World Bank Document · Agriculture and Urban Development Operations Division ... MOF Ministry of Finance ... PBs Participating Banks SAR Staff Appraisal Report SPA State Property

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 14729

IMPLEMENTATION COMPLETION REPORT

HUNGARY

AGROPROCESSING MODERNIZATION PROJECT(LOAN 2936-HU)

JUNE 27, 1995

Agriculture and Urban Development Operations DivisionCountry Department IIEurope and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit - Hungarian Forints (HUF)

1988 US$ I = HUF 50.41989 US$ I = HUF 59.11990 US$ 1= HUF 63.21991 US$ I = HUF 74.71992 US$ 1 = HUF 79.01993 US$ I = HUF 91.91994 US$ I = HUF 105.1

WEIGHTS AND MEASURES(metric)

FISCAL YEAR

January 1 - December 31

ABBREVIATIONS AND ACRONYMS

AGROBER Agricultural Construction and Engineering FirmAMP Agroprocessing Modernization ProjectAMPO Agroprocessing Modernization Project OfficeCMEA Council of Mutual Economic AssistanceEFSAL Enterprise and Financial Sector Adjustment LoanEU European UnionFRR Financial Rate of ReturnGDP Gross Domestic ProductICR Implementation Completion ReportMHB Hungarian Credit BankMOA Ministry of AgricultureMOF Ministry of FinanceNBH National Bank of HungaryOKHB Commercial and Credit BankPBs Participating BanksSAR Staff Appraisal ReportSPA State Property Agency

FOR OFFICIAL USE ONLY


HUNGARY

AGROPROCESSING MODERNIZATION PROJECT(Loan 2936-HU)

CONTENTS

Preface .1........................................................ i

Evaluation Summary ................................................ iii

Part 1: Project Implementation Assessment ............. .. 1.................. A. Project Objectives ........................................... 1B. Evaluation of Objectives ....................................... 1C. Achievement of Project Objectives ................................. 2D. Implementation Record and Major Factors Affecting Project Implementation .... . . 5E. Project Sustainability ......................................... 6F. Bank Performance ........................................... 7G. Borrower Performance ........................................ 8H. Assessment of Outcome ...................... 8I. Future Operation ............................................ 9J. Key Lessons Learned ......................................... 9

Part II: Statistical AnnexesTable 1: Sunmmary of Assessments .................................. 12Table 2: Related Bank Loans ..................................... 13Table 3: Project Timetable ....................................... 13Table 4: Loan Disbursements: Cumulative Estimated and Actual .............. 14Table 5: Key Indicators for Project Implementation ....................... 14T'able 6: Key Indicators for Project Operation ........................... 15Table 7: Studies Included in Project ................................. 15Table 8A: Project Costs ........................................ 16Table 8B: Project Financing ........... .......................... 16Table 9: Economic Costs and Benefits ............................... 17Table 10: Status of Legal Covenants ................................. 18Table 11: Compliance with Operational Manual Statements .......... ....... 19Table 12: Bank Resources: Staff Inputs .............................. 19Table 13: Bank Resources: Missions .. .............................. 20

Appendices:A. Aide-Memoire of ICR Initiation MissionB. Borrower's Contribution to the ICRC. Map - IBRD No. 27107

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.


HUNGARY


PREFACE

This is the Implementation Completion Report (ICR) for the Agroprocessing ModernizationProject (AMP) in Hungary, for which an IBRD loan in the amount of US$70 million equivalent wasapproved on May 5, 1988; signed on June 2, 1988; and made effective on August 10, 1988.

At the Borrower's request, an amount of US$20 million equivalent was cancelled on October 12,1993. The loan closed, as originally scheduled, on June 30, 1994, and the last disbursement from theloan account was made on October 28, 1994. The final amount utilized was US$48.144 millionequivalent and the unutilized balance of US$1.856 million was cancelled on October 31, 1994.

The ICR was prepared in the Agriculture and Urban Development Operations Division of theCentral Europe Department (Country Department II) in the Europe and Central Asia Region. The TaskManager is Kishore Nadkarni; the report was reviewed by Rory O'Sullivan, Division Chief and JaneLoos, Project Adviser. The Borrower-the National Bank of Hungary (NBH)-and the Ministry ofAgriculture (MOA) provided written contributions. A summary, jointly prepared by MOA and NBH,is included as an Appendix to the ICR.

Preparation of the ICR was begun in the last supervision mission in October 1993 and elaboratedfurther during the Bank's completion mission in August 1994. It is based on material in the project files,discussions with relevant NBH and MOA officials, interviews with representatives of the participatingbanks, and with selected agencies and subborrowers. The Borrower contributed in the preparation of theICR by: (i) discussing major points included in the report; (ii) providing information on the credit lineand institutional components; (iii) coordinating collection of necessary data; and (iv) providing its sectionof the report.


HUNGARY


EVALUATION SUMMARY

INTRODUCTION

i. Since lending to Hungary began in 1983, the Bank's strategy of assistance has focussed onsupporting the country's program of structural adjustment to make the economy more efficient, flexible,market responsive and competitive in external markets. In the agricultural sector, the AgroprocessingModernization Project was preceded by Bank operations to improve efficiency and competitiveness ingrain storage and farm mechanization; production and marketing of livestock and meat products; and cropproduction. It was followed by two ongoing operations to support the growth of private, new ruralinvestors and to strengthen the food and non-food consumer goods marketing and distribution systems,respectively.

PROJECT OBJECTIvES AND COMPONENTS

ii. Objectives. The development objectives of the Agroprocessing Modernization Project (AMP) wereto enhance the international competitiveness of Hungarian agroprocessed exports and increase theefficiency of production and effectiveness of marketing of agroprocessed products by: (a) increasingearnings of agroprocessed and forestry exports, particularly to the convertible currency markets, byimproving the quality and marketing of exports; (b) improving the efficiency of operations of enterprisesin the agroprocessing subsector by reducing their unit costs of operations and improving theirproductivity; and (c) creating a more effective business climate in the agroprocessing subsector in linewith macroeconomic price and tax reforms (para. 1).

iii. Components. The main project components were: (a) a US$60 million equivalent line of credit;(b) an institutional component to upgrade support services to agroprocessing enterprises including: (i)export trade promotion and marketing; (ii) training in management and marketing; (iii) grading andquality control of raw materials and final products; and (iv) research and development; and (c) a sectorpolicy component consisting of: (i) a phased reduction of agricultural subsidies; (ii) an action programfor improvements in the poultry industry; and (iii) studies leading to the modernization and restructuringof the glass and metal container industries relevant to agroprocessed products (para. 2).

IMPLEMENTATION EXPERIENCE AND RESULTS

iv. Achievement of Objectives. In 1988, when the loan for the project was approved, there was noconsensus that radical change was the only solution. Bank operations focused therefore on securing gainsin selected subsectors, chosen on an assessment of their potential comparative advantage, throughimprovement in the productivity and efficiency of state-owned enterprises. Although the project's goalsand objectives were realistic in the circumstances prevailing in Hungary in 1988 at the time of project

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conception and preparation, they were overtaken by the rapid and sweeping changes that occurred in Eastand Central Europe following the collapse of communism and the abrupt demise of the CMEA. Thesechanges included the accelerated program of macroeconomic and structural reform undertaken in 1990by Hungary's first democratically elected Government under which foreign trade was largely liberalized,prices were freed, subsidies to consumers and producers drastically reduced, and progress made in raisingthe private sector's contribution to GDP to more than 50 percent. These changes had major consequencesfor the project's development impact, particularly in regard to the attainment of the original financialobjectives of increasing convertible currency export earnings and improving the productivity andefficiency of medium to large agroprocessing enterprises. Nevertheless, this was counterbalanced to someextent by the project's success in supporting the Government's evolving priorities of promoting thegrowth of new, private investors in agroprocessing. The project's institutional development objectiveswere largely met with the successful establishment of an Agromarketing Office to assist in the promotionof agroprocessed exports; upgrading of the skills and facilities at leading packaging and qualityinformation centers; and modernization of equipment, instrumentation and facilities at selected producttesting and certification laboratories. Project-supported activities have helped the institutions to enhancetheir market relevance and to increase the extent of their self-financing. Achievement of the project'ssectoral objectives was mixed. Importantly, in the area of agricultural subsidies, there were dramaticreductions in the level of subsidies (as a share of GDP) in the early years of the project which, however,the Government was not able to maintain in the face of external factors, such as the years of successivedroughts. While subsidies have increased as a result, overall they remain at substantially lower levels,at around 2 percent of GDP as compared to 8 percent in 1987 (paras. 6 to 22).

v. Major Factors Affecting the Project. The above factors and the sudden shift in Hungary fromgradual reform of the socialist system to a market system altered very substantially the original parametersof the project. Factors beyond the Government's control included the major changes that occurred inCMEA markets after 1990 which were critical for many Hungarian exporters who had oriented theirproduction to the increasing trade in convertible currency within CMEA markets, and who weresubsequently unable to switch their production to the more demanding markets of the west withoutsubstantial additional investments. This was further compounded by the deleterious effects of an unusualperiod of three successive years of drought which severely affected agricultural production, therebyreducing product quality and increasing unit costs of production for processors. Changes ensuing in theearly years of the Government's implementation of its economic reform program also had, on balance,the effect of reducing the demand on the part of medium to large enterprises for undertaking investments,resulting from a combination of factors including: the sharp contraction in industrial output, real GDPand aggregate fixed investment (despite large inflows of foreign investment); increasing liquidity andsolvency problems of the commercial banks; uncertainties in the enterprises' status pending theirrestructuring or privatization; the reluctance of commercial banks to lend to enterprises with unclearprospects; and delays in completion of administrative and judicial proceedings in the case of enterprisesengaged in work-outs with their creditors (paras. 23 to 28).

