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ASIAN DEVELOPMENT BANK RRP:PRC 26459

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON A

PROPOSED LOAN

TO THE

PEOPLE'S REPUBLIC OF CHINA

FOR THE

WEST HENAN AGRICULTURAL DEVELOPMENT PROJECT

November 2000

CURRENCY EQUIVALENTS(as of 1 November 2000)

Currency Unit – Yuan (Y)Y1.00 = $0.12$1.00 = Y8.30

The exchange rate of the yuan is determined under a floating exchange ratesystem. In this report, a rate of $1.00=Y8.3, the rate prevailing at the time ofappraisal of the Project, has been used.

ABBREVIATIONS

ABC - Agricultural Bank of ChinaADB - Asian Development BankADBC - Agricultural Development Bank of ChinaBA - Bureau of AgricultureBF - Bureau of ForestryBL - Bureau of LivestockBME - benefit monitoring and evaluationEA - executing agencyEIA - environmental impact assessmentEIRR - economic internal rate of returnEPB - Environmental Protection BureauFA - force accountFAO - Food and Agriculture Organization of the United NationsFCOC - financial cost of capitalFDI - foreign direct investmentFIRR - financial internal rate of returnGDP - gross domestic productGTZ - Deutsche Gesellschaft für Technische Zusammenarbeit

(German Agency for Technical Cooperation)GVO - gross value outputHAAS - Henan Academy of Agricultural ScienceHADP - Henan Agriculture Development ProjectHAU - Henan Agricultural UniversityIA - implementing agencyICB - international competitive biddingIDA - International Development AssociationIDC - interest and other charges during constructionIFAD - International Fund for Agriculture DevelopmentIRR - internal rate of returnJICA - Japan International Cooperation Agency

NOTES

(i) The fiscal year of the Government ends on 31 December.(ii) In this report, “$” refers to US dollars.

LCB - local competitive biddingMOF - Ministry of FinanceNBFI - nonbank finance institutionNFYP - Ninth Five-Year PlanNGO - nongovernment organizationNGWT - national guidelines on water tariffsNPV - net present valueO&M - operation and maintenanceOCC - opportunity cost of capitalOCR - ordinary capital resourcesOECF - Overseas Economic Cooperation FundPADO - Poverty Alleviation and Development OfficePFB - Provincial Finance BureauPGH - provincial government of HenanPMO - project management officePRC - People's Republic of ChinaRAP - resettlement action planRCC - rural credit cooperativeSEIA - summary environmental impact assessmentSHWSC - Sanmenxia Huaiba Water Supply CompanySOE - State-owned enterpriseSV - switching valueTA - technical assistanceTVE - township and village enterpriseUNDP - United Nations Development ProgrammeVAT - value-added taxWFP - World Food ProgrammeWTO - World Trade Organization

WEIGHTS AND MEASURES

ha = hectarekm2 = square kilometerl = literm3 = cubic metermu = 15 mu equivalent to 1 hat = metric ton

CONTENTSPage

LOAN AND PROJECT SUMMARY iii

Map vi

I. THE PROPOSAL 1

II. INTRODUCTION 1

III. BACKGROUND 1

A. Sector Description 1B. Government Policies and Plans 6C. External Assistance to the Sector 8D. Governance and Lessons Learned 9E. ADB’s Country Strategy 11F. Policy Dialogue 12

IV. THE PROPOSED PROJECT 16

A. Rationale 16B. Objective and Scope 18C. Cost Estimates 20D. Financing Plan 20E. Implementation Arrangements 22F. The Executing Agency 25G. Environmental and Social Measures 25

V. PROJECT JUSTIFICATION 27

A. Financial and Economic Analyses 27B. Social Dimensions 32

VI. ASSURANCES 33

VII. RECOMMENDATION 34

APPENDIXES 35

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LOAN AND PROJECT SUMMARY

Borrower People's Republic of China (PRC)

Project Description The Project promotes economic growth in the poverty-strickenwestern portion of Henan Province through development ofhorticulture and livestock involving low-income households, anddiversion of water from the Yellow River to supply two areassuffering particularly acute water shortages. Fruits, medicinal plants,and vegetables with high commercial value and ready markets willbe grown. Breeding, raising, and fattening cattle, goats, pigs, andsheep will be assisted. These activities will increase householdincomes and reduce poverty in the poorest region of the province.Technical advice and training will improve the quality of produce.Environmentally sound agronomic practices and land developmenttechniques will be introduced to prevent soil erosion and pollution.

Classification Primary objective - economic growthSecondary objective – poverty reduction

EnvironmentalAssessment Category A

An environmental impact assessment (EIA) was undertaken, andthe summary EIA was circulated to the Board on 4 November 1998.

Rationale The economic development of West Henan is severely constrainedby its high population density, hilly to mountainous terrain, scarcearable land, harsh climatic conditions, and limited water resources.Average per capita annual income is Y1,864 ($225). The incidenceof poverty (at $1 per day) in this region is high12 percent asagainst less than 10 percent for the PRC. Of the 32 counties in WestHenan, 12 are nationally designated absolute poverty counties. Theregion is suitable for the cultivation of a number of temperate fruitsand nuts and a variety of medicinal plants. The region is alsobecoming a major supplier of beef, mutton, and pork because of theavailability of underutilized pastures and cattle and small livestockwell adapted to local conditions. The shortage of medium- and long-term rural credit and inadequate potable and irrigation water supplyhave constrained horticultural and livestock development. TheProject is designed to help remove these constraints.

Objectiveand Scope The Project’s primary objective is to promote pro-poor economic

growth by increasing the incomes of predominantly poor farmers inWest Henan. The Project consists of three components:

(i) horticulture development, which supports the rehabilitation,development, and improvement of fruit tree crops (apples, Chinesedates, kiwi fruit), medicinal plants (gingko and eucommia), and field

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and greenhouse vegetables;

(ii) livestock development, which supports household cattle and pigbreeding and raising, purebred piggeries, and sheep and goatbreeding and raising, using crop residues and underutilizedgrasslands; and

(iii) water supply and irrigation scheme, which provides pumping andconveying facilities to draw and transfer water from the Yellow Riverto Yima City and Mianchi County to meet their acute rural, urban,and industrial water demands, and to supply water for orchardirrigation and livestock uses.

Cost Estimates The total project cost is estimated at $151.3 million equivalent, ofwhich $66.1 million is the foreign exchange cost and $85.2 millionequivalent is the local cost.

Financing Plan ($ million)

Source Foreign Local Total PercentageExchange Currency Cost

ADB 64.3 – 64.3 42

Local Sources 1.8 85.2 87.0 58

Total 66.1 85.2 151.3 100

Loan Amountand Terms $64.3 million from ADB's ordinary capital resources, with a maturity

of 25 years, including a grace period of 5 years, an interest ratedetermined in accordance with ADB’s pool-based variable lendingrate system for US dollar loans, a commitment fee of 0.75 percentper annum, and a front-end fee of 1.0 percent.

Allocation andRelending Terms The Ministry of Finance will onlend the ADB loan under the same

terms and conditions to the provincial government of Henan. TheProvincial Finance Bureau will relend the funds to municipal andcounty finance bureaus under the same terms and conditions. Endusers (i.e., farm households, enterprises, and water supplycompanies) will receive loan funds from the relevant financebureaus at not less than commercial bank rates, under repaymentterms based on profitability and cash-flow projections.

Period of Utilization Until 30 September 2006

v

Executing Agency Provincial Government of Henan

ImplementingAgencies Bureaus of livestock, agriculture, and forestry; water supply and

irrigation companies; and pilot enterprises

Implementation Arrangements The Project Management Office (PMO) of the provincial government

of Henan will implement the Project in conjunction with relevanttechnical agencies. An interagency leading group will coordinate andoversee overall Project implementation and resolve policy issues.PMO will review and recommend specific activities for assistanceunder the Project, prepare the annual work program and budget,and arrange procurement contracts.

Procurement Goods and services will be procured in accordance with ADB'sGuidelines for Procurement. Each supply contract for plant andequipment, vehicles, and materials costing $500,000 or more will beawarded through international competitive bidding (ICB); that forless than $500,000 but more than $100,000, through internationalshopping; and that for less than $100,000, by direct purchase. Eachcivil works contract costing $2 million or more will be awardedthrough ICB. Contracts for less than $2 million will be awardedthrough local competitive bidding, except that civil works relating tohorticulture and livestock components may be carried out throughforce account, or through contracts awarded to village teams andeligible farmer beneficiaries (community participation inprocurement), where suitable. ADB’s domestic preference schemewill apply in procurement. Advance procurement action for certainitems has been approved.

Consulting Services No consulting services will be required.

Estimated Project Completion Date 31 March 2006

Project Benefits and Beneficiaries

The Project will directly benefit about 204,900 households (almost900,000 people). Nonfarm employment opportunities will be createdin pig breeding and water supply. About 340,000 people will be liftedabove the rural poverty line of $1 per day and the urban poverty lineof $2 per day. At full development, household incomes will increasesignificantly, with incremental household net incomes averagingY1,631 in horticulture and Y1,983 in livestock. Total annualproduction will be 72,600 metric tons (t) for fruits, 2,640 t formedicinal plant products, and 197,900 t for vegetables. Livestockdevelopment will expand annual production by 122,400 sheep,122,400 goats, 17,955 cattle, and 68,000 pigs (porkers). Pilotlivestock enterprises will produce 24,600 breeding pigs, 25,000piglets, and 12,440 fattened and culled pigs. Annually, 83 millioncubic meters of water will be supplied to various users.

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I. THE PROPOSAL

1. I submit for your approval the following Report and Recommendation on a proposedloan to the People’s Republic of China (PRC) for the West Henan Agricultural DevelopmentProject.

II. INTRODUCTION

2. A feasibility study for the Project was carried out in 1995 under Asian Development Bank(ADB) technical assistance (TA).1 The study examined resource availability and use to identifythe causes of low rural incomes in the project area, and made proposals for sustainableeconomic development. Subsequent project processing over several years allowed carefulassessment of issues related to project design and quality, implementation arrangements, andpoverty targeting, thus improving project quality at entry. A Fact-Finding Mission visited thePRC in February-March 1997, with follow-up Fact-Finding/Consultation Missions in August1998, January 1999, September 1999, and January 2000. The missions resulted in substantialscaling down of the Project, removal of a large agroprocessing component, deletion ofcommercially risky components, focus reorientation toward poverty reduction, and change of theExecuting Agency (EA). A small-scale TA2 approved in October 1999 updated the results ofthe earlier studies and confirmed the technical assumptions. This TA was followed by anAppraisal Mission3 in April-May 2000. This report is based on the findings of ADB Missions, theADB-funded feasibility study and small-scale TA, as well as extensive discussions with national,provincial, and local government officials, prospective local investors, target beneficiaries, andothers who may be affected by the Project.

III. BACKGROUND

A. Sector Description

1. The Agriculture and Rural Sector

3. Poverty in the PRC is primarily a rural problem, although there are emerging pockets ofurban poverty.4 In 1978, the household responsibility system was introduced, providing farmerswith greater incentives for production. From 1978 to 1984, agricultural terms of trade wereprogressively improved. In combination, these measures brought down the number of the ruralpoor (based on national standards) from 260 million in 1978 to 89 million (11 percent of thepopulation) in 1984. By 1999, the official number of the rural poor had dropped to 34 million(under 3 percent of the population). Many of these poor households are located in areas thatare relatively disadvantaged due to remoteness, climatic constraints, steep slopes or erosion, orsubject to frequent natural disasters.

4. Agriculture, including crops, livestock, forestry, fisheries, and rural sideline activities,provides an important source of income for about 200 million farm families and accounted for18.7 percent of PRC’s gross domestic product (GDP) in 1998. About 96.7 million hectares (ha)

1 TA 2042-PRC: West Henan Agricultural Development Project, for $600,000, approved on 29 December 1993.2 TA 3281-PRC: West Henan Agricultural Development, for $150,000, approved on 26 October 1999.3 The Mission comprised Peter N. King (Mission Leader), Emile Gozali (Project Economist), David Sobel (Programs

Officer), Susanna Price (Senior Social Development Specialist), Christophe Gautrot (Counsel), Barry Deren (StaffConsultant – Economist), and Wu Guabao (Staff Consultant – Poverty Specialist).

4 TA 3150-PRC: Study on Ways to Support Rural Poverty Reduction Projects, for $715,000, approved on 31December 1998.

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of PRC’s land area of 960 million ha is cultivated7 percent of the world’s farmland to support22 percent of its people. From 1990-1996, an average of 400,000 ha per year was convertedfrom agriculture to industrial, infrastructure, and housing use. To address this issue, theGovernment enacted the 1998 Land Administration Law to protect arable land and limitconversion to other uses to 160,000 ha per year,5 with an equivalent amount of wastelandconverted to agricultural use. Because of the pressure on agricultural land, farming systems areintensive with heavy inputs of labor, chemical and organic fertilizers, small machinery, andwater. Intensive farming has allowed meeting the basic food requirements of the people alongwith the development of a sophisticated mix of cash and commercial crops.

5. The economic reform programs in agriculture undertaken in the late 1970s and early1980s provided successful examples later used in other sectors. The most important aspect ofthe agriculture sector’s reform program was the replacement of the commune system with ahousehold contract responsibility system in which plots of collectively owned land wereallocated to households under fixed-term contracts. The contract required the households tosupply the State with mandatory production quotas at fixed prices, with output above the quotaallowed to be sold at market prices. State procurement prices were gradually increased, privateplots were enlarged and contract periods extended, diversification of agricultural production wasencouraged, and restrictions on rural markets and nonagricultural activities were relaxed.Economic reforms also encouraged the establishment of township and village enterprises(TVEs), which are now an important part of the industrial structure and the major source of off-farm employment for the surplus rural labor.

6. The reforms successfully improved the terms of trade for agriculture, increasedagricultural production, and created rural employment, particularly during 1978-1984 whenagricultural output grew by an annual average of 8.8 percent. However, agricultural growthslowed to an average 2.5 percent in 1984-1990 before recovering to 3.8 percent in the early1990s. During 1988-1998, agricultural growth averaged 4.4 percent, well in excess ofpopulation growth (less than 1 percent), but much lower than the overall GDP growth of 10.3percent. Agricultural growth is expected to remain at 3-4 percent per annum because of (i)unfavorable terms of trade for agricultural produce, as the domestic market is opened tointernational competition following entry to the World Trade Organization (WTO); (ii) relativelylow investment in rural infrastructure; (iii) outflow of labor from agriculture to other sectors, (iv)continued decline in the area of cultivated land compounded by desertification and soil erosion;(v) fragmentation of landholdings; and (vi) recurrence of natural disasters such as floods anddrought. Within agriculture, the crop subsector has experienced the greatest slowdown.Nevertheless, food grain output increased by 1.7 percent per annum during 1991-1998,reaching 512 million tons (t) in 1998, while population growth averaged less than 1 percent overthe same period. Other subsectors (e.g., livestock, fisheries, and horticulture), whereGovernment interventions are less and market forces play a greater role, are still growingrapidly at up to 10 percent per year.

7. Early reform of the agriculture sector allowed rural incomes to rise rapidly so that theratio of urban to rural incomes fell from 2.3 in 1980 to 1.7 in 1984. From the mid-1980s,however, the rural-urban income disparity increased to a ratio of 2.7 in 1999, when average percapita urban income was Y5,854 compared with Y2,210 for rural income. From 1990 to 1993,annual urban income growth averaged 11.2 percent in real terms while rural income grew by 3.2

5 In 1997, only 136,000 ha of cultivable land was reported to have been lost to other uses.

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percent.6 Nonagricultural real rural income grew at 8.5 percent annually while real agriculturalincomes remained almost constant, increasing by only 0.4 percent a year. From 1978 to 1998,the share of crop farming in agricultural gross value output (GVO) fell from 80 percent to 58percent. The contribution of all agricultural output to rural GVO fell from 74 percent in 1978 to47 percent in 1998, largely due to the rapid growth of TVEs. The widening gap between urbanand farm incomes has provided compelling incentives for migration from rural to urban areas.The income gap, coupled with the easing of restrictions on internal movements, has resulted inabout 100 million rural residents migrating to urban areas in the PRC.

2. The Agriculture and Rural Sector in Henan

8. Henan Province comprises 17 prefectures with 112 counties consisting of 2,137townships, and 46 districts under the jurisdiction of cities. The population is about 94 million—the largest among PRC’s provinces and autonomous regions—with 83 percent living in farmhouseholds. The arable land area is 6.8 million ha, 40 percent of the 16.7 million ha total landarea, located mainly in the east of the province. Pasture covers about 0.3 million ha, forestabout 2.1 million ha, and wasteland and nonagricultural land about 7.3 million ha. Arable landper capita is 1.5 mu7 (0.1 ha)—the national average is 2.1 mu, ranging from 0.8 mu in Fujian to8.2 mu in Heilongjiang Province. Henan is a major producer of wheat, corn, and cotton, mostlygrown under irrigated conditions on about 4.3 million ha. With an average annual rainfall of only785 millimeters and frequent droughts, productivity of field crops in non-irrigated lands is low.Tree crops, both fruits and forest species, form an integral part of farming systems in theprovince, particularly in the mountainous western part. In 1998, fruit orchards covered 385,000ha and output was 3,126,000 t. The orchards, mostly in West Henan, are in specific regions,depending on tradition, farmer knowledge, soil type and climatic conditions. In 1999, fieldvegetables covering 934,000 ha had an output of 31 million t and greenhouses in 133,300 haproduced 12 million t of vegetables.

9. Livestock is an important activity of farming households in counties with natural pasturesand grassland. There are about 13 million cattle, 34.4 million pigs, 23.6 million goats, and 1.9million sheep in the province. Cattle production has been increasing due to higher meat pricesand changing dietary preferences to include more protein as disposable incomes rise. Increaseduse is being made of by-products from wheat and other crops as livestock fodder. Goatproduction has increased substantially because of the development of an export market for goathide.

10. Agriculture contributes about one quarter of the provincial GDP. The sector hasprogressively increased its market orientation. By 1998, the value of agricultural outputmarketed had risen to 51 percent of total output; in the livestock subsector, the share wassubstantially higher.

11. Henan is a relatively poor interior province. Its rural agricultural population is poorcompared with the national rural population. In 1998, the per capita rural income in Henan wasY1,864 ($225), 86 percent of the national rural average of Y2,162 ($260). Henan ranked 19th

among PRC’s 31 provinces and autonomous regions in terms of rural income. Average percapita rural income in the province substantially varies, ranging from Y1,360 in Nanzhao County

6 In nominal terms, average annual per capita incomes of rural households increased by 15.9 percent during 1990-

1996, while urban incomes increased by 17.8 percent over the same period, reflecting the improved marketconditions for agriculture post-1993.

7 15 mu = 1 hectare.

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to Y2,760 in Mengzhou County. Farming accounts for two thirds of the rural household incomein the province; farm wages, and off-farm activities and employment account for the other third.Off-farm activities and employment in the 157,000 TVEs in Henan are important sources offamily income in rural areas, often leaving women in charge of agricultural activities.

3. Marketing and Agricultural Support Services in Henan

12. The efficient marketing and movement of some commodities and processed productsare constrained by inadequate infrastructure capacity in wholesale and retail market outlets,transportation, storage, and processing. While the number of rural, urban, and city marketsincreased in the 1990s in response to market changes, most have limited, if any, storagefacilities. The increased transportation of produce and goods to nonlocal markets has increasedthe demand for investment in cost-effective, efficient transportation and improved road and railinfrastructure. The provincial government of Henan (PGH) is currently undertaking majorinfrastructure projects8 to overcome the transportation, storage, and processing constraints.

13. The major sources of agricultural credit are the Agricultural Bank of China (ABC), theAgricultural Development Bank of China (ADBC), and the rural credit cooperatives (RCCs). ABCis widely represented throughout the province, with 18 branches at the prefecture level, 213subbranches at the county level, and 2,904 business offices at the township and village levels.In 1998, the Henan ABC lent a total of Y56.3 billion ($6.8 billion), of which 59 percent was forrural commerce (for grain and cash crop purchases), infrastructure, and other commercialactivities; 23.1 percent for agriculture; and 17.9 percent for TVEs and industries. An ABC loancovers part of the investment cost, and the borrower is expected to contribute up to 60 percentof the value of the investment. Accordingly, ABC loans are accessed mainly by the wealthierfarmers, who can provide fixed assets as collateral. In poor areas like West Henan, ABCprovides loans for poverty relief on behalf of the provincial Poverty Alleviation and DevelopmentOffice9 (PADO), at subsidized interest rates (3 percent in 1999).10 The main policy bank in ruralareas, ADBC is responsible for providing credit for purchasing State quotas of grain, cotton, andoil-bearing crops.

14. Nonbanking finance institutions (NBFIs) provide an alternative source of credit (andsavings accounts) for farm households. About 25 percent of the capital available in Henan isheld in the NBFIs. The 7,437 RCCs in the province are the major sources of credit for individualfarmers. The RCCs cover 2,600 townships and have subbranches in 4,837 villages. About 55percent of rural households are RCC members who can secure credit on rates lower than fornonmember borrowers. RCC funds have not been used exclusively for investment in the ruralareas. To rectify this, the RCC system was being reorganized with ADB assistance.11 Totallending by RCCs in 1996 was Y37 billion ($4.5 billion), comprising Y15.7 billion (42.4 percent)for agriculture, Y15.6 billion (42.2 percent) for TVEs, and Y5.7 billion (15.4 percent) for othercommercial activities. Total lending by RCCs reached Y52 billion ($6.3 billion) in 1998. The

8 The Xian-Hefei railway, funded by ADB, will pass through the project area. In May 2000, the World Bank approved

$150 million for a highway project to the southeast of the project area.9 PADO exists at national, provincial, prefecture, and county levels, and reports to the Leading Group Office on

Poverty Alleviation and Development at the national and provincial levels, which in turn are under the leadership ofthe State Council’s Leading Group on Poverty Alleviation and Development. The national PADO is located in theMinistry of Agriculture. Under provincial government restructuring, PADO may be renamed as IntegratedAgricultural Development Office.

10 Recovery rates from farm households are typically over 70 percent (although local officials claim higher rates),while loans to TVEs and county-owned enterprises (which was the policy during 1990-1996) had much lowerrepayment rates (typically under 20 percent).

11 TA 2214-PRC: Cooperative Banking Development, for $600,000, approved on 1 December 1994.

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average loan size of RCCs is much smaller than ABC loans, but the number of borrowersserved is much larger.

15. Additional sources of credit in Henan include the Mutual Aid Fund for Disaster Relief andPoverty Alleviation (established under the Civil Affairs Department), Individual Laborer’s MutualAid Fund under the Industry and Commerce Department, and Supply and MarketingCooperative (SMC) Share Service. In a 1997 review, one county in West Henan had 246registered NBFIs, although the actual number operating was much higher. Most of the loansoffered by these institutions are less than Y5,000, with maturities of less than six months, andhighly variable interest rates. Most NBFIs in rural areas have low operating costs, do not paytaxes, and offer high interest rates on deposits (although officially prohibited) and hence havegrown quite rapidly in recent years, often attracting deposits from the official banking sector.

16. Agricultural research services are the responsibility of the Henan Academy ofAgricultural Sciences (HAAS), which operates 12 specialized commodity institutes, a well-equipped central research laboratory, and the Agricultural Science and Technology InformationInstitute.12 At the field level, there are 17 research stations and 32 experimental stations. HAASruns a comprehensive program on breeding, agronomy, crop production, soil fertility, andintegrated pest management, and has achieved notable successes in breeding wheat, corn, andpeanut varieties. The Henan Agricultural University (HAU) also plays an important role inresearch and breeding programs. For livestock, HAU and HAAS have comprehensiveprograms on disease control, animal breeding, animal husbandry, and fodder production.Limited operational budgets are a key constraint in research activities.13 With the progressiveimplementation of market reforms, some research units began undertaking semi-commercialseed multiplication, feed milling, and crop production in the 1990s to help generate researchfunds.

17. Extension services at the provincial, prefecture, county, and township levels areprovided for agriculture, forestry, horticulture, livestock, and aquaculture by the relevant lineagencies. Each agency maintains at the township level a technical station that trains andsupervises the part-time farmer technicians who work at the village level. The townships fundthe technical stations. The level of funding and the quantity and quality of service depend on theability of the townships to pay. At the township, the ratio of technicians to farmers for horticultureis about 1:2,100, which improves to 1:318 when the part-time farmer technicians are included.14

The corresponding figures for livestock are 1:1,800 and 1:300, respectively. A major inadequacyin extension is the insufficient training, of technician and key farmers, to take full advantage ofcurrent research results and convey this information to farmers with practical advice.

18. Nongovernment organizations (NGOs) are progressively being established throughoutthe PRC, and provide alternative sources of assistance to the rural poor in Henan. Funding thePoor Cooperatives have been established at county and township levels in several experimentalareas, to motivate qualified poor people to form small groups, deliver loans to members throughsmall groups and centers, organize activities such as training and extension, collect due loans,

12 ADB’s regional technical assistance to the Consultative Group on International Agricultural Research, especially for

livestock and horticulture is generating results that are relevant to the PRC and Henan (e.g. TA 5812-REG: ThirdAgriculture and Natural Resources Research at CGIAR Centers – Increasing Productivity of Crop-LivestockSystems in Asia (International Livestock Research Institute), for $1,000,000, approved on 1 October 1998).

13 TA 3446-PRC: Study of Funding Options for Agricultural Research in PRC, for $150,000, approved on 25 May2000.

14 The Food and Agriculture Organization of the United Nations (FAO) uses a guideline of 1:500 as a satisfactorylevel of full-time staffing.

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and monitor the working of the groups and centers. One of two pilot microfinance schemesundertaken in Henan, was in the project area, in Nanzhao County. Though no specificorganization has been established in Henan, the Program of Happiness has operated projectsin two poor counties to help poor mothers escape poverty. Project Hope has been a veryinfluential poverty-related activity organized by the Communist Youth League. From 1990 to1999, Project Hope in Henan raised about Y100 million and helped 96,377 child dropouts returnto school. The Henan Women’s Federation has organized 7,495 poor households in 21 poorcounties to operate microfinance-based income-generating activities. Another important activityorganized by the Women's Federation is the Spring Bud Plan to help girl dropouts return toschool. In the past six years, this plan has raised Y13.48 million and helped 65,000 girldropouts return to schools. The Brilliant Cause was started in July 1994 in Henan to promotethe participation of private enterprises and other non-State-owned enterprises in the cause ofpoverty reduction.

