AQS/GS/LSIMSIIE/AGS 2 I OS/LC/PP/SP

Supervision 4 11/93 4 24 APS/CS/AQS/OO I 1 OS/LC/CF/SP

Supervision 5 06/94 4 22 CS/APS/OO S S CF/SP/EI

Supervision 6 05/95 4 13 CS/APS/AQS/OO S S SP

Supervision 7 05/96 1 3 EC S S LC

Completion 03/97 4 20 CS/EC/APS/AQS

/a AGS: Agricultural Specialist; APS: Agroprocessing Specialist; AQS: Aquacultural Specialist; CS: Credit Specialist;DS: Disbursement Specialist; EC: Economist; EN: Engineer; FA: Financial Analyst; GS: Grassland (Rangeland) Specialist;HS: Horticulture Specialist; IDS: Institutional Development Specialist; IE: Irrigation Engineer; LS: Livestock Specialist;LW: Lawyer; MS: Marketing Specialist; 00: Operation Officer.

/b 1: Highly satisfactory; 2: Satisfactory; S: Satisfactory./c CF: Counterpart Funds; El: Environmental Issues; LC: Legal Covenant; OS: Overall Status; PP: Procurement Progress; SP:

Studies Progress.

- 35 - ANNEX A

ANNEX A: BORROWER'S CONTRIBUTION TO THE ICR

IMPLEMENTATION COMPLETION REPORTPREPARED BY ABC

FOURTH RURAL CREDIT PROJECT

(CREDIT 2182-CHA; LOAN 3265-CHA

1. The Project

1.01 Name of project: Fourth Rural Credit ProjectCredit No.: CREDIT 2182-CHA/LOAN 3265-CHARegion: East Asia and Pacific regionCountry: ChinaSector: AgricultureSubsector: Rural CreditLoan Amount: CR 2182: SDR 143.7 Million/LN 3265: USD 75 Million

2. Project Background

2.01 Following the introduction of economic reforms since 1979, China's agriculturehas achieved a remarkable progress, with a rapid growth in the output of grain, poultryand animal husbandry. The outstanding feature of the buoyant farn sector performancein 1996 was a record grain harvest of 490 million tons, about 25 million tons above theprevious record in 1995, enabling the country, for the first time, to reach the level of percapita grain consumption close to the world average. However, it is premature to supposethat China's grain production has hit a new, consistently upward trend considering thefactors such as relatively small size of cultivated land per capita, increasing reduction infarm land due to diversion to non-agricultural uses, relatively backward methods ofproduction, and production losses caused by natural disasters such as floods and drought.Also, with growing population and per capita incomes, demand pressures on agriculturalproduction are increasing. It is, therefore, imperative for China to continue to improveagricultural efficiency through increased production, productivity, product diversificationand quality improvement, accompanied by more efficient agro-processing and marketingsystems.

2.02 Since its re-establishment in 1979, the Agricultural Bank of China (ABC) wasmandated to support rural development and poverty alleviation programs. In 1994, thegovernment launched major financial sector reforms, with ABC and other state-ownedspecialized banks beginning their transition to genuine commercial banks. Following the

- 36 - ANNEX A

promulgation of the Commercial Banking Law, the ABC was split and its policy lending(for government-sponsored programs) was transferred to the newly establishedAgricultural Development Bank of China (ADBC). Subsequently, the government alsoseparated the network of Rural Credit Cooperatives (RCCs) from ABC's supervision in1996 to PBC, in order to accelerate ABC's transition to a genuine commercial bank.

2.03 At the time launching of the Fourth Rural Credit Project (RCIV) in 1991, ABChad successfully implemented the first two IDA-assisted rural credit projects, while thethird one was under implementation. These projects played an important role bysupplementing ABC's longer term resources for rural development, and ABC'sinstitutional development.

Name of Project Project No. Total Loan Completion Date

Rural Credit I 1462-CHA 47.2m. SDR June 1988Rural Credit II 1642-CHA 84.0m. SDR September 1991Rural Credit III 1871-CHA 123 .8m. SDR June 1994

3. Project Objectives and Design

3.01 The main objectives (as followings) of the Fourth Rural Credit Project were asfollows:

(a) to stimulate growth and diversification of agriculture by financinginvestments by farmers, collectives and enterprises; and

(b) to promote efficiency of rural financial intermediation throughintroduction of sound, market-oriented policies and development of themain rural financial institutions.