vi. Bank and Borrower Performance. Bank performance was satisfactory in all stages of the projectcycle as acknowledged by the Borrower. During project identification and preparation, the Bank wassubstantially involved in assisting the Borrower in the design and development of the project, committingconsiderable staff and consultant resources on its own account. The Bank was flexible as well inmodifying the project's provisions in response to changing circumstances, (e.g., in removing the export-orientation requirement and in simplifying administrative procedures to encourage participation by private,new investors). Project supervision was satisfactory overall but, during the critical period of mid-projectimplementation between 1990 and 1992, it suffered from some discontinuities on account of the severalregional reorganizations and consequent staff reassignments. The Borrower's performance was

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satisfactory as well through all the project stages. A well-staffed Project Office was set up for theproject, with dedicated staff that contributed greatly to project monitoring and regular reporting of theprograms of the institutional components of the project. NBH, the Borrower, carried out well itsresponsibility of monitoring and reporting of the progress of the credit line component. Compliance withcovenants was satisfactory overall in respect of the main covenants. Cooperation between the Borrowerand Bank staff remained responsive and cordial at all times (paras. 30 to 36).

vii. Assessment of Project Outcome. On balance, the outcome of the project is assessed assatisfactory. The project's institutional objectives were largely achieved. Substantial progress was madein the important sectoral policy objective of reduction of agricultural subsidies (from 8 percent of GDPin 1987 to about 1 percent in 1990) although subsequent events, including severe droughts, have causedthe Government to increase its support levels (to about 2 percent of GDP). In regard to the financialobjectives, although the project achieved rather modest gains as to the original objective of increasingexport earnings and improving productivity of medium to large agroprocessing enterprises, it contributedsignificantly to furthering the Government's evolving priorities of promoting the growth of private, newinvestors in agroprocessing (paras. 37 and 38).

PROJECT SUSTAINABILITY AND FUTuRE OPERATIONS

viii. The sustainability of the main project achievements is likely but would depend to a large extenton the Government's success in turning around the overall macroeconomic situation which continues toconstrain many enterprises in improving their operations and deters potential clients from utilizing morefully the services that can be provided by the institutions. Recent trends in the external environment aremore favorable for the project entities with the resumption of growth in western markets and progressiveimplementation of Hungary's Association Agreement with the EU. No specific plan has been preparedfor future operations of the project. However, actions to be taken by the Government under its programof enterprise and financial sector structural adjustment, including a resolution for the portfolio problemsof commercial banks, would be of critical importance for the enterprises as well as the commercial banksconcerned. The Bank is closely involved in assisting the Government in regard to the adjustment programthrough a proposed Enterprise and Financial Sector Adjustment Loan (EFSAL) that is under preparation(paras. 29 and 39 to 43).

KEY LESSONS LEARNED

ix. The main lessons from the project (as summarized in para 44) are:

a) successful restructuring of medium to large state-owned enterprises cannot be accomplishedwithout sweeping reforms that address questions of enterprise ownership and governance,and sustained exposure to domestic and foreign competition;

b) the dangers of too restrictive a specification in terms of targeting of credit, and the need toensure movement towards more general, open lines of credit that are available to a broadspectrum of users;

c) greater reliance on the appraisal process and capabilities of the financial intermediarieswould not only reduce Bank inputs but also help the institutional development of thefinancial institutions and increase their commitment to the ownership of the project;

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d) the need for close follow-up and frequent assessment of the situation in regard to projectimplementation, and for flexibility to adapt the project's provisions and procedures tochanging circumstances;

e) the limitation against use of Bank funds for financing transfers of existing, used assets is animportant constraint in the ability of Bank credit lines to assist in the early stages of theprivatization process; and

f) the importance of careful design of the Bank's subloan application, evaluation and reportingrequirements, taking account of the additional burden that this imposes on private sectorparticipants, both participating banks and investors, operating in a competitive environment.


HUNGARY


PART I: PROJECT IPLEMENTATION ASSESSMENT

A. PROJECT OBJECTIVES

1. The development objectives of the Agroprocessing Modernization Project (AMP) were to enhancethe international competitiveness of Hungarian agroprocessed exports and increase the efficiency ofproduction and effectiveness of marketing of agroprocessed products by: (a) increasing earnings ofagroprocessed and forestry exports, particularly to the convertible currency markets, by improving thequality and marketing of exports; (b) improving the efficiency of operations of enterprises in theagroprocessing subsector by reducing their unit costs of operations and improving their productivity; and(c) creating a more effective business climate in the agroprocessing subsector in line with macroeconomicprice and tax reforms.

2. The main project components were: (a) a US$60 million equivalent line of credit; (b) aninstitutional component to upgrade support services to agroprocessing enterprises including: (i) exporttrade promotion and marketing; (ii) training in management and marketing; (iii) grading and qualitycontrol of raw materials and final products; and (iv) research and development; and (c) a sector policycomponent consisting of: (i) a phased reduction of agricultural subsidies; (ii) an action program forimprovements in the poultry industry; and (iii) studies leading to the modernization and restructuring ofthe glass and metal container industries relevant to agroprocessed products.

B. EVALUATION OF OBJECTIVES

3. The operation's fundamental goal of increasing export competitiveness and efficiency in theagroprocessing subsector was clear. Objectives (a) to (c) were well-defined to achieving these goals.The objectives were also fully consistent with the Bank's strategy of assistance to Hungary at the timewhich focussed on supporting Hungary's program of economic reform, to make it more efficient, flexible,market responsive, and competitive in external markets, particularly in the convertible currency area.The project's goals were realistic in the circumstances existing at the time. In 1988, when the loan forthe project was approved, although socialism was under strain and the demand for reform was growing,there was no consensus that radical change was the only solution. Bank operations focussed thereforeon securing gains in selected subsectors, chosen on an assessment of their potential comparativeadvantage, through improvement in the productivity and efficiency of state-owned enterprises. Inhindsight, the objectives remained restricted in that they did not seek further reforms of such broaderissues as enterprise ownership, governance, skills and technology policies.

4. Project design took into account the experience under previous credit line projects in the sectorwhich also involved both NBH, as the Borrower in each case, and MOA. Since NBH and MOA had bothparticipated under the earlier projects, the project was not considered unduly complex in relation to theimplementation capacity of the project agencies. The main risks to project implementation and

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achievement of project objectives were recognized and assessed at appraisal-the possible effects on thesubsector from variations in implementation of the overall economic transformation and structural reformprograms, and the potential impact of adverse changes in world markets.

5. As described later (para. 24), in addition to the transitional effects of the economic and structuralreform programs, the project's implementation period was marked also by major, unforeseen, externalfactors, including the collapse of the former CMEA markets after 1990, and an unusual series ofconsecutive droughts which severely affected agricultural production. Two significant modifications weremade to the project during implementation. First, at the Borrower's request, in November 1989, asubstantial amount of the loan, US$15 million (or about 20 percent) was allocated to finance emergencyworking capital imports of animal feed to allow continued operations in the agroprocessing enterprisesconcerned. Second, in support of the Government's policy of encouraging the growth of new, privateproducers in the agroprocessing subsector, the original export-orientation criteria were significantlymodified in July 1992 by waiving the minimum quantitative export-orientation requirement. In addition,other modifications were made between 1991 and 1994 to simplify application, evaluation and approvalprocedures, all aimed at encouraging greater participation by emerging small, private investors.

C. ACHE:VEMENT OF PROJECT OBJECTIVES

6. The project succeeded in substantial achievement of its institutional development objectives insupport of creating a more effective business climate in the agroprocessing subsector, and in encouragingthe growth of new, private investors in agroprocessing. Sector policy and financial objectives werepartially achieved, to a lesser extent than in the case of the institutional objectives.

Sector Policy Objectives

7. Achievement of sector policy objectives was partial. In respect of agricultural subsidies, majorreductions were made between 1988 and 1990, as agreed under the project, with the level of agriculturalsubsidies declining from 8 percent of GDP in 1988 to around 1 percent in 1990. However, agriculturalsubsidies have increased from these levels to around 2 percent of GDP at present, due in part to thepressures arising from the adverse effects of the successive droughts between 1990 and 1993. In respectof the action program for the poultry industry, although significant measures were taken to encouragehigher productivity with the liberalization of animal feed protein imports, no significant headway couldbe made given structural problems in the industry. Finally, in respect of the glass and metal containerindustries relevant to agroprocessed products, although studies for modernization and restructuring of theindustries were undertaken, as planned, their findings prudently were not implemented in the prevailingcircumstances with the financial difficulties of the container-making enterprises and the continuinguncertainties in the main container-consuming agroindustries.

Financial Objectives

8. Achievement of financial objectives was also partial. With the modifications made during projectimplementation in support of the Government's policies for private sector development in theagroprocessing subsector, the original emphasis in the financial objectives on increasing export earnings,particularly to convertible currency markets, and on improving efficiency through unit cost reductions,was modified to include the financing of viable private agroprocessing projects, even if not destined forexports.