4. Recent Economic Development in Henan

19. Despite being a poor interior province, Henan has actively implemented the nationaleconomic reforms. Provincial GDP grew at an annual average rate of 10.9 percent during 1979-1998—about equal to the national growth rate—and currently stands at Y4,712 per capita,ranking 18th in the PRC. GDP growth was led by services, industry, and agriculture, which grewat 14.5 percent, 12.8 percent, and 6.2 percent, respectively. In 1998, real GDP grew by 8.7percent, reaching Y435.7 billion ($52.5 billion) with output from agriculture reaching Y107 billion($12.9 billion). The rapid economic growth resulted in significant income increases for both ruraland urban populations. Since 1995, the growth rates in agricultural GVO (9 percent) and GDP(10 percent) in Henan have exceeded the national averages (5 percent, 8 percent).

20. As in other agriculture-based interior provinces, foreign direct investment (FDI) in Henanhas been modest compared with that in coastal provinces. During the Eighth Five-Year Plan(1991-1995), FDI in the province totaled $1.4 billion. In 1998, it was $618 million. Most FDI is inthe industry and construction sectors and only a small amount is channeled to agriculture. Toincrease FDI in agriculture and the rural areas and to achieve a better balance between urbanand rural economic growth, the province is actively considering further incentives in the areas ofland-use rights, land-use fees, income tax concessions, and agroprocessing.

B. Government Policies and Plans

1. Agriculture

21. The Government’s medium-term sector objectives are to (i) increase food production tomeet the increase in demand resulting from the growth in population and income, and (ii)increase rural incomes and employment opportunities to check the widening rural-urban incomedisparities. Given the arable land constraints (0.1 ha per capita) in the PRC, the sectordevelopment strategy focuses on increasing productivity, developing underutilized andunutilized lands, crop diversification, and adopting an integrated approach to farming. Thestrategy also seeks to increase value added for agricultural produce and to create off-farmemployment opportunities.

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22. The Ninth Five Year Plan (NYFP - 1996-2000) identified agricultural development asPRC’s top priority.15 The key elements of the agricultural development plan include (i) protectingarable land from urban/industrial encroachment and desertification; (ii) improving agriculturalproduction technologies; (iii) improving support services and delivery of inputs and marketinformation; (iv) enhancing rural infrastructure including irrigation, drainage facilities, watersupply, and roads; (v) improving postharvest handling, storage, and distribution facilities; (vi)integrating crop production with forestry, livestock, and aquaculture; (vii) providing productionincentives to farmers by deepening agricultural reforms; and (viii) creating off-farm employmentopportunities through the development of rural agroprocessing industries. The NYFP envisageda substantial increase in investments in agriculture and rural development, to be met through anincrease in the appropriations from the Government budget, supplemented by external funding.In 1998, the Government committed itself to major increases in investment in forestry, waterconservation, and poverty relief in rural areas. In 1999, it affirmed its commitment todevelopment in the interior provinces, with focus on providing infrastructure and improvingnatural resources management, to overcome an emerging prosperity gap between coastal andinterior regions. At the crossroads between east and west, north and south in the PRC, Henanstands to benefit indirectly from the Government plan to accelerate development in the westernprovinces over the next decade.

23. To reduce rural poverty, Henan has focused its agricultural and rural developmentassistance on the following programs: (i) intensifying lowland agriculture, particularly grainproduction, through increased investment in rural infrastructure and improved support services;(ii) promoting sustainable agricultural development for poor communities in uplands, by adoptingsoil conservation measures and diversifying crop production; (iii) improving postharvesthandling, storage, and marketing of both grain and nongrain produce; and (iv) promoting ruralindustries to generate off-farm employment opportunities for poor rural communities andsupporting downstream processing facilities.

2. Poverty Reduction

24. PRC’s national poverty reduction program was introduced in 1985. The program wasdesigned to attack absolute poverty and set an official poverty line at an annual average percapita net income of Y150 ($18) and a grain ration of 200 kilograms. The Seventh Five-YearPlan (1986-1990) incorporated explicit poverty reduction measures for poverty counties throughincome generation, relief aid, preferential taxes, and targeted assistance based on incomecriteria. The program identified 328 poverty counties for national Government assistance. Since1985, progress in reducing poverty has been substantial. The number of people classified asabsolute poor declined from 125 million in 1985 to 80 million in 1993. In July 1993, theGovernment initiated the Eight-Seven Poverty Alleviation Campaign to lift the 80 millionabsolute poor above the poverty line during the remaining seven years of the century.

25. The majority of the poor live in rural areas, mostly in areas with limited natural resources,poor agricultural land, limited off-farm employment opportunities, and inadequate physical andsocial infrastructure. The strategic thrust of the poverty alleviation campaign was to promoteintegrated socioeconomic development and human resource development in areas where thepoor are concentrated. The campaign has been successful and the number of the absolute poor

15 The Tenth Five Year Plan (2001-2005) will continue this emphasis, as the Government is concerned about

emerging disparities between coastal and interior areas and between rural and urban areas. The Tenth Planperiod will see major Government investment in the western portion of the PRC. Through its location at thecrossroads of the national transportation system, Henan stands to benefit indirectly from this investment.

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at the end of 1999 was estimated at about 34 million. It is recognized that about 20 million willremain very difficult to reach under existing programs by the end of 2000. The Tenth Five-YearPlan (2001-2005) will continue to emphasize poverty reduction. The central Government iscurrently mapping out a poverty reduction and development program that targets western PRC,ethnic minority areas, and regions lacking in resources. Infrastructure construction,environmental protection, and social infrastructure (health, education, housing) will be priorityprojects for the impoverished areas.

26. While national attempts to assist the absolute poor have been successful, the narrowincome definition of the national poverty line (about $0.66 per day on a purchasing power paritybasis) does not take account of poverty’s wider characteristics. Adoption of a wider definitionrequires, in addition to income, attention to education, gender equality, infant and maternalmortality, health care, housing, and environmental sustainability. A logical next step in theGovernment’s drive to eliminate rural poverty would entail recognition of relative income povertyand a commensurate shift in the poverty line, to the international standard of $1 per day or thebottom 10 percent of the population in terms of income (both currently around Y1,000 per capitaper annum).16 Estimates for the year 2000 indicate that 106 million people fall below thispoverty line; therefore the task of reducing poverty remains substantial.

27. At the international poverty line of $1 per day per person (adjusted for purchasing powerparity), the incidence of poverty in Henan was 13 percent in 1997, with about 10 million peoplebelow this line (more than 2.5 times the absolute poverty incidence). In 1998, this proportionwas reduced slightly to 11.2 percent of the population (10.5 million people). About half of thesepoor families live in West Henan. The poverty threshold is marginally above the basic grainrequirements, so many households with incomes above it still lack basic livelihood needs andmay slide back to poverty in a bad crop year or after natural disasters.

28. Previously, most of the poor in Henan were located in the 28 officially designatednational poverty counties, including the 12 poor counties in West Henan (see map), as well assix province-designated poverty counties. Due to the success of the poverty reduction program,however, nonpoverty counties now have 47.6 percent of the total absolute poor rural populationin Henan (an increase from 31.3 percent in 1993). Even in the poorer western counties ofHenan, substantial differences in the incidence of relative poverty occur—from 23 percent inSongxian to 1 percent in Mianchi. The majority of the poor counties are concentrated in difficultareas: high mountains, dry rolling hills, waterlogged gullies, sandbanks of Yellow River basins,and regions of endemic diseases such as goiter. The province is placing priority on removingthese pockets of rural poverty, using more location-specific criteria in determining developmentpriorities and targeting development assistance at poor village and household levels. Since theearly 1980s, designated poverty counties have received about Y5 billion in poverty reductionfunds. In 1998, new programs were developed to target poor households in nonpoor counties.

C. External Assistance to the Sector

29. At the end of 1997, 7,896 foreign-funded agriculture projects sector in the PRC, involved$12 billion in foreign capital (Appendix 1). Since 1985, the World Bank, the main source ofexternal assistance to agriculture, has provided 11 loans amounting to $250 million foragriculture projects covering Henan Province for (i) land development, irrigation, and drainage;(ii) agriculture support service improvement; (iii) development of specialized subsectors,

16 Emerging urban poverty suggests that $3 per day in coastal cities and $2 per day in interior cities may be

appropriate urban poverty lines, pending additional study by ADB.

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including forestry, livestock, and horticulture; and (iv) area development projects. All of theWorld Bank lending to agriculture and rural development has used concessional funds underthe International Development Association (IDA). The World Bank has successfully supportedprovince-level multicomponent area development projects, aimed partly at poverty reduction,which were prepared and implemented by local governments.

30. The latter category of projects includes the $110 million Henan Agricultural DevelopmentProject (HADP), which commenced in May 1991 and was completed in 1999. HADP covered20 counties in the northern and eastern part of Henan (along the Yellow River) and comprised11 agroprocessing plants, 16 seed processing plants, and livestock and horticulture. The WorldBank evaluated project progress and presented to the project to other provinces as a model.The accounting system of the World Bank project was extended to other provinces, and theProject Management Office (PMO) was praised for its efficiency and professionalism. Theproject completion report noted project success for all components, with greenhouses andlivestock exceeding the targets. The economic internal rate of return (EIRR) was estimated at40 percent, compared with 35.8 percent at appraisal.

31. Throughout the PRC, the International Fund for Agriculture Development (IFAD) hassupported six projects for $161 million, and the World Food Programme (WFP) hasimplemented 11 projects for $174 million. In Henan, the Food and Agriculture Organization ofthe United Nations (FAO) completed two fruit processing projects with a total investment of$15.1 million, and WFP funded a farmland rehabilitation project, with investments of $16.6million.

32. Japan previously provided foreign assistance through the Japan InternationalCooperation Agency (JICA, for TAs) and the former Overseas Economic Cooperation Fund(OECF, for loans). In Henan, JICA supported a project for the rehabilitation of rice fields ($3million). A fruit processing project in the province was financed by a Japanese NGO. Germany’sdevelopment assistance to the PRC is mainly related to environment/forestry and one projecttargets poverty reduction in Henan. The Netherlands is assisting the province with a livestockproject focused on dairy cattle. The United Kingdom financed a $7.1 million duck raising projectin the province.

33. ADB’s operation in the agriculture sector in the PRC commenced in 1988. To date, ADBhas provided $779.6 million to finance eight projects (10 loans). The loans were complementedby 53 TAs totaling $31 million for institutional strengthening, enterprise reform, environmentalmanagement, poverty reduction, and project preparation. This Project will be ADB’s firstagricultural project in Henan Province.

D. Governance and Lessons Learned

34. The PRC has demonstrated strong project implementation capability. Most projects inADB’s PRC portfolio have been implemented efficiently, with some completed ahead ofschedule. There is a strong sense of project ownership at local levels and consequentcommitment to effective implementation. Other factors that have contributed to efficient projectimplementation include (i) rigorous screening of projects proposed for ADB assistance to ensurefinancial viability, debt servicing capability, and adequate provision of counterpart funds; (ii)effective interagency coordination; (iii) well-developed institutional arrangements for projectimplementation; (iv) good technical skills in the EAs; and (v) strong emphasis on anticorruptionat all levels of government. The strategic use of TA to upgrade the capabilities of EAs and

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holding of seminars and workshops to familiarize EA staff with ADB’s procedures and practiceshave also contributed to good project quality.

35. Despite this overall satisfactory performance, the performance of individual projects inthe agriculture sector has been mixed. Of the eight ADB-assisted agriculture projects, two (ABCand Hexian pulpmill) have been completed and postevaluated, four are at various stages ofimplementation (Guangdong tropical crops, Yunnan-Simao forestation and sustainable woodutilization, ABC II, and Fujian soil conservation and rural development), one (Hainan agricultureand natural resources development) may be canceled, and one (North China marine culture andcoastal resources management) lapsed before effectiveness due to closure of the financialintermediary.

36. Postevaluation of the ABC project concluded that the project was generally successful,achieved its objectives, and was efficiently implemented. Two projects (Hainan and North Chinamarine culture) demonstrated that institutional arrangements need to be carefully worked outand the financial performance and viability of financial intermediaries must be carefullyassessed. The Hexian pulpmill project, completed in October 1994, demonstrates the need tocarefully assess production targets, quality goals, and financial viability. The project was rankedunsuccessful during postevaluation. The problems can be attributed to some technical errorsand omissions in the process design, using a technology that was relatively new in the PRC,and inadequate arrangements for transfer of the process technology.17 Yunnan-Simao isexperiencing serious implementation difficulties, which confirm the need to carefully assess theeconomic viability and sustainability of the project benefits for State-sponsored agroprocessingenterprises.

37. The 1998 Country Assistance Program Evaluation report for the PRC found that ADBoperations in the agriculture sector over the period 1986-1997 had not achieved significantperformance in relation to the strategic sectoral objectives espoused in the 1991 CountryOperational Strategy. Less than satisfactory performance appears to be associated with State-owned agroprocessing industries,18 where the Government engaged in directed lending andattempted to pick winners in a rapidly changing sector, that is increasingly exposed tointernational competition. Projects that promoted direct Government investment in agriculturalproduction and private sector involvement in downstream processing (such as Fujian andGuangdong tropical crops) were more successful. These lessons have been incorporated in thedesign of subsequent projects, including the proposed Project, which is partly modeled on theFujian soil conservation and rural development project.19

38. Several World Bank postcompletion reviews of agriculture projects20 have also beendrawn upon for lessons learned to be applied in the project design. The projects reviewed aremulticomponent projects implemented in many counties and in more than one province, and aretherefore similar to the proposed Project in design. The postcompletion reviews do not cite

17 These problems were partly addressed under TA 2574-PRC: Capacity Building for Hexian Pulpmill, for $600,000,

approved on 24 May 1996.18 For these reasons, an agroprocessing component that would have supported 19 agroprocessing plants was

deleted from the project scope during processing.19 The main similarities are funding through relevant line agencies, terracing and soil conservation measures prior to

establishing tree crops in sloping areas, and strong linkages with provincial research and extension systems.20 Credit 1261-CHA: North China Plain Agricultural Development Project, Impact Evaluation Report, June 1994 and

PAR No.7736, April 1989; Loan 2579-CHA: Pishihang-Chaohu Area Development Project, PCR Report No.12013,July 1993; Credit 1733-CHA: Red Soil Area Development Project, PAR No.12033, June 1993 and PCR No.11691,February 1993; and Loan 2261-CHA and Credit 1347-CHA: Heilongjiang Land Reclamation Project, PAR No.10657, May 1992.

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complexity of multicomponent and multilocation projects as a significant problem, largelybecause of strong commitment from local levels, strong project management offices atprovincial levels, and the active participation of the beneficiaries. The findings, however,highlight a need for (i) flexibility in project design to respond to site-specific technical problemsand rapid market changes, and (ii) specific measures to ensure poverty reduction impacts byproviding increased extension and support to farmers.

39. The implementation completion report for the World Bank’s HADP found that anintegrated system linking production, processing, and marketing was the cornerstone of theproject’s success. The model of linking companies to farm households benefited both partiesand reduced market risks. Introduction of advanced technologies enabled products to competesuccessfully in the marketplace. On average, farmer net per capita income increased from Y550to Y2,179 in the project area an annual growth rate of 25.8 percent, compared with theprovincial average of 21.5 percent over the same period. It was noted, however, that several ofthe agroprocessing plants were running into difficulty in obtaining adequate operating funds,thus raising questions of sustainability.

40. The Project design and implementation arrangements took these findings into accountand provide for (i) a midterm review of the Project to assess implementation status, review theproject parameters, and take appropriate measures to ensure achievement of the objectives; (ii)strengthening of extension services and training; (iii) beneficiary selection criteria giving priorityto the poorer members of the local community; (iv) structuring assistance packages so that theyare attractive and affordable to poor households, and allow them to progressively expand theirfarm operations through repeat lending; and (v) pilot testing the company + householdenterprise model as a potential model for future lending in the sector, rather than thecornerstone of the Project as originally envisaged.

E. ADB’s Country Strategy

41. ADB’s overarching objective is poverty reduction. In pursuit of this objective, ADB’soperational strategy for the PRC emphasizes three broad objectives: (i) improving economicefficiency, (ii) promoting growth to reduce poverty in inland provinces, and (iii) enhancingenvironmental protection and natural resources management. For agriculture, the countryoperational strategy focuses on (i) increasing efficiency in agricultural production, processing,and marketing; (ii) reducing rural poverty and increasing rural income opportunities throughcash crops and off-farm employment; (iii) improving management and development of soil,water, forest, and marine resources for sustainable development; (iv) supporting the transition toa market economy through improved incentives for private sector investment and establishmentof market information systems; and (v) supporting enterprise reforms.

42. Agricultural projects are also designed to simultaneously address crosscutting concerns,particularly poverty reduction, improving natural resource management, and environmentalprotection. ADB’s operations are designed to help reduce the disparity in incomes betweenrural and urban areas by facilitating the development of efficient markets in agricultural goodsand improving incentives for agricultural production, including improved land tenure andtransfer.

43. Most of PRC’s poor live in resource-constrained inland provinces like Henan, which havenot received the special incentives provided to coastal provinces to accelerate economicgrowth. Instead of encouraging preferential incentives that tend to exacerbate or create newfactor market distortion and misallocation of resources, ADB’s strategic thrust to reduce poverty

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in inland provinces is to help (i) promote market-based policy changes to attract more foreignand domestic investments; (ii) address infrastructure and institutional constraints to ruraldevelopment; (iii) develop integrated agriculture and agrobased industries; (iv) developtransportation, communications, and marketing linkages between the interior provinces and thecoast; and (v) locate development projects in poverty counties or in areas where the averageincome is well below the national average (and below the $1 per day poverty line).

F. Policy Dialogue

1. Land Use and Land Tenure Reform

44. A critical factor in rural poverty reduction is access to adequate land resources. Landuse and land tenure in Henan are covered by the provincial regulations within the broad policyframework of the national Government.21 Accordingly, an important step in reducing ruralpoverty is reform of the legal framework covering land use and land tenure.22 The LandAdministration Law, drafted with ADB assistance, became effective on 1 January 1999. The lawprovides for a national land use plan, which will stipulate the total amount of arable land to beput under protection. After the State Council approves this plan, every province, county andtownship will be assigned quotas of arable land for protection. The area of cultivated landshould comprise more than 80 percent of the arable land. Any arable land that is unavoidablyrequired for urban/industrial expansion must be replaced by a similar area of wastelandreclaimed by the project proponent. Each local government area will be required to work out itsown plans to protect arable land, with standards no less strict than those set by the State.

45. ADB assisted Sichuan Province to draft a model enabling provincial law,23 which couldbe applied nationwide, and the findings were discussed with PGH. The new Sichuan land lawmakes changes in four significant areas: (i) registration of land rights and issuance ofcertificates by which landholders can confirm their rights against intrusions by other landholdersand claimants, and against arbitrary actions by State or local agencies; (ii) local governmentresponsibilities to prepare the overall land use plans, with plans prepared by one level of localgovernment and submitted to the next higher level for approval; (iii) formulas for payments forrural land undergoing conversion to urban construction land, based on the measurement of theproductivity of the rural land being acquired, and full compensation for collective farmorganizations and individual families; and (iv) citizen participation in the processes of land useplanning and in the procedures for conversion of rural land to urban uses. A national supervisionand inspection system for land resources and land occupation will be set up under the Ministryof Land and Resources. PGH has prepared implementing guidelines for the Land AdministrationLaw, which are similar to those prepared for Sichuan Province. Under the Project, a specificcovenant ensures that tree crops are not established on protected arable land, cultivation willnot be permitted on slopes greater than 25 degrees, and long-term leases will be assured for allbeneficiaries (30-50 years, depending on type of crop and land quality).

21 ADB assistance has been provided under TA 2735-PRC: Capacity Building for Natural Resources Legislation, for

$800,000, approved on 24 December 1996. At the provincial level, land use and tenure were addressed under TA2408-PRC: Land Use and Land Use Tenure Policy in Fujian Province, for $600,000 approved on 28 September1995.

22 The need for a transparent land title registration system is one of the lessons of the Hainan Agriculture Project.Under that project, one of the problems was the difficulty ascertaining the legal ownership of the assets claimed bythe implementing agencies.

23 TA 3123-PRC: Provincial Legislation on Environmental Protection and Natural Resources Conservation, for$300,000, approved on 15 December 1998.

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2. Poverty Reduction

46. The nature of poverty in the PRC is changing, with large income gaps opening upbetween rural and urban areas, and with many of the remaining absolute poor living in remotemountainous areas, where provision of adequate infrastructure is uneconomic and delivery ofsocial services is difficult.24 Also, with the restructuring of inefficient State-owned enterprises(SOEs), there is an emerging class of urban poor, which is potentially destabilizing and, hence,is attracting increased attention through provision of an adequate social safety net. TheGovernment had previously opted not to make extensive use of ADB’s ordinary capitalresources (OCR) funds for poverty reduction, arguing that financial returns should be high,relatively short term, and capable of full cost recovery with a premium to cover market andforeign exchange risks. The previous availability of the World Bank’s IDA concessionalresources led the Government to be less inclined to use ADB’s OCR resources in agriculture.Accordingly, a major aspect of the policy dialogue was to reach an understanding with theGovernment that ADB’s OCR resources could be applied successfully to poverty reductionprojects in the PRC.

47. Despite its status as a poor province, Henan has been paying much attention to thesocial security of rural dwellers by providing access roads to poor villages; promoting appliedtechnologies in poor areas to increase incomes; providing special funds for children who havedropped out of school; and providing vocational, technical, and skills training in poor areas. Thecommitment to rural infrastructure in poor areas is consistent with the policy dialogue conductedunder TA 3150-PRC (footnote 3), which emphasized that provision of roads in rural areas(carefully bundled with other essential services) is one of the most effective means of combatingpoverty by providing poor farmers with access to markets as well as to social services. As aresult of this policy dialogue with PGH, the project design has focused on targeting the poor,and the involved Government agencies are now eager to demonstrate that ADB’s OCR fundscan also be used for poverty reduction.

3. Environmental Protection

48. The economic loss attributable to pollution and associated degradation of PRC’s naturalresources is estimated at between 3.5 and 7.7 percent of GDP. Environmental improvement hasbeen a constant item on ADB’s policy agenda for the PRC. ADB has provided TA forstrengthening the institutional capacities of the Government agencies responsible for assessingand monitoring environmental impacts and formulating environmental protection laws.25 ADB

24 In 1997, the income ratio between the 10 percent of households with the highest income and the lowest 5 percent

of financially stressed families in PRC's cities and towns was 4.7:1. In the same year, 5 percent of the ruralhouseholds had an average per capita annual net income of over Y5,000, while 4.4 percent had less than Y600 percapita. The ratio between the 5 percent of rural residents at the upper level and 5 percent of those at the lowerlevel was about 8.3:1.

25 TA 987-PRC: Institutional Strengthening of the National Environmental Protection Agency, for $340,000, approvedon June 1988; TA 1436-PRC: Environmental Impact Assessment (EIA) and Training, for 600,000, approved on 10December 1990; TA 1988-PRC: EIA Training Phase II, for $900,000, approved on 18 November 1993; and TA2090-PRC: Legislative Reform for Protecting the Environment and Natural Resources, for $500,000, approved on18 May 1994; TA 2975-PRC: Environmental Impact Assessment Training and Curriculum Development, for$600,000, approved on 31 December 1997; TA 3123-PRC: Provincial Legislation on Environmental Protection andNatural Resources Conservation, for $300,000, approved on 15 December 1998; TA 3290-PRC: Capacity Buildingin Ministerial Status Responsibilities in State Environmental Protection Administration, for $810,000, approved on 8November 1999.

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has also provided TA for soil and water conservation, forest and grassland ecosystemsconservation, and agro-industrial pollution control.26

49. The major environmental concerns in Henan are soil and water conservation andindustrial pollution. The province, with the assistance of the national Government, has beenimplementing various measures for soil and water conservation, particularly in the Yellow Rivercatchment and the loess27 areas. The horticulture component of the proposed Project willcontribute to the ongoing efforts to conserve soil and water in the loess region.

50. The TA on efficient utilization of agricultural wastes28 reflects conclusions from the studyon rural energy development,29 which was completed in 1996, and the TA for renewable energydevelopment.30 These two TAs recommended an integrated agricultural development approachto improve the environment and livelihood of farm households in rural PRC through moreefficient utilization of agricultural waste products to produce low-cost and cleaner energysources, and improve agricultural production. Utilization of agricultural wastes has beenincorporated into the livestock component of the Project, through use of ammoniated straw aslivestock feed, and use of piggery wastes to generate methane for heating in winter.

51. PGH has been very serious in combating industrial pollution. Thousands of small andmedium-size polluting industrial enterprises were closed and many medium-size and largeindustries paid penalties. Policy dialogue during project design resulted in the assurance thatindustrial units to benefit from the water supply subcomponent will be connected only if theymeet the national standards for industrial emission, wastewater treatment, and solid wastedisposal. It was also agreed that polluting industries upstream of the regulating reservoir wouldbe closed to protect the quality of the stored water and reduce treatment costs.

4. Water Tariff Rationalization

52. The continued strong growth of the economy has caused water demand to outstripsupply in most parts of the PRC, especially along the Yellow River, where the Project is located.The gap between demand and supply is widening, and the situation is exacerbated by theoverall shortage of freshwater sources in many regions and the inefficient use of water,particularly in agriculture. It is increasingly recognized that financing of water supply schemesand pricing of water need to be changed to generate funds for subsequent investmentrequirements, provide market-based incentives to effectively manage water demands, andprovide incentives for commercially oriented water companies to improve their efficiency. ADBhas funded TA31 for formulating appropriate guidelines and policies in the water sector, whichhave led to the adoption of National Guidelines on Water Tariffs (NGWT) and mechanisms fortheir implementation, and is continuing assistance in this area. Major TA recommendationsreflected in the NGWT include (i) selection of a tariff structure based on local conditions; (ii) atwo-part tariff with a volumetric and fixed demand charge; (iii) adoption of full cost recovery as

26 TA 2073-PRC: Chang Jiang Soil and Water Conservation and Environmental Protection, for $600,000, approved

on 24 March 1994; TA 2119-PRC: Forest Ecosystem Planning and Agro-industrial Pollution Control, for $600,000,approved on 30 June 1994; TA 2156-PRC: Improvement of Grassland Ecosystem in North China, for $746,000,approved on 16 September 1994; and TA 2407-PRC: Capacity Building for Soil and Water Conservation, for$590,000, approved on 28 September 1995.

