ASIAN DEVELOPMENT BANK

Transcription

1 ASIAN DEVELOPMENT BANK RRP:SRI REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE BOARD OF DIRECTORS ON PROPOSED LOANS TO THE DEMOCRATIC SOCIALIST REPUBLIC OF SRI LANKA FOR THE PLANTATION DEVELOPMENT PROJECT August 2002

2 CURRENCY EQUIVALENTS (as of 25 July 2002) Currency Unit Sri Lanka rupee/s (SLRe/SLRs) SLRe1.00 = Y or $ $1.00 = SLRs96.15 Y Y1.00 = SLRs $ The exchange rate of the rupee is determined under a system of managed float against the currency of Sri Lanka's major trading partners. ABBREVIATIONS ADB Asian Development Bank AWDR average weighted deposit rate CARE Christian American Relief Everywhere CBSL Central Bank of Sri Lanka CEA Central Environmental Authority CRI Coconut Research Institute EIRR economic internal rate of return ERD External Resources Department EWHCS Estate Workers Housing Cooperative Societies FIRR financial internal rate of return FLO Fairtrade Labeling Organization GDP gross domestic product GIS geographical information system GPS geographical positioning system JEDB Janatha Estate Development Board LIBOR London interbank overnight rate MOF Ministry of Finance MPI Ministry of Plantation Industries NGO nongovernment organization NIPM National Institute of Plantation Management OCR ordinary capital resources Oxfam Oxford Committee for Famine Relief PA Planters' Association of Ceylon PCC project coordination committee PF plantation fund PFI participating financial institution PHSWT Plantation Housing and Social Welfare Trust PIU project implementation unit RPC regional plantation company RRI Rubber Research Institute SDR Special Drawing Rights SLSPC Sri Lanka State Plantation Corporation SLTB Sri Lanka Tea Board SOE statement of expenditure TRI Tea Research Institute TSHDA Tea Smallholdings Development Authority TSP Tea Sourcing Partnership UK United Kingdom

3 NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 December. In this report, "$" refers to US dollars. "This Report was prepared by a team consisting of: Loh Ai Tee (Team Leader), Melinda Good, Marzia Mongiorgi, Eva Maria Mayerhofer".

4 CONTENTS Page LOAN AND PROJECT SUMMARY ii MAP vii I. THE PROPOSAL 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Performance Indicators and Analysis 1 B. Analysis of Key Problems and Opportunities 1 III. THE PROPOSED PROJECT 3 A. Objectives 3 B. Components and Outputs 4 C. Special Features 9 D. Cost Estimates 9 E. Financing Plan 10 F. Implementation Arrangements 11 IV. PROJECT BENEFITS, IMPACTS, AND RISKS 17 V. ASSURANCES 19 A. Specific Assurances 19 B. Conditions for Loan Effectiveness 19 C. Condition for Disbursement 20 VI. RECOMMENDATION 20 APPENDIXES 1. Project Framework External Assistance for Plantation Sector and Industrial Tree Crops Sector Analysis Problem Analysis and Project Action The Plantation Fund Summary Poverty Reduction and Social Strategy Social Analysis Ethical Trade Initiatives and Fair Trade Project Cost Estimates and Financing Plan Implementation Schedule Financial and Economic Analyses Environmental Aspects in Approving the Subproject 51 SUPPLEMENTARY APPENDIXES (available upon request) A. Financial Statements of RPCs B. Detailed Cost Estimates C. Analysis of Sample RPCs D. Detailed Financial and Economic Analyses E. Summary Initial Environmental Examination F. Rapid Environmental Asessment (REA) Checklist

5 LOAN AND PROJECT SUMMARY Borrower Classification Environment Assessment Project Description Rationale The Democratic Socialist Republic of Sri Lanka Poverty reduction Thematic: Economic growth and human development Category B An initial environmental examination (IEE) was undertaken, and the summary IEE is a supplementary appendix The Project is a follow-on to the ongoing Plantation Reform Project (ongoing project), which was designed to transfer ownership of the plantation sector through divestment of the 23 regional plantation companies (RPCs). The Project will maintain the momentum for the reform process to create an enabling environment that will put RPCs on a sound financial footing for long-term sustainability without external assistance. This development will improve RPCs profitability and enable them to provide the estate workers with better working and living conditions, which are currently very poor. The Project will provide long-term financing to meet RPCs investment needs. A plantation fund (PF) will be established to invest in equity and quasi-equity instruments of RPCs as an alternative to traditional collateral-based lending. The Project will address the estate workers poor working, living, and social conditions through a social component that includes amenities in the residential and work areas, and empowerment of the workers through strengthened estate-level institutions, awareness programs, and training. Attention will be paid to marketing initiatives and institutional strengthening to address the current overly regulated marketing of tea and to give RPCs easier access to export markets. With 20 RPCs divested under the ongoing project, the sector s performance has improved in terms of yields, production, and profitability. However, the sector is still faced with high production cost and low profitability because of the legacy of neglect and poor management during nationalization. Due to the excessive regulations, including restrictions on direct exports of tea, the sector has remained a producer of primary commodities and has not diversified sufficiently to broaden its profit base. The banking system provides no long-term financing for long-term investments. The sector also faces a looming labor shortage because of outmigration and voluntary youth unemployment stemming from the poor living and working conditions of the estate workers that have stigmatized estate employment. Further assistance is needed to transform producers of primary commodities to agribusiness entities capable of providing a competitive remuneration package to attract and retain the talents needed for development. Assistance to the divested RPCs is justified because the sector is

