Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 13840-ME

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(LOAN 2837-ME)

DECEMBER 30, 1994

Operations Evaluation Department

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 - New Mexican Peso (Mex$)(year end)

1987: US$1.00 = Mex$ 2.211988: US$1.00 = Mex$ 2.281989: US$1.00 = Mex$ 2.641990: US$1.00 = Mex$ 2.951991: US$1.00 = MeX$ 3.071992: US$1.00 = Mex$ 3.12

The US$ loan amounts in this report should be understood to mean US$ equivalent.

ACRONYMS AND ABBREVIATIONS

ACF - Average Cost of FundsAGROASEMEX - Aseguradora de M6xico para la Agricultura (Agricultural Insurance Company of Mexico)ANAGSA - Aseguradora Nacional Agicola (National Agricultural Insurance Company)AGSAL - Agricultural Sector Adjustment LoanBANRURAL - Banco Nacional de Crdito Rural (National Rural Credit Bank)BANXICO - Banco de Mxico (Central Bank of Mexico)CETES - Cerificados de Tesorerla (Mexican Treasury bills)CONASUPO - Compafia Nacional de Subsistencias Populares (National Commission for Distribution of Basic

Foods)FEFA - Fondo Especial par Financiamientos Agropecuarios (Special Fund for Agricultural Financing)FEGA - Fondo de Garantia y Asistencia Tdnica (Fund for Loan Guarantees and Technical Assistance)FEPS Final Executive Project SummaryFICART - Fideicomiso para Crdito en Areas de Riego y de Temporal (Trust Fund for Credit in Irrigated and

Rainfed Areas)FIRA - Fideicomisos Instituidos en Relaci6n con a Agricultura (Agricultural Trust Funds)FIRCAVEN - Fideicomiso para a Restructuraci6n de la Carters Vencida (Trust Fund for Restructuring Portfolios

in Arre-ars)FONDO - Fondo de Garantia y Fomento pars Ia Agricultura, Ganadera y Avicultura (Guarantee and

Development Fund for Agriculture, Livestock and Poultry)FOPESCA - Fondo de Garantia y Fomento pars las Actividades Pesqueras (Guarantee and Development Fund

for Fisheries)FSAL - Financial Sector Adjustment LoanGATT General Agreement on Tariffs and TradeGDP - Gross Domestic ProductGIRA - General Interest Rate AgreementGOM - Government of MexicoIDB Inter-American Development BankLIPs - Low Income ProducersM&E - Monitoring & EvaluationMIS Management Information SystemNAFTA - North American Free Trade AgreementNPC Nominal Protection CoefficientOED - Operations Evluation DepartmentOPs - Other Producers (as opposed to LIPs)PAR - Performance Audit ReportPBs Participating BanksPCR - Project Completion ReportPRONASOL - Program Nacional de Solidaridad (National Solidarity Programme)SAR - Staff Appraisal ReportSARH - Secretaia de Agricultura y Recursos Hydraulicos (Secretariat of Agriculture)SDI Subsidy Dependence IndexSERC - Sistem de Evaluaci6n de los Resultados del Cr6dito (Credit Impact Evaluation System)SHCP - Secretarfa de Hacienda y Crdito Publico (Secretariat of Finance)SIM - Sistema de Inspecci6n por Muestre (System of Monitoring by Sampling)SIPA - Sistema d Indices de Precios Agrfcolas (System of Agricultural Price Indices)SUECO - Sistema Unico de Elaboraci6n de Costos de Cultivo (integral System for Determining the Costs of

Cultivation)TA - Technical AssistanceTORs Terms of Reference

WEIGHTS AND MEASURES

Metric System

FISCAL YEAR

January 1 BnDecember 31

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D C. 20433U.S.A.

Office of Director-GeneralOperations Evaluation

December 30, 1994

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Performance Audit Report on MexicoNinth A.ricultural Credit Project (Loan 2837-ME)

Attached is the Performance Audit Report on Mexico-Ninth Agricultural Credit Project(Loan 2837-ME) prepared by the Operations Evaluation Department.

The project outcome is rated as satisfactory. Subsidies on loans to agricultural producers werereduced by at least 7 percent of agricultural GDP, exceeding appraisal targets; interest rates tofarmers are now positive in real terms, although on average they remain below market rates. Theinvestment and incremental short-term credit provided under the project supported financially viableinvestments in irrigated areas, but the performance of investments in rainfed areas was mixed. Theproject strengthened the productive support systems of the Government's Agricultural Trust Funds(FIRA) by providing civil works, training and technical assistance.

Institutional development is rated as substantial. In particular, the Bank insisted on athorough analysis of the rural financial sub-sector, both in the context of a project-financedAgricultural Financial Sub-sector Study and of preparation of a follow-on operation. Although thestudy was weak, these efforts yielded data and findings that catalyzed key reforms, such asrationalization of the National Rural Credit Bank (BANRURAL) and elimination of the NationalAgricultural Insurance Company (ANAGSA).

Preparation of the proposed follow-on operation was suspended in January 1993, due todisagreements on the pace of interest rate reforms. However, Government appears to be committedto the policies supported under the project, the reform process went beyond the project's statedobjectives, Government transfers to FIRA and BANRURAL have fallen sharply, and the value oftheir equity has increased in real terms in spite of the reduced support. Overall, the sustainabilityof project benefits is rated as likely.

Attachment

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

FOR OFFICIAL USE ONLY

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(Loan 2837-ME)

TABLE OF CONTENTS

Page No.

Preface ..........................................................Basic Data Sheet ..................................................... iiiEvaluation Summary .................................................. v

I. BACKGROUND ................................................ 1

II. DESIGN AND IMPLEMENTATION ................................. 4A. Project Design ............................................... 4B. Project Implementation ......................................... 8

III. PROJECT OUTCOME ........................................... 14A. Farm-Level Impact ............................................ 14B. Institutional Development ....................................... 19C. Impact on Financial Intermediaries ................................ 20D. Impact on Sectoral Reforms ..................................... 26

IV. FINDINGS AND ISSUES ......................................... 30A. Overall Assessment of the Project ................................. 30B. Key Findings Regarding FIRA/FICART 9 ........................... 31C. Subsequent Developments and Outstanding Issues .................... 34

Figures

1. Agricultural Lending by FIRA, BANRURAL and Commercial Banks . 182. Ratio of Arrears to Loan Portfolio for Commercial Banks

on Loans to Agriculture and All Sectors ............................ 263. Interest Subsidies on Loans via FIRA and BANRURAL

as a Percentage of GDP ......................................... 274. Area Insured for Selected Crops .................................... 33

This repoi t was p, cpared by Edward B. Rice (Task Manager), and McDonald Benjamin (cnsultant),who audited the project. Silvana Valle provided the administrative support.

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.

Page No.Tables

1. Appraisal and Actual Project Costs .................................. 92. Appraisal and Actual Project Financing ................................ 93. Increments in Assets and Equity during Project Years

for a Stratified Sample of FIRA Borrowers ........................... 164. Subsidy Dependence Indices for FIRA ............................... 215. Example of the Tasa Mezcla's Effect on Subsidies and Interest Rates

for a Hypothetical Short Term Loan to a "Basic OP" .................... 24

Annex 1: Statistical Overview of the Mexican Economy and the Rural Financial Sector

1. The M acroeconomy .............................................. 392. A griculture .................................................... 393. T rade ......................................................... 394. Finance ....................................................... 395. The Banking System's Non-Agricultural Portfolio ........................ . 406. The Banking System's Agricultural Portfolio ........................... . 407. Agricultural Interest Rates ......................................... 418. Agricultural Insurance ............................................ 419. Subsidies to Agricultural Lenders .................................... 4110. BANRURAL's Key Financial Ratios ................................. 4211. FIRA Interest Subsidy Passed to Commercial Banks

Intended for Farmers............................................ 4212. BANRURAL's Interest Subsidy to Farmers ............................ . 4213. Returns to Farmers on Selected Crops ................................ 4314. Sources of D ata ................................................. 43

Map IBRD 26569

1

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(Loan 2837-ME)

PREFACE

This is a Performance Audit Report (PAR) on the Ninth Agricultural Credit Project in Mexico,involving an IBRD loan in the amount of US$400 million. The objectives of the project were to (i)increase agricultural productivity and thus agricultural exports, real farm income and ruralemployment; (ii) help the Government improve agricultural sector policies by further reducinginterest subsidies, and (iii) help to maintain the financial integrity of participating financialintermediaries. The loan was approved on June 16, 1987, became effective on August 28, 1987, wasfully disbursed on April 2, 1992, and was closed on June 30, 1992, one year later than the originalClosing Date of June 30, 1991.

The PAR is based on the Project Completion Report (PCR) prepared by the NaturalResources and Rural Poverty Operations Division in Country Department II of the Latin Americaand Caribbean Regional Office (LA2NR)* and submitted to the Board on December 21, 1993, theStaff Appraisal Report (SAR), the President's Report, the loan documents, the transcripts of theExecutive Directors' meeting at which the project was considered, on a study of project files, and ondiscussions with Bank staff. An OED mission visited Mexico in February/March 1994, and discussedthe effectiveness of the World Bank's assistance with the Agricultural Trust Funds of the CentralBank (FIRA), the Secretariats of Finance and Agriculture, the Central Bank, the National RuralCredit Bank (BANRURAL), other relevant Government agencies, commercial banks and agriculturalproducers. Their kind cooperation and valuable assistance in the preparation of this report isgratefully acknowledged.

The PCR provides a thorough account and assessment of the project experience, and discussesthe performance of the Bank and the project executing agencies with a particular focus on sectoralreforms. The PAR elaborates on particular aspects of the overall lending period (1987-1992),including the allocation of resources at the farm level, the problem of arrears, subsidisation of farmbeneficiaries and the institutional viability of FIRA. Following standard OED procedures, copies ofthe draft were sent to Government, FIRA and BANRURAL for comments in November 1994. TheBorrower informed OED in December 1994 that it had no comments regarding the Audit Report.

* Formerly known as the Agricultural Operations Division in Country Department 11 of the Latin America and Caribbean Regional Office(LA2AG).

Ill

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(LOAN 2837-ME)

BASIC DATA SHEET

Key Project Data

Item Appraisal Actual or Actual as Percent ofExpectation Current Estimate Appraisal Estimate

Total Project Costs (US$ million) 1,000.0 920.0 92Loan Amount US$ million 400.0 400.0 100Number of Beneficiaries 550,000 868,400 158Project Rating Satisfactoryinstitutional Performance SubstantialSustainability Likely

Cumulative Estimated and Actual Disbursements

FY88 FY89 FY90 FY91 FY92

Appraisal Estimate (US$ million) 150.0 250.0 360.0 400.0 400.0Actual (US$ million) 173.9 371.4 389.9 395.4 400.0Actual as Percent of Appraisal 116% 149% 108% 99% 100%

Date of Final Disbursement: April 2, 1992

Project Dates

Original Plan Revisions Actual

Appraisal Mission 03/85 11/85 11/25/85Post-AppraisalUpdate Mission 05/04/87Negotiations 11/86 11/86 & 05/87Board Approval 07/85 06/87 06/16/87Loan Signature 07/31/87 07/31/87Loan Effectiveness 09/30/87 10/29/87 08/28/87Project Completion 12/31/90 12/31/91 12/31/91Project Closing 06/30/91 06/30/92 06/30/92

Iv

Staff Inputs(staff weeks)

FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 TOTAL

Pre-appraisal 4.3 7.7 12.0Appraisal 32.7 5.3 38.0Negotiation 26.6 26.6Supervision 1.4 20.6 20.4 6.7 0.8 15.6 4.8 1.6 71.9Other 2.6 1.3 9.1 13.0

Total 6.9 41.7 42.4 20.6 20.4 6.7 0.8 15.6 4.8 1.6 161.5

Mission Data

Mission Dates No.of Staff- Specializations Overall Project Development(mo.yr) Persons Weeks Represented Status b MgMt. b impact b

in Field

Preparation 03/85 3 2 F, E, AEPre-appraisal 10/85 1 1 FAppraisal 11/85 5 3 F, A, AE, C, 0

Full Supervision 1 08/87 2 4.5 TM, AE n.a. n.a. n.a.Full Supervision 2 10/87 2 6 TM, F 1 1 1Partial Supervision 3 11/87 2 1 TM, CPartial Supervision 4 05/88 * 1 1 TMFull Supervision 5 09/88 1 1.5 TM 2 2 1Partial Supervision 6 01/89 1 1.0 ARPartial Supervision 7 02/89 1 0.3 LWFull Supervision 8 03/89 2 2.5 TM, C 1 2 1Partial Supervision 9 05/89 1 1 CPartial Supervision 10 06/89 2 1.3 TM, CPartial Supervision 11 07/91 1 0.5 ARPartial Supervision 12 08/91 3 6 F, E, AEPCR Preparation 10/92 2 2.5 PA, AR

TOTAL 35.1

Other Project Data

Borrower: Nacional Financiera (NAFIN)Executing Agencies: Fidelcomisos Instituidos en Relaci6n con la Agricultura (FIRA)

Fideicomiso para Cr6dito en Areas de Riego y Temporal (FICART)

Proposed Follow-On Prolect (Suspended)Name: Proposed Rural Financial Sector ProjectProposed Loan Amount: US$300 millionProcessing Suspended on: January 11, 1993

a. F = financial analyst; E = economist; AE = agricultural economist; A = agriculturalist; C = credit specialist;0 = operations assistant; TM = task manager; AR = architect; LW = lawyer; PA = project assistant.

b. 1 = Problem-free or minor problems; 2 = moderate problems; 3 = major problems.

V

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(Loan 2837-ME)

EVALUATION SUMMARY

Introduction 3. The project was to be implemented bytwo apex institutions: FIRA, the Agricultural

1. Mexico is the World Bank's second Trust Funds of the Central Bank, andlargest borrower for agricultural credit. Since FICART, a trust fund of the Government-1965, the Bank has approved ten loans totalling owned National Rural Credit Bank,US$1,805 million for agricultural credit projects BANRURAL. The Borrower (Nacionaland earmarked an additional US$334 million Financiera, or NAFIN) was to on-lend thefor credit components in six rural development World Bank loan of US$400 million equivalentprojects. The initial thrust of Bank policy was to FIRA (US$300 million) and FICARTto promote agricultural production by large (US$100 million) for production credit (9commercial farmers; however, by the fourth percent), investment credit (79 percent) andproject (approved in 1973), the Bank began to institutional development (2 percent). Tenemphasize access to credit for low income percent of the loan was unallocated. Duringproducers (LIPs). The Bank also attempted to negotiations in May, 1987, support was agreedplace greater emphasis on institutional for the construction of FIRAKs newdevelopment and on sectoral reforms. The size headquarters.of agricultural interest subsidies was a particularconcern for the Bank and was addressed under 4. The Bank loan was to cover the foreigna General Interest Rate Agreement (GIRA) exchange costs of the project, or 40 percent ofthat has governed agricultural credit since 1984. the total project cost of US$1,000 million. TheThis Audit reviews the Ninth Agricultural remaining 60 percent of costs were to beCredit Project (FIRA/FICART 9), the last in financed by FIRA and FICART (32 percent),the series of ten agricultural credit projects. commercial banks (14 percent) and sub-

borrowers (14 percent). The total project costProject Design and Implementation of US$1,000 million represented about 15

percent of FIRA's and FICART's projected2. The objectives of FIRA/FICART 9 were investment programme of US$6,911 million forto (i) increase agricultural productivity and thus the years 1987-1991.agricultural exports, real farm income and ruralemployment; (ii) help the Government improve 5. When the project was identified in 1985,agricultural sector policies by further reducing the Bank informed the Government of Mexicointerest subsidies, and (iii) help to maintain the (GOM) that continued disbursement at thefinancial integrity of participating financial rapid rates experienced under earlierintermediaries. An important but unstated operations could only be justified if furtherobjective was to provide the Mexican progress was achieved on sectoral issues. TheGovernment with rapid access to foreign Bank initially called for a 50 percent reductionexchange. in interest subsidies to LIPs, the preparation of

vi

a study of the agricultural financial sub-sector 8. Project implementation was complicated(hereafter the Study), and financial self- by delays in GOM adherence to the GIRA,sustainability for FIRA and FICART within 5 problems with the construction of FIRA's newyears. headquarters and disagreements with GOM

regarding the Study. Government delays in6. Negotiations broke down in November, raising interest rates to farmers as mandated by1986 over the issue of financial self- the GIRA led to temporary suspensions ofsustainability for FIRA and FICART (para. disbursements in 1988. Nevertheless, the loan2.6). In January, 1987, GOM failed to increase disbursed well ahead of schedule, except for theinterest rates to LIPs as agreed under the FIRA headquarters component, whichGIRA. Bank management was informed in experienced major delays (para. 2.19). TheApril that the proposed loan would slip to project was extended by one year to allow forFY88, "unless Bank management sees a way in the completion of the civil works, but furtherwhich we could proceed more quickly". Senior delays led to reallocation of loan funds frommanagement and regional staff agreed that civil works to on-lending and the project wasrapid movement with some accommodation was closed on June 30, 1992. The Study wasrequired. The conditionality on interest rates executed in two phases. Te phase I reportwas weakened and the requirement of financial was completed in May, 1988. GOM initiallyself-sustainability for FIRA and FICART was withheld most of the report from the Bank,dropped. Instead, GOM agreed to provide arguing that the Guarantee Agreement onlybudgetary support to FIRA and FICART so as required it to "exchange views with the Bankto prevent a decline in the real value of their on the conclusions and recommendations ofequity below the levels prevailing in January, such study" (paras. 2.20 ff). A complete copy1986. Processing of the loan proceeded quickly of the phase I report was later given to theafter that: a post-Appraisal update mission Bank, but was found to be unsatisfactory.visited Mexico early in May, a second round of Phase 11 of the Study was begun in March,negotiations that month resolved outstanding 1989 and completed in July, 1990. The Bankissues and the project was approved by the was also dissatisfied with the phase 11Board on June 16, signed on July 31, and document, but did not insist on improvementsbecame effective on August 28, 1987. as it had begun to obtain information for its

own analysis.7. The project was designed to disburserapidly (paras. 2.9 ff). There was no up-front 9. The project had relatively few covenantsconditionality, no linkage of disbursements to and compliance was acceptable, albeitactions such as preparation of the Study, and incomplete (paras. 2.27 ff). Bank supervisionno cap on the disbursement rate. Moreover, was on the whole thorough and timely, and thethe appraisal report (SAR) and the staff's Bank's policy dialogue with GOM flourishedBoard Presentation were both characterised by when the new Administration adopted a moreimportant lapses in the accuracy and laissez-faire approach ater the 1988 elections.completeness of information (paras. 2.12, 2.13and 2.16). Lending pressure was clearly a Project Outcomefactor: Board Approval of this project wasneeded to meet the FY87 lending programme 10. According to FIRA/FICART estimates,target for Mexico of US$2,000 million. the number of beneficiaries (870,000) wasBesides, disbursement of the third tranche of a higher than appraisal projections (550,000).commercial bank package for Mexico was LOW income producers (i.e. those with annuallinked to Effectiveness of this loan, family incomes less than Mn times the

vii

regional minimum daily rural wage) received a funds that appears to have been important islarger proportion of the Bank loan than commercial banks' provision of FIRA-expected. However, lending to LIPs fell rediscounted sub-loans to wealthier farmerssharply as a share of FIRA's total lending, from who could have qualified for short-term credit49 percent in 1987 to 19 percent in 1993. at market rates using commercial banks' ownFIRA correctly points out that the minimum funds (para. 3.13).rural wage declined significantly in real termsduring the project, so that certain low income 13. The project was to support institutionalfarmers could have experienced declines in real development (ID) at FIRA by providingincome and still have graduated involuntarily to equipment for FIRA's demonstration centres,the other producers (OP) category. The Bank training for FIRA staff and funding for thestood by the increasingly strict definition of construction of FIRA's new headquarters. TheLIPs. Since interest rates to OPs were higher project had little impact on the demonstrationthan rates to LIPs, graduation of loanees to the centres (less than 30 percent of Bank fundsOP category brought interest rates on their allocated for equipment and vehicles wereloans closer to market rates. disbursed) but the centres had a visible impact

