INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized,RESTRICTED Report No. p-777 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF T HE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE AGRICULTURAL DEVELOPMENT FUND OF IRAN UNDER THE GUARANTEE OF IRAN January 28, 1970

2 REPORT AND REC011diKNDATIOZ OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE AGPICULTU-RAL DEVELOPK ENT FUND OF IRAN UNDER THE GUARANTEE OF IRAN 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$6.5 million to the Agricultural Development rund of Iran (ADFI). The loan would be used to finance part of the foreign exchange component of ADFI's lend-ng program for an estimated period of two years. PART I - HISTORICAL 2. The proposed loan would be the first financing provided by the Bank for agricultural credit in Iran. 1DFI wfas established in 1968 to encourage private investment in large-scale farming, livestock production, agricultural processing and associated industries. Largely through missions and exchanges with the Government and the management of ADFI, the Bank has been closely associated with its formation and develcpment as an institution. 3. Negotiations took place in?'ashington during the week beginning October 6, The President of ADFI, Dr. Nasser Ameri, represented the borrower, and Mr. E. Shapoorian, Financial Counselor of the Iranian Economic Mission in Wlashington, represented the Governmen-t as guarantor. Subsequent discussions betwjeen Bank staff and responsible officials in Iran clarified certain details.

3 The proposed loan wiould be the Bank's fourteenth loan to Iran. The following is a summary statement of Bank loans to Iran as of December 31, 1969: Amount (US$ Million) Year No. Borrower Purpose Bank Undisbursed IRN Iran General development IRbq Iran Road construction IRN IMDBI Assist private industry IRdN Iran Dez Multipurpose Project IRNq Iran Road construction IRN Iran Road construction IRN Iran Feeder Road constrlction IRN I1IDBI Assist private industry Inl IMDBI Assist private industry IRN Iran Ghazvin Project IRN IMDBI Assist private industry IRK Iran Dez Irrigation Project IRN IPIDBI Assist private industry Total (less cancellations) Of which has been repaid to Bank and others Total now outstanding Amount sold 22.0 Of wihich has been repaid Total now held by Bank Total undisbursed Disbursements for some projects have been slow. There have been delays in the Ghazvin Agricultural Project (517-IR1q) but a supervision mission noted improvements in project implementation. Disbursements on the Dez Irrigation Project (594-IR1) have only recently begun. This project was originally designed to promote improved small-scale, traditional farming and develop some large-scale farming. It now appears that the Government has decided to proceed with only large-scale farming in the Dez area. The full implications of this change in policy cannot yet be assessed and further information has been requested from Government. Disbursements on loans for highwjays have also fallen behind schedule, but performance has recently improved. Commitment of loans to IINDBI are somewhat ahead of schedule, undisbursed amounts represent funds whl-ch have been committed, but which have not yet been drawn down by IPIDBI clients.

4 Further loans for projects in the fields of il lustry, power, roads, education and telecommunications are under ccnsideration. 7. IFC has so far invested in two companies in Iran. A US$300,000 loan was extended in 1965 to Sherkat Sahlami Kahkashan, a manufacturer of ceramic tiles. In 1967 a loan of US33 million was made for the Ahwaz Steel Rolling Mill, together with an equity investment of US$800,000. PART II - DESCRIPTION OF THE PROPOSED LOAN 8. Borrower: Agricultural Development Fund of Iran. Guarantor: Amount: Purpose: Amortization: Commitment Charge: Interest Rate: Economic Rate of Return: Iran. Various currencies equivalent to USS6.5 million. To provide funds to enable AMIU to make loane for the development of large corimercial farme :nd for plants for packagin-g, preparation an( storage of acriculturll products, and to pay the foreign exchange cost of an advieor. Fifteen years, including four years of grace, repayable in 22 equal semi-annual repayments of principal and interest, beginning on January 1, 1974 and ending July 1, /b4 of 1 percent per annum. 7 percent per annum. 17 percent. PART III - THE PROJECT 9. A report entitled "Agricultural Development Fund of Iran" (PA-23a) dated January 26, 1970, is attached. 10. Agriculture in Iran accounts for about one-fourth of the gross national product and employs about two-fifths of the labor force. During the 's agricultural production increased by about five percent per year even though these were years of adjustment associated with the land reform program. There is an acute need for credit, limited amounts have been available to small farmers througil the Agricultural Bank of Iran, an institution associated with the cooperative system and land reform. Until the establishment