6 iii one of the largest exporters and employers with 265,000 estate workers. Objectives and Scope Cost Estimates Financing Plan The Project aims to (i) enhance the profitability of the sector, and (ii) improve the living and working conditions of the estate workers. The project area covers 15 districts where RPC estates are located. The project components comprise (i) an investment component to provide long-term finance in the form of a credit line and equity and quasi-equity instruments for tea, rubber and coconuts; crop and noncrop diversification; factory consolidation and automation; and effluent treatment plants and marketing; (ii) a social and environmental component to cover self-help housing and amenities, social awareness programs, strengthening of estate-level institutions, and land surveys to enhance planning and land use; (iii) marketing initiatives through product research and development; fair trade labeling; and support for compliance with requirements of ethical trade; and (iv) institutional strengthening through support for an industry umbrella body, consulting services, and training and development of outgrower models. The Project is expected to replant and infill 1,750 hectares (ha) and 2,370 ha of tea, replant 3,750 ha of rubber, plant 2,500 ha of oil palm and 10,000 ha of forest plantation, and establish five marketing alliances. The Project will provide housing loans to 6,000 estate workers, reroof 11,000 line rooms and provide welfare facilities and amenities in the workplace. The total project cost is estimated at $114.4 million equivalent, with $34.4 million (30%) in foreign exchange and $80.0 million (70%) equivalent in local currency. Source Foreign Local Total Exchange Currency Cost ($ million) Percent ADB-OCR Loan ADB-ADF Loan PFIs Beneficiaries Government Total ADB=Asian Development Bank, ADF=Asian Development Fund, OCR=ordinary capital resources, PFI=Participating Financial Institutions.

7 iv Loan Amount and Terms A loan of Y1,171,600,000 (equivalent to $10,000,000) from ADB s ordinary capital resources will be provided under ADB s LIBORbased lending facility for the investment component. The loan will have a 20-year term including a grace period of 5 years, an interest rate determined in accordance with ADB s LIBOR-based lending facility, a commitment charge of 0.75% per annum, a frontend fee of 1.0%, and such other terms and conditions set forth in the draft Loan and Project Agreements. The equivalent in various currencies of SDR15,043,000 ($20,000,000) from ADB s Special Funds resources will be provided for the other components. The loan will have a maturity period of 32 years including a grace period of 8 years, with an interest rate of 1% per annum during the grace period and 1.5% per annum during the amortization period. Allocation and Relending Terms The OCR loan will be used for a credit line and to establish the PF. The funds will be relent to the participating financial institution (PFIs) through the apex body and the PF at the average weighted deposit rate (AWDR). The PFIs will onlend to eligible subborrowers at AWDR plus a maximum spread of 5%. The PF will invest in equity and quasi-equity instruments of RPCs. Period of Utilization Until 30 June 2009 A portion of the loan from Special Funds will be relent through the apex body to qualified financial institutions at AWDR and this will be onlent to estate workers for housing loans at AWDR plus a maximum 5% spread. Estimated Project Completion Date Executing Agency Implementation Arrangements 31 December 2008 Ministry of Plantation Industries (MPI) The project implementing unit (PIU) established in MPI for the ongoing project will be responsible for overall project implementation and supervision. The PIU will implement the Project in collaboration with the Plantation Housing and Social Welfare Trust (PHSWT), DFCC Bank, PFIs, the PF, the Planters Association (PA), and nongovernment organization (NGOs). The PHSWT will assist in the self-help housing loan scheme, common amenities, and social awareness programs. DFCC Bank will be the apex body responsible for designating the PFIs and channeling to them the funds for the credit lines. The PFIs will onlend to eligible subborrowers for the investment component and the self-help housing loan scheme while the PF will invest in equity and quasiequity instruments of eligible RPCs. PA will assist in identifying gaps in expertise in RPCs and recruiting of consultants and NGOs. The NGOs will assist in implementing the social programs and fair trade labeling.

