Internet-Plus Agriculture Development Project (RRP PRC 50393)

ECONOMIC ANALYSIS A. Introduction

1. The economic analysis was conducted separately for all seven subprojects. The results for the individual subprojects were aggregated by output (subprojects 1 and 2 comprising output 1 and subprojects 3–7 comprising output 2) and for the overall project to verify the economic viability of both the outputs and overall project. Capacity building costs were only included in the overall economic analysis.

B. Macroeconomic and Sector Context

2. Gansu province, located in the northwest of the People’s Republic of , is the seventh-largest province in the country with a population of 26.2 million, of which 14.44 million (55.1%) live in rural areas.1 In 2016, Gansu’s total gross domestic product was CNY720 billion, of which agriculture accounted for 13.7%. In 2017, Gansu’s gross domestic product per capita of CNY29,326 (equivalent to about $4,417)2 was the lowest of all provinces in the People’s Republic of China, and half of the province’s 87 counties are designated as national poverty counties. In the proposed project cities,3 6.5%–10.5% of the rural population live below the national annual income poverty line of CNY2,300 per capita. Agriculture is still an important means of rural livelihoods in Gansu province, yet low productivity and low-value addition of the agriculture sector limit the opportunities for income generation.

3. The low productivity of Gansu’s agriculture sector originates from constraints on different areas of agricultural production. Operations in the agriculture processing segment are too small and fragmented to have adequate quality assurance systems for sourced raw materials. Business upscaling of processing operations to realize economies of scale is constrained by high sourcing costs for inputs because of high transaction costs with small-scale scattered production and distribution entities. Many operations in the processing segment lack adequate storage, transportation, and marketing capacity to produce the volume and quality needed to access premium online and offline markets with high-quality food products.

C. Rationale

4. Uncoordinated business relationships between the primary and processing segments predominate the agriculture sector. Information asymmetry about product quality and safety characteristics (e.g., origin of inputs, farming system, food safety, nutrition values) has led to adverse selection of low-value products which are not competitive in developing high-value online and offline markets in Gansu and other provinces. Automated and credible traceability systems covering the entire value chain from farmer to consumer are rare. Farmers’ decisions on the quality and quantity of applied water, fertilizers, and pesticides for crop growth are not documented while real-time information services tailored to agro-ecological conditions, such as soil fertility, moisture, and temperature, are missing for decision support. Limited information and communication technology capacity of farmers, processors, and other service providers is constraining the adoption of integrated and automated information exchange systems which could facilitate coordination and cooperation between business entities in the production and marketing segments.

1 Government of the People’s Republic of China, National Statistics Bureau. 2017. China Statistical Yearbook 2017. http://www.stats.gov.cn/tjsj/ndsj/2017/indexeh.htm 2 Based on an average 2016 exchange rate of $1.00 = CNY6.64. 3 Project interventions are planned in , , , Wuwei, and prefectures with some project activities also in and cities. 2

5. The primary production segment is characterized by low-value crop production. Excessive application of water, fertilizers, and pesticides is one common cause for inefficient input use in crop production, resulting in high production costs, negative externalities on the environment and food safety, and inefficient water usage. Adoption of modern agricultural technologies is constrained by deficiencies in technical knowledge of smallholders. In addition, smallholders’ access to extension services is hampered by the absence of adequate agricultural technology and management support services.

D. Project Description

6. The project will contribute to increased economic opportunities and reduced poverty in the rural areas of Gansu province. The project outcome will be increased income-generating opportunities from agricultural production and marketing. The project aims to develop internet- plus based agricultural production and marketing in seven demonstration projects covering five prefectures in Gansu province (footnote 3) as described in Table 1.

