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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (LOAN 2936-HU) JUNE 27, 1995 Agriculture and Urban Development Operations Division Country Department II Europe and Central Asia Region Report No This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS Currency Unit - Hungarian Forints (HUF) 1988 US$ I = HUF US$ I = HUF US$ 1= HUF US$ I = HUF US$ 1 = HUF US$ I = HUF US$ I = HUF WEIGHTS AND MEASURES (metric) FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AGROBER AMP AMPO CMEA EFSAL EU FRR GDP ICR MHB MOA MOF NBH OKHB PBs SAR SPA Agricultural Construction and Engineering Firm Agroprocessing Modernization Project Agroprocessing Modernization Project Office Council of Mutual Economic Assistance Enterprise and Financial Sector Adjustment Loan European Union Financial Rate of Return Gross Domestic Product Implementation Completion Report Hungarian Credit Bank Ministry of Agriculture Ministry of Finance National Bank of Hungary Commercial and Credit Bank Participating Banks Staff Appraisal Report State Property Agency

3 FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (Loan 2936-HU) CONTENTS Preface.1... Evaluation Summary... i iii Part 1: Project Implementation Assessment A. Project Objectives... 1 B. Evaluation of Objectives... 1 C. Achievement of Project Objectives... 2 D. Implementation Record and Major Factors Affecting Project Implementation E. Project Sustainability... 6 F. Bank Performance... 7 G. Borrower Performance... 8 H. Assessment of Outcome... 8 I. Future Operation... 9 J. Key Lessons Learned... 9 Part II: Statistical Annexes Table 1: Sunmmary of Assessments Table 2: Related Bank Loans Table 3: Project Timetable Table 4: Loan Disbursements: Cumulative Estimated and Actual Table 5: Key Indicators for Project Implementation T'able 6: Key Indicators for Project Operation Table 7: Studies Included in Project Table 8A: Project Costs Table 8B: Project Financing Table 9: Economic Costs and Benefits Table 10: Status of Legal Covenants Table 11: Compliance with Operational Manual Statements Table 12: Bank Resources: Staff Inputs Table 13: Bank Resources: Missions Appendices: A. Aide-Memoire of ICR Initiation Mission B. Borrower's Contribution to the ICR C. Map - IBRD No This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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5 IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (Loan 2936-HU) PREFACE This is the Implementation Completion Report (ICR) for the Agroprocessing Modernization Project (AMP) in Hungary, for which an IBRD loan in the amount of US$70 million equivalent was approved on May 5, 1988; signed on June 2, 1988; and made effective on August 10, At the Borrower's request, an amount of US$20 million equivalent was cancelled on October 12, The loan closed, as originally scheduled, on June 30, 1994, and the last disbursement from the loan account was made on October 28, The final amount utilized was US$ million equivalent and the unutilized balance of US$1.856 million was cancelled on October 31, The ICR was prepared in the Agriculture and Urban Development Operations Division of the Central Europe Department (Country Department II) in the Europe and Central Asia Region. The Task Manager is Kishore Nadkarni; the report was reviewed by Rory O'Sullivan, Division Chief and Jane Loos, Project Adviser. The Borrower-the National Bank of Hungary (NBH)-and the Ministry of Agriculture (MOA) provided written contributions. A summary, jointly prepared by MOA and NBH, is included as an Appendix to the ICR. Preparation of the ICR was begun in the last supervision mission in October 1993 and elaborated further during the Bank's completion mission in August It is based on material in the project files, discussions with relevant NBH and MOA officials, interviews with representatives of the participating banks, and with selected agencies and subborrowers. The Borrower contributed in the preparation of the ICR by: (i) discussing major points included in the report; (ii) providing information on the credit line and institutional components; (iii) coordinating collection of necessary data; and (iv) providing its section of the report.

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7 IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (Loan 2936-HU) EVALUATION SUMMARY INTRODUCTION i. Since lending to Hungary began in 1983, the Bank's strategy of assistance has focussed on supporting the country's program of structural adjustment to make the economy more efficient, flexible, market responsive and competitive in external markets. In the agricultural sector, the Agroprocessing Modernization Project was preceded by Bank operations to improve efficiency and competitiveness in grain storage and farm mechanization; production and marketing of livestock and meat products; and crop production. It was followed by two ongoing operations to support the growth of private, new rural investors and to strengthen the food and non-food consumer goods marketing and distribution systems, respectively. PROJECT OBJECTIvES AND COMPONENTS ii. Objectives. The development objectives of the Agroprocessing Modernization Project (AMP) were to enhance the international competitiveness of Hungarian agroprocessed exports and increase the efficiency of production and effectiveness of marketing of agroprocessed products by: (a) increasing earnings of agroprocessed and forestry exports, particularly to the convertible currency markets, by improving the quality and marketing of exports; (b) improving the efficiency of operations of enterprises in the agroprocessing subsector by reducing their unit costs of operations and improving their productivity; and (c) creating a more effective business climate in the agroprocessing subsector in line with macroeconomic price and tax reforms (para. 1). iii. Components. The main project components were: (a) a US$60 million equivalent line of credit; (b) an institutional component to upgrade support services to agroprocessing enterprises including: (i) export trade promotion and marketing; (ii) training in management and marketing; (iii) grading and quality control of raw materials and final products; and (iv) research and development; and (c) a sector policy component consisting of: (i) a phased reduction of agricultural subsidies; (ii) an action program for improvements in the poultry industry; and (iii) studies leading to the modernization and restructuring of the glass and metal container industries relevant to agroprocessed products (para. 2). IMPLEMENTATION EXPERIENCE AND RESULTS iv. Achievement of Objectives. In 1988, when the loan for the project was approved, there was no consensus that radical change was the only solution. Bank operations focused therefore on securing gains in selected subsectors, chosen on an assessment of their potential comparative advantage, through improvement in the productivity and efficiency of state-owned enterprises. Although the project's goals and objectives were realistic in the circumstances prevailing in Hungary in 1988 at the time of project

8 - iv - conception and preparation, they were overtaken by the rapid and sweeping changes that occurred in East and Central Europe following the collapse of communism and the abrupt demise of the CMEA. These changes included the accelerated program of macroeconomic and structural reform undertaken in 1990 by Hungary's first democratically elected Government under which foreign trade was largely liberalized, prices were freed, subsidies to consumers and producers drastically reduced, and progress made in raising the private sector's contribution to GDP to more than 50 percent. These changes had major consequences for the project's development impact, particularly in regard to the attainment of the original financial objectives of increasing convertible currency export earnings and improving the productivity and efficiency of medium to large agroprocessing enterprises. Nevertheless, this was counterbalanced to some extent by the project's success in supporting the Government's evolving priorities of promoting the growth of new, private investors in agroprocessing. The project's institutional development objectives were largely met with the successful establishment of an Agromarketing Office to assist in the promotion of agroprocessed exports; upgrading of the skills and facilities at leading packaging and quality information centers; and modernization of equipment, instrumentation and facilities at selected product testing and certification laboratories. Project-supported activities have helped the institutions to enhance their market relevance and to increase the extent of their self-financing. Achievement of the project's sectoral objectives was mixed. Importantly, in the area of agricultural subsidies, there were dramatic reductions in the level of subsidies (as a share of GDP) in the early years of the project which, however, the Government was not able to maintain in the face of external factors, such as the years of successive droughts. While subsidies have increased as a result, overall they remain at substantially lower levels, at around 2 percent of GDP as compared to 8 percent in 1987 (paras. 6 to 22). v. Major Factors Affecting the Project. The above factors and the sudden shift in Hungary from gradual reform of the socialist system to a market system altered very substantially the original parameters of the project. Factors beyond the Government's control included the major changes that occurred in CMEA markets after 1990 which were critical for many Hungarian exporters who had oriented their production to the increasing trade in convertible currency within CMEA markets, and who were subsequently unable to switch their production to the more demanding markets of the west without substantial additional investments. This was further compounded by the deleterious effects of an unusual period of three successive years of drought which severely affected agricultural production, thereby reducing product quality and increasing unit costs of production for processors. Changes ensuing in the early years of the Government's implementation of its economic reform program also had, on balance, the effect of reducing the demand on the part of medium to large enterprises for undertaking investments, resulting from a combination of factors including: the sharp contraction in industrial output, real GDP and aggregate fixed investment (despite large inflows of foreign investment); increasing liquidity and solvency problems of the commercial banks; uncertainties in the enterprises' status pending their restructuring or privatization; the reluctance of commercial banks to lend to enterprises with unclear prospects; and delays in completion of administrative and judicial proceedings in the case of enterprises engaged in work-outs with their creditors (paras. 23 to 28). vi. Bank and Borrower Performance. Bank performance was satisfactory in all stages of the project cycle as acknowledged by the Borrower. During project identification and preparation, the Bank was substantially involved in assisting the Borrower in the design and development of the project, committing considerable staff and consultant resources on its own account. The Bank was flexible as well in modifying the project's provisions in response to changing circumstances, (e.g., in removing the exportorientation requirement and in simplifying administrative procedures to encourage participation by private, new investors). Project supervision was satisfactory overall but, during the critical period of mid-project implementation between 1990 and 1992, it suffered from some discontinuities on account of the several regional reorganizations and consequent staff reassignments. The Borrower's performance was