8 v Procurement Consulting Services Project Benefits and Beneficiaries Goods and services for implementing the Project will be procured in accordance with ADB s Guidelines for Procurement. The OCR loan for the credit line and the PF will follow procurement procedures applicable to ADB loans for development finance institutions. Civil works to be carried out by RPCs may be done on a force account basis. Civil works that will not be carried out by RPCs may be undertaken through local competitive bidding in accordance with procedures acceptable to ADB. PA will engage 23 person-months of international and 24 personmonths of domestic consulting services in consultation with the PIU and in accordance with ADB s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for engaging domestic consultants. The overall Project has a financial internal rate of return of 14% and economic internal rate of return of 16%. The beneficiaries are the privatized RPCs and the 265,000 estate workers. The Project is expected to enhance the profitability of the RPCs through improved productivity, diversification, and marketing initiatives. The quantifiable benefits include incremental annual production of 5,000 tons of tea and 7,900 tons of rubber with an export value of $8.5 million per annum; $2.8 million in export value from crop diversification per annum; and $10 million in incremental income from marketing alliances. The nonquantifiable benefits include greater opportunities for value addition, direct sales, enhanced buyer-friendly processes, and improved outward-bound logistics. Enhanced profitability will give rise to more gainful employment and increased income for the estate workers. The social component of the Project will also give rise to nonquantifiable benefits to the estate workers in the form of improved physical well-being, self-esteem and social image, and reduced alcoholism and indebtedness. The social awareness programs will reduce conflicts between management and workers, and empower the estate population to improve their lives by moving away from the captive labor model of the past and integrating into the mainstream society. The Project will also have positive impacts on the environment through heightened awareness of the role of land capability and productivity, and sound forest management to address and reduce the serious problem of soil erosion and degradation and to protect the watersheds. Installing and rehabilitating pollution control structures in existing and new rubber factories will improve the water quality of rivers and streams in the project area.

9 vi Risks and Assumptions The main risk lies in the uncertainties of world market prices for tea and rubber, which will affect the profitability of the sector. Lack of RPC commitment and cooperation of the workers' unions for social changes also constitute a risk. The Project assumes that RPCs are able to make strategic business decisions to improve their profitability and adopt innovative technology to improve productivity. It assumes political stability, and appropriate and consistent policies for the sector. It also assumes Government commitment to reforms toward deregulation.

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11 I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on proposed loans to the Democratic Socialist Republic of Sri Lanka for the Plantation Development Project. 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES A. Performance Indicators and Analysis 2. The tree crop (tea, rubber, and coconuts) sector contributes 15.6% of agriculture gross domestic product (GDP) and 3% of total GDP. About 40% of the tea and rubber land is in the hands of the regional plantation companies (RPCs), with the balance in the hands of smallholders, 2 whereas only about 2% of coconut land is in the hands of RPCs. The plantation sector accounts for 19% of foreign earnings and employs 265,000 workers. 3. The plantation sector has underperformed since nationalization in the 1970s when 500 tea and rubber estates and 400 factories were put under the management of two state plantation corporations: Janatha Estate Development Board (JEDB) and Sri Lanka State Plantation Corporation (SLSPC). Underperformance is reflected in low productivity relative to that in other countries. The current yields for tea (1,500 kilograms/hectare [kg/ha]) and rubber (900 kg/ha) are far below those of other producing countries such as India (1,700 kg/ha) and Kenya (2,200 kg/ha) for tea, and Indonesia, Malaysia, and Thailand (1,400 kg/ha) for rubber. B. Analysis of Key Problems and Opportunities 4. The poor performance of the sector is attributed to restrictive regulations and inappropriate fiscal policies that have eroded the competitive advantage. 3 The project framework is in Appendix 1. The lessons learned from past projects (Appendix 2) show that providing investment costs is not enough. Policy issues must also be addressed. In supporting the state corporations, past projects had prolonged state ownership, promoted inefficiency, and contributed to the sector s decline. As a result, the two state plantation corporations incurred huge losses and were a drain on the state coffers. 5. Restructuring took place in 1992 when 450 estates were formed into 22 RPCs 4 and their management contracted out to private management companies. In addition, export duties were eliminated and the cess reduced under the Second Agriculture Program 5 to improve the competitiveness of the sector. Further reforms were undertaken with the support of the ongoing Plantation Reform Project 6 (ongoing project) whose main policy agenda is to divest of the 23 RPCs. Other reforms included liberalization of direct tea exports, restructuring of JEDB and SLSPC, and reconstitution of the boards of Tea Research Institute (TRI), Sri Lanka Tea Board (SLTB), National Institute of Plantation Management (NIPM), Tea Smallholdings Development 1 The project preparatory technical assistance was approved in December Smallholdings are defined as holdings up to 20 hectares in accordance with the Land Reform Acts of 1972 and The estates that were nationalized and later clustered into regional plantation companies (RPCs) now make up the plantation sector. 3 Asian Development Bank Impact Evaluation Study on Bank Assistance to the Industrial Crops and Agro- Industry Sector in Sri Lanka. Post Evaluation Office. 4 Another RPC was formed out of 11 estates in July ADB Report and Recommendation of the President to the Board of Directors on a Proposed Loan to Sri Lanka for the Second Agriculture Program. Manila. 6 ADB Report and Recommendation of the President to the Board of Directors on a Proposed Loan to Sri Lanka for the Plantation Reform Project. Manila.