27 Loess is yellowish brown loamy soil, usually unstratified and prone to rain and wind erosion.28 TA 3370-PRC: Efficient Use of Agricultural Wastes, for $703,000, approved on 26 December 1999.29 TA 2100-PRC:Rural Energy Development Study, for $500,000, approved on 16 June 1994.30 TA 3056-PRC:Renewable Energy Development, for $656,000, approved 19 August 1998.31 TA 2817-PRC: Strategic Options for the Water Sector, for $1.18 million, approved on 26 June 1997, and TA 2773–

PRC: Water Supply Tariff Study, for $600,000, approved on 24 March 1997.

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the main objective in setting and approving tariff levels; and (iv) adoption of a simplified processfor tariff regulation, requiring evaluation and approval at the local level and supported by reviewand monitoring at the provincial and State levels.

53. To recover the full cost of operation and maintenance (O&M) and a reasonable portionof the investment cost, water tariffs in Henan have been increased substantially since the mid-1990s, particularly in water-deficit areas. For example, in Sanmenxia City within the projectarea, the tariff for industrial water increased from Y0.35/cubic meter (m3) in 1990 to Y2.00-4.00/m3 in 1997. During project processing, on ADB’s agenda for policy dialogue weredevelopment of a better balance between public water supply and private access togroundwater, introduction of higher tariffs for groundwater extraction, installation of wastewatertreatment facilities whenever urban water supplies are increased, and water tariffs to include theinvestment and operating costs for wastewater treatment systems. As a result of this policydialogue, the project water authorities agreed that water tariffs will be set at levels ensuring thefull recovery of both capital investment and O&M costs, and a reasonable return on investment.It was also agreed that the Project would provide for investment in water supply systems, watertreatment plants and wastewater treatment, and water-saving irrigation systems, in a phaseddevelopment program.

5. Enterprise Reform

54. Promoting enterprise reform is a strategic objective of ADB’s PRC operations. ADB hasencouraged company restructuring to introduce shareholding with diversified ownership. Themain thrust of the policies is to introduce a modern enterprise structure, focus on profitorientation, and increase managerial autonomy and accountability. In the project area, thispolicy advice is directly related to agricultural enterprises where improved managementcapabilities, attention to product quality and competitive pricing, and enhanced marketinganalysis are needed. Experience has shown that private ownership of agricultural enterprises inthe PRC has been a significant factor in profitability. The supply and marketing cooperatives,which link the State and farmers in over 30,000 cooperatives nationwide, have incurred lossesamounting to Y32.2 billion ($3.88 billion) since 1992 and must be reformed. In January 1999,the State Council announced that local governments should sever their ties with businessoperations. Accordingly, the Project targets four private sector pilot enterprises to demonstratethe future role of corporate production systems with export potential, which can mobilize groupsof farmers and provide them with technical advice and inputs.

6. Governance and Anticorruption

55. During project processing, ADB’s anticorruption policy was explained to central and localgovernment officials. Attention was drawn to the section on fraud and corruption in ADB’sGuidelines on Procurement, particularly the need for bidders/suppliers/contractors to observethe highest standards of ethics in the procurement and execution of ADB financed contracts,and the sanctions if fraud and corruption are discovered. Similarly, the anticorruption provisionsadded to ADB’s Guidelines on the Use of Consultants were discussed. The PRC CountryAssistance Program includes assistance to the Government that will improve governance andprovide incentives to reduce the incidence of corruption in the longer term. In 1998, ADB TArelated to the consulting industry and auditing addressed some of the elements of ADB’santicorruption policy. Under TA 3138,32 ADB consultants are assisting the Government in

32 TA 3138-PRC: Regulatory Framework for the Engagement of Consultants, for $700,000, approved on 22

December 1998.

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developing detailed guidelines for the selection and engagement of consultants, which increasetransparency, take account of the principles of ADB’s anticorruption policy, and provide forequal opportunity competition. TA 310333 will strengthen the Government's auditing system toconform with the requirements of the Audit Law and, as far as practicable, of internationalauditing standards by helping to (i) formulate government auditing standards and procedures,and (ii) design and implement an audit-training program to promote full and consistentadherence to such auditing standards and procedures by government auditors. Whencompleted, this work should strengthen the Government's ability to detect fraud and corruption.

56. The Government is increasingly concerned with governance issues and has conductedwell-publicized campaigns against official corruption. Under TA 2845,34 assistance was providedto draft procurement regulations and standard bidding documents. The six sets of draftregulations and the three sets of sample bidding documents produced under the TA containprovisions related to corrupt or fraudulent practices, in accordance with ADB’s anticorruptionpolicy. Under this TA, ADB provided comments on the draft of a national Law on Tendering andBidding of the PRC (adopted at the 11th Session of the Standing Committee of the NinthNational People's Congress on 30 August 1999, promulgated by Order No. 21 of the Presidentof the PRC on 30 August 30 1999) that became effective as of 1 January 2000. The lawstipulates that tender and bidding activities will follow the principles of openness, fairness,impartiality, and good faith (Article 5). This law covers key construction projects funded by theState and all externally funded projects. Article 6 stipulates that “no organizations or personsshall, by any means, limit or exclude legal persons or other organizations outside from otherregions or systems from participating in the bidding procedure. No illegal interference in anyform is permitted in the bidding process.” Article 32 specifically prohibits bribes and collusion,while Articles 49-64 specify appropriate sanctions for all abuses of the law, including substantialfines and criminal prosecution.

IV. THE PROPOSED PROJECT

A. Rationale

57. Henan is a relatively poor interior province (ranking 18th in the PRC), with GDP percapita of Y4,356 in 1998, compared with the national average of Y6,392. The rural economy inthe western part of the province is the most disadvantaged. West Henan accounts for aboutone third of the province’s land area and one fifth of its population. The high population density(340 persons per square kilometer (km2), hilly to mountainous terrain (79 percent of land area),scarce arable land (0.07 ha per capita), climatic extremes, lack of infrastructure, and limitedwater resources have impeded economic development and kept farmers poor.35

58. High population density has resulted in intensive cultivation of crops on 40 percent of theland area in West Henan, which comprises highly fragile loess soils. The resulting extensive soilerosion causes downstream environmental degradation and reduces land productivity. Theprovince has been attempting since the 1980s to increase agricultural production and controlsoil erosion, through development of temperate fruit, nut, and medicinal plant tree crops.Livestock development has been promoted in 20 of the 32 project area counties that have

33 TA 3103-PRC: Strengthening the Government Auditing System, for $700,000, approved on 26 November 1998.34 TA 2845-PRC: Establishment of National Procurement Regulation for the Public Sector, for $565,000, approved on

20 August 1997.35 These resource constraints have resulted in 12 percent poverty incidence (at $1 per day) exceeding the national

and provincial averages; 12 of the 32 project area counties are officially designated poverty counties; and 42percent of the rural poor reside outside the poverty counties.

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200,000 ha of natural pastures. West Henan has emerged as a major supplier of beef, pork, andmutton to domestic and export markets. These horticulture and livestock programs have beensuccessful in raising farm incomes, a contributing factor in the selection of West Henan as thelocation for ADB’s first poverty-related project in agriculture in the PRC.

59. The inability to access medium- and long-term rural credit has limited the ability of poorfarmers to move out of subsistence farming through investment in cash crop and livestockdevelopment. This problem has also constrained the development of downstreamagroprocessing and marketing by agro-industrial enterprisesespecially in the privatesectorwhich are needed to create an effective demand for the farmers’ produce, maintain highfarm-gate prices, and generate off-farm employment opportunities. Credit constraints and thelack of fixed assets collateral hinder the Government’s strategic effort to integrate agriculturalproduction with agroprocessing and marketing.36 Accordingly, the Government offers poorhouseholds credit requiring no fixed collateral, so that they may establish a credit history andgraduate to commercial credit sources for future expansion of their farm enterprises. The keychallenge to the Project is to demonstrate that subsidized credit is not needed by poorhouseholds and is not desirable because of the market distortions introduced.

60. Poverty is not limited to income considerations alone. A clear correlation between non-income measures and poverty exists in the project area. Poor families have less arable land,consume more than they earn, have smaller and poorer quality housing, and are more likely tobe illiterate. Accordingly, per capita net income acts as an adequate proxy for other quality-of-life measures in the project area. Based on non-income indicators of poverty, the project areahas lower rates than the province average for (i) under-5 child mortality rate (0.78 percent), (ii)underweight rate of under-4 children (6.9 percent), and (iii) households lacking access to water(10.3 percent). While statistically the project area has reasonable access to primary health care(94 percent), in reality, there is no clinic in 8.5 percent of the villages. A socioeconomic profile ofthe project beneficiaries is given in Appendix 2.

61. Lack of access to water is the most critical welfare concern in drought-prone regions ofthe PRC. While the limited availability of water resources has generally constrained the qualityof life along the Yellow River basin, Yima and Mianchi counties in the project area suffer fromparticularly acute water shortages adversely affecting about 290,000 people in the urban andrural areas, livestock, and small and medium-size industries. During the dry months, localgovernments need to arrange at high cost emergency water supply in tanker trucks to supportthe people and livestock in the affected areas. In these dry periods, local residents pay up to 20times as much for water as the cost of the piped supply. Industries are tapping deepgroundwater at an unsustainable rate and shallow wells are drying up.

62. The Project will address the major constraints limiting poverty reduction, quality of life,and agricultural development in project area: (i) scarcity and poor quality of agricultural land, (ii)inadequate access to credit by poor farmers, and (iii) inadequate rural infrastructure (especiallywater). The Project will increase farm incomes of the less advantaged farmers throughproductive and environmentally sound development of sloping and degraded land forhorticulture and livestock at household and enterprise levels, and provide credit for the neededinvestments. The Project will develop water supply systems to meet the need for rural, urbanand industrial water in one of the most severely water-scarce areas.

36 During processing, commercial banks indicated that they were not keen to act as a financial intermediary due to the

lack of collateral, market risks, and high transaction costs.

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63. The success of the Government’s poverty reduction program demonstrates theimportance of carefully targeting assistance to such poor, resource-constrained areas; however,even more important is to target poor households within those areas. The horticulture andlivestock components will be targeted toward areas where there poverty incidence is high andthe people are disadvantaged by resource constraints. The potential direct beneficiaries ofthese two components are about 140,000 households. In addition, the Project will specificallytarget at least 40 percent of beneficiaries below the international poverty line.

B. Objective and Scope

64. The primary objective is to promote economic growth and increase farm incomes of poorfarmers in West Henan. The Project will include (i) environmentally sustainable development ofsloping lands for horticulture; (ii) expansion of livestock production using underutilized naturalpastures and crop residues; and (iii) provision of reliable water supplies for rural, urban, andindustrial use. The Project will initially cover 22 of 32 counties in West Henan and three otherdistricts or suburban areas. Nine of the counties are nationally designated poverty counties.The project framework is in Appendix 3. The project components are described below.

1. Horticulture Development

65. The horticulture component will cover 11,267 ha in 18 counties and involve about114,000 farm households. It will support the development and rehabilitation of fruit tree cropsand traditional medicinal plants, and field and greenhouse vegetables. The tree crops on 8,300ha include apples, Chinese date, kiwi fruit (Chinese gooseberry), gingko, and eucommia.37 Kiwifruit, gingko and eucommia will be planted from saplings, and apple and date varieties will begrafted onto old varieties. Field vegetables will cover 2,800 ha, and 5,000 greenhouses (on 167ha) will be established.

66. The Project will provide technical and financial support for the development andmaintenance of orchards, including training of extension workers and farmers, landdevelopment, procurement of farm inputs, and development of irrigation systems for someselected crops. The topography of the orchards varies from flat and gently undulating land tosteep hillsides. Areas with less than a 10-degree slope will be planted on the contour and thespace in-between the trees will be planted with ground cover crops. Areas with slopes of 10-25degrees will be terraced, and full technical services on proper terrace construction,maintenance, and rehabilitation will be provided at each site.38 No area steeper than 25 degreeswill be used for agricultural production and no area of protected arable land will be used for treecrops.

37 The bark and leaves of the eucommia tree are used as herbal medicines.38 Useful experience can be drawn from Loan 1336-PRC: Beijing Environment Improvement, for $157 million,

approved on 29 November 1994, which dealt with pollution abatement at drinking water reservoirs and carried outthe following activities (i) planting trees and contouring hills in the high-elevation area at the first control belt outsidethe Beijing in the Miyun and Huairou Reservoirs; (ii) planting trees and constructing terraces, check dams, andponds at the second control belt; and (iii) planting trees, developing water conservation and ponds, constructingdams and drainage canals at the third control belt. About 401 km2 of land was rehabilitated, including 4,784 ha ofterraces, 21,550 ha of conservation forest, and 11,603 ha of economic forest. Three demonstration comprehensivewatershed management and development areas, and two mud and rock debris control and forecasting areas havebeen established. About 25,141 check dams, 34 km of drainage canals, and 7.1 km of protective dams have beencompleted.

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67. The Project will support a program for training project participants at the village,township, county, and provincial levels.39 The training and technical support program will takeon several formats generally based on group formation (such as farmer technical associations,where they exist) for the specific crop to be grown. In the case of crops that will be processed(eucommia, gingko and field vegetables), processing companies will give training and technicalsupport, with support from high-level research institute staff and extension technicians. Keyfarmers will receive special and extended training, and will transfer this knowledge to otherfarmers in the locality. Training and technical support will be channeled through the lineagencies responsible for each crop. Research institute staff and extension technicians willconduct extended and specialized training for selected key farmers and township technicians. Atleast one member of all participant farmer households will receive basic training. Updatedtechnical and market information will be available to farmers during project implementation, toenable them to make informed choices on crop selection.

2. Livestock Development

68. The livestock component is designed following proven farm models,40 which aretechnically sound and make optimal use of underutilized pastureland and crop residues in theproject area. The component will support cattle breeding and raising in about 9,500 households,and sheep and goat breeding and raising in about 14,400 households. In addition, the Project isexpected to support the establishment of an integrated 600 head purebred piggery, 3,000 headfirst-cross piggery,41 and 2,000 pig-raising households.42 The Project will provide technical,financial, and marketing support to the participating households, including training of extensionworkers and farmers. In particular, it will provide for (i) farmer training in livestock management,including straw and forage treatment and grassland utilization; and (ii) a system for monitoringthe component’s impact on pastures and grasslands. Established enterprises with crossshareholding will be involved in the breeding piggeries.

3. Water Supply and Irrigation Scheme

69. This component will mitigate serious water shortages in Yima City and Mianchi Countythrough the construction of facilities for lifting and conveying 83 million m3 of water per year fromthe Yellow River for rural and urban household consumption,43 industrial and livestock uses, andirrigation. The component involves (i) construction of a pumping station on the right bank of theYellow River at Huaiba, near Sanmenxia City, which will draw water into settlement basins; (ii)construction of three pumping stations to lift the water in stages, and a 12.4 km longconveyance system; (iii) construction at Xiduancun of a regulating reservoir with a capacity of24.6 million m3, behind an earth-filled 45-meter (m)-high dam (with crest length of 642.5 m), tostore part of the water released from the conveyance system for use during periods when watercannot be supplied directly from the river because of high sediment content; (iv) construction ofwater treatment plants and expansion of the water reticulation systems in the Yima and Mianchiservice areas; (v) development of an irrigation system to serve 1,300 ha of orchards; and (vi)

39 Separate grant funding is sought to support curriculum development and training, demonstration projects, a pilot

information system, and strengthening of extension and NGOs supporting poverty reduction in the project area.40 The livestock models are based on the successful experience of the World Bank’s HADP, completed in 1999.41 The purebred stock will be partly imported, whereas the first-cross animals (three-way cross offspring of the

purebreds) will be born in the PRC.42 The Government has also studied the importation of purebred boar semen, but problems of semen preservation

and quarantine restrictions currently render this approach impractical.43 The inclusion of an associated sewage treatment system for the urban areas will be funded entirely by the

Government.

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resettlement of 1,603 persons in 367 households. The pumps, most of the conveyance system,and the reservoir will be constructed for a capacity of 3 m3/second (s), while sections of tunnelswill be designed for 7 m3/s to allow for future expansion of the system. The component willdirectly benefit about 65,000 households in Yima, Mianchi, and three rural villages; provideirrigation water for 1,300 ha in six villages; and supply water for employment-creating industries.

70. The Yellow River Basin Commission, which regulates the extraction of water from theYellow River, has approved the diversion of water at a maximum rate of 7 m3/s. The waterauthority concerned, in accordance with the relevant regulations of the PRC (which areconsistent with ADB policies), prepared a resettlement action plan (RAP), and the relativelysmall-scale resettlement of the affected families (367 households) has been substantiallycompleted without any significant problems to date. Appendix 2 contains a summary RAP.

C. Cost Estimates

71. The total cost of the Project is $151.3 million equivalent, comprising a foreign exchangecomponent of $66.1 million equivalent and a local currency component of $85.2 millionequivalent (Table 1). The cost estimate includes physical and price contingencies, taxes andduties, front-end fee, and interest during construction (IDC) on ADB and domestic loans.Detailed cost estimates are in Appendix 4.

Table 1: Cost Estimates$ million

Component Foreign Local TotalExchange Currency Cost

A. Water Supply and Irrigation 20.1 26.7 46.8

B. Horticulture (1.) Tree Crops (2.) Vegetables

16.6 8.1 8.5

31.017.014.1

47.625.022.6

C. Livestock 11.3 18.7 30.1

Project Management 0.4 2.1 2.5 Price Contingencies 2.2 2.6 4.8

Physical Contingencies 2.6 4.1 6.6 IDC, Commitment Charge, Front-end Fee 12.9 0.0 12.9

TOTAL 66.1 85.2 151.3 IDC = interest during construction.

D. Financing Plan

1. Sources

72. The Government has requested ADB to provide a loan of $64.3 million from ordinarycapital resources (OCR). The loan amount will finance the foreign exchange costs of theProject, with the exception of $1.8 million in foreign exchange costs of the sewage treatmentplants and minor PMO operating costs that will be entirely funded by the Government. Interestwill be determined in accordance with ADB’s pool-based variable lending rate system for USdollar loans. The ADB loan will have a maturity of 25 years including a grace period of 5 years,0.75 percent progressive commitment charge, and 1.0 percent front-end fee.

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73. The counterpart local currency requirements will be provided by the provincial,municipal, county, and township level governments through annual budgets, and by projectenterprises44 and beneficiaries, who will contribute either in cash or in kind. Loan funds repaidprior to the ADB maturity date will be revolved by the county finance bureaus into the agriculturesector, with a significant portion earmarked for poverty reduction.45 A summary of the financingplan is given in Table 2.

Table 2: Financing Plan($ million)

Source Foreign Local Total PercentageExchange Currency

ADB 64.3 – 64.3 42

Local Sources 1.8 85.2 87.0 58

Government 1.8 63.5 65.3Enterprises - 7.7 7.7Households (cash) - 1.7 1.7Households (labor) - 4.5 4.5Local Bank - 7.8 7.8

Total 66.1 85.2 151.3 100

2. Relending and Onlending

74. The Borrower will relend the proceeds of the ADB loan to the Provincial Finance Bureau(PFB), which will onlend to municipal, county, and township finance bureaus at the same ratesand terms as for the ADB loan. The relevant finance bureau, in turn, will be responsible forchanneling the loan proceeds and counterpart funds to the project implementing agencies (IAs),enterprises, and farmers. The Finance Bureaus will also be responsible for recovery of the Loanproceeds, foreign exchange risks (with the exception of loans to enterprises), and servicing thedebt obligations to the Borrower. The onlending interest rates to the endusers (farmers, farmergroups, and enterprises) would be not less than the rate charged by commercial banks forsimilar loans of similar currency and terms. The repayment periods will be based on theprojected cash flow and profitability of each component.

75. The county finance bureaus, through their township financial offices, will onlend tofarmers or farmer groups selected by the relevant technical agency (assisted by PADO) at aninterest rate not lower than the equivalent commercial bank rate (currently about 7.5 percent),with a grace period based on 1 – 2 years after receiving income from the project investment anda repayment period of at least four years, based on the projected payback period of eachcomponent. Farmer beneficiaries will enter into legally binding contracts with the relevant

44 A Construction Bank of China loan for $7.8 million equivalent has been prearranged for the water supply

component.45 Monitoring reports will examine whether this revolving fund mechanism is generating additional support for poor

farmers.

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technical bureau (on technical implementation arrangements) and the finance bureau (on termsand conditions of the loan).46

76. For the enterprise + household financing, the Provincial or County Finance Bureau willonlend the ADB funds in US dollars, at an interest rate not lower than the equivalent commercialbank rate, with repayment terms of 10-15 years, depending on projections of profitability, and agrace period of 1-2 years. The enterprises will take the foreign exchange risk and repay theloans in US dollar equivalents. For the water supply and irrigation enterprises, the CountyFinance Bureau will onlend the ADB funds on the same terms and conditions as the originalloan, with the enterprises taking the foreign exchange risk.

E. Implementation Arrangements

1. Project Implementation and Coordination

77. The Project will be implemented over a period of five years commencing in early 2001and will be executed by PGH (Appendix 5). PGH has established a Project Leading Groupwhose members include a vice governor as chairman, the director of the Henan ProvincialFinance Bureau, the director of the Henan Development Planning Commission, and the headsof the provincial line agencies concerned (bureaus of agriculture, forestry, livestock, waterconservancy, environment, statistics, and PADO). The Project Leading Group will beresponsible for overseeing project implementation, coordinating the various IAs, and resolvingpolicy issues.

78. PGH has established, under the administrative control of PFB, a Project ManagementOffice (PMO) staffed with trained and qualified technical, financial, and management personneland headed by a director. PMO will (i) compile all feasibility studies pertaining to the projectcomponents and subcomponents; (ii) draw up annual work programs and budgets; (iii) applyapproved selection criteria47 in preparing lists of households and enterprises that mayparticipate in the horticulture and livestock components; (iv) supervise local and internationalprocurement; (v) supervise Project construction, inspection, and acceptance; (vi) monitor thephysical and financial progress of activities; (vii) coordinate and compile progress reporting; and(viii) conduct, in coordination with the IAs, benefit monitoring and evaluation (BME) inconjunction with the provincial PADO. The provincial PMO will be assisted by subordinatePMOs established in the project municipalities and counties. The provincial PMO will also serveas the secretariat for the Project Leading Group.

79. Under PFB guidance, PMO will (i) review the continued financial viability of the activitiesproposed under the Project and recommend appropriate actions; (ii) approve the loanagreements with participating households and enterprises, ensuring that priority is given to thepoorer members of the local communities; (iii) review and approve the annual work program andbudget; (iv) ensure that adequate counterpart funding is provided; and (v) coordinate loanrepayments by the local governments and, if necessary, withhold annual budgets fromdefaulting local governments.

80. The IAs for the horticulture and livestock components will be county PMOs with thesupport of the local bureaus of Agriculture (BA), Livestock (BL) and Forestry (BF). The pilot

46 For simplicity, these two aspects may be combined in one contract, to avoid farmer confusion.47 Poor townships and villages will be targeted first, with at least 40 percent of poor households targeted as

beneficiaries. Details are in Appendix 2.

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enterprises for these components have been preselected according to the agreed uponselection criteria. Substitution of pilot enterprises during project implementation must have priorapproval of ADB. The Sanmenxia Huaiba Water Supply Company (SHWSC) established by theSanmenxia Municipal Government, Yima and Mianchi Water Supply Companies, and MianchiIrrigation Company established by the Mianchi Water Conservancy Bureau, will be the IAs forthe water supply and irrigation component. A dam safety panel of eminent domestic engineerswill be formed to oversee dam construction. The project organization is shown schematically inAppendix 5.

2. Procurement

81. Goods and services financed under the ADB loan will be procured in accordance withthe ADB Guidelines for Procurement and ADB’s domestic preference scheme for procurement.Each supply contract for plant and equipment, vehicles, and materials estimated to cost$500,000 or more will be awarded through international competitive bidding (ICB). Eachcontract estimated to cost $100,000 or more, but less than $500,000, will be awarded throughinternational shopping. Contracts for less than $100,000 will be by direct purchase (Appendix 6).The civil works contract packages for the water supply and irrigation component will range from$0.3 million to $6.0 million. Each contract estimated to cost $2.0 million or more will be awardedthrough ICB. Civil works contracts valued at less than $2.0 million will be awarded through localcompetitive bidding (LCB), as they are unlikely to be of interest to foreign contractors becauseof the relatively small size of the works, the remote location, and the availability of many capablelocal contractors with a competitive advantage to carry out such labor-intensive works. Theprocedures used for LCB in Henan Province are acceptable to ADB. Some civil works which aresimple and labor-intensive and/or where there is no possibility of competition, may be carriedout through force account (FA), or through contracts awarded to village teams composed mostlyof eligible farmer beneficiaries (Community Participation in Procurement), where suitable. Priorto loan negotiations, PMO engaged (using counterpart funds) a company acceptable to ADB toassist the IAs in international procurement.

3. Advance Action and Retroactive Financing

82. For timely project implementation, ADB has approved advance procurement action,48 upto the stage of signing contracts. ADB also approved, in principle, retroactive financing of $6million in aggregate, for the following items of expenditure incurred from the date of completionof project appraisal by ADB to the date of effectiveness of the ADB loan (i) land preparation andexpansion of nurseries for the horticulture component; (ii) training of extension staff andpotential farmer beneficiaries; and (iii) preparatory civil works for the water supply and irrigationcomponent (Appendix 6). Without retroactive financing, delays in project implementation wouldadversely affect project performance. For example, after several years delay in projectprocessing, the Huaiba Water Supply and Irrigation scheme was forced to borrow short termbridge financing to commence construction of the pumping station on the Yellow River, whenimpounded water behind the Xiaolangdi dam threatened to inundate the pump offtake site.Retroactive financing will allow construction to continue prior to loan effectiveness, thusobviating the extra costs in demobilizing construction crews and equipment. The Governmenthas been advised that ADB’s concurrence with the advance action and retroactive financingdoes not constitute ADB commitment to finance the relevant expenditures under the Project orthe Project itself.