9 - v - satisfactory as well through all the project stages. A well-staffed Project Office was set up for the project, with dedicated staff that contributed greatly to project monitoring and regular reporting of the programs of the institutional components of the project. NBH, the Borrower, carried out well its responsibility of monitoring and reporting of the progress of the credit line component. Compliance with covenants was satisfactory overall in respect of the main covenants. Cooperation between the Borrower and Bank staff remained responsive and cordial at all times (paras. 30 to 36). vii. Assessment of Project Outcome. On balance, the outcome of the project is assessed as satisfactory. The project's institutional objectives were largely achieved. Substantial progress was made in the important sectoral policy objective of reduction of agricultural subsidies (from 8 percent of GDP in 1987 to about 1 percent in 1990) although subsequent events, including severe droughts, have caused the Government to increase its support levels (to about 2 percent of GDP). In regard to the financial objectives, although the project achieved rather modest gains as to the original objective of increasing export earnings and improving productivity of medium to large agroprocessing enterprises, it contributed significantly to furthering the Government's evolving priorities of promoting the growth of private, new investors in agroprocessing (paras. 37 and 38). PROJECT SUSTAINABILITY AND FUTuRE OPERATIONS viii. The sustainability of the main project achievements is likely but would depend to a large extent on the Government's success in turning around the overall macroeconomic situation which continues to constrain many enterprises in improving their operations and deters potential clients from utilizing more fully the services that can be provided by the institutions. Recent trends in the external environment are more favorable for the project entities with the resumption of growth in western markets and progressive implementation of Hungary's Association Agreement with the EU. No specific plan has been prepared for future operations of the project. However, actions to be taken by the Government under its program of enterprise and financial sector structural adjustment, including a resolution for the portfolio problems of commercial banks, would be of critical importance for the enterprises as well as the commercial banks concerned. The Bank is closely involved in assisting the Government in regard to the adjustment program through a proposed Enterprise and Financial Sector Adjustment Loan (EFSAL) that is under preparation (paras. 29 and 39 to 43). KEY LESSONS LEARNED ix. The main lessons from the project (as summarized in para 44) are: a) successful restructuring of medium to large state-owned enterprises cannot be accomplished without sweeping reforms that address questions of enterprise ownership and governance, and sustained exposure to domestic and foreign competition; b) the dangers of too restrictive a specification in terms of targeting of credit, and the need to ensure movement towards more general, open lines of credit that are available to a broad spectrum of users; c) greater reliance on the appraisal process and capabilities of the financial intermediaries would not only reduce Bank inputs but also help the institutional development of the financial institutions and increase their commitment to the ownership of the project;

10 - vi - d) the need for close follow-up and frequent assessment of the situation in regard to project implementation, and for flexibility to adapt the project's provisions and procedures to changing circumstances; e) the limitation against use of Bank funds for financing transfers of existing, used assets is an important constraint in the ability of Bank credit lines to assist in the early stages of the privatization process; and f) the importance of careful design of the Bank's subloan application, evaluation and reporting requirements, taking account of the additional burden that this imposes on private sector participants, both participating banks and investors, operating in a competitive environment.

11 IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (Loan 2936-HU) PART I: PROJECT IPLEMENTATION ASSESSMENT A. PROJECT OBJECTIVES 1. The development objectives of the Agroprocessing Modernization Project (AMP) were to enhance the international competitiveness of Hungarian agroprocessed exports and increase the efficiency of production and effectiveness of marketing of agroprocessed products by: (a) increasing earnings of agroprocessed and forestry exports, particularly to the convertible currency markets, by improving the quality and marketing of exports; (b) improving the efficiency of operations of enterprises in the agroprocessing subsector by reducing their unit costs of operations and improving their productivity; and (c) creating a more effective business climate in the agroprocessing subsector in line with macroeconomic price and tax reforms. 2. The main project components were: (a) a US$60 million equivalent line of credit; (b) an institutional component to upgrade support services to agroprocessing enterprises including: (i) export trade promotion and marketing; (ii) training in management and marketing; (iii) grading and quality control of raw materials and final products; and (iv) research and development; and (c) a sector policy component consisting of: (i) a phased reduction of agricultural subsidies; (ii) an action program for improvements in the poultry industry; and (iii) studies leading to the modernization and restructuring of the glass and metal container industries relevant to agroprocessed products. B. EVALUATION OF OBJECTIVES 3. The operation's fundamental goal of increasing export competitiveness and efficiency in the agroprocessing subsector was clear. Objectives (a) to (c) were well-defined to achieving these goals. The objectives were also fully consistent with the Bank's strategy of assistance to Hungary at the time which focussed on supporting Hungary's program of economic reform, to make it more efficient, flexible, market responsive, and competitive in external markets, particularly in the convertible currency area. The project's goals were realistic in the circumstances existing at the time. In 1988, when the loan for the project was approved, although socialism was under strain and the demand for reform was growing, there was no consensus that radical change was the only solution. Bank operations focussed therefore on securing gains in selected subsectors, chosen on an assessment of their potential comparative advantage, through improvement in the productivity and efficiency of state-owned enterprises. In hindsight, the objectives remained restricted in that they did not seek further reforms of such broader issues as enterprise ownership, governance, skills and technology policies. 4. Project design took into account the experience under previous credit line projects in the sector which also involved both NBH, as the Borrower in each case, and MOA. Since NBH and MOA had both participated under the earlier projects, the project was not considered unduly complex in relation to the implementation capacity of the project agencies. The main risks to project implementation and

12 - 2 - achievement of project objectives were recognized and assessed at appraisal-the possible effects on the subsector from variations in implementation of the overall economic transformation and structural reform programs, and the potential impact of adverse changes in world markets. 5. As described later (para. 24), in addition to the transitional effects of the economic and structural reform programs, the project's implementation period was marked also by major, unforeseen, external factors, including the collapse of the former CMEA markets after 1990, and an unusual series of consecutive droughts which severely affected agricultural production. Two significant modifications were made to the project during implementation. First, at the Borrower's request, in November 1989, a substantial amount of the loan, US$15 million (or about 20 percent) was allocated to finance emergency working capital imports of animal feed to allow continued operations in the agroprocessing enterprises concerned. Second, in support of the Government's policy of encouraging the growth of new, private producers in the agroprocessing subsector, the original export-orientation criteria were significantly modified in July 1992 by waiving the minimum quantitative export-orientation requirement. In addition, other modifications were made between 1991 and 1994 to simplify application, evaluation and approval procedures, all aimed at encouraging greater participation by emerging small, private investors. C. ACHE:VEMENT OF PROJECT OBJECTIVES 6. The project succeeded in substantial achievement of its institutional development objectives in support of creating a more effective business climate in the agroprocessing subsector, and in encouraging the growth of new, private investors in agroprocessing. Sector policy and financial objectives were partially achieved, to a lesser extent than in the case of the institutional objectives. Sector Policy Objectives 7. Achievement of sector policy objectives was partial. In respect of agricultural subsidies, major reductions were made between 1988 and 1990, as agreed under the project, with the level of agricultural subsidies declining from 8 percent of GDP in 1988 to around 1 percent in However, agricultural subsidies have increased from these levels to around 2 percent of GDP at present, due in part to the pressures arising from the adverse effects of the successive droughts between 1990 and In respect of the action program for the poultry industry, although significant measures were taken to encourage higher productivity with the liberalization of animal feed protein imports, no significant headway could be made given structural problems in the industry. Finally, in respect of the glass and metal container industries relevant to agroprocessed products, although studies for modernization and restructuring of the industries were undertaken, as planned, their findings prudently were not implemented in the prevailing circumstances with the financial difficulties of the container-making enterprises and the continuing uncertainties in the main container-consuming agroindustries. Financial Objectives 8. Achievement of financial objectives was also partial. With the modifications made during project implementation in support of the Government's policies for private sector development in the agroprocessing subsector, the original emphasis in the financial objectives on increasing export earnings, particularly to convertible currency markets, and on improving efficiency through unit cost reductions, was modified to include the financing of viable private agroprocessing projects, even if not destined for exports.