12 2 Authority (TSHDA), Coconut Research Institute (CRI) and Rubber Research Institute (RRI) for greater effectiveness. To date 20 RPCs have been divested of while an invitation to bid has been put up for one (Elkaduwa Plantation Ltd.), and two (Chilaw and Kurunegala Plantations Ltd.) remain in private management and will be divested of in The ceiling on direct exports of bulk tea by producers was raised to 50% of production and further liberalization will be carried out in line with the policy of deregulation. The boards of TRI, SLTB, NIPM, and TSHDA were reconstituted and amendments to the respective acts drafted and submitted to Parliament. With the dissolution of Parliament in October 2000 and the change in government, however, the bills need to be resubmitted and Cabinet approval has been obtained for this. A decision has been taken to divest of the estates and warehouses of JEDB/SLSPC. 6. With divestment and assistance under the ongoing project, the RPCs' tea yields have increased 3% while rubber yield has stabilized at about 900 kg/ha. The sector s profitability has improved significantly: RPCs collective losses of SLRs1.7 billion in 1993 turned into collective profits of SLRS1.6 billion in 2000, thus relieving the State Treasury from supporting the sector. The housing improvement program of the ongoing project has benefited an estimated 25% of workers in terms of improved living conditions, and the training program has benefited up to 30% of the workers. In addition, the ongoing project brought about an important change in the management attitude toward the workers. 7. Nevertheless, the profitability of the plantation sector is low because of low productivity and high production cost, which are in turn due to the poor condition of the estates and overaged plantings (Appendixes 3 and 4). The mixed financial positions of RPCs (seven financially strong, nine moderate, and four weak) are partly attributable to the inherent properties of the estates and partly to RPCs vulnerability to fluctuations in international prices because they remain producers of primary commodities. The limited diversification and downstream activities stem partly from lack of technical expertise within RPCs and partly from the restrictive regulations on import of planting materials and direct tea exports. Although producers can directly export 50% of their bulk tea production, the regulations imposed by SLTB effectively enforce marketing through auction. 8. The sector s development is also constrained by lack of long-term funds in the banking sector to finance long-gestation investments. Lending by some commercial banks has limits on exposure to the sector. Besides, some RPCs are considered no longer creditworthy because of their weak financial position. The extraction of management fees by parent companies 7 and the escalation of lease rental payments to the Government also threaten to undermine the financial position of RPCs. The Government is presently negotiating with RPCs to cap management fees and revise the lease rental payments on a case-by-case basis. A looming labor shortage caused by out-migration and reluctance of the youth to work on the estates also constrains the development of the sector. The stigma attached to estate employment is associated with poor living environment, harsh working conditions, and traditional top-down management style. 9. To improve profitability and provide strategic direction for the tea industry, which contributes 12.6% of the total export earnings, the ongoing project undertook a strategy study for the tea sector. The study concluded that the global over supply of tea will continue to exert a downward pressure on tea prices. This, coupled with increasing production cost, will render a significant proportion of Sri Lanka s tea industry unprofitable in the near future. To ensure long- 7 Although the management fees are in accordance with the Government's privatization prospectus, they are high relative to the level of profits. The minority shareholders of one RPC had raised the issue at an annual meeting, causing the share price to decline.

13 3 term industry competitiveness and viability, the industry needs to capture a greater share of the global tea value chain through branding and marketing of its tea. This would require drastic changes in the industry, such as transforming RPCs from primary producers to agribusiness entities, deregulation, redirecting research to product development, and improving product quality through an industry-administered quality assurance program. The Government has accepted these recommendations in line with its policy of deregulation, and a private sector-led industry umbrella body, Tea Association of Sri Lanka, is being registered under the Companies Act. The Ministry of Plantation Industries (MPI) has appointed three task forces to work on regulatory reforms, quality assurance, and process improvement. The task force on regulatory reforms has submitted its report, and the Government is considering the recommendations. The regulatory reforms will be reviewed on an ongoing basis. 10. The plantation sector is still in transition and this is reflected in changes in ownership within the private sector: one RPC has already changed hands twice. A tea marketing company that bought into three RPCs reflects the vertical integration of production into blending, packing, and marketing. The changes in ownership and vertical integration are likely to continue as part of market-driven adjustments. In the meantime, the sector requires assistance to transform RPCs from primary producers into agribusiness entities so as to improve profitability and ensure sustainability. Assistance will involve strategic investments in replanting and process improvement to improve productivity, and diversification and downstream activities to broaden the profit base. It will also entail maintaining the momentum for policy reforms for further deregulation and liberalization to build an enabling environment for the sector. Further assistance is needed to put in place mechanisms to enable RPCs to build up their capital reserve and to ensure transparency in their operations. While the ultimate objective is to enable RPCs to provide employment terms comparable to those in other sectors, the immediate poor conditions of the estate workers will need to be addressed. Although the majority of the households have more than one income earner and the estate family's income is higher than that of nonestate rural families, the standard of living in the estate sector is lower than that in other sectors of the economy. This is indicated by the lower literacy rates, higher school dropout rates, and negative savings rates. Mismanagement of household finances and alcoholism keep estate households in the lower strata of Sri Lankan society. 11. As RPCs are collectively the largest net foreign exchange earner and employer, assistance to them will have an indirect poverty reduction impact; promote social harmony, stability, and ethnic reconciliation; and contribute to conflict prevention. Such assistance is in line with the Government s policy of transforming the plantations into engines for pro-poor growth and regional development. It is also in line with MPI s policy to promote downstream activities and diversification to improve profitability in the sector. ADB s further involvement in the sector is consistent with its strategy to support the Government s development efforts and reform objectives as well as promote the environment for higher and sustained growth to reduce poverty. Assistance in transforming the plantation sector and putting in place a policy environment for greater efficiency of the plantation sector will wrap up ADB s long involvement in the sector. III. THE PROPOSED PROJECT A. Objectives 12. The goal of the Project is to ensure the plantation sector's long-term sustainability without further external assistance. The objectives are to (i) enhance the profitability of the plantation sector, and (ii) improve the living and working conditions of the estate workforce to a