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9. Consequently, only 14 of the total of 56 subloans (accounting for about 25 percent of the amountonlent) were for export-oriented subprojects. With a few notable exceptions, actual exports were generallysignificantly lower than projected, reflecting the combined adverse effect of the collapse of the CMEAmarkets, the difficulties in switching to Western markets, and the effects of the droughts that affected rawmaterial availability and quality, and resulted in increased production costs.

10. The objective of improved efficiency through reductions in unit costs in medium to largeagroprocessing enterprises was also achieved only to a limited extent. While the new machinery andequipment, and upgrading of domestic and imported working capital inputs, enabled by the subloansresulted in improved technical capability, the efficiency aspects could be realized to only a limited extentgiven the excess capacity in face of the weak domestic and external markets. In some cases, even thoughthe subproject was successfully implemented, the sponsoring enterprise faced severe problems from othersources, leading to, in some cases, institution of bankruptcy or liquidation proceedings. Notably, in somecases, the viability of the subproject operations resulted in the subproject being spun off as a separate,autonomous entity even while the original sponsoring enterprise was undergoing major reorganization.

11. Portfolio Characteristics: A total of 56 subloans was made under the project for an amount ofabout US$ 45 million of which about US$26 million was for financing of working capital (including theemergency imports of animal feed) and about US$19 million for investment financing. The subloansranged between US$ 18,000 to US$ 6.8 million; subloans for export-oriented subprojects, on average,were about US$ 780,000 while those for other investment projects were about US$250,000 per loan.

12. There were some significant differences as compared to expectations at appraisal. First, only asmall number of the medium to large agroprocessing enterprises that were expected to participate underthe project did in fact do so. This was due to a combination of factors, all leading to a reduced demandfor borrowed funds for investment purposes-the continued interest of foreign investors which resultedin some of the better-performing enterprises having access to equity and other funds through the foreigninvestor; the uncertainties caused in the medium to large state owned enterprises in the face of impendingtransformation or privatization; high interest rate levels which deterred some enterprises from undertakinginvestments; the weakness in domestic markets following from the macroeconomic adjustment processas consumers reduced their demand for certain agroprocessed products; the collapse of the CMEAmarkets; and the difficulties in penetrating Western markets in the face of quality and other requirements.Second, the subsectoral composition of the subloans was significantly different from expectations atappraisal. While, earlier, the poultry and wine industries had been expected to be the largest participants,in the vastly changed circumstances since 1990, they had relatively small shares with the largest sharesgoing to processed fruits and vegetables (28 percent) followed by meat processing and grain milling(about 16 percent each).

13. In regard to performance, about 70 percent of the project investments appear to be operatingprofitably even in the difficult economic environment described earlier. However, a significantproportion (about 25 percent) of the larger subprojects faced problems due to a combination of the effectsof weak domestic markets, the loss of CMEA markets, and the financial problems caused by inter-enterprise arrears and high interest costs. In six cases, involving subloans in the amount of US$ 10million, the enterprises are engaged in bankruptcy or liquidation proceedings with their creditors. Work-out and reorganization plans are being negotiated in most cases. Other medium to large subprojectsappear to be operating profitably although achievements in most cases are lower than expected.Performance in respect of the smaller subprojects has been more even, with arrears affecting around tenpercent of the total number of such subloans.

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14. Rates of Return: Actual financial rates of return (FRRs) are estimated to be significantly lowerthan projected in most cases as a result of the effect of the unfavorable factors discussed above.Calculation of FRRs for many of the larger subprojects has been affected by the changes in the originalsponsoring enterprise pursuant to voluntary, or involuntary, reorganization. Against the expectationsat appraisal of FRRs ranging from 26 to 51 percent with an average of around 35 percent, the actualFRRs for the larger subprojects are likely to be substantially lower, even negative in a few extreme cases.For smaller subprojects, sampled FRRs suggest a range of around 18 to 50 percent.

15. Participating Banks: Only three banks participated under the project although many more hadbeen cleared in terms of eligibility to participate. As expected, Commercial and Credit Bank (OKHB -which was formed in 1987 from the Central Bank's agricultural lending department) had the largest shareof the subloans, accounting for about 60 percent of the total amount onlent; the other two PBs, theHungarian Credit Bank, and Mezobank, had smaller shares at about 25 and 15 percent each. Reasonsfor the limited participation of the banks include the fact that several of the eligible banks weresimultaneously participating under other concurrent Bank credit lines, including some available to theagricultural sector.

16. Loan evaluation and supervision procedures under the project contributed to strengthening of thePBs' lending activities to agroprocessors, particularly in respect of servicing new, small, private sectorclients. More general development of the PBs' institutional and operational capabilities was pursuedthrough other concurrent and successor Bank operations. In common with many other Hungarianconmmercial banks, the PBs under the project are facing systemic problems, particularly in relation to non-performing and problem parts of their portfolios. The Government has taken some measures tostrengthen the financial situation of the banks through injections of new capital. However, substantialfurther progress is needed, and this is being sought to be pursued under a proposed Enterprise andFinancial Sector adjustment operation currently being discussed with the Government.

Institutional Objectives

17. Most institutional objectives were substantially achieved. This extended as well to the completionof the studies under the project for the modernization of the glass and metal container industries whichcould not be implemented, however, due to the unfavorable situation in the container manufacturing andconsuming industries.

18. In respect of export promotion and marketing programs for agroprocessed products, theAgromarketing Office, set up under the project, has become well-established as a focal point forinformation for exporters. It has also had a central role in developing trade marks suitable for certifyingproduct quality and origin. The Office has been active in organizing trade promotion fairs and seminars,and has had some success in acting as a middleman in enabling the establishment of joint ventures.

19. One of the earliest institutional programs under the project was that aimed at training of exportmarketing and management instructors. The programs were well-received by the user community inagroprocessing enterprises, and seminars and training courses were regularly held.

20. The Packaging and Quality Information Centers supported under the project have been enabledto significantly upgrade their capabilities and have successfully established networks with counterpartsabroad. Both centers have been able to maintain a client-oriented focus, reflected in steady demand fromthe customers.

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21. Capabilities for grading and quality control were significantly upgraded at five major qualitycontrol centers, which serve as demonstration projects for others.

22. The project also provided for pilot operations at leading research institutes for testing innovativetechniques for quality enhancement of raw materials for the food industry, and for goat husbandry,including cheese making.

D. IMPLEMENTATION RECORD AND MAJOR FACTORS AMCEC-NG PROJECT IMPLEMENTATION

Implementation Record

23. The project was appraised in October 1987; loan negotiations were held in March 1988; the loanwas approved in May 1988 and became effective in August 1988. Disbursement was substantially slowerthan expected at appraisal. Disbursements slowed down in particular after 1990 as the effects of thetransformation process and the impact of exogenous shocks coincided. While the several modificationsthat were made in consultation with the Borrower to reflect the changing circumstances (e.g., increasingthe share of working capital financing; simplification of procedures to encourage new, private investors;and raising of procurement limits to increase the flexibility given to the PBs) all helped to increase loanutilization, an amount of US$20 million equivalent (or about 28 percent of the original amount) wascancelled in October 1993 at the Borrower's request, and a further US$1.856 million in October 1994at loan closing. In seeking these cancellations, the Borrower took into account the fact that funds wouldcontinue to be available for financing of viable agroindustrial subprojects under another ongoing Bankcredit line (Loan 3020-HU).

Factors Not Generally Subject to Government Control

24. Two factors in particular had a major impact on project implementation. First, the majorchanges that occurred after 1990 in the former CMEA markets which were critical for many Hungarianexporters. The effect was even more pronounced as, encouraged by the increasing trade in convertiblecurrency within CMEA participants prior to 1990, many enterprises, including some of the largersubborrowers under the project, had undertaken investments aimed primarily at these CMEA convertiblecurrency markets, but which were not readily switchable to the more demanding Western markets whenthe CMEA markets disappeared. The second was the deleterious effect of an unusual period of threesuccessive droughts between 1990 and 1993 which severely affected agricultural production, therebyreducing product quality and increasing unit costs of production for processors. The prolonged droughtperiod also contributed to escalating pressures on the Government for reversing the falling trend inagricultural subsidies until 1990.

Factors Generally Subject to Government Control

25. A major economic change occurred in 1990 as the first democratically elected Government inHungary undertook an accelerated program of macroeconomic and structural reform. This programdiffered radically from earlier efforts in its clear vision of a Hungarian market economy fully integratedinto Westem Europe. Foreign trade was liberalized (the only goods requiring licenses were those subjectto international agreements), prices were freed, subsidies to consumers and producers were drasticallyreduced, and legal restrictions on hiring and firing of workers were removed. Progress was also achievedin reforming the enterprise and financial sectors, including the creation of a large number of private banksand sale of state-owned enterprises to domestic and foreign investors, raising the share of private sectorcontribution to GDP to more than 50 percent.

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26. Changes ensuing from these programs affected project implementation in various ways, but thecombined effect was to reduce the demand for borrowed funds for undertaking investments.Implementation of these reforms was accompanied by a sharp contraction of industrial output and realGDP. The contraction of activity was accompanied by a pronounced decline in aggregate fixedinvestment despite large inflows of foreign investment. The pace of structural reforms decreased,significantly affecting the performance of key economic sectors. The major banks faced increasingliquidity and solvency problems. As a result of large losses by state-owned enterprises and a persistentlarge fiscal deficit, bank lending to the more dynamic sectors in the economy became severely limited.