Table 1: Project Outputs Output Description Comprehensive This output will develop data centers with information platforms to process data generated from information project facilities for increased production and processing efficiency and for e-commerce marketing service and purposes. This will include (i) construction of data and training centers, (ii) procurement of ICT management equipment and technical advisory services, and (ii) training of farmers and enterprise staff to build platform capacity in ICT application in agricultural production and processing. The platform will provide developed product origin, quality, and safety monitoring services as well as management advice for the coordination and optimization of agricultural production, processing, and marketing activities. The integrated network will also reduce transaction costs between service providers and establish access to high-value markets via links to e-commerce platforms. The platform is intended to be scalable and inclusive to provide project-generated market information and agricultural support services to a wide range of beneficiaries, especially farmers who lack access to markets and high- quality technical support services. Agricultural This output will (i) establish demonstration agricultural production enterprises for high-value crop production, production including summer vegetables, potatoes, fruits, and licorice; and forage crop processing, production, in particular mulberry plants; (ii) equip the demonstration enterprises with internet-of- storage, and thingsa applications for product quality and safety monitoring, increased production efficiency, and marketing coordination with other segments of the agriculture sector; (iii) construct warehouses, cold storage modernized facilities, and market facilities to increase value addition; and (iv) finance ICT and transport equipment to promote an integrated and automated information exchange network for enhanced coordination and quality assurance at distribution, storage, processing, and marketing facilities. Global positioning systems together with network-connected sensors for soil moisture, temperature, and optical spectrum will be utilized to monitor and optimize the quantity and/or timing of irrigation, fertilizer application, and harvesting depending on the intrafield variability of crops and soil conditions. Project-financed improvements to processing and storage services will benefit small farmers, including women and vulnerable groups, through enhanced market access. The production enterprises will be used for demonstration and training purposes to increase access to and quality of agriculture technology and management support services for small farmers, including women and vulnerable groups in rural areas who will benefit as suppliers or members of the cooperatives. Capacity of This output will (i) provide on-the-job training to GSSMCU staff in the implementation of projects GSSMCU relating to use of the internet-of-things; (ii) support national study tours, in particular with respect to improved precision agriculture, modern internet-based marketing, quality control, and traceability; and (iii) promote participation in national and regional conferences. The output will improve the capacity of GSSMCU staff to implement projects and to work within the internet-based environment. GSSMCU = Gansu Supply and Marketing Cooperatives Union, ICT = information and communication technology. a Internet-of-things refers to physical devices embedded with sensors and network connection capability that enable these devices to collect and exchange data. It allows remote sensing and control of devices through existing internet infrastructure. Source: Asian Development Bank.

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E. Economic Analysis

7. Assumptions. The analysis is in accordance with the Asian Development Bank’s Guidelines for the Economic Analysis of Projects and the good practices guides.4 All project costs and benefits are estimated in constant 2019 prices. The adopted exchange rate is CNY6.7564 = $1.00. Costs and benefits are converted to economic values using the domestic price numeraire. Because the participating enterprises produce and/or process local specialty agricultural products, most of the inputs and outputs were considered nontraded and are therefore valued at their market prices net of domestic taxes. Traded goods are adjusted to their economic values using a shadow exchange rate factor of 1.03. Land valuation was not used in the analysis since the subproject enterprises are operating on their own land or on land that has already been rented for their enterprises; therefore, incremental land acquisition is not expected with the project. Labor for production and service staff, seasonal workers, laborers, and contract workers is treated as being in surplus, and wages and welfare expenses were converted to economic prices using a shadow wage factor of 0.91. Management and technical staff are treated as scarce labor, and welfare expenses were converted using a shadow wage factor of 1.0. The financial costs of electricity, water, and fuel are converted to economic values using economic conversion factors of 1.0 and 1.25. Construction of all subprojects takes place over an expected 5-year period from the first quarter of 2020 to the fourth quarter of 2024, although some subprojects are expected to be completed in 2 years. The project life is 25 years from project opening, which is considered reasonable for this type of subproject as long as regular investments are made to replace information and communication technology equipment. Physical contingencies are set at 5%. Costs and benefits are discounted at the economic opportunity cost of capital of 9%, which was also used as the cut-off rate for the economic internal rate of return.