14 4 level comparable with that in other sectors. The project area (map) covers 15 districts where RPC estates are located (Badulla, Chilaw, Colombo, Galle, Gampaha, Kalutara, Kandy, Kegalle, Kurunegala, Matale, Matara, Monaragala, Nuwara Eliya, Puttalam, and Ratnapura). B. Components and Outputs 1. Investment Component 13. To improve the productivity of the core crops and broaden the profit base, investments are required in core crop activities and diversification. The ongoing project provided about $80 million 8 through the banking sector to meet part of the requirements of RPCs for investments. The amount has been fully utilized. MPI set up a revolving fund at Central Bank of Sri Lanka (CBSL) to recycle the funds for the credit line and about $3 million in subloans were provided to RPCs. However, the revolving fund will fall short of the credit demand from 2005 onward when repayments fall due. To meet the sector s long-term financing requirements, the Project will provide long-term funds in the form of a credit line to RPCs through participating financial institutions (PFIs) and equity and quasi-equity instruments in RPCs through the plantation fund (PF). By investing in these instruments, the PF will enable RPCs to strengthen their capital base and increase their debt-bearing capacity, thus generating incremental lending from PFIs (Appendix 5). 14. The credit line and the PF will be available for (i) field development and mechanization in tea, rubber, and coconuts; (ii) crop and noncrop diversification including spices, coffee, forestry, and estate tourism; (iii) factory consolidation and process automation, effluent treatment for rubber and rehabilitation of minihydro stations; and (iv) marketing ventures. 9 It is envisaged that 1,750 ha tea and 3,750 ha rubber will be replanted; 2,375 ha tea will be infilled; 2,500 ha of oil palm, 2,400 ha other crops, and 10,000 ha forest will be planted and five marketing alliances will be established. 15. RPCs will be encouraged to undertake enterprise diversification on their own or by leasing their land to private firms, joint ventures, or subsidiary firms. As such, the credit line will be available to divested RPCs, lessees of RPC land, joint ventures with RPCs, subsidiaries of RPCs, and divested JEDB/SLSPC estates. To avail of project funds, RPCs and the eligible RPC-related entities are expected to submit strategic business plans showing how the enterprises, intend to enhance their profitability and how the subprojects fit into the strategic plans. The strategic plans will also indicate the plans and approaches for diversification. In addition, RPCs will sign an agreement with the Government to cap their management fee in return for a revision in the lease rental payments to the Government. 16. For social and environmental sustainability, RPCs will be encouraged to consider in their core crop and diversification activities various options that will optimize labor opportunities and land use and, at the same time, build up soil organic matter and improve soil fertility. RPCs will be assisted in developing and adopting sound forest management plans to optimize land use and set up clear and feasible objectives for better utilization of timber and forest products. Wellinformed local nongovernment organization (NGOs) and community-based organizations, such 8 The ongoing project (footnote 6) has a credit line of about $40 million from ADB and Y4,076 million from the Japan Bank of International Cooperation. 9 If the Project will involve planting and processing of products such as palm oil, a detailed economic, physical, environmental, and social environmental impact assessment will be carried out. The report will be submitted to the ADB for review, and the summary environmental impact assessment as well as the report will be circulated to the Board 120 days before implementation.