13 Consequently, only 14 of the total of 56 subloans (accounting for about 25 percent of the amount onlent) were for export-oriented subprojects. With a few notable exceptions, actual exports were generally significantly lower than projected, reflecting the combined adverse effect of the collapse of the CMEA markets, the difficulties in switching to Western markets, and the effects of the droughts that affected raw material availability and quality, and resulted in increased production costs. 10. The objective of improved efficiency through reductions in unit costs in medium to large agroprocessing enterprises was also achieved only to a limited extent. While the new machinery and equipment, and upgrading of domestic and imported working capital inputs, enabled by the subloans resulted in improved technical capability, the efficiency aspects could be realized to only a limited extent given the excess capacity in face of the weak domestic and external markets. In some cases, even though the subproject was successfully implemented, the sponsoring enterprise faced severe problems from other sources, leading to, in some cases, institution of bankruptcy or liquidation proceedings. Notably, in some cases, the viability of the subproject operations resulted in the subproject being spun off as a separate, autonomous entity even while the original sponsoring enterprise was undergoing major reorganization. 11. Portfolio Characteristics: A total of 56 subloans was made under the project for an amount of about US$ 45 million of which about US$26 million was for financing of working capital (including the emergency imports of animal feed) and about US$19 million for investment financing. The subloans ranged between US$ 18,000 to US$ 6.8 million; subloans for export-oriented subprojects, on average, were about US$ 780,000 while those for other investment projects were about US$250,000 per loan. 12. There were some significant differences as compared to expectations at appraisal. First, only a small number of the medium to large agroprocessing enterprises that were expected to participate under the project did in fact do so. This was due to a combination of factors, all leading to a reduced demand for borrowed funds for investment purposes-the continued interest of foreign investors which resulted in some of the better-performing enterprises having access to equity and other funds through the foreign investor; the uncertainties caused in the medium to large state owned enterprises in the face of impending transformation or privatization; high interest rate levels which deterred some enterprises from undertaking investments; the weakness in domestic markets following from the macroeconomic adjustment process as consumers reduced their demand for certain agroprocessed products; the collapse of the CMEA markets; and the difficulties in penetrating Western markets in the face of quality and other requirements. Second, the subsectoral composition of the subloans was significantly different from expectations at appraisal. While, earlier, the poultry and wine industries had been expected to be the largest participants, in the vastly changed circumstances since 1990, they had relatively small shares with the largest shares going to processed fruits and vegetables (28 percent) followed by meat processing and grain milling (about 16 percent each). 13. In regard to performance, about 70 percent of the project investments appear to be operating profitably even in the difficult economic environment described earlier. However, a significant proportion (about 25 percent) of the larger subprojects faced problems due to a combination of the effects of weak domestic markets, the loss of CMEA markets, and the financial problems caused by interenterprise arrears and high interest costs. In six cases, involving subloans in the amount of US$ 10 million, the enterprises are engaged in bankruptcy or liquidation proceedings with their creditors. Workout and reorganization plans are being negotiated in most cases. Other medium to large subprojects appear to be operating profitably although achievements in most cases are lower than expected. Performance in respect of the smaller subprojects has been more even, with arrears affecting around ten percent of the total number of such subloans.

14 Rates of Return: Actual financial rates of return (FRRs) are estimated to be significantly lower than projected in most cases as a result of the effect of the unfavorable factors discussed above. Calculation of FRRs for many of the larger subprojects has been affected by the changes in the original sponsoring enterprise pursuant to voluntary, or involuntary, reorganization. Against the expectations at appraisal of FRRs ranging from 26 to 51 percent with an average of around 35 percent, the actual FRRs for the larger subprojects are likely to be substantially lower, even negative in a few extreme cases. For smaller subprojects, sampled FRRs suggest a range of around 18 to 50 percent. 15. Participating Banks: Only three banks participated under the project although many more had been cleared in terms of eligibility to participate. As expected, Commercial and Credit Bank (OKHB - which was formed in 1987 from the Central Bank's agricultural lending department) had the largest share of the subloans, accounting for about 60 percent of the total amount onlent; the other two PBs, the Hungarian Credit Bank, and Mezobank, had smaller shares at about 25 and 15 percent each. Reasons for the limited participation of the banks include the fact that several of the eligible banks were simultaneously participating under other concurrent Bank credit lines, including some available to the agricultural sector. 16. Loan evaluation and supervision procedures under the project contributed to strengthening of the PBs' lending activities to agroprocessors, particularly in respect of servicing new, small, private sector clients. More general development of the PBs' institutional and operational capabilities was pursued through other concurrent and successor Bank operations. In common with many other Hungarian conmmercial banks, the PBs under the project are facing systemic problems, particularly in relation to nonperforming and problem parts of their portfolios. The Government has taken some measures to strengthen the financial situation of the banks through injections of new capital. However, substantial further progress is needed, and this is being sought to be pursued under a proposed Enterprise and Financial Sector adjustment operation currently being discussed with the Government. Institutional Objectives 17. Most institutional objectives were substantially achieved. This extended as well to the completion of the studies under the project for the modernization of the glass and metal container industries which could not be implemented, however, due to the unfavorable situation in the container manufacturing and consuming industries. 18. In respect of export promotion and marketing programs for agroprocessed products, the Agromarketing Office, set up under the project, has become well-established as a focal point for information for exporters. It has also had a central role in developing trade marks suitable for certifying product quality and origin. The Office has been active in organizing trade promotion fairs and seminars, and has had some success in acting as a middleman in enabling the establishment of joint ventures. 19. One of the earliest institutional programs under the project was that aimed at training of export marketing and management instructors. The programs were well-received by the user community in agroprocessing enterprises, and seminars and training courses were regularly held. 20. The Packaging and Quality Information Centers supported under the project have been enabled to significantly upgrade their capabilities and have successfully established networks with counterparts abroad. Both centers have been able to maintain a client-oriented focus, reflected in steady demand from the customers.

15 Capabilities for grading and quality control were significantly upgraded at five major quality control centers, which serve as demonstration projects for others. 22. The project also provided for pilot operations at leading research institutes for testing innovative techniques for quality enhancement of raw materials for the food industry, and for goat husbandry, including cheese making. D. IMPLEMENTATION RECORD AND MAJOR FACTORS AMCEC-NG PROJECT IMPLEMENTATION Implementation Record 23. The project was appraised in October 1987; loan negotiations were held in March 1988; the loan was approved in May 1988 and became effective in August Disbursement was substantially slower than expected at appraisal. Disbursements slowed down in particular after 1990 as the effects of the transformation process and the impact of exogenous shocks coincided. While the several modifications that were made in consultation with the Borrower to reflect the changing circumstances (e.g., increasing the share of working capital financing; simplification of procedures to encourage new, private investors; and raising of procurement limits to increase the flexibility given to the PBs) all helped to increase loan utilization, an amount of US$20 million equivalent (or about 28 percent of the original amount) was cancelled in October 1993 at the Borrower's request, and a further US$1.856 million in October 1994 at loan closing. In seeking these cancellations, the Borrower took into account the fact that funds would continue to be available for financing of viable agroindustrial subprojects under another ongoing Bank credit line (Loan 3020-HU). Factors Not Generally Subject to Government Control 24. Two factors in particular had a major impact on project implementation. First, the major changes that occurred after 1990 in the former CMEA markets which were critical for many Hungarian exporters. The effect was even more pronounced as, encouraged by the increasing trade in convertible currency within CMEA participants prior to 1990, many enterprises, including some of the larger subborrowers under the project, had undertaken investments aimed primarily at these CMEA convertible currency markets, but which were not readily switchable to the more demanding Western markets when the CMEA markets disappeared. The second was the deleterious effect of an unusual period of three successive droughts between 1990 and 1993 which severely affected agricultural production, thereby reducing product quality and increasing unit costs of production for processors. The prolonged drought period also contributed to escalating pressures on the Government for reversing the falling trend in agricultural subsidies until Factors Generally Subject to Government Control 25. A major economic change occurred in 1990 as the first democratically elected Government in Hungary undertook an accelerated program of macroeconomic and structural reform. This program differed radically from earlier efforts in its clear vision of a Hungarian market economy fully integrated into Westem Europe. Foreign trade was liberalized (the only goods requiring licenses were those subject to international agreements), prices were freed, subsidies to consumers and producers were drastically reduced, and legal restrictions on hiring and firing of workers were removed. Progress was also achieved in reforming the enterprise and financial sectors, including the creation of a large number of private banks and sale of state-owned enterprises to domestic and foreign investors, raising the share of private sector contribution to GDP to more than 50 percent.