on the cultivation practices of neighbouring11. While the impact of the project on farms (para. 3.15). Nonetheless, 3 of the 9agricultural production in Mexico cannot be FIRA-operated centres were shut down in thequantified, it is feasible to consider whether or past two years by the State Governments thatnot investments that the World Bank helped to owned them. Over 13,800 participants receivedsupport were financially viable (paras. 3.5 ff). training in more than 850 training events forThe Audit concludes that investments in farmers and FIRA staff under the project. Theirrigated crops were financially viable long term benefits of the training have notthroughout 1986-1990, but that the picture is been evaluated. The new FIRA headquartersless encouraging for rainfed crops. were completed more than two years afterFurthermore, not all financially viable Project Closing and FIRA staff moved into theinvestments were necessarily economically new facility in October, 1994.sound, since the policy environment was highlydistorted. The main sources of inefficiency 14. The ID component for FICART waswere trade, exchange rate and input/output implemented with funding from non-projectprice factors, rather than cheap credit. sources. No information is available on the

component, since FICART has been disbanded.12. Diversion of sub-loans was rampant Significant institutional development ofamong BANRURAL clients, primarily due to BANRURAL began during the project period,lack of monitoring and little pressure to repay, (although not with project funding), notably inrather than to below-market rates of interest. the form of training programmes and upgradingDiversion of sub-loans was much rarer among of computerised systems. There was alsocommercial bank clients, due to more intensive substantial institutional development atsupervision. While substitution by sub- commercial banks, which benefitted fromborrowers of loan funds for other resources FIRA's TA and training (para. 3.18).cannot be ruled out, the Audit found noevidence of widespread capital flight using 15. GOM fulfilled the covenant requiringFIRA/commercial bank loan funds during FIRA's equity to be maintained at least atFIRA/FICART 9. Capital flight was allegedly January, 1986 levels in real terms. FIRAsa serious problem during earlier operations. strong financial position at the end of theOne type of substitution (or crowding out) of project could not have been achieved without

viii

GOM's support. A subsidy dependence index programme of restructuring of agricultural(SDI) was calculated to assess the extent of loans. Commercial banks' contaminatedFIRA's reliance on subsidies (excluding the agricultural portfolio amounts to Mex$5,000guarantee fund, FEGA). The Audit found that million (US$1,540 million), of which about halfduring 1988-93 FIRA would have had to charge is overdue. Most overdues are on commercialinterest rates 85 to 121 percent higher than its banks'own funds, rather than FIRA (or Worldactual average on-lending rates (e.g. 44 percent Bank) funds, since commercial banks advancedinstead of 24 percent in 1990) in order to cover bridging loans to agricultural producers atthe opportunity cost of its liabilities and equity unrealistically high real rates of interest in theand operate without GOM grants (paras. 3.19 late 1980s. Since 1990, commercial banks haveff). The required increases would have been been more selective, and agricultural credit haslower (74 to 110 percent) if FIRA's costly TA declined as a share of their total lending.activities had been excluded. Moreover, FIRAbecame a more efficient institution in the 18. Commercial banks have also called forcourse of the project. The spread (over the increased spreads on rediscounted agriculturalmarket rate) required for self-sufficiency loans. This request was partly satisfied by thedeclined from 6 percent in 1988 to 2.4 percent introduction of the tasa mezcla or blendedin 1992. Excluding FIRA's TA activities, the interest rates scheme introduced in 1989 (paras.respective figures were 3.6 percent and 1.2 3.27 ff). The scheme applies only to short termpercent. This was achieved by halving FIRA's loans to OPs. It allows participating banksratio of administrative costs to risk assets. On (PBs, i.e. commercial banks and BANRURAL)the other hand, FIRA's guarantee and TA to charge unrestricted interest rates on anyfund, FEGA, saw a five-fold real increase in funds they contribute to FIRA-rediscountednet guarantee payments (after subtracting sub-loans above the minimum 20 percentpremium income and recoveries on guarantees) contribution. The blend of controlled andduring the project, due to rising arrears on unrestricted rates has resulted in market ratesguaranteed loans and to sharp reductions in the to OPs on these loans.area indemnified by agricultural insurers.

19. The project adopted a two-pronged16. FICART"s equity rose 9 percent in real approach to reduce interest subsidies andterms over the life of the project, but the encourage further reforms in the rural financialincrement was a mere 10 percent of total GOM sector. First, it mandated increases in interesttransfers to FICART during the project period. rates to farmers in accordance with the GIRA,FICART was shut down in 1992. FICART's and second, it called for sectoral reforms basedtrustee, BANRURAL, made significant losses on the recommendations of the Study. Theevery year, due to low interest rates and an limited objectives with regard to reducingextremely serious problem with loan recoveries. interest subsidies were achieved (para. 3.34).GOM has allowed BANRURAL to shrink Subsidies also became more transparent duringconsiderably and bear the losses it makes on the project period. GOM's agriculturalbad loans. As a result, BANRURAL's recovery insurance agency, ANAGSA, which had maderate on current dues appears to have doubled huge losses during the 1980s, was shut down.to 80 percent. BANRURAL's deposits barely increased in real

terms, but rose significantly as a share of17. Arrears have increased dramatically on liabilities. The closure of ANAGSA andagricultural loans and indeed on all loans by shrinking of BANRURAL are partlycommercial banks (paras. 3.31 ff). In March, attributable to the Study, which otherwise had1994, GOM and the Mexican Banking little impact on sectoral reforms (paras. 3.38 ff).Association (AMB) negotiated a massive

agricultura potoi-mutst e$,0

ix

Findings and Issues 0 Commercial bank lending to wealthierfarmers rose sharply following the introduction

20. The project was largely implemented as of the lasa mezcla scheme, suggesting thatplanned at appraisal and is rated satisfactory. FIRA had crowded out short term lending toWhile there is a problem of attribution of these OPs.results, institutional development wassubstantial during the project period. GOM E Interest subsidies fell by at least 0.6 percentwas reluctant to undertake certain reform of GDP during the project period, (or moremeasures proposed by the World Bank and the than 7 percent of agricultural GDP). GreaterInter-American Development Bank (IDB) as transparency and the use of the SDI wouldconditions for a follow-on operation, but help GOM to evaluate remaining subsidies forappears to be committed to the policies FIRA's and BANRURAL's developmentsupported under the project. Transfers to activities.FIRA and BANRURAL have fallen sharply,and several market-friendly reforms have been U The replacement of ANAGSA withintroduced in the broader agricultural and AGROASEMEX, a more commerciallyfinancial markets. Overall, the project's oriented agricultural insurer, was an importantbenefits are considered sustainable. success. Both AGROASEMEX's insurance

premia and FEGA's loan guarantee premia21. The Audit underscores the following need to be raised towards actuarially fair ratesproject findings (paras. 4.4-4.12): in order to reduce the cost to GOM, allow

FEGA and AGROASEMEX to expand theira The unstated objective of providing GOM coverage and encourage entry into thewith rapid access to foreign exchange was agricultural insurance market by privateachieved. However, this objective was not companies.entirely consistent with the project's long termdevelopment objectives. U Preparation of a follow-on operation was

suspended early in 1993, but significant policyn The farm-level impact of the project cannot measures were nonetheless adopted. Thebe quantified. While FIRA's M&E findings promise of funding and Bank/IDB coordinationpoint to large increases in asset and equity were essential for the constructive dialogue.holdings of FIRA clients, there was no controlgroup. This difficulty should be addressed, 22. The Audit also highlights the followingeven if only by second-best measures. outstanding issues (paras. 4.13-4.19):

f Lack of pressure to repay (rather than low a FIRA's future as an institution is beinginterest rates) led to significant diversion of debated as the Central Bank prepares tofunds by BANRURAL clients. Diversion was relinquish trusteeship of all its trust funds.much rarer for FIRAFcommercial bank loanees, Establishment of FIRA as a second-tierdue to more intensive supervision, development bank or a transfer of FIRA's

trusteeship to NAFIN should be explored.tn 7e problem of OPs masquerading as LIPs

was rarely confirmed by FIRA's monitoring t FIRA must assume greater risks in order tostaff. The incentive for such masquerading has fulfill its mission of expanding the formaldeclined as LIP rates have approached OP financial frontier to new, viable and potentiallyrates, and penalties for PBs are severe if viable clients. This may require expanding theirregularities are detected. coverage of FEGA's loan guarantees.

x

Crowding out of commercial bank lending to borrowers. More generally, Bank supervisionestablished clients should be avoided. of any future financial intermediary loans in

Meico should include an annual review of thea BANRURAL should mobilise more rural financial performance of all participating banks.savings, lend on the basis of stringent criteriaand gradually diversify its portfolio into non- E The bold measures taken by GOM sinceagricultural rural lending. Part of its 1987 have reduced inefficiency in rural financialtransaction costs could be covered by a markets. However further measures aretransparent, time-bound subsidy that would also needed, especially liberalisation of agdculturalbe made available to other participating banks interest rates, in order to increase farmers'for loans to new, potentially viable clients. access to credit. The Bank should seek to

conduct a more intensive policy dialogue witha The restructuring of arrears on commercial GOM, tailoring any future financial support forbanks' agricultural loans should be monitored the sector to GOM's willingness to considerclosely to assess implications for FIRA and further necessary reforms.PBs, and repayment incentives for sub-

PERFORMANCE AUDIT REPORT

MEXICO

NINTH AGRICULTURAL CREDIT PROJECT(Loan 2837-ME)

I. BACKGROUND

1.1 The Macroeconomy: Until the debt crisis of the early 1980s, Mexico pursued an inward-looking industrialisation strategy that yielded high rates of growth but led to structural imbalances andgrowing inefficiency. The discovery of major oil reserves in 1977 allowed the Government of Mexico(GOM) to increase external borrowing dramatically and to postpone urgent economic reforms. In1982, declining oil prices, rising real interest rates and the strength of the US Dollar precipitated adebt crisis that obliged GOM to break with earlier policies and adopt an IMF-supported stabilisationprogramme. This programme reduced fiscal and current account deficits, however rising inflation andthe collapse of oil prices in 1986 entailed the need for a more fundamental restructuring of theeconomy. Consequently, the Government cut public spending and the fiscal deficit, reduced tariffsand quantitative restrictions, and allowed the Peso to depreciate significantly in real terms. In 1986Mexico acceded to the GATT. A commercial bank financing package was arranged to support thegovernment's 1986/87 structural adjustment programme and release of the third tranche of thepackage was made conditional on the Effectiveness of this loan (FIRA/FICART 9, Loan 2837-ME).

1.2 The Agricultural Sector: About 17 percent of Mexico's surface area is dedicated toagriculture, 24 percent to woodlands and rainforests and 51 percent to grass and pasture lands.Landholdings are highly fragmented, averaging three hectares per farmer. Nearly two-thirds of thetracts are semi-communal ejido lands.' Around eighty percent of agricultural producers areconsidered low income producers (LIPs), that is, their annual net family incomes amount to less thanone thousand times the regional minimum daily rural wage. In 1985, the agricultural sector accountedfor about 9 percent of GDP and 35 percent of employment. Growth in agricultural productionaveraged 2.5 percent annually in the early 1980s but was virtually stagnant in the late 1980s, as theagricultural sector took time to recover from changes in the macroeconomy, the trade regime andsectoral policies.

1.3 Agricultural Policy: Government policy towards agriculture has aimed to combine low pricesfor urban consumers with sufficient incentives for agricultural producers. This policy is implementedthrough a combination of subsidies and price controls. The National Commission for Distributionof Basic Foods (CONASUPO) purchases staple crops from producers at guaranteed prices andadministers food subsidies to consumers. Fertilisers, irrigation water and farm credit were heavilysubsidised until the mid-1980s, when GOM began to reduce input subsidies. During the projectperiod (1987-91), import restrictions on agricultural products were reduced or removed, and

1. These lands belong to ejidal communities established after the Mexican revolution in the 1920s. The ejidatarios were to cultivate thelands communally and were not to sell, rent or pledge their parcels. Usufruct rights were to be passed from one generation of eOidatariosto the next. In 1992, restrictions on the exchange of ejidal lands were eased slightly with the revision of Article 27 of the Constitution,however their value as collateral for bank loans remains limited.

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guarantee prices were eliminated in 1990 for all crops except maize and beans. The World Bank

supported these and other reforms with sectoral adjustment operations, including two in agriculture.

1.4 Agricultural Credit Institutions: In order to stimulate lending to the agricultural sector andinduce greater participation by private banks, GOM established three trust funds, collectively knownas FIRA (the Agricultural Trust Funds), within the central bank. The first of these, FONDO, wasestablished in 1955 as a promotion and guarantee fund for agriculture. It rediscounts primarily short-term commercial bank loans to agriculture. FEFA, the special fund for agricultural financing, wasestablished in 1965 as a channel for foreign loans to agriculture. It rediscounts medium- and long-term loans to the sector by public and commercial banks. The guarantee and technical assistancefund, FEGA, was created in 1973 to guarantee a portion of commercial bank loans to agriculture andsubsidise transaction costs for commercial bank loans to low income producers.

1.5 FIRA's network consists of 10 regional offices, 38 state offices and 90 local agencies. A newheadquarters is currently being completed in Morelia, MichoacAn. FIRA also administers sixdemonstration farms, of which three are owned by state governments. FIRA's highly qualified staffprovide TA to farmers and commercial bank staff, supervise sub-borrowers' projects, monitorparticipating banks (PBs) and assist PBs with the evaluation of larger loans.

1.6 Mexico's commercial banks were nationalised in 1982 and denationalised in 1991. As their newprivate sector owners are attempting to recover their investments rapidly, banks are reducing theshare of agriculture in their portfolios and paring the number of agricultural loan staff, which hadincreased significantly with FIRA assistance during the 1980s. The banks are also charging highspreads on their activities. The Government has attempted to inject greater competitiveness into thesector by admitting new banks, including affiliates of US banks, although it has balked at admittinglarge European banks into the Mexican market.

1.7 In order to reach (primarily low income) agricultural clients that commercial banks arereluctant to lend to, GOM complemented FIRA's second-tier activities with direct lending to theagricultural sector via the publicly owned National Bank for Rural Credit, (BNCR). BANRURAL,as it is also called, was formed in 1975 as the result of a merger of three agricultural developmentbanks, two of which were financially weak institutions. Although BANRURAL was the largest bankin Mexico during the 1980s with over 25,000 staff, 500 branches and about 40 percent of all financingfor agriculture, it suffered from significant loan delinquencies that proved to be unsustainable. Overthe past five years, BANRURAL's staff and scale of operations have shrunk dramatically and in 1991a large part of its portfolio was written over to a trust fund for the collection of arrears(FIRCAVEN).3

1.8 FICART (the trust fund for credit in irrigated and rainfed areas) was established in 1976 asa second-tier institution just to rediscount sub-loans made by BANRURAL, its trustee. FICARTprovided a conduit for loans from the Inter-American Development Bank (IDB) that enabled theIDB to avoid having to deal with BANRURAL directly. Although FICART had helped to execute

2. Mexico - Agricultural Sector Adjustment Loan (2918-ME), US$300 million, approved on 22nd Februarv, 1988. and Mexico - SecondAgricultural Sector Adjustment Loan (3357-ME), US$400 million, approved 25th June, 1991.

3. FIRCAVEN has in turn given way to a trust fund known as FI)ELIQ, for the liquidation of bankrupt companies. FIRCAVEN'srecoveries on Banrural loans in arrears had been negligible.

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credit components under four earlier Bank-supported projects, FIRA/FICART 9 was the first onein which it participated as a direct beneficiary. It has since been disbanded, due to a weak rationalefor its existence, reforms at BANRURAL and high operating costs. BANRURAL assumedFICART"s assets and liabilities in 1993.

1.9 During the 1980s, almost 50 percent of BANRURAL's recoveries were direct transfers fromthe now defunct national agricultural insurance company, ANAGSA. ANAGSA's coverage wasrelatively limited in the 1960s and 1970s, but in 1981 a change in the law made insurance withANAGSA mandatory for BANRURAL loanees. ANAGSA thus crowded out private insurers and,with policies involving no deductible and full coverage, moral hazard problems set in, includingsignificant corruption of ANAGSA staff. The losses became unsustainable and in 1990, ANAGSAwas replaced with an agro-insurance company (AGROASEMEX) that is run on a more commercialbasis.

1.10 In 1988, the Salinas Administration introduced a national Solidarity program (PRONASOL),with a view to channelling funds to municipalities for development activities. One channel ofresources provides financing for small, interest-free loans, averaging Mex$400. These loans areapproved by municipal monitoring and evaluation committees and are repaid to a municipal fund forfurther investment at the village level. This is intended to encourage communal pressure to repay.Loans are unsecured and are based on credito a la palabra, i.e. on the word of the loanee. Recoveryrates are around 55 percent, compared to an estimated 20 percent under BANRURAL. A largesegment of BANRURAL's less bankable clients have been redirected to PRONASOL, whichtherefore serves the most risky and least viable tier of agricultural producers. Although the WorldBank is supporting PRONASOL with two rural development loans (3310-ME and 3790-ME), it hasexplicitly ruled out direct funding of PRONASOL's credit activities.

1.11 World Bank Support for Agricultural Credit in Mexico: Mexico is the Bank's second largestborrower for agricultural credit. Since 1965, the World Bank has financed ten agricultural creditprojects totalling US$1,805 million and six agricultural projects with credit components, for whichUS$334 million were earmarked for on-lending.4 The initial thrust of Bank policy was to promoteagricultural production by large commercial farmers; however, by the fourth project (approved in1973), the World Bank began emphasizing access to credit for low income producers. In order toreach them, BANRURAL was made eligible for Bank-supported FIRA rediscounts from 1977onwards under the fifth and subsequent projects. Interest subsidies became the subject of increasinglyfrank exchanges between the World Bank and the Borrower, and a General Interest Rate Agreement(GIRA) was eventually reached in 1984. The GIRA called for scheduled increases in agriculturalinterest rates towards a market reference rate; however, the onset of inflation and rising market ratesled to frequent breaches in the agreement and repeated interruptions in disbursements under theseventh and subsequent loans. The slow pace of interest reform had important fiscal and sectoralimplications, and all five agricultural credit projects immediately preceding this one were ratedunsatisfactory.' Furthermore, disagreement on the pace of interest rate adjustments led the WorldBank and the Borrower to suspend preparation of a follow-on to this project and interrupted anconstructive dialogue on reforming rural financial markets.

4. Throughout the report, US dollars means US dollars equivalent (in current terms, unless otherwise indicated).

5. OED: Project Performance Audit Report for Mexico, Fifth Agricultural and Livestock Credit Project (Loan 1217-ME), SixthAgricultural Credit Project (Loan 1569-ME), Seventh Agricultural Credit Project (Loan 1891-ME), Eighth Agricultural Credit Project(Loan 2454-ME), Agricultural Credit Project (Loan 2610-ME), Report No. 8860, June 29, 1990.

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II. DESIGN AND IMPLEMENTATION

A. Project Design

2.1 The Context. The Eighth Agricultural Credit Project (Loan 2454-ME), approved in June,1984, became effective in December, 1984, and was expected to close in September, 1988. However,by March, 1985, two-thirds of the US$300m loan had already been disbursed. In order to allowsufficient preparation time for the Ninth Agricultural Credit project, while maintaining the continuityof World Bank flows to the agricultural sector, an interim loan of US$180m (Agricultural CreditProject, or FIRA 8A, Loan 2610-ME) was approved in July, 1985. Over half the loan was disbursedby June, 1986, within six months of effectiveness, but in principle adequate time had been bought fora thorough preparation of the Ninth Agricultural Credit Project.'

2.2 Project Objectives and Description: The objectives of FIRA/FICART 9 were to (i) increaseagricultural productivity and thus agricultural exports, real farm income and rural employment; (ii)help the Government improve agricultural sector policies by further reducing interest subsidies, and(iii) help to maintain the financial integrity of participating financial intermediaries. An importantbut unstated objective was to provide the Mexican Government with rapid access to foreign exchange:Mexico's debt-service ratio in 1987 was 55 percent and release of the third tranche of a commercialbank package supporting the Government's structural policy reforms was tied to Effectiveness of thisloan.