48 This was reported in the May 2000 issue of ADB Business Opportunities.

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4. Disbursement

83. Because of numerous small expenditures and FA works involved in implementing thehorticulture and livestock components, PFB will establish an imprest account with a local bankacceptable to ADB, and ADB’s statement of expenditures procedures will apply in disbursementof the loan funds. The imprest account will cover procurement of such items as plantingmaterials, small tools, materials for livestock holding pens, and veterinary supplies. TheExternal Debt Management Division of PFB will be authorized to have direct access to theimprest account. The accounting systems and procedures of PFB are satisfactory, and theirfinancial controls and discipline are adequate for the application of the statement of expenditureprocedure.

5. Project Accounts, Audits, and Reports

84. PMO will maintain records of all expenditures and prepare consolidated projectaccounts. PFB will ensure that the accounts are audited annually by auditors acceptable toADB. The audited reports will be submitted to ADB not later than six months after the end of thefiscal year. PMO, in coordination with the other IAs, will submit consolidated quarterly progressreports to ADB within one month of the close of the quarter. The quarterly reports will include (i)physical and financial accomplishments, (ii) problems encountered or anticipated and actionstaken, and (iii) a work plan for the following quarter. Within six months after project completion,PMO will prepare and submit to ADB a project completion report summarizing the projectimplementation, the attainment of objectives and targets, and a critical evaluation of theimplementation experience.

6. Implementation Review

85. During inception, further details on the poverty targeting mechanisms will be agreedupon with the Government. ADB and PGH will jointly undertake a special poverty targetingmission after one year of project implementation to ensure that the Project is reaching poorfamilies, and a midterm review of the Project in the third year of implementation. Regular reviewmissions will assess implementation progress and examine the appropriateness of the projectdesign and scope, the effectiveness of poverty targeting arrangements, the criteria for creditassistance, and the implementation arrangements. The reviews will recommend any necessarymodifications to the design and implementation arrangements to attain the project objectives.

7. Benefit Monitoring and Evaluation

86. PGH will establish a BME system in PMO to monitor and assess project impact andachievement of the objectives following ADB’s Handbook for Benefit Monitoring and Evaluation.Sample surveys using the rapid rural appraisal method and household interviews will monitorfarmer participation in the activities; their access to extension and training services, agriculturalinputs, and other support assistance; and changes in household incomes and off-farmemployment. Similar surveys will be carried out to monitor the access of target beneficiaries todependable water supplies for irrigation and for domestic and industrial consumption,consumers’ ability to pay for water supply, and the impact of the water supply and irrigationcomponent on the local economy in the service area. Two such surveys will be conductedduring project implementation: one in the third year, prior to the midterm review, and another inthe fifth year. The provincial rural and urban survey teams attached to the Statistics Bureau,which assisted during project preparation, will be engaged to conduct these surveys. Thesocioeconomic data of the potential beneficiaries collected during project preparation,

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supplemented by PADO’s database on poverty incidence, will serve as the baseline for theBME. PADO will assist PMO in preparing the annual progress reports, by providing data onpoverty reduction. After completion, PGH will evaluate the Project impact in accordance with aschedule and terms of reference to be agreed upon with ADB.

F. The Executing Agency

87. The Provincial Government of Henan will be the Executing Agency for this Project.PGH, through its PMO, has been the EA for several World Bank-assisted agricultural, rural, andwater resources development projects. The organizational and management structures in thoseprojects are similar to those being proposed under the Project, i.e., a leading group and PMOsat the provincial, municipal, and county levels, with technical support and services provided bythe concerned line agencies at various levels. PGH’s performance in these projects has beengenerally satisfactory. Several of the experienced PMO staff will be involved in the proposedProject.

G. Environmental and Social Measures

1. Environmental Measures

88. An environmental impact assessment (EIA) was carried out in accordance with ADB’sGuidelines as part of the feasibility study, and a summary environmental impact assessment(SEIA) was circulated to ADB’s Board of Directors on 4 November 1998.49 The mainenvironmental concerns relate to the likely impact of the regulating reservoir for the water supplyand irrigation component. Measures to address these concerns were identified and incorporatedin the project design. Other concerns raised in the SEIA (and a major reason for a Category Arating) related to an agroprocessing component, which was deleted in later processing of theProject because of concerns about project quality.

89. The water supply and irrigation component will include the construction of the Xiduancunreservoir, which will have a surface area of 182 ha at full supply level. It will inundate land thathas been heavily modified by long human use: thus, impacts on biological resources will benegligible. Although a survey of the inundation area found no historical relics or cultural artifacts,procedures have been established to halt work and preserve artifacts should they be unearthedduring construction. Sloping land along the reservoir periphery will be shaped and revegetatedto minimize landslips. Based on 17 years data, sedimentation will not substantially reduce thevolume of active storage for at least 50 years. Downstream impacts are expected to be largelybeneficial because the Project will require the relocation of the discharge points from coalindustries that have heavily polluted the Jianhe stream passing through the reservoir area. Thecompensation release past the dam will provide reliable potable water to downstreamcommunities. Spoil from excavation for the water conveyance system and the pump station andsettling basins will be deposited on land that is not under productive use, and will not impedenatural drainage systems. Spoil sites will be landscaped and revegetated under monitoringsupervision by the Henan Environmental Protection Bureau (EPB). Adverse impacts ongroundwater levels will be negligible. The impact of pumping on the Yellow River will benegligible because only 1.6-3.8 percent of the average minimum flow will be diverted. The

49 An updated version of the SEIA is available on request. As no environmentally significant components were added

to the project design and most of the potentially adverse activities covered by the original EIA have been removedduring subsequent processing, the revised SEIA was not required to be recirculated.

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Project will establish within SHWSC an environmental protection unit responsible for monitoringenvironmental impacts, and supervised by the Henan EPB.

90. The Project’s horticulture and livestock components are expected to either havecomparatively minor environmental impacts, for which mitigation measures have been includedin the Project, or actually improve environmental conditions. The horticulture component will beundertaken with strict adherence to soil conservation guidelines. Slopes of cultivated land willnot exceed 25o, and other soil conservation measures such as erosion interceptors and broad-based terracing will be employed. Any agrochemicals financed under the Project will requireprior approval from the Institute for the Control of Agrochemicals. The level of support forlivestock production in each village will be based on an assessment of grazing land carryingcapacity. Grassland management strategies such as rotational grazing, which is alreadypracticed in the area, and introduction of undersown leguminous fodder plants will be supported.Intensive production of breeding pigs will require careful attention to treatment of wastes, but,generally, wastes will be fully utilized for biogas generation and heating during winter.

2. Resettlement Action Plan

91. The water supply and irrigation component requires resettlement of approximately 1,603persons in 367 households (338 households in the regulating reservoir inundation area and 29households at the pump site on the Yellow River). The magnitude of resettlement is minor byPRC standards. Households in the inundation area will be relocated to four sites around thereservoir and, in most cases, will move less than 1 km from their current dwellings. An updatedRAP, prepared in 1999, and consistent with ADB policy, provides a time-bound agenda forrelocation and adequate compensation.50 The main concerns are a decrease in the average percapita agricultural land from the present 2.04 mu to 1.38 mu after relocation, and a possiblelowering of grain yields on the new land. To avoid a fall in on-farm income, the resettlement planincludes financial and technical support for cultivating high-value, irrigated orchard andvegetable crops on about half of the new agricultural land. Also, the resettled households will beexempted from agricultural and special product taxes for 3-5 years. There will be preferentialhiring of resettled adults, including females, in the construction of the dam and associatedstructures. The living conditions of the resettled households are expected to improveimmediately because the housing conditions and amenities such as schools, water supply, andelectricity at the resettlement sites are superior to those at the present sites. On-farm incomesare expected to reach or exceed current levels after three years. Support will be provided tomaintain living standards during this interim period. For example, resettled households will be(i) given preference for off-farm industrial employment in the project area; (ii) given preferentialaccess to agricultural assistance, the poverty aid fund, and social development funds; (iii)exempted from various levies and taxes; and (iv) exempted from the mineral resource levy forbuilding materials and roof tiles.

92. Among the households to be resettled, 29 households at the pump site have alreadybeen relocated, 19 to a site about 500 m from their original dwellings, and 10 to Mianchi, 23 kmaway, to join relatives living there. To date, about 125 families, mainly from the damconstruction area, have been relocated, although some of the public infrastructure in the newvillages is still under construction. About 242 families remain to be resettled, mainly from thetailwater of the regulating reservoir. A survey of the resettlement sites and interviews withpeople already resettled indicate that conditions at the resettlement sites are a significantimprovement over their previous residences. Those interviewed expressed their satisfaction with

50 The RAP was made available to all affected persons and is available for review on request.

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arrangements thus far, and indicated that the local resettlement bureau had made regular andfrequent visits to monitor conditions in the resettlement areas. Many of those compensated todate have invested in construction equipment (such as trucks), which they anticipate will beneeded once full-scale construction starts, or pooled their compensation funds to invest in off-farm activities.

3. Public Consultation

93. Since the Project was first proposed for ADB funding in 1993, there has been extensiveconsultation with all stakeholders. During project planning, public meetings, group interviews inthe field, questionnaires, key informant interviews, and public display of project documents wereused to solicit public input and feedback. Representatives of the National People’s Congressand People’s Consultative Committee in the municipalities and counties were interviewed,senior officials at all levels of government were consulted, and NGOs (such as the Women’sFederation, Brilliant Cause, and Foundation for Poverty Reduction) offered advice on how toeffectively tackle poverty reduction in the area. Consultation will continue throughout projectimplementation through newsletters, technical group formation, development of a marketinformation system, and follow-up surveys and progress reports.

V. PROJECT JUSTIFICATION

A. Financial and Economic Analyses

1. Production and Markets

94. The horticulture component promotes five fruit and medicinal tree crops, and vegetables,carefully selected after extensive technical and marketing studies. At full production, 5,800 ha offruit trees will produce about 72,600 t of fresh fruit per year (apples, kiwi fruit, and Chinesedates). Annual medicinal plant production on 2,500 ha will be about 2,640 t (gingko leaves andnuts, eucommia leaves and bark), field vegetable production on 2,800 ha will be 176,000 t, and5,000 sets of greenhouses will produce 21,900 t of vegetables. This component is part of anongoing development of tree crops and vegetables by farmers in the project area, and willaccelerate the rate of planting and reworking trees with improved varieties. Without the Project,it is assumed the same areas would be planted over 10 years instead of 4.

95. The demand for fresh fruit and traditional medicines in the PRC has increased rapidlysince 1990. The rising demand has been met by a rapid increase in production. Fruit productionand vegetable production have increased 4.9 and 3.4 times, respectively, since 1990. There is adanger of overproduction in some crops, and falling prices unless quality products areproduced. Therefore, the Project has been cautious to promote only selected crops for whichextensive market analysis has been conducted. Moreover, a flexible strategy will be followed,so that farmers can minimize their risk through diversification or choosing activities adapted tochanging market conditions. Market information and projections will be provided to all farmersthrough the network of PMOs established throughout the project area.

96. The household cattle raising activity will produce 15,580 18-month-old cattle and about2,375 aged cows per year at full production. The sheep raising activity will produce 108,000surplus animals per year, with live weight of 5,400 t, and 14,400 aged sheep for slaughter withlive weight of 936 t. Raising goats for meat will produce a total of 108,000 surplus animals peryear with a total live weight of 6,075 t and 14,400 aged goats with live weight of 720 t. Thebreeding piggeries will produce 4,600 purebred sows, 20,000 crossbred sows, 25,000 piglets,

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11,200 porkers, and 1,240 culled sows each year. The Project will assist 2,000 households topurchase crossbred animals for raising porkers. These households will produce about 68,000animals annually. The pigs will be sold in the local markets for lean pork production. Totalannual meat production will be absorbed in the local market, which is expanding rapidly.

97. The water supply component addresses the needs of an area where water is shortageand unreliable supply result in the poor quality of rural and urban life and constrain agriculturaland industrial development. An adequate water supply is necessary to support the growth in thearea’s population, which is projected to rise from 290,000 in 2000 to 586,000 by 2022. Of thisnumber, 84,000 will be migrant workers attracted by industrial development dependent onprovision of water. Initially 11 percent of the water will be used for rural domestic, irrigation, andlivestock uses, but that will rise to 17 percent in 2022 due primarily to an increase in thelivestock population by 330,000 when water constraints are removed. If water were available,8,000 ha in the area is potentially suitable for future orchard development. Urban and domesticusers initially will consume 13 percent of the supplied water, increasing to 27 percent in 2022 asthe population increases. Priority will be given to satisfying all nonindustrial water demandsbefore any industrial demands are met. On the basis of existing industries, industry underdevelopment, and additional planned industry, industrial demand will exceed water supply by 25million m³ in 2022. That excess demand, plus the demand from new industries, will be met by asecond-phase development for which part of the conveyance capacity is provided in the projectcosts, but no benefits are included in the analysis. The water supplied will be readily marketableand will contribute to substantial improvements in the quality of life and economic development.

2. Financial and Economic Rates of Return

98. Financial and economic analyses were carried out for the Project as a whole and foreach of the three components. Assumptions underlying the analyses are given in Appendix 7and the results of the analysis, including sensitivity tests, are summarized in Table 3. TheProject is financially and economically viable with a financial internal rate of return (FIRR) of 14percent and an EIRR of about 17 percent. The Project is relatively robust under sensitivityanalysis, but with some differences among the components.

99. The FIRR and EIRR for the horticulture component overall are 16.7 percent and 18.1percent, respectively. The subcomponent FIRRs range from 14.4 percent for field vegetables to20.3 percent for greenhouses (assuming half of the greenhouses are of the simple type and halfare the standard model). As the component accelerates the assumed without-Project pace ofdevelopment, it is sensitive to delay, but not excessively so. One year’s delay in benefitsreduces the net present value (NPV) by about 30 percent, lowering the FIRR to 12 percent, butstill well above the financial cost of capital (FCOC), which is estimated to be about 8 percent. Nosubcomponent is excessively sensitive to changes in investment or operating costs, butChinese dates and field vegetables are sensitive to price variations.

100. For the household livestock activities as a whole, the FIRR is estimated at 18.4 percentand the EIRR at 19.9 percent, with the FIRRs ranging from about 17.1 percent for cattlebreeding to about 21 percent for sheep.

101. The financial returns to the proposed livestock enterprises (purebred piggery andcrossbred piggery) are about 13 percent for purebred pigs and 22 percent for crossbred pigbreeding. The corresponding EIRRs for these activities are estimated at 15 and 25 percent,respectively. In aggregate, the estimated base FIRR for the piggery enterprise investments isabout 19 percent. The aggregate base EIRR is estimated at just under 22 percent.

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102. The rates of return show some sensitivity to adverse changes in investment costs ordelays in implementation, but substantial sensitivity to changes in prices and operating costs,particularly among the FIRRs of the individual proposals. Maintaining efficiency in operations isa primary consideration for success of the investments, but equally important for all enterprisesis securing high volumes of sales that reward consistently high product quality.

103. Purebred pig breeding, with an FIRR of about 13 percent, should provide a satisfactoryfinancial return, provided that consistently efficient management and quality control areimplemented. Its viability, however, is sensitive to changes in revenues and operating costs.For example, a decrease in sales revenue by 10 percent reduces the return to about 3 percent.Performance is less sensitive to increases in operating costs (operating costs are estimated atabout 78 percent of the total value of sales at full development). The returns to thecrossbreeding piggery investment are more robust than for the purebred breeding unit. A 10percent reduction in revenues would reduce the base FIRR to about 15 percent and the EIRRwould decline from 25 to about 16 percent. As there is substantial cross shareholding in bothcompanies, the overall risk is minimized.

104. For the overall water supply component, the FIRR is estimated at 11.7 percent and theEIRR at 16 percent. The overall figures include the performance of the consolidated watersupply and distribution companies and the performance of the 1,300 ha of orchards to bedeveloped in Mianchi’s North Irrigation Area. Separately, the FIRRs for the water companiesand irrigated orchard development range between 8 and 14 percent, but cluster around 12percent. The EIRRs are similarly clustered around 16 percent. The consolidated EIRR for thewater and irrigation companies is estimated at 16 percent while the economic return to irrigatedorchard development alone is calculated to be about 15 percent. Individually, the EIRR isestimated at 16 percent for Sanmenxia, about 22 percent for the Mianchi Water DistributionCompany, 17 percent for the Mianchi Irrigation Company, and 17 percent for the Yima WaterDistribution Company. The component FIRRs are sensitive to changes in operating costs, butlocal authorities can and have adjusted water tariffs to compensate for anticipated increasedcosts. The sensitivity analysis can be misleading, as increased operating costs of the waterdistribution companies will trigger an increase in revenues for the bulk water company and, atthe same time, prompt a process to adjust water tariffs.

105. The base case EIRRs for the water companies should be regarded as lower bounds.Without the Project, the incremental supply of water for the area in the future would be muchless than with the Project, and the cost of supply would be much higher. Many urban userscurrently pay 5-10 times the price of water that has been applied in the analysis. The trueeconomic return to the component is therefore likely to be much higher than what is presentedhere. On the basis of these lower bound estimates for the economic value of water supplybenefits, the overall economic return to water supply, distribution, and irrigation companyinvestments should remain satisfactory even with a 10 percent decrease in revenues. Likewise,a 10 percent increase in operating costs will not have a devastating impact. Changes in totalinvestment costs do not strongly affect returns. These sensitivity results, based on substantialunderestimation of the value of water, suggest that the economic viability of the water supplyscheme may be assured.

106. Table 3 summarizes the returns and sensitivity analysis of the separate components.Switching values (SV, or the percentage change in the base value of a variable that wouldequate to the internal rate of return to a chosen discount rate) are calculated using 8 percent as

30

the FCOC (for the financial sensitivity analysis) and 12 percent as the opportunity cost of capital(OCC) (for the economic sensitivity analysis).

Table 3 : Results of Financial, Economic and Sensitivity Analyses(percent)

Horticulture HouseholdLivestock

LivestockEnterprises

Water Supply Total Project

Financial AnalysisBase Case IRR 16.7 18.4 18.6 11.7 13.9Output Prices –10 % IRR 12.0 9.4 9.0 9.7 10.2 SV -18.7 -11.6 -10.9 -18.0 -15.9Operating Costs +10% IRR 14.4 11.1 11.2 7.8 9.8 SV 40.4 14.4 13.7 9.3 13.1Investment Costs +10% IRR 15.7 17.0 17.1 10.7 12.7 SV 162.1 150.7 116.6 43.2 39.2Benefits Delay 1 Year IRR 12.4 10.2 9.3 10.6 10.9Economic AnalysisBase Case IRR 18.1 19.9 21.8 16.0 17.3Output Prices –10 % IRR 11.0 9.6 13.5 12.2 11.9 SV -8.7 -7.6 -15.9 -10.5 -9.9Operating Costs +10% IRR 15.5 11.5 15.6 11.0 12.5 SV 24.2 9.4 15.5 8.0 10.9Investment Costs +10% IRR 17.1 18.3 20.1 14.8 16.0 SV 84.6 72.6 91.4 38.3 31.7Benefits Delay 1 Year IRR 13.8 10.4 12.1 14.3 13.5IRR = internal rate of return, SV = switching value.

107. The financial and economic analyses of the water supply and irrigation component donot include the potential benefits of the second phase development, although some of theinfrastructure costs are incurred for the second phase. The second phase water supply willincrease capacity utilization and the internal rates of return, especially for SHWSC and the YimaWater Distribution Company.

3. Subsidies, Taxes, and Cost Recovery

108. Subsidies associated with the Project consist of agricultural extension and trainingservices provided without cost recovery for the horticulture and livestock components. However,the Project will generate additional tax revenues for the Government, including (i) value-addedtaxes and import duties on the development costs; (ii) sales taxes in the form of agriculturalproduction tax, value-added tax, development tax, and education tax on component salesrevenues; and (iii) corporate income tax on all commercial enterprises in each component. Thewater supply and irrigation component will ensure cost recovery through approved tariffadjustments, which are based on full cost recovery. Where possible, project loans to end-userswill be matched by physical collateral, detailed in legally binding contracts, thus providingincentives for on-time loan repayment. The total cost of the Project, including subsidies, will berecovered through these taxes, tariffs, and repayment of loans by each component.

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4. Risks

109. The project design takes into account potential institutional, marketing, and technicalrisks. As formulated, the Project is not expected to face any unusual institutional risks. PMO hasexperience in project implementation based on its good performance in implementing therecently completed World Bank-funded HADP. The municipal and county governments haveexperience in implementing similar developments, and were integrally involved in project designduring the preparation stage. Counties with excessive debts or unsure about their ability toprovide counterpart funds were permitted to withdraw from the Project, thus ensuring strongcommitment on the part of local governments.51

110. Each component will produce a wide range of products, primarily for the domesticmarket, for which marketing arrangements exist and in which incremental project production willbe a relatively small addition to total production in the PRC. Extensive market assessment hasbeen undertaken to ensure that the risk of inadequate market demand is minimal. In addition,PGH will assess the extent to which other provinces in the PRC are undertaking similarproduction increases and make appropriate changes to areas planted and livestock numbers,during project implementation. Farmers will be provided with up-to-date market information toinform their choice of horticulture or livestock options and will be encouraged to diversifyproduction rather than concentrate all their investments on one activity.

111. The issue of risk has been addressed in each of the horticulture subcomponents so as toreduce the risk imposed by reduced market demand due to oversupply and inadequate producequality:

(i) The Project will not require farmers to follow precisely the production models ofthe selected tree crops outlined for the project analysis. Rather farmers will beallowed to select diverse tree crops based on their own informed assessment,plus market information from the Project and other sources.

(ii) All project farmers will receive training and technical support to ensure a qualityof produce that can compete successfully in the market.

(iii) Apple trees will be grafted with early-maturing varieties that will produce applesbefore the market is oversupplied and while prices are still high.

(iv) Kiwi fruit will be produced in a warmer location in which the fruit will matureearlier than those of competitors in neighboring provinces and therefore can besold easily in the Zhengzhou market. Moreover, a controlled atmosphere storagechamber for kiwi fruit (3,000 t) is under construction in Zhengzhou.

(v) Gingko leaf production will be coordinated with the Lushan Mingkang GingkoProcessing Company that exports gingko extract throughout the PRC andoverseas. The gingko production model considers compensatory production ofnuts and leaves.

(vi) Other products such as Chinese dates and vegetables are not anticipated tomeet marketing difficulties, provided product quality is maintained.

112. In the livestock component, risk has been mitigated by recommending that pregnantanimals be procured by the Project, to ensure quick returns to farmers. Highly fecund andproductive breeds of livestock have been selected to ensure that offspring will command amarket premium. Pig breeding based on improved imported breeds will substantially increase

51 To date, 3 of the 12 national poverty counties have declined to be involved due to previous foreign assistance, high

levels of debt, or lack of counterpart funds.

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the quality of porkers, with lean pigs increasingly commanding a price premium on both localand export markets. The risk of animal diseases, and hence loss to farmers, will be minimizedwith the provision of veterinary services by the pilot enterprise or livestock bureau. Farmers willbe encouraged to diversify livestock production to mitigate the risks of adverse price changes.Farmers can also revert to locally available nonpurchased feed if input prices rise, and retaintheir animals longer to reach desirable sales weights.

113. PMO and the relevant government agencies will need to be sufficiently sensitive to thedifficult task of effectively targeting poor households. Risks will be minimized by effectivemonitoring and evaluation arrangements during implementation, especially by relativelyindependent observers, such as PADO and other poverty-related agencies, and by continuingpolicy dialogue between ADB and PGH. Poor households will be permitted to enter the Projectat a level of debt with which they feel comfortable, and the Project will enable poor householdsthat repay loans on time to take out repeat loans to expand their production. All poorhouseholds will be given time to decide on whether to participate or not, will be provided withadequate training and encouraged to join support groups, and will be given the chance to reviewthe experience of other households within the same village or county. Poor farmers areexpected to establish a satisfactory credit history as well as build up collateral during theProject, which will enable them to access commercial rural credit for future expansion. Earlyrepayment of loans will enable local governments to establish a revolving fund, part of whichmay be earmarked for additional poverty assistance.

B. Social Dimensions

114. An estimated 204,900 households (0.9 million people) will benefit directly from theproject interventions: 114,000 households in horticulture, 25,900 in household livestock, and atleast 65,000 rural and urban households through domestic, livestock, and irrigation watersupply. In total, about 340,000 poor people are expected to benefit from the Project and willraise their annual income above the international poverty line.

115. Several hundred households will benefit from the creation of permanent nonfarmemployment opportunities. The intensive piggery breeding units will create 290 jobs with annualremuneration of Y1.7 million. Water supply will directly create about 500 jobs, with annualremuneration of Y2.94 million, and many nonfarm jobs will be created indirectly throughindustrial and commercial development dependent on the water supply component.

116. Most employment, and highest returns to labor, will be in the horticulture and householdlivestock components. At full development, the horticulture component will create 30,070person-years equivalent of annual employment with a total remuneration for labor and net farmincome of Y271 million, or an average of Y36 per labor-day,52 reflecting the moderate laborinput and high returns from established orchards. The household cattle, goat, and sheepactivities will create 4,150 person-years of work at a total remuneration of Y51.4 million,averaging Y39 per labor-day. Women will actively participate in the household-based activities,especially those related to horticulture and livestock.

117. At full development, household incomes will increase significantly. Before imputinghousehold labor costs, incremental household income in horticulture53 will range from around

52 The return per labor-day averages Y16 from existing grain production and Y20 from existing apple orchards.53 Incremental household incomes are based on average landholdings of 0.3 ha. Some poor households have even

less land and incremental incomes would be smaller, in proportion to landholding.

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Y500 for gingko, Y1,219 for field vegetables, and Y1,340 for Chinese dates, to Y2,100 for appledevelopment, Y5,370 for kiwi fruit, and Y7,460 on average for greenhouse development. Inlivestock activities, incremental household income will range from Y1,650 for sheep and meatgoat raising, Y2,330 for breeding porkers, and to Y2,420 for cattle raising. The averageincremental household income in horticulture will be about Y1,631, an increase of about 36percent in the household incomes of 60 percent of the beneficiaries near the poverty line, andabout 12 percent on average for other participating households. The average incrementalhousehold income from livestock is estimated at Y1,983 to give poor households an increase inincomes of about 44 percent, and less poor households an increase of about 14 percent. About60 percent of the beneficiary livestock households are classified as absolute poor. Beforeimputing household labor costs, total net incremental farm household income attributable to theProject is estimated at Y251 million per year: Y200 million from horticulture and Y51 million fromlivestock.

VI. ASSURANCES

118. The Government and the Provincial Government of Henan have given the followingassurances, in addition to the standard assurances, which have been incorporated in the legaldocuments.