27. Hungary's success in attracting foreign investment increased capital available to the better-performing agroprocessing enterprises, reducing their dependence on debt financing. At the same time,several medium to large agroprocessing enterprises that continued to be under state ownership, weresubject to uncertainties arising from impending changes in their status, and chose to postpone majorinvestments. The initial effects of some other major economic reform measures were also to discourageinvestments and use of borrowed funds. The new banking law and regulations introduced in 1990required banks to increase loan loss provisioning which also contributed to the high interest rates duringthe period by requiring the banks to charge higher spreads. While the application of the new bankruptcyand liquidation regulations since 1991 has contributed to increased financial discipline, enterprises havebeen caught up in lengthy proceedings given the limited administrative capacities of the courts and otheragencies concerned.

Factors Generally Subject to Implementing Agency Control

28. MOA carried out well its role in relation to the institutional components under the project asmany of the institutions concerned continued to be under its jurisdiction. For the credit line component,MOA was unable to have any significant impact in expediting either credit utilization or the earlyresolution of pending cases for agroprocessing enterprises that were nominally under its aegis but wereeither in the process of being transformed and transferred to other agencies such as the State PropertyAgency (SPA) and local governments. Similarly, in the case of participating banks, with the autonomousstatus of the banks pursuant to the banking sector reforms, NBH had limited influence in requiring banksto take necessary actions to expedite project implementation and credit line utilization. Around mid-waythrough project implementation, starting from 1991, the project also faced competition from somebilateral credit lines that were made available to Hungary at lower nominal interest rates than the Bank'srates and also provided greater flexibility to potential users by permitting the financing of transfers ofused assets (not permissible under Bank credit lines) as well as purchase of new equipment. NBH onlentfunds from these competing credit lines to participating banks at a rate which was substantially (25%)below that for the Bank line under the project.

E. PROJECT SUSTAINABILITY

29. The sustainability of main project achievements is likely but would depend to a large extent onthe Government's success in turning around the overall macroeconomic situation which continues toconstrain many enterprises in improving their operations and deters potential clients from utilizing morefully the services that can be provided by the institutions. Recent trends in the external environment aremore favorable for the project with resumption of growth in Western markets and progressiveimplementation of Hungary's Association Agreement with the EU. Enterprises that have been successfulin exports are expected to continue to do so in the more favorable external environment. For others, theoutcome would depend upon the actions to be taken by the Government, including early transformationof status, and early completion of reorganization proceedings where the enterprises have been caught up

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in bankruptcy or liquidation proceedings. Participating banks are expected to continue to financeagroprocessing projects for viable private and cooperative investors. Progress under the enterprise andfinancial sector adjustment reform program, being pursued by the Government with Bank assistance inthe form of a possible EFSAL, would further reinforce the banks' ability and willingness to lend.Measures to be taken to deal with the banks' portfolio problems under the adjustment program areexpected to lower the levels of mandatory provisioning by the banks and thus reduce the pressure on highinterest rates. The project's institutional achievements are likely to be sustained as upgrading of skills,facilities and technology under the project have increased the market relevance of the institutions'activities and helped them to increase their levels of self-financing. However, to the extent that severalof the institutions continue to rely to a various extent on Government budgetary support which is subjectto increasing uncertainties in the face of the urgent need to reduce deficit levels, their future continuedeffective performance would depend upon continued efforts to increase even further the extent of self-financing, which itself would depend upon the rate of pick-up in the overall economy.

F. BANK PERFORMANCE

30. Bank performance was satisfactory in all stages of the project cycle as acknowledged by theBorrower. During project identification and preparation, the Bank was substantially involved in assistingthe Borrower in the design and development of the project, committing considerable staff and consultantresources on its own account. The Bank provided guidance in the preparation of extensive marketstudies, including export prospects to Western markets for selected agroprocessing branches. Considerablework was carried out as well on an assessment of the enterprises as a result of which about 70 enterpriseswere identified as likely participants under the project. During project preparation, the Bank found thatits early emphasis on targeting selected agroprocessing industry branches (e.g., poultry, wine, woodproducts, etc.) as well as on selected enterprises was likely to prove too restrictive in the changingeconomic circumstances, and by appraisal, the Bank moved towards opening the credit line to all eligibleagroprocessing exporters. The Bank was also instrumental in helping the Borrower to design a packageof institutional development aimed at providing exporting agroprocessing enterprises with appropriatesupport.

31. The main project risks-the potential impact on the agroprocessing subsector of the extent andpace of economic reform being pursued by the Government, and of unfavorable developments in exportmarkets-were identified at appraisal. However, what could not be foreseen was the major accelerationof the economic reform after 1990 and the resulting transitional discontinuities -- including the years ofnegative GDP growth and weaknesses in domestic markets -- and the sudden collapse of the CMEAmarket.

32. The Bank mounted nine supervision missions between 1988 and 1994, roughly at six-monthintervals. Supervision missions were staffed either by agricultural economists or financial analysts; inhindsight, the involvement of agroindustries specialists from time to time may have been beneficial inenabling an assessment of problems by specific branches and enterprises. The critical mid-implementation(1990 to 1992) supervision period was marked by some staff discontinuities resulting from internal Bankreorganizations and reassignments. In respect of the credit line component, supervision focussed, fromthe outset, on the banks' agroprocessing lending activities; more general issues relating to the PBs' overallfinancial performance and operations were addressed under concurrent other Bank operations, includingcredit lines to the industrial sector and a loan to the PBs themselves for undertaking modernization oftheir operating systems and facilities.

- 8 -

33. From an early stage, supervision focussed on the need to improve the slow pace of subloancommitment and disbursement. Efforts were made to bring Hungarian firms into contact with possibleforeign partners for forming trading joint ventures. PBs were consistently advised to raise the level oftheir promotional activities for generating greater investor interest in the credit line. The Bank showedflexibility in making several modifications to the credit line provisions to reflect changing needs andcircumstances. This included the modifications to permit greater working capital financing; waiving ofthe minimum export-orientation requirement to enable wider participation, including from emerging new,private investors; simplification of application, evaluation and approval procedures to encourage smallinvestors; and raising procurement and subloan processing limits to give greater flexibility to the PBs toutilize the credit line. In one respect, however, the Bank was not able to respond fully to the Borrower'srequests -- this was in regard to the use of Bank funds for financing transfers of existing assets e.g. forenabling new private investors to purchase existing assets of state farms and enterprises. Nevertheless,the Bank emphasized that Bank funds should be used in a complementary manner for financing thepurchase of new equipment, facilities and working capital in conjunction with the purchase of used assets.Supervision missions also visited subborrowers on a sample basis or where problems were known toexist. However, tracking of progress in remedial action was difficult once the enterprises had enteredinto judicial proceedings (e.g., into bankruptcy or liquidation negotiations with creditors).

G. BORROWER PERFORMANCE

34. The Borrower's performance was satisfactory through all stages of the project cycle. MOA puttogether an experienced team to work with Bank staff during project preparation which successfullycoordinated the preparation of the several market and financial analytical studies that were undertaken.A well-staffed Agroprocessing Modernization Project Office (AMPO) was set up in AGROBER, anagency which had participated extensively under the previous project. AMPO functioned effectively withdedicated staff, and contributed greatly to project monitoring and regular reporting of the progress of theinstitutional components of the project. Responsibility for monitoring and reporting of the credit linecomponent was placed on the section already set up in NBH under earlier Bank credit lines. This sectionwas again well-staffed, and monitoring and reporting were regular. Both MOA and NBH officialsremained accessible at all times for consultation and cooperated fully with supervision missions.

35. The Borrower substantially complied with project financial and reporting covenants. Compliancewas partial in respect of some of the sector undertakings. Thus, the action plan for the poultry industrywas only partially implemented.

36. Some of the measures being pursued by the Government in the broader context of macroeconomicand structural reform also impacted on project implementation (e.g., the uncertainties caused byimpending transformation and privatization/restructuring of state owned enterprises which led them todefer investments; the time taken to deal with the banks' non-performing portfolio problems whichincreased the pressure on interest rate levels through the mandatory higher provisioning; and delays incompletion of bankruptcy or liquidation proceedings in the face of limited capacities of the courts andother agencies concerned).

H. ASSESSMENT OF OUTCOME

37. Major changes, not foreseeable at appraisal, took place in the internal and external economicenvironments with the events since 1990 described earlier. Ensuing transitional changes impacted on theproject's implementation. Consequently, the project's original financial objectives-increasing exportearnings, particularly to convertible currency markets and improving enterprise efficiency through

reductions in unit costs in medium to large agroprocessing enterprises-could be achieved to only alimited extent as compared to earlier expectations. However, this is compensated to some extent by theproject's success in supporting other emerging priorities under the Government's ongoing reform programsuch as encouraging the growth of new, private investors in agroprocessing activities. Overall, asindicated earlier (para 13), around 70 percent of the project investments appear to be operating profitablyeven in the difficult economic environment in recent years. On the other hand, institutional objectiveswere largely met. With project supported activities, institutional capacities have been built up which arelikely to be sustained. The project contributed to the participating banks' capabilities for evaluating andmonitoring agroprocessing investments. Finally, substantial improvements were made in reducing levelsof agricultural subsidies during the period of project implementation although much more needs to bedone in the context of the urgent need to reduce budgetary deficits in Hungary.