8. Demand analysis. Production from the subprojects can be broadly categorized into three types: (i) fresh and processed agricultural products including vegetables, fruits, and potatoes for consumption; (ii) forage mulberry plants for livestock feed; and (iii) Chinese medicinal products. The demand for safe fresh and processed agricultural products is growing rapidly with the rapid increase in middle-class urban consumers at whom this production is aimed. Forage production will enable lower-cost production together with increased output to satisfy the urban demand for high-quality meat and meat products, particularly from sheep and cattle. Similarly, the demand for traditional Chinese medicines is increasing with the urbanization and growing wealth of the population, and current supplies are well below current demand.

9. Least-cost analysis. Since the subproject investments are focused on small and medium-scale agro-industrial enterprises (either private or state owned rather than the traditional large-scale government investment), there was little scope to address specific least-cost investment from the approach of comparing two or more approaches. Rather, the investments prepared by the design institutes in collaboration with the enterprises are considered to represent the least-cost approach to expanding their enterprises.

F. Project Benefits

10. Output 1 of the project will connect about 110,000 farm households to internet services including improved access to input supply, extension services, and output markets, which will result in reduced production costs and improved market access. Output 2 of the project will result in (i) increased production and processing of local specialty products, including fruits and vegetables, potatoes, licorice, and mulberry plants and mulberry forage; and (ii) improved processing and storage of high-quality products. All increased production is the result of increased

4 Asian Development Bank. 2017. Guidelines for the Economic Analysis of Projects. Manila. 4

areas of crops grown using high-technology methods. The reduced costs for output 1 were quantified in collaboration with the two participating subproject enterprises and were based on their expectations of the uptake of the services they will be offering and the benefit they anticipate will be obtained from each use. Based on the productive areas for each crop and the anticipated yields, the incremental annual outputs expected for the five subproject enterprises in output 2 are about 2,200 tons of Gobi plateau deep processed vegetables, 10,000 tons of cherry tomatoes, 4,500 tons of strawberries, 120 million stems of cut roses, 10 million stems of cut lilies, 15,000 tons of processed potato products, 10,500 tons of licorice products, 60 million mulberry plants, and 200,000 tons of mulberry forage. While the expected incremental production of each of these products is substantial, none are considered large enough within their specific markets to have an impact on price, particularly taking into account the expanding urban middle class.

11. Economic benefits are expected to build up rapidly, reaching full development by 2026, because of the rapid adoption of information and communication technology by the rural population who will benefit from output 1 and from internet-plus technology by the enterprises benefitting from output 2. This is consistent with observed adoption of internet technologies elsewhere in the People’s Republic of China. While there may be small increments in benefits subsequently, major increases will require substantial additional investment and have therefore not been included in the analysis.

G. Evaluation

12. The overall project has an economic internal rate of return (EIRR) of 20.4%, well in excess of the economic opportunity cost of capital of 9.0% (Table 2) The economic net present value is CNY1.20 billion. The EIRR for output 1 is 17.1% and for output 2 21.8%, while the EIRRs for individual subprojects range between 10.1% for subproject 5 and 26.8% for subproject 3 (Table 3), indicating that both outputs and all subprojects are economically viable.