5 of ADFI, laiger farmers could obtain credit only in simall amounts at high cost and on short term from commercial banks. 11. ADFI was created in April 1968 as a part of the Government's effort to accelerate the rate of increase in agricultural production by shifting the emphasis of agricultural policy to greater support of the larger farming units. These are believed to be better able to make use of modern farming techniques. Thus, ADFI complements already existing credit institutions by providing larger farmers with medium and long-term credit facilities. It is wholly Government owned. Its two governing bodies are the General Assembly, a ministerial-level, policy-forming body and the High Council, the equivalent of a board of directors, chaired by the Governor of the Central Bank. Day-today operations and management are the responsibility of Dr. Nasser Ameri, the President, who is also a member of the High Council. An Executive Vice President satisfactory to the Bank, will be appointed prior to signing of the loan. The professional staff, although not yet experienced in agricultural lending, appears to be well-qualified. Several staff members have undergone training at IBRD, and the Economic Development Institute has recently conducted a course in Iran on project evaluation, primarily for ADFI personnel. 12. ADFI has paid-up share capital of Rls.340 million (US$4.5 million) and borrowers' deposits of about Rls.1 million (US$130,000). Under the terms of the Guarantee Agreement the Government of Iran has agreed to provide funds in the form of equity contributions to ADFI's share capital amounting to a total of about Rls.l,000 million (US$13.2 million). Under its founding statute ADFI has extensive borrowing powers, which amount to US$200 million equivalent for foreign loans and Rls.5,000 million (US$66 million equivalent) from resources within Iran. Loans from the Government are to be at a rate of interest three and one half percent lower than ADFI's current lending rate and will be drawn upon when needed as a result of ADFI's own commitments and disbursements. ADFI also has authority to borrow from commercial banks, may issue tax-free bonds and accept time deposits (of at least two years) at a rate of interest not exceeding seven percent per year. ADFI does not expect to cover its costs in the first few years, but should be able to break even within three or four years. 13. The project is designed to help in the financing of the development of commercial farms together with improvement of crop preparation, packaging and storage. It comprises loans by ADFI to sub-borrowers to be contracted over two years (with disbursements over three years) for priority investment in oil seeds, deciduous and citrus fruits, dairy farming, and limited poultry and sheep production. The financing plan is based on the principle that the Bank should finance the foreign exchange costs, subject to ADFI providing a reasonable proportion of the project c6st and farmers also making a suitable contribution. The estimated cost of the development to be financed under the project is Rls.1,204 million (US$16.0 million), of which the foreign exchange cost is about US$8.9 million for the import of agricultural machinery and