(i) Within three months of loan effectiveness, PGH will establish a suitably staffedBME unit within PMO and will appoint a dam safety panel of eminent nationalengineers to oversee dam construction at Huaiba. PMO will conduct routinemonitoring surveys during implementation (including progress of the RAP), andreport the results of such surveys to ADB in a timely manner.

(ii) In selecting farmer participants, the assistance of PADO and other povertyagencies will be sought to give priority to the absolute and relative poor membersof the local communities. For the horticulture development component, theamount of land to be allocated to any household will not exceed 5 mu (0.33 ha)for any crop, PMO will issue guidelines on model contracts, and the land useright contract will include a tenure of up to 50 years for barren upland areas. PGHwill select at least 40 percent of intended project beneficiaries with incomesbelow Y1,000 per year.

(iii) Prior to the construction of the Huaiba pumping station and the Xiduancun damand reservoir under the water supply and irrigation component, the affectedfamilies will be resettled in other areas and so compensated that they will notsuffer a reduction in income, deterioration in their living conditions, orunnecessary social dislocation. Households relocated before projecteffectiveness will be given priority, thus ensuring that they are adequatelycompensated and their livelihood restored, before the remaining households arerelocated. Land acquisition and resettlement will be carried out in accordancewith the agreed upon RAP. The RAP will be publicly available for review, andany concerns or grievances will be adequately addressed.

(iv) The national, provincial, municipal, and county governments and theircorporations, in aggregate, will not own more than 49 percent of the shares ofany pilot enterprise to be supported under the Project.

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(v) The water tariffs under the water supply component will be set at levels adequateto recover the full investment and O&M costs and obtain a reasonable return oninvestments under the Project by the water utilities companies.

(vi) All activities to be supported under the Project will meet the nationalenvironmental standards and EIA procedures which are based on ADB’sEnvironmental Guidelines for Selected Agriculture and Natural ResourcesDevelopment Projects and for Selected Infrastructure Projects and no CategoryA or B subproject will be approved for financing without a comprehensive EIAreport reviewed and approved by the Henan EPB.

(vii) Each industrial unit to be served by the water supply component will be requiredto submit to the IA a certificate from the appropriate environmental authorities ofthe Government stating that the unit fully meets the national standards forindustrial emission, wastewater treatment, and solid waste disposal.

(viii) Tree crop production will not be permitted on protected arable land, as defined bythe Land Administration Law, or on slopes greater than 25 degrees.

(ix) PFB will onlend the proceeds of the subsidiary loan to municipal and countyfinance bureaus at the same rates and terms as the ADB Loan. PGH will ensurethat adequate counterpart funds are made available in a timely manner. With theexception of onlending to enterprises and water supply and irrigation companies,the municipal and county finance bureaus, where appropriate, will bear theforeign exchange risk.

(x) With the exception of onlending to water supply and irrigation companies, therespective finance bureaus will onlend funds to end users at terms andconditions satisfactory to ADB and at a rate of interest not lower than the rates ofinterest for equivalent lending by commercial banks.

VII. RECOMMENDATION

119. I am satisfied that the proposed loan would comply with the Articles of Agreement ofADB and recommend that the Board approve the loan of $64,300,000 from ADB’s ordinarycapital resources to the People’s Republic of China for the West Henan AgriculturalDevelopment Project, with a term of 25 years, including a grace period of 5 years and withinterest to be determined in accordance with ADB’s pool-based variable lending rate system forUS dollar loans and such other terms and conditions as are substantially in accordance withthose set forth in the draft Loan and Project Agreements presented to the Board.

TADAO CHINO President

27 November 2000

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APPENDIXESNumber Title Page Cited on

(page, para.)

1 External Assistance to the Agriculture Sector in --,29Henan Province

2 Poverty and Social Dimensions Analysis, and --,63Summary Resettlement Action Plan

3 Project Framework --,67

4 Detailed Cost Estimates --,74

5 Implementation Arrangements, --,80Organization Chart, and Implementation Schedule

6 Contract Packages --,84

7 Financial and Economic Analyses --,100

SUPPLEMENTARY APPENDIXES(available on request)

A Detailed Description of Project Components

B Summary Environmental Impact Assessment

C Resettlement Plan

D Marketing Assessment

E Pilot Enterprise Analysis

F Project Costs

G Supporting Tables for Financial and Economic Analyses

H Poverty Assessment

Appendix 1, page 1

EXTERNAL ASSISTANCE TO THE AGRICULTURE SECTOR IN HENAN PROVINCE

1. The World Bank has been the main source of external assistance to the agriculture andrural development sector in the People’s Republic of China (PRC). All previous World Banklending to agriculture and rural development used concessional funds under the InternationalDevelopment Association (IDA).

2. The World Bank has successfully supported provincial multicomponent areadevelopment projects prepared and implemented by the local governments. Eleven World Bankprojects covered Henan Province with a total investment of $250.8 million. Four of them focusedon forestry, two on livestock, two on irrigation, two on seed commercialization, and one onagricultural development. The latter project is the Henan Agriculture Development Project(HADP) which, between May 1991 and June 1998, provided $110 million in foreign exchange.HADP is very similar to the proposed Project. It covers 20 counties in the northern and easternpart of Henan (along the Yellow River). HADP comprised an agroprocessing component for 11plants, horticulture, livestock and some pig farms. After evaluating progress, the World Bankpresented HADP to the other provinces as a model project. In contrast to critical ratings by theMinistry of Finance (MOF) of agroprocessing projects in other parts of the PRC (36 percentsuccess rate), the agroprocessing component in Henan Province ($38 million investment) wasfound to be 80 percent successful, although there are ongoing difficulties in relation to operatingfunds.

3. In Henan, the Food and Agriculture Organization (FAO) completed two fruit processingprojects with a total investment of $15.1 million, and the World Food Programme (WFP) fundeda farmland rehabilitation project, with investments of $16.6 million.

4. A participatory poverty reduction project in Tongbai County was supported by the UnitedNations Children’s Fund (UNICEF). The project started in 1997 and covered six townships witha total investment of Y2.14 million. The project integrated social development, capacity building,and empowerment of women, with income-generation activities. It used a participatorymethodology to select and implement project activities, and community development throughgroup formation and training was a priority activity.

5. Bilateral projects in Henan have been relatively few. The Japan InternationalCooperation Agency (JICA) supported a project for the rehabilitation of rice fields ($3 million). Afruit processing project in the province was financed by a Japanese nongovernmentorganization (NGO). Previously, the United Kingdom (UK) had a $7.1 million duck raisingproject in the province. The Netherlands is currently supporting a dairy cow project.

6. The Henan Water and Irrigation Project of the German Agency for Technical Cooperation(GTZ) was started in early 1998. The project covers 57 communities of eight townships in fourof the project counties: Songxian and Yichuan in Luoyang City, Neixiang and Xichuan inNanyang City. The GTZ project was designed to improve the conditions of water supply andirrigation in the project area. Total project investment was Y12.46 million, of which Y5.85 millionwas from GTZ, Y4.52 million from the local counterpart fund, and Y2.09 million was the value oflocal labor. The water supply works were expected to help 7,800 people in the project area toaccess safe drinking water. The water conservation component, including construction ofterraces and dams, and planting of tree crops, will cover 719 ha and 930 households.

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Appendix 1, page 2

7. Between 1987 and 1998, the Asian Development Bank (ADB) has financed 10 loans (for8 projects) in the agriculture sector in the PRC with a total investment of $779.6 million, and 53technical assistance (TA) grants amounting to $31 million. This Project will be ADB’s first inHenan. In the past, the Government’s foremost concern in selecting projects for externalassistance was the capacity of the executing agency to repay the loan. In view of thisconsideration, ADB’s program in agriculture needed to focus on revenue-generating productionand agroprocessing projects to justify the Government’s use of funds from the ordinary capitalresources (OCR). As a result, ADB financing for agriculture focused on agricultural productionand production credit. In the mid-1990s, increased environmental concerns were integrated intothe project designs. With economic reforms and more emphasis placed on poverty reduction,ADB now has new opportunities to diversify its operations in the sector and specifically addresspoverty.

8. Table A1 provides a summary of foreign assistance projects to the agriculture and ruraldevelopment sector in the PRC from 1984-1998.

Table A1: Foreign Assistance to Agriculture and Rural Development (1984-1999)

Origin Loans Technical Assistance andGrants

Number Amount($’ million)

Number Amount($ million)

Asian DevelopmentBank

10 779.6 53 31.0

Australia 2 12.0Canada 3 46.2European Union 2 13.7Germany 21 82.9IFAD 9 214.1Japan 26 459.3Norway 1 9.7United Kingdom 1 6.4WFP 20 302.3World Bank 71 10,303.0

TOTAL 117 11,670.9 102 589.3

Note: The sector comprises investments in agriculture (including livestock, land improvement/soil conservation),agroprocessing industries, and irrigation.

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Appendix 2, page 1

POVERTY AND SOCIAL DIMENSIONS ANALYSIS, AND SUMMARYRESETTLEMENT ACTION PLAN

A. Introduction

1. The Project specifically targets poverty intervention by addressing critical agriculturaland water supply constraints in a poor inland province. Because the water supply and irrigationcomponent necessitates some resettlement from the pump site and regulating reservoir, aresettlement action plan was prepared.

B. Socioeconomic Profile of Potential Beneficiaries

2. Demographic features. Agricultural communities in West Henan constitute about 83percent of the total population, rising to 95 percent in Yichuan and Songxian. Twelve of the 32counties in the project area are nationally designated poverty counties.1 While 98.4 percent ofthe population is ethnically Han, there are 18 different ethnic minority groups in the project area.Most counties have one or more ethnic minorities, on average 12 minority groups each. Almost80 percent of the total minority population is accounted for by the three largest minorities:Muslim Hui, 61 percent of all minorities and 1 percent of total population, are concentrated inZhengping, Dengfeng, Yuzhou, and Xinmi counties; Manchus, 11 percent of minorities, areconcentrated in Nanzhao County; and Mongols, 7 percent of minorities, are concentrated inNeixiang County. The average household size is 4.20, slightly smaller than the provinceaverage of 4.59. Average household sizes in counties range from 3.3 in Luoyang to 5.0 inYichuan. The average family size in Henan Province is 3.86, suggesting that, on average, mostfamilies have one additional household occupant (often a grandparent).

3. Settlement pattern and production systems. Population density in West Henan is 463households per square kilometer (km²), or 1,945 people per km². Households range from 91 perkm² in Songxian to 1,101 per km² in Yima. On average, 41 percent of the population live inmountainous areas with over 90 percent in Xichuan, Lushi, Songxian, Nanzhao and Luanchuan.More than half of the slopes in the mountainous areas are over 25 degrees and, thus, cropcultivation on them is officially prohibited.

4. Due to the uneven distribution of good and poor land under agricultural reform, mostfarms comprise several plots of varying quality, resulting in diversified farming systems ratherthan monoculture. In the project area, almost half of the arable land is wholly or partiallyirrigated.

5. Many villages in the hilly areas are difficult to access by road and lack electricity. Inaddition, 14.8 percent of the households in the project area lack adequate drinking water.2 Theaverage household size in 332 sample families in the project area was 5.47,3 compared with theaverage of 4.2 in West Henan.

1 They are Yiyuang, Xin’an, Ruyang, Luoning, Yichuan, Songxian, Luanchuan, Lushan, Mianchi, Lushi, Nanzhao,

and Xichuan.2 With the exception of Mengxia, all counties and 27 percent of the townships (i.e., 13,484 villages) in the project

area experience potable water shortages. The situation is most severe in Shanxian (24 percent of households) andLuanchuan (14 percent).

3 Minority families are exempted from strict family planning targets.

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Appendix 2, page 2

6. Labor availability and gender issues . The labor force in West Henan is about 8 millionpeople, or 45.5 percent of the population. Total employment in the People’s Republic of China(PRC) increased by 9.46 percent from 1990 to 1998. At the same time, employment in Henanincreased by 22.4 percent. Most new employment in Henan over 1990-1998 was absorbed inthe rural areas, although not necessarily in agriculture.

7. The ratio of the male-to-female working population is 52:48. On-farm tasks are typicallyundertaken equally by men and women with few exceptions, such as men undertaking treefelling and women traditionally raising pigs. Survey data suggest that households relyingprimarily on their own labor are income maximizers, placing priority on increased economicactivity over increased leisure. This work ethic contributes to effective labor availability.

8. There is a slight male bias in the total workforce, but the gender-biased seasonalmigration of male labor to off-farm activities results in a developing female bias in farm labor.Women rarely undertake off-farm employment, using slack time for cottage industry andhousehold tasks, but men increasingly take advantage of greater off-farm employmentopportunities. Tree crops, requiring little labor input compared with arable crops except inharvesting, will increase the amount of slack time for both men and women. The result will beincreased seasonal migration of male labor and increased farm-based activities, such ascottage industry, vegetable growing, and small livestock raising by women.

9. Current income status. The latest detailed income survey of the project area wasundertaken in 19954 (Table A2.1). In 1995, about 36 percent of the horticulture households hadincomes in the band immediately above the poverty threshold, corresponding to theinternational poverty standard. In total, almost 70 percent of the target horticulture householdswere below or only marginally above the international poverty standard.5 Around 61 percent oftarget livestock households were below or only marginally above the international poverty line.6

10. The per capita net income of rural dwellers in the PRC increased 46.8 percent from1990 to 1998. The growth rates of farmers' income in the project area and Henan Provincewere 119 percent and 72.4 percent, respectively, during the same period. The disposableincome of residents in urban areas in the PRC and Henan increased 66.5 percent and 61.1percent, respectively, from 1990 to 1998. Despite this growth, the majority of the projectbeneficiaries have annual incomes below the average rural incomes in the PRC and below theHenan annual average rural income of Y1,864.7

4 Although there have been changes in project design since 1995, the target group of beneficiaries has remained the

same.5 In 1995 prices, the officially determined poverty threshold income for Henan was Y530 per capita (currently Y700).

In target groups for horticulture development, 32.7 percent of households had incomes below Y530, including 17percent with incomes below Y400 per capita.

6 The proportion of households below the official poverty level in 1995 was 23.1 percent. About 38 percent oflivestock households were in the marginal group above the poverty level.

7 One third of beneficiaries were estimated to be below the official absolute poverty level in Henan Province of Y700per annum (compared with 29.9 percent in 1995). This suggests that the distribution of poverty among potentialbeneficiaries remains as in the 1995 survey.

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Appendix 2, page 3

Table A2.1: Income Status of Farmer Households in the Project Area (1995)

Item Horticulture LivestockWater Supplyand Irrigation Total

185,222 21,000 18,645 218,367Total Households Persons 775,034 89,073 51,277 916,104

Per Capita Income in 1995 (yuan)

31,780 1,381 0 33,101<400 Households Persons 136,804 5,383 0 142,267

28,814 3,467 0 32,281400 – 530 Households Persons 121,660 13,874 0 135,534

66,118 7,905 210 74,233531 – 850 Households Persons 280,065 33,301 840 315,000

40,799 3,020 2,422 49,041851 - 1,232 Households Persons 164,576 26,261 10,210 201,047

11,269 2,207 5,404 18,8801,232 – 1,578 Households Persons 43,421 9,261 21,580 74,262

5,442 200 4,609 11,331> 1,578 Households Persons 20,428 993 18,647 40,068

11. Social development . Social development has progressed significantly in Henan and thePRC after the economic reforms. From 1978 to 1998, life expectancy at birth rose from 68.2 to70.8 years in the PRC, and from 68 to 70 years in Henan. The adult illiteracy rate declined from22.8 to 15.78 percent in the PRC, and from 21 to 14.44 percent in Henan.

C. Poverty Focus

12. Poverty in the PRC. The PRC has made significant progress in reducing the incidenceof poverty and improving the living standards of the majority of its population. From 1990 to1998, the input of funds from the central Government to poverty reduction increased almostthree times. Using international standards, currently about 106 million people, or around 13.5percent of the rural population, live in poverty.8 Only 0.8 percent of the urban population livebelow the poverty line of $1 per day, but consumption requirements are higher and a povertyline of at least $2 per day is more relevant. As a by-product of enterprise and other structuralreforms, poverty is reappearing in urban centers and non-income poverty indicators may bemore important.

8 In this period, the incidence of official absolute poverty declined from 9.4 percent to 4.6 percent in the PRC. Such

absolute poverty is concentrated in the remote and interior provinces. The latest official statistics suggest thatcurrently about 34 million inhabitants live in absolute poverty.

40

Appendix 2, page 4

13. Government policy toward poverty reduction has followed an area-based concept ratherthan beneficiary targeting. In 1994, 592 counties were identified as particularly poor, andGovernment investments were concentrated in these areas. The Poverty Alleviation andDevelopment Office (PADO) was set up at the national, provincial, and county levels to promotearea-based development in poverty counties. Funds were used according to local plans forlabor-intensive infrastructure (particularly farm-to-market roads and irrigation), agriculturaldevelopment, and livelihood and rural micro-credit projects.9 PADOs at the local levels areresponsible for identifying projects and beneficiaries and maintain a very good recording systemof poor households.

14. Particularly vulnerable households such as those of the disabled,10 the elderly, thosewithout shelter, (i.e., the five guarantee households) are supported by the Civil Affairs Bureau(CAB), which undertakes welfare work, distributes grain to households in need, undertakessome livelihood training, and provides disaster relief.

15. Poverty incidence in Henan Province . The rate of reduction of rural poverty in Henanhas been much higher than in the PRC as a whole. Henan reduced its official rural povertyincidence from 16.5 percent in 1989 to 4.1 percent in 1998. However, the incidence of absolutepoverty in the project area was 50 percent higher than in Henan and the PRC in 1998,indicating that the area needs special attention to poverty reduction. Henan has 10 percent ofthe poor in the PRC, and 10 percent of the rural population.11 Between 12 million and 18 millionpeople in Henan are seasonal surplus laborers, and 6 million are employed in industry andservices.

16. The provincial government of Henan (PGH) is highly committed to reducing poverty. Ofthe Y18.3 billion budget provision for poverty reduction in 1997 from the central Government,Henan received Y1 billion, of which about Y360 million was allocated for the 12 poverty countiesin the project area. In addition, the province, prefectures, and counties raised Y30 million fromtheir own revenue to complement the budget in the poverty counties. Thus, each poverty countyhas a budget of about Y60 million for poverty reduction.

17. The remaining absolute poor and welfare households (about 0.25 million) in West Henanare often located in isolated upland regions with few natural resources and lack the human andphysical assets to benefit from or make use of economic growth. New approaches to povertyreduction programs and more sensitive targeting mechanisms may help to bring them into theeconomic and social mainstream.

18. The standards for defining poor townships and villages have changed with time. Thestandards were Y1,280 and Y1,000, respectively, in 1998 current prices. Poor townships andpoor villages in Henan were 237 and 2,962, respectively. In 1998, 1.52 million poorest of thepoor rural dwellers lived in neither national nor provincial poor counties, and accounted for 47.6percent of the total poor rural population in the province. The poor population in nonpoorcounties were in 1,540 villages of 53 counties.

9 Although the Government program has achieved remarkable poverty reduction, there are some criticisms about the

sustainability of the subprojects and the spending of funds. An evaluation by the former State PlanningCommission showed that out of the Y10 billion special funds for poor counties allocated in 1994, Y2 billion was notproperly allocated or was misused

10 Generally, the rural disabled are not included in the statistics of rural poor.11 In 1997, about 4 million people in Henan (5 percent of the provincial population) lived below the official provincial

per capita annual poverty threshold of Y700 ($85), down from 13.8 million in 1986.

41

Appendix 2, page 5

19. Poverty in the project area. The poor population in Henan is unevenly distributed. Ofthe 17 regions at prefecture level, 5 (Nanyang, Luoyang, Zhumadian, Xingyang, andPingdingshan) are considered particularly poor (Table A2.2). Three of the five regions in whichthe poor population is concentrated are in the project area. According to the internationalpoverty threshold, about 70 percent of the targeted households for horticulture and 61 percentof those for livestock in West Henan are living in relative poverty.

20. Of the 22 counties and three other administrative areas or districts currently committedto participating in the Project, 9 are officially designated national poverty counties, but poverty isspread throughout all the project counties, even in the urban areas. About 12 percent of the12.6 million population in the project area live below the international poverty threshold,compared with 9 percent nationwide.

Table A2.2: Distribution of Rural Poverty in Henan (1998)

Region Poor counties(%)

Poor townships(%)

Poor villages(%)

Total 100.0 100.0 100.0Xingyanga 26.5 25.7 14.4Luoyanga 20.6 13.9 11.2Zhumadian 14.7 9.7 11.0Shangqiu 11.8 1.7 3.3Nanyanga 8.8 9.7 10.1Puyang 8.8 12.2 7.8Sanmenxiaa 5.9 2.1 5.2Pingdingshana 2.9 9.7 9.1Zhengzhou 0 2.1 4.1Kaifeng 0 7.6 7.4Xinxiong 0 4.2 5.2Anyang 0 0.4 3.0Kebi 0 0.8 2.5Jiyuana 0 0 2.5Zhoukou 0 0 1.4Jiaozhuo 0 0 1.2Xuchang 0 0 0.5

aCounty within the project area.

Source: Henan Provincial PADO.

21. In the project area, 41.6 percent of the poor rural population reside outside thedesignated poor counties. The proportion of the poor population living in the nonpovertycounties has increased with time, mainly due to the effective regional targeting policy for povertyreduction. Since the mid-1980s, poor counties in Henan have received poverty reduction fundsof Y5 billion, while the poor households in nonpoor counties received almost nothing before1998. Compared with poverty in the officially designated poor counties, the situation of poorhouseholds in nonpoor counties is even worse. In 1998, the per capita income and consumptionexpenditure for the poor in nonpoor counties were 9.1 percent and 8.8 percent lower than thosefor the poor in the poor counties.

22. There is a clear correlation between non-income measures and poverty in the projectarea (Table A2.3). Poor families have less arable land, consume more than they earn, have

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Appendix 2, page 6

smaller and poorer quality housing, and are more likely to be illiterate. Accordingly, per capitanet income acts as an adequate proxy for other quality-of-life measures in the project area.

Table A2.3: Income distribution and variation of non-income welfare in project area(1998)

Item Average < Y700Y700-Y962

Y962-Y1,924

Y1,924-Y3,140

Y3,140-Y6,280

> Y6,280

Per capita net income 1,912.7 550.9 842.4 1,437.0 2,388.9 4,030.3 8,320.1Per capita arable land (mu) 1.25 0.98 1.01 1.19 1.38 1.48 1.23Per capita consumptionexpenditure 1,234.1 799.7 824.7 1,039.1 1,422.9 2,141.4 3,082.3Per capita housing area (m2) 24.3 17.8 18.6 23.0 26.2 32.8 36.4Adult illiteracy rate (%) 4.2 7.0 6.8 4.3 3.9 1.4 1.6Source: Henan Provincial Rural Social and Economic Survey Team

D. Poverty Reduction as a Secondary Project Objective

23. Strategic thrust. Sustainable poverty reduction must structurally address thesocioeconomic conditions that prevent poor people from creating opportunities for themselvesand allow the Government and other stakeholders to include vulnerable groups in thesocioeconomic mainstream. Hence, projects with poverty reduction as a strategic developmentobjective need to change the underlying conditions that cause poverty, in addition to includingpoor people as project beneficiaries.

24. Baseline socioeconomic information and the PGH commitment to poverty reductionhave been used to determine the new poverty classification most appropriate to the Project.The Asian Development Bank’s (ADB’s) current classification system requires that in a projectwith poverty as a secondary development objective, at least one third of direct beneficiariesmust be poor, or one or more of the project components and 20 percent or more of the totalproject budget must be designed specifically for the poor. This Project meets theserequirements and adds a specific poverty targeting and monitoring mechanism.

25. ADB’s Poverty Reduction Agreement with the central Government will be prepared in2000. PGH indicated its strong support for the Project’s help to the poor and noted that ADB'snew strategy is in line with current Government policy calling for sustained efforts to eradicateabsolute poverty. The project area poverty agencies and the Rural and Urban InvestigationTeams of the Statistics Bureau will assist the implementing agencies (IAs) to select at least 40percent of the direct rural and urban beneficiary households with an annual per capita incomelevel below $1 and $2, respectively. The agencies will use the established poverty recordingsystem to monitor the contribution of the Project to poverty reduction. The agencies will preparean annual progress report to be integrated in the progress report of the Project ManagementOffice (PMO), which can be used for further beneficiary targeting and adjustment of the projectdesign.

26. Generating income and employment. Project components are integrated to benefit thepoor. By (i) focusing on labor-intensive production in horticulture and livestock, (ii) assuring afair mechanism of income distribution between pilot enterprises and households, and (iii)addressing problems in the rural marketing system, the Project will significantly reduce povertyand promote equitable growth on a sustainable basis. The Project will also stimulate ruraleconomic growth (primary objective) and will directly benefit about 0.9 million people in WestHenan.

43

Appendix 2, page 7

27. During implementation, project impact data need to be generated: (i) the increase in theaverage per capita income in West Henan during the project period, (ii) the number ofhouseholds in the target area lifted out of poverty, and (iii) the Project’s contribution to reductionof the incidence of poverty in the province.

28. Targeting poor beneficiaries. PADO and other poverty agencies will work together withPMO to ensure that at least 40 percent of the beneficiary households are currently pooraccording to international poverty definitions. However, selection needs to be carefully done soas not to threaten the economic viability of the subprojects. The selection process will betransparent and villagers will be able to comment on whether the process is equitable andaccurate.

29. Financing ongoing poverty reduction. The Project will generate at the county level asustainable mechanism to finance poverty reduction. By establishing a revolving fund, theProject will enable the county governments to generate additional income that can be targetedfor additional poverty reduction projects in agriculture. Early repayments from onlending to endusers will be channeled through the Provincial Finance Bureau (PFB) to supplement the budgetof PADO and/or the participating technical agencies. For example, the provincial povertyreduction budget for the 99 Henan counties is currently about Y60 million: Y30 million from thecentral and Y30 million from the local governments. The Project could generate about Y40million per year as additional agricultural funds for 22 counties in West Henan.

E. Summary of Resettlement Action Plan (RAP)

30. Land totaling 2,448 mu (1 mu = 0.06 ha) will be acquired for the Project, and 367households (1,603 people) will need to be resettled. The RAP formulates measures to alleviateadverse impacts in accordance with national and regional laws and regulations and theresettlement policies of ADB. The objective is effective land acquisition and resettlementactivities so that the production and livelihood of the affected population can be restored to thepre-project level (if not higher).