3.02 Objective (1) was achieved through the provision of credit for commerciallyviable production and productivity improvements in crops, livestock and fisheries, agro-processing, and agro-products market development with a special emphasis onenvironmental protection and poverty alleviation.

3.03 Objective (2) was achieved mainly through the provision of technical assistance toABC for its and RCCs' institutional development, in conjunction with major ruralfinancial sector reforms that were introduced by the govenment in 1993.

3.04 The RCIV was processed as per the following schedule:

Preparation: 1988 Pre-appraisal: August 1989Appraisal: January 1990 Negotiations: September 1990Effectiveness: March 1991 Completion: December 1996

- 37 - ANNEX A

3.05 The Project covers following eleven provincial branches: Beijing, InnerMongolia, Liaoning, Jilin, Jiangxi, Fujian, Hubei, Hunan, Guangdong, Guangxi andShaanxi.

3.06 The project was implemented according to the Credit, Loan and ProjectAgreements consistent with the government's macro-economic policies and sectoraldevelopment strategies. The project made use of available natural resources andcompetitive advantages to develop local economies. The project generated about 656,000incremental full time jobs especially for women and assisted in poverty alleviation.

4. Project Organization

4.01 ABC headquarters had set up a Project Office which was responsible mainly forexternal liaison and correspondence, and developing project implementation strategiesand management including guidelines for subproject appraisal, monitoring, procurement,staff training and study tours. The project office also conducted project supervision,monitoring and evaluation. ABC's provincial branches were responsible for subprojectappraisal except for subloans in excess of their approval powers; monitoring subprojectperformance; resource mobilization; and subloan collection. ABC headquartersundertook regular supervisions with focus on assessing subborrowers' financial status,subprojects' market analysis, environmental protection and portfolio management.

4.02 Subproject approvals were made generally in compliance with the covenants andguidelines outlined in the Loan/Credit and Project Agreements. Subloans exceedingUSD 3 million equivalent were to be approved by the Bank Group, USD 2-3 millionequivalent by ABC headquarters and others by provincial branches. The projectimplementation indicated that the free limit for provincial branches and ABCheadquarters were rather low to ensure the achievement of institutional developmentobjectives.

5. Project Implementation

5.01 A total of 1,780 subprojects were implemented under the Project. Detailedinformation are as following:

Category No. of Projects Total Investment IBRD/IDA Funds(000 RMB) (000 RMB)

Crops 1,135 905,100 393,281Livestock 142 559,954 282,514Fishery 141 390,670 146,780Agro-processing 339 1,773,538 750,212Wholesale market 23 357,180 150,460

Total 1,780 3,986,442 1,723,247

- 38 - ANNEX A

5.02 By the end of 1996, the project had financed planting of over 320,840 mu of fruitstrees, 69,660 mu of tea, 889,520 mu of other crops; construction of 137,280 mu of fishery(including freshwater and sea water); raising of 110,840 cattle, 65,600 sheep and goat,165,500 pigs, 13.3 million poultry; building or improving of about 340 agriculturalproduct and by-products processing plants and supporting of 23 markets. The combinedoutput value reached 6.9 billion RMB yuan.

5.03 At the beginning of the project implementation, ABC Headquarters hadestablished a Technical Expert Group (TEG) at the national level. The TEG's mainfunctions were to provide advice to subborrowers on technical designs and layouts;review subproject feasibility studies and ABC subloan approvals; and supervisesubproject compliance with technical aspects. The Group carried out its responsibilitiessatisfactorily. ABC headquarters and provincial branches used the project cycle approachin implementing the project, by carrying out individual subprojects' feasibility studies,appraisal and monitoring, with necessary attention to procurement of goods and servicesand environmental requirements as per the Bank Group guidelines. These approacheshave now been extended to ABC's non-project lending undertaken by mainstream creditdepartments. In fact, many subprojects' good performance could be attributed to theintroduction of systematic appraisal procedures through a series of Bank/IDA-assistedprojects.

5.04 The project period was extended by one year mainly due to: (a) a substantialincrease in the lending program resulting from the depreciation of the yuan relative to USdollar (from 1:4.7 in 1991 to 1:8.7 in 1994) and (b) high rates of inflation during 1992-1994, which caused a remarkable increase in the project investment cost, whichinevitably created problems for ABC to find increased amount of counterpart resources,and financially sound sub-projects in subsectors and areas included in the project.