2.3 The World Bank loan of US$400 million equivalent was to be on-lent by the Borrower(Nacional Financiera, or NAFIN) to FIRA (US$300 million) and FICART (US$100 million) forproduction credit (9 percent), investment credit (79 percent) and institutional development (2percent). Ten percent of the loan was unallocated. The loan was to cover the foreign exchange costsof the project, or 40 percent of the total project cost of US$1,000 million. The remaining 60 percentof costs were to be financed by FIRA and FICART (32 percent), commercial banks (14 percent) andsub-borrowers (14 percent). The total project cost represented about 15 percent of FIRA's andFICARTs projected investment programme of US$6,911 million for the years 1987-1991.

2.4 Project Genesis: An initiating brief, dated February 5, 1985, indicated GOM's intention torequest a follow-on to FIRA 8 in the amount of US$300-400. The Bank's initial position was thatcontinued disbursement at high rates could only be justified if further progress was achieved onsectoral issues, primarily reductions in the interest subsidies to LIPs and improvements inBANRURAL's operations. The Appraisal mission that visited Mexico in November, 1985,recommended a 50 percent reduction in LIP subsidies during the project period, over and aboveGIRA requirements as a condition for negotiations. The GIRA was to end in January, 1987 with anincrease in interest rates to LIPs from 70 percent to 80 percent of the market reference rate, namely

6. In practice, the preparation was far from thorough. Lending pressure entailed a high degree of tolerance for careless if not misleadinganalysis that cannot be attributed to a shortage of preparation time (see the section on the quality of appraisal (para. 2.12) and the sectionon disbursements (para. 2.9)). Thus the Audit does not concur with the PCR's assessment that the project could have benefitted fromadditional preparation (PCR para. 12). One exception, however, is the FIRA Headquarters sub-component, which was hastily appraisedand included at the last minute.

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the weighted average cost of funds (ACF) to commercial banks.' Thus project staff regarded thiscondition as having been met in August, 1986, when a letter of amendment to the GIRA set a targetrate of interest of 85 percent of ACF for LIPs by July 1, 1987 and 90 percent by January 1, 1988.'The Appraisal mission also recommended inclusion of a component for FICART, which it found tobe "a reasonably good institution, both in its administration and in its delivery of credit", provided thatBANRURAL arrears did not exceed 15 percent of outstanding balances discounted by FIRA orFICART. A decision meeting in January, 1986 strengthened the requirements for FICART'sparticipation in the project by calling for a study of the rural finance sector that would quantifysubsidies to financial institutions. The aim of the FICART component and its conditionality was toacquire previously unobtainable information and thus to be in a position to influence developmentsin the entire rural financial sector.

2.5 In September, 1986, the loan committee introduced new conditionality for the project,requiring that FIRA and FICART become financially self-sustaining within five years. The samemeeting decided to link disbursement of FIRA/FICART 9 to that of the 1986-87 commercial bankfinancing package for Mexico, in order to ensure that the project would be implemented within anacceptable macroeconomic environment. The commercial bank package was part of Mexico'sEconomic Program of Growth-Oriented Adjustment and Structural Reform, launched in October,1986, and as mentioned earlier, release of the third tranche of the package was in turn tied to theEffectiveness of the FIRA/FICART 9 loan.

2.6 A Breakdown in Negotiations: Negotiations were held in November, 1986, but broke downover the issue of financial self-sustainability for FIRA and FICART."o The Government's positionwas that the trust funds were established with specific socio-economic goals that did not includefinancial viability. In January, 1987, GOM failed to increase the interest rate to LIPs to 80 percentof ACF, as agreed under the GIRA. With progress stalled on FIRA/FICART 9, an internal briefingnote to World Bank management in April, 1987, reminded them that the commercial bank packagewas linked to loan Effectiveness, that another project would have to be brought forward to meet theUS$2 billion commitment target for FY87, and that FIRA/FICART 9 would inevitably slip to FY88,"unless Bank management sees a way in which we could proceed more quickly".

7. This indicator is tracked by the Central Bank and reported on a monthly basis. It measures commercial banks' weighted average costof term deposits, discounted notes and other deposits except savings and sight deposits. The cost of bank acceptances and bank-endorsedcommercial paper have also been included in the ACF since November, 1988.

8. Since on-lending rates to LIPs would have to be well above 100 percent of ACF for commercial banks to have an adequate margin tocover administrative costs and doubtful loans, it was misleading to regard an increase in rates from 80 to 90 percent of ACF as a 50 percentcut in subsidies.

9. Appraisal Mission Issues Paper, dated January 10, 1986.

10. The Bank's position was that FIRA and FICART should earn a net operating profit that would be sufficient to maintain the real valueof their equity and provide them with a return of at least 10 percent on their beginning-of-year equity. Their net operating profits wouldbe adjusted as necessary to ensure that their average cost of funds would be equal to at least the Reference Rate, as defined in the GIRA.Furthermore, all grants and subventions received by FIRA and FICART would be related to corresponding development expenses andall extraordinary income and expenditure items would be excluded. Note that this definition of self-sufficiency would still have entailedsubsidies to FIRA and FICART: the clause on grants and subventions was unclear, and the average cost of funds to commercial banksdid not include costs associated with the reserve requirement (from which FIRA and FICART were exempted) or administrative costsassociated with deposit mobilisation (which FIRA and FICART would not have had to incur).

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2.7 Weakened Conditionality and Rapid Approval: At a meeting on April 27, 1987, chaired bythe Senior Vice President for Operations, it was agreed that the ultimate goal was to promote loansat market rates for all borrowers, with up-front cash subsidies where required for social purposes.In the interim, rapid movement with some accommodation was required for FIRA/FICART 9.Satisfactory conditions for Board presentation would be: (i) GOM's agreement to increase LIPinterest rates to 75 percent by May 1, 1987 and to 85 percent by December 1, 1987 (instead of 80percent by January 1, 1987, 85 percent by July 1 and 90 percent by January 1, 1988, as called for bythe amended GIRA); (ii) signature of a Memorandum of Understanding for an umbrella agreementon budgeting and controlling credit subsidies that would replace the GIRA; (iii) an increase in LIPinterest rates to 90 percent of ACF during the project, pending agreement on the GIRAreplacement; (iv) agreed terms of reference (TORs) for a study of financial intermediation andsubsidies in the agricultural sector, and (v) a satisfactory policy statement by GOM on the protectionof FIRA's and FICART's financial integrity.

2.8 Processing of the loan proceeded rapidly thereafter. A Memorandum of Understanding wassigned in late April, the increase in LIP interest rates to 75 percent of ACF took place on May 1,a post-Appraisal update mission visited Mexico on May 4, a second round of negotiations was heldon May 11-15 and agreement was reached on TORs for the rural financial sector study, as well as onmaintaining the real value of FIRA's and FICART's equity at least at levels prevailing on January1, 1986. The project was approved by the Board on June 16, signed on July 31, and became effectiveon August 28, 1987.

2.9 Rapid Disbursement by Design: The initial Project Brief, dated August 7, 1985, noted therapid pace of disbursements under FIRA 8 and FIRA 8A, arguing that "[w]hile these two loansprovide much needed resources to the agricultural sector, their quick disbursement limits the WorldBank's ability to influence the development process". It therefore suggested that "to ensure that theBank is allowed to fulfill its development role, it would be necessary that disbursements be spreadover a reasonable period. As a result, it is proposed that Bank disbursements under the projectwould be limited to no more than US$125 million per year. This would be achieved by eitherimposing the above annual limit or by limiting Bank disbursements to an appropriate percentage ofannual total lending." This ceiling was subsequently dropped, without any comment in the projectfiles.

2.10 The Project Brief also proposed that "short-term credit should be limited to incremental creditin real terms", noting that FIRA 8 had financed short-term credit that was incremental in nominalterms only. This proposal was upheld during project preparation, and it was made clear to theMexican delegation during the November, 1986 negotiations, that the World Bank wanted to finance"real" incremental short-term lending only. However, a memorandum to project files dated December12, 1986, states that "[a]ctually, the way the condition in the Project Agreements...is spelled out, itallows some freedom--the word "real" is not specifically mentioned. The reason for this is that shouldMexico need faster disbursements, this could be permitted at the discretion of the Bank by notimposing incremental in real terms".

2.11 At the second round of negotiations, the Bank agreed to retroactive financing of 10 percentof the loan amount (US$40 million) for discounts made after January 1, 1987, although they violatedthe GIRA, and agreed to a doubling of the Special Account to US$40 million "to facilitate loan

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disbursements.."" As the PCR notes, there was no up-front conditionality, nor was there any linkagebetween disbursements and the preparation and delivery to the Bank of the Agricultural FinancialSub-sector Study (hereafter the Study), or to implementation of its recommendations. Nojustification is provided in the SAR for presuming that FIRA/FICART 9 would be disbursed over afour-year period (1987-91). Since the project amounted to only 15 percent of the FIRA/FICARTinvestment programme for 1987-91 and no criteria were established to distinguish between projectinvestments and non-project investments that met GIRA conditions, there was nothing in theappraisal or loan documents to preclude disbursement of the entire loan within one year.

2.12 The Quality of Appraisal: The Staff Appraisal Report (SAR) reveals several shortcomingsthat are attributable to poor analysis or to a deliberate attempt to remove any obstacles to BoardApproval.12 For example, a memorandum by project staff dated June 1, 1987, called for the SARto add a paragraph that drew attention to the poor collection performance of commercial banks. Itnoted that the reported 4 to 5 percent arrears rate (as a share of outstanding loans) did not reflectsignificant rollovers of dubious loans, and that the true arrears rate was closer to 30 to 40 percent.However, since loan conditionality limited World Bank rediscounts to participating banks with arrearsunder 15 percent of the loan portfolio and Board Approval might have been complicated by thesedata, Bank management decided to remove the paragraph from the final SAR. Similarly, the SARfor FIRA 8 reported loan losses at BANRURAL of around 20 percent of the portfolio. The SARfor FIRA/FICART 9 made no reference to the write-offs, reporting instead that BANRURAL's"overall arrears position of 9.5% in 1980 has been progressively reduced to 3%".

2.13 A third example is drawn from paragraph 2.13 of the SAR, which affirms that thedecapitalisation of FIRA's equity in 1982/83 due to high inflation was reversed during 1984-86, whenFIRA's equity increased by an annual average of about 42 percent. This was impossible, since, as theSAR failed to mention, inflation ranged from 59 percent to 105 percent during 1984-86. Finally,Annex 3 includes the following quixotic assertion: "...profits would be insufficient to offset thedecapitalization of its loan portfolio caused by...remaining sub-loans at fixed and negative real interestrates. However, as those sub-loans are repaid (within the next five to six years), FIRA would becomeself-sustaining, earning sufficient profits to avoid decapitalization and further Government support."With FIRA's on-lending rate below the rate charged to LIPs (to provide commercial banks with aspread) and rates to LIPs below the ACF and the ACF below the inflation rate, this was also simplyimpossible.

2.14 Board Presentation: The need to avoid obstacles to Board Approval led to further lapses inthe accuracy and completeness of information during Board Presentation. Staff affirmed thatpreferential rates were within a narrow band around the market cost of funds, failing to note that therate to LIPs was 25 percent lower than the ACF and that the ACF itself was well below the rate ofinflation. When asked directly whether very large farmers received any measure of subsidy, staff saidno. There was no mention of the fact that at ACF plus one percentage point, the on-lending rateto large farmers was insufficient to cover the cost of funds, administrative costs and a provision forrisk, that the on-lending rate was insufficient to maintain the real value of the loan, or that loans to

11. See the Summary of Negotiations, dated May 22, 1987.

12. See OED's "Review of World Bank Agricultural Credit Operations in Medco", dated July 21, 1988, which was prepared as a workingpaper for "A Review of Bank Lending for Agricultural Credit and Rural Finance (1948-1992)", OED Report No. 12143, dated June 29,1993. Also, see para. 2.16 in this Audit Report.

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producers in other sectors were at higher rates of interest. One Executive Director remarked on thedecapitalisation of Mexico's agricultural credit system, drains on the central Government's budget andthe misallocation of scarce resources. The loan was then approved.

B. Project Implementation

2.15 General Performance: Difficulties arose during project implementation as a result of delaysin adherence to the GIRA, disagreements with GOM regarding the Study and problems with theconstruction of FIRA's new headquarters. The project was extended by one year to allow for thecompletion of the civil works, eventually closing on June 30, 1992. Nevertheless, the three fullsupervision missions that visited Mexico in October, 1987, September, 1988, and March, 1989, gavethe project respective ratings of 1, 2 and 1. Disbursements proceeded well ahead of schedule, whilethe objective of reducing interest subsidies was greatly assisted by a sharp decline in inflation. Indeed,interest rates to agriculture have been positive in real terms since 1988. Furthermore, the newAdministration that took office in 1988 introduced a series of reforms that increased efficiency in thebroader agricultural and financial sectors (see para. 3.41). These reforms benefitted the project,although few if any of them are attributable to it.

2.16 Project Costs and Financing: Project costs at completion were US$920 million, or 8 percentbelow appraisal estimates (see Table 1). The shortfall was more pronounced for medium and longterm investments (9 percent) than for seasonal investments (1 percent), due to a sharp increase inreal interest rates to agriculture. Expenditures on institutional development were almost one-thirdlower than projected, as a result of new restrictions on the purchase of vehicles and limited use oftechnical assistance. Panel 2 of Table 1 shows the distribution of project costs and World Banklending for sub-loans by type of beneficiary. It suggests that LIPs received a considerably larger shareof funds than was expected at appraisal. However, detailed comparisons with appraisal figures arevitiated by errors and internal inconsistencies in the appraisal data."

2.17 Overall, the World Bank financed 43 percent of project costs, as opposed to the 40 percentestimated at appraisal. Commercial bank loanees also contributed a larger share than projected,whereas FIRA/FICART, the commercial banks and in particular BANRURAL contributed less thanoriginally planned (see Table 2). Although BANRURAL's shortfall was partly compensated byFICART, both BANRURAL's participation and that of its borrowers were lower than required underthe BANRURAL Project Agreement (see PCR para. 42 and Part III, Table 5.2).

13. The SAR simply divides sub-loan costs equally between LIPs and Other Producers (OPs), even though the Loan Agreement allocatesless funds for LIPs than for Other Producers and includes the same disbursement percentage for each category (which implies a lowerproject cost for LIPs than for OPs). There are several other difficulties with the Appraisal data. For example, the project cost table inAnnex 1 of the SAR shows that participating banks would contribute US$148 million and sub-borrowers would contribute a further US$148million. The financing plan on the same page includes contributions of $141 million by each group. It is furthermore clear, from acomparison of the project cost tables in Schedule A of the President's Report and Annex I of the SAR, that the latter erroneously allocatesthe entire PB and borrower contributions to long term investments and none to short term investments. As noted earlier, no attempt ismade to reconcile the original appraisal cost allocation of US$16 million for institutional development with the total of US$22.5 millionafter negotiations, which includes funding for the FIRA Headquarters. Finally, both the project cost panel and the financing plan panelin Annex 1, Table 1 of the SAR estimate total project costs at USS6,911 million. However, Annex 1, Table 2 indicates total project costsof US$9,865 million. This major discrepancy is not the result of a typographical error, but rather of double counting of PB and borrowercontributions.

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Table 1: Appraisal and Actual Project Costs(US$ Millions)

Appraisal Actual

Panel 1: Total Project Cost Total Cost I Bank Loan Total Cost J Bank Loan

Medium & Long Term Investments 785.0 314.0 714.9 317.2

Short Term Investments 192.5 37.0 189.8 77.0

Institutional Development 22.5 9.0 15.41 5.8

1 Total 1,000.0 400.0 920.o 400.0

Panel 2: Cost of Investments'

Low Income Producers (LIPs) 492.0 169.5 487.2 243.2

Other Producers (OPs) 492.0 181.5 417.4 151.0

Unallocated -- 40.0

Total 984.01 391.0 6 394.2

a. The cost of the LIP and OP investments estimated at appraisal (US$984 million) does not equal the appraisal estimate of short plusmedium and long term investments (US$977.5 million), because of an inconsistency in the SAR: the institutional development (ID) wasoriginally costed at US$16 million, but with the addition of the new FIRA headquarters at the last moment, the ID component rose toUS$22.5 million. The SAR reduced the size of the investment components in the cost table by type of investment (short term versusmedium/long term), but not in the cost table by type of borrower (LIP versus OP).

Table 2: Appraisal and Actual Project Financing(US$ Millions)

Appraisal Actual

Amount Share Amount Share

The World Bank 400.0 40.0% 400.0 43.4%

FIRA 205.5 22.3%> 318.0 31.8%

FICART 65.9 7.2%

Participating Banks 86.4 9.4%

BANRURAL > 141.0 14.1% 1.8 0.2%

Sub-borrowers' Contribution 141.0 14.1% 160.4 17.4%

Total 1,000.0 100.0% 920.0 100.0%

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2.18 Disbursements: Disbursements began rapidly (reaching 30 percent of the loan amount withinfour months of Effectiveness), but were held up briefly in the first quarter of 1988 because GOMfailed to introduce the interest rate increases mandated by the GIRA. Indeed, the Bank had agreedto a temporary 5 percent reduction in long term rates for LIPs (relative to the ACF), together witha 2 percent increase in short term rates, effective November and December, 1987, with theunderstanding that rates would return to GIRA levels as of January 1, 1988. The Governmentadjusted agricultural interest rates in June and again in August, 1988, bringing them to levelsexceeding those required under the GIRA. This opened the way for disbursement against loansdiscounted after April, 1988, even though they had not met GIRA conditions. By June, 1989, i.e.within two years of Board Approval, 93 percent of the loan had been disbursed. Slow progress onthe FIRA headquarters led to a one-year postponement of the Closing Date, so that FIRA could useup World Bank funds for this component. Due to further difficulties with the contractors, the fundswere reallocated for on-lending and the project was closed on June 30, 1992.

2.19 FIRA Headquarters: Funding for the construction of FIRA's new headquarters in Morelia,Michoacin, was added during the second round of loan negotiations in May, 1987. Draft biddingdocuments were sent to the World Bank one year later. The Bank questioned the sharp escalationin estimated costs and suggested revisions in the bidding documents. In January, 1989, the Bankwarned FIRA to improve the consistency and completeness of its tendering documents "to protectFIRA from likely high-cost overruns and delays in the time during the construction period", and sentdown a consultant with detailed comments to review the tendering documents. The Bank finallycleared the fourth version of the bidding documents in June, 1989. Although project staff at firstobjected to FIRA's criteria for the selection of a construction agency, they eventually agreed toFIRA's choice and the contract was signed in November, 1989. The contractor experienced liquidityproblems from the outset, supplied less materials to the building site than might have been purchasedwith their 20 percent advance payment, and delayed construction throughout 1990. In March 1991,the World Bank was notified by NAFIN that costs had gone up from Mex$11,850 million (US$4.54million) to Mex$27,297 million (US$9.65 million). Although FIRA supervisors were aware of thedifficulties, feedback to FIRA management regarding the problems was inadequate and FIRAtolerated the delays until April, 1991, when the decision was taken to cancel the contract. The legalwranglings with the contractor that followed the cancellation remain unresolved. The Bank approvedFIRA's decision to elicit bids for a new contract and a second contractor was hired early in 1992.Notwithstanding the extension of the project by one year, FIRA headquarters were unfinished atProject Closing. They were still incomplete in March, 1994, when the Audit mission visited Mexico,but by October, 1994 landscaping and interior arrangements had been completed and FIRA staff hadmoved in.' 4

2.20 The Agricultural Financial Sub-Sector Study: Through the Study, the Bank hoped to acquirepreviously unavailable information and thus to be able to conduct a more informed policy dialoguewith GOM regarding the rural financial sector. The Government was concerned that this policydialogue would lead to conditionality in future operations that would be at odds with GOM's socio-political objectives for the agricultural sector. The Government agreed to the Study because theWorld Bank made it a condition for including the FICART component, but was averse to any Bank

14. FIRA staff attributed the delays in construction partly to the refusal of the State Government of MichoacAn (which ceded the 28-hectare site to FIRA) to allow the use of explosives for excavation of the foundations. Since the ground is hard rock, labour costs andconstruction time were considerably higher than projected.