31. The pump site works affect Xipo village, Chencun Xiang, Mianchi County, and the wholevillage has to be relocated. Xipo has 29 households and a population of 130. The averagefamily size is 4.13 persons, and the average farmland is 1.6 mu per person. It is very difficult toget drinking water, and the villagers fetch water 3 km away from the village. Accommodationsare poor, and most villagers live in mudbrick and wood houses and caves. In 1996 (beforerelocation), the average annual household income was Y5,200: Y1,800 - Y3,000 for 4households, Y3,000 - Y6,000 for 19 households, and Y6,000 - Y9,200 for 6 households.

32. The Xiduan village regulating reservoir affects Xiduan village of Chidi Xiang, Houhe andChencun villages of Chencun Xiang. There are 338 resettlement households (1,473 people).The average farmland is 2.4 mu, and the average family size is 4.01. The average income perperson is Y2,295, 19 percent higher than the average for the countyY1,927.

33. A detailed land acquisition and resettlement design was completed in 1996 and aResettlement Management Office was set up at Huaiba Water Resources Bureau. The draftresettlement plan was reviewed by ADB consultants (and staff) at least three times since 1996and has been substantially improved by the time of appraisal. Two of the five planned newresettlement villages have already been set up, and 125 households (496 people) have been

44

Appendix 2, page 8

resettled. Of the four planned schools, two have been set up and put into operation. To date,an area of about 1,000 mu has been acquired.

34. The RAP preparation encompassed the following steps.

(i) Set up resettlement management organization.(ii) Determine the scope of land acquisition and relocation according to the project

design.(iii) In accordance with the requirements of Reservoir Inundation Treatment Design

Specification for Hydropower Projects and the Physical Index InvestigationGuidelines for Reservoir Inundation by Hydropower Projects issued by theMinistry of Water Resources, investigate the physical conditions in the landacquisition area. The social and economic conditions in the affected area of theProject are also to be investigated.

(iv) Determine the appropriate rates of compensation for land acquisition andresettlement.

(v) Verify the results of physical index investigation and household questionnaires.(vi) Select relocation destinations for the people to be resettled.(vii) Formulate livelihood resettlement plan for new settlers.(viii) Formulate production resettlement and income restoration plan for the new

settlers.(ix) Formulate a resettlement implementation plan.(x) Before implementing the resettlement plan, provide systematic training to the

staff at the resettlement office.(xi) Formulate reporting mechanisms and hire a monitoring and evaluation

organization.(xii) Prepare to organize for implementation.(xiii) Publicize the resettlement plan and seek feedback from affected persons.

35. The county resettlement office formed a property measuring team with the townships,villages, and production teams concerned, and the properties of the people to be resettled havebeen measured, calculated, and verified according to different categories. The settlers areinvolved in the measuring process, the results are publicized on the spot, and the settlersconcerned acknowledge the results by signing the documents. The results are posted asbulletins, so that the settlers can monitor the calculated property results for the village. Thecompensation rates and the amount for each household are publicized on bulletin boards, andafter verification by the resettlement household concerned, registration cards are filled out foreach item and each household. Then the household, production team, village, township, andcounty sign and stamp the card. One copy is kept in archives, the other copies are kept by theresettlement household concerned, the Relocation Branch. and the Finance Branch of theCounty Resettlement Office, respectively.

36. The survey shows that 367 households (1,603 people) must be relocated, andproduction resettlement carried out for 1,551 people. The Project needs to acquire 2,448 mu,including 2,061 mu farmland, accounting for 84 percent of the total amount of land acquired.Channel construction requires the lease of 613 mu. Houses totaling 48,046 m2 will be relocated,including 4,476 m2 brick-cement houses, 20,027 m2 brick-wood houses, 1,248 m2 brick caves,9,160 m2 earth caves, and 2,703 m2 houses of other types.

4545

Appendix 2, page 9

37. The land compensation rate for permanently acquired land is determined at six times theunit output, plus a resettlement subsidy at four times, giving a total land compensation rate of tentimes the unit output. The farmland compensation rate was calculated to be Y2,570 per mu. Theannual output value of fruit orchards was calculated on the basis of produce and price, and amature fruit garden ready for harvest was estimated at Y15,000 per mu, while an immatureorchard was Y4,500 per mu. The compensation for land for housing and public work areas is thesame as for dry land. In addition, each resettled household receives resettlement subsidies formoving and transportation, material loss, loss of work, and others.

38. Five new resettlement villages are planned: Xipo of Huaiba village, Dongling of Duancunvillage, West Slope of Duancun village, South Slope of Houhe village and North Slope of Houhevillage. The new villages have advantageous locations and flat surfaces. Vacant landsurrounding the villages ensures the potential for future development. More important, the newvillages are within 1 km of the original villages, so that the transportation, power, and watersupply facilities are easily upgraded.

39. The following preferential policies apply to the resettled persons: (i) projects related toindustrial and agricultural production in the project area are given priority, and in the recruitmentprocess, the workforce of the resettled and the residents of the relocation destinations are givenpriority; (ii) agricultural aid, poverty-aid fund, and other social development funds such astransportation, post, education and health services are provided to support the livelihood andproduction activities of the resettled: (iii) housing construction for the resettled households isexempt from the farmland utilization levy, land utilization levy, real estate taxes, and other fees;(iv) the industrial, agricultural, and animal farming levies of the townships are adjustedaccording to the impact after relocation; (v) stone, sand, and roof tiles for the construction of thesettlers' new houses are exempt from the mineral resource levy; and (vi) a support fund is setup as a poverty-aid fund for the new settlers in later stages, to ensure that they can make aliving even in special circumstances. The settlers from the reservoir area also benefit from thereservoir area maintenance fund and the reservoir area construction fund. The directcompensation for such settlers (land, houses, relocation, and house construction subsidy) totalsY22.3 million. Relocation of public facilities costs Y4.8 million, while other costs are Y1.8million. Combined with price and physical contingencies, the total resettlement cost is Y27.9million ($3.4 million), which has been incorporated in the project costs.

F. Summary

40. In summary, the Project is expected to bring direct benefits to approximately 205,000households. The plan is to have at least 40 percent of poor peopleaccording to theinternational poverty standardamong the Project area beneficiaries. About 340,000 people12

are expected to increase their per capita income above Y1,000 as a result of the Project.

12 The total number of beneficiaries is derived from the production models. Counties responded to a questionnaire

identifying the poor townships and villages they would include in the Project, and the proportion of poor peoplewithin those poor areas identified for each project activity.

46

Appendix 3, page 1

PROJECT FRAMEWORK

Design Summary Targets Means of Verification Risks and Assumptions1.Project Goal• Promote economic growth

in poor and disadvantagedwestern areas in HenanProvince

• Reduce rural poverty

• Increased value ofagricultural outputs

• Decreased number ofhouseholds living belowthe poverty line

• Provincial statistics• Benefit monitoring

and evaluation (BME)system and projectcompletion report

• Government policiesare favorable toagricultural production

• SustainableGovernment investmentin rural infrastructure

• Government remainscommitted to povertyreduction

2. Project Purpose• Increase agricultural

production and ruralincomes through integratedagricultural development

• Poverty reduction throughtargeted assistance to poorrural households

• Sustainable incrementalannual production of- 72,600 tons (t) fruits

and 198,275 tvegetables

- 2,640 t medicinalleaves, barks, andnuts

- 17,955 cattle (18-mosurplus and culls),122,400 sheep(surplus and culls),122,400 goats(surplus and culls),and 105,440 pigs(piglets, porkers, andculled sows)

- 4,600 purebred sows& boars, 20,000crossbred sows

• Provision of 83 millioncubic meters (m3) watersupply for rural, urban,and industrial uses

• Increased incomes andquality of life for about900,000 beneficiaries,including 280,000 poorpeople (>30 percent),amounting to one thirdof remaining poorpeople, in the projectarea

• Provincial statistics• BME system• Postevaluation

reports

• Market prices foragricultural products arestable.

• Farmers respondfavorably to land andwater resourcesmanagementtechnologies.

• Changes in productiondo not adversely affectindividual workload andhousehold labor division

• Appropriate measuresfor mitigation of adversesocial andenvironmental impactsare carried out duringproject implementation

• Government suppliescredit services tobeneficiaries.

3. Component/Output3.1 Horticulture

Development• Rehabilitation of apple

orchards through varietalimprovements

• Establishment of new fruitorchards, medicinal plantplantations, and vegetableproduction under field andgreenhouse conditions

• Developed 3,200hectares (ha) for apple,increased annualproduction by 38,400 tof early-maturingvarieties

• Developed 1,200 haChinese dates,increased production by4,200 t/year

• Project progressreports and reviewmissions

• Project completionreports

• Postevaluationreports

• Nursery certificationscheme will beestablished and properlyoperated

• Farmer trainingprograms will beeffectively carried out

47

Appendix 3, page 2

Design Summary Targets Means of Verification Risks and Assumptions• Developed 1,400 ha

kiwifruit, increasedproduction by 30,000t/year

• Developed 1,900 hagingko, increasedproduction by 1,140 tnuts/year

• Developed 600 haeucommia, producingleaf 1,125 t/year andbark 375 t/year

• Developed 2,800 ha offield vegetables,producing 176,400t/year

• Developed 5,000 sets ofgreenhouses, producing21,875 t/year ofvegetables

• Total householdsbenefiting about107,500, with averagegross income of Y6,130($740) per poorhousehold per year andY15,360 ($1,850) perless-poor household peryear

• Orchard farmers areissued land use rightslong enough to providethem incentives forinvesting in landdevelopment andorchard establishment

• Adequate credit isprovided for investmentand working capital

3.2 Livestock Development• Development of livestock

activities at household level• Development of pilot

livestock enterprises

• 9,500 householdsbreeding and raisingcattle, producing 15,58018-mo. cattle and 2,375culls per year

• 7,200 householdsbreeding and raisinggoats, producing108,000 surplus animalsand 14,400 culls peryear

• 7,200 sheep-raisinghouseholds, producing108,000 sheep and14,400 culls per year

• 2,000 poor pig-raisinghouseholds, raising68,000 pigs

• Establishment of 2breeding piggeries withcapacity to produce4,600 purebredbreeding animals,20,000 crossbred sows,25,000 piglets, 11,200porkers, and 1,240culled sows per annum

• About 167,000beneficiary householdswith average gross




• Farmer training programwill be carried outeffectively

• Adequate technicalservices will be madeavailable to monitor thefeed mix for livestockfattening activities

• Adequate credit isprovided for investmentand working capital

48

Appendix 3, page 3

Design Summary Targets Means of Verification Risks and Assumptionsincomes of Y6,480($781) per poorhousehold per year andY15,710 ($1,892) perless-poor household peryear

3.3 Water Supply andIrrigation Component• Development of facilities for

diversion and conveyanceof water for rural, urban,and industrial uses,involving construction of(i) pumping station at

Huaiba,(ii) 12.4-kilometer-long

conveyance system withmultistage pumping,

(iii) an earth-filled dam with24.6 million m3 capacity,

(iv) expansion of waterreticulation system inthe service areas,

(v) development of irrigationfacilities, and

(vi) resettlement of 367families

• Delivery of 83 millionm3 water per annum tobenefit 23,000 livestockand 197,500 people in22 rural villages, 2towns, 14 small andmedium-size industries,1 thermal power station,and 1,300 ha of fruitorchards

• North irrigation area of1,300 ha to benefitabout 6,500 households

• Project progressreports



• Construction of the damwill be supervised by aDam Safety Panel

• The resettled populationwill be adequatelycompensated so thattheir living conditionsare at least as good asthose without the Project

• Water tariffs for varioususers will be set at suchlevels so as to recoverat least the investmentand operation andmaintenance costs

• The reservoir will notaffect any critical habitatof flora and fauna, orany cultural relics.

• Government willproceed withconstruction ofsewerage treatmentsystem, using localfunds.

• Adequate credit isavailable for investment

4. Activities/Inputs$ million

FX LC Total• Horticulture development 16.6 31.0 47.6• Livestock development 11.3 18.7 30.1• Water supply and irrigation 20.1 26.6 46.8• Project management 0.4 2.1 2.5

Base Cost 48.4 78.6 127.0Physical Contingency

Price ContingencyIDC Commitment

Front-end FeeTotal


• Project completionreport

• Project accounts

• Local counterpart fundswill be available on timeand in adequate quantity

IDC - interest during construction

49

% % TotalYuan Ten Thousand $ million Foreign Base

Item Local Foreign Total Local Foreign Total Exchang e Costs

A. Water Supply and Irrigation System Huaiba Water Supply System 15,314 9,776 25,090 18.45 11.78 30.23 39.0 23.8Mianchi Water Treatment & Distribution 2,085 1,871 3,955 2.51 2.25 4.77 47.3 3.8Yima Water Treatment & Distribution 2,211 2,269 4,480 2.66 2.73 5.40 50.7 4.3Mianchi Irrigation Company 2,505 2,797 5,303 3.02 3.37 6.39 52.8 5.0

Subtotal Water Supply and Irrigation System 22,114 16,714 38,828 26.64 20.14 46.78 43.0 36.8B. Horticulture

1. Tree Crops Apples 4,000 2,217 6,217 4.82 2.67 7.49 35.7 5.9Ginkgo 3,863 1,665 5,528 4.65 2.01 6.66 30.1 5.2Kiwifruit 3,988 1,805 5,794 4.81 2.18 6.98 31.2 5.5Eucommia 1,014 428 1,442 1.22 0.52 1.74 29.7 1.4Chinese Dates 1,216 580 1,795 1.46 0.70 2.16 32.3 1.7

Subtotal Tree Crops 14,081 6,696 20,776 16.96 8.07 25.03 32.2 19.72. Vegetables

Greenhouses 5,644 3,711 9,355 6.80 4.47 11.27 39.7 8.9Irrigated Field Vegetables 6,037 3,331 9,368 7.27 4.01 11.29 35.6 8.9

Subtotal Vegetables 11,681 7,042 18,723 14.07 8.48 22.56 37.6 17.8

50

Subtotal Horticulture 25,762 13,737 39,499 31.04 16.55 47.59 34.8 37.5C. Livestock Development

Household Cattle Production 5,948 3,390 9,338 7.17 4.08 11.25 36.3 8.9Household Sheep & Goat Production 4,172 2,298 6,470 5.03 2.77 7.80 35.5 6.1Commercial Pig Breeding 2,764 2,573 5,336 3.33 3.10 6.43 48.2 5.1Household Pig Production 2,675 1,146 3,821 3.22 1.38 4.60 30.0 3.6

Subtotal Livestock Development 15,558 9,407 24,965 18.74 11.33 30.08 37.7 23.7D. Project Management 1,771 340 2,111 2.13 0.41 2.54 16.1 2.0Total Costs 65,205 40,198 105,403 78.56 48.43 126.99 38.1 100.0

Physical Contingencies 3,384 2,124 5,507 4.08 2.56 6.64 38.6 5.2Price Contingencies 2,121 1,859 3,980 2.56 2.24 4.80 46.7 3.8

Total Costs 70,709 44,181 114,890 85.2 53.2 138.4 38.5 109.0Interest During Construction - 9,481 9,481 - 11.4 11 100.0 9.0Commitment Charges - 627 627 - 0.8 0.8 100.0 0.6

Subtotal 70,709 54,289 124,998 85.19 65.41 150.60 43.4 118.6Front-End Fee 0.0 583.4 583.4 0.0 0.7 0.7 100 0.6

Total Costs to be Financed 70,709 54,872 125,581 85.2 66.1 151.3 44 119Total ADB Financing 0.0 53,352 53,352 0.0 64.3 64.3 100ADB = Asian Development Bank.

DETAILED COST ESTIMATES

Table A4.1: Components Project Cost SummaryA

ppendix 4, page 1

%Yuan Ten Thousand $ million Foreign

Local Foreign Total Local Foreign Total Exchange

I. Investment Costs A. Land Acquisition and Resettlement

Land Acquisition for Resettlement 677 - 677 0.8 - 0.8 -Land Acquisition by Enterprises 513 - 513 0.6 - 0.6 -Resettlement Work 1,727 - 1,727 2.1 - 2.1 -

Subtotal Land Acquisition and Resettlement 2,916 - 2,916 3.5 - 3.5 -B. Civil Works

1. Water Supply Water Supply 12,459 8,060 20,520 15.0 9.7 24.7 39Enterprises 1,581 598 2,179 1.9 0.7 2.6 27Soil Conservation/Afforestation 1,804 - 1,804 2.2 - 2.2 -

Subtotal Water Supply 15,844 8,658 24,502 19.1 10.4 29.5 352. Farm Development

Minor Structures /a 11,154 7,387 18,540 13.4 8.9 22.3 40Farm Labour 1,902 - 1,902 2.3 - 2.3 -

Subtotal Farm Development 13,055 7,387 20,442 15.7 8.9 24.6 36Subtotal Civil Works 28,899 16,045 44,944 34.8 19.3 54.1 36C. Equipment 3,833 8,067 11,900 4.6 9.7 14.3 68D. Materials

Farm Inputs and Goods /b 16,163 5,314 21,477 19.5 6.4 25.9 25Planting/Grafting Material 6,128 4,750 10,877 7.4 5.7 13.1 44Livestock 4,634 5,580 10,214 5.6 6.7 12.3 55Enterprise Goods & Materials /c 454 179 633 0.5 0.2 0.8 28

Subtotal Materials 27,378 15,823 43,202 33.0 19.1 52.1 37E. Vehicles 220 220 440 0.3 0.3 0.5 50F. Training

Staff Training 216 43 259 0.3 0.1 0.3 17Extension Services 341 - 341 0.4 - 0.4 -

Subtotal Training 557 43 601 0.7 0.1 0.7 7G. PMO Services 480 - 480 0.6 - 0.6 -

Total Investment Costs 64,285 40,198 104,483 77.5 48.4 125.9 38ADB = Asian Development Bank, PMO = Project Management Office.a Irrigation facilities, including small pumps, distribution hoses, storage rooms, animal sheds, other structures.b Excluding planting material.c Including working capital.

Table A4.2: Expenditure Accounts Pro ject Cost Summar y

Item

Appendix 4, page 2

51

%Item Yuan Ten Thousand $ million Foreign

Local Foreign Total Local Foreign Total ExchangeII. Recurrent Costs

H. PMO Staff Salaries & Office Overheads 920 - 920 1.1 - 1.1 -Total Recurrent Costs 920 - 920 1.1 - 1.1 -Total Baseline Costs 65,205 40,198 105,403 78.6 48.4 127.0 38

Physical Contingencies 3,384 2,124 5,507 4.1 2.6 6.6 39Price Contingencies 2,121 1,859 3,980 2.6 2.2 4.8 47

Total Project Costs 70,709 44,181 114,890 85.2 53.2 138.4 38Interest During Construction - 94,808 94,808 - 11.4 11.4 100Commitment Charges - 627 627 - 0.8 0.8 100

Subtotal 70,709 139,616 210,326 85.2 65.4 150.6 43 Front End Fee 0.0 583.4 583.4 0.0 0.7 0.7 100

Total Costs to be Financed 70,709 140,200 210,909 85.2 66.1 151.3 44Total ADB Financing 0.0 138,680 138,680 0.0 64.3 64.3 100ADB - Asian Development Bank; PMO - Project Management Office

Table A4.2: Expenditure Accounts Project Cost Summary(continued)

52A

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Table A4.4: Expenditure Accounts Breakdown($ million)

PhysicalBase Cont.

Costs + PlusPrice Price

Local Local Local Local Cont. on Cont. onItem For. (Excl. Duties & For. (Excl. Duties & For. (Excl. Duties & For. (Excl. Duties & Base Physical

Exch. Taxes) Taxes Total Exch. Taxes) Taxes Total Exch. Taxes) Taxes Total Exch. Taxes) Taxes Total Costs Cont.


Land Acquisition for Resettlement - 0.8 - 0.8 - 0.0 - 0.0 - 0.0 - 0.0 - 0.9 - 0.9 0.8 0.0Land Acquisition by Enterprises - 0.6 - 0.6 - 0.0 - 0.0 - 0.0 - 0.0 - 0.6 - 0.6 0.6 0.0Resettlement Work - 2.1 - 2.1 - 0.1 - 0.1 - 0.0 - 0.0 - 2.2 - 2.2 2.1 0.1

Subtotal Land Acquisition and Resettlement - 3.5 - 3.5 - 0.2 - 0.2 - 0.0 - 0.0 - 3.7 - 3.7 3.5 0.2B. Civil Works

1. Water Supply Water Supply 9.7 11.4 3.6 24.7 0.6 0.7 0.2 1.5 0.4 0.2 0.1 0.7 10.7 12.3 3.9 26.9 25.3 1.6Enterprises 0.7 1.4 0.5 2.6 0.0 0.1 0.0 0.1 0.0 0.0 0.0 0.0 0.8 1.5 0.5 2.8 2.7 0.1Soil Conservation/Afforestation - 2.2 - 2.2 - 0.1 - 0.1 - 0.0 - 0.0 - 2.3 - 2.3 2.2 0.1

Subtotal Water Supply 10.4 15.0 4.1 29.5 0.7 0.9 0.2 1.8 0.4 0.3 0.1 0.7 11.5 16.1 4.4 32.0 30.2 1.82. Farm Development

Minor Structures a/ 8.9 10.3 3.2 22.3 0.4 0.5 0.2 1.1 0.5 0.4 0.1 1.0 9.8 11.1 3.5 24.4 23.3 1.2Farm Labor - 2.3 - 2.3 - 0.1 - 0.1 - 0.1 - 0.1 - 2.5 - 2.5 2.4 0.1

Subtotal Farm Development 8.9 12.6 3.2 24.6 0.4 0.6 0.2 1.2 0.5 0.4 0.1 1.0 9.8 13.6 3.5 26.9 25.6 1.3Subtotal Civil Works 19.3 27.6 7.3 54.1 1.1 1.5 0.4 3.0 0.9 0.7 0.2 1.8 21.3 29.8 7.9 58.9 55.8 3.1C. Equipment 9.7 2.5 2.1 14.3 0.5 0.1 0.1 0.7 0.3 0.0 0.1 0.4 10.5 2.7 2.2 15.5 14.7 0.7D. Materials

Farm Inputs and Goods b/ 6.4 15.7 3.8 25.9 0.3 0.8 0.2 1.3 0.4 0.7 0.2 1.3 7.1 17.2 4.1 28.5 27.1 1.4Planting/Grafting Material 5.7 5.5 1.9 13.1 0.3 0.3 0.1 0.7 0.3 0.2 0.1 0.6 6.3 5.9 2.1 14.3 13.7 0.7Livestock 6.7 4.0 1.6 12.3 0.3 0.2 0.1 0.6 0.3 0.1 0.1 0.5 7.4 4.3 1.7 13.5 12.8 0.6Enterprise Goods & Materials c/ 0.2 0.4 0.1 0.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.2 0.5 0.1 0.8 0.8 0.0

Subtotal Materials 19.1 25.6 7.3 52.1 1.0 1.3 0.4 2.6 1.1 1.1 0.3 2.5 21.1 28.0 8.1 57.1 54.4 2.7E. Vehicles 0.3 0.2 0.1 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.2 0.1 0.6 0.5 0.0F. Training

Staff Training 0.1 0.3 - 0.3 0.0 0.0 - 0.0 0.0 0.0 - 0.0 0.1 0.3 - 0.3 0.3 0.0Extension Services - 0.4 - 0.4 - 0.0 - 0.0 - 0.0 - 0.0 - 0.4 - 0.4 0.4 0.0

Subtotal Training 0.1 0.7 - 0.7 0.0 0.0 - 0.0 0.0 0.0 - 0.0 0.1 0.7 - 0.8 0.7 0.0G. PMO Services - 0.5 0.1 0.6 - 0.0 0.0 0.0 - 0.0 0.0 0.0 - 0.5 0.1 0.6 0.6 0.0

Total Investment Costs 48.4 60.6 16.8 125.9 2.6 3.1 0.9 6.6 2.2 1.8 0.6 4.7 53.2 65.6 18.4 137.2 130.4 6.8II. Recurrent Costs

PMO Staff Salaries & Office Overheads - 1.1 - 1.1 - 0.1 - 0.1 - 0.1 - 0.1 - 1.2 - 1.2 1.2 0.1Total Recurrent Costs - 1.1 - 1.1 - 0.1 - 0.1 - 0.1 - 0.1 - 1.2 - 1.2 1.2 0.1Total 48.4 61.7 16.8 127.0 2.6 3.2 0.9 6.6 2.2 1.9 0.6 4.8 53.2 66.8 18.4 138.4 131.5 6.9 PMO - Project Management Office.a Irrigation facilities, including small pumps, distribution hoses, storage rooms, animal sheds, other structures.b Excluding planting material.c Including working capital.