5.05 Most of the subprojects financed by RCIV are performing satisfactorily.However, some 123 subprojects (including a group of small citrus subloans inGuangdong), about 7% of the total, approved during the project's first two years, 1991-93have problems with achieving expected rates of return and subloan collections. Theproblem subloans amount to 632 million yuan or 15.9% of the total investment. Most ofthe problem subprojects are predominantly in tree crops followed by livestock, fisheriesand agro-processing. These subprojects are relatively small and located in remote and/orpoverty areas where there is an acute shortage of trained manpower making it difficult forsubborrowers to secure satisfactory technical and marketing services. Performanceproblems are more acute for subprojects undertaken by state-owned enterprises whichoften lack flexibility, resilience and incentives required for effective management.

5.06 In support of the project's poverty alleviation objective, the RCIV approvedsubprojects in as many as 90 counties in eleven project provinces, which are classified aspoverty counties, with total loans of RMB 476 million, financing investments in sub-sectors such as crops and livestock.

-39- ANNEX A

5.07 Unlike RCI to III, the Ministry of Finance (MOF) wanted ABC to bear the foreignexchange risk on Bank Group funds and, therefore, passed on the entire amount of aboutUSD 275 million to ABC in US dollars. ABC headquarters used part of the dollar fundsfor expanding its own foreign exchange business (by providing corresponding localresources to provincial branches) and passed on the rest to provincial branches also in USdollars. The provincial branches used dollar funds for financing their respective foreignexchange business and issued subloans in local currencies using their domestic funds.Except for a few subloans which financed export-oriented activities, all other subloanswere expressed in the local currency. Subborrowers operating in the domestic marketwere generally unwilling to undertake foreign exchange risk. The People's Bank ofChina continued regulation of interest rates and the limited ability of the subprojects tobear market rates of interest, it was difficult for ABC to use the flexible interest ratepolicy proposed by the RCIV. ABC therefore could not comply with the projectcovenant that required it to ensure a minimum interest spread of at least 2.5%. ABCreceived an average interest spread of about 2.16%.

6. Adjustment of the Project

6.01 In a changing macroeconomic environment characterized by high rates ofinflation and responding to the problems faced in implementing numerous subprojectsspread over a vast area, ABC made some adjustments in the project's lending programand included some investments in agricultural wholesale markets most of which haveproved to be successful.

7. Onlending to RCCs

7.01 By the end of 1996, ABC had onlent SDR 8.62 million of Bank Group funds toRCCs. The objective was to orient, on a pilot basis, a few RCCs to undertake project-type lending. The subloans under this component were provided mainly to individualfarmers which helped improve their living standards, and in some measure contributed topoverty alleviation in remote areas.

8. Implementation of Part B

8.01 By December 31, 1996, ABC used SDR 1.597 million (under Part B of theproject): SDR 925,000 for staff training and SDR 0.672 million for procurement ofoffice equipment. A total of 24,750 persons(including 500 trainers from ABC's threecolleges and training school) received training through various programs, and 354persons (including 20 trainers from three colleges) participated in overseas training andstudy tours. Training courses focused on project appraisal, management, monitoring andevaluation; benefit-cost analysis; financial management; risk management; and marketanalysis. In addition, some 10 foreign experts were invited to undertake grasslandregional planning and training and provide technical assistance on flax textile industryloans. Through these training activities, ABC's credit management level has beensubstantially upgraded and staff quality improved.

-40- ANNEX A

8.02 ABC carried out a study to review its lending policies for three major types ofclient groups under the project's TA program, including state farms; poverty alleviation;and township and village industries. Besides, ABC has reviewed its middle and long-term lending strategies, information technology, portfolio status, and business planingprocedures. In conjunction with RCIV, ABC used ADB-provided TA to review its RiskManagement Policy and Procedures, Project Lending Review, and Accounting SystemImprovement. All these initiatives have contributed to ABC's commercializationprocess.

8.03 As part of RCIV preparation, ABC had carried out a comprehensive loan portfolioaudit and agreed to update this information annually for ABC as a whole, and for theproject provinces for purposes of assessing ABC's overall subloan collectionperformance; and adequacy of interest spreads, provisions and capital. Because thedecisions on loan provisioning and write-offs rest with the government, ABC could noteffectively follow up on the measures proposed by the project.