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involvement in the Study from the outset. The difference in perspective between the World Bankand GOM, which simply reflected a broader disagreement on the need for reforms in the sector, wasnot reconciled prior to Board Approval. Furthermore, provisions in the Guarantee Agreementregarding the Study were weak, possibly to avoid further delays in approval and disbursement ofproject funds. The inadequate preparation and weak conditionality for this key component greatlycomplicated implementation.

2.21 The Bank sent three missions in the first three months following Effectiveness to monitorprogress on the Study and ensure that the January, 1988 deadline would be met. The deadline wasoptimistic. The Secretariat of Finance (SHCP), which was responsible for the Study, initially refusedto provide details on the work programme or on the staff involved. However, draft plans for theStudy were eventually forwarded to the Bank in November, 1987. In May, 1988, the Bank requesteda copy of the first phase of the Study from GOM (field work had been postponed to a second phase).The Government reminded the Bank that Section 3.02 of the Guarantee Agreement only requiredGOM "..by not later than January 31, 1988, [to] carry out the study included in Part E of the project,under terms of reference as agreed between the Guarantor and the Bank, and thereafter exchangeviews with the Bank on the conclusions and recommendations of such study" [italics added]. Asupervision mission in May/June, 1988 was duly given a copy of Chapter IV of the Study, entitled"Conclusions and Recommendations". The Bank argued that it was in no position to comment onthe methodology, assumptions and data included in the Study without receiving a copy of the fulldocument. After repeatedly requesting a copy of the Study from GOM and linking reallocations offunds between loan categories to receipt of the full document, the Bank was provided with a copy.The Study fell short of its stated objectives and the Bank warned that a follow-on operation wouldbe contingent on a more detailed analysis of subsidisation, transaction costs and arrears.

2.22 Phase II of the study began in March, 1989, and the Bank was initially optimistic about itsexecution, but a February, 1990 supervision reversed this assessment, advising the Bank to obtain theraw data for its own analysis. GOM declined to provide the data, but sent a revised document inJuly, 1990. The analysis was still regarded as limited, but the Bank began to obtain data, andconducted its own analysis in the context of the preparation of a follow-on operation.

2.23 Monitoring and Evaluation (M&E): Towards the end of the project period, FIRAindependently upgraded its capacity for monitoring rediscounts, known as the Sistema de Inspeccionespor Muestreo (SIM). Currently FIRA monitors about 13 percent of sub-loans. Eighty percent of thissample is randomly selected, whereas 20 percent are chosen on the basis of prior informationregarding possible irregularities. Both participating banks and sub-borrowers are monitored, and loansare recalled if off-farm diversion is uncovered. In the case of irregularities by the PBs, such asdeviations from agreed loan terms, a penalty interest rate is charged. The penalty was increased in1992 from 1/2 to 3 times the ACF. FIRA staff maintained that the incidence of diversions and otherirregularities was quite low and that it had not varied significantly over time, although they could notpresent corroborating data to support the latter judgment (see para. 3.11).

2.24 FIRA's ex-post evaluation capacity was established at the World Bank's insistence in 1976.The SAR for FIRA/FICART 9 also noted (para. 3.18) that "[t]he project would assist FIRA tomaintain itself as an efficient institution, strengthening those areas that show weakness, such asmonitoring and evaluation procedures". Nevertheless, during the project period, FIRA's M&E unitreceived little attention from Bank supervision missions and the Sistema de Evaluaci6n de losResultados del Crdito (SERC), as it is known, is not even mentioned in the PCR. There has also

12

been little support for ex-post evaluation within FIRA itself and in 1991 FIRA's management nearlyabolished the SERC. The evaluation unit nevertheless tracked returns, equity and assets for astratified sample of about 700 farms across the country during the project period, focussing onparticular lines of crop and livestock production. It issued information bulletins covering the 1983-87and the 1988-90 periods respectively that suggest that the farm investments supported by FIRA werefinancially viable (see para. 3.7).

2.25 At present, FIRA is attempting to integrate the SERC and the SIM with three otherinformation systems, one for costs of production (SUECO), one for agricultural price indices (SIPA)and one for the ex-ante analysis of the profitability of various lines of production. The last of thesewas introduced in 1991 and has been well received by FIRA staff. The integration of these fivesources of data should yield a unified information system of greater relevance to FIRA's needs.

2.26 Reporting and Auditing: The PCR reports inconsistencies in the financial records maintainedby the Borrower (NAFIN) and the implementing agencies (FIRA and FICART, see PCR para. 81).Indeed, in 1991 the World Bank reallocated funds among disbursement categories since some wereoverdrawn, possibly as a result of inadequacies in record-keeping. Delays in reporting contributedto a slow response by FIRA management and by the World Bank to problems with the contractorsfor FIRA's new headquarters. However, compliance with the project's reporting and auditingrequirements was generally good. On the World Bank's side, important weaknesses in appraisaldocumentation were identified earlier in this Report (see paras. 2.12 and 2.16).

2.27 Compliance with Covenants: The project had relatively few covenants and compliance wasacceptable, albeit incomplete." The objective of improving agricultural sector policies by reducinginterest subsidies was supported with a covenant requiring adherence to the GIRA. The Governmentmade the required adjustments to interest rates with some delay, but the 1988 increases in interestrates for LIPs went beyond those required under the GIRA. The objective of maintaining thefinancial integrity of participating financial intermediaries was supported by a covenant in the ProjectAgreement with the Central Bank (BANXICO), requiring GOM to "take all necessary action toensure that adequate funds are budgeted annually to FIRA and FICART so as to prevent anymaterial capital erosion, in real terms, which FIRA or FICART may have incurred during theimmediately preceding year on account of all their lending operations after January 1, 1986". Thiswas adhered to for both FIRA and FICART by the end of the project period, although in December,1987, FICART's equity was found to be 40 percent lower in real terms than in January, 1986, andFICART was dissolved after Project Closing. No such covenant was included in the ProjectAgreement for BANRURAL, which absorbed FICART's assets and liabilities in 1993.

2.28 Another covenant that was meant to support the objective of improving agricultural sectorpolicies was the requirement that an Agricultural Financial Sub-sector Study be prepared and thatits recommendations be implemented according to an agreed schedule (see para. 2.20 ff. and Section3.02 of the Guarantee Agreement). The covenant was too weak to achieve its objectives. Not onlydid the covenant fail to guarantee World Bank access to the full Study, it also predictably failed toensure that the Study would be of acceptable quality. Indeed, since the Bank was dissatisfied withthe Study's analysis, it did not insist on implementation of the Study's recommendations.

15. See the PCR, Part III, Table 9, for a list of covenants and their status.

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2.29 There were violations in the following covenants: first, in March, 1989, a World Banksupervision mission found that about $13.5m had been claimed by FIRA for disbursements at LIPrates to ejidatarios who earned more than 1000 times the minimum daily rural wage in their region.This problem arose because, until 1990, GOM defined all ejidatarios as LIPs, irrespective of theirincomes. FIRA replaced these rediscounts with eligible sub-loans at the World Bank's insistence.Second, participating banks, notably BANRURAL, did not make the minimum contributions to sub-loans that were required under the Loan Agreement. The World Bank did not enforce this covenant.Finally, the Project Agreements required that access to rediscounts be suspended for participatingbanks whose arrears exceeded 15 percent of the aggregate outstanding amount of loans rediscountedunder the project. However, due to the lack of a clear definition of what constituted arrears and toparticipating banks' ability to restructure loans just before the reporting dates, this covenant was hardto enforce, and indeed never was enforced. It appears to have been violated, insofar as 40 percentof BANRURAL's portfolio was written off in 1991 for collection by other agencies, suggesting thatarrears exceeded 15 percent by any acceptable definition.

2.30 World Bank Supervision: The Bank was on the whole thorough and timely in its monitoringand support of project implementation, providing 10 missions and over 40 staff-weeks of supervisionthrough June, 1989. One possible exception is the Bank's delayed response (in May, 1988) to GOM'sfailure to increase rates as required by the GIRA in January, 1988. The intensity of supervisiondropped sharply after June, 1989, when most of the credit component had been disbursed. Indeed,there was a two-year hiatus in missions between June, 1989 and July, 1991, when a World Bankmission visited Mexico to address problems with the construction of FIRA's headquarters. The PCR(para. 75) rightly states that the project would probably have benefitted from more intensivesupervision of the productive support component. However, World Bank staff took advantage of theproject and of preparation of a follow-on operation to conduct a fruitful dialogue on rural financialsector reforms (see para. 3.10, 4.2).

2.31 Bank-Borrower Relations: As noted in the PCR (para. 78), the Bank-Borrower relationshipwas generally satisfactory. It can be divided into three distinct phases. The first phase, lasting fromproject preparation until the Summer of 1988, was marked by relatively paternalistic GOM policiestowards agriculture and by sensitivity at what was regarded to be undue World Bank influence in therural financial sector. Loan negotiations were broken off in 1986 over the issue of self-sufficiencyfor FIRA and FICART, the Government refused to allow the World Bank to participate in its reviewof BANRURAL's operations and, once the project was under way, GOM was reluctant to share thefindings and data of the Study with the Bank. A change of Administration in 1988 accelerated thepace of reform in the Mexican economy, and the Bank-Borrower policy dialogue on rural financeflourished as GOM adopted a more laissez-faire approach to trade and finance. Most of this policydialogue was conducted in the context of the preparation of a follow-on operation, to be financedby the World Bank and the IDB. This phase of the relationship ended late in 1992 with a breakdownin the dialogue that coincided with the promulgation of OD8.30 in the Bank, the adoption of a moredoctrinaire approach to rural finance by the IDB, and importantly, electoral considerations in Mexicoas the Sexenio (or six-year administration of the President) began to draw to a close. TheGovernment recognised the economic merits of most of the World Bank/IDB policies but argued thatthe policies were inconsistent with GOM's socio-political objectives in the agricultural sector. Therehas been little serious exchange of ideas on formal agricultural credit since Project Closing. On theother hand, GOM and the World Bank have jointly undertaken research on informal financialmarkets during the past two years. It is expected that the Bank and GOM will conduct a broaderand more intensive dialogue now that the new Administration has taken office.

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III. PROJECT OUTCOME

A. Farm-level Impact

3.1 Number and Type of Beneficiaries: According to FIRA/FICART estimates, the projectexceeded appraisal expectations with regard to the number of beneficiaries. A total of 190,436families (about 870,000 individuals) were reached, compared to the appraisal target of 100,000families (about 550,000 individuals)."' It is also likely that the project helped to create more jobsthan estimated by the SAR, although this cannot be confirmed because data on job creation are notavailable for FICART. About 72 percent of the appraisal target of 240,000 jobs was achievedthrough FIRA's project-related activities.

3.2 Although the reallocation of loan funds resulted in LIPs receiving 61.7 percent of World Bankrediscounts, compared to 50 percent at appraisal, the overall share of LIPs in the FIRA portfolio hasdeclined dramatically since 1987, from 49 percent to about 19 percent of all rediscounts. FIRA'srecent SIM data suggest that incorrect classification of wealthier borrowers as low income producersis negligible, but data were not available for the project period. Furthermore, for FIRA loans thatwere not discounted by the World Bank, LIPs were defined according to the Government's definition,which, until 1990, included all ejidatarios as low income producers. This made non-project FIRAresources available to an undetermined number of OPs at the subsidised rates intended for lowincome producers. Moreover, after Project Closing, FIRA began to use a cutoff of 3,000, rather than1,000, times the regional minimum daily wage to distinguish between LIPs and other producers forthe purpose of technical assistance grants."

3.3 The definition of Low Income Producers was a bone of contention between the World Bankand GOM during this and earlier projects. FIRA correctly pointed out that the real value of theminimum regional daily wage had fallen dramatically (see Annex 1.2), so that farmers could haveexperienced a real decline in incomes and still have graduated from the LIP category to become OPs.The World Bank stood by the increasingly strict definition, arguing that it had evidence from Mexicancensus data that 80 percent of farmers still fell below the 1,000-times-the-daily-wage cutoff. Inpractice, World Bank staff wanted to address the issue of targeting subsidies to poorer farmers moreeffectively in the context of the follow-on project; besides, the tightening of the definition was aconvenient way of raising agricultural interest rates towards market rates for a broader segment ofthe market.

3.4 Throughout the 1980s, the World Bank suspected that masquerading of OPs as low incomeproducers was far more widespread than FIRA indicated and that suspect definitions of producers'income were being used, but it could not muster sufficient evidence. The Audit team has not seenFIRA's SIM data for the relevant period and cannot comment on these issues, except to note that

16. The PCR states that 'The credit component of the project has benefitted an estimated 868,400 individuals and about 190,436 families.."

[emphasis added], which suggests that the number of families has been double-counted.

17. At the end of 1989, (half-way through the project), the lowest regional minimum daily wage was about US$3.40 per day. A farm familywith an annual income equal to 1,000 times this wage, i.e. (US$3,400) would have earned 35 percent more than the average Mexican (basedon a GNP/caput of US$ 2,440). A farm income of 3,000 times the minimum daily wage would have equalled more than four times thenational average. Since the minimum daily wage was more than US$3.40 in certain regions, farmers with slightly higher incomes couldhave fallen below the cut-offs in those regions.

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the incentive for cheating has declined significantly, because the difference between LIP and OP ratesis far smaller. Nevertheless, the incentive is still there and continues to entail unnecessary monitoringcosts.

3.5 Returns on Investments: Mexican agriculture went through a difficult adjustment in 1988 and1989, as a result of the removal of trade barriers following Mexico's accession to the GATT, thereduction of support prices for key crops, a sharp increase in real interest rates and the significantdeclines in input subsidies, including credit subsidies. However, agricultural production reboundedin 1990 and 1991, more or less returning to 1987 levels in real terms, so that the overall picture isone of stagnation, rather than decline, during the project period.

3.6 It is difficult to discern the impact of FIRA/FICART credit on agricultural production andproductivity, and thus of the World Bank project on Mexican agriculture. However, the Audit doesnot agree with the PCR's contention that the project had no demonstrable impact because the WorldBank financed only a small share of FIRA/FICART's lending and agricultural production wasstagnant during the project period. As long as all credit is extended to sub-borrowers on the sameterms, the share of FIRA/FICART credit that is rediscounted by the World Bank has no bearing onthe impact of that credit." Furthermore, the stagnation observed in Mexico's agricultural economyduring the project period does not rule out the conclusion that credit had a positive impact, since therelevant counterfactual may have been negative growth. This point holds a fortiori if one observesthat conditions in the late 1980s were particularly difficult for less viable farmers, who had little orno access to FIRA/FICART funding, whereas asset and equity holdings of a representative sampleof FIRA clients were found to have increased in real terms throughout the project period (see Table3).19

3.7 While the impact of the project on agricultural production in Mexico cannot be quantified, itis feasible to consider whether or not the investments that the World Bank helped to finance werefinancially viable. To this end, Annex 1.13 presents figures on prices to farmers and costs ofproduction per irrigated or rainfed hectare for wheat, maize, rice, beans and sorghum. Cost datawere obtained from FIRA's SUECO database and price and yield data from the Secretariat ofAgriculture (SARH). For each crop, financial prices and yields were used for the state that accountsfor the largest share of Mexico's total output, e.g. Tamaulipas for sorghum and Sonora for wheat.The Audit concludes that investments in irrigated crops were financially viable, although notnecessarily economically sound (because of the distorted policy environment). Gross returns tofarmers were positive for irrigated maize, rice and wheat, and increased in real terms over the period1986-1990 for all three crops, even though production costs rose more rapidly than output prices formaize and rice. The picture is less encouraging for rainfed production. Gross returns on rainfed

18. It is, however, true that the additionality and therefore the impact of the Bank's funds, as opposed to credit per se, is difficult toestablish. Regional staff noted in an internal communication, dated November 30, 1994, that "without FIRA IX, FIRA would haveresorted, as it actually did once the credit line was disbursed, to increase rediscounts from BANXICO" (sic.). This line of argumentregarding the additionality/impact of Bank funding is clearly also applicable in sectors other than agricultural credit.

19. The data are drawn from FIRA's SERC database. For details on the methodology, see the Boletin Informativo: Evaluacion deResultados de Credito, Etapa 1988-1990, prepared by FIRA's evaluation unit. Unfortunately the SERC data does not include a controlgroup, therefore the difference in performance between FIRA and non-FIRA clients cannot be quantified. Furthermore, it is probablyno coincidence that FIRA clients performed better than others, since they would in all likelihood have been offered credit precisely becausethey were good credit risks. This further vitiates attempts to isolate the "impact" of FIRA's credit.

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sorghum were marginal and returns were generally negative on rainfed beans in Zacatecas until1990.' These findings are less sanguine than the FIRA findings presented in Part III, Table 7 ofthe PCR. FIRA's models compare appraisal with re-estimated investment plans for rainfed annualcrops, irrigated annual crops, beef cattle ranching and dual purpose cattle ranching. The farminvestment plans suggest that re-estimated net benefits at full development were positive for allinvestments, and exceeded appraisal estimates in the case of irrigated annual crops and of beef cattleranching.

Table 3: Increments in Assets and Equity during Project Yearsfor a Stratified Sample of FIRA Borrowers

Sample Size Base Value in Value in Increment1988 Mex$ '000s PBIs OPs Year Base Year 1990

Annual Crop Producers: 195 94 1988Average Assets 330 473 44%Average Equity 303 412 36%

Perennial Crop Farmers: 46 59 1985Average Assets 316 616 95%Average Equity 295 560 90%

Dual Livestock Producers: 89 55 1986Average Assets 326 507 55%Average Equity 316 465 47%

3.8 The Audit mission met with larger farmers and groups of farmers in Guanajuato and Sinaloaand found that yields had increased following the opening of the Mexican market to competition fromforeign producers. In particular, maize yields doubled to 7-8 tons per hectare for farmer groups withirrigated land in Sinaloa. Yields for wheat and barley increased by about 50 percent to 6 tons/ha forfarmers influenced by the conservation tillage techniques disseminated by FIRA's demonstrationcentre in Guanajuato. However, yields increased far less for small, individual producers and wereessentially unchanged for those operating on rainfed land.

3.9 Efficiency of Resource Allocation: Although the investments supported by the World Bankwere financially viable, it is very likely that many of them were inefficient from an economic pointof view. The price of fertilisers, water and electricity were highly subsidised, while prices to theproducer were fixed by GOM for most crops until 1990, often at levels above world prices. Forexample, the PCR for AGSAL II estimates average nominal protection coefficients (NPCs) ranging

20. Between 1986 and 1989, yields on rainfed beans in Zacatecas were well below the 0.6 tons/ha required for an acceptable return tothe farmer. If yields in Zacatecas had equalled the national averages of 0.45 to 0.6 tons/ha during 1986-90, gross returns would have beensmall but positive in four of the five years.

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from 1.18 for sorghum to 1.65 for maize during 1988-92.1 It should be noted that the primarysources of inefficiency in this highly distorted environment were trade, exchange rate and input/outputprice factors, rather than credit at below-market rates of interest. These factors have been addressedquite comprehensively via trade and agricultural sector adjustment operations.' One concern thatthe Audit mission was not able to address was the question of whether below-market rates of interesthad induced excessively capital-intensive development by sub-borrowers and therefore acceleratedmigration to urban areas. This concern merits investigation by Mexican research institutions.

3.10 Diversion of Sub-Loans: Diversion of loans appears to have been rampant amongBANRURAL clients during the project period.' For example, the Secretariat of Finance (SHCP)estimates that BANRURAL financed about 800,000 ha of non-existent crops during 1988.' TheAudit Mission was repeatedly informed by different sources about the high incidence of diversion ofBANRURAL loans. The problem was attributable primarily to the poor design of the compulsoryinsurance scheme managed by ANAGSA and to weak supervision by BANRURAL. Low rates ofinterest were at best a minor explanatory factor, since pressure to repay the loan was minimal. Thetypical ruse involved diversion to consumption purposes of at least part of the BANRURAL loan,claims to ANAGSA for "crop damage" and reimbursement by ANAGSA to the farmer and toBANRURAL. According to a World Bank study, an incredible 68 percent of the area insured byANAGSA was damaged or destroyed in 1989.' However, ANAGSA and BANRURAL agents arebelieved to have benefitted considerably under the scheme.