16 Changes ensuing from these programs affected project implementation in various ways, but the combined effect was to reduce the demand for borrowed funds for undertaking investments. Implementation of these reforms was accompanied by a sharp contraction of industrial output and real GDP. The contraction of activity was accompanied by a pronounced decline in aggregate fixed investment despite large inflows of foreign investment. The pace of structural reforms decreased, significantly affecting the performance of key economic sectors. The major banks faced increasing liquidity and solvency problems. As a result of large losses by state-owned enterprises and a persistent large fiscal deficit, bank lending to the more dynamic sectors in the economy became severely limited. 27. Hungary's success in attracting foreign investment increased capital available to the betterperforming agroprocessing enterprises, reducing their dependence on debt financing. At the same time, several medium to large agroprocessing enterprises that continued to be under state ownership, were subject to uncertainties arising from impending changes in their status, and chose to postpone major investments. The initial effects of some other major economic reform measures were also to discourage investments and use of borrowed funds. The new banking law and regulations introduced in 1990 required banks to increase loan loss provisioning which also contributed to the high interest rates during the period by requiring the banks to charge higher spreads. While the application of the new bankruptcy and liquidation regulations since 1991 has contributed to increased financial discipline, enterprises have been caught up in lengthy proceedings given the limited administrative capacities of the courts and other agencies concerned. Factors Generally Subject to Implementing Agency Control 28. MOA carried out well its role in relation to the institutional components under the project as many of the institutions concerned continued to be under its jurisdiction. For the credit line component, MOA was unable to have any significant impact in expediting either credit utilization or the early resolution of pending cases for agroprocessing enterprises that were nominally under its aegis but were either in the process of being transformed and transferred to other agencies such as the State Property Agency (SPA) and local governments. Similarly, in the case of participating banks, with the autonomous status of the banks pursuant to the banking sector reforms, NBH had limited influence in requiring banks to take necessary actions to expedite project implementation and credit line utilization. Around mid-way through project implementation, starting from 1991, the project also faced competition from some bilateral credit lines that were made available to Hungary at lower nominal interest rates than the Bank's rates and also provided greater flexibility to potential users by permitting the financing of transfers of used assets (not permissible under Bank credit lines) as well as purchase of new equipment. NBH onlent funds from these competing credit lines to participating banks at a rate which was substantially (25%) below that for the Bank line under the project. E. PROJECT SUSTAINABILITY 29. The sustainability of main project achievements is likely but would depend to a large extent on the Government's success in turning around the overall macroeconomic situation which continues to constrain many enterprises in improving their operations and deters potential clients from utilizing more fully the services that can be provided by the institutions. Recent trends in the external environment are more favorable for the project with resumption of growth in Western markets and progressive implementation of Hungary's Association Agreement with the EU. Enterprises that have been successful in exports are expected to continue to do so in the more favorable external environment. For others, the outcome would depend upon the actions to be taken by the Government, including early transformation of status, and early completion of reorganization proceedings where the enterprises have been caught up

17 - 7 - in bankruptcy or liquidation proceedings. Participating banks are expected to continue to finance agroprocessing projects for viable private and cooperative investors. Progress under the enterprise and financial sector adjustment reform program, being pursued by the Government with Bank assistance in the form of a possible EFSAL, would further reinforce the banks' ability and willingness to lend. Measures to be taken to deal with the banks' portfolio problems under the adjustment program are expected to lower the levels of mandatory provisioning by the banks and thus reduce the pressure on high interest rates. The project's institutional achievements are likely to be sustained as upgrading of skills, facilities and technology under the project have increased the market relevance of the institutions' activities and helped them to increase their levels of self-financing. However, to the extent that several of the institutions continue to rely to a various extent on Government budgetary support which is subject to increasing uncertainties in the face of the urgent need to reduce deficit levels, their future continued effective performance would depend upon continued efforts to increase even further the extent of selffinancing, which itself would depend upon the rate of pick-up in the overall economy. F. BANK PERFORMANCE 30. Bank performance was satisfactory in all stages of the project cycle as acknowledged by the Borrower. During project identification and preparation, the Bank was substantially involved in assisting the Borrower in the design and development of the project, committing considerable staff and consultant resources on its own account. The Bank provided guidance in the preparation of extensive market studies, including export prospects to Western markets for selected agroprocessing branches. Considerable work was carried out as well on an assessment of the enterprises as a result of which about 70 enterprises were identified as likely participants under the project. During project preparation, the Bank found that its early emphasis on targeting selected agroprocessing industry branches (e.g., poultry, wine, wood products, etc.) as well as on selected enterprises was likely to prove too restrictive in the changing economic circumstances, and by appraisal, the Bank moved towards opening the credit line to all eligible agroprocessing exporters. The Bank was also instrumental in helping the Borrower to design a package of institutional development aimed at providing exporting agroprocessing enterprises with appropriate support. 31. The main project risks-the potential impact on the agroprocessing subsector of the extent and pace of economic reform being pursued by the Government, and of unfavorable developments in export markets-were identified at appraisal. However, what could not be foreseen was the major acceleration of the economic reform after 1990 and the resulting transitional discontinuities -- including the years of negative GDP growth and weaknesses in domestic markets -- and the sudden collapse of the CMEA market. 32. The Bank mounted nine supervision missions between 1988 and 1994, roughly at six-month intervals. Supervision missions were staffed either by agricultural economists or financial analysts; in hindsight, the involvement of agroindustries specialists from time to time may have been beneficial in enabling an assessment of problems by specific branches and enterprises. The critical mid-implementation (1990 to 1992) supervision period was marked by some staff discontinuities resulting from internal Bank reorganizations and reassignments. In respect of the credit line component, supervision focussed, from the outset, on the banks' agroprocessing lending activities; more general issues relating to the PBs' overall financial performance and operations were addressed under concurrent other Bank operations, including credit lines to the industrial sector and a loan to the PBs themselves for undertaking modernization of their operating systems and facilities.

18 From an early stage, supervision focussed on the need to improve the slow pace of subloan commitment and disbursement. Efforts were made to bring Hungarian firms into contact with possible foreign partners for forming trading joint ventures. PBs were consistently advised to raise the level of their promotional activities for generating greater investor interest in the credit line. The Bank showed flexibility in making several modifications to the credit line provisions to reflect changing needs and circumstances. This included the modifications to permit greater working capital financing; waiving of the minimum export-orientation requirement to enable wider participation, including from emerging new, private investors; simplification of application, evaluation and approval procedures to encourage small investors; and raising procurement and subloan processing limits to give greater flexibility to the PBs to utilize the credit line. In one respect, however, the Bank was not able to respond fully to the Borrower's requests -- this was in regard to the use of Bank funds for financing transfers of existing assets e.g. for enabling new private investors to purchase existing assets of state farms and enterprises. Nevertheless, the Bank emphasized that Bank funds should be used in a complementary manner for financing the purchase of new equipment, facilities and working capital in conjunction with the purchase of used assets. Supervision missions also visited subborrowers on a sample basis or where problems were known to exist. However, tracking of progress in remedial action was difficult once the enterprises had entered into judicial proceedings (e.g., into bankruptcy or liquidation negotiations with creditors). G. BORROWER PERFORMANCE 34. The Borrower's performance was satisfactory through all stages of the project cycle. MOA put together an experienced team to work with Bank staff during project preparation which successfully coordinated the preparation of the several market and financial analytical studies that were undertaken. A well-staffed Agroprocessing Modernization Project Office (AMPO) was set up in AGROBER, an agency which had participated extensively under the previous project. AMPO functioned effectively with dedicated staff, and contributed greatly to project monitoring and regular reporting of the progress of the institutional components of the project. Responsibility for monitoring and reporting of the credit line component was placed on the section already set up in NBH under earlier Bank credit lines. This section was again well-staffed, and monitoring and reporting were regular. Both MOA and NBH officials remained accessible at all times for consultation and cooperated fully with supervision missions. 35. The Borrower substantially complied with project financial and reporting covenants. Compliance was partial in respect of some of the sector undertakings. Thus, the action plan for the poultry industry was only partially implemented. 36. Some of the measures being pursued by the Government in the broader context of macroeconomic and structural reform also impacted on project implementation (e.g., the uncertainties caused by impending transformation and privatization/restructuring of state owned enterprises which led them to defer investments; the time taken to deal with the banks' non-performing portfolio problems which increased the pressure on interest rate levels through the mandatory higher provisioning; and delays in completion of bankruptcy or liquidation proceedings in the face of limited capacities of the courts and other agencies concerned). H. ASSESSMENT OF OUTCOME 37. Major changes, not foreseeable at appraisal, took place in the internal and external economic environments with the events since 1990 described earlier. Ensuing transitional changes impacted on the project's implementation. Consequently, the project's original financial objectives-increasing export earnings, particularly to convertible currency markets and improving enterprise efficiency through