8.04 Overall, ABC actively pursued RCIV's institutional development objectives andprepared itself for a rapid transition from a specialized bank to a commercial bank. Withthe promulgation of the Commercial Banking Law in 1995, ABC has improved its assetquality by introducing asset/liability ratio management and risk management,commenced rationalizing the organizational structure by closing down unprofitablebanking office and laying off credit agencies and setting up new banking offices indeveloped suburb areas; and begun reform of its internal management. (ABC'sadditional comments on the Bank's assessment of the institutional development objectiveare included as Appendix 1.)

9. Execution of Legal Documents

9.01 In general, ABC followed the project implementation requirements stipulated bythe legal documents.

9.02 Compared with the previous projects, ABC made remarkable progress incomplying with project covenants concerning procurement of goods and services;subloan approvals; monitoring; and environmental regulations.

10. Project Sustainability

10.01 RCIV's contribution to ABC's institutional capacity building, especially thespheres of financial management, project appraisal and portfolio management, wouldcontinue to remain relevant to its new role as a commercial bank. ABC expects furtherBank project support to upgrade its internal management including development ofmanagement procedures, human resource development and information technology toaccelerated commercialization within the country's broader framework for financialsector development.

-41- ANNEX A

10.02 Following its on-going transition from a specialized bank for rural development toa commercial bank, ABC is in the process of adjusting its internal organization andbranch network to enable it perform as a universal bank, in a competitive environment,and going to develop its market-oriented lending business.

11. Bank and ABC Performance

11.01 The Bank Group supervision missions made important contributions for smoothand successful implementation of the project. The missions' comments on key issueswere promptly reviewed, and effectively followed up by ABC. The missions includedexperts in agricultural marketing; project monitoring, financing and supervision; andprocurement.

11.03 ABC, as a project beneficiary and implementing agency made necessary efforts toensure timely and successful implementation of the project, with a focus on improvedportfolio management and institutional capacity building.

11.04 During the project period, ABC worked out a series of loan portfolio managementrules and procedures; held diverse training courses for managers and trainers; reviewedits loan portfolio performance; studied lending policies for its major client groups; andassisted in improving subproject management. All these initiatives made were critical forsuccessful implementation of the project.

11.05 ABC and the World Bank have, over the years, established a collegial relationshipwhich was fundamental to the successful implementation of the project.

12. Lessons Learned

12.01 Because real sectors assisted by the project were limited to crop planting, animalhusbandry, aquaculture and agro-processing, ABC's lending choices were limited to ruraland poverty areas where there was considerable lack of trained manpower for technicalassistance to subborrowers and project management. Consequently, several subprojectsmay not realize their expected financial rates of return which has partially affected theefficiency of the project.

12.02 Future financial sector and financial intermediary operations should ensure greatercoordination (among the Bank, ADB and IFAD) to avoid wasteful overlap andduplication in technical assistance provided for financial sector development includingrural finance.

12.03 While ABC's institutional capacity for project appraisal, implementation andsupervision has significantly increased through the implementation of the RCIV andearlier projects, it needs to be further strengthened and broad-based, especially in contextof ABC's new mandate for commercial banking. ABC should aim to integrate project-type lending with its mainstream credit departments and not run it as a parallel activity.This will help to achieve greater impact on institutional development and bring to bear

-42 - ANNEX A

professionalism and quality in project lending; and ensure better performance of loanportfolio and financial management.

12.04 The new ABC commercialization project proposed for World Bank assistanceshould not restrict its line of credit to specific real sectors but allow ABC to lend to anyactivity that is commercially viable based on market conditions. Subprojects should notbe widely dispersed making it difficult for the branches to exercise effective supervision.