3.11 In sharp contrast, off-farm diversion of loan funds appears to have been fairly modest forFIRA/commercial bank clients. FIRA could not present data for the project period, but affirmed thatthere had been little variation in the incidence of "irregularities" since 1987. Their data for the thirdquarter of 1993 indicate that irregularities were found in 11 percent of cases surveyed. The incidencewas higher for long term credit (16 percent) than for short term credit (5 percent) and for wealthierproducers (13 percent) than for low income producers (9 percent). Thirteen percent of theirregularities were classified as diversions; this amounts to only 1.4 percent of the sample surveyedby FIRA.

3.12 Of course, the mere existence of a sub-project investment does not rule out the possibility thatthe sub-loan might have substituted for other funds which would otherwise have been used for theinvestment - these funds would be freed up for non-farm purposes as a result of the sub-loan.

21. Draft Project Completion Report: Mexico - Second Agricultural Sector Adjustment Loan (3357-ME), dated June 28, 1994. Note:the nominal protection coefficient measures the ratio of domestic to import parity prices. An NPC greater than unity implies a subsidy.

22. Trade Policy Loan 2745-ME, Second Trade Policy Loan 2918-ME, Agricultural Sector (AGSAL I) Loan 2918-ME, and SecondAgricultural Sector Adjustment (AGSAL II) Loan 3357-ME. See OED's forthcoming Performance Audit Report on AGSALs I and II.

23. The Audit could not obtain data on whether the problem was less serious for sub-loans rediscounted by FIRA/FICART than for otherloans in BANRURAL's portfolio.

24. See "Mexico - The Banrural Agricultural Credit System", LA2AG, 16th January, 1990.

25. The problem was also openly acknowledged in the press. For example, a front page headline in El Diario de Sinaloa (14th March,1994) stated that "Diversions swelled the debt" and quoted a government official as saying that "a large part of the overdues of the ejidalsector is the result of diversions in the use of loans".

26. Page 10 of the BANRURAL study (see footnote 22).

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Although conclusive evidence is not available one way or another regarding this issue, the Auditmission met with wealthy farmers in Guanajuato and Sinaloa who did not borrow when interest rateswere highly negative (before 1988) but are currently borrowing in spite of high real interest rates, orare continuing to rely on own funds. Indeed, if loans had been taken out during 1986-90 at short-term OP rates to cover 80 percent of the working capital costs for selected irrigated crops (maize,rice and wheat -- see Annex 1.13), the resulting ex-post returns on farmers' equity contributionswould have exceeded the market reference rate. Investments in rainfed crops would, ex-post, haveperformed poorly until 1990, relative to the market reference rate. The Audit found no support forallegations of widespread capital flight using FIRA/commercial bank loans. Allegations of this typehad surfaced in the course of Bank operations in the early 1980s.

Figure 1: Agricultural Lending by FIRA, BANRURAL and Commercial Banks

10

14-Commercial Banks

10-

C rR

0 BANRURZAL

1986 1987 1988 1989 1990 1991 1992

3.13 Crowding-Out of Commercial Bank Lending: One type of substitution of funds that the Auditbelieves to have been important is the provision of FIRA-rediscounted sub-loans to wealthiercommercial farmers who could have qualified for short-term credit at market rates using thecommercial banks' own resources. This echoes the finding of the PAR on the previous five Bank-supported agricultural credit project, which notes that "[w]herever possible, commercial bankssubstituted FIRA funds for their own"." There is indirect evidence to support this postulate in theincrease in commercial bank funding for agriculture that followed the introduction of the tasa mezclasystem in 1989 (see para. 3.29). This system effectively liberalised interest rates on short term loans

27. OED Performance Audit Report No. 8860, paragraph 78.

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to OPs by allowing commercial banks to blend funding at unrestricted rates with funds at controlledrates for an overall loan rate to OPs that roughly equalled market lending rates. That year,commercial banks lending to agriculture increased 139 percent in real terms, compared to 34 percentfor HRA and a real decline for BANRURAL (see Figure 1).' Agricultural lending also grew morerapidly in 1989 than lending to other sectors (see Annex 1.5, 1.6). However, the problem ofincreasing arrears on agricultural loans soon curtailed the rapid growth in agricultural lending.

B. Institutional Development

3.14 The project contributed to the institutional development of FIRA in three ways: it fundedequipment for FIRA's demonstration centres, it provided training to FIRA staff and it supported theconstruction of FIRA's new headquarters. FICART's institutional development component was notfinanced by the project and little information is available about it since FICART has been disbanded.

3.15 Demonstration Centres: The Audit mission visited FIRA's demonstration centre "Villa Diego"in the State of Guanajuato. It had been transformed from a livestock centre to an agricultural centrein 1987, as agriculture became more important regionally and good results had been achieved withlivestock. Villa Diego is one of six remaining demonstration centres administered by FIRA - therewere nine at project completion, but three centres, owned by the State Governments of Tlaxcala,MichoacAn and Guerrero, have since been closed. While the Audit mission found that the centrewas having a noticeable impact on the production of nearby farmers, it did not find that the projecthad a significant effect on the activities of the demonstration centre. Furthermore, much of thedissemination is conducted via meetings held on over 400 demonstration farms that cultivateexperimental plots with FIRA guidance and support, but civil works were restricted to the ninecentres because Mexican law precludes permanent investments on demonstration farmers' lands.FIRA and GOM restrictions also constrained investment in equipment and vehicles - less than 30percent of the World Bank funds allocated for these items were disbursed.

3.16 Training and Technical Assistance: External training and the use of consultants were alsorestricted under regulations introduced by the new Administration in 1988-89. Only one foreignconsultant was hired, to evaluate bidding documents. Greater reliance on consultants in constructionmanagement would have been helpful. Foreign training consisted mainly of study tours, seminars,English language courses, conferences and trade shows. Only one foreign postgraduate degree wasfinanced with project funds. However, 631 events were organised during the project period toprovide training to FIRA's technical and administrative staff. A total of over 7,200 participantsbenefitted from courses including computer technology, strategic planning and financing, economics,and credit supervision.' An additional 226 events were organised for training small farmers,

28. In 1989, the entire banking system's agricultural portfolio rose by an average of 45 percent in real terms, compared to 27 percent forthe system's non-agricultural portfolio. The exceptionally rapid expansion in agricultural lending reflects increases in relative, rather thanabsolute, expected returns on agricultural loans. The tasa mezcla is an important explanatory factor for the relative increase in expectedreturns on loans to agriculture. The expansion of FIRA/PB credit also allowed commercial banks to issue more bridging loans in the formof preswmos quirografarios to their agricultural clients. These bridging loans were at higher interest rates and were often recovered fromthe rediscounted portion of the FIRA/PB loans. Finally, while interest rates were high and spreads on agricultural loans were expressedas a percentage of ACF, it was more attractive to rediscount agricultural loans with FIRA. However, the decline in the ACF reduced thespread on rediscounted sub-loans until these spreads were well below those obtainable using commercial banks' own funds without FIRArediscounts (see Table 5), i.e. substitution of FIRA funds for own funds became less attractive. (This eventually led to the de-linking ofspreads on rediscounted sub-loans and the ACF.)

29. The total number of participants is higher than the number of beneficiaries, since many beneficiaries participated in more than oneevent.

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benefitting about 6,600 participants.' The long term benefits of this training has not been evaluated

by FIRA and cannot be determined by the Audit.

3.17 FIRA Headquarters: The new FIRA headquarters are still incomplete. The site is impressive,located on 28 hectares of land on the outskirts of Morelia, and the large main structure appears tobe well constructed. Although the designs provided an already generous 7,700m 2 of office space for350 staff, this was grossed up about 100 percent to over 15,000m2 , instead of by the usual 35 to 45percent grossing factor, to cover conference rooms, halls and so on. During the Audit mission's visitin March, 1994, preparations were being made to elicit bids for landscaping and completion of theinterior. FIRA staff eventually moved into the new facility in October, 1994.

3.18 Commercial Banks and BANRURAL: During the project period, commercial banks alsobenefitted from institutional development, notably in the form of FIRA technical assistance andtraining for their agricultural staff. However, since the privatisation of commercial banks in 1991, thenumber of agricultural loan officers has declined steadily. This decline is not unwarranted, since theuse of private agricultural consultants as intermediaries between banks and borrowers has increasedconsiderably. The cost of their assistance is covered under the sub-loans and is frequently subsidisedvia FEGA. One concern, however, is that their technical assistance focuses on financialintermediation rather than on improved cultivation practices. Another new service that has easedcommercial bank processing of agricultural sub-loans is on-line access to a computerised FIRAdatabase on agricultural investments. This service was introduced after Project Closing and is notattributable to the project, but it is highlighted as it has been well received by commercial bank staff.The Audit also found that significant institutional development of BANRURAL began during theproject period (although not with project funding), particularly in the form of training programmesand upgrading of computerised systems.

C. Impact on Financial Intermediaries

3.19 FIRA: Section 2.03 of the Guarantee Agreement required the Government to provideadequate funding to FIRA and FICART "so as to prevent any material capital erosion, in real terms,which FIRA or FICART may have incurred during the immediately preceding year on account oftheir lending operations after January 1, 1986". Government fulfilled the covenant and by 1991,FIRA's equity was 20 percent higher in real terms than in January, 1986. FIRA also bore no creditrisk on its loans, because its trustee, Banco de Mexico, ensured that FIRA's loans to commercialbanks were repaid automatically on their due date from commercial bank reserve funds withBANXICO.

3.20 Clearly, FIRA could not have achieved its strong financial position without GOM's support.A subsidy dependence index (SDI) was calculated to assess the extent of FIRA's reliance on subsidies(see Table 4 below and Annex 1.9).' It suggests that if FIRA had borrowed at market rates ofinterest and had recorded no Government transfers in its income statement, it could have earned amarket return on its equity by charging interest rates 85 to 121 percent higher than the rates itactually charged. For example, in 1990, FIRA earned 23.9 percent on its loan portfolio. If FIRA's

30. Part 11 of the PCR reports just 3,907 domestically trained staff and PBI, since it only covers the period 1987-89.

31. The SDI was applied to the consolidated balance sheet of FONDO, FEFA and FOPESCA (FEGA was excluded from the analysis).For details on the methodology see J. Yaron: "Assessing Development Finance Institutions - A Public Interest Analysis", World BankDiscussion Paper 174 and OED: Jamaica - Export Crops Project (Loan 2414-JM), Performance Audit Report No. 10656. For a quickoverview of the SDI approach, see Box 8.1 in the World Bank, Operations Policy Department: "Handbook on Financial Sector Operations",1993.

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average on-lending rate had been 85.4 percent higher, i.e. 44.4 percent instead of 23.9 percent, FIRAwould have been self-sufficient, because the resulting spread of 4.3 percent over the market referencerate of 40.1 percent would have been enough to cover administrative costs and earn FIRA a marketreturn on its equity. With inflation at 29.9 percent in 1990, the nominal rate of 44.4 percent requiredfor self-sufficiency would have equalled 11.1 percent in real terms."

Table 4: Subsidy Dependence Indices for FIRA(Figures in Percent)

Panel 1: SDI for FIRA, Including Costs of TA 1988 1989 1990 1 1991 11992 1993

11 FIRA's average on-lending rate to PBs 43.5 30.8 23.9 14.2 11.0 11.5

21 Subsidy Dependence Index for FIRA 94.0 90.3 85.4 102.9 120.9 85.5

31 Minimum on-lending rate for self- 84.4 58.6 44.4 28.8 24.2 21.4sufficiencya

41 Market reference rate 78.4 52.9 40.1 25.6 21.8 17.9

51 Spread required for self-sufficiency, [31 - [41 6.0 5.7 4.3 3.2 2.4 3.5

[Panel 2: SDI for FIRA, Excluding Costs of TA 1988 1989 1990 1 1991 1199211993

61 Subsidy Dependence Index for FIRA 88.6 82.8 78.4 93.3 109.5 74.1

71 Minimum on-lending rate for self- 82.1 56.3 42.7 27.4 23.0 20.1sufficiency'

8] Spread required for self-sufficiency, [71 - [4] 3.6 3.4 2.6 1.8 1.2 2.2

a. This is found by multiplying the average on-lending rate in line [1] by (1+SDI), where the SDI is given in line [2]. E.g. for 1988,

84.4% = 43.5% x 194%.

b. The minimum on-lending rate for self-sufficiency excluding TA is derived by multiplying the actual average on-lending rate in line [1]

by (I+SDI), where the SDI is now given in line [6]. E.g. for 1988, 82.1% = 43.5% x 188.6%.

32. The market reference rate was determined by adding a risk margin of 3 percentage points to a base rate and adjusting the resultingrate for reserve requirements. The base rate used by the Audit was determined by the GIRA. For 1988 and 1989 it was the average costof funds (see footnote 5); thereafter, it was the 28-day Mexican treasury bill (CETES) rate. FIRA's SDI was calculated as the ratio oftotal subsidies to interest income. For example, in 1990 subsidies to FIRA (excluding FEGA) were MexS1,223 million and interest incomewas Mex$1,432 million, resulting in an SDI of 85.4 percent. That year, total subsidies comprised Mex$1,051 million as a result of accessto liabilities at an average cost of 14.6 percent instead of the market reference cost of 40.1 percent, and Mex$172 million as a result ofaccess to equity at a below-market rate of return (the return on equity was only 32 percent). No grants or subventions were recorded inthe income statement for 1990. See Annex 1.9 for annual figures on the subsidy to FIRA, excluding FEGA, broken down by source ofsubsidy.

22

3.21 Since FIRA's activities reach well beyond simple financial intermediation to include asubstantial technical assistance programme, the SDI was also calculated without FIRA's income andexpenses related to technical assistance. The Audit finds that on-lending rates would have had toincrease by less, namely by 74 to 110 percent. At just 2.6 percent, the spread over the marketreference rate required for self-sufficiency in 1990 would also have been lower in the absence ofFIRA's technical support activities.

3.22 An important finding is that FIRA became a more efficient institution in the course of theproject. The spread required for self-sufficiency declined from almost 6 percent in 1988-89 to around3 percent during 1991-93. If FIRA's technical assistance activities are excluded, the required spreadwould have been between 1.2 percent and 2.2 percent during 1991-93, down from about 3.5 percentin the early years of the project. This was achieved by halving FIRA's ratio of administrative coststo risk assets. It should be noted that, notwithstanding a sharp fall in the SDI in 1993, relative to1992, FIRA actually became less efficient in 1993, insofar as its margin for self-sufficiency widenedby one percentage point. This increase is almost entirely attributable to increased intermediationcosts rather than to higher technical assistance costs (see rows [5] and [8] in Table 4).

3.23 FEGA: FIRA's trust fund for guarantees and technical assistance performed less well than thetrust funds that primarily provided credit (FONDO and FOPESCA also provide loan guarantees, butthese are for OPs and fisheries, rather than for low income agricultural producers). The opening ofthe economy to competition from foreign agricultural producers, together with a sharp increase inreal interest rates in 1988-89, led to an increase in arrears and therefore higher guarantee paymentsby FEGA (see Annex 1.8 and the PCR, Annex A). Furthermore the area indemnified by agriculturalinsurers fell sharply with the dissolution of ANAGSA, leading to a greater call on FEGA guaranteeson loans to LIPs. FEGA's premia are insufficient to cover its payouts and net payments (afterrecoveries on paid guarantees) increased more than five-fold in real terms over the life of the project.

3.24 FICART/BANRURAL: The real value of FICART's equity was maintained after 1988,(although it had been allowed to decline during the first two years of the project) and in 1991 it was9 percent higher than in January, 1986. The increment (1991 Mex$133 million) is equal to a mere10 percent of the real value of total Government transfers to FICART during 1986-91." With littlerationale for its existence and high operating costs, FICART was dissolved as of December 1992.

3.25 BANRURAL made significant losses every year and the real value of its equity fell 20 percentin the first year of the project. Thereafter, massive capital injections (almost US$3,000 million in1990 alone) contributed to an overall increase in real terms in BANRURAL's stated equity over theproject period. The Audit did not attempt to calculate the subsidy dependence index forBANRURAL because audited financial statements for the project period conceal an extremelyserious problem with loan recoveries. BANRURAL's assets and equity are significantly overstatedand its operating losses understated. It is estimated, for example, that in 1988 direct recoveries fromborrowers amounted to no more that 10-15 percent of the volume on-lent and that indirect recoveriesfrom ANAGSA only increased the overall recovery rate to around 60 percent of annual lending.'

33. Government transfers to FICART during 1986-91 totalled 1991 Mex$1,343 million, or about 1991 US$330 million.

34. See LA2AG: "Mexico - The Banrural Agricultural Credit System", 16th January, 1990.

23

Furthermore, the arrears figures were kept down by rescheduling and rolling over as much as one-third of the portfolio. In 1990, around 40 percent of BANRURAL's portfolio was written over toFIRCAVEN and to PRONASOL, which inherited BANRURAL's weakest clients. FIRCAVEN'srecoveries were negligible. There are no data on PRONASOL recoveries for former BANRURALclients, but PRONASOL's overall recovery rate on its unsecured loans is around 55 percent.

3.26 During project implementation, the Bank and GOM began an intensive dialogue onBANRURAL that contributed to positive measures aimed at addressing the above problems. Since1990, the Government has allowed BANRURAL to shrink considerably and bear the losses it makeson bad loans, in an attempt to increase efficiency and reduce the cost of lending to small farmers.In turn, BANRURAL has attempted to counter the culture of non-payment more consistently bydenying credit to delinquent borrowers and by applying a policy of zero tolerance for irregularitiesby BANRURAL staff. As an added incentive for timely repayment or prepayment of sub-loans,BANRURAL is offering borrowers interest rebates of up to 10 percent of the total interest paid.Local pressures on BANRURAL staff to continue with the old ways are still considerable, butBANRURAL's senior management appears to be supporting rural managers' attempts to applysounder credit policies. In February, 1994, BANRURAL's recovery rate had reportedly risen toaround 80 percent of current dues.

3.27 Commercial Banks: The US$300 million FIRA/commercial bank component of the loanamounted to less than one-half of one percent of Mexican commercial banks' assets in 1989.However, the World Bank's influence on PB's lending to agriculture was fairly significant, becauseGOM consulted with the World Bank during project implementation regarding spreads on agriculturalloans. The Bank had hoped to base its recommendations on the Study's findings regarding theadequacy of the financial margins accorded under the GIRA (10 percent of ACF for loans to LIPsand 7 percent of ACF for loans to OPs), but the Study never examined the costs of intermediationor the adequacy of spreads for commercial banks. No data are available on the profitability ofagricultural lending by commercial banks."

3.28 In July, 1988, the World Bank refused to agree to an increase in spreads to 12.5 percent ofACF on loans to LIPs and 8.5 percent of ACF on loans to OPs, because the increase would havebeen at FIRA's and FICART's expense and would therefore have increased subsidisation to the ruralfinancial sector. However, following a sharp decline in the reference rate (ACF), the World Bankconcurred with GOM's decision to change the spread from a given percentage of ACF to givenpercentage points of interest, 6 on loans to LIPs and OPs who produced basic products (hereafter"basic OPs"), and 5 percentage points on loans to other OPs.' Commercial banks had proposedspreads of 10 to 12 percentage points, and project staff estimates suggest that administrative costs forprocessing agricultural loans are about 8 to 10 percent of amounts lent, but the 5 to 6 percentagepoint spread on agricultural loans is augmented by PBs in several ways: first, they receive transactioncost subsidies from FEGA; second, they assess several fees for services they provide, e.g. registeringthe contract and transmitting the loan; third, they often require that compensating balances bemaintained with them (notwithstanding SHCP regulations); fourth, they often advance bridge loans

35. Commercial banks did provide elaborate models to support their request for a large increase in spreads on agricultural loans, but theseare likely to have been inflated. Hard data on administrative costs and returns on agricultural loans were not provided. This deficiencysuggests that reporting requirements for participating banks may have been inadequate.