19 reductions in unit costs in medium to large agroprocessing enterprises-could be achieved to only a limited extent as compared to earlier expectations. However, this is compensated to some extent by the project's success in supporting other emerging priorities under the Government's ongoing reform program such as encouraging the growth of new, private investors in agroprocessing activities. Overall, as indicated earlier (para 13), around 70 percent of the project investments appear to be operating profitably even in the difficult economic environment in recent years. On the other hand, institutional objectives were largely met. With project supported activities, institutional capacities have been built up which are likely to be sustained. The project contributed to the participating banks' capabilities for evaluating and monitoring agroprocessing investments. Finally, substantial improvements were made in reducing levels of agricultural subsidies during the period of project implementation although much more needs to be done in the context of the urgent need to reduce budgetary deficits in Hungary. 38. On balance, therefore, the project outcome is assessed as satisfactory. Even though a substantial part of the loan was not utilized and the original financial objectives achieved only to a limited extent, the project achieved important sectoral and institutional gains; strengthened the participating banks' capabilities in financing agroinvestments; and supported private sector development in agroprocessing activities. 1. FUTURE OPERATION 39. The Borrower has not prepared a formal operational plan given the multiplicity of participants. The Borrower's submission, jointly prepared with MOA, is annexed to the ICR. However, during the ICR completion mission, NBH and MOA confirmed that the main project objectives continue to be generally valid and reiterated their commitment to enable the sustaining of viable project components. 40. In respect of the sector policy comfponient, the issue of agricultural subsidies was discussed between the Governiment and the Bank in the context of the joint review of the sector report titled Agricultural Policy Review in September The Government has indicated that it would continue to assess the levels and forms of agricultural subsidies in the light of the evolving situation, including Hungary's obligations under GATT and the EU Association Agreement. 41. In regard to the institutional component, the institutions supported under the project are being encouraged to increase the extent of their self-financing through direct commercial contacts with potential end-users. Their success in doing so would depend critically upon a revival of the overall economy which would encourage end-users to increase their utilization of such services. 42. For the credit component, resolution of the cases where enterprises have entered into bankruptcy or liquidation proceedings, including possible work-outs and reorganizations, depends upon the speed of the judicial and administrative process. Actions to improve the situation, including measures to strengthen the performance of the banking system, are being pursued in the context of the proposed EFSAL that is being discussed with the Government. 43. Given the concurrence and common elements in implementation of various ongoing credit lines in Hungary, it is recommended that an OED review be planned for the second half of 1996 to cover jointly both the Agroprocessing Modernization and the Integrated Agricultural Exports Development Projects (Loan 3229-HU). The latter is currently scheduled to close by end-december 1995.

20 J. KEY LESSONS LEARNED 44. The main lessons from the project, which may also have more general relevance for other projects, are: (i) successful restructuring of medium to large state-owned enterprises cannot be accomplished without sweeping reforms that address questions of enterprise ownership and governance, and sustained exposure to domestic and foreign competition; (ii) the dangers of too restrictive a specification in terms of targeting of credit, and the need to ensure movement towards more general, open lines of credit that are available to a broad spectrum of users; (iii) greater reliance on the appraisal process and capabilities of the financial intermediaries would not only reduce Bank inputs but also help the institutional development of the financial institutions and increase their commitment to the ownership of the project; (iv) the need for close follow-up and frequent assessment of the situation in regard to project implementation, and for flexibility to adapt the project's provisions and procedures to changing circumstances; (v) the limitation against use of Bank funds for financing transfers of existing, used assets is an important constraint in the ability of Bank credit lines to assist in the early stages of the privatization process; and (vi) the importance of careful design of the Bank's subloan application, evaluation and reporting requirements, taking account of the additional burden that this imposes on private sector participants, both participating banks and investors, operating in a competitive environment.

21 IMPLEMENTATION COMPLETION REPORT HUNGARY AGROPROCESSING MODERNIZATION PROJECT (Loan 2936-HRJ) PART II. STATISTICAL ANNEXES Table 1: Table 2: Table 3: Table 4: Table 5: Table 6: Table 7: Table 8A: Table 8B: Table 9: Table 10: Table 11: Table 12: Table 13: Summary of Assessments Related Bank Loans Project Timetable Loan Disbursements: Cumulative Estimated and Actual Key Indicators for Project Implementation Key Indicators for Project Operation Studies Included Under the Project Project Costs Project Financing Economic Costs and Benefits Status of Legal Covenants Compliance with Operational Manual Statements Bank Resources: Staff Inputs Bank Resources: Missions

22

23 Table 8A: Project Costs (US$ million) Appraisal Estimate Actual/Estimated LoOcstal Local Forei-n Foreign Total ~~LocalFoeg Costs Total Costs Costs Costs Wine and Juice Processed Vegetables and Fruits Poultry Forestry Breweries Bakeries Meat Other Technical Assistance Agricultural Program (incl. marketing) Total Table 8B: Project Financing (US$ million) Appraisal Actual\EstimaLed Subloans Subloans from Govt. Prol'ect from Govt. Project IBDToa Commercial Contrib. Beneficiaries IBRD Total Commercial Contrib. Beneficiaries Banks Banks Equipment Civil Works Incremental Working Capital Training & Technical Assistance Agricultural Program (incl. export marketing) Other Total Percentage Share

24 - 17- Table 9: Economic Costs and Benefits At appraisal, the project as a whole was estimated to account for: (i) incremental sales revenue of US$522 million at full development; (ii) profit before taxes and depreciation of about US$250 million; and (iii) incremental convertible currency savings of about US$280 million yearly. The minimum financial rate of return (FRR) required for subproject eligibility was 18 percent. Ex-post data on project benefits are not available because of major organizational changes within many of the larger participating enterprises. Based on available samples, FRRs for the larger subprojects appear to range between negative in a few extreme cases to about 50 percent while those for smaller subprojects range typically between 18 to 50 percent.

25 Overall Project Rating: 2 Table 10: Status of Legal Covenants Original Agreement Section Covenant Status Fulfillment Description of Covenant Comments Type Date LA 3.0)1(h) M C For carrying out Pan A of tde Project, Borrower is to make available to Complied the Guarantor funds under Subsidiary Financing Agreements terms and conditions approved by the Bank. LA 3.01(c) M C For carrying out Part B of the Project, Borrower is to niake available Complied participating Banks finds under Subsidiary Financing Agreements temis and conditions approved by the Bank. LA 3.01(d) NI C Borrower to supervise the carrying out by the Participating Banks of Complied their obligations under the Subsidiary Financing Agreements, and ensure that the individual subloan limits and the aggregate loans to any one enterprise shall niot exceed the stipulated limits. LA 3.02 P C Procuremnenito he govemed by Schedule 4 to the LA. Coniplied LA 4.01(b) F C Borrower to maintain satisfactory records and accounts in accordance Complied with sound accounting practices. LA 4.01(h) F C Borrower to have records and accounts, including those for the Special Complied Account, audited not later than five months after the close of the fiscal year. LA 4.01(c) F C Borrower to maintain appropriate records and accounts for all Coniplied expenditures for which withdrawals were made form the Special Accounts and ensure that audit report contains a separate opinion by the auditors. GA 3.01 MN C Guarantor to provide funds to finance technical assistance, training and Coniplied technical services of Part A. GA 3.()2 N4 C Guaranitor to employ consultants satisfactory to the Bank for carrying Complied out Part A of the Project. GA 3.05(a) M C Guarantor to carry utit export trade promotion program. Complied GA 3.05(a) M C 4/'20/Mi) Guarantoir to establish agrornarketing office, to assist exporters. Complied GA 4.03 M C Guarantor to set tip interindustry consultative panel to deterniine work Coniplied priorities of lihfl regarding R & D in agroprocessing. GA 4.01(h) F C Guarantor to liave records and accounts for each fiscal year audited in Coniplied accordanice with appropriate auditing principles not later than five months after the end of the f iscal year. SLI Aniex I L C' Guaraittor to reduce invcstinent, production and consumer subsidies by Complied tine-thiri between 1987 and SLI Annex 2 E (CP Guarantor to carry out a poultrv industry plan of action. Partially Complietd Covenant type: Status: M = Managerial C = Complied F = Financial CP = Partially Complied T = Technical P = Procurement E = Economic