38. On balance, therefore, the project outcome is assessed as satisfactory. Even though a substantialpart of the loan was not utilized and the original financial objectives achieved only to a limited extent,the project achieved important sectoral and institutional gains; strengthened the participating banks'capabilities in financing agroinvestments; and supported private sector development in agroprocessingactivities.

1. FUTURE OPERATION

39. The Borrower has not prepared a formal operational plan given the multiplicity of participants.The Borrower's submission, jointly prepared with MOA, is annexed to the ICR. However, during theICR completion mission, NBH and MOA confirmed that the main project objectives continue to begenerally valid and reiterated their commitment to enable the sustaining of viable project components.

40. In respect of the sector policy comfponient, the issue of agricultural subsidies was discussedbetween the Governiment and the Bank in the context of the joint review of the sector report titledAgricultural Policy Review in September 1994. The Government has indicated that it would continueto assess the levels and forms of agricultural subsidies in the light of the evolving situation, includingHungary's obligations under GATT and the EU Association Agreement.

41. In regard to the institutional component, the institutions supported under the project are beingencouraged to increase the extent of their self-financing through direct commercial contacts with potentialend-users. Their success in doing so would depend critically upon a revival of the overall economywhich would encourage end-users to increase their utilization of such services.

42. For the credit component, resolution of the cases where enterprises have entered into bankruptcyor liquidation proceedings, including possible work-outs and reorganizations, depends upon the speed ofthe judicial and administrative process. Actions to improve the situation, including measures tostrengthen the performance of the banking system, are being pursued in the context of the proposedEFSAL that is being discussed with the Government.

43. Given the concurrence and common elements in implementation of various ongoing credit linesin Hungary, it is recommended that an OED review be planned for the second half of 1996 to coverjointly both the Agroprocessing Modernization and the Integrated Agricultural Exports DevelopmentProjects (Loan 3229-HU). The latter is currently scheduled to close by end-December 1995.

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J. KEY LESSONS LEARNED

44. The main lessons from the project, which may also have more general relevance for otherprojects, are:

(i) successful restructuring of medium to large state-owned enterprises cannot be accomplishedwithout sweeping reforms that address questions of enterprise ownership and governance,and sustained exposure to domestic and foreign competition;

(ii) the dangers of too restrictive a specification in terms of targeting of credit, and the need toensure movement towards more general, open lines of credit that are available to a broadspectrum of users;

(iii) greater reliance on the appraisal process and capabilities of the financial intermediarieswould not only reduce Bank inputs but also help the institutional development of thefinancial institutions and increase their commitment to the ownership of the project;

(iv) the need for close follow-up and frequent assessment of the situation in regard to projectimplementation, and for flexibility to adapt the project's provisions and procedures tochanging circumstances;

(v) the limitation against use of Bank funds for financing transfers of existing, used assets is animportant constraint in the ability of Bank credit lines to assist in the early stages of theprivatization process; and

(vi) the importance of careful design of the Bank's subloan application, evaluation and reportingrequirements, taking account of the additional burden that this imposes on private sectorparticipants, both participating banks and investors, operating in a competitive environment.

- 11 -


HUNGARY

AGROPROCESSING MODERNIZATION PROJECT(Loan 2936-HRJ)

PART II. STATISTICAL ANNEXES

Table 1: Summary of AssessmentsTable 2: Related Bank LoansTable 3: Project TimetableTable 4: Loan Disbursements: Cumulative Estimated and ActualTable 5: Key Indicators for Project ImplementationTable 6: Key Indicators for Project OperationTable 7: Studies Included Under the ProjectTable 8A: Project CostsTable 8B: Project FinancingTable 9: Economic Costs and BenefitsTable 10: Status of Legal CovenantsTable 11: Compliance with Operational Manual StatementsTable 12: Bank Resources: Staff InputsTable 13: Bank Resources: Missions

- 16 -

Table 8A: Project Costs(US$ million)

Appraisal Estimate Actual/Estimated

Local Forei-n ~~LocalFoegLoOcstal Foreign Total Costs TotalCosts Costs Costs

Wine and Juice 17.5 17.0 34.5 1.3 1.0 2.3

Processed Vegetables and Fruits 7.5 12.3 19.8 3.4 7.3 10.7

Poultry 28.1 29.6 57.7 0.7 0.7 1.4

Forestry 12.0 16.7 28.7 3.7 4.4 8.1

Breweries --- --- --- 1.9 1.9 3.8

Bakeries --- --- --- 22 1.6 3.8

Meat --- --- --- 7.1 4.5 11.6

Other --- --- --- 4.8 11.2 16.0

Technical Assistance 7.2 4.8 12.0 0.8 6.1 6.9

Agricultural Program (incl. marketing) 1.3 6.2 7.5 11.6 11.6

Total 73.6 86.6 160.2 25.9 50.3 76.2

Table 8B: Project Financing(US$ million)

Appraisal Actual\EstimaLed

Subloans Subloansfrom Govt. Prol'ect from Govt. Project IBDToa

Commercial Contrib. Beneficiaries IBRD Total Commercial Contrib. BeneficiariesBanks Banks

Equipment 24.8 - 25.0 58.8 108.6 4.5 2.2 5.5 15.7 25.9

Civil Works 28.3 - 7.1 - 35.4 1.0 0.7 6.1 - 7.2

Incremental Working - - - - - 5.5 - 4.1 13.7 19.7Capital

Training & Technical - 3.2 - 5.5 8.7 - 0.9 0.8 6.0 7.7Assistance

Agricultural Program - - 1.8 5.7 7.5 - - - 11.6 11.6(incl. export marketing)

Other - - - - - 0.6 - 2.5 1.0 4.1

Total 53.1 3.2 33.9 70.0 160.2 11.7 1.2 15.3 48.0 76.2

Percentage Share 33 2 21 44 100 15 2 20 63 100

- 17-

Table 9: Economic Costs and Benefits

At appraisal, the project as a whole was estimated to account for:

(i) incremental sales revenue of US$522 million at fulldevelopment;

(ii) profit before taxes and depreciation of about US$250 million;and

(iii) incremental convertible currency savings of about US$280million yearly. The minimum financial rate of return (FRR)required for subproject eligibility was 18 percent.

Ex-post data on project benefits are not available because of majororganizational changes within many of the larger participatingenterprises. Based on available samples, FRRs for the largersubprojects appear to range between negative in a few extreme casesto about 50 percent while those for smaller subprojects range typicallybetween 18 to 50 percent.

- 18 -

Table 10: Status of Legal Covenants

Overall Project Rating: 2Original

Agreement Section Covenant Status Fulfillment Description of Covenant CommentsType Date

LA 3.0)1(h) M C For carrying out Pan A of tde Project, Borrower is to make available to Compliedthe Guarantor funds under Subsidiary Financing Agreements terms andconditions approved by the Bank.

LA 3.01(c) M C For carrying out Part B of the Project, Borrower is to niake available Compliedparticipating Banks finds under Subsidiary Financing Agreements temisand conditions approved by the Bank.

LA 3.01(d) NI C Borrower to supervise the carrying out by the Participating Banks of Compliedtheir obligations under the Subsidiary Financing Agreements, and ensurethat the individual subloan limits and the aggregate loans to any oneenterprise shall niot exceed the stipulated limits.

LA 3.02 P C Procuremnenit to he govemed by Schedule 4 to the LA. Coniplied

LA 4.01(b) F C Borrower to maintain satisfactory records and accounts in accordance Compliedwith sound accounting practices.

LA 4.01(h) F C Borrower to have records and accounts, including those for the Special CompliedAccount, audited not later than five months after the close of the fiscalyear.

LA 4.01(c) F C Borrower to maintain appropriate records and accounts for all Conipliedexpenditures for which withdrawals were made form the SpecialAccounts and ensure that audit report contains a separate opinion by theauditors.

GA 3.01 MN C Guarantor to provide funds to finance technical assistance, training and Conipliedtechnical services of Part A.

GA 3.()2 N4 C Guaranitor to employ consultants satisfactory to the Bank for carrying Compliedout Part A of the Project.

GA 3.05(a) M C Guarantor to carry utit export trade promotion program. Complied

GA 3.05(a) M C 4/'20/Mi) Guarantoir to establish agrornarketing office, to assist exporters. Complied

GA 4.03 M C Guarantor to set tip interindustry consultative panel to deterniine work Conipliedpriorities of lIHFl regarding R & D in agroprocessing.

GA 4.01(h) F C Guarantor to liave records and accounts for each fiscal year audited in Conipliedaccordanice with appropriate auditing principles not later than fivemonths after the end of the f iscal year.

SLI Aniex I L C' Guaraittor to reduce invcstinent, production and consumer subsidies by Compliedtine-thiri between 1987 and 1990.

SLI Annex 2 E (CP Guarantor to carry out a poultrv industry plan of action. PartiallyComplietd

Covenant type: Status:M = Managerial C = CompliedF = Financial CP = Partially CompliedT = TechnicalP = ProcurementE = Economic

- 19 -

Table 11: Compliance with Operational Manual Statements

Basically, there was compliance with the applicable Bank Operational Manual Statements.