36. Basic products are 15 essential crop and livestock products for Mexican consumers, including maize, beans, rice, milk and eggs.

24

at commercial rates of interest, informing borrowers that the FIRA loan has not yet come through(even though the bulk of the delays occur at the commercial bank level), and then recover the bridgeloan through the FIRA loan." Interviews by the Audit mission at the farm level and the FIRA levelprovided independent confirmation of the use of this approach, which is not peculiar to Mexicanbanks.'

Table 5: Example of the Tasa Mezcla's Effect on Subsidies and Interest Ratesfor a Hypothetical Short Term Loan to a "Basic OP"

Share of Cost of On-lendinT Spread1Total Loan Funds Rate __ I

Commercial bank participation on-lent at FIRA rate 20% 18.0% 21.0% 3.0%FIRA participation on-lent at FIRA rate 40% 15.0% 21.0% 6.0%Extra commercial bank funds on-lent at unrestricted rate 40% 18.0% 31.0% 13.0%Overall (short-term) loan to a "Basic OP" 100% 16.8% 25.0% 8.2%

AssumptionsThis is a hypothetical example of a short-term commercial bank loan of Mex$100 to an OP whoproduces basic products and therefore qualifies for FIRA credit at CETES + 3 percentagepoints. The commercial bank could rediscount 80 percent of the loan with FIRA and make onlythe 20 percent mandatory contribution. Instead it decides to rediscount 40 percent of the loanand cover the remaining 40 percent with its own voluntary contribution, which it can on-lend atan unrestricted rate of interest. Suppose that ACF = CETES = 18 percent, and that this is thecost to the bank of its own resources. Since GOM accords a spread of 6 percentage points tocommercial banks on loans rediscounted with FIRA, and FIRA's rate to sub-borrowers isCETES + 3 percentage points, or 21 percent, the cost to the commercial bank of the FIRAresources is 15 percent. Finally, suppose that the average on-lending rate in the market forloans to other sectors is ACF plus 7 percentage points, i.e. 25 percent.FindingsBy charging an interest rate of 31 percent on the unrestricted portion of the loan, thecommercial bank can obtain an overall return on the loan that is equal to the market rate of 25percent. The subsidy of 4 percentage points intended for the sub-borrower (i.e. the differencebetween the controlled rate of CETES plus 3 percentage points, or 21 percent, and the marketrate of ACF plus 7 percentage points, or 25 percent) is absorbed by the bank. Without theFIRA funds, the bank's spread would have been 7 percentage points (since the market rate is 25percent and the ACF is 18 percent). With the FIRA funds and the tasa mezcla, the spreadincreases to 8.2 percentage points, i.e. the difference between the market rate (25 percent) andthe average cost of funds for this loan (16.8 percent). Note: without the tasa mezcla, the bankcould have rediscounted 80 percent of the loan with FIRA, entailing an average cost of fundsfor the loan of 15.6 percent, and on-lent 100 percent of the resources at the FIRA rate of 21percent, for a spread of 5.4 percent.

37. According to figure for 1992-93 from FIRA's SIM database, participating banks on average take almost three months (81-86 days)to process sub-loan applications.

38. See Jamaica - Export Crops Project, Loan 2414-JM, PAR no. 10656. Other features of Mexican commercial bank lending toagriculture that are observed elsewhere are collateral requirements well in excess of the loan amount as well as undervaluation of collateral.

25

3.29 However, the key factor that increased commercial banks' spreads on agricultural loans wasthe introduction of the tasa mezcla, or mixed rate on short-term loans to OPs, in June 1989. Thisscheme allows commercial banks to charge unrestricted interest rates on any funds that they provideover and above the 20 percent participation required on short term loans to basic OPs. For example,these sub-loans might be funded by a 20 percent mandatory participation at controlled rates by thePB, an additional voluntary contribution of 40 percent by the PB at unrestricted rates, and a 40percent (rather than 80 percent) participation at controlled rates by FIRA (see Table 5 andaccompanying notes for an example). In practice, the unrestricted portions of the loans have beenprovided at rates well above market rates, bringing the average interest rate to sub-borrowersapproximately to market rates.

3.30 The World Bank's initial reaction to the scheme was cautious, because it was concerned thatthe application of the scheme only to short term loans to OPs would increase fragmentation of ruralfinancial markets and reduce the transparency of subsidies." Project staff recognised that the FIRArate to sub-borrowers (and thus to participating banks) would no longer determine the final rate tosub-borrowers on the entire loan (which would approximate market rates), so that the PBs couldappropriate the subsidy intended for borrowers. However, Bank staff were more concerned with theoverall level of subsidies than with the allocation of those subsidies between financial intermediariesand ultimate borrowers. They did not comment on the inappropriateness of the tasa mezcla schemeas an instrument for targeting subsidies.' The World Bank at first agreed to the scheme as atemporary measure, calling for further improvements at a later stage, but during preparation of theproposed follow-on project, the World Bank accepted the tasa mezcla as a longer term arrangementand the scheme is still in place.

3.31 An important concern regarding agricultural lending, and indeed all lending by PBs, has beenthe rapid rise in arrears as a percentage of the loan portfolio (see Figure 2 below). In 1992, totalcommercial bank arrears exceeded the value of their equity (excluding revaluation of assets).Furthermore, the arrears figures do not include loans that have been restructured.

3.32 The problem is particularly severe in the agricultural sector. During the Audit mission inMarch 1994, GOM and the Mexican Banking Association (AMB) were negotiating a massiveprogramme of restructuring of agricultural loans. It was estimated that commercial banks'contaminated agricultural portfolio amounted to Mex$5,000 million (US$1,540 million), of whichabout half was overdue. Most of the overdues are on commercial bank funds, rather than FIRA (orWorld Bank) funds, since commercial banks advanced bridging loans, known as pr6stamosquirografarios, to agricultural producers at unrealistically high rates of interest in the late 1980s.Commercial bank staff attribute the arrears to the very rapid growth in indebtedness (a fivefoldincrease in real terms during 1987-93), a sluggish economy, poor risk management, weak monitoring,and provision of short term loans for sub-projects that should have been financed with long termloans. Indeed, the Audit mission met with large agricultural and aquaculture producers in Sinaloa

39. Combined Back-to-Office Report and Full Report, dated July 11, 1989, for a Partial Supervision of the Ninth Agricultural CreditProject and Preparation of the Proposed Rural Financial Subsector Project.

40. The subsidies inherent in the scheme are unrelated to loan size. This deficiency would hold even if transparency were to be enhancedby combining the two PB contributions, as suggested by project staff, and if fragmentation concerns were to be addressed by ertendingthe scheme to all categories of sub-borrowers.

26

who were experiencing liquidity problems but were continuing to invest in recovery of adjacent landsfor production." Since 1990, commercial banks have been considerably more selective in theirlending, and credit to the agricultural sector has declined as a share of their total lending.

Figure 2: Ratio of Arrears to Loan Portfolio for Commercial Bankson Loans to Agriculture and All Sectors

0.07%-

;5.5%

6%- 5.5%

c5%-

0 .. 6IZ4%-

0 2.6% .2%

.0%

CL 2%-1.2%19%

Agric. Portfolio

0% Total Portfolio1988 1989 1990 1991 1992

D. Impact on Sectoral Reforms

3.33 Key Issues: The World Bank's principal concern regarding the Mexican rural financial sectorwas that FIRA and FICART/BANRURAL were providing credit to a small fraction of Mexicanfarmers at subsidised rates of interest. The subsidies tended to accrue to wealthier farmers and toencourage inefficient use of sub-loan funds (or of the equity that they replaced). Furthermore, theprogramme was extremely expensive for the Government. The project therefore adopted a two-pronged approach to reduce interest subsidies and encourage further reforms in the rural financialsector. First, it mandated increases in interest rates to sub-borrowers in accordance with the GIRA,and second, it called for sectoral reforms based on the recommendations of the Agricultural FinancialSub-sector Study.

3.34 Reduction in Interest Subsidies to Farmers: At the Decision Meeting held in January, 1986,it was agreed that "subsidy control and targeting would involve a saving to the Treasury in the order

41. Another factor explaining the arrears is the use of moneylender credit during the planting season to proceed with land preparationand sowing before the commercial bank or Banrural sub-loan arrives. The delays in the formal bank loan are attributable to slowprocessing by PBs, as well as to late applications by sub-borrowers.

27

of 0.4 percent of GDP, and that this impact would be sufficient to support the proposed loan".Between 1987 and 1991, interest subsidies to final borrowers through BANRURAL fell by anestimated 0.52 percent of GDP (5.9 percent of agricultural GDP, see Figure 3 below and Annex1.12). Subsidies on loans via FIRA fell from 0.22 percent of GDP in 1988 to 0.12 percent of GDPin 1991-92 (or from 2.7 to 1.4 percent of agricultural GDP). Thus, the objective of reducing interestsubsidies through these institutions by 0.4 percent of GDP to was clearly achieved during the projectperiod. This success is of course offset to some extent by increased budgetary commitments toPRONASOL, whose beneficiaries include former BANRURAL clients.

Figure 3: Interest Subsidies on Loans via FIRA and BANRURALas a Percentage of GDP'

0.7%

0.6% ....... ..

0.5%-

.20.4%-

:2(n0.3% -

.S 0. 2% -

<0.1%

a. FIRA

0.0% n. BANRURAL1987 1988 1989 1990 1991 1992

3.35 Other Reforms in Agricultural Finance: Prior to the project, the World Bank's policyobjectives centred on the reduction of interest subsidies to final beneficiaries. During the projectperiod, the World Bank formulated a broader policy agenda that was crystallized in the preparationof the proposed follow-on operation. The policy agenda included greater transparency in theprovision of subsidies to FIRA and BANRURAL; self-sufficiency for the two institutions; increasedsavings mobilisation and better lending practices by BANRURAL; increased competition in theagricultural insurance market; more incentive-compatible insurance policies and practices atANAGSA, and the assessment of actuarially fair premia by the Government-owned agency.

42. Note: there are no figures for FIRA in 1987 and Banrural in 1992.

28

3.36 Considerable progress was made towards these objectives during the project period, althoughnot necessarily as a result of the project. The 1989 Convenio de Derivaci6n de Fondos transferredthe onus for repayment of external loans from GOM to development banks and trust funds that hadpreviously received the loans as equity injections. Any differences between the development banks'repayments to GOM (at the CETES rate) and the actual interest plus foreign exchange risk liabilitiesto the external donor were specifically budgeted by GOM. This increased the transparency ofsubsidies to FIRA and BANRURAL considerably, although the World Bank remains concernedabout the provision of hidden subsidies to FIRA via concessional loans from BANXICO.' Progresson self sufficiency for FIRA and BANRURAL has been slower: while the SDI for FIRA excludingFEGA fell marginally during the project period (from 94 percent to 91 percent), subsidies to FEGAhave increased considerably. The increase is attributable to external shocks to the agricultural sector,as well as to higher real interest rates, which affected both sub-borrowers' capacity and theirwillingness to repay. Precise data on BANRURAL are unavailable, but its administrative costs(including write-offs and provisions for depreciation) have risen from 21 percent of the loan portfolioin 1986 to almost 32 percent in 1992, without a corresponding increase in its financial margin."Nevertheless, progress has been made in sanitising BANRURAL's portfolio, recording overdues morerealistically and improving BANRURAL's lending practices (see para. 3.24 ff and Annex 1.10).

3.37 Very slow progress was made on savings mobilisation: the volume of deposits mobilised byBANRURAL rose by only 4 percent in real terms between 1986 and 1992, but their share of totalliabilities rose from 4 percent to 25 percent during the period. It would arguably have beeninappropriate for BANRURAL to have mobilised substantial savings without first improving thequality of its portfolio. Finally, ANAGSA was replaced by AGROASEMEX in 1990 and FICARTwas absorbed by BANRURAL in 1992. AGROASEMEX is operating more commercially than itspredecessor and its premium income exceeds its indemnity payments. However, AGROASEMEXis still dependent on Government subsidies and has a significant monopoly of the agriculturalinsurance market.

3.38 The Role of the Agricultural Financial Sub-sector Study: Many of the World Bank's sectoralobjectives outlined above were expected to be supported by findings in the Agricultural FinancialSub-sector Study. Indeed, GOM officials suggested to the Audit that the World Bank approachedthe rural financial policy dialogue with orthodox preconceptions and used the Study to confirm theirbeliefs, rather than as a diagnostic tool. In practice, the Study could not fail to provide evidence ofcostly distortions that all parties were fully aware of, and project staff argue that it was theirquantification of the costs of distortions, e.g. those attributable to the BANRURAL/ANAGSA nexus,that prompted the reforms undertaken by GOM.

3.39 While the PCR appropriately downplays the overall value of the Study's analysis, it credits theStudy with a greater impact than it probably had (see PCR para. 57)." The Secretariat of Financehad already begun to study the BANRURAL system in 1986. Besides, much of the policy dialoguebetween the World Bank and GOM during the project period was conducted in the context of aproposed Rural Financial Sub-sector Project, for which an Initial Executive Project Summary was

43. For example, in 1992 FIRA's average cost of funds (7 percent) was less than half the CETES rate of 14.9 percent.

44. BANRURAL's financial margin reportedly rose from 8.2 percent in 1986 to 19.8 percent in 1989, before falling back to 8.4 percentin 1992.

45. The Study is credited, inter alia, for increases in PBI rates, the adoption of the tasa mezcla, the restructuring of Banrural, the closingof ANAGSA, the elimination of FICART and the introduction of a new transaction cost subsidy scheme for commercial banks that isdesigned to encourage increased lending to LIPs.

29

issued in September, 1989. FIRA, FICART, BANRURAL and SHCP were jointly required toprepare a feasibility report for the follow-on operation, including historical institutional analysiscomplemented by field work by SHCP. Finally, the reform-minded Administration that assumedoffice in 1988 probably would have undertaken several improvements in the sector even without theBank-supported Study, in some cases out of strictly budgetary concerns rather than considerationsof economic efficiency. For example, the introduction of the tasa mezcla was driven by the need toincrease commercial bank participation in agricultural credit, due to GOM's budgetary constraints.

3.40 The Study cannot be credited for the elimination of FICART, which was clearly duplicatingFIRA and BANRURAL work and for which an analysis of audited financial statements (plus somereadily available SHCP and BANXICO data) was sufficient to reveal the costs of operation. Nor canthe Study be credited for the transaction cost subsidy scheme introduced in 1992 to encourage greatercommercial bank lending to LIPs, since the topic was neglected in the Study's analysis.' Howeverthe Audit does believe that research related to the Study influenced GOM's decision to increaseinterest rates to LIPs beyond GIRA requirements. Together with SHCP's related research onBANRURAL, data from the Study inclined the Government to close down ANAGSA and rationaliseBANRURAL's operations, although there were also other incentives at work.47 The Study alsoenabled project staff to conduct a more informed and influential policy dialogue with theGovernment, thereby fulfilling a key objective from the World Bank's point of view (see para. 2.20).

3.41 Related Developments in the Broader Financial Sector: The reforms in agricultural financetook place in the context of a broader reform of the financial sector: controls on deposit interest rateswere eliminated as of 1988; the reserve requirement was abolished in 1989; other types of forcedlending were phased out by 1991, including a 30 percent liquidity requirement; commercial bankswere reprivatised during 1991-92; new banking charters were granted in 1993, including to affiliatesof United States banks, and in 1994 the Central Bank of Mexico became fully autonomous.Furthermore, banking supervision was upgraded, a new loan classification and provision system wasintroduced, commercial bank capital requirements were brought in line with guidelines issued by theBank for International Settlements (BIS), and several development banks and trust funds outside theagricultural sector were merged or liquidated. Several of these reforms were supported by the WorldBank's FSAL. These developments have increased the efficiency of financial intermediation inMexico, but are likely to entail reduced lending to agriculture in the short run, relative to othersectors, largely because of continuing controls on on-lending rates to agriculture.' The mostimportant development that benefitted agricultural financial intermediaries was the control of theinflation rate, which fell from 159 percent in 1987 to 20 percent in 1989 and 12 percent in 1992. Asa result, even controlled interest rates to agriculture have been positive in real terms since 1988,except on loans to LIPs in 1992 (see Annex 1.7).

46. The idea of subsidising transaction costs was proposed in OED's Performance Audit Report of FIRA 5 through FIRA 8A in June,1990 (Report No. 8860, para. 132).

47. First, restructuring of Banrural and ANAGSA were key actions to be taken before disbursement of the second tranche of the Bank'sFinancial Sector Adjustment Loan (FSAL, Loan 3085-ME, approved in June, 1989); second, the Bank and the IDB made a combinedUS$700 million for a follow-on operation contingent on substantial reform of the two agencies; third, there were important budgetaryconsiderations (see Annex 1.9 for data on the cost of GOM transfers to the two agencies).

48. Other factors include the on-going arrears situation, problems with titling of land and its use as collateral, as well as commercial banks'aversion to "pulverising" their loan portfolio by granting a large number of relatively small loans. Thus liberalising agricultural interestrates (or raising them to market rates) is not sufficient to guarantee substantially higher commercial bank lending to LIPs, but it is anecessary condition. Put another way, as long as interest rates remain controlled and below market rates, there can be no sustainablesolution to the problem of ensuring access to commercial bank lending (of their own resources) for a majority of viable low incomeproducers. The same statement holds for long term loans to OPs.

30

IV. FINDINGS AND ISSUES

A. Overall Assessment of the Project

4.1 Project Rating: The project was largely implemented as planned at appraisal: investment andincremental short-term credit was provided to farmers; training, TA and civil works were providedto strengthen FIRA's productive support mechanisms, albeit less than envisaged in the SAR(FICART's productive support was financed with other sources of funds); interest subsidies werereduced in accordance with the GIRA; the Government eventually prepared an Agricultural FinancialSub-sector Study with World Bank support and instituted several reforms, although they were notnecessarily based on the Study's recommendations; and the Government ensured that budgetprovisions were adequate to materially maintain the capital structure of FIRA and FICART. Theproject clearly achieved its (albeit limited) objectives regarding interest subsidies and maintenance ofFIRA's and FICART's financial integrity. Available data suggest that investments in irrigated cropsfinanced during the project period were financially viable, although not necessarily economicallysound. The picture is less sanguine for rainfed crops. Overall, FIRA's M&E results suggest thatFIRA clients enjoyed substantial increases in asset and equity holdings. While diversion of funds wassignificant among BANRURAL clients, FIRA/commercial bank clients generally undertook theplanned sub-projects. Finally, compliance with covenants was acceptable. Overall, the project is ratedas satisfactory.

4.2 Institutional Development: The Audit believes that in the absence of the project, policydialogue with GOM would have been minimal during the late 1980s. Indeed, since the suspensionof the follow-on operation, the World Bank has had little or no influence on developments inMexican rural financial markets. The existence of the Ninth project, coupled with the promise ofboth World Bank and IDB funds under the proposed follow-on operation, provided the World Bankwith an important voice at a time when the Government was willing to consider far reaching reformof financial markets in general and agricultural finance in particular. The World Bank's insistenceon thorough analysis of the rural financial sub-sector, both in the context of the Study and of thefeasibility report for the follow-on, yielded data and findings that catalysed key reforms, such asrationalisation of BANRURAL and elimination of ANAGSA. While there is clearly a problem ofattribution of results and the Audit believes that certain reforms (e.g. the reformulated transactionscost subsidy scheme) were spurred by the promise of a follow-on rather than disbursement of theNinth project, institutional development was substantial during the project period.

4.3 Sustainability: On the one hand, the Government has been reluctant to undertake severalof the reform measures proposed by the World Bank and the IDB as a condition for a follow-onoperation. On the other hand, GOM appears to be committed to the policies supported under theproject and was prepared to consider some additional measures. Furthermore, there is widerrecognition among farmers that the earlier paternalism of the State has given way to a competitiveenvironment in which the key to viability is increased sales and productivity. At the institutional level,three of the nine demonstration centres assisted under the productive support component have beenshut down. Also, although FIRA and BANRURAL are far from self-supporting, total GOM transfersto the two institutions have fallen sharply (almost 80 percent in real terms - see Annex 1.9) and thevalue of their equity has increased in real terms in spite of the reduced support. Overall, the project'sbenefits are considered sustainable.