Physical ContingenciesBase Cost Price Contingencies Total Including Contingencies

Appendix 4, page 6

55

Component 2000 2001 2002 2003 2004 Total 2000 2001 2002 2003 2004 Total

A. Water Supply and Irrigation System Huaiba Water Supply System 18,765 8,431 - - - 27,196 22.6 10.2 - - - 32.8Mianchi Water Treatment & Distribution 2,170 2,085 - - - 4,255 2.6 2.5 - - - 5.1Yima Water Treatment & Distribution 2,309 2,526 - - - 4,835 2.8 3.0 - - - 5.8Mianchi Irrigation Company 2,513 1,950 1,092 121 97 5,772 3.0 2.3 1.3 0.1 0.1 7.0

Subtotal Water Supply and Irrigation System 25,757 14,992 1,092 121 97 42,059 31.0 18.1 1.3 0.1 0.1 50.7B. Horticulture

1. Tree Crops Apples 1,740 1,865 2,687 298 239 6,828 2.1 2.2 3.2 0.4 0.3 8.2Ginkgo 1,271 1,550 2,290 621 365 6,098 1.5 1.9 2.8 0.7 0.4 7.3Kiwifruit 1,474 1,700 2,450 475 275 6,374 1.8 2.0 3.0 0.6 0.3 7.7Eucommia 360 419 607 126 74 1,586 0.4 0.5 0.7 0.2 0.1 1.9Chinese Dates 574 586 800 - - 1,959 0.7 0.7 1.0 - - 2.4

Subtotal Tree Crops 5,418 6,119 8,835 1,519 953 22,845 6.5 7.4 10.6 1.8 1.1 27.52. Vegetables

Greenhouses 2,993 3,057 4,176 - - 10,227 3.6 3.7 5.0 - - 12.3Irrigated Field Vegetables 2,995 3,059 4,178 - - 10,232 3.6 3.7 5.0 - - 12.3

Subtotal Vegetables 5,989 6,116 8,355 - - 20,459 7.2 7.4 10.1 - - 24.6Subtotal Horticulture 11,407 12,235 17,190 1,519 953 43,305 13.7 14.7 20.7 1.8 1.1 52.2C. Livestock Development

Household Cattle Production 2,368 3,049 3,950 886 - 10,253 2.9 3.7 4.8 1.1 - 12.4Household Sheep & Goat Production 2,069 2,112 2,886 - - 7,067 2.5 2.5 3.5 - - 8.5Commercial Pig Breeding 3,488 2,258 - - - 5,747 4.2 2.7 - - - 6.9Household Pig Production 1,221 1,246 1,702 - - 4,169 1.5 1.5 2.1 - - 5.0

Subtotal Livestock Development 9,146 8,666 8,538 886 - 27,236 11.0 10.4 10.3 1.1 - 32.8D. Project Management 1,463 199 204 210 216 2,291 1.8 0.2 0.2 0.3 0.3 2.8Total Project Costs 47,773 36,092 27,023 2,736 1,266 114,890 57.6 43.5 32.6 3.3 1.5 138.4

Totals Including Contingencies ($ million)

Table A4.5: Project Components, by Year -- Totals Including Contingencies

Totals Including Contingencies (Yuan ten thousand)

Appendix 4, page 7

56

Item 2000 2001 2002 2003 2004 Total 2000 2001 2002 2003 2004 Total


Land Acquisition for Resettlement 717 - - - - 717 0.9 - - - - 0.9Land Acquisition by Enterprises 522 - - - - 522 0.6 - - - - 0.6Resettlement Work 1,829 - - - - 1,829 2.2 - - - - 2.2

Subtotal Land Acquisition and Resettlement 3,068 - - - - 3,068 3.7 - - - - 3.7B. Civil Works

1. Water Supply Water Supply 13,076 9,268 - - - 22,344 15.8 11.2 - - - 26.9Enterprises 2,025 294 - - - 2,319 2.4 0.4 - - - 2.8Soil Conservation/Afforestation 949 981 - - - 1,929 1.1 1.2 - - - 2.3

Subtotal Water Supply 16,050 10,543 - - - 26,592 19.3 12.7 - - - 32.02. Farm Development

Minor Structures a/ 5,933 6,059 8,278 - - 20,269 7.1 7.3 10.0 - - 24.4Farm Labour 604 616 842 - - 2,062 0.7 0.7 1.0 - - 2.5

Subtotal Farm Development 6,537 6,675 9,119 - - 22,332 7.9 8.0 11.0 - - 26.9Subtotal Civil Works 22,587 17,218 9,119 - - 48,924 27.2 20.7 11.0 - - 58.9C. Equipment 9,029 3,645 168 - - 12,842 10.9 4.4 0.2 - - 15.5D. Materials

Farm Inputs and Goods b/ 4,915 6,269 8,882 2,526 1,050 23,642 5.9 7.6 10.7 3.0 1.3 28.5Planting/Grafting Material 3,483 3,558 4,860 - - 11,901 4.2 4.3 5.9 - - 14.3Livestock 3,245 4,290 3,640 - - 11,175 3.9 5.2 4.4 - - 13.5Enterprise Goods & Materials c/ - 688 - - - 688 - 0.8 - - - 0.8

Subtotal Materials 11,643 14,805 17,382 2,526 1,050 47,406 14.0 17.8 20.9 3.0 1.3 57.1E. Vehicles 410 61 - - - 471 0.5 0.1 - - - 0.6F. Training

Staff Training 224 53 - - - 276 0.3 0.1 - - - 0.3Extension Services 109 111 151 - - 370 0.1 0.1 0.2 - - 0.4

Subtotal Training 332 163 151 - - 647 0.4 0.2 0.2 - - 0.8G. PMO Services 509 - - - - 509 0.6 - - - - 0.6

Total Investment Costs 47,578 35,893 26,820 2,526 1,050 113,867 57.3 43.2 32.3 3.0 1.3 137.2II. Recurrent Costs

PMO Staff Salaries & Office Overheads 195 199 204 210 216 1,023 0.2 0.2 0.2 0.3 0.3 1.2Total Recurrent Costs 195 199 204 210 216 1,023 0.2 0.2 0.2 0.3 0.3 1.2Total Project Costs 47,773 36,092 27,023 2,736 1,266 114,890 57.6 43.5 32.6 3.3 1.5 138.4

PMO = Project Management Office.a Irrigation facilities, including small pumps, distribution hoses, storage rooms, animal sheds, other structures.b Excluding planting material.c Including working capital.

Table A4.6: Expenditure Accounts, by Years -- Totals Including Contingencies

Totals Including Contingencies ($ Million)Totals Including Contingencies (Yuan Ten Thousand)

57A

ppendix 4, page 8

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58Appendix 4, page 9

Asian

Households Households Development Construction Interest

Enterprises (Cash) (Labour) Bank Bank Project Durin g Commitment Cash Cumulative

Amount Amount Amount Amount Amount Total Costs Construction Charges b/ Total Flow b/ Cash Flow

1 0.0 0.0 0.0 6,000.0 0.0 6,000.0 28,779.1 0.0 170.2 28,949.4 -22,779.1 -22,779.12 2,027.1 148.5 850.1 7,796.3 2,341.8 13,163.7 28,779.1 190.8 175.7 29,145.6 -15,615.4 -38,394.53 2,027.1 148.5 850.1 7,796.3 2,341.8 13,163.7 21,741.9 438.6 141.0 22,321.5 -8,578.1 -46,972.74 976.0 208.7 874.0 8,711.8 1,606.0 12,376.5 21,741.9 686.5 111.8 22,540.2 -9,365.3 -56,338.05 976.0 208.7 874.0 8,711.8 1,606.0 12,376.5 16,279.2 963.5 79.1 17,321.8 -3,902.7 -60,240.66 849.0 302.4 523.6 5,742.5 0.0 7,417.5 16,279.2 1,240.5 46.4 17,566.1 -8,861.7 -69,102.37 849.0 302.4 523.6 5,742.5 0.0 7,417.5 1,647.9 1,423.1 24.9 3,095.9 5,769.6 -63,332.78 0.0 118.6 0.0 335.9 0.0 454.4 1,647.9 1,605.7 3.4 3,257.0 -1,193.5 -64,526.29 0.0 118.6 0.0 335.9 0.0 454.4 762.6 1,616.3 2.1 2,381.1 -308.2 -64,834.410 0.0 52.0 0.0 112.7 0.0 164.7 762.6 1,627.0 0.8 2,390.5 -597.9 -65,432.311 0.0 52.0 0.0 112.7 0.0 164.7 0.0 1,630.6 0.4 1,631.0 164.7 -65,267.6

7,704.2 1,660.4 4,495.2 51,398.4 7,895.6 73,153.9 138,421.5 11,422.7 755.9 150,600.1 -65,267.6 -65,267.6

a Total retroactive financing available = $6,000.0.b Net retroacitve financingc Excluding interest during construction and charges.

Financial Char ges

The Government

TableA4.8: Disbursements, b y Semesters, and Government Cash Flow($ million )

Financin g Available Net of Retroactive Financin g a/ Costs to be Financed

Item Loan DisbursementAmount % Forei gn Local Total Forei gn Local Total Total Forei gn Local Total Forei gn Local Total

1. Land Acquisition and Resettlement - - - 864.0 864.0 - - - - - - - - - -2. Civil Works 20,763.1 33.9 22,589.4 42,042.1 64,631.4 97.1 - 33.9 21,935.7 1,172.5 - 1,172.5 20,763.1 - 20,763.13. Equipment, Vehicles, Furniture 7,723.9 55.4 9,287.6 5,347.0 14,634.6 87.3 - 55.4 8,110.1 386.2 - 386.2 7,723.9 - 7,723.94. Goods and Materials 20,282.6 37.0 21,296.7 36,197.5 57,494.3 100.0 - 37.0 21,296.7 1,014.1 - 1,014.1 20,282.6 - 20,282.65. Training b/ 53.3 7.0 55.9 741.3 797.2 100.0 - 7.0 55.9 2.7 - 2.7 53.3 - 53.3Unallocated 2,575.5 - - - - - - - - - - - - - -

51,398.4 37.1 53,229.6 85,191.9 138,421.5 - - - 51,398.4 2,575.5 - 2,575.5 48,822.9 - 48,822.9

a Loan amounts financed by the Asian Development Bank (ADB).b ADB-financed overseas training/study tours for staff of the Project Management Office.

Total

Loan Amounts ($'000)Suggested Allocation of

Loan Proceeds

Table A4.9: Allocation of Loan ProceedsAsian Develo pment Bank

Total Project Cost Avera ge Disbursement (%) Unallocated Allocated

($'000)

59A

ppendix 4, page 10

Appendix 5, page 1

IMPLEMENTATION ARRANGEMENTS, ORGANIZATION CHART, ANDIMPLEMENTATION SCHEDULE

A. Project Leading Group

1. The Provincial Government of Henan (PGH) has set up a West Henan EconomicDevelopment Leading Group to provide policy guidance, supervision, and coordination for theProject implementation. A vice governor heads the Leading Group, with directors of the HenanDevelopment Planning Commission and Provincial Finance Bureau (PFB) as deputies.Directors of the Provincial Poverty Alleviation and Development Office (PADO) and otherprovincial rural and urban poverty-related agencies including the Statistics Bureau,Environmental Protection Bureau, and sector bureaus of agriculture (BA), livestock (BL), waterconservancy, and forestry (BF) are also members of the Leading Group (Figure A5).

B. Executing Agency

2. Under PFB, a provincial Project Management Office (PMO) comprising about 8professional staff will be responsible for supervision and management of projectimplementation. The duties of the PMO will include

• providing primary contact with the Asian Development Bank (ADB), Ministry of Finance(MOF), State Development Planning Commission, and other agencies;

• formulating annual implementation plans and budgets;• supervising construction and quality control;• monitoring physical and financial progress, and preparing routine progress reports;• supervising international and domestic procurement;• organizing relevant institutions to monitor and evaluate project benefits;• setting up and managing the special fund for the ADB loan;• reviewing applications of withdrawal and fund disbursement to implementing agencies (IAs);• monitoring the impact of the Project on the rural and urban poor; and• coordinating collection and repayment of the loan.

3. Within the project area, most prefectures/cities and counties involved have alreadyestablished their own leading groups and PMOs. The number of professional and technicalstaff involved in the lower level PMOs is estimated to be 5-8 at each office. The PMOs will beassisted by staff of the relevant line agencies.

C. Implementing Agencies

4. It was agreed that a small number of company + household models should be tried, on apilot basis, but most of the IAs will be either a township finance office or a township BA, BF orBL, with the choice determined by the local government involved. These “ultimate” borrowerswould be responsible not only for entering into contracts with farmers, providing technical inputs,and arranging marketing of products, but also for repayment of the loan.

5. Tree crops component. For the production of apples, kiwi fruit, Chinese dates, andmedicinal plants (eucommia and gingko), the Forestry Bureau will be the IA.

6. Vegetables component. The agriculture component comprising 2,800 hectares (ha) offield vegetables and 5,000 greenhouses will be implemented by the Agriculture Bureau. Part of

60

Appendix 5, page 2

the field vegetable component may be implemented with the support of the Jiyuan VegetableSeeds Company Ltd.

7. Livestock component. County/township livestock bureaus will be responsible fororganizing implementation of beef, sheep, and goat production. The proposed breeding farm forpurebred pigs will be implemented by a livestock company at the provincial level in Zhengzhou(Henan Xinda Livestock Company Limited). The breeding farm for first-cross pigs will beimplemented by the Jiyuan Dazhong Livestock Industry Company Limited, a limited liabilitycompany already successfully operating pig and poultry production enterprises.

8. Water supply and irrigation component. The Sanmenxia Huaiba Water SupplyCompany has been set up to construct, operate, and maintain the Huaiba Water SupplyScheme. This commercial enterprise will sell bulk water to (i) Yima and Mianchi Water SupplyCompanies, which will construct, operate, and maintain water supply networks and treatmentfacilities in Yima City and Mianchi County at commercial tariffs; and (ii) Mianchi IrrigationCompany, a commercial enterprise under the jurisdiction of the County Water ConservancyBureau, which will construct, operate, and maintain the irrigation distribution system and collectwater fees from the farmer beneficiaries.

D. Financial Management

9. MOF will be the principal Borrower. MOF will onlend the funds at the same interest rateand conditions (about 6.46 percent interest, 25 years maturity, 5 years grace period, 0.75percent commitment fee, and 1.0 percent front-end fee) to PFB. PFB will open a separateaccount for the Project through which the funds for implementation will be channeled to thefinance bureaus at the prefecture/city and county levels of the project area. With the exceptionof onlending to the pilot enterprises and water supply and irrigation companies, thecounty/municipal finance bureau will take the foreign exchange risk. These bureaus will relendthe funds to the farm enterprises and participating households on terms and conditions that willvary according to the profitability of the activities and ability to repay the loans, according to draftloan agreements (between the finance bureau and ultimate borrower) submitted to ADB.

10. Subject to the general principle that terms and conditions to end users will be no lessthan commercial bank lending,1 the local government level will provide funds to end users inthree modalities. First, to farmers, funds will be provided in local currency through townshipfinancial offices, at interest rates not lower than commercial bank rates for equivalent loans, withat least 4-year maturity and grace period of 1-2 years. Wherever possible, loans will be securedby fixed assets collateral under a formal loan agreement. However, it is accepted that poor farmhouseholds have extremely limited fixed assets of any value, so emphasis will be on carefulselection of participants and group pressure, where appropriate. Second, to the water supplyand irrigation companies, funds will be provided at the same terms and conditions as the ADBfunds, although these companies will take the foreign exchange risk. Third, the pilot enterpriseswill be expected to take the foreign exchange risk and will receive funds from the relevantfinance bureaus at interest rates not lower than commercial bank rates for equivalent loans,thus reflecting a balance of several factors including longer repayment terms (10-15 years) thanfarmers, foreign exchange risk, and risk of nonrepayment to PFB.

11. As the ADB loan will only provide 44 percent of the total project costs and few of thehorticulture and livestock activities are likely to be attractive to commercial banks, counterpart

1 The Mission confirmed that the current interest rates on commercial bank loans in domestic currency for 5-year

repayment terms (generally the maximum term available) are about 7.5 percent.

61

Appendix 5, page 3

local funding amounting to about $65.3 million is needed. PFB will ensure that the relevantmunicipality and/or county government is prepared to commit the necessary amount ofcounterpart funding (up to $3 million - $5 million per county), to be released through the normallocal government budget mechanisms. Counties that have excessive exposure to foreigncurrency debt or are not prepared to enter into additional debt will be excluded from the Project.

12. PFB will establish a separate loan account (special account) in a commercial bank forthe ADB funds. PFB will process loan withdrawal applications, following preparation by theprovincial PMO and certification by the provincial PMO that the relevant works or procurementhave been carried out to an acceptable standard. PFB will authorize the release of funds tobank branches at municipal/county level, where they can be withdrawn by the enterprise, PMO,or farm household (depending on which end user has incurred the authorized expense). ADBfunds advanced to the special account will be reimbursed under ADB’s statement of expenditureprocedure.

E. Procurement

13. Generally the relevant level of the PMO will be responsible for procurement of goodsand materials, which will then be distributed to either groups of farmers or individual farmhouseholds. For items that must be procured elsewhere in the People’s Republic of China(PRC) or overseas, the provincial PMO will be responsible for procurement by tender. For itemsthat can be procured locally, the county PMOs will be responsible. The PMO will also beresponsible for procurement of training services, inspection/acceptance surveys, and technicaladvice to farmers. The main exceptions to this arrangement will be procurement for the watersupply and irrigation component, which will be undertaken by the relevant water supplycompany, and procurement by pilot enterprises.

14. Procurement of goods and services will be undertaken in accordance with ADB'sGuidelines for Procurement. ADB’s domestic preference scheme will apply in procurement.

62

Appendix 5, page 4

ADB has approved advance procurement action and retroactive financing for certain items inthe horticulture and water supply components, amounting to no more than $6 million.

15. PGH is aware of ADB’s new anticorruption policy and indicated that severe penaltieswould be imposed for any proven case of corruption during implementation. PMO will makeappropriate arrangements for independent inspection and auditing to ensure that the Projecthas adequate checks and balances to avoid any possibility of corruption.

F. Guidelines for Selection of Pilot Enterprises

16. Introduction. On a pilot basis, the Project will provide funds for development ofselected commercial enterprises connected to household production models. These guidelinesprovide criteria for selecting enterprises. The guidelines seek: (i) consistency with overall projectobjectives; (ii) financial and technical viability of the proposals; and (iii) financial, managerial,and technical quality of sponsors.

17. The following criteria are to be applied in selecting applicant enterprises:

(i) At least 20 percent of the enterprise inputs or outputs must be linked toagricultural households of the project area of West Henan, with priority given toproposals that utilize the outputs of the Project’s agricultural components.

(ii) Priority will be given to proposals that benefit poor households and/or areeffective in creating off-farm employment in terms of investment cost per new joband share of labor in total costs.

(iii) Proposals must be environmentally sound in input production and processing,incorporating adequate treatment and disposal of all liquid, gaseous, and solidwastes.

(iv) The maximum loan per enterprise is $4 million.(v) Minimum pretax financial internal rate of return (FIRR) is 15 percent, and posttax

FIRR is 12 percent after full allowance for all incremental cash flows.(vi) At least 30 percent of the new investment, excluding both working capital and the

value of any existing fixed assets to be used, must be financed by sponsors’equity.

18. Enterprise qualifications. If the component involves a new, separate enterprise, thenthe following will apply to that enterprise and its principal sponsor, but if it involves theexpansion of an existing enterprise, the following will apply to the whole enterprise:

(i) Borrowers must be small and medium-size shareholding enterprises with at leasta controlling 51 percent of the shares held by PRC entities that are neitherdirectly nor indirectly State-owned, and in which management is autonomous.

(ii) The ratio of long-term debt, including overdraft facilities and renewable short-term loans, to equity should not exceed 70:30 and the liquidity ratio, including theportion of long-term loans due for payment within one year, should not be lessthan 1.25 in any projected year of the proposed loan period.

(iii) The debt/service ratio should also not be less than 1.25 at any time after theprojected level of full production is achieved.

(iv) Sponsors must have a good track record in general, financial, commercial,processing and marketing management.

63

Appendix 5, page 5

G. Implementation Schedule

Activity Year 1 Year 2 Year 3 Year 4 Year 5 Year 6-25

A. Horticulture Development

(i) Orchard Establishment/Rehabilitation

(ii) Orchard MaintenanceB. Livestock Development

(i) Household Livestock UnitsEstablishment

(ii) Livestock EnterprisesEstablishment

(iii) Livestock MaintenanceC. Water Supply and Irrigation

Development(i) Huaiba Scheme Construction

(ii) Water Supply and IrrigationDistribution System

D. Project Management

64

Appendix 6, page 1

CONTRACT PACKAGES

1. Procurement packages are divided into three phases: (i) retroactive financing, (ii)prepared under advance action for procurement, and (iii) balance of procurement.

Table A6.1: Procurement Packages for Retroactive Financing ($ million)

Package Amount Loan Financing ProcurementMode a

I. Water SupplyA. Huaiba WSC1 No. 2 tunnel 0.723 0.340 LCB2 Access road, Wu Huai 0.453 0.213 FA3 Access road, Cao Huai #1 0.678 0.319 LCB4 Access road, Cao Huai #2 0.746 0.351 LCB5 Power transmission line, 110kV

and communication line 0.672 0.538 FA/IS6 Transmission substations 0.761 0.609 FA/IS7 Transmission line, 10kV, to reservoir 0.502 0.401 FA/IS8 Communications system 0.054 0.044 DP9 Water supply system for construction 0.057 0.027 FA10 Construction tunnel 0.055 0.026 FA11 Office building 0.327 0.154 LCB12 Steel gate, No. 1 intake pumping station 0.308 0.246 IS13 Pumps (pump stations No 2, 3, 4) 0.281 0.225 IS14 Electrical equipment/control

(pump stations No 2, 3, 4) 0.257 0.206 IS15 Electrical motors (pump stations 2, 3, 4) 0.440 0.352 IS16 Special vehicles 0.190 0.158 ISB. Mianchi WDC1 Auxiliary works (gatehouse, office,

garage, fence, gate, access road)0.215 0.101 LCB

C. Yima WDC1 Auxiliary works (Treatment plant, gate

house, dormitory, works outside plant)0.581 0.273 LCB

D. Mianchi Irrigation Co.1 Office and temporary buildings 0.099 0.047 LCB

Subtotal 7.399 4.627II. Agriculture EnterprisesA. Crossbred Pigs1 Office 0.052 0.014 LCBB. Purebred Pigs2 Enclosure and road 0.026 0.007 LCB

Subtotal 0.078 0.020III. Agriculture MaterialsA. Horticulture (small items summary) 3.919 1.763 DP

Subtotal 3.919 1.763TOTAL 11.396 6.411a. DP = direct purchase, FA = force account/small contract, ICB = international competitive bidding, IS = international shopping,LCB = local competitive bidding.

65

Appendix 6, page 2Table A6.2: Indicative Procurement Packages beyond Retroactive Financing

Package Amount Procurement($ million) (Y million) Mode a

I. Water SupplyA. Huaiba WSC1 No. 3 tunnel, contract 1 0.624 5.177 LCB2 No. 3 tunnel, contract 2 0.893 7.413 LCB3 No. 4 tunnel & No.3 siphon and aqueduct 0.994 8.254 LCB4 Xiduancun reservoir-dam 5.701 47.321 ICB5 Discharge tunnel, metal and electrical work 0.992 8.230 LCB6 Conveyance tunnel and pumping station 0.711 5.898 LCB7 Excavation and backfill 0.416 3.449 FA8 Pipe installation 0.779 6.470 LCB9 Ditch crossing and siphons 0.989 8.212 LCB10 Steel pipes and installation 0.537 4.455 ICB11 Concrete pipe and installation 1.271 10.550 LCB12 Pipe material, steel plate 0.293 2.430 FA13 Office building 0.435 3.606 LCB14 Power transmission line 0.665 5.520 IS15 Equipment (fire prevention, maintenance) 0.474 3.938 DP16 Special vehicles

Huaiba 0.142 1.180 ISMianchi 0.021 0.176 ISYima 0.053 0.441 IS

B. Mianchi WDC1 Water treatment plant 1.178 9.777 LCB (2 contracts)2 Water distribution network 1.892 15.704 LCB (2 contracts)3 Auxiliary works maintenance room, storage 0.045 0.370 FA4 Water purification equipment 0.315 2.611 ISC. Yima WDC1 Water treatment plant 1.380 11.458 LCB (2 contracts)2 Water distribution network 0.979 8.123 LCB3 Auxiliary works office, misc. 0.189 1.569 LCB4 Water purification equipment 0.560 4.648 IS/ICBD. Mianchi Irrigation Co.1 Pumping stations, main and trunk pipes 0.965 8.007 LCB (2 contracts)2 Metal works 1.504 12.480 ICB3 Electrical equipment 0.830 6.888 ICB

Subtotal 25.826 214.356II. Agriculture EnterprisesA. Crossbred Pigs1 Civil works 1.024 8.500 LCB2 Equipment 0.794 6.590 IS/ICB3 Light truck 0.026 0.214 IS/ICB4 Livestock, local breeds 1.655 13.737 DP5 Inputs 0.324 2.688 DPB. Purebred Pigs1 Civil works 0.908 7.539 LCB2 Equipment 0.477 3.961 IS/ICB3 Light truck 0.024 0.200 IS/ICB4 Livestock, local breeds 0.028 0.231 DP5 Livestock, foreign breeds 0.072 0.595 IS6 Inputs 0.664 5.511 DP

Subtotal 5.996 49.766TOTAL 31.822 264.122a. DP = direct purchase, FA = force account/small contract, ICB = international competitive bidding, IS = international shopping,LCB = local competitive bidding.

66

Appendix 7, page 1

FINANCIAL AND ECONOMIC ANALYSES

A. Review of Proposed Horticultural Activities

1. Hectare crop budgets and areas of development. The analysis of the horticulturecomponent was based on per hectare crop budgets for grafted apples, gingko, kiwifruit, graftedChinese dates, field vegetables, and greenhouses. Where possible, the with-Project caseincludes an initial wheat and maize intercrop until the canopy is fully developed. The analysisalso factored in the impact of periodic crop failures for apple, kiwifruit, and gingko plantings, anduses conservative estimates for greenhouse and field vegetable production. To account for thefuture impacts of increasing surface water scarcity in the central part of the People’s Republic ofChina (PRC), the analysis uses irrigation tariffs that increase faster than domestic inflation. Theanalysis assumes that kiwifruit, gingko, eucommia, greenhouse, and field vegetabledevelopment replaces the existing grain production, and accounts for this opportunity cost. Asfarmers are presently planting areas in tree crops, the analysis assumes that the Project willaccelerate a process that would otherwise occur over a period of 10 years. Table A7.1 gives thefull development yields expected under the Project. Table A7.2 estimates the per hectareinvestment costs and working capital required.

Table A7.1: Horticultural Yields with the Project

Crop Project Yield (t/ha) Area (ha)

Apples 12.0 3,200Gingko (fruit) 0.6 1,900Kiwifruit 21.4 1,400Dates (dry weight) 3.5 1,200Eucommia – ratoon (every three years) Leaf: 2.2, bark: 3, poles: 10 300Eucommia – plantation (annual average) Leaf: 1.5, bark: 0.25 300Simple Greenhouse 142.5 83.5Standard Greenhouse 142.5 83.5Field Vegetables 63.0 2,800

Table A7.2: Investment Summary of Horticultural Activities (Y/ha)

Crop LaborCivil Works

& EquipmentPlantingMaterial

OtherGoods &Materials

WorkingCapital Total

Apples 484 950 11,730 3,750 2,797 19,711Gingko 968 950 15,272 2,600 10,456 30,245Kiwifruit 1,451 17,750 7,728 5,750 12,797 45,476Dates 484 950 8,625 2,450 2,450 14,959EucommiaRatoon

2,419 950 17,250 3,975 14,828 39,421

EucommiaPlantation

3,225 3,450 2,575 885 10,135

SimpleGreenhouse

840 8,150 1,600 677 11,267

StandardGreenhouse

1,590 20,450 1,600 1,549 26,689

FieldVegetables

1,650 22,500 450 8,856 33,456

2. Summary of results. At full development (9-10 years from the start of the Project), theproposed horticultural plantings have the potential to achieve sooner than would otherwise bepossible in the project area an additional annual production of 38,400 tons (t) of early-maturing

67

Appendix 7, page 2

apples, approximately 1,140 t of ginkgo fruit, 30,000 t of kiwifruit, 4,200 t of Chinese dates, anaverage 375 t of eucommia bark, 1,125 t of eucommia leaf and 198,400 t of vegetables.