Table 12: Bank Resources: Staff Inputs(Staff-Weeks)

Stage of Project Cycle Planned Revised Actual

Through appraisal n.a. n.a. 17.8

Appraisal-Board n.a. n.a. 45.2

Board-Effectiveness

Supervision 82.0 100.6 88.4

Completion 12.0 11.0 6.4

TOTAL n.a. n.a. 157.8

- 20 -

Table 13: Bank Resources: Missions

PerformanceNo. of Days in Rating 2 Types of

Stage of Project Cycle Month/Year Persons Field Specialization Implementation Development Problems

status objectives

Through Appraisal 3/85 1 18 R na na na6/85 1 6 E na na na10/85 1 3 R na na na2/8610/86 2 10 E, R na na na2/87 6 15 E, F, M na na na6/87 5 11 E, F, M, R, A na na na

1 14 E na na na

Appraisal - Board Approval 10/87 5 17 E, F, R, A na na na

Board Approval - 6/88 6 10 E na na naEffectiveness

Supervision I 3/89 2 16 E, E I I ---Supervision H 9/89 2 12 E, A 2 1 F, MSupervision m 11/90 2 10 E, R 2 2 F, MSupervision IV 4/91 2 10 E, F 2 2 F, MSupervision V 10/91 1 10 F 2 2 F, MSupervision VI 9/92 3 10 F 2 2 F, MSupervision VII 4/93 1 3 F 2 2 F, MSupervision VEII 10/93 2 10 F, E 2 2 F, M

Completion 8/94 1 5 F 2 2

Follow-Up 2/95 1 3 F 2 2 F, M

1 - Specialization 2 - Performance Rating 3 - Types of Problems

A = Agriculturalist I = Minor problems F = FinancialE = Economist 2 = Moderate Problems T = TechnicalD = Education Specialist 3 = Major Problems M = ManagerialF = Financial AnalystH = HorticulturistL = Livestock SpecialistM = Marketing SpecialistN = EngineerR = Forester

m:\AhN=mpmatr.iCr

APPENDIX APage 1 of 6

HUNGARY

AGROPROCESSING MODERNIZATION PROJECT(LOAN 2936-HU)

AIDE MEMOIRE OF IMPLEMENTATION COMPLETION REPORT MISSION

1. A World Bank (WB) mission visited Hungary between August 3 to 9, 1994 to initiate work onthe Implementation Completion Report (ICR) for the Agroprocessing Modernization Project (AMP). Themission met with representatives of the Borrower (NBH), the Ministry of Agriculture (MOA), the AMPProject Unit, the main participating banks, and visited selected subprojects. The mission would like tothank the various Hungarian counterparts for all the cooperation and courtesies extended to it. Themission's views expressed in this Aide Memoire are subject to confirmation by WB management on themission's return to Washington.

PROJECT OBJECTIVES

2. The Borrower and MOA confirmed that the project objectives as expressed in para 4.03 of theStaff Appraisal Report (SAR) remain generally relevant. However, major changes have taken place inthe project's environment since it was appraised in 1987, which have had extensive impact on theproject's implementation and execution. These include:

-- the major political changes since 1990;-- the new governments' economic and structural reform programs;- the collapse of the CMEA markets since 1990;-- Hungary's Association Agreement with the EU;- new laws on banking, and on bankruptcy/liquidation of enterprises.

3. The combined effect of these factors has been that, while some of the project components havebeen successfully implemented, others have faced various degrees of difficulties. This has beenparticularly true of the credit component under the project.

PROJECT IMPLEMENTATION AND OPERATIONAL PLAN

4. Part A of the project has, on the whole, been implemented as planned. Although major studiesunder the project were completed, e.g. on the glass and can container industries, their findings could notbe implemented due to the changing situation in the user and feeder industries resulting from the ongoingchanges in the domestic and external (notably CMEA) markets.

5. In regard to the component on the establishment of an agricultural marketing office andpreparation of an export marketing promotion program, modifications were made to the original concept.The Borrower's ICR should indicate the reasons for the modifications, the alternative arrangements made,and the impact on agricultural marketing and exports.


6. Under Part B of the project, while many subprojects have achieved their objectives, aconsiderable number are facing various degrees of operational and financial difficulties, includingbankruptcy and liquidation proceedings in some cases.

OPERATIONAL PLAN

7. The WB's revised guidelines (April 1994) on preparation of ICRs requires the preparation of anoperational plan by the Borrower and the implementing agencies, indicating actions and measures to betaken by the Borrower, the relevant Government agencies, and the project entities, to ensure satisfactoryfuture implementation and operations under the project, and the achievement of the project's objectives.The mission welcomed very much the assurances of the Borrower and the project agencies as to providingtheir best efforts to meet the revised requirements. It was agreed that a draft operational plan would beprepared and sent to the WB by October 31, 1994. The draft operational plan should include:

* the Government's views on the continued relevance of the project objectives;* actions and measures to be taken to ensure sustainability and continued satisfactory

operation of institutions and technical assistance programs under the project; and* actions and measures to be taken to resolve the situation in case of subprojects and

subborrowers facing financial difficulties, including enterprises that continue to be understate ownership.

The operational plan should be supported by a table that indicates clearly, for each major item under thepolicy, institutional, technical assistance, and credit components, the following:

- major issues/problems;- major actions/measures already taken, being taken or to be taken;- schedule and timing of each major action/measure; and- the main Government and/or project agencies responsible for the actions/measures.

BORROWER'S EVALUATION OF PROJECT IMPLEMENTATION

8. The mission drew the attention of NBH, MOA and the project entities to the Borrower'sresponsibilities in the preparation of the ICR as indicated in the WB's Operational Manual Statement andGood Practices for ICR Preparation (GP 13.55 of April 1994, paras 4 and 5). Copies of the WB's BP13.55 and relevant parts of GP 13.55 were left with the Borrower, MOA and the AMP Project Unit.

9. As indicated in BP 13.55 and GP 13.55, the Borrower's ICR should include a summary notexceeding 10 pages, together with the supporting report and annexes.

10. The Borrower's complete ICR is to be submitted to the WB latest by October 31, 1994.

PROJECT COST AND FINANCING PLAN

11. To enable a comparison of appraised and actual project costs and financing plan, the Borrowerand the project agencies should update the relevant tables (Tables 3 and 4) on pages 23 and 24 of theStaff Appraisal Report No. 7091-HU of April 11, 1988.


INFORMATION TO BE SENT TO THE WORLD BANK

12. To enable the WB to complete the draft of Part I of the ICR, it was agreed that the Borrower andMOA would ensure that the information indicated in Annex 1 is sent to the WB by October 31, 1994together with the updated project costs and financing table (para. 11) and the draft operational plan(para. 7).

13. The proforma in Annex 1 should be used for all large subprojects (those with subloans overUS$300,000). For smaller subprojects, a less detailed proforma could be used, for example, excludingthe sections on subproject financial rate of return, procurement, and investor financial rates of return fromPart II, and excluding Parts III to V. However, financial rates of return should be calculated for arepresentative sample of the smaller subprojects.

14. The mission indicated that the WB's draft of Part I of the ICR would be submitted to NBH andMOA within two weeks of receipt of the information in Washington.

COORDINATION OF ICR PREPARATION

15. The following persons would coordinate the preparation of the Borrower's and the WB'spreparation of the ICR:

For the Borrower: Mr. Emil Keleti (Dept. of Food Processing, Ministry of Agriculture)Ms. Maria Deak (National Bank of Hungary)Mr. Zsolt Papp (APM Project Office)

For the WB: Mr. Kishore Nadkarni (Central Europe Department)

Budapest/WashingtonAugust 8, 1994 andAugust 29, 1994


Annex 1

Subproject Information Summarm to be Submittedfor Each Large Subloan/Subproject

(for each subloan over US$300,000 equivalent)

PART I. Background Information

Name of Investing Enterprise:

Location:

Type of Ownership: majority state-owned/cooperative/majority private-owned

Tvpe of Organization: state enterprise, joint stock company, limited liability company, etc.

Main Activities of Investine Enterprise:

Short Description of Subproiects: e.g. new facility/expansion/diversification for production of (nameof product) of which .......... percent aimed at exports to convertible currency markets (if applicable)

Subloan Information:

* name of participating bank* date of subloan approval by participating banka amount of subloan (US$ equivalent)* maturities, grace periodX interest rate charged by participating bank* date of first repayment of subloan principal* are interest/principal payments current? -- indicate extent of arrears, default,

rescheduling, etc., if applicable

Subproject Completion/Expected Completion Date: month/year

PART II. Performance Summary

Subpro*ect Performance:Appraisal Actual/Current Estimate

(in US$)

incremental salesincremental exports to CC marketsincremental employment (in nos.)