31

B. Key Findings Regarding FIRA/FICART 9

4.4 Disbursement Objectives versus Development Objectives: The unstated project objective ofproviding the Mexican Government with rapid access to foreign exchange was achieved." OverUS$370 million were disbursed within two years, as was the 1986 commercial bank package to whichthe project was linked. At the macroeconomic level, the project was part of an overall countrystrategy involving several World Bank projects that was extremely successful. However, the shortterm liquidity objective was not entirely consistent with the long term development objective. First,the major deficiencies in the appraisal report presented to the Board (para. 2.12) are explained bylending pressure. Second, hasty processing of the loan in May/June, 1987, precluded a thoroughappraisal of the FIRA headquarters component. There were several difficulties with this componentduring implementation. Third, lending pressure led to postponement of a sectoral approach withmeaningful conditionality in favour of the same project orientation of the previous nine operations:there was no linkage of project funds to policy improvements beyond the GIRA conditionality, whichitself was weakened to expedite the project. In particular, there was no linkage between projectfunding and completion of the Study, although the Study was the principal vehicle for the project'spolicy objectives. Indeed, the World Bank could at first not even obtain a copy of the full report,because the wording in the Guarantee Agreement did not require GOM to submit it.Notwithstanding its adherence to the letter of the Guarantee Agreement, GOM was clearly notinterested in a wide-ranging dialogue with the World Bank on the rural financial sector during theearly stages of the project. It is doubtful that much progress would have been made on the Studybeyond the first phase without the World Bank's insistence on it as a condition for a follow-on.Finally, since policy dialogue between the World Bank and the Government is most effective beforeproject funds are fully disbursed, the lack of control on the rate of disbursement greatly reduced thesupervision staff's time for effective discussions with GOM."

4.5 The Project's Farm LUvel Impact. FIRA/FICART 9 reached more beneficiaries than expectedat appraisal and probably exceeded SAR targets with regard to job creation. The project's impactat the farm level cannot be quantified. However, FIRA's M&E unit has tracked asset and equityholdings for a sample of beneficiaries and has found significant increases in real terms during theproject period. Unfortunately there was no control group with which to compare the findings,because farmers who were not loanees were unwilling to supply information. Second-best solutionsmay be to compare clients with both investment and working capital loans to those with only seasonalcredits, or to accept some measurement error and subsidise a control group. The viability ofinvestments supported by the project was highly dependent on access to irrigation, and thoseinvestments that were financially viable within the distorted economic environment of the mid-late1980s may not all have been economically warranted. Since most of the trade and price distortionshave been removed in the past 7 years, financially viable agricultural investments are generally morewarranted from an economic point of view today than they were during the project period. Whileit is too late to alter the production impact of investments financed under FIRA/FICART 9, futureincreases in agricultural production and exports in these less restricted markets will "depend largelyon continuing rural credit reforms to stimulate future agricultural investment", as noted in the PCR(para. 8).

49. This success did not affect the project rating, since the Audit rated the project against its stated objectives.

50. Ninety-three percent of the loan was disbursed by June, 1989, rather than December, 1990, as hoped for at appraisal.

32

4.6 Misallocation of Sub-Loans: There was significant diversion of sub-loans by BANRURALclients during the project period, primarily because there was little pressure on clients to repay, (loanfunds could thus be used for activities that yielded little or no cash return). Under the circumstances,the interest rate to small farmers hardly mattered. Diversion of funds was much rarer forFIRA/commercial bank clients, as both FIRA and PBs monitored the loans and the banks madeserious efforts to enforce repayment. There are no data on substitution of project funds for othersources, but there are reasons to believe that it was not a major factor (para. 3.10 ff). The lesson tobe drawn from the project is that there must be a credible commitment by all intermediaries tomonitoring of sub-projects and to recovery of sub-loans.

4.7 The Problem of Wealthy "Low Income" Producers: The problem of OPs masquerading as LIPswas rarely uncovered by FIRA's monitoring staff - penalties for commercial banks are severe (threetimes the ACF) if it is detected. The incentive for such masquerading has declined as LIP rates haveapproached OP rates." The main difficulty lies in the definition of LIPs: GOM has treated allejidatarios as LIPs, and both non-farm incomes and borrowers' relatives' incomes have often beenignored. The World Bank held to the increasingly restrictive definition of LIPs (namely farmers withan annual net family income not exceeding 1,000 times the minimum daily rural wage for the region)for three reasons: 80 percent of farmers still fell below the cutoff, World Bank staff hoped tonegotiate new targeting criteria based on loan size under the follow-on operation, and the graduationof loanees to the OP category brought interest rates on their loans closer to market rates.

4.8 Crowding-out of Commercial Bank Lending: The tasa mezcla scheme introduced in 1989effectively allowed commercial banks to charge market rates on short term loans to at least someOPs. Commercial bank lending to agriculture rose sharply that year, suggesting that FIRA hadcrowded out short term lending by PBs to wealthier farmers. Furthermore, since the tasa mezclaeffectively insulated the FIRA rate to borrowers from the actual rate to borrowers, it permittedcommercial banks to capture the subsidy intended for their clients. As this scheme applied only toOPs, there was less of an incentive to lend to LIPs; indeed, lending to LIPs fell sharply for this andother reasons. FIRA management is aware of the need for their clients to graduate from FIRAsupport to a direct relations with commercial banks. This should be initiated by freeing interest rateson all loans to OPs. The Government's willingness to consider the extension of the tasa mezclascheme to long term credit for OPs suggests that this is not infeasible. FIRA still has an importantrole to play at the level of LIPs (and of less wealthy OPs). The provision of pr6stamos quirografariosto FIRA clients by commercial banks can be taken as an indication of FIRA's success in extendingthe formal financial frontier. It should lead to a scheduled reduction in FIRA rediscounts of shortterm sub-loans to established clients (whether they are LIPs or OPs), so that FIRA's intermediationactivities focus on the dual challenge of introducing new, potentially viable clients to commercialsources of credit and of encouraging PBs to extend longer term loans to agriculture.

4.9 The Volume and Transparency of Subsidies for Rural Credit: The World Bank maintainedthat the project would be justified if interest subsidies fell by around 0.4 percent of GDP. In practice,they fell by at least 0.6 percent during the project period (para. 3.34). Progress was also made in

51. In the case of PRONASOL, loans are interest-free, so the incentive for rent sceking behaviour by non-targeted farmers remainssignificant. Indeed, one member of the Audit team met with an OP who was developing his farm with an interest-free loan of aboutUS$15,000 through PRONASOL. Thus the elimination loans at below-market rates through 13ANRURAI 4commercial banks may simplylead to the provision of cheap credit via alternative channels (viz. the experience in Tunisia - OED Performance Audit Report for the Thirdand Fourth Agricultural Credit Projects, Loans 1885-TUN and 2865-IN, Report No. 11977).

33

increasing the transparency of the significant subsidies that FIRA and BANRURAL still enjoy.Transfers to the two agencies (particularly to FIRA) could be made more transparent by chargingCETES plus a zero to three percent margin as appropriate on BANXICO loans and increasingexplicit subsidies through the income statement to offset the higher cost of finance. In addition,accounting of BANRURAL's financial situation still needs to be improved, particularly with regardto provisions for doubtful loans. BANRURAL's financial statements have regularly overstated profitsand therefore equity, as well as the value of the portfolio, by including inadequate provisions fordoubtful loans. Greater transparency, coupled with the use of the SDI, would go a long way towardshelping GOM to evaluate the subsidies it provides against the merits of FIRA's and BANRURAL'sdevelopment activities.

Figure 4: Area Insured for Selected Crops

7

6-

3-

0

c2-

01

1986 1987 1988 1989 1990 1991 1992

E Beans [ ] Maize Rice

E Sorghum [ Wheat

4.10 Loan Guarantees and Agricultural Insurance: The replacement of ANAGSA with a morecommercially oriented agricultural insurer was a significant institutional development." With thedisappearance of ANAGSA, the insured crop area plunged dramatically (see Figure 4). Althougha substantial part of the area insured by ANAGSA probably never existed, coverage should beincreased, particularly for crops that are more vulnerable to shocks such as droughts or frosts. Animportant precondition for this is raising AGROASEMEX's premia towards actuarially fair rates andincreasing competition in agricultural insurance markets. The coverage of FEGA loan guaranteeswill also need to be expanded as FIRA draws more LIPs into banking relations with commercial

52. Unlike ANAGSA, Agroasemex is chartered under a general agricultural insurance law, rather than a specific law for it alone.

34

lenders and FEGA's guarantee premia should be increased to reflect FEGA's true exposure to risk.Current premia are inadequate to cover payouts and the cost to Government has grown rapidly inrecent years.

C. Subsequent Developments and Outstanding Issues

4.11 The Preparation of the Follow-on Operation: The proposed Rural Financial Sub-sectorProject would have made the break from the project-oriented approach of the earlier ten operationsto the sector-oriented approach recommended by OED's Audit of the Fourth project." The changein approach was appropriate, as was coordination between the World Bank and the IDB, since lackof collaboration between the two agencies had hampered efforts to institute reforms under earlierprojects.' Given the substantial volume of lending under other World Bank projects during 1989-92,there was also little pressure to lend for the proposed follow-on. The proposed World Bank loanof US$300 million and IDB loan of US$400 million gave the donors leverage in discussions on policyreforms that far exceeded the donors' importance in FIRA's and BANRURAL's lending programme.The promise of World Bank/IDB funding and their stance on reforms also helped reform-mindedparties in GOM to persuade more conservative ones to accept further change in the rural financialsector. To conclude, the promise of funding was essential for constructive dialogue, and significantpolicy measures proposed under the follow-on operation were adopted even though the project wasnever approved (e.g. the transaction cost subsidy scheme and the closure of FICART).Notwithstanding this success, the above can clearly not be regarded as a sustainable or replicableapproach to achieving policy reform.

4.12 The Suspension of the Proposed Follow-On Operation: In October 1992, GOM and theWorld Bank established final positions on policy matters that were considered irreconcilable. Thekey issue that was not negotiable for the Government was liberalisation of interest rates to LIPs."Other key points of disagreement were the weighted average rate to commercial banks on FIRArediscounts, and how to handle non-commercial farmers who were too good for PRONASOL (GOMmaintained that targeted interest subsidies were an appropriate instrument for reaching them).Perhaps a greater loss than the funding (which hindsight suggests was not strictly "needed") was thereduction in the intensity of the World Bank-Government dialogue, which had been very constructiveduring 1989-91. Since early 1993, an exchange of ideas has been maintained in the context of a joint

53. Mexico - Fourth Livestock and Agricultural Development Project, Loan 910-ME, OED Project Performance Audit Report No. 2577,dated July 3, 1979.

54. See OED's Performance Audit Report of FIRA 5 through FIRA 8A, Report no. 8860, dated June 29, 1990-

55. The Audit agrees with regional staff that a firm stance on policy matters was "warranted after ten operations and recurrent requestsof our Board in previous projects to avoid subsidies" (sic., internal correspondence dated November 30, 1994). Nonetheless, while GOMand Bank staff ascribe a particularly doctrinaire stance to IDB negotiators, draft Bank documents and correspondence tiles on the proposedproject contain categorical statements that suggest a rather rigid interpretation of the rural financial market policy embodied in the LevyReport and in OD8.30. For example: "There is no particular reason for the government to be lending for agriculture.." (draft Report onthe Rural Financial Sector Project, dated 28th December, 1990), or "Government development banks and trust funds dominate the Mexicanrural financial market, having crowded out private intermediaries" (Final Eecutive Project Summary, dated 28th December, 1990)[emphasis added]. 'There are good reasons for government lending to agriculture, and while this Audit argues that there was clearly somecrowding out, it is doubtful that Mexico's (publicly-owned) commercial banks would have offered substantially more long term credit orwould have had a much larger short term lending programme tor LlPs - the FIPS simply overstates a good case for reform. Note: TheLevy Report, which was presented to the Board in August, 1989, is formally known as the Report of the Task Force on Financial SectorOperations. Operational Directive 8.30 on Financial Sector Operations was released in February, 1992.

35

study of informal rural financial markets. However, with the election of a new Administration inAugust, 1994, and with the World Bank reexamining its policy on rural finance as it recasts OD8.30,it is expected that a broader and more intensive dialogue on rural financial sector reform can beresumed in the new sexenio.

4.13 The Future of FIRA as an Institution: With the establishment of an autonomous central bank,the future of FIRA has become a subject of debate. Within the next 18 months, BANXICO mustrelinquish trusteeship for its numerous trust funds to other trustees. It is as yet undecided whetherFIRA should fall under NAFIN (the Borrower for this project), BANRURAL or another agency, orwhether FIRA should become a separate development bank. At this point, the Audit favoursestablishing FIRA either as a separate, second-tier development bank or alternatively as a trust fundunder NAFIN.' In either case, the quality of FIRA's able technical staff must be maintained, asmust their focus on activities to encourage commercial bank lending to viable agricultural producers.The technical assistance support continues to be valuable and warranted for the immediate future,both for the commercial banks' agricultural staff and for final borrowers. Nevertheless, the meritsof FIRA's TA should be assessed continuously in the light of its cost implications and of the qualityand availability of alternative, private sources of technical support.

4.14 FIRA's Future Mission: The Audit believes that FIRA must assume greater risks in order tofulfill its mission of expanding the formal financial frontier. It should discontinue its short termlending operations for wealthier farmers within the next two or three years and phase out long termlending for them more gradually. This could be done by setting a cap on the Peso value of FIRArediscounts for any given loan and loanee, in addition to the 80 percent limit on FIRA rediscounts.The Peso cap would be reduced over time as commercial banks begin to extend the terms of theirloans in response to liberalised interest rates (see below). Note that the Peso cap would be mostbinding on commercial bank loans to large borrowers. Loans to LIPs and relatively poor OPs mightstill qualify for FIRA rediscounts of up to 80 percent of the loan. The focus of FIRA's activitiesshould be on drawing viable and potentially viable LIPs (as they are currently defined) into relationswith the formal banking sector. In addition, FIRA should continue to encourage commercial banklending to poorer OPs. Commercial banks should not be allowed to obtain rediscounts from FIRAfor given clients for more than e.g. five years. Thereafter, the banks' continuing concerns regardingthe riskiness of LIP clients should be addressed via FEGA guarantees at actuarially fair rates. Anexpanded programme of guarantees may thus be required. To conclude, FIRA has an importantmission to reach out to new clients and address information constraints which commercial banks maybe reluctant to confront. There can be little justification for continued subsidisation of an establishedclientele, or for crowding out lending by the private sector.

4.15 BANRURAL's Future Mission: This is articulated well in draft documents for the proposedRural Financial Sector Project. BANRURAL should use its extensive network of branches tomobilise deposits and to lend on the basis of stringent criteria, with an adequate margin to coverdefault risks and most administrative costs. To this end, BANRURAL and other participating banksshould be allowed to charge unrestricted interest rates to sub-borrowers (see paragraph 4.18). Anyremaining administrative costs could be covered by transparent, time-bound transaction cost subsidiesfrom GOM. These subsidies should not be peculiar to BANRURAL, but rather should be extendedto any participating bank for the first few (e.g. two or three) loans that it offers to new, potentially

56. BANRURAL needs to be strengthened considerably before it can be considered as a potential trustee.

36

viable clients." The Audit believes that producers who are not regarded as potentially viable shouldcontinue to be directed to PRONASOL sources of funds. On the other hand, BANRURAL shouldexpect to lose some of its better clients through competition from FIRA-rediscounted commercialbank loans. Competition between commercial banks and BANRURAL for wealthier clients shouldnot be ruled out. BANRURAL should also seek to diversify its lending, gradually increasing theproportion of non-agricultural, rural sector loans in its portfolio as BANRURAL staff gain experiencewith the evaluation of new types of credit. Finally, banking supervisors should hold BANRURALto the same banking standards as other participating banks.

4.16 The Problem of Commercial Bank Arrears: Commercial bank lending to all sectors increasedfive-fold in real terms during 1987-1993. It increased more than six-fold in real terms to agriculturebetween 1987 and 1992. The rapid increase in indebtedness and numerous trade and macroeconomicfactors (including high real rates of interest in 1988-89) led to a sharp increase in arrears oncommercial bank loans to all sectors. The problem was particularly pronounced in agriculture (para.3.31), and more severe for PB-funded credit than for FIRA-rediscounted sub-loans. In March, 1994,the Mexican Banking Association and GOM negotiated a programme of restructuring of some 18,000agricultural loans totalling Mex$5,500 million. Payments are to be restructured over 15 years withinterest payable at inflation plus 4 to 4.5 percentage points, though there is a five-year grace periodfor the 86 percent of clients whose loans amount to less than Mex$200,000." The programme needsto be monitored closely to establish the implications for returns to FIRA and commercial banks, andfor borrowers' incentives to repay future credit. More generally, Bank supervision of any futurefinancial intermediary loans in Mexico should include an annual review of the financial performanceof all participating banks, with a particular focus on the profitability and performance of sub-loansthat are supported by the World Bank.

4.17 The Vision for the Sector and the World Bank's Role: The opening of new tradeopportunities through the North American Free Trade Agreement offers Mexican agriculturalproducers a great opportunity, as well as a great challenge, to increase their efficiency and serve avastly expanded market. To this end, rural financial reforms must keep pace with advances in tradeand pricing policies, as well as in the broader financial markets. As a result of bold measures takenby GOM, considerable progress was achieved during the Ninth Agricultural Credit Project and duringthe preparation of the proposed follow-on operation. However, much remains to be done. Forexample, there is little justification for subsidising short term commercial bank loans to wealthier OPs.Therefore the tasa mezcla should be discarded in favour of liberalised interest rates and a higherFIRA rate to commercial banks. Transaction cost subsidies would still be provided for sub-loansbelow a given size. The same approach should be pursued on long term loans to OPs (for whichGOM has already consider applying the tasa mezcla).

57. The amount of these transaction cost subsidies should be minimised by funding only the diflerence between t.e 0n-lending raterequired for an acceptable return to PBs on agricultural loans and the maximum feasible on-lending rate to clients, wAhere the latter isdetermined by calculating the expected return on sub-borrowers' equity for farm investments ani assessmg the maximum interest expensethat could be supported while guaranteeing an acceptable return on equily lor the sub-!or!ower. The aii should be to cover as muchof the administrative costs of lending to 'Bis as is possible via interest income raler than v;,' Governmei grants.

58. A programme of restructuring of Mex$18,000 million in overdues on industrial loans was also being negotiated during the Auditmission.

37

4.18 There is no shortage of demand for credit even at higher interest rates. The Audit missionfound that LIPs were willing and able to borrow from moneylenders to ensure timely soil preparationand planting of seasonal crops. The main problem is access to formal credit for LIPs and poorerOPs, since they generally require small loans and commercial banks tend to avoid small loans becauseof high transaction costs per Peso lent. Thus a more effective way of providing immediate assistanceto LIPs is to subsidise commercial banks' transaction costs on small loans, instead of providing interestsubsidies to farmers. Interest subsidies to LIPs should be phased out according to a preestablishedschedule over the short to medium term (four years or less)." At the end of this period, interestrates to all agricultural borrowers should be fully liberalised. Any further transaction cost subsidiesshould be limited to the first few loans to new clients (see para. 4.15). The Audit team believes thatsubsidies for subsistence or marginal farmers are better targeted via investments in physical and socialinfrastructure, particularly improved roads, rural electrification, education and health services. TheGovernment's commitment to PRONASOL is evidence of GOM's awareness of the merits of suchan approach.' Other measures to be undertaken include simplifying the rate structure on FIRAloans and replacing the income-based criterion for targeting with alternative criteria based, e.g. onloan size.