26 Table 11: Compliance with Operational Manual Statements Basically, there was compliance with the applicable Bank Operational Manual Statements. Table 12: Bank Resources: Staff Inputs (Staff-Weeks) Stage of Project Cycle Planned Revised Actual Through appraisal n.a. n.a Appraisal-Board n.a. n.a Board-Effectiveness Supervision Completion TOTAL n.a. n.a

27 Table 13: Bank Resources: Missions Performance No. of Days in Rating 2 Types of Stage of Project Cycle Month/Year Persons Field Specialization Implementation Development Problems status objectives Through Appraisal 3/85 1 6/ R E na na na na na na 10/ R na na na 2/86 10/ E, R na na na 2/ E, F, M na na na 6/ E, F, M, R, A na na na 1 14 E na na na Appraisal - Board Approval 10/ E, F, R, A na na na Board Approval - 6/ E na na na Effectiveness Supervision I 3/ E, E I I --- Supervision H 9/ E, A 2 1 F, M Supervision m 11/ E, R 2 2 F, M Supervision IV 4/ E, F 2 2 F, M Supervision V 10/ F 2 2 F, M Supervision VI 9/ F 2 2 F, M Supervision VII 4/ F 2 2 F, M Supervision VEII 10/ F, E 2 2 F, M Completion 8/ F 2 2 Follow-Up 2/ F 2 2 F, M 1 - Specialization 2 - Performance Rating 3 - Types of Problems A = Agriculturalist I = Minor problems F = Financial E = Economist 2 = Moderate Problems T = Technical D = Education Specialist 3 = Major Problems M = Managerial F = Financial Analyst H = Horticulturist L = Livestock Specialist M = Marketing Specialist N = Engineer R = Forester m:\ahn=mpmatr.icr

28

29 APPENDIX A Page 1 of 6 HUNGARY AGROPROCESSING MODERNIZATION PROJECT (LOAN 2936-HU) AIDE MEMOIRE OF IMPLEMENTATION COMPLETION REPORT MISSION 1. A World Bank (WB) mission visited Hungary between August 3 to 9, 1994 to initiate work on the Implementation Completion Report (ICR) for the Agroprocessing Modernization Project (AMP). The mission met with representatives of the Borrower (NBH), the Ministry of Agriculture (MOA), the AMP Project Unit, the main participating banks, and visited selected subprojects. The mission would like to thank the various Hungarian counterparts for all the cooperation and courtesies extended to it. The mission's views expressed in this Aide Memoire are subject to confirmation by WB management on the mission's return to Washington. PROJECT OBJECTIVES 2. The Borrower and MOA confirmed that the project objectives as expressed in para 4.03 of the Staff Appraisal Report (SAR) remain generally relevant. However, major changes have taken place in the project's environment since it was appraised in 1987, which have had extensive impact on the project's implementation and execution. These include: -- the major political changes since 1990; -- the new governments' economic and structural reform programs; - the collapse of the CMEA markets since 1990; -- Hungary's Association Agreement with the EU; - new laws on banking, and on bankruptcy/liquidation of enterprises. 3. The combined effect of these factors has been that, while some of the project components have been successfully implemented, others have faced various degrees of difficulties. This has been particularly true of the credit component under the project. PROJECT IMPLEMENTATION AND OPERATIONAL PLAN 4. Part A of the project has, on the whole, been implemented as planned. Although major studies under the project were completed, e.g. on the glass and can container industries, their findings could not be implemented due to the changing situation in the user and feeder industries resulting from the ongoing changes in the domestic and external (notably CMEA) markets. 5. In regard to the component on the establishment of an agricultural marketing office and preparation of an export marketing promotion program, modifications were made to the original concept. The Borrower's ICR should indicate the reasons for the modifications, the alternative arrangements made, and the impact on agricultural marketing and exports.

30 APPENDIX A Page 2 of 6 6. Under Part B of the project, while many subprojects have achieved their objectives, a considerable number are facing various degrees of operational and financial difficulties, including bankruptcy and liquidation proceedings in some cases. OPERATIONAL PLAN 7. The WB's revised guidelines (April 1994) on preparation of ICRs requires the preparation of an operational plan by the Borrower and the implementing agencies, indicating actions and measures to be taken by the Borrower, the relevant Government agencies, and the project entities, to ensure satisfactory future implementation and operations under the project, and the achievement of the project's objectives. The mission welcomed very much the assurances of the Borrower and the project agencies as to providing their best efforts to meet the revised requirements. It was agreed that a draft operational plan would be prepared and sent to the WB by October 31, The draft operational plan should include: * the Government's views on the continued relevance of the project objectives; * actions and measures to be taken to ensure sustainability and continued satisfactory operation of institutions and technical assistance programs under the project; and * actions and measures to be taken to resolve the situation in case of subprojects and subborrowers facing financial difficulties, including enterprises that continue to be under state ownership. The operational plan should be supported by a table that indicates clearly, for each major item under the policy, institutional, technical assistance, and credit components, the following: - major issues/problems; - major actions/measures already taken, being taken or to be taken; - schedule and timing of each major action/measure; and - the main Government and/or project agencies responsible for the actions/measures. BORROWER'S EVALUATION OF PROJECT IMPLEMENTATION 8. The mission drew the attention of NBH, MOA and the project entities to the Borrower's responsibilities in the preparation of the ICR as indicated in the WB's Operational Manual Statement and Good Practices for ICR Preparation (GP of April 1994, paras 4 and 5). Copies of the WB's BP and relevant parts of GP were left with the Borrower, MOA and the AMP Project Unit. 9. As indicated in BP and GP 13.55, the Borrower's ICR should include a summary not exceeding 10 pages, together with the supporting report and annexes. 10. The Borrower's complete ICR is to be submitted to the WB latest by October 31, PROJECT COST AND FINANCING PLAN 11. To enable a comparison of appraised and actual project costs and financing plan, the Borrower and the project agencies should update the relevant tables (Tables 3 and 4) on pages 23 and 24 of the Staff Appraisal Report No HU of April 11, 1988.

31 APPENDIX A Page 3 of 6 INFORMATION TO BE SENT TO THE WORLD BANK 12. To enable the WB to complete the draft of Part I of the ICR, it was agreed that the Borrower and MOA would ensure that the information indicated in Annex 1 is sent to the WB by October 31, 1994 together with the updated project costs and financing table (para. 11) and the draft operational plan (para. 7). 13. The proforma in Annex 1 should be used for all large subprojects (those with subloans over US$300,000). For smaller subprojects, a less detailed proforma could be used, for example, excluding the sections on subproject financial rate of return, procurement, and investor financial rates of return from Part II, and excluding Parts III to V. However, financial rates of return should be calculated for a representative sample of the smaller subprojects. 14. The mission indicated that the WB's draft of Part I of the ICR would be submitted to NBH and MOA within two weeks of receipt of the information in Washington. COORDINATION OF ICR PREPARATION 15. The following persons would coordinate the preparation of the Borrower's and the WB's preparation of the ICR: For the Borrower: For the WB: Mr. Emil Keleti (Dept. of Food Processing, Ministry of Agriculture) Ms. Maria Deak (National Bank of Hungary) Mr. Zsolt Papp (APM Project Office) Mr. Kishore Nadkarni (Central Europe Department) Budapest/Washington August 8, 1994 and August 29, 1994

32 APPENDIX A Page 4 of 6 Annex 1 Subproject Information Summarm to be Submitted for Each Large Subloan/Subproject (for each subloan over US$300,000 equivalent) PART I. Background Information Name of Investing Enterprise: Location: Type of Ownership: majority state-owned/cooperative/majority private-owned Tvpe of Organization: state enterprise, joint stock company, limited liability company, etc. Main Activities of Investine Enterprise: Short Description of Subproiects: e.g. new facility/expansion/diversification for production of (name of product) of which... percent aimed at exports to convertible currency markets (if applicable) Subloan Information: * name of participating bank * date of subloan approval by participating bank a amount of subloan (US$ equivalent) * maturities, grace period X interest rate charged by participating bank * date of first repayment of subloan principal * are interest/principal payments current? -- indicate extent of arrears, default, rescheduling, etc., if applicable Subproject Completion/Expected Completion Date: month/year PART II. Performance Summary Subpro*ect Performance: Appraisal Actual/Current Estimate (in US$) incremental sales incremental exports to CC markets incremental employment (in nos.)