6 - 5 - equipment, pumps and piping for deep we-us, cold storage and packing plant equipment, and dairy cattle. The contribution of the farmers will be 30 percent in accordance with ADFI practice. ADPI's c.-n contribution will also be 30 percent, leaving 40 percent to be finanmed out of thle Bank's loan. Loans made by ADFI to sub-borrowers will be denominated in foreign exchange, for that portion of the loan which represents the proceeds of the Bank Loan, so that the foreign exchange risk is bone by ADFI's sub-borrowers. Loans will be for periods of six to twelve years depending on the type of subproject and will carry interest at 7-1/2 percent with a service charge of 1/2 percent. The sum of US$100,000 will pormit ADFI to employ an advisor for two years. 14. Direct benefits from the project will take the form of increased production from larger commercial farmers, who through the use of long term credits will be ab'e to develop their propcrties, Considerable benefits will also accrue to the eccroipy thtrough the operation of preparation, packaging and storage facilities. The estimated net annual increase in the value of agricultural production from the project when all sub-projects reach maturity is Rls.380 million (US$5.0 million). The estimated rate of return to the economy of Iran is about 17 percent. 15. The project should substantially increase income from existing farms and provide a good income on new ones with a return on incremental investment ranging from 16 to 22 percent, before payment of debt service and taxation. While the expected rates of return are believed to be high enough to attract investment, they are not excessively high. Tax payments would start only after completion of debt service. Tax revenue receivable by Government as a result of the project is difficult to assess, because of the number of assumptions which have to be made, but the average annual net taxable income is estimated to total Rls.400 million at full development, yielding, at a tax rate of about 30 percent, a total of Rls.120 million (US.40.6 million) to Government annually. 16. Farmers will buy their equipment through local commercial channels. Farm machinery and equipment, in general, can be imported without restrictions, subject to normal commercial tariffs (5 percent) and are available at reasonable prices. Local servicing facilities are adequate. Tractors of between 45 and 65 horsepower are imported under bilateral arrangements with Eastern European countries which are not members of the Bank and will not be financed from the Bank Loan. 17. ADFI will submit to the Bank for review and prior approval any sub-loan or aggregate of sub-loans to the same farmer made under the project in excess of the equivalent of US$200,000. The same requirement is imposed also upon all sub-loans to agricultural processors for preparation, packaging and storage. ADFI is not permitted to withdraw in excess of the equivalent of US$1 million from the loan account in respect to any loan or combination of loans to the same beneficiary.

7 The Bank loan Til. be disbursed on statements, certified by A!IFI, that sub-loans had 'been disbursed for approved purposes. The Banl -ill disburse up to a total of U&S6-4 rrillion, 57 percent of the amount of these sub-loans, or in respect of sub-loans above JS750;00O, either 57 percent or the actual foreign exchange cost, wthichever is less. PART IV - LEGAL DMSTRUMENTS AND AUThORITY 19. The Draft Loan Agreement between the Bank and the Agricultural Development Fund of Iran, the Draft Guarantee Agreement betw,een the Government of Iran and the Baik and the Report of the Committee provided for in Arti.cle III, Section 4 (iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 20. The provisions of the Loan Agreement generally conform to the pattern of Bank agricultural credit loais. PART V - THE ECOHOZY 21. An economic report entitled 'Economic Situation and Prospects of Iran t (SA-8a) dated December 31, 1969 uas distributed on January 7, 1970 (R70-2). 22. Since the early sixties, Iran's development efforts have met with considerable success. Gross national product at constant prices has been growing at more than 8 percent per annum and investment at more than twice the rate of growjth of income. These rates of growth were made possible by the tremendous increase in oil revenues during the period. How,iever, in recent years the rate of growth of domestic savings, particularly in the public sector, has not kept pace with the very ambitious investment program. The ensuing savings gap was met by heavy reliance on short- and medium-term foreign borrowing. These developments have led to a sharp rise in the country's debt service obligations. 23. The prospects for the continued growth of the economy are favorable. Iran is creditworthy. However, if price stability is to be maintained and balance of payments difficulties are to be avoided, the Government will have to take measures to improve the mobilization of domestic resources for investment. The prospects for non-oil exports, the present low rate of taxation and the flexibility inherent in a rapidly growing economy offer considerable scope. At the same time, Iran will need external financing on longer terms. The Iranian authorities recognize the importance of securing a larger proportion ol' external financing on longer terms and the need to improve project selection and management.

8 PART VI - COI2LI-ACE!ZHE,-TTI A"TICLES OF AG: ;ielt 24. I am satisfied that the proposed loan will comdply with the Articles of Agreement of the Banc. PART VII - RECO 'Ilr4ENDATION 25. I recommend that the axecutive Directors approve the proposed loan. Attachment Robert S. lmcnamara President January 28, 1970