15 5 as youth groups, recognize the value of forest preservation and diversity sufficiently to ensure that RPCs harvest the timber in an environmentally sound manner. These groups have also exerted pressure on RPCs to build effluent treatment plants in accordance with the Environmental Protection Licensing guidelines for existing and new rubber factories so as to reduce toxic contamination of groundwater, streams, rivers, and adjacent lands. With respect to factories, the implementation of environmental health and safety standards is weak. Improvements will not only increase the efficiency of the processing plants but will allow them to qualify for international certification schemes, thereby increasing their competitiveness. 2. Social and Environment Programs a. Workers Housing and Amenities 17. A better living environment is the first priority for the estate workers, both the resident workers housed in cramped and overcrowded line rooms and the nonresident workers deprived of access to basic estate facilities. To meet the workers aspirations for improved living conditions and house ownership, the Project will provide housing loans to 6,000 (or 3% of worker families) to enable the workers to construct their own houses. The maximum loan amount will be SLRs100,000 and the lease on the land will pass on to the workers from RPCs upon completion of the loan repayment. Joint ownership by husband and wife will be promoted. Before beginning any construction, environmental screening will assess any significant impacts on the environment. Before starting the housing loan schemes, the Project will assist the workers in activating/strengthening the Estate Workers Housing Cooperative Societies (EWHCS) and other estate-level institutions, which are currently inactive or nonexisting in 80% of the estates. These institutions are a prerequisite to successful housing loan schemes and the thrust of the Project is strengthening/establishing these institutions to enable the workers to access credit from sources other than the Project. EWHCS will promote workers participation in implementing housing schemes and maintaining of common amenities so as to eventually reduce management s role in housing activities. The programs will be conducted by RPCs, using their own in-house resources, or by contracted NGOs. 18. Given the time and resource constraints in replacing the existing barracks with the individual estate housing model, the Project will continue the reroofing scheme for 11,000 line rooms to address the immediate problem of leaking roofs. In addition, the Project will provide 150 common site services as required at the housing compounds. The Project will also examine different options for improving sanitation upgrading septic tanks, monitoring groundwater for bacterial contamination, and awareness raising. The selected options should build on experience from similar projects and activities should be low cost. b. Social Development Programs 19. To improve the living conditions of the estate workers, the Project will have a comprehensive social development program comprising social awareness programs, training, and construction of worker welfare facilities in the residential and work areas. The programs will seek to improve the well-being of the workers, reduce the negative social image associated with plantation work, and reduce tension between the workers and management. The programs also aim to empower the workers by strengthening workers institutions and offering training in technical and life skills to reduce ethnic tension and facilitate integration into the mainstream society. The anti-alcoholism program is aimed at reducing alcoholism, domestic violence, and indebtedness. Orientation on human resources and social development issues will be provided to estate management, human resource and health staff to sensitize them to the problems and

16 6 needs of the workers and also to improve the labor-management relationship. The Project will assist RPCs to replicate the quality circle model and other participatory management models to address the issues of productivity, quality, workers morale, and conflict in the workplace. The social awareness programs, gender awareness programs and training in household cash management conducted by NGOs under the ongoing project will be continued and expanded according to need. Allocation of funds for these programs will continue to be demand-driven. 20. To improve working conditions and the productivity of the workers, the Project will provide for worker welfare facilities both in the residential and work areas. Thirty playgrounds and 250 social development centers within the estates will meet the training and recreational needs of the estate; 300 rest rooms and sanitary facilities in the factories and in the field will help RPCs to meet the requirements for the fair trade labeling schemes; and 60,000 units of ergonomic and protective work equipment, such as aluminum plucking baskets with nylon mesh bags, cutting devices, and raincoats, will provide more comfort, improve productivity, and enhance workers dignity. A number of tea factories have been or are in the process of being certified under ISO This has led to a considerable improvement in health and hygiene standards. The fair trade labeling schemes will further encourage tea factories to adhere to the required standards. The summary poverty reduction and social strategy is set out in Appendix 6, and poverty analysis in Appendix 7. c. Environmental Initiatives 21. Land use and cover change are important features of development in plantations. A better understanding of land use transformations should assist in developing more appropriate land use systems, not only to help degraded lands but also to increase profitability. Current land use and management planning on the estates are not efficient for lack of detailed land and soil surveys, including the exact areas and location of fields, infrastructure, property boundaries, and soil and terrain types. The Project will assist RPCs to carry out these critical surveys using a geographic information system (GIS) and geographic positioning system (GPS) to clearly define the resource base to allow better strategic planning in land use (such as fertilizer and pesticide use, and appropriate vegetative cover) and, in the process, mitigate the deterioration and erosion of the soil. Subsequent surveys will cover all holdings of RPCs, estates and areas for subleasing. The surveys will be conducted to standards applied by professional agencies in Sri Lanka utilizing GPS/GIS. Land surveys will cover an area of 190,000 ha. 3. Marketing Initiatives a. Research and Development 22. In recognition of the lack of work on processing, product research, and development, the Project will support research for developing more efficient manufacturing machinery and product development research in collaboration with local engineering companies and international food technology institutes. For tea, product research will focus on developing optimum Ceylon blends of tea and packing specifications to cater to the changing demands of the global consumer. Such research will be on an industry level, and not support individual RPCs development and launching of their own brand. To ensure sustainability, part of the cess funds allocated for research will be provided to the industry umbrella body to fund such research by local engineering companies and international food technology institutes.