3. Based on the following budgets, the posttax base financial internal rates of return(FIRRs) to these horticultural investments range from about 14 percent (for field vegetables) toabout 17 percent (for apples and dates) to 20 percent (for greenhouses). Estimated benefits perhousehold are summarized in Table A7.3. The sensitivity of these base results to adversechanges in output prices, operating costs, investment costs, and delays in benefits is presentedin Table A7.4.

4. Given its relatively small operating margin, field vegetable production appears to besusceptible to variations in revenues and operating costs. The profitability of Chinese dates isless sensitive to such changes. Apple plantings appear to continue to be profitable in the eventthat the average farmgate price turns out 10 percent lower than the output price used in thebudget, which is a premium price for early-maturing varieties. The results for eucommia areaverages based on the assumption that half of the cultivation will be through ratooning and halfthrough an alternative plantation approach that provides a higher concentration of the activechemicals in the bark. Although the investment cost for ratooning eucommia is much higherthan the plantation model, because of several advantages ratooning appears to be the moreprofitable and financially feasible choice.

5. In economic terms, the proposed activities produce satisfactory returns, although thesereturns appear to be more sensitive to changes in revenues than to changes in operating costs(Table A7.4). The economic internal rates of return (EIRRs) of apples, gingko, kiwifruit, andeucommia are calculated to be about 14 percent each. At 27 percent, dates have a relativelyhigh economic return primarily because, in the farm model, production and land taxes representa high share of the financial costs of production. Following grafting, the maintenance input andlabor costs of a stand are low compared with those for other tree crops. Greenhouse and fieldvegetable production generate economic returns approaching 26 and 22 percent. Farmers can,of course, reduce the risks pertaining to revenues derived from horticulture by diversifying theirtree crop holdings. Households participating in field vegetable development may also secureseasonal stability in revenues by negotiating purchase contracts with vegetable processingenterprises.

Table A7.3: Estimated Household Benefits from Horticulture

HorticultureCrop

Area(ha)

Area/House-

hold(ha/hh)

Totalhh

(‘000)

NetIncome(Y/ha)a

AverageNet

Income(Y/hh)

TotalNet

Income(Y’000)

GrossIncome(Y/ha)b

AverageGross

Income(Y/hh)

TotalGross

Income(Y’000)

Apples 3,200 0.20 16.0 7,793 1,559 24,936 10,485 2,097 33,553Gingko 1,900 0.07 28.5 11,174 745 21,231 7,694 513 14,619Kiwifruit 1,400 0.20 7.0 23,392 4,678 32,748 26,842 5,368 37,578Eucommia 600 0.20 3.0 10,807 2,161 6,484 7,926 1,585 4,755Chinese date 1,200 0.20 6.0 2,384 477 2,861 6,678 1,336 8,014Greenhouses 167 0.03 5.0 102,209 3,407 17,035 223,709 7,457 37,285FieldVegetables

2,800 0.07 42.0 3,977 265 11,136 18,227 1,215 51,036

HuaibaOrchard

1,300 0.20 6.5 7,793 1,559 10,130 10,485 2,097 13,631

TOTAL 12,567 114 126,562 200,472Weighted Av.Horticulture

10,071 1,110 15,953 1,759

Weighted Av.Tree Crops

10,241 1,469 11,682 1,674

Weighted Av.Vegetables

9,496 599 29,771 1,879

hh = households.a Full development incremental gross margin after imputing labor costs. b Incremental gross margin after taxes and before imputing labor costs.

68

Appendix 7, page 3

Table A7.4: Sensitivity of Returns to Horticulture a

Apple Gingko Kiwi-fruit

ChineseDate Eucommia

Green-houses

FieldVeg.

WholeComponent

FinancialAnalysis1. Base case

Yuan ‘000IRRNPV

17.2%14,879

15.1%18,941

16.2%32,352

17.2%3,143

18.4%5,200

20.3%34,041

14.4%10,453

16.7%119,008

2. Outputprices – 10percent

IRRNPVSV

13.9%9,387

-27.1%

11.4%8,338

-17.8%

12.5%17,222-21.4%

6.4%-430

-8.8%

12.1%2,089

-16.6%

15.9%24,655-36.1%

3.5%-5,917-6.4%

12.0%55,344-18.7%

3. Operatingcosts + 10percent

IRRNPVSV

16.3%12,63066.3%

14.7%18,422

360.8%

15.4%29,385

110.1%

9.6%462

11.7%

16.9%4,532

76.9%

17.4%28,23558.5%

5.0%-4,102

7.2%

14.4%89,56440.4%

4. Investmentcosts + 10percent

IRRNPVSV

15.8%13,30093.8%

14.6%18,230

265.7%

15.7%31,482

368.0%

15.7%2,858

110.4%

17.6%5,001

259.9%

18.3%31,708

144.1%

13.1%9,140

79.2%

15.7%111,719162.1%

5. Delay of 1year

IRRNPV

14.6%11,252

14.0%16,740

14.4%26,812

4.6%-2,004

19.1%5,502

12.7%19,872

7.3%-2,074

12.4%76,100

EconomicAnalysis1. Base case

Yuan ‘000IRRNPV

14.6%3,572

14.7%5,822

16.8%15,047

27.1%3,938

14.5%1,311

25.9%17,433

21.9%12,487

18.1%59,610

2. Outputprices – 10percent

IRRNPVSV

10.8%-1,578-7.2%

10.9%-2,310-7.4%

5.6%-13,827

-5.2%

16.3%1,056

-13.7%

9.5%-1,480-4.5%

19.6%10,222-24.2%

11.4%-800

-9.4%

11.0%-8,717-8.7%

3. Operatingcosts + 10percent

IRRNPVSV

13.0%1,282

15.9%

13.7%3,569

26.3%

16.1%12,64463.1%

18.9%1,751

19.1%

15.2%1,651

-37.9%

21.5%12,19533.3%

13.5%1,855

11.8%

15.5%34,94624.2%


IRRNPVSV

14.1%2,979

59.9%

14.3%5,080

77.3%

16.4%14,106

155.7%

24.8%3,637

130.1%

14.0%1,089

58.9%

22.8%14,59961.5%

20.1%11,08188.2%

17.1%52,57284.6%

5. Delay of 1year

IRRNPV

12.5%635

13.9%4,118

15.1%9,851

13.8%850

15.0%1,481

15.3%6,455

11.2%-1,749

13.8%21,642

FCOC = financial cost of capital, IRR = internal rate of return, OCC = opportunity cost of capital, SV = switching value.a NPVs, expressed in yuan ‘000, are calculated using the FCOC or OCC as appropriate. SVs are calculated to

produce a zero NPV/IRR equal to the discount rate (FCOC or OCC).

B. Review of Household Livestock Production Proposals

6. The Project will support household meat goat, sheep, cattle, and pig raising.Approximately 14,400 households are expected to participate in raising sheep or goats, 9,500 inraising cattle, and 2,000 in raising porkers. The budgets for livestock activities haveincorporated the costs of annual animal mortality (and replacement outside normal culling) thatshould be expected for households that are new to the activities (or new to the demands ofmeeting certain levels of product quality), and that should be expected even in the presence ofexcellent veterinary care. Table A7.5 summarizes the estimated investment cost per householdfor each activity.

Table A7.5: Investment Summary of Livestock Activities (Y/farm)

Livestock LaborCivil Works

& EquipmentBreedingAnimals

Other Goods& Materials

WorkingCapital Total

Meat Goats 150 800 3,000 60 1,025 5,035Sheep 150 800 3,000 60 1,116 5,126Cattle 225 2,206 4,000 380 3,018 9,829Pigs 150 5,621 2,800 60 10,474 19,105

7. At full development, household cattle raising will produce 15,580 18-month-old cattle andabout 2,375 aged cows per year. Sheep raising will produce 108,000 surplus animals per year,with live weight of 5,400 t, and 14,400 aged sheep for slaughter at 936 t live weight. Meat goat

69

Appendix 7, page 4

raising activity will produce 108,000 surplus animals per year having a total weight of 6,075 t,and 14,400 aged goats at 720 t live weight. The Project will also assist 2,000 households topurchase crossbred pigs for raising porkers. These households will produce about 68,000animals annually. The local markets will absorb all annual meat production. Table A7.6 showsestimated benefits per household, by activity.

8. The base FIRRs for meat goats, sheep, cattle, and pig raising investments are estimatedto be about 18, 21, 17, and 20 percent, respectively. Together, these activities generate a returnof about 18 percent (Table A7.7). The meat goats, sheep, and cattle raising investmentsindicate relatively moderate risk. The porker production entails greater risk, which is mitigatedby the company + household model, where the enterprise guarantees minimum protectionprices. Household porker production also operates on a rather narrow margin. At fulldevelopment, operating costs represent approximately 93 percent of the value of sales, chieflydue to the feed requirements, as these households act as contract out-growers.

9. The base return to the cattle component appears satisfactory although, in general, beefproduction by households in the PRC may be marginally profitable in areas with inadequatefeed supply. For the selected communities in Henan, with access to productive grassland,raising cattle should provide adequate financial returns. Households can also manage risks byraising different types of livestock.

10. The base EIRRs for the household livestock production are estimated at 21, 23, 19, andabout 16 percent for the goats, sheep, cattle, and pig investments. The economic return tohousehold livestock production as a whole is almost 20 percent. Pig raising remains sensitive tovariations in revenues and costs. The EIRRs of other livestock activities display moderatesensitivity comparable with the results of the financial sensitivity analysis (Table A7.7).

Table A7.6: Number of Beneficiaries and Benefits per Householdfrom Livestock Production

Livestock HeadAnimals/

householdTotal

Households

NetIncome(Y/hh)a

Total NetIncome(Y’000)

GrossIncome(Y/hh)b

TotalGross

Income(Y’000)

Cattle 19,000 2 9,500 1,522 14,457 2,422 23,007Sheep/Goats 144,000 10 14,400 926 13,330 1,646 23,698Pigs 4,000 2 2,000 1,818 3,636 2,328 4,656TOTAL 167,000 25,900 1,213 31,423 1,983 51,361a Full development incremental gross margin after imputing labor costs.b Incremental gross margin after taxes and before imputing labor costs.

C. Implications of Debt Financing of Household Activities

11. Possible loan conditions have been calculated for the debt financing of each householdactivity. The calculations are based on the incremental cash flows implied by the presentedactivity budgets, assuming that household borrowing through the Project has a nominal interestrate of 8.5 percent, households provide all labor required for investments and operations,households on balance contribute 10-20 percent for input costs, interest payments can bedeferred and capitalized into total amounts of debt held, financing for operations are part oflong-term debt, and households self-finance the next period’s input costs from the currentperiod’s retained earnings as soon as it is feasible.

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Appendix 7, page 5

Table A7.7: Sensitivity of Returns to Household Livestock Production

Pigs Goats Sheep CattleWhole

ComponentFinancial AnalysisBase Case

Yuan ‘000IRRNPV

20.1%4,991

18.4%7,860

20.7%10,190

17.1%17,514

18.4%40,556

Output Prices – 10 percent IRRNPVSV

-3.9%-5,531-4.7%

9.9%1,501

-12.3%

11.7%3,029

-14.2%

11.5%6,606

-16.1%

9.4%5,605

-11.6%Operating Costs + 10 percent IRR

NPVSV

-2.1%-4,700

5.1%

11.6%2,837

15.6%

13.5%4,598

18.2%

12.9%9,590

21.9%

11.1%12,32614.4%

Investment Costs + 10 percent IRRNPVSV

18.3%4,659

148.6%

16.9%7,310

141.7%

19.1%9,640

184.9%

15.8%16,281

141.2%

17.0%37,890

150.7%Delay of 1 Year IRR

NPV5.9%

-2,80310.4%3,149

11.4%4,886

11.5%10,061

10.2%15,293

Economic AnalysisBase Case

Yuan ‘000IRRNPV

15.5%1,116

20.8%4,418

23.1%5,931

19.3%9,542

19.9%21,006

Output Prices – 10 percent IRRNPVSV

-5.1%-7,183-1.3%

10.9%-575

-8.8%

12.6%323

-10.6%

12.8%1,076

-11.3%

9.6%-6,359-7.6%

Operating Costs + 10 percent IRRNPVSV

-4.0%-6,714

1.4%

12.9%465

11.2%

14.8%1,515

13.4%

14.6%3,358

15.5%

11.5%-1,375

9.4%Investment Costs + 10 percent IRR

NPVSV

14.2%759

30.5%

19.0%3,819

73.5%

21.1%5,332

97.7%

17.8%8,214

71.7%

18.3%18,12372.6%

Delay of 1 Year IRRNPV

4.7%-7,776

11.0%-932

11.9%-77

12.4%710

10.4%-8,075

Notes: NPVs, expressed in Yuan ‘000, are calculated using the FCOC or OCC as appropriate. Switching values (SV)are calculated to produce a zero NPV/IRR equal to the discount rate (FCOC or OCC).

12. Where investments in tree crops are replacing the existing cultivation of grainas is thecase for gingko, kiwifruit and eucommiaand there is loss of income in the period prior to thematurity of a tree crop, the calculations for total household debt financing and cash flows haveconsidered amounts of credit for financing operating expenses that would keep the welfare ofhouseholds about the same as without the Project. The scheduling of repayments for theseinvestment loans are worked out with the assumption that household borrowings for operatingexpenses in the period prior to a sufficient tree crop harvest are such as to allow households, inthe absence of adequate savings, to avoid becoming temporarily poorer while participating inthe Project.

13. Of the horticultural activities, apples, Chinese dates, ratooned eucommia, greenhousesand field vegetables appear to be best able to accommodate repayment of credits within sevenyears, or less, including two to three years grace. Apple financing appears feasible with threeyears grace and a repayment period of four years. Eucommia development with ratooning couldsustain repayment within four years following three years’ grace. The grafting of Chinese datescould be financed with repayments over three years following two years’ grace. Thegreenhouses and field vegetables should repay credits within three to four years, including twoyears grace. Kiwifruit and gingko development, however, appear difficult to finance withincomparable periods of time due to the relatively long periods before maturity. One way toimprove the situation is to have households contribute more cash for the investments, but thiscould conflict with the Project’s poverty reduction objectives. The preferred response is toaccord considerable flexibility in the amount and scheduling of credit repayments for theseinvestments, as provided under the Project. Alternatively, some grant financing from localsources might be available.

71

Appendix 7, page 6

14. While the investment costs for the two-sow model are high compared with those forother livestock activities, the operating costs are also high, primarily because of the feedrequired. It is likely that these households will require five years to repay the credit following twoyears’ grace. Also, given the margin on porker production, it would be some time untilhouseholds are able to fully self-finance operating expenses. This is in contrast to the apparentability of households taking credits for cattle to repay their debts within five years, including twoyears’ grace. These households should then be able to finance their operating expenses withintwo years thereafter. Households borrowing for goats or sheep should be able to repay theirdebts within four years, including two years’ grace.

D. Review of Enterprises

15. Apart from the Huaiba water supply companies (see next section), the Project wouldpartially finance the investments of two livestock enterprises: a crossbred piggery and apurebred piggery. One piggery, located at Jiyuan, would produce crossbred pigs for breedingporkers. The other, the Xinda company located near Zhengzhou, would produce purebred pigs,some of which would be supplied to the piggery in Jiyuan.

16. The breeding piggeries will produce 4,600 purebred sows, 20,000 crossbred sows,25,000 piglets, 11,200 porkers, and 1,240 culled sows each year. The FIRRs to the crossbredpiggery and purebred piggery investments are estimated at 22 and 13 percent. Thecorresponding EIRRs for these activities are estimated at 25 and 15 percent. In aggregate, theestimated base FIRR for the three livestock enterprise investments is about 19 percent. Theiraggregate base EIRR is estimated at about 22 percent.

17. Purebred pig breeding, with an FIRR of about 13 percent, can provide a satisfactoryfinancial return – provided that consistently efficient management and quality control can beimplemented. The returns to the crossbreeding piggery investment can be more easilyaccommodated than those for the purebred breeding unit. A reduction in revenues of 10 percentdrops the base FIRR to about 11 percent, while the EIRR would decline from 25 to about 16percent. In contrast to the purebred piggery these returns hold up well under other combinationsof varied costs and income. As there is substantial cross shareholding in these enterprises, theoverall result for the whole component is more significant and shows a robust result (TableA7.8).

Table A7.8: Sensitivity of Returns to Livestock Enterprises a

Financial Analysis Economic Analysis

Item CrossbredPiggery

PurebredPiggery

WholeComponent

CrossbredPiggery

PurebredPiggery

WholeComponent

1. Base caseYuan ‘000

IRRNPV

21.7%23,502

13.0%1,231

18.6%24,733

25.0%29,609

15.1%3,248

21.8%32,856

2. Output prices– 10 percent

IRRNPVSV

10.9%-2,324

-12.3%

5.4%-7,508-6.9%

9.0%-9,832

-10.9%

16.2%9,080

-14.4%

7.6%-4,221-9.4%

13.5%4,859

-15.9%3. Operatingcosts + 10percent

IRRNPVSV

13.3%2,858

15.3%

7.2%-5,767

8.6%

11.2%-2,90913.7%

18.4%14,31119.3%

9.4%-2,590

5.7%

15.6%11,72115.5%


IRRNPVSV

19.9%20,671

153.2%

11.7%-387

50.8%

17.1%20,284

116.6%

23.2%27,339

130.1%

13.7%1,942

24.7%

20.1%29,28191.4%

5. Delay of 1Year

IRRNPV

10.4%-6,297

6.9%-8,852

9.3%-15,149

13.7%5,922

8.3%-5,370

12.1%552

a NPVs, expressed in Yuan ‘000, are calculated using the FCOC or OCC as appropriate. Switching values (SV) arecalculated to produce a zero NPV/IRR equal to the discount rate (FCOC or OCC).

72

Appendix 7, page 7

E. Review of the Water Supply and Irrigation Component

18. The water supply system will be designed to provide 3 m3/s in Phase 1, but parts of theconveyance system will be constructed to allow for the proposed expansion of the water supplyin Phase 2 to 7 m3/s. The base case evaluation reviewed here does not incorporate any benefitsof this second phase of construction. The evaluation reflects estimated losses of 5 percent inthe conveyance system and 8 percent in the distribution network. At full capacity utilization,electricity costs for pumping will approach 90 percent of the operating costs.

19. Demand projections for nonindustrial uses are based on projections by municipal andprovincial authorities. The rates of water consumption are assumed to be as follows: 100 liters(l)/person/day for urban domestic users, 70 l/person/day for urban migrant workers, 30l/person/day for general urban public use, 75 l/person/day for rural domestic users, and 50l/animal/day for rural livestock. Consumption levels are expected to reach these averages withinfive years after water supplies are made available. Industrial demand in 2001 is based onexisting enterprises plus identified industries either planned or now under construction. The totalannual demand is expected to exceed supply by 10 percent in 2001. As there will be excessdemand, the evaluation assumes that all nonindustrial water demands will be met before anyindustrial demands: i.e., all of the excess demand will be industrial.

20. The analysis calculates a return to irrigation development based on the establishment of1,300 ha of orchards following the expansion of water supplies. To approximate the net benefitsof horticultural development of this area, the analysis assumes plantings of kiwifruit as arepresentative crop.

21. The financial analysis uses revised investment costs and cost estimates for resettlementworks. Using tariff information provided by the Sanmenxia authorities, the FIRR for theproposed investment in the Sanmenxia Water Supply Company is about 11 percent. The FIRRsfor investments in the Mianchi and Yima Water Distribution Companies are estimated at 12 and8 percent, respectively. The overall FIRR for the development of water supplies is about 11percent. At approximately 14 percent, the returns to orchard development are comparable withthose to the horticulture component. The overall FIRR for the water supply component isestimated at just under 12 percent.

22. Table A7.9 summarizes the results of sensitivity analysis for this component. The YimaWater Distribution Company has lower returns and greater sensitivity than the Mianchi WaterDistribution Company due to the priority given to nonindustrial uses and Mianchi’s fasterpopulation growth. The second phase development, however, should improve Yima’sperformance.

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Appendix 7, page 8

TableA7.9: Sensitivity of Returns to Development of Water Supplies in Sanmenxia County a

San-menxiaWater

MianchiWaterSupply

YimaWaterSupply

TotalWaterSupply

MianchiIrrigationCompany

TotalWater &Irrigation

IrrigatedOrchard

WholeComp-onent

FinancialAnalysisBase case(Y’000)

IRRNPV

10.6%75,177

11.9%2,417

8.0%-17

10.6%77,577

9.4%508

10.6%78,085

14.5%80,813

11.7%158,898

Outputprices – 10percent

IRRNPVSV

8.4%10,791-11.7%

8.0%-16

-9.9%

1.9%-3,161

0.0%

8.3%7,614

-11.0%

7.6%-156

-7.8%

8.3%7,458

-11.0%

13.5%63,752-44.3%

9.7%71,210-18.0%

Operatingcosts + 10percent

IRRNPVSV

8.5%13,54112.2%

N/A-31,008

1.0%

N/A-56,223

0.0%

5.1%-73,690

5.3%

N/A-6,346

0.7%

4.9%-80,035

5.1%

13.7%70,34477.4%

7.8%-9,692

9.3%InvestmentCosts + 10percent

IRRNPVSV

9.5%45,31825.0%

10.5%1,667

31.7%

6.5%-1,018

0.0%

9.4%45,96824.4%

8.2%75

10.8%

9.4%46,04224.2%

13.9%76,149

173.0%

10.7%122,192

43.2%Delay of 1Year

IRRNPV

9.3%38,427

9.2%833

5.2%-1,992

9.2%37,268

7.8%-100

9.2%37,168

14.5%80,813

10.6%117,981

EconomicAnalysisBase Case

Y ‘000IRRNPV

16.1%71,489

22.4%4,417

17.2%2,301

16.2%78,207

17.1%1,346

16.2%79,553

15.3%26,384

16.0%105,938

OutputPrices – 10percent

IRRNPVSV

11.8%-2,449-9.6%

15.0%1,180

-13.6%

6.4%-1,873-5.5%

11.8%-3,142-9.6%

14.3%598

-18.0%

11.9%-2,545-9.6%

13.1%8,261

-14.5%

12.2%5,716

-10.5%OperatingCosts + 10percent

IRRNPVSV

13.5%25,90016.0%

N/A-22,675

1.6%

N/A-41,691

0.5%

9.6%-38,466

6.7%

N/A-5,883

1.9%

9.3%-44,349

6.4%

14.4%18,89735.3%

11.0%-25,452

8.0%InvestmentCosts + 10percent

IRRNPVSV

14.7%50,07432.8%

20.3%3,816

73.3%

15.1%1,500

28.4%

14.8%55,39033.7%

15.5%998

38.7%

14.8%56,38833.7%

14.7%22,74571.8%

14.8%79,13338.3%

Delay of 1Year

IRRNPV

13.9%35,358

17.0%2,519

11.9%-39

13.9%37,838

13.5%468

13.9%38,306

15.3%26,384

14.3%64,690

a NPVs, expressed in Yuan ‘000, are calculated using the FCOC or OCC as appropriate. SVs are calculated toproduce a zero NPV/IRR equal to the discount rate (FCOC or OCC). N/A indicates that the IRR cannot becalculated.

23. The EIRRs of the water companies are 16 percent for the Sanmenxia Water SupplyCompany, 17 percent for the Yima Water Distribution Company, and 22 percent for the MianchiWater Distribution Company. The total return to water supply (the water supply and distributioncompanies considered as a consolidated unit) is estimated at 16 percent. The EIRR of theirrigation company is calculated to be about 17 percent while the return to the development ofthe North Irrigation Area is estimated to be near 15 percent. The overall EIRR for thecomponent is estimated at 16 percent. The sensitivity of these base economic results more orless mirrors the pattern of their financial counterparts.

24. The estimated base EIRRs for the water companies should be regarded as lowerbounds as the economic value of the water supplied in the analysis was assumed to be no lessthan its total financial value, which is related to the cost of its supply. In the future without theProject, the incremental supply of water for the area would be much less than with the Project,and the cost of supply would be much greater. The true economic return to the component istherefore likely to be much higher than presented here. Sensitivity results, based on aconservative economic value of water, suggest that the economic viability of the water supplyscheme is assured.

F. Overall Project Performance

25. The base FIRR for the entire Project is estimated at about 14 percent. ComponentFIRRs range from 12 percent to about 19 percent. The corresponding EIRR for the Project is

74

Appendix 7, page 9

estimated at about 17 percent, with a range in returns to subcomponents similar to thosecalculated for the financial analysis. Sensitivity analysis (Table A7.10) shows that the Project inaggregate is moderately sensitive to adverse changes in output values and operating costs, withlivestock among the most sensitive. The Project, however, has a large number ofsubcomponents, covering a wide range of products. This diversity should reduce the probabilityof simultaneous adverse price and cost movements that would jeopardize the overall economicviability of the Project.

Table A7.10: Sensitivity of Total Project Returns a

Item Base Case Output -10%Operating

Costs +10%InvestmentCosts +10% 1 Year Delay

FinancialIRR 13.9% 10.2% 9.8% 12.7% 10.9%NPV 372,427 136,656 106,716 321,142 219,365SV - -15.9% 13.1% 39.2% -EconomicIRR 17.3% 11.9% 12.5% 16.0% 13.5%NPV 219,410 -4,500 19,839 179,109 78,809SV - -9.9% 10.9% 31.7% -a NPVs, expressed in Y’000, are calculated using the FCOC or OCC as appropriate. SVs are calculated to produce

zero NPV/IRR equal to the discount rate (FCOC or OCC as appropriate).

75

ASIAN DEVELOPMENT BANK RRP:PRC 26459 › sites › default › files › project...production will be 72,600 metric tons (t) for fruits, 2,640 t for medicinal plant products, and 197,900

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