33 APPENDIX A Page 5 of 6 Subproject Cost: * civil works * machinery & equipment * incremental working capital * other Total subproject cost ApDraisal Actual Appraisal Actual (in HUF) (in US$ equivalent) Subproject Financing: * investors' own funds * local loans * world bank subloan * other foreign loans Total subproject financing Appraisal Actual (in HUF) Sub_roject Financial Rate of Return: Appraisal Current Estimate Subproject Procurement: No. of Contracts Value (in US$) - International Competitive Bidding - International Shopping * Direct Contracting Other (specify) Total Investina Enterpnrise Performance: (in HUF or ratios, as relevant) * total sales * net profit/loss * net worth * current ratio Note: net worth = assets minus liabilities owed to others current ratio = current assets/current liabilities

34 APPENDIX A Page 6 of 6 PART III. Maior Issues/Problems (in order of importance) For example, * excess capacity due to lack of domestic/foreign markets * difficult financial situation due to * organizational and management weaknesses such as * high costs of production due to * low/negative profitability due to PART IV. Actions/Measures Taken or To Be Taken to Address the Above Issues/Problems For example, * voluntary restructuring by enterprise is under way * involuntary restructuring/bankruptcy/liquidation proceedings are under way * privatization/restructuring of enterprise is actively under way * enterprise is being restructured under consolidation program Adequate information should be provided to give a clear indication of the actions/measures taken or to be taken, with an indication of their timing, and the agency or agencies responsible for implementation or enforcement. PART V. Expected Outcome and Timing An indication should be provided of the expected outcome of the actions/measures being taken and the timing/expected timing of the outcome. m:vmnkamp2936

35 APPENDIX B Page 1 of 8 BoRROWER'S CONTRIBUTION TO THE ICR (Prepared jointly by the National Bank of Hungary and the Ministry of Agriculture) INTRODUCTION 1. In the second half of the 1980s, the Hungarian Government developed and introduced a number of financial incentives to encourage state-owned food-industry enterprises to increase their exports to convertible currency markets. However, those efforts sometimes failed to succeed because: most of the products were sold to Eastern Europe countries; there were only a few industrial facilities capable of restructuring their product profile in a quick and flexible manner; lack of strategic concepts suitable to support the making of consistently organized marketing efforts by the management; * compared to the value of fixed assets, the amount of working funds remained excessively low; * lack of external sources needed to finance imports from convertible currency countries. 2. In order to solve the above problems and to support implementation of the Government's creative endeavors, the World Bank (IBRD) and the Hungarian Government designed and launched an Agroprocessing Modernization Project, with due regard to: * the existing organizational and production structure of the state-owned foodprocessing companies; * the features and capabilities of institutions designed to control operations of the agroprocessing industry, knowing that those institutions were in need of being transformed and/or restructured; * the existing financial conditions of lending; furthermore; * the then existing system of subsidies granted by the state to encourage exports. CONTINUED VALIDITY OF THIE AGROPROCESSING MODERNIZATION PROJECT'S OBJECTIVE 3. The objective of the Agroprocessing Modernization Project is to enhance the international competitive edge of exported goods produced by the Hungarian agriculture and agroprocessing industry, to improve the efficiency of production and to promote efficient marketing of products made by Hungarian food industry companies. Within the Project, the most important targets are as follows: * increase of the exports of food and forestry products, through improved quality and applying better marketing skills; * improvement of efficiency throughout the operations and management of the companies concerned, by means of cutting their specific costs and improving their productivity; * development of a more favorable "climate" in business life and market economy, in conformity with the reform of the pricing and tax regime to be accomplished at the level of the national economy.

36 APPENDIX B Page 2 of 8 4. In conformity with the policy adopted by the Hungarian Government concerning the economic reform, the World Bank experts have identified five major areas within the plan focusing on the establishment of a proper institutional framework, which areas have been considered to have a decisive effect on the selection of the Project's objectives. These areas are the following: * development of a legal framework regarding the founding and liquidation of companies; * completion of the refortn of pricing and tax regime (removal of subsidies, broader application of free pricing policy); * liberalization of foreign trade; * introduction of a uniform and restriction-free wage policy (including removal of various legal provisions making adverse effects on organizations active in the domestic agriculture and food industry); * granting significantly more autonomy to companies in financing their businesses. 5. The Hungarian Government definitely confirmed its commitment regarding validity of the Agroprocessing Modernization Project's objectives in a document published in June 1991 to discuss some major agrarian policy issues and in the Government Program of Both documents specified the same targets, i.e., agribusinesses must improve their efficiency, should adjust their production and product profile to the market demand and should react to market changes in a more flexible and sensitive manner. The Government Program of 1994 laid a special emphasis on the increase of exports of competitive agroprocessed goods. 6. The Project was designed to be implemented over a four-year period and consisted of (i) an institutional development part and (ii) an investment component. * the institutional development part was designed to upgrade support services to enterprises, in terms of: (a) export trade promotion and marketing; (b) training in management and marketing; (c) grading and quality control of raw materials and final products; (d) research and development; (e) creating a basis for the restructuring of the glass container industry and can manufacturing. * under the investment component, long term funds were provided for strengthening of the agroprocessors' management and marketing capabilities, the rehabilitation and expansion of their facilities, and the carrying out by these entities of export trade promotion and marketing schemes. AcBvEVEMENT OF OBJECTIVES 7. The economic policy objectives of the Project were completely achieved: * The transformation of the price, subsidy and tax systems and their comprehensive reform in conformity with the market economy were outlined in Parallel with project implementation, the price system of agricultural products was liberalized. Agricultural subsidies fell radically starting from 1990 and subsidies were phased out across a significant span of production. Foreign trade in general and imports in particular were liberalized, constraints were only imposed through the Agricultural Market Regime, which were in place to protect the local market. Under the auspices of tax reform, a

37 APPENDIX B Page 3 of 8 transparent, uniform and competitive tax system was created comprising three major types of taxes (VAT, personal income tax and corporate profit tax). The Ministry of Agriculture took major action in order to improve the competitiveness of poultry production. Breeders and poultry producers were mobilized in keeping with project objectives through the Association of Poultry Producers. Loan funds were made available through the participating commercial banks for the establishment of new production integrations, installation and restructuring of hatching farms and the implementation of the veterinary system. 8. Achievements under the Institutional Development Component: * The Agromarketing Office achieved significant results in the process of developing a trademark suitable for certifying product quality and origin. In addition, the Office has assumed the role of "middleman" or trade promoter. The Office had developed a Collective Food Marketing Project and its trade promotion efforts met with much success. The Office had an active role in encouraging the establishment of international joint ventures, as well. * The subproject of "Training of Export Marketing and Management Instructors" has also proved its merits. A number of successful seminars and training courses certify the success of this subproject which is reflected by numerous cases of positive feedback received from businessmen and companies. * In the frame of the Research and Development subproject, a number of useful relationships were established between fellow researchers working in universities and research institutions abroad and the domestic food industry companies. The services offered by this subproject have met great demand. * The Packaging Center and the Quality Information Center have been established and both are operational. Both centers established extensive international relations and have received numerous orders placed by domestic customers. A very intensive demand has been experienced for the information provided by the Quality Information Center. * The equipment used for grading and quality control were modernized and upgraded at five state-owned quality control stations, as a result of the development subprojects provided by AMP. * The studies discussing the issues related to qualification of food industry raw materials, modernization and development of the supply of glass food containers and the restructuring of can manufacturing have been completed. * From the "unallocated" portion of the Agroprocessing Loan, the Szarvas Faculty of the Debrecen University of Agricultural Sciences launched a pilot farm to support the development of the profitable production of food industry raw materials which are capable of satisfying quality requirements across a wider variety; and the Research Institute of the University of Veterinary Sciences (Ullo, Dora farm) set up a pilot goat farm which is to develop goat production and cheese production technology to be spread across the county with the assistance of Dutch specialists; study tours were organized for