17 7 b. Support for Alternative Marketing Initiatives 23. The Project will support the industry in keeping up with the times by developing and testing software for automated tea auction and electronic trading. To enable the industry to become more customer focused, the Project will establish and finance a Market Intelligence and Promotion Center to facilitate overseas alliances and promotion of Ceylon tea. The Fairtrade Labeling Organization (FLO) and Oxford Committee for Famine Relief (Oxfam) already have fair trade labeling schemes for tea suppliers in Sri Lanka (Appendix 8). The Project will support FLO and Oxfam initiatives in fair trade labeling certification in the plantation sector to meet the requirements of a small, albeit growing, niche market for fair trade and sustainable tea market. To meet the consumers increasing concern over the working, living, and social conditions of estate workers, the Project will assist RPCs to comply with the audit terms of the Tea Sourcing Partnership (TSP), 10 by rectifying the shortcomings in the social and welfare facilities of the estate workers and to obtain certification as authorized suppliers. These programs aim to assist in marketing as noncompliance will eventually result in the inability of RPCs to sell tea in the open market. They also have a direct social effect on the workers as they will ensure that RPCs abide by some minimum standards with regard to workers working and living conditions as well as the environment. In addition, the Project will conduct awareness programs for Government officials and the public in collaboration with NGOs, to raise their awareness of pressing issues, such as the present over regulation in tea marketing, and the implications of such issues for the future of the plantation sector. Oxfam is exploring the possibility of playing an advocacy role in fair trade of tea. FLO, through its Regional Consultative Body in Colombo, can raise awareness of trade issues and conduct education programs on them and eventually play an advocacy role. 4. Institutional Development and Project Management a. Support for Industry Umbrella Body 24. The Tea Sector Strategy Study recommended the establishment of a self-regulated industry umbrella body comprising all stakeholders (smallholders, RPCs, private tea factory owners, brokers, and exporters) to champion the implementation of the recommendations of the task forces on regulatory reform, quality assurances and process improvement. The umbrella body s role is to unite the divided stakeholder groups, provide a common platform for the industry to work together, and represent the private sector in formulating government policy on deregulation. Its tasks will include (i) initiating product development and research, quality assurance certification and consumer and generic trade promotion; (ii) facilitating strategic alliances and collaboration with supporting institutions (TRI, SLTB and TSHDA) to ensure alignment with industry needs; (iii) serving as the conduit for establishing the market intelligence and promotion center, automated tea auction and electronic trading; (iv) establishing liaisons with NGOs for raising awareness on international codes of conduct and certification standards relating to social, welfare, and environmental conditions; (v) initiating research and development for ergonomic equipment; (vi) initiating incentive and award schemes on the industry level to promote social and processing standards; and (vii) organizing trade fairs for information exchange. The registration of the umbrella body, Tea Association of Sri Lanka, under the Companies Act is in process. The Project will finance the initial establishment operations of the umbrella body, which is expected to be self-financed by subscription from the private sector as well as part of the cess fund on terms and conditions to be determined by MPI by the end of the Project. 10 Representing 80% of the tea trade of the United Kingdom.

18 8 b. Consulting Inputs 25. With the past isolation of the sector from development in other countries, RPCs have limited experience in diversification and marketing activities to identify diversification opportunities and to respond to the changing preferences of consumers. To bridge the gaps in technical expertise, RPCs have hired consultants at their own cost to assist in their diversification subprojects. The Project will not finance such consulting inputs for feasibility studies and implementing individual subprojects; however, it will provide consulting inputs in areas where expertise is commonly lacking in all RPCs with the strong involvement of RPCs and the Planters Association of Ceylon (PA) in identifying, absorbing, and adopting new technology through on-the-job-training of staff. The expertise and inputs required will be determined during project implementation and will include strategic planning, marketing, silviculture, forest management, process engineering, and mechanical engineering. Consulting inputs are envisaged for studies pertaining to the industry, e.g., a study on the social and environmental implications of expanding oil palm cultivation in Sri Lanka. RPCs will bear part of the cost of these consulting inputs. c. Training 26. Transformation of the plantation sector will depend on the ability of RPCs to reposition themselves as beverage marketers and, ultimately, agribusiness companies. Such transition is envisaged to entail some reorganization to utilize new production systems. Training the management staff is crucial for the transition and will focus on management for change, strategic management, and human resource development to improve management capability to formulate strategies and programs with available resources and to better cope with the market economy. Although NIPM conducts some courses, these courses have not been revised and no longer meet the industry s needs. Other avenues such as the Institute of Chartered Accountants of Sri Lanka should be sought for such training. 27. Technical training for estate staff will comprise estate accounting, office automation, and information technology. Training for workers will concentrate on support for mechanization and factory automation, in addition to traditional training on agricultural practices such as plucking, pruning, and tapping. The training courses will be conducted by NIPM, other public or private training organizations, or RPCs. The Project will train some estate staff as trainers to deliver social and gender awareness programs to develop RPCs' in-house training capability so as to eventually take over from NGOs. To ensure the sustainability and efficiency of the rehabilitated or installed pollution control structures for the rubber factories and processing plants, the Project will provide operation and maintenance training to identified staff. d. Support for Developing Subleasing and Outgrower Models 28. In recognition of the looming labor shortage, some RPCs recognize that satisfactory arrangements will eventually have to be developed to transform the workers to outgrowers (or contract growers). RPCs operations will then be limited to factory operation and provision of extension services to outgrowers. In this regard, some RPCs have allocated blocks of land to the workers for maintenance and plucking/tapping to develop a sense of ownership, as a prerequisite to subleasing blocks of land to the workers. As land is a sensitive issue, such subleasing can only be piloted after an in-depth study of the legal, social, and ethnic implications. The Project will support the study and implementing of the pilot schemes.