Table 2: Economic Evaluation of Overall Project (CNY million) Economic Costs Economic Net Incremental Cash Flow Year Investment Recurrent Total Benefits 2020 484.7 0.0 484.7 0.0 (84.7) 2021 349.7 35.0 384.7 44.6 (340.1) 2022 164.6 108.9 273.5 122.3 (151.3) 2023 11.7 202.9 214.6 337.8 123.2 2024 0.9 209.2 210.1 423.0 212.9 2025 0.0 216.7 216.7 509.5 292.7 2026 0.0 219.2 219.2 559.4 340.2 2027 0.0 219.2 219.2 559.4 340.2 2028 0.0 219.2 219.2 559.4 340.2 2029 0.0 219.2 219.2 559.4 340.2 2030 280.6 219.2 499.8 559.4 59.6 2031 0.0 219.2 219.2 559.4 340.2 2032 0.0 219.2 219.2 559.4 340.2 2033 0.0 219.2 219.2 559.4 340.2 2034 0.0 219.2 219.2 559.4 340.2 2035 0.0 219.2 219.2 559.4 340.2 2036 0.0 219.2 219.2 559.4 340.2 2037 0.0 219.2 219.2 559.4 340.2 2038 280.6 219.2 499.8 559.4 59.6 2039 0.0 219.2 219.2 559.4 340.2 2040 0.0 219.2 219.2 559.4 340.2 2041 0.0 219.2 219.2 559.4 340.2 2042 0.0 219.2 219.2 559.4 340.2 5

Economic Costs Economic Net Incremental Cash Flow Year Investment Recurrent Total Benefits 2043 0.0 219.2 219.2 559.4 340.2 2044 0.0 219.2 219.2 559.4 340.2 ENPV 1,038.4 1,692.4 2,730.7 3,935.5 1,204.8 EIRR 20.4% ( ) = negative, EIRR = economic internal rate of return, ENPV = economic net present value. Source: Asian Development Bank estimates.

H. Sensitivity Tests

13. Five sensitivity scenarios were tested: (i) 10% increase in investment costs, (ii) 10% decrease in net benefits, (iii) 10% increase in investment costs combined with a 10% decrease in net benefits, (iv) 10% increase in recurrent costs, and (v) 1-year delay in benefits. Six subprojects, both outputs, and the overall project are considered robust. Subprojects 5 is sensitive to investment and recurrent cost increases and benefit decreases as well as a lag in benefits (Table 3).

Table 3: Sensitivity Test Results EIRR ENPV EIRR (%) (%) (CNY 10% 10% (i) + (ii) 10% 1-Year million) Investment Benefit Recurrent Benefit Cost Incr. Decrease Cost Delay Subproject (i) (ii) Increase 1. Gansu Internet-Plus Based 16.7 122.5 15.3 14.0 12.7 15.6 13.3 Socialized Agricultural Service (76.5) (26.2) (66.3) System Platform 2. Zhangye County-Level Internet- 17.7 96.8 15.9 13.6 11.9 15.7 12.6 Plus Based Socialized (64.9) (19.4) (38.2) Agricultural Service System in 3. Zhangye Whole Industrial Chain 26.8 138.1 24.4 17.8 16.0 20.6 14.6 Service System for Gobi (148.9) (18.8) (27.3) Agriculture in Linze County 4. Wuwei Integrated Industry for 24.9 267.4 23.5 22.7 21.4 24.3 21.0 Potatoes in Gulang County (258.7) (56.7) (264.5) 5. Baiyin Whole Industrial Chain 10.1 7.6 8.8 4.8 3.8 6.5 6.1 Service System for Licorice in (8.2) (2.2) (3.1) 6. Application Base of the Internet- 25.2 458.3 23.2 22.5 20.7 24.7 20.5 of-Things for Featured (150.5) (50.3) (310.5) Agricultural Products in Lanzhou New District 7. Tianshui Whole Industrial Chain 15.7 121.6 14.7 13.2 12.2 14.4 12.5 Service System for Forage (94.8) (23.9) (46.8) Mulberry Output 1 (subprojects 1–2) 17.19 219.3 15.6 13.8 12.4 15.6 13.0 (70.9) (22.7) (50.0) Output 2 (subprojects 3–7) 21.8 992.9 20.2 18.4 16.9 20.3 16.7 (137.6) (33.4) (79.2) Overall Project 20.4 1,204.8 18.8 17.1 15.7 19.0 15.7 (116.0) (30.6) (71.2) ( ) = switching values in percentages, EIRR = economic internal rate of return, ENPV = economic net present value. Source: Asian Development Bank estimates.