- 43 - ANNEX A

APPENDIX 1: ADDITIONAL BORROWER COMMENTS ON WORLD BANK ASSESSMENTRATINGS

Agriculurar Bank of ChinaIaternadonal Department

SiF,Yulong Hota40Fuch=gRoad- Beijing 100036, Th Pcop1c'sRepublicofChina

FAX COVER SHEET

Dare: Augusr 4,1997 No. of Pages: 2(including this page)

To: Mr. Rick Scobev, Senior EcoxlomistRural Development and Naurral Resource UaitEast Asia ar.d PaciJlc Region, The World Bank

Fax Na.: 1-202-5-7 "1561From: Min Wei, Deputy General Manager

International Deoar=eat, ABCFax No.: 86-10-68416011Sabjecr: Revised ICR-RCIV

Message:

Dear-2r. Rick Scobey,

Thank you very much fr your fax dated July l0, 1997 whichclearly addressed the details of :he Bankk's views and the internal raingson RCIV project Regarding to the issues mentioned in your x wewould lile to have fbllowing co=enzs:

Based on the imnlementation of the forth rural credit project,we view the project was successfil and we caa get tie same conclusionfrom the Banies revised ICR. However, the project's objecrive design forits sector refoxm i light of the nare of nural credit project was tooambitious. RCIW was a Un of credit, not a projec for systm taasftrm,so its desiged fnancial sector reform objectives could not be achievedby this project itself From the Borrower side, issues regarding adecuateprovisioning for bad debts, preparation of a re-capitalizaion plan andrationalizaton of the general interest rate siaucture which were ptoposedby the Bank could not be imiemented completely tbroum theimplementaticn of RCIV project in few years under the governernt'stime-based policy framework. We believe that it could be more effectiveand efcient for the project implementatian if the Bank could have takeinto consideration of this Government's approach. In fact, the Chinesefinancial sector reforms in the past; especiaEly in recent three yeats, have

- 44 - ANNEX A

made remarkable progress arnd some of them even exceeded whar theBank requeird during the project anpraisal. Three policy banks had beeaestablished in 1994. In 1996, Rural Credit Cooperatives de-hooked fromABC's supervision, which gave ABC another chance to concentre itsefforcs on the commzeriTi7-qron tmder Central Bank Law andCommercial Bank Law. ABC has strengthened rt inernal corrrltbrough establishment of asset-Liability management committee, loanapproval committee and inz=mal auditing committee; graduallyimproving accotmting system; establishing management infoblionsystem, and enhancing human resource management. We understand thefinancial system in China has a long way to go, but both the Govemmentand ABC is moving at rizt direction. The process will defi3itely lead osolve die issues like re capicaizaion plan, provision for bad debts andinrerest rare liberation.

Based on above e=1-n-ion, I hove the Bank would take intoaccount of ABC's comments, arnd reconsider the project rating.

in view of their intresTs on this matter, I am sending ccpies toMr. Li Yong, executive director at the Worid Bank and Mr. Zhu Xan,acdog direcnor of World Bank Desarr-ent, MOF. I am loolnrl forwardto hearing from youL

IMy best regards,

Sincerey Yours

Mi Wei

cc: Mr. Li YongExecutive Director for China at the World BanlkFax: 1-202-5221579

M r. Zhu XianActing DirecrorWorld Bank DeparrmentThe Ministry ofFinc:Fax: 68511062

- 45 - ANNEXB

ANNEX B: ICR MISSION'S AIDE MEMOIRE

A World Bank mission' visited China from March 3 to 24, 1997 to review theimplementation of the Fourth Rural Credit Project (RCIV), with a focus on assessingprimarily the degree of achievement of project objectives; prospects of the project'ssustainability; Bank and the borrower performance; project outcome; plan for theproject's future operation; and lessons learned.

The mission visited ABC's Beijing; Liaoning; Jiangxi; Hubei; and Guangdongbranches to review their experience with project implementation. At these centers, themission also met with ABC's project staff from other provincial branches whichparticipated in the project, including Inner Mongolia; Jilin; Fujian, Guangxi; Hunan andShaanxi, and visited a few representative subprojects to assess client perspective. AtABC headquarters in Beijing, the mission reviewed ABC's own project completionreport and offered suggestions to improve its analytical content and conclusions. Themission's conclusions were reviewed and agreed with ABC officials.2 It was agreed thatsubject to further review of the ABC's revised ICR, government comments on the ICR,and the discussions with the Bank management, the ICR mission's aide memoire be kepton project file and the main conclusions and lessons learned be incorporated in the finalICR.

1 The mission comprised of Ramesh Deshpande (Bank), Christopher Cronberg, Andrew Kaelin andZhou Weiguo (Consultants).

2 ABC headquarters officials included: Mss. Min Wei, Deputy General Manager; Hua Ruoming,Division Chief; Li Shiqin, Liu Pei and Mr. Zhang Jun, Project Officers.

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Report No: 1738Type: 1CR