4.19 There has been a hiatus both in GOM's reform process and in World Bank involvement inMexico's formal rural financial sector during the past two years. Full disengagement was correctlyregarded as an ineffective way for the World Bank to ensure that Mexican rural financialintermediaries attain the high standards established in OD8.30. Therefore, responding to explicitGOM interest, the World Bank attempted to remain engaged in dialogue on rural financial marketsby directing its attention to the heretofore neglected informal financial sub-sector. It is expected that,now that the new Administration has assumed office, the World Bank and GOM will begin a broaderand more intensive dialogue on policy reforms for the entire rural financial sector. The scale of anyfuture World Bank support for the sector should be tailored to the Government's willingness toconsider further necessary reforms.

59. One way to do this would be to extend the asa mezcla to all agricultural loans over the transition period. If necessary, a capped tasamezcla could be considered as an interim measure, with e.g. twice the spread allowed on any commercial bank contributions exceeding theminimum requirement on loans to LIPs. The cap would be raised and removed before full liberalisation of interest rates.

60. On the other hand, during implementation of the two AGSAIs, the Bank repeatedly expressed concern regarding the adequacy ofpublic investment in agricultural infrastructure (see OED's forthcoming PAR on the AGSAL).

1986 1987 1988 1989 1990 1991 1992

[1] The Macroeconomy

Nominal GDP (Mex$ millions) 79,191 193,312 390,451 507,618 686,406 865,166 1,033,224GDP Deflator (1991 = 100) 10.6 25.3 50.5 63.5 82.2 100.0 116.2Real GDP (1991 Mex$ millions) 750,032 763,969 773,471 799,285 834,918 865,166 888,921Population (Millions) 79.6 81.2 82.8 84.5 86.2 87.8 89.5Real GDP per caput (1991 Mex$ '000s) 9,423 9,408 9,341 9,459 9,686 9,854 9,932 .Growth in real GDP per caput (%) -0.1% -0.7% 1.3% 2.4% 1.7% 0.8%Unemployment Rate (narrow definition, 2) 3.9% 3.6% 3.0% 2.8% 2.6% 2.9%Consumer Price Index (year end, 1991 = 100) 13.8 35.7 54.1 64.8 84.2 100.0 111.9Inflation Rate (Z) 86.2% 159.2% 51.7% 19.7% 29.9% 18.8% 11.92

1986 1987 1988 1989 1990 1991 19920[21 Agriculture

Nominal Agricultural GDP (Mex$ millions) 7,466 16,825 30,690 39,246 54,810 66,682 87,295 *Real Agricultural GDP (1991 Mex$ millions) 65,406 66,310 63,806 62,368 66,052 66,682 66,601 4Agriculture/Total GDP (%) 9.4% 8.7% 7.9% 7.7% 8.0% 7.7% 8.4%Growth in Real Ag. GDP (%) 1.4% -3.8% -2.3% 5.9% 1.0% -0.1% $.(Lowest) Nominal Regional Min. Daily Wage (Mex$) 2,060 5,395 6,670 8,405 9,920 11,115 11,115 0Real Regional Minimum Daily Wage (1991 Mex$) 14,959 15,116 12,323 12,973 11,784 11,115 9,930

1986 1987 1988 1989 1990 1991 1992

(3) Trade

Exchange Rate (average annual, Mex$/US$) 0.61 1.38 2.27 2.46 2.81 3.02 3.09 6Debt Service Ratio (%) 55.3% 40.12 47.3% 36.9% 26.7%Agricultural Exports (Hex$ millions) 647 1,231 2,354 2,521 4,690 5,571Agricultural Imports (Mex$ millions) 554 1,291 3,780 4,601 5,480 5,808Surplus or Deficit (Mex$ mitlions) 93 (60) (14426) (2,080) (790) (237)

1986 1987 1988 1989 1990 1991 1992

[4) Finance

Deposit Rate (%) 90.2% 115.7% 31.0% 32.5% 22.6% 14.7% 17.9%ACF (average annual, 2) 80.9% 94.6% 67.6% 44.6% 37.1% 22.6% 18.8%CETES (%) 99.5% 122.5% 52.3% 45.0% 34.8% 19.3% 15.6% fReserve Requirement (%) 10.0% 10.0% 10.0% 10.0% 2Harket Reference Rate (2, *) 93.2% 108.4% 78.4% 52.9% 40.1% 25.6% 21.81

*: Defined as fb+3Z]/[1-r], where b u the base rate (ACF for 1986/89, CETES thereafter); r the reserve requirement. 1z

(Continued..)

1986 1987 1988 1989 1990 1991 1992

(5) The Banking System's Non-Agricultural Portfolio

Banking System's Portfolio (Excl loans to GOM, Mex$m) 24,819 58,837 80,496 122,486 188,563 274,139 399,958Real Growth in Portfolio (2) -8.5% -9.8% 27.11 18.5% 22.4% 30.3%Loan Portfolio in Arrears (Excl loans to GOM, Mex$m) 757 1,185 1,627 6,233 8,171 9,578 17,231System's Arrears/Loan Portfolio (%) 3.1% 2.0% 2.0% 5.1% 4.3% 3.51 4.3%Coamercial Bank Arrears/Loan Portfolio (%) 0.9% 1.2% 2.0%1 3.2% 5.5% .

Banking System's Industrial Portfolio (Mex$ millions) 10,552 24,234 29,388 40,702 56,620 79,593 112,851Industrial Portfolio / Total Non-Govt. Portfolio (%) 42.5% 41.2% 36.51 33.2% 30.0% 29.0% 28.2%Real Growth in Industrial Portfolio (%) -11.4% -20.0% 15.7% 7.1% 18.3% 26.7%Industrial Portfolio in Arrears (Mex$ millions) 338 476 653 1,714 2,226 2,352 4,301Industrial Arrears/Industrial Portfolio (t) 3.2% 2.0% 2.2% 4.2% 3.9% 3.0% 3.8%

Banking System's Housing Portfolio (Mex$ millions) 1,241 2,834 6,128 8,523 12,453 15,484 18,569Housing Portfolio / Total Non-Govt. Portfolio (%) 5.0% 4.8% 7.6% 7.0% 6.6% 5.6% 4.6%Real Growth in Housing Portfolio (%) -11.9% 42.6% 16.2% 12.5% 4.7% 7.1%Housing Portfolio in Arrears (Mex$ millions) 18 8 19 24 23 191 389 CrHousing Arrears/Housing Portfolio (%) 1.5% 0.3% 0.3% 0.3% 0.2% 1.2% 2.1%

Banking System's Loans for Services (Mex$ millions) 6,923 17,430 21,753 33,291 62,360 99,585 154,761Services Portfolio / Total Non-Govt. Portfolio (Z) 27.9% 29.6% 27.0% 27.2% 33.1% 36.3% 38.7% i.Real Growth in Services Portfolio (%) -2.9% -17.7% 27.9% 44.2% 34.4% 38.8%Services Portfolio in Arrears (Mex$ millions) 96 183 293 574 1,232 1,713 5,153 SServices Arrears/Services Portfolio (%) 1.4% 1.0% 1.3% 1.7% 2.0% 1.7% 3.3%

Banking System's Comercial Portfolio (Mex$ millions) 2,378 5,327 8,634 20,332 31,911 49,431 75,584 0Commercial Portfolio / Total Non-Govt. Portfolio (%) 9.6% 9.1% 10.7% 16.6% 16.9% 18.0% 18.9%Real Growth in Commercial Portfolio (2) -13.6% 6.9% 96.7% 20.8% 30.4% 36.6%Commercial Portfolio in Arrears (Mex$ millions) 113 180 183 523 1,320 2,851 3,729 'e

Commercial Arrears/Commercial Portfolio (%) 4.8% 3.4% 2.1% 2.6% 4.1% 5.8% 4.9%

1986 1987 1988 1989 1990 1991 1992 a16) The Banking System's Agricultural Portfolio I

Banking System's Agricultural Portfolio (Mex$m, *) 1,818 3,691 8,862 15,381 21,956 26,844 33,393Agric. Portfolio / Total Non-Govt. Portfolio (2) 7.3% 6.3% 11.0% 12.6% 11.6% 9.8% 8.3%Real Growth in Agricultural Portfolio (%) -21.7% 58.3% 45.0% 9.9% 2.9% 11.1%Loans to LIPs / Agricultural Loans (%) 48.9% 49.7% 40.9% 26.9% 19.1%Agricultural Portfolio in Arrears (Mex$m, *) 149 227 395 1398 2786 2363 3357System's Agric. Arrears/Agricultural Portfolio (%) 8.2% 6.2% 4.5% 9.1% 12.7% 8.8% 10.1%Commercial Bank Agric. Arrears/Agric. Portfolio (%) 2.1% 2.6% 3.6% 5.5% 7.0%

Commercial Banks' Agric. Portfolio (Mex$ millions) 377 824 2,416 6,901 12,199 14,118 16,192Commercial Banks' Share of Agricultural Loans (%) 20.7% 22.3% 27.3% 44.9% 55.6% 52.6% 48.5%FIRA's Portfolio (Hex$ millions) 597 1,044 2,411 3,871 6,535 9,789 13,184FIRA's Share of Agricultural Loans (Z) 32.9% 28.3% 27.2% 25.2% 29.8% 36.5% 39.5% ZBANRURAL's Portfolio (Mex$ millions) 844 1,823 4,035 4,609 3,223 2,937 4,017 '

BANRURAL's Share of Agricultural Loans (%) 46.4% 49.4% 45.5% 30.0% 14.7% 10.9% 12.0%

*: Excludes mining, fisheries & forestry (Annex Continued..)

1986 1987 19887 1989 F 1990 191991 196[7] Agricultural Interest Rates

Nominal Rates to LIPs - Short Term (%) 58.2% 74.8% 65.6% 43.3% 33.8% 18.7% 15.1%Nominal Rates to LIPs - Long Term (%) 56.6% 66.3% 64.3% 42.4% 33.1% 18.3% 14.8%Nominal Rates to "Basic OPs" - Short Term (%) 82.9% 99.4% 70.6% 47.6% 37.82i 22.3%i 18.6%jNominal Rates to "Basic OPs" - Long Term (%) 80.9% 90.9% 68.6% 45.6% 35.8% 21.3% 17.621Nominal Rates to Other OPs - Short Term (%) 82.9% 101.2% 74.6% 51.6% 4l.82 26.3t 16.7%iNominal Rates to Other OPs - Long Term (2) 80.9% 92.7% 72.6% 49.6% 39.8% 24.3% 16.4% MReal Rates to LIPs - Short Term (%) -15.0% -32.6% 9.2% 19.7% 3.0% -0.1% 2.9%Real Rates to LIPs - Long Term (%) -15.9% -35.8% 8.3% 19.0% 2.4% -0.4% 2.6%Real Rates to "Basic OPs" - Short Term (%) -1.8% -23.1% 12.5% 23.3% 6.1% 3.0% 6.0%Real Rates to "Basic OPs" - Long Term (%) -2.8% -26.3% 11.2% 21.6% 4.5% 2.1%; 5.1%Real Rates to Other OPs - Short Term (%) -1.8% -22.4% 15.1% 26.7% 9.1% 6.3%' 4.2% fReal Rates to Other OPs - Long Term (%) -2.8% -25.6% 13.8% 25.0% 3.8% 4.6% 4.6% '

1986 1987 1988 1989 1990 1991 1992[83 Agricultural Insurance

-MBeans - Area Covered by Insurance ('000s Hectares) 949 1,023 1,080 755 239 29 32Maize - Area Covered by Insurance ('000s Hectares) 2,911 3,179 2,998 1,932 375 108 141Rice - Area Covered by Insurance ('0008 Hectares) 169 155 144 181 20 9 5Sorghum - Area Covered by Insurance ('000s Hectares) 1,224 1,193 909 756 254 57 87Wheat - Area covered by Insurance ('000s Hectares) 732 581 499 507 186 42 95 0Total Area Covered by ANAGSA Insurance ('000s Ha) 7,100 7,300 6,600 4,900Total Area Indemnified ('000s Hectares) 5,400 5,500 5,200 3,100Area Indemnified / Area Covered M) 76.1% 75.3% 78.8% 63.3%GOM Transfers to ANAGSA/AGROASEMEX (Mex$ millions) 215 476 1,149 991 1,848 2 65(8]Sbsdst Agricultural suranc

FIRA Incmea From Lova Suranes (Mex$ mecaos s) 0 843 9,96 23 2,6 264a uaran Coe eid to Bnks (Mex$) 28 6,4 8, 51,918 11912

R- Ne OutfovEredy on ansuranes( e rs) 153) 9 ( (1)

[9a Subsidies oered by Inurace (000 Hectaes) Lend

FoA (excl. FEGA): bya A Sbsdins r eTA (millions) 7,0100 1,22 1,313 1,0

Toa Subsid nemnceidn(a00 Liailtres) 5,4008 64 1,5 118,0GO Trasfers oEut (x millions)AEME 753x$06illions))215FIR Suarantes Aplid to Bancom (Mex$ millis) 000 18 5

1986

FIRA (excl. FEGA): So excluding TA (e) 88.6% 82.8% 78.4% 93.3% 109.5%FEGA Subsidy on Equity + Grant Income (Mex$ millions) 2 4 22 30 197

(panel [9] Continued..)

1986 1987 1988 1989 1990 1991 1992

(9] Subsidies to Agricultural Lenders (..Continued)

GOM: Total Fiscal Transfers to FIRA (1991 Mex$m) 1,637 998 1,415 595 319 330GOM: Total Fiscal Transfers to FICART (1991 Mex$m) 386 282 451 149 39 36

GOM: Total Fiscal Transfers to BANRURAL (1991 Mex$m) 4,566 3,712 5,799 4,096 9,916 949

1986 1987 1988 1989 1990 1991 1992

(10) BANRURAL's Key Financial Ratios (*)

Ratio of Equity to Loan Portfolio (%) 15.8% 15.1% 53.9% 72.4% 51.7% 49.8% 58.9%

Loans Classified as Overdue / Loan Portfolio (%) 3.0% 2.4% 3.7% 8.9% 7.0% 16.5% 16 2%

Ratio of Deposits to Total Liabilities (%) 3.6% 3.7% 4.6% 9.8% 9.0% 9.3% 25:8%

Ratio of Total Liabilities to Equity (Units) 17.8 20.3 3.7 2.6 1.6 1.7 1.4

(Interest Income-Interest Expense)/Avg. Portfolio (%) 8.2% 14.0% 19.2% 19.8% 16.0% 10.8% 8.4%

Admin. Costs Excl. Provisions/Avg. Loan Portfolio (%) 13.2% 15.3% 15.1% 13.9% 15.3% 18.2% 19.4% W

Total Financial & Admin. Expenses/Avg. Portfolio (%) 55.4% 70.6% 63.8% 60.3% 55.3% 40.5% 38.3%

Return on Equity, before GOM Income Transfers (%) -81.1% -44.2% -10.9% 17.4% -29.4% -37.6% -40.5%

Return on Equity, after GOM Income Transfers (%) -1.2% -1.5% -0.8% -0.3% -27.0% -30.2% -30.3% f

CData should be used with caution since earlier financial statements understate the volume of non-performing loans.

1986 1987 1988 1989 1990 1991 1992

111) FIRA Interest Subsidy Passed to Commercial BanksIntended for Farmers '-

Minimum On-lending Rate for Viability of FIRA (, )84.4% 58.6% 42.0% 25.3% 20.9% 0

Actual Average FIRA On-lending Rate (%) 43.5% 30.8% 23.9% 14.2% 11.0%

interest Subsidy / FlRA's Portfolio (6) 40.9% 27.8% 18.1% 11.1% 10.0%

Real Value of Interest Subsidy (1991 14ex$ millions) 1,554 1,574 1,283 1,002 1,10

Interest Subsidy Agricultural GDP (-) 2.7% 2.6% 2.0% 1.5% 1.4%

Interest Subsidy /DP (%) 0.22% 0.20% 0.16% 0.12% 0.12%

*: Actual average on-lending rate multiplied by [i+SDI].

1986 1987 1988 1989 1990 1991 1992

(12] BANRURAL's Interest Subsidy to Farmers

Estimated Minimum Rate for Viability of BANRURAL (% 136.5% 66.3% 59.0% 43.3% 25.3%

Actual (Reported) Interest / Loan Portfolio () 47.3 43.2% 36.1% 32.0%1 18.12%

Interest Subsidy / BANRURAL's Portfolio (%) 89.2% 23.1% 22.9% 16.8% 15.2% 1

Real Value of Interest Subsidy (1991 Mex$ millions) 4,732 1,596 1,684 1,072 832 1Interest Subsidy / Agricultural GDP (%) 7.1% 2.5% 2.7% 1.6% 1.2%1

Interest Subsidy / GDP (%) 0.62 0.21%; 0.21% 0.13%1 0.10% 0

EsEstimated at CETES + 14% (Annex Continued.)

1986 1987 1988 1989 1990 1991 1992

[131 Returns to Farmers on Selected Crops

Jalisco, Irrigated Maize: Cost (Mex$/hectare) 152 323 838 1,042 1,257Jalisco, Irrigated Maize: Yield (tons/hectare) 4.9 3.0 3.5 3.2 4.0Jalisco, Irrigated Maize: Price (Mex$/ton) 131 242 373 432 636Jalisco, Irrigated Maize: Revenue (Mex$/hectare) 635 735 1,308 1,365 2,538Jalisco, Irrigated Maize: Gross Return (Mex$/hectare) 483 412 470 323 1,281

Sinaloa, Irrigated Rice: Cost (Mex$/hectare) 193 354 757 1,112 1,434Sinaloa, Irrigated Rice: Yield (tons/hectare) 3.8 4.3 4.1 4.3 4.2Sinaloa, Irrigated Rice: Price (Mex$/ton) 98 238 450 476 420Sinaloa, Irrigated Rice: Revenue (Mex$/hectare) 376 1,023 1,851 2,035 1,754Sinaloa, Irrigated Rice: Gross Return (Mex$/hectare) 183 669 1,094 923 320

Sonora, Irrigated Wheat: Cost (Mex$/hectare) 146 284 676 894 1,141Sonora, Irrigated Wheat: Yield (tons/hectare) 4.4 5.3 5.2 4.7 5.3Sonora, Irrigated Wheat: Price (Mex$/ton) 58 120 310 380 484Sonora, Irrigated Wheat: Revenue (Mex$/hectare) 256 637 1,601 1,801 2,556Sonora, Irrigated Wheat: Gross Return (Mex$/hectare) 110 353 925 907 1,415

Tamaulipas, Rainfed Sorghum: Cost (Mex$/hectare) 92 144 270 370 468Tamaulipas, Rainfed Sorghum: Yield (tons/hectare) 1.6 1.5 1.8 1.2 2.3Tamaulipas, Rainfed Sorghum: Price (Mex$/ton) 58 117 225 319 320Tamaulipas, Rainfed Sorghum: Revenue (Mex$/hectare) 92 174 409 370 736Tamaulipas, Rainfed Sorghum: Gross Return (Mex$/ha) 0 30 139 0 268

Zacatecas, Rainfed Beans: Cost (Mex$/hectare) 85 203 380 490 690Zacatecas, Rainfed Beans: Yield (tons/hectare) 0.4 0.5 0.3 0.1 0.6Zacatecas, Rainfed Beans: Price (Mex$/ton) 224 507 793 1,180 1,742Zacatecas, Rainfed Beans: Revenue (Mex$/hectare) 82 234 266 165 965Zacatecas, Rainfed Beans: Gross Return (Mex$/hectare) (3) 31 (114) (325) 275

CL

[14] Sources of Data

LA2AG: Project Completion Report, Ninth Agricultural Credit Project (Ln.2837-ME) PCRLA2AG: Draft Agricultural Sector Memorandum, 1994Correspondence Files for Loan 2837-MEFinancial Statements for FIRA, FICART & BANRURALIMF: International Financial StatisticsINEGI: Anuario Estadistico de los Estados Unidos Mexicanos, Edicion 1992Banco de Mexico: Indicadores Economicos, various issuesSARH: Anuario Estadistico de la Produccion Agricola de los Estados Unidos Mexicanos, various issuesComision Nacional Bancaria: Banca Multiple, Diciembre 1982 - Diciembre 1992Comision Nacional de Salarios MinimosFIRA Databases (incl. SUECO) and direct communications

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