19 9 e. Project Management 29. The project implementation unit (PIU) of the ongoing project will continue to be responsible for implementing and monitoring the Project, and coordinating social programs, and training. In line with the focus on strategic business planning, the PIU will be strengthened with the recruitment of a management finance specialist to develop a comprehensive management information system and assist in preparing of strategic business plans. The Project will finance the vehicles, equipment, and recurrent cost of the PIU. C. Special Features 30. Apart from meeting the investment needs of RPCs, the Project seeks to bring about transformation in the plantation sector. To do so, the Project has adopted the direction of the future development set out in the Tea Sector Strategy Study. In implementing the action plan, the Project has incorporated mechanisms for dialogue with the Government and consensus building among the stakeholders through the industry umbrella body that provides the platform for the industry to work together. This is essential as senior officials are still more attuned to being regulators rather than facilitators, and the stakeholders, including workers and members of the tea trade, have different interests. 31. A special feature of the Project is the setting up of the PF to complement the traditional collateral based-banking system, promote financial discipline and strengthen RPCs' capital base. The PF will use different equity and quasi-equity instruments depending on the associated risks, such as preference shares with attractive dividends or convertible debt instruments that give the right to convert debt into equity at the discretion of the fund manager. The convertible instruments have special application for high-risk RPCs as such instruments impose financial discipline. The tenure of the investments may be medium to long term, depending on the prevailing market conditions, and the fund manager may employ hedging techniques to minimize the default risk. As the PF s investments in RPCs will be based on their strategic plans, RPCs will be encouraged to do long-term planning, which will ultimately increase their profitability and maximize shareholder value. 32. Another special feature of the Project is the support for RPCs in fair trade labeling and in meeting the requirements of ethical trade initiatives. Fair trade and ethical trade are relatively new concepts and are sustainable alternatives to conventional international trade to provide stakeholders along the value chain with their fair share of margin. Supporting RPCs in the sustainable tea market will provide them with an alternative in marketing. In addition, the requirements of fair trade and ethical trade initiatives will lead to improvements in the social welfare conditions of the workers, the relationships among the stakeholders of the industry, and the environmental practices of the estates. The Project seeks to apply the concept of fair and ethical trade to RPCs, which are charged with responsibility for the workers welfare but are not treated equitably as a trading partner because of regulations that favor marketing through the auction and restrict their marketing efforts. D. Cost Estimates 33. The total project cost, inclusive of taxes and duties and physical and price contingencies, is $114.4 million equivalent, comprising $34.4 million (30%) in foreign exchange and $80.0 million (70%) in local currency equivalent. Table 1 summarizes the cost estimates. The details are set out in Appendix 9.

20 10 Component Table 1: Cost Estimates ($ million) Foreign Exchange Local Currency Total Cost A. Base Cost 1. Investment Component Social and Environment Programs Marketing Initiatives Institutional Development Subtotal (A) B. Contingencies 1. Physical Contingencies a Price Contingencies b Interest During Construction Subtotal (B) a b c Total c % Physical contingencies at 5% for all items. Annual foreign and local price escalation at 2.4% ( ). Including taxes and duties estimated at $9.3 million equivalent, of which $7.7 million equivalent relates to subprojects. E. Financing Plan 34. The Government has requested a loan of Y1,171,600, from ADB s ordinary capital resources (OCR) for relending and onlending through the apex body to PFIs and investment by the PF for the investment component. The loan will have a 20-year term including a grace period of 5 years on account of the long gestation period of plantation crops, which have an immaturity period of at least 3 years and reach peak production a few years after. The loan will have an interest rate determined in accordance with ADB s LIBOR-based lending facility, a commitment charge of 0.75% per annum, a front-end fee of 1.0% (the fee will be capitalized in the loan), and such other terms and conditions set forth in the draft Loan and Project Agreements. The Government has provided ADB with (i) the reasons for its decision to borrow under ADB s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) an undertaking that the choices were its own independent decision and not made in reliance on any communication or advice of ADB. 35. A loan of $20 million equivalent from ADB s Special Funds resources will be provided for the workers housing loan scheme and social and other components. The loan will have a maturity period of 32 years including a grace period of 8 years, with an interest rate of 1% per annum during the grace period and 1.5% per annum thereafter. The Borrower will relend $3.9 million equivalent through the apex body to the PFIs for onlending to estate workers under the workers housing loan scheme. The Borrower will allocate $15.3 million equivalent through budgetary appropriation through MPI for RPCs and the umbrella body to carry out the social and 11 Equivalent to $10 million, at the exchange rate of Y117.16=$1 as of 25 July 2002.