Subproject Cost:

ApDraisal Actual Appraisal Actual(in HUF) (in US$ equivalent)

* civil works* machinery & equipment* incremental working capital* other

Total subproject cost

Subproject Financing:

Appraisal Actual(in HUF)

* investors' own funds* local loans* world bank subloan* other foreign loans

Total subproject financing

Sub_roject Financial Rate of Return: Appraisal Current Estimate

Subproject Procurement: No. of Contracts Value(in US$)

- International Competitive Bidding- International Shopping* Direct Contracting

Other (specify)Total

Investina Enterpnrise Performance: (in HUF or ratios, as relevant)

1992 1993

* total sales* net profit/loss* net worth* current ratio

Note: net worth = assets minus liabilities owed to otherscurrent ratio = current assets/current liabilities


PART III. Maior Issues/Problems (in order of importance)

For example,

* excess capacity due to lack of domestic/foreign markets* difficult financial situation due to* organizational and management weaknesses such as* high costs of production due to* low/negative profitability due to

PART IV. Actions/Measures Taken or To Be Taken toAddress the Above Issues/Problems

For example,

* voluntary restructuring by enterprise is under way* involuntary restructuring/bankruptcy/liquidation proceedings are under way* privatization/restructuring of enterprise is actively under way* enterprise is being restructured under consolidation program

Adequate information should be provided to give a clear indication of the actions/measures takenor to be taken, with an indication of their timing, and the agency or agencies responsible forimplementation or enforcement.

PART V. Expected Outcome and Timing

An indication should be provided of the expected outcome of the actions/measures being takenand the timing/expected timing of the outcome.

m:Vmnkamp2936

APPENDIX BPage 1 of 8

BoRROWER'S CONTRIBUTION TO THE ICR

(Prepared jointly by the National Bank of Hungary and the Ministry of Agriculture)

INTRODUCTION

1. In the second half of the 1980s, the Hungarian Government developed and introduced a numberof financial incentives to encourage state-owned food-industry enterprises to increase their exports toconvertible currency markets. However, those efforts sometimes failed to succeed because:

most of the products were sold to Eastern Europe countries;there were only a few industrial facilities capable of restructuring their product profilein a quick and flexible manner;lack of strategic concepts suitable to support the making of consistently organizedmarketing efforts by the management;

* compared to the value of fixed assets, the amount of working funds remained excessivelylow;

* lack of external sources needed to finance imports from convertible currency countries.

2. In order to solve the above problems and to support implementation of the Government's creativeendeavors, the World Bank (IBRD) and the Hungarian Government designed and launched anAgroprocessing Modernization Project, with due regard to:

* the existing organizational and production structure of the state-owned foodprocessingcompanies;

* the features and capabilities of institutions designed to control operations of theagroprocessing industry, knowing that those institutions were in need of beingtransformed and/or restructured;

* the existing financial conditions of lending; furthermore;* the then existing system of subsidies granted by the state to encourage exports.

CONTINUED VALIDITY OF THIE AGROPROCESSING MODERNIZATION PROJECT'S OBJECTIVE

3. The objective of the Agroprocessing Modernization Project is to enhance the internationalcompetitive edge of exported goods produced by the Hungarian agriculture and agroprocessing industry,to improve the efficiency of production and to promote efficient marketing of products made byHungarian food industry companies. Within the Project, the most important targets are as follows:

* increase of the exports of food and forestry products, through improved quality andapplying better marketing skills;

* improvement of efficiency throughout the operations and management of the companiesconcerned, by means of cutting their specific costs and improving their productivity;

* development of a more favorable "climate" in business life and market economy, inconformity with the reform of the pricing and tax regime to be accomplished at the levelof the national economy.


4. In conformity with the policy adopted by the Hungarian Government concerning the economicreform, the World Bank experts have identified five major areas within the plan focusing on theestablishment of a proper institutional framework, which areas have been considered to have a decisiveeffect on the selection of the Project's objectives. These areas are the following:

* development of a legal framework regarding the founding and liquidation of companies;* completion of the refortn of pricing and tax regime (removal of subsidies, broader

application of free pricing policy);* liberalization of foreign trade;* introduction of a uniform and restriction-free wage policy (including removal of various

legal provisions making adverse effects on organizations active in the domestic agricultureand food industry);

* granting significantly more autonomy to companies in financing their businesses.

5. The Hungarian Government definitely confirmed its commitment regarding validity of theAgroprocessing Modernization Project's objectives in a document published in June 1991 to discuss somemajor agrarian policy issues and in the Government Program of 1994. Both documents specified thesame targets, i.e., agribusinesses must improve their efficiency, should adjust their production andproduct profile to the market demand and should react to market changes in a more flexible and sensitivemanner. The Government Program of 1994 laid a special emphasis on the increase of exports ofcompetitive agroprocessed goods.

6. The Project was designed to be implemented over a four-year period and consisted of (i) aninstitutional development part and (ii) an investment component.

* the institutional development part was designed to upgrade support services to enterprises,in terms of: (a) export trade promotion and marketing; (b) training in management andmarketing; (c) grading and quality control of raw materials and final products; (d)research and development; (e) creating a basis for the restructuring of the glass containerindustry and can manufacturing.

* under the investment component, long term funds were provided for strengthening of theagroprocessors' management and marketing capabilities, the rehabilitation and expansionof their facilities, and the carrying out by these entities of export trade promotion andmarketing schemes.

AcBvEVEMENT OF OBJECTIVES

7. The economic policy objectives of the Project were completely achieved:

* The transformation of the price, subsidy and tax systems and their comprehensive reformin conformity with the market economy were outlined in 1988. Parallel with projectimplementation, the price system of agricultural products was liberalized. Agriculturalsubsidies fell radically starting from 1990 and subsidies were phased out across asignificant span of production. Foreign trade in general and imports in particular wereliberalized, constraints were only imposed through the Agricultural Market Regime,which were in place to protect the local market. Under the auspices of tax reform, a


transparent, uniform and competitive tax system was created comprising three majortypes of taxes (VAT, personal income tax and corporate profit tax).

The Ministry of Agriculture took major action in order to improve the competitivenessof poultry production. Breeders and poultry producers were mobilized in keeping withproject objectives through the Association of Poultry Producers. Loan funds were madeavailable through the participating commercial banks for the establishment of newproduction integrations, installation and restructuring of hatching farms and theimplementation of the veterinary system.

8. Achievements under the Institutional Development Component:

* The Agromarketing Office achieved significant results in the process of developing atrademark suitable for certifying product quality and origin. In addition, the Office hasassumed the role of "middleman" or trade promoter. The Office had developed aCollective Food Marketing Project and its trade promotion efforts met with muchsuccess. The Office had an active role in encouraging the establishment of internationaljoint ventures, as well.

* The subproject of "Training of Export Marketing and Management Instructors" has alsoproved its merits. A number of successful seminars and training courses certify thesuccess of this subproject which is reflected by numerous cases of positive feedbackreceived from businessmen and companies.

* In the frame of the Research and Development subproject, a number of usefulrelationships were established between fellow researchers working in universities andresearch institutions abroad and the domestic food industry companies. The servicesoffered by this subproject have met great demand.

* The Packaging Center and the Quality Information Center have been established and bothare operational. Both centers established extensive international relations and havereceived numerous orders placed by domestic customers. A very intensive demand hasbeen experienced for the information provided by the Quality Information Center.

* The equipment used for grading and quality control were modernized and upgraded atfive state-owned quality control stations, as a result of the development subprojectsprovided by AMP.

* The studies discussing the issues related to qualification of food industry raw materials,modernization and development of the supply of glass food containers and therestructuring of can manufacturing have been completed.

* From the "unallocated" portion of the Agroprocessing Loan, the Szarvas Faculty of theDebrecen University of Agricultural Sciences launched a pilot farm to support thedevelopment of the profitable production of food industry raw materials which arecapable of satisfying quality requirements across a wider variety; and the ResearchInstitute of the University of Veterinary Sciences (Ullo, Dora farm) set up a pilot goatfarm which is to develop goat production and cheese production technology to be spreadacross the county with the assistance of Dutch specialists; study tours were organized for


researchers from the Agricultural Biotechnology Research Institute (Godollo), theIrrigation Research Institute (Szarvas), the Agricultural Research Institute of theHungarian Academy of Sciences (Martonvasar), and the PANNON University ofAgricultural Science (Kaposvar) to study the developments of the food industry and themethods and instruments to promote increasingly efficient market entry of food products.

9. Under the credit line (investment) component, the achievement of objectives can be evaluated asfollows:

* The export performance of the food industry increased. In 1993, USD 133 million ofincremental exports were realized on account of the Project. In 1994, incrementalexports exceeded USD 140 million in line with the projections.

* Significant efficiency improvement can be noted both at large and small companiesparticipating in the Project. During 1992-1993, project beneficiaries experienced a 16percent reduction in the number of employees, while their value-added increased by 7percent. Consequently, the per capita value added was 28 percent higher in 1993 thanin the previous year.

* Contrary to the appraisal estimates, loan funds were not financed exclusively by thepreselected subsectors. Altogether 16 food industry subsectors were covered by thecreditline component (the majority of subprojects were identified in the canning industry,meat industry, forestry, wood processing, breweries, and bakery industry).

MAJOR FACTORs AFFCTING TE PROJECT

10. The most important institutional conditions of a market economy emerged by the time of projectcompletion. Acts were enacted concerning bankruptcy, financial institutions, accounting, corporate profittaxation, companies, the transformation of cooperatives, land and privatization.

11. Hungary signed the Europe Treaty with the EC. Granting to Hungary the status of associatedmember of EC increased the chances of Hungarian agroprocessed goods to be sold to EC markets.

12. The Act on Agricultural Market Regime was also passed. The Product Councils and theAgricultural Market Regime Authority have become operational. Foreign trade was liberalized. Wageregulations affecting the public sector were incorporated into a uniform legal framework. Therestructuring of the pricing and tax system in conformity with the market economy was completed by1990.

13. Several factors, however, having been beyond the control of project authorities, adversely affectedthe implementation of the Project credit component and mitigated the impact of the Project on the overalldevelopment of the food industry.

* Agriculture and the food processing industry were severely hit by the collapse of theCMEA markets in 1991. Between 1991 and 1993, the value of agriculture and foodindustry exports declined by 26 percent from USD 2.7 billion to USD 2.0 billion.Although Hungary signed the Association Agreement with the EC in 1991, which hasgranted better market access for Hungarian agricultural and food products into the


European Union, agro-industrial trade performance under the Project was insufficient tooffset the losses which the Hungarian agro-industries have suffered due to the collapseof the CMEA market.

* The continuous decline in the consumption of domestic food products also had a negativeimpact on the food processing sector. As a result of the decrease in primary productionand a drop in exports and domestic demand, output of the food sector declined by about40 percent between 1988 and 1992.

* Due to the contraction of both the domestic and export markets, most of the largeagricultural and food processing enterprises found themselves in a difficult financialsituation and banks were reluctant to increase their exposure in the food processingsector. The number of food industry enterprises subject to bankruptcy proceedingsincreased in the last four years. Poultry, canning and meat processing companies havebeen the most affected by liquidation proceedings. Thus, significant parts of potentialbeneficiaries have not been able to comply with the project viability, creditworthinesscriteria and collateral requirements of commercial banks. The Government launched aprogram in December 1993 to clean up the bad debts of several food processingcompanies. Due to the fact that the Government program started only in 1994, it couldnot have major impact on project implementation.

* sThe structure of the food processing sector has also undergone a radical transformationsince 1990. By March 1994, 58 percent of the large-scale state-owned enterprises wereprivatized and the number of enterprises in the sector increased dramatically, which canbe attributed to the split-up and sale of the state-owned food enterprises into independentunits and the entry of new, small and medium-size private enterprises. This had apositive impact upon the utilization of project funds since dozens of small and medium-size private enterprises applied for a loan under the Project successfully. Uncertaintieslinked to the privatization process led the managers of the state-owned enterprise topostpone investment decisions until agreements on the development projects can bereached with the new owners.

* Foreign investments had a major role in the privatization of a large proportion of foodindustry enterprises. The competitiveness and financial performance of these privatizedfirms improved due to the considerable resources invested in upgrading the technical,management and organizational standards of the firms concerned. These investments,while playing an important role in improving the competitiveness of the Hungarian foodindustry, reduced interest of large food companies in applying for the AMP loan.

* Further specific conditions strengthened the negative impact of the above factors on loanutilization:

the increase in interest rates;

the availability of sources on more favorable terms -- the JEXIM loan was a casein point. This latter, due to lower costs of borrowing which should have beenreflected in the onlending agreements between NBH and the commercial banks,became the more preferable source of borrowing for ventures. The possibilityof financing expenditures not eligible under World Bank financing from, e.g.,


the JEXIM line, and supplementing such financing with long term resourcesavailable under the AMP credit line, was adequately communicated to the banks.Despite the efforts of NBH to proliferate information on the possiblecomplementarity of World Bank financed credit lines (including the AMP funds)with these preferential resources, this latter received priority in borrowingdecisions of enterprises.

- while it is clear that the operational policies of the Bank preclude the possibilityof financing of real estate, used assets and permanent working capital under anyWorld Bank project, significant demand was reported by the banks on thefinancing of such expenditures during project implementation.

14. The above highlighted major changes in the Hungarian economy as well as the already mentionedspecific conditions affected adversely the utilization of loan proceeds. This required the cancellation ofa part of the loan facility (20 million US Dollars) almost one year prior to the Closing Date.

SUSTAINABiLITY OF THE PROJECT

15. The Government of Hungary undertook a number of measures in the last four years to facilitatethe recovery of agriculture and the food industry. The measures include (a) changes in institutions andregulations to enhance the functioning of the markets, and (b) promotion programs for producers,processors and traders. As a result of the measures taken, several companies carried out developmentprojects under the Project, and were able to shift their exports from the former CMEA markets toWestern markets and/or increase their convertible exports. The sustainability of the main projectobjective in the future is not only a possibility for Hungary, but a "must" considering the share ofagriculture and food industry in the total economy and foreign exchange earnings (together accountingfor one quarter of total exports). It is the declared intention of the Government to increase the value ofexports of agricultural and food products to USD 3 billion per year. The Government launched severalexport promotion programs to sustain the export performance of the food sector.

16. The World Bank assumed, in general, a flexible stand and tried to arrive at a compromiseconcerning every issue that might have an impact on the progress of the Project. On the initiative of theHungarian counterparts (NBH, commercial banks, MoA), the World Bank:

* abandoned the strict requirement of export orientation;* confirmed that small enterprises in private hands also may become beneficiaries under

AMP;* allowed for financing the entire amount of working capital (although set a ceiling: the

total amount used for financing working capital ought not to exceed USD 30 million);* increased the ceiling of IS procurement from USD 150,000 to USD 300,000;* allowed for financing the purchase of machines and equipment needed for the production

of seeds.

BANK PERFORMANCE

17. We should highlight the importance and efficiency of continuous dialogue between the Bank andthe Hungarian counterpart in order to improve loan utilization and project implementation. The Bank


demonstrated great flexibility in adapting loan conditions to the changed situation in Hungary. As a resultof this work, the above modifications were made to the loan agreement.

18. A good example of the Bank's flexibility was the speedy and efficient assistance the Bankprovided to the Hungarian Government in 1990 allowing the financing of importation of animal feed inorder to mitigate the consequences of the severe drought under the four existing agricultural credit lines.

19. The relationship between the Bank and the NBH was good throughout the preparation and theimplementation of the Project. Hungarian institutions received valuable assistance from the Bank staff.Their continuous assistance in early stages of project implementation in the elaboration of loanapplications reflecting the real financial status of the borrowers, viable options for future developmentand realistic assessment of the marketing perspectives are good examples for that.

ASSESSMENT OF OUTCOME

20. During project implementation, substantial progress was made in the achievement of Projectobjectives: convertible currency revenues of food-processing companies have been increased, significantefficiency improvement was recorded at project beneficiaries, policy steps agreed in the context of theAMP have been met and the institutional background of supporting services -- such as export tradepromotion, raw material and final product grading system, Research and Development and training -- wasestablished and developed.

21. Changes in external economic and macroeconomic conditions, however, slowed down theimplementation of the investments component. After 1990 the Project was no longer able to keep pacewith the disbursement schedule projected during loan appraisal.

22. Even mutual efforts of the Bank and the Hungarian counterpart to adjust the loan conditions tothe changed situation could not counterbalance the impact of the already mentioned serious changes inthe economy. Therefore, in agreement with the Ministry of Agriculture, in 1993 NBH initiated thecancellation of the loan amount which, according to the future loan demand estimates of the participatingcommercial banks, could not have been disbursed by the Closing Date for financing of subprojects. TheBank, having taken account of the reasons for under-utilization and having been informed on future loandemand estimates of the banks, agreed to cancel the 20 million US dollar equivalent from the originalloan amount.

23. Simultaneously with the cancellation, conditions of the Third Industrial Restructuring Project werechanged so as to include, inter alia, the financing of food processing subprojects. Thus the possibilityof growth in investment and loan demand has been reckoned with.

FUTURE OPERATIONS

24. By the closing date of the Project, the implementation phase of the institutional developmentcomponents was completed and the most important project institutions are functional. The sustainabilityof the components and their future operation can be guaranteed if the following important problems aresolved:


* The absence of the conditions required for self-financing characterizes all institutions thathave emerged. To varying degrees, each component requires government financing toestablish the conditions required for further continued operation.

* Due to a change in ownership and privatization, the number of small and medium-sizecompanies increased significantly in the food industry subsectors. The development ofmarketing training centers for managers and their ability to accommodate large numbersof new entrepreneurs to provide high-level professional training is particularly urgent.

* To coordinate the further continued operation of project institutions, the incorporation ofnecessary developments and the coordination of the new and existing instruments forfinancing and implementation, coordinating activities similar to the activities of theexisting project Unit should be maintained.

25. If the conditions required for the continued operation of the project institutions are put in place,the operation of the following institutions can be envisaged for the future:

* Agro-Marketing Office in charge of national food marketing;- food industry marketing training centers for managers;* Packaging Center;* Quality Information Center;* new systems of raw materials rating suitable for introduction;* new systems for quality control and food testing;* launching export-oriented Research and Development projects;* a Project Unit, coordinating the operation of the existing project institutions, which keeps

track of their activities and launches new projects.

26. Due to the redistribution of tasks and authorities among different ministries, the majority ofinstitutions set up and operated under the Project -- except for the Packaging Center, Quality InformationCenter and the Project Unit -- have been gotten out of the auspices of the MoA.

27. The professional relationship with these institutions and relevant ministries, however, will bemaintained further on by the MoA. Activities of the above referenced institutions are carried out mainlyon a market basis. If they are involved in the performance of public tasks as well, the financing of suchscope of activities is beyond the control of the MoA.

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Documents

World Bank Document · Agriculture and Urban Development Operations Division ... MOF Ministry of Finance ... PBs Participating Banks SAR Staff Appraisal Report SPA State Property