38 APPENDIX B Page 4 of 8 researchers from the Agricultural Biotechnology Research Institute (Godollo), the Irrigation Research Institute (Szarvas), the Agricultural Research Institute of the Hungarian Academy of Sciences (Martonvasar), and the PANNON University of Agricultural Science (Kaposvar) to study the developments of the food industry and the methods and instruments to promote increasingly efficient market entry of food products. 9. Under the credit line (investment) component, the achievement of objectives can be evaluated as follows: * The export performance of the food industry increased. In 1993, USD 133 million of incremental exports were realized on account of the Project. In 1994, incremental exports exceeded USD 140 million in line with the projections. * Significant efficiency improvement can be noted both at large and small companies participating in the Project. During , project beneficiaries experienced a 16 percent reduction in the number of employees, while their value-added increased by 7 percent. Consequently, the per capita value added was 28 percent higher in 1993 than in the previous year. * Contrary to the appraisal estimates, loan funds were not financed exclusively by the preselected subsectors. Altogether 16 food industry subsectors were covered by the creditline component (the majority of subprojects were identified in the canning industry, meat industry, forestry, wood processing, breweries, and bakery industry). MAJOR FACTORs AFFCTING TE PROJECT 10. The most important institutional conditions of a market economy emerged by the time of project completion. Acts were enacted concerning bankruptcy, financial institutions, accounting, corporate profit taxation, companies, the transformation of cooperatives, land and privatization. 11. Hungary signed the Europe Treaty with the EC. Granting to Hungary the status of associated member of EC increased the chances of Hungarian agroprocessed goods to be sold to EC markets. 12. The Act on Agricultural Market Regime was also passed. The Product Councils and the Agricultural Market Regime Authority have become operational. Foreign trade was liberalized. Wage regulations affecting the public sector were incorporated into a uniform legal framework. The restructuring of the pricing and tax system in conformity with the market economy was completed by Several factors, however, having been beyond the control of project authorities, adversely affected the implementation of the Project credit component and mitigated the impact of the Project on the overall development of the food industry. * Agriculture and the food processing industry were severely hit by the collapse of the CMEA markets in Between 1991 and 1993, the value of agriculture and food industry exports declined by 26 percent from USD 2.7 billion to USD 2.0 billion. Although Hungary signed the Association Agreement with the EC in 1991, which has granted better market access for Hungarian agricultural and food products into the

39 APPENDIX B Page 5 of 8 European Union, agro-industrial trade performance under the Project was insufficient to offset the losses which the Hungarian agro-industries have suffered due to the collapse of the CMEA market. * The continuous decline in the consumption of domestic food products also had a negative impact on the food processing sector. As a result of the decrease in primary production and a drop in exports and domestic demand, output of the food sector declined by about 40 percent between 1988 and * Due to the contraction of both the domestic and export markets, most of the large agricultural and food processing enterprises found themselves in a difficult financial situation and banks were reluctant to increase their exposure in the food processing sector. The number of food industry enterprises subject to bankruptcy proceedings increased in the last four years. Poultry, canning and meat processing companies have been the most affected by liquidation proceedings. Thus, significant parts of potential beneficiaries have not been able to comply with the project viability, creditworthiness criteria and collateral requirements of commercial banks. The Government launched a program in December 1993 to clean up the bad debts of several food processing companies. Due to the fact that the Government program started only in 1994, it could not have major impact on project implementation. * sthe structure of the food processing sector has also undergone a radical transformation since By March 1994, 58 percent of the large-scale state-owned enterprises were privatized and the number of enterprises in the sector increased dramatically, which can be attributed to the split-up and sale of the state-owned food enterprises into independent units and the entry of new, small and medium-size private enterprises. This had a positive impact upon the utilization of project funds since dozens of small and mediumsize private enterprises applied for a loan under the Project successfully. Uncertainties linked to the privatization process led the managers of the state-owned enterprise to postpone investment decisions until agreements on the development projects can be reached with the new owners. * Foreign investments had a major role in the privatization of a large proportion of food industry enterprises. The competitiveness and financial performance of these privatized firms improved due to the considerable resources invested in upgrading the technical, management and organizational standards of the firms concerned. These investments, while playing an important role in improving the competitiveness of the Hungarian food industry, reduced interest of large food companies in applying for the AMP loan. * Further specific conditions strengthened the negative impact of the above factors on loan utilization: the increase in interest rates; the availability of sources on more favorable terms -- the JEXIM loan was a case in point. This latter, due to lower costs of borrowing which should have been reflected in the onlending agreements between NBH and the commercial banks, became the more preferable source of borrowing for ventures. The possibility of financing expenditures not eligible under World Bank financing from, e.g.,

40 APPENDIX B Page 6 of 8 the JEXIM line, and supplementing such financing with long term resources available under the AMP credit line, was adequately communicated to the banks. Despite the efforts of NBH to proliferate information on the possible complementarity of World Bank financed credit lines (including the AMP funds) with these preferential resources, this latter received priority in borrowing decisions of enterprises. - while it is clear that the operational policies of the Bank preclude the possibility of financing of real estate, used assets and permanent working capital under any World Bank project, significant demand was reported by the banks on the financing of such expenditures during project implementation. 14. The above highlighted major changes in the Hungarian economy as well as the already mentioned specific conditions affected adversely the utilization of loan proceeds. This required the cancellation of a part of the loan facility (20 million US Dollars) almost one year prior to the Closing Date. SUSTAINABiLITY OF THE PROJECT 15. The Government of Hungary undertook a number of measures in the last four years to facilitate the recovery of agriculture and the food industry. The measures include (a) changes in institutions and regulations to enhance the functioning of the markets, and (b) promotion programs for producers, processors and traders. As a result of the measures taken, several companies carried out development projects under the Project, and were able to shift their exports from the former CMEA markets to Western markets and/or increase their convertible exports. The sustainability of the main project objective in the future is not only a possibility for Hungary, but a "must" considering the share of agriculture and food industry in the total economy and foreign exchange earnings (together accounting for one quarter of total exports). It is the declared intention of the Government to increase the value of exports of agricultural and food products to USD 3 billion per year. The Government launched several export promotion programs to sustain the export performance of the food sector. 16. The World Bank assumed, in general, a flexible stand and tried to arrive at a compromise concerning every issue that might have an impact on the progress of the Project. On the initiative of the Hungarian counterparts (NBH, commercial banks, MoA), the World Bank: * abandoned the strict requirement of export orientation; * confirmed that small enterprises in private hands also may become beneficiaries under AMP; * allowed for financing the entire amount of working capital (although set a ceiling: the total amount used for financing working capital ought not to exceed USD 30 million); * increased the ceiling of IS procurement from USD 150,000 to USD 300,000; * allowed for financing the purchase of machines and equipment needed for the production of seeds. BANK PERFORMANCE 17. We should highlight the importance and efficiency of continuous dialogue between the Bank and the Hungarian counterpart in order to improve loan utilization and project implementation. The Bank

41 APPENDIX B Page 7 of 8 demonstrated great flexibility in adapting loan conditions to the changed situation in Hungary. As a result of this work, the above modifications were made to the loan agreement. 18. A good example of the Bank's flexibility was the speedy and efficient assistance the Bank provided to the Hungarian Government in 1990 allowing the financing of importation of animal feed in order to mitigate the consequences of the severe drought under the four existing agricultural credit lines. 19. The relationship between the Bank and the NBH was good throughout the preparation and the implementation of the Project. Hungarian institutions received valuable assistance from the Bank staff. Their continuous assistance in early stages of project implementation in the elaboration of loan applications reflecting the real financial status of the borrowers, viable options for future development and realistic assessment of the marketing perspectives are good examples for that. ASSESSMENT OF OUTCOME 20. During project implementation, substantial progress was made in the achievement of Project objectives: convertible currency revenues of food-processing companies have been increased, significant efficiency improvement was recorded at project beneficiaries, policy steps agreed in the context of the AMP have been met and the institutional background of supporting services -- such as export trade promotion, raw material and final product grading system, Research and Development and training -- was established and developed. 21. Changes in external economic and macroeconomic conditions, however, slowed down the implementation of the investments component. After 1990 the Project was no longer able to keep pace with the disbursement schedule projected during loan appraisal. 22. Even mutual efforts of the Bank and the Hungarian counterpart to adjust the loan conditions to the changed situation could not counterbalance the impact of the already mentioned serious changes in the economy. Therefore, in agreement with the Ministry of Agriculture, in 1993 NBH initiated the cancellation of the loan amount which, according to the future loan demand estimates of the participating commercial banks, could not have been disbursed by the Closing Date for financing of subprojects. The Bank, having taken account of the reasons for under-utilization and having been informed on future loan demand estimates of the banks, agreed to cancel the 20 million US dollar equivalent from the original loan amount. 23. Simultaneously with the cancellation, conditions of the Third Industrial Restructuring Project were changed so as to include, inter alia, the financing of food processing subprojects. Thus the possibility of growth in investment and loan demand has been reckoned with. FUTURE OPERATIONS 24. By the closing date of the Project, the implementation phase of the institutional development components was completed and the most important project institutions are functional. The sustainability of the components and their future operation can be guaranteed if the following important problems are solved: