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 rate system. In this report, a rate of $1.00=Y8.3, the rate prevailing at the time of appraisal of the Project, has been used.

ABBREVIATIONS

ABC - Agricultural Bank of China ADB - Asian Development Bank ADBC - Agricultural Development Bank of China BA - Bureau of Agriculture BF - Bureau of Forestry BL - Bureau of Livestock BME - benefit monitoring and evaluation EA - executing agency EIA - environmental impact assessment EIRR - economic internal rate of return EPB - Environmental Protection Bureau FA - force account FAO - Food and Agriculture Organization of the United Nations FCOC - financial cost of capital FDI - foreign direct investment FIRR - financial internal rate of return GDP - gross domestic product GTZ - Deutsche Gesellschaft für Technische Zusammenarbeit (German Agency for Technical Cooperation) GVO - gross value output HAAS - Henan Academy of Agricultural Science HADP - Henan Agriculture Development Project HAU - Henan Agricultural University IA - implementing agency ICB - international competitive bidding IDA - International Development Association IDC - interest and other charges during construction IFAD - International Fund for Agriculture Development IRR - internal rate of return JICA - 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 bidding MOF - Ministry of Finance NBFI - nonbank finance institution NFYP - Ninth Five-Year Plan NGO - nongovernment organization NGWT - national guidelines on water tariffs NPV - net present value O&M - operation and maintenance OCC - opportunity cost of capital OCR - ordinary capital resources OECF - Overseas Economic Cooperation Fund PADO - Poverty Alleviation and Development Office PFB - Provincial Finance Bureau PGH - provincial government of Henan PMO - project management office PRC - People's Republic of China RAP - resettlement action plan RCC - rural credit cooperative SEIA - summary environmental impact assessment SHWSC - Sanmenxia Huaiba Water Supply Company SOE - State-owned enterprise SV - switching value TA - technical assistance TVE - township and village enterprise UNDP - United Nations Development Programme VAT - value-added tax WFP - World Food Programme WTO - World Trade Organization

WEIGHTS AND MEASURES ha = hectare km2 = square kilometer l = liter m3 = cubic meter mu = 15 mu equivalent to 1 ha t = metric ton CONTENTS Page

LOAN AND PROJECT SUMMARY iii

Map vi

I. THE PROPOSAL 1

II. INTRODUCTION 1

III. BACKGROUND 1

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

IV. THE PROPOSED PROJECT 16

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

V. PROJECT JUSTIFICATION 27

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

VI. ASSURANCES 33

VII. RECOMMENDATION 34

APPENDIXES 35 iii

LOAN AND PROJECT SUMMARY

Borrower People's Republic of China (PRC)

Project Description The Project promotes economic growth in the poverty-stricken western portion of Henan Province through development of horticulture and livestock involving low-income households, and diversion of water from the Yellow River to supply two areas suffering particularly acute water shortages. Fruits, medicinal plants, and vegetables with high commercial value and ready markets will be grown. Breeding, raising, and fattening cattle, goats, pigs, and sheep will be assisted. These activities will increase household incomes 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 development techniques will be introduced to prevent soil erosion and pollution.

Classification Primary objective - economic growth Secondary objective – poverty reduction

Environmental Assessment Category A An environmental impact assessment (EIA) was undertaken, and the summary EIA was circulated to the Board on 4 November 1998.

Rationale The economic development of West Henan is severely constrained by its high population density, hilly to mountainous terrain, scarce arable land, harsh climatic conditions, and limited water resources. Average per capita annual income is Y1,864 ($225). The incidence of poverty (at $1 per day) in this region is high12 percent as against less than 10 percent for the PRC. Of the 32 counties in West Henan, 12 are nationally designated absolute poverty counties. The region is suitable for the cultivation of a number of temperate fruits and nuts and a variety of medicinal plants. The region is also becoming a major supplier of beef, mutton, and pork because of the availability of underutilized pastures and cattle and small livestock well adapted to local conditions. The shortage of medium- and long- term rural credit and inadequate potable and irrigation water supply have constrained horticultural and livestock development. The Project is designed to help remove these constraints.

Objective and Scope The Project’s primary objective is to promote pro-poor economic growth by increasing the incomes of predominantly poor farmers in West Henan. The Project consists of three components:

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

and greenhouse vegetables;

(ii) livestock development, which supports household cattle and pig breeding and raising, purebred piggeries, and sheep and goat breeding and raising, using crop residues and underutilized grasslands; and

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

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

Financing Plan ($ million)

Source Foreign Local Total Percentage Exchange 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 Amount and 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 rate determined in accordance with ADB’s pool-based variable lending rate system for US dollar loans, a commitment fee of 0.75 percent per annum, and a front-end fee of 1.0 percent.

Allocation and Relending Terms The Ministry of Finance will onlend the ADB loan under the same terms and conditions to the provincial government of Henan. The Provincial Finance Bureau will relend the funds to municipal and county finance bureaus under the same terms and conditions. End users (i.e., farm households, enterprises, and water supply companies) will receive loan funds from the relevant finance bureaus at not less than commercial bank rates, under repayment terms based on profitability and cash-flow projections.

Period of Utilization Until 30 September 2006 v

Executing Agency Provincial Government of Henan

Implementing Agencies 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 relevant technical agencies. An interagency leading group will coordinate and oversee overall Project implementation and resolve policy issues. PMO will review and recommend specific activities for assistance under the Project, prepare the annual work program and budget, and arrange procurement contracts.

Procurement Goods and services will be procured in accordance with ADB's Guidelines for Procurement. Each supply contract for plant and equipment, vehicles, and materials costing $500,000 or more will be awarded through international competitive bidding (ICB); that for less than $500,000 but more than $100,000, through international shopping; and that for less than $100,000, by direct purchase. Each civil works contract costing $2 million or more will be awarded through ICB. Contracts for less than $2 million will be awarded through local competitive bidding, except that civil works relating to horticulture and livestock components may be carried out through force account, or through contracts awarded to village teams and eligible farmer beneficiaries (community participation in procurement), where suitable. ADB’s domestic preference scheme will apply in procurement. Advance procurement action for certain items has been approved.

Consulting Services No consulting services will be required.

Estimated Project Completion Date 31 March 2006

Project Benefits The Project will directly benefit about 204,900 households (almost and Beneficiaries 900,000 people). Nonfarm employment opportunities will be created in pig breeding and water supply. About 340,000 people will be lifted above the rural poverty line of $1 per day and the urban poverty line of $2 per day. At full development, household incomes will increase significantly, with incremental household net incomes averaging Y1,631 in horticulture and Y1,983 in livestock. Total annual production will be 72,600 metric tons (t) for fruits, 2,640 t for medicinal plant products, and 197,900 t for vegetables. Livestock development will expand annual production by 122,400 sheep, 122,400 goats, 17,955 cattle, and 68,000 pigs (porkers). Pilot livestock enterprises will produce 24,600 breeding pigs, 25,000 piglets, and 12,440 fattened and culled pigs. Annually, 83 million cubic meters of water will be supplied to various users. vi I. THE PROPOSAL

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

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 identify the causes of low rural incomes in the project area, and made proposals for sustainable economic development. Subsequent project processing over several years allowed careful assessment of issues related to project design and quality, implementation arrangements, and poverty targeting, thus improving project quality at entry. A Fact-Finding Mission visited the PRC in February-March 1997, with follow-up Fact-Finding/Consultation Missions in August 1998, January 1999, September 1999, and January 2000. The missions resulted in substantial scaling down of the Project, removal of a large agroprocessing component, deletion of commercially risky components, focus reorientation toward poverty reduction, and change of the Executing Agency (EA). A small-scale TA2 approved in October 1999 updated the results of the earlier studies and confirmed the technical assumptions. This TA was followed by an Appraisal Mission3 in April-May 2000. This report is based on the findings of ADB Missions, the ADB-funded feasibility study and small-scale TA, as well as extensive discussions with national, provincial, and local government officials, prospective local investors, target beneficiaries, and others 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 of urban poverty.4 In 1978, the household responsibility system was introduced, providing farmers with greater incentives for production. From 1978 to 1984, agricultural terms of trade were progressively improved. In combination, these measures brought down the number of the rural poor (based on national standards) from 260 million in 1978 to 89 million (11 percent of the population) 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 that are relatively disadvantaged due to remoteness, climatic constraints, steep slopes or erosion, or subject 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 for 18.7 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 (Staff Consultant – 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 31 December 1998. 2 of PRC’s land area of 960 million ha is cultivated7 percent of the world’s farmland to support 22 percent of its people. From 1990-1996, an average of 400,000 ha per year was converted from agriculture to industrial, infrastructure, and housing use. To address this issue, the Government enacted the 1998 Land Administration Law to protect arable land and limit conversion to other uses to 160,000 ha per year,5 with an equivalent amount of wasteland converted to agricultural use. Because of the pressure on agricultural land, farming systems are intensive with heavy inputs of labor, chemical and organic fertilizers, small machinery, and water. Intensive farming has allowed meeting the basic food requirements of the people along with the development of a sophisticated mix of cash and commercial crops.

5. The economic reform programs in agriculture undertaken in the late 1970s and early 1980s provided successful examples later used in other sectors. The most important aspect of the agriculture sector’s reform program was the replacement of the commune system with a household contract responsibility system in which plots of collectively owned land were allocated to households under fixed-term contracts. The contract required the households to supply the State with mandatory production quotas at fixed prices, with output above the quota allowed to be sold at market prices. State procurement prices were gradually increased, private plots were enlarged and contract periods extended, diversification of agricultural production was encouraged, 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, increased agricultural production, and created rural employment, particularly during 1978-1984 when agricultural output grew by an annual average of 8.8 percent. However, agricultural growth slowed to an average 2.5 percent in 1984-1990 before recovering to 3.8 percent in the early 1990s. During 1988-1998, agricultural growth averaged 4.4 percent, well in excess of population growth (less than 1 percent), but much lower than the overall GDP growth of 10.3 percent. 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 to international competition following entry to the World Trade Organization (WTO); (ii) relatively low 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 and drought. 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 over the same period. Other subsectors (e.g., livestock, fisheries, and horticulture), where Government interventions are less and market forces play a greater role, are still growing rapidly at up to 10 percent per year.

7. Early reform of the agriculture sector allowed rural incomes to rise rapidly so that the ratio 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 per capita 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. 3 percent.6 Nonagricultural real rural income grew at 8.5 percent annually while real agricultural incomes 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 58 percent. The contribution of all agricultural output to rural GVO fell from 74 percent in 1978 to 47 percent in 1998, largely due to the rapid growth of TVEs. The widening gap between urban and 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 in about 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 2,137 townships, 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 farm households. The arable land area is 6.8 million ha, 40 percent of the 16.7 million ha total land area, located mainly in the east of the province. Pasture covers about 0.3 million ha, forest about 2.1 million ha, and wasteland and nonagricultural land about 7.3 million ha. Arable land per capita is 1.5 mu7 (0.1 ha)—the national average is 2.1 mu, ranging from 0.8 mu in Fujian to 8.2 mu in Heilongjiang Province. Henan is a major producer of wheat, corn, and cotton, mostly grown under irrigated conditions on about 4.3 million ha. With an average annual rainfall of only 785 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 the province, particularly in the mountainous western part. In 1998, fruit orchards covered 385,000 ha 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, field vegetables covering 934,000 ha had an output of 31 million t and greenhouses in 133,300 ha produced 12 million t of vegetables.

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

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

11. Henan is a relatively poor interior province. Its rural agricultural population is poor compared with the national rural population. In 1998, the per capita rural income in Henan was Y1,864 ($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 per capita 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 market conditions for agriculture post-1993. 7 15 mu = 1 hectare. 4 to Y2,760 in Mengzhou County. Farming accounts for two thirds of the rural household income in 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 of family 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 products are constrained by inadequate infrastructure capacity in wholesale and retail market outlets, transportation, storage, and processing. While the number of rural, urban, and city markets increased in the 1990s in response to market changes, most have limited, if any, storage facilities. The increased transportation of produce and goods to nonlocal markets has increased the demand for investment in cost-effective, efficient transportation and improved road and rail infrastructure. The provincial government of Henan (PGH) is currently undertaking major infrastructure projects8 to overcome the transportation, storage, and processing constraints.

13. The major sources of agricultural credit are the Agricultural Bank of China (ABC), the Agricultural Development Bank of China (ADBC), and the rural credit cooperatives (RCCs). ABC is widely represented throughout the province, with 18 branches at the prefecture level, 213 subbranches 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 for rural commerce (for grain and cash crop purchases), infrastructure, and other commercial activities; 23.1 percent for agriculture; and 17.9 percent for TVEs and industries. An ABC loan covers part of the investment cost, and the borrower is expected to contribute up to 60 percent of the value of the investment. Accordingly, ABC loans are accessed mainly by the wealthier farmers, who can provide fixed assets as collateral. In poor areas like West Henan, ABC provides loans for poverty relief on behalf of the provincial Poverty Alleviation and Development Office9 (PADO), at subsidized interest rates (3 percent in 1999).10 The main policy bank in rural areas, ADBC is responsible for providing credit for purchasing State quotas of grain, cotton, and oil-bearing crops.

14. Nonbanking finance institutions (NBFIs) provide an alternative source of credit (and savings accounts) for farm households. About 25 percent of the capital available in Henan is held in the NBFIs. The 7,437 RCCs in the province are the major sources of credit for individual farmers. The RCCs cover 2,600 townships and have subbranches in 4,837 villages. About 55 percent of rural households are RCC members who can secure credit on rates lower than for nonmember borrowers. RCC funds have not been used exclusively for investment in the rural areas. To rectify this, the RCC system was being reorganized with ADB assistance.11 Total lending 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 other commercial 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 of the State Council’s Leading Group on Poverty Alleviation and Development. The national PADO is located in the Ministry of Agriculture. Under provincial government restructuring, PADO may be renamed as Integrated Agricultural 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 lower repayment rates (typically under 20 percent). 11 TA 2214-PRC: Cooperative Banking Development, for $600,000, approved on 1 December 1994. 5 average loan size of RCCs is much smaller than ABC loans, but the number of borrowers served is much larger.

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

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

17. Extension services at the provincial, prefecture, county, and township levels are provided for agriculture, forestry, horticulture, livestock, and aquaculture by the relevant line agencies. Each agency maintains at the township level a technical station that trains and supervises the part-time farmer technicians who work at the village level. The townships fund the technical stations. The level of funding and the quantity and quality of service depend on the ability of the townships to pay. At the township, the ratio of technicians to farmers for horticulture is 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 inadequacy in extension is the insufficient training, of technician and key farmers, to take full advantage of current research results and convey this information to farmers with practical advice.

18. Nongovernment organizations (NGOs) are progressively being established throughout the PRC, and provide alternative sources of assistance to the rural poor in Henan. Funding the Poor Cooperatives have been established at county and township levels in several experimental areas, to motivate qualified poor people to form small groups, deliver loans to members through small 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: Third Agriculture and Natural Resources Research at CGIAR Centers – Increasing Productivity of Crop-Livestock Systems 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 May 2000. 14 The Food and Agriculture Organization of the United Nations (FAO) uses a guideline of 1:500 as a satisfactory level of full-time staffing. 6 and monitor the working of the groups and centers. One of two pilot microfinance schemes undertaken in Henan, was in the project area, in Nanzhao County. Though no specific organization has been established in Henan, the Program of Happiness has operated projects in two poor counties to help poor mothers escape poverty. Project Hope has been a very influential poverty-related activity organized by the Communist Youth League. From 1990 to 1999, Project Hope in Henan raised about Y100 million and helped 96,377 child dropouts return to school. The Henan Women’s Federation has organized 7,495 poor households in 21 poor counties to operate microfinance-based income-generating activities. Another important activity organized by the Women's Federation is the Spring Bud Plan to help girl dropouts return to school. In the past six years, this plan has raised Y13.48 million and helped 65,000 girl dropouts return to schools. The Brilliant Cause was started in July 1994 in Henan to promote the participation of private enterprises and other non-State-owned enterprises in the cause of poverty reduction.

4. Recent Economic Development in Henan

19. Despite being a poor interior province, Henan has actively implemented the national economic 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 grew at 14.5 percent, 12.8 percent, and 6.2 percent, respectively. In 1998, real GDP grew by 8.7 percent, 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 rural and 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 Henan has 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 in the industry and construction sectors and only a small amount is channeled to agriculture. To increase FDI in agriculture and the rural areas and to achieve a better balance between urban and rural economic growth, the province is actively considering further incentives in the areas of land-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 to meet 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 income disparities. Given the arable land constraints (0.1 ha per capita) in the PRC, the sector development strategy focuses on increasing productivity, developing underutilized and unutilized lands, crop diversification, and adopting an integrated approach to farming. The strategy also seeks to increase value added for agricultural produce and to create off-farm employment opportunities. 7

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

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

2. Poverty Reduction

24. PRC’s national poverty reduction program was introduced in 1985. The program was designed to attack absolute poverty and set an official poverty line at an annual average per capita net income of Y150 ($18) and a grain ration of 200 kilograms. The Seventh Five-Year Plan (1986-1990) incorporated explicit poverty reduction measures for poverty counties through income generation, relief aid, preferential taxes, and targeted assistance based on income criteria. The program identified 328 poverty counties for national Government assistance. Since 1985, progress in reducing poverty has been substantial. The number of people classified as absolute poor declined from 125 million in 1985 to 80 million in 1993. In July 1993, the Government initiated the Eight-Seven Poverty Alleviation Campaign to lift the 80 million absolute 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 and social infrastructure. The strategic thrust of the poverty alleviation campaign was to promote integrated socioeconomic development and human resource development in areas where the poor 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 Plan period will see major Government investment in the western portion of the PRC. Through its location at the crossroads of the national transportation system, Henan stands to benefit indirectly from this investment. 8 at the end of 1999 was estimated at about 34 million. It is recognized that about 20 million will remain very difficult to reach under existing programs by the end of 2000. The Tenth Five-Year Plan (2001-2005) will continue to emphasize poverty reduction. The central Government is currently 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 priority projects for the impoverished areas.

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

27. At the international poverty line of $1 per day per person (adjusted for purchasing power parity), the incidence of poverty in Henan was 13 percent in 1997, with about 10 million people below this line (more than 2.5 times the absolute poverty incidence). In 1998, this proportion was reduced slightly to 11.2 percent of the population (10.5 million people). About half of these poor families live in West Henan. The poverty threshold is marginally above the basic grain requirements, so many households with incomes above it still lack basic livelihood needs and may 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 designated national poverty counties, including the 12 poor counties in West Henan (see map), as well as six 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 population in Henan (an increase from 31.3 percent in 1993). Even in the poorer western counties of Henan, substantial differences in the incidence of relative poverty occur—from 23 percent in Songxian to 1 percent in Mianchi. The majority of the poor counties are concentrated in difficult areas: 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 removing these pockets of rural poverty, using more location-specific criteria in determining development priorities and targeting development assistance at poor village and household levels. Since the early 1980s, designated poverty counties have received about Y5 billion in poverty reduction funds. 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 of external assistance to agriculture, has provided 11 loans amounting to $250 million for agriculture 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. 9 including forestry, livestock, and horticulture; and (iv) area development projects. All of the World Bank lending to agriculture and rural development has used concessional funds under the International Development Association (IDA). The World Bank has successfully supported province-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 Development Project (HADP), which commenced in May 1991 and was completed in 1999. HADP covered 20 counties in the northern and eastern part of Henan (along the Yellow River) and comprised 11 agroprocessing plants, 16 seed processing plants, and livestock and horticulture. The World Bank 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 the Project Management Office (PMO) was praised for its efficiency and professionalism. The project completion report noted project success for all components, with greenhouses and livestock exceeding the targets. The economic internal rate of return (EIRR) was estimated at 40 percent, compared with 35.8 percent at appraisal.

31. Throughout the PRC, the International Fund for Agriculture Development (IFAD) has supported six projects for $161 million, and the World Food Programme (WFP) has implemented 11 projects for $174 million. In Henan, the Food and Agriculture Organization of the 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 $16.6 million.

32. Japan previously provided foreign assistance through the Japan International Cooperation 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 ($3 million). A fruit processing project in the province was financed by a Japanese NGO. Germany’s development assistance to the PRC is mainly related to environment/forestry and one project targets poverty reduction in Henan. The Netherlands is assisting the province with a livestock project focused on dairy cattle. The United Kingdom financed a $7.1 million duck raising project in the province.

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

D. Governance and Lessons Learned

34. The PRC has demonstrated strong project implementation capability. Most projects in ADB’s PRC portfolio have been implemented efficiently, with some completed ahead of schedule. There is a strong sense of project ownership at local levels and consequent commitment to effective implementation. Other factors that have contributed to efficient project implementation include (i) rigorous screening of projects proposed for ADB assistance to ensure financial viability, debt servicing capability, and adequate provision of counterpart funds; (ii) effective interagency coordination; (iii) well-developed institutional arrangements for project implementation; (iv) good technical skills in the EAs; and (v) strong emphasis on anticorruption at all levels of government. The strategic use of TA to upgrade the capabilities of EAs and 10 holding of seminars and workshops to familiarize EA staff with ADB’s procedures and practices have also contributed to good project quality.

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

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 China marine culture) demonstrated that institutional arrangements need to be carefully worked out and the financial performance and viability of financial intermediaries must be carefully assessed. The Hexian pulpmill project, completed in October 1994, demonstrates the need to carefully assess production targets, quality goals, and financial viability. The project was ranked unsuccessful during postevaluation. The problems can be attributed to some technical errors and 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 is experiencing serious implementation difficulties, which confirm the need to carefully assess the economic viability and sustainability of the project benefits for State-sponsored agroprocessing enterprises.

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

38. Several World Bank postcompletion reviews of agriculture projects20 have also been drawn upon for lessons learned to be applied in the project design. The projects reviewed are multicomponent projects implemented in many counties and in more than one province, and are therefore 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. 11 complexity of multicomponent and multilocation projects as a significant problem, largely because of strong commitment from local levels, strong project management offices at provincial 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 problems and rapid market changes, and (ii) specific measures to ensure poverty reduction impacts by providing increased extension and support to farmers.

39. The implementation completion report for the World Bank’s HADP found that an integrated system linking production, processing, and marketing was the cornerstone of the project’s success. The model of linking companies to farm households benefited both parties and reduced market risks. Introduction of advanced technologies enabled products to compete successfully in the marketplace. On average, farmer net per capita income increased from Y550 to Y2,179 in the project area an annual growth rate of 25.8 percent, compared with the provincial average of 21.5 percent over the same period. It was noted, however, that several of the 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 account and provide for (i) a midterm review of the Project to assess implementation status, review the project parameters, and take appropriate measures to ensure achievement of the objectives; (ii) strengthening of extension services and training; (iii) beneficiary selection criteria giving priority to the poorer members of the local community; (iv) structuring assistance packages so that they are attractive and affordable to poor households, and allow them to progressively expand their farm operations through repeat lending; and (v) pilot testing the company + household enterprise model as a potential model for future lending in the sector, rather than the cornerstone 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’s operational strategy for the PRC emphasizes three broad objectives: (i) improving economic efficiency, (ii) promoting growth to reduce poverty in inland provinces, and (iii) enhancing environmental protection and natural resources management. For agriculture, the country operational strategy focuses on (i) increasing efficiency in agricultural production, processing, and marketing; (ii) reducing rural poverty and increasing rural income opportunities through cash crops and off-farm employment; (iii) improving management and development of soil, water, forest, and marine resources for sustainable development; (iv) supporting the transition to a market economy through improved incentives for private sector investment and establishment of 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 environmental protection. ADB’s operations are designed to help reduce the disparity in incomes between rural and urban areas by facilitating the development of efficient markets in agricultural goods and improving incentives for agricultural production, including improved land tenure and transfer.

43. Most of PRC’s poor live in resource-constrained inland provinces like Henan, which have not received the special incentives provided to coastal provinces to accelerate economic growth. Instead of encouraging preferential incentives that tend to exacerbate or create new factor market distortion and misallocation of resources, ADB’s strategic thrust to reduce poverty 12 in inland provinces is to help (i) promote market-based policy changes to attract more foreign and domestic investments; (ii) address infrastructure and institutional constraints to rural development; (iii) develop integrated agriculture and agrobased industries; (iv) develop transportation, communications, and marketing linkages between the interior provinces and the coast; and (v) locate development projects in poverty counties or in areas where the average income 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. Land use and land tenure in Henan are covered by the provincial regulations within the broad policy framework of the national Government.21 Accordingly, an important step in reducing rural poverty is reform of the legal framework covering land use and land tenure.22 The Land Administration Law, drafted with ADB assistance, became effective on 1 January 1999. The law provides for a national land use plan, which will stipulate the total amount of arable land to be put under protection. After the State Council approves this plan, every province, county and township will be assigned quotas of arable land for protection. The area of cultivated land should comprise more than 80 percent of the arable land. Any arable land that is unavoidably required for urban/industrial expansion must be replaced by a similar area of wasteland reclaimed by the project proponent. Each local government area will be required to work out its own 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 could be applied nationwide, and the findings were discussed with PGH. The new Sichuan land law makes changes in four significant areas: (i) registration of land rights and issuance of certificates by which landholders can confirm their rights against intrusions by other landholders and claimants, and against arbitrary actions by State or local agencies; (ii) local government responsibilities to prepare the overall land use plans, with plans prepared by one level of local government and submitted to the next higher level for approval; (iii) formulas for payments for rural land undergoing conversion to urban construction land, based on the measurement of the productivity of the rural land being acquired, and full compensation for collective farm organizations and individual families; and (iv) citizen participation in the processes of land use planning and in the procedures for conversion of rural land to urban uses. A national supervision and inspection system for land resources and land occupation will be set up under the Ministry of Land and Resources. PGH has prepared implementing guidelines for the Land Administration Law, which are similar to those prepared for Sichuan Province. Under the Project, a specific covenant ensures that tree crops are not established on protected arable land, cultivation will not be permitted on slopes greater than 25 degrees, and long-term leases will be assured for all beneficiaries (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 TA 2408-PRC: Land Use and Land Use Tenure Policy in Fujian Province, for $600,000 approved on 28 September 1995. 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 by the implementing agencies. 23 TA 3123-PRC: Provincial Legislation on Environmental Protection and Natural Resources Conservation, for $300,000, approved on 15 December 1998. 13

2. Poverty Reduction

46. The nature of poverty in the PRC is changing, with large income gaps opening up between rural and urban areas, and with many of the remaining absolute poor living in remote mountainous areas, where provision of adequate infrastructure is uneconomic and delivery of social 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. The Government had previously opted not to make extensive use of ADB’s ordinary capital resources (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 and foreign exchange risks. The previous availability of the World Bank’s IDA concessional resources 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 the Government that ADB’s OCR resources could be applied successfully to poverty reduction projects in the PRC.

47. Despite its status as a poor province, Henan has been paying much attention to the social security of rural dwellers by providing access roads to poor villages; promoting applied technologies in poor areas to increase incomes; providing special funds for children who have dropped out of school; and providing vocational, technical, and skills training in poor areas. The commitment to rural infrastructure in poor areas is consistent with the policy dialogue conducted under 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 combating poverty by providing poor farmers with access to markets as well as to social services. As a result 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 funds can also be used for poverty reduction.

3. Environmental Protection

48. The economic loss attributable to pollution and associated degradation of PRC’s natural resources is estimated at between 3.5 and 7.7 percent of GDP. Environmental improvement has been a constant item on ADB’s policy agenda for the PRC. ADB has provided TA for strengthening the institutional capacities of the Government agencies responsible for assessing and 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 rural households had an average per capita annual net income of over Y5,000, while 4.4 percent had less than Y600 per capita. The ratio between the 5 percent of rural residents at the upper level and 5 percent of those at the lower level was about 8.3:1. 25 TA 987-PRC: Institutional Strengthening of the National Environmental Protection Agency, for $340,000, approved on June 1988; TA 1436-PRC: Environmental Impact Assessment (EIA) and Training, for 600,000, approved on 10 December 1990; TA 1988-PRC: EIA Training Phase II, for $900,000, approved on 18 November 1993; and TA 2090-PRC: Legislative Reform for Protecting the Environment and Natural Resources, for $500,000, approved on 18 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 and Natural Resources Conservation, for $300,000, approved on 15 December 1998; TA 3290-PRC: Capacity Building in Ministerial Status Responsibilities in State Environmental Protection Administration, for $810,000, approved on 8 November 1999. 14 has also provided TA for soil and water conservation, forest and grassland ecosystems conservation, and agro-industrial pollution control.26

49. The major environmental concerns in Henan are soil and water conservation and industrial pollution. The province, with the assistance of the national Government, has been implementing various measures for soil and water conservation, particularly in the Yellow River catchment and the loess27 areas. The horticulture component of the proposed Project will contribute 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 study on rural energy development,29 which was completed in 1996, and the TA for renewable energy development.30 These two TAs recommended an integrated agricultural development approach to improve the environment and livelihood of farm households in rural PRC through more efficient utilization of agricultural waste products to produce low-cost and cleaner energy sources, and improve agricultural production. Utilization of agricultural wastes has been incorporated into the livestock component of the Project, through use of ammoniated straw as livestock 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 and medium-size polluting industrial enterprises were closed and many medium-size and large industries paid penalties. Policy dialogue during project design resulted in the assurance that industrial units to benefit from the water supply subcomponent will be connected only if they meet the national standards for industrial emission, wastewater treatment, and solid waste disposal. It was also agreed that polluting industries upstream of the regulating reservoir would be 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 outstrip supply 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 the overall 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 schemes and pricing of water need to be changed to generate funds for subsequent investment requirements, provide market-based incentives to effectively manage water demands, and provide incentives for commercially oriented water companies to improve their efficiency. ADB has funded TA31 for formulating appropriate guidelines and policies in the water sector, which have led to the adoption of National Guidelines on Water Tariffs (NGWT) and mechanisms for their implementation, and is continuing assistance in this area. Major TA recommendations reflected in the NGWT include (i) selection of a tariff structure based on local conditions; (ii) a two-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. 15 the main objective in setting and approving tariff levels; and (iv) adoption of a simplified process for tariff regulation, requiring evaluation and approval at the local level and supported by review and monitoring at the provincial and State levels.

53. To recover the full cost of operation and maintenance (O&M) and a reasonable portion of 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 project area, 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 were development of a better balance between public water supply and private access to groundwater, introduction of higher tariffs for groundwater extraction, installation of wastewater treatment facilities whenever urban water supplies are increased, and water tariffs to include the investment and operating costs for wastewater treatment systems. As a result of this policy dialogue, the project water authorities agreed that water tariffs will be set at levels ensuring the full 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, water treatment plants and wastewater treatment, and water-saving irrigation systems, in a phased development program.

5. Enterprise Reform

54. Promoting enterprise reform is a strategic objective of ADB’s PRC operations. ADB has encouraged company restructuring to introduce shareholding with diversified ownership. The main thrust of the policies is to introduce a modern enterprise structure, focus on profit orientation, and increase managerial autonomy and accountability. In the project area, this policy advice is directly related to agricultural enterprises where improved management capabilities, attention to product quality and competitive pricing, and enhanced marketing analysis are needed. Experience has shown that private ownership of agricultural enterprises in the 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 losses amounting 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 business operations. Accordingly, the Project targets four private sector pilot enterprises to demonstrate the future role of corporate production systems with export potential, which can mobilize groups of 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 local government officials. Attention was drawn to the section on fraud and corruption in ADB’s Guidelines on Procurement, particularly the need for bidders/suppliers/contractors to observe the 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 provisions added to ADB’s Guidelines on the Use of Consultants were discussed. The PRC Country Assistance Program includes assistance to the Government that will improve governance and provide incentives to reduce the incidence of corruption in the longer term. In 1998, ADB TA related to the consulting industry and auditing addressed some of the elements of ADB’s anticorruption 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. 16 developing detailed guidelines for the selection and engagement of consultants, which increase transparency, take account of the principles of ADB’s anticorruption policy, and provide for equal opportunity competition. TA 310333 will strengthen the Government's auditing system to conform with the requirements of the Audit Law and, as far as practicable, of international auditing standards by helping to (i) formulate government auditing standards and procedures, and (ii) design and implement an audit-training program to promote full and consistent adherence to such auditing standards and procedures by government auditors. When completed, this work should strengthen the Government's ability to detect fraud and corruption.

56. The Government is increasingly concerned with governance issues and has conducted well-publicized campaigns against official corruption. Under TA 2845,34 assistance was provided to draft procurement regulations and standard bidding documents. The six sets of draft regulations and the three sets of sample bidding documents produced under the TA contain provisions related to corrupt or fraudulent practices, in accordance with ADB’s anticorruption policy. Under this TA, ADB provided comments on the draft of a national Law on Tendering and Bidding of the PRC (adopted at the 11th Session of the Standing Committee of the Ninth National People's Congress on 30 August 1999, promulgated by Order No. 21 of the President of the PRC on 30 August 30 1999) that became effective as of 1 January 2000. The law stipulates 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 the State and all externally funded projects. Article 6 stipulates that “no organizations or persons shall, by any means, limit or exclude legal persons or other organizations outside from other regions or systems from participating in the bidding procedure. No illegal interference in any form 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 substantial fines and criminal prosecution.

IV. THE PROPOSED PROJECT

A. Rationale

57. Henan is a relatively poor interior province (ranking 18th in the PRC), with GDP per capita of Y4,356 in 1998, compared with the national average of Y6,392. The rural economy in the western part of the province is the most disadvantaged. West Henan accounts for about one 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 limited water 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 the land area in West Henan, which comprises highly fragile loess soils. The resulting extensive soil erosion causes downstream environmental degradation and reduces land productivity. The province has been attempting since the 1980s to increase agricultural production and control soil 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 42 percent of the rural poor reside outside the poverty counties. 17

200,000 ha of natural pastures. West Henan has emerged as a major supplier of beef, pork, and mutton to domestic and export markets. These horticulture and livestock programs have been successful in raising farm incomes, a contributing factor in the selection of West Henan as the location 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 poor farmers to move out of subsistence farming through investment in cash crop and livestock development. This problem has also constrained the development of downstream agroprocessing and marketing by agro-industrial enterprisesespecially in the private sectorwhich are needed to create an effective demand for the farmers’ produce, maintain high farm-gate prices, and generate off-farm employment opportunities. Credit constraints and the lack of fixed assets collateral hinder the Government’s strategic effort to integrate agricultural production with agroprocessing and marketing.36 Accordingly, the Government offers poor households credit requiring no fixed collateral, so that they may establish a credit history and graduate to commercial credit sources for future expansion of their farm enterprises. The key challenge to the Project is to demonstrate that subsidized credit is not needed by poor households 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 to be 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 area has 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 of the project beneficiaries is given in Appendix 2.

61. Lack of access to water is the most critical welfare concern in drought-prone regions of the PRC. While the limited availability of water resources has generally constrained the quality of life along the Yellow River basin, Yima and Mianchi counties in the project area suffer from particularly acute water shortages adversely affecting about 290,000 people in the urban and rural areas, livestock, and small and medium-size industries. During the dry months, local governments need to arrange at high cost emergency water supply in tanker trucks to support the people and livestock in the affected areas. In these dry periods, local residents pay up to 20 times as much for water as the cost of the piped supply. Industries are tapping deep groundwater 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 (especially water). The Project will increase farm incomes of the less advantaged farmers through productive and environmentally sound development of sloping and degraded land for horticulture and livestock at household and enterprise levels, and provide credit for the needed investments. The Project will develop water supply systems to meet the need for rural, urban and 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. 18

63. The success of the Government’s poverty reduction program demonstrates the importance of carefully targeting assistance to such poor, resource-constrained areas; however, even more important is to target poor households within those areas. The horticulture and livestock components will be targeted toward areas where there poverty incidence is high and the people are disadvantaged by resource constraints. The potential direct beneficiaries of these two components are about 140,000 households. In addition, the Project will specifically target 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 poor farmers in West Henan. The Project will include (i) environmentally sustainable development of sloping lands for horticulture; (ii) expansion of livestock production using underutilized natural pastures and crop residues; and (iii) provision of reliable water supplies for rural, urban, and industrial use. The Project will initially cover 22 of 32 counties in West Henan and three other districts 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 about 114,000 farm households. It will support the development and rehabilitation of fruit tree crops and traditional medicinal plants, and field and greenhouse vegetables. The tree crops on 8,300 ha include apples, Chinese date, kiwi fruit (Chinese gooseberry), gingko, and eucommia.37 Kiwi fruit, gingko and eucommia will be planted from saplings, and apple and date varieties will be grafted onto old varieties. Field vegetables will cover 2,800 ha, and 5,000 greenhouses (on 167 ha) will be established.

66. The Project will provide technical and financial support for the development and maintenance of orchards, including training of extension workers and farmers, land development, procurement of farm inputs, and development of irrigation systems for some selected crops. The topography of the orchards varies from flat and gently undulating land to steep hillsides. Areas with less than a 10-degree slope will be planted on the contour and the space in-between the trees will be planted with ground cover crops. Areas with slopes of 10-25 degrees 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 degrees will be used for agricultural production and no area of protected arable land will be used for tree crops.

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 out the following activities (i) planting trees and contouring hills in the high-elevation area at the first control belt outside the Beijing in the Miyun and Huairou Reservoirs; (ii) planting trees and constructing terraces, check dams, and ponds at the second control belt; and (iii) planting trees, developing water conservation and ponds, constructing dams and drainage canals at the third control belt. About 401 km2 of land was rehabilitated, including 4,784 ha of terraces, 21,550 ha of conservation forest, and 11,603 ha of economic forest. Three demonstration comprehensive watershed management and development areas, and two mud and rock debris control and forecasting areas have been established. About 25,141 check dams, 34 km of drainage canals, and 7.1 km of protective dams have been completed. 19

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 take on 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 technical support, with support from high-level research institute staff and extension technicians. Key farmers will receive special and extended training, and will transfer this knowledge to other farmers in the locality. Training and technical support will be channeled through the line agencies responsible for each crop. Research institute staff and extension technicians will conduct extended and specialized training for selected key farmers and township technicians. At least one member of all participant farmer households will receive basic training. Updated technical and market information will be available to farmers during project implementation, to enable them to make informed choices on crop selection.

2. Livestock Development

68. The livestock component is designed following proven farm models,40 which are technically sound and make optimal use of underutilized pastureland and crop residues in the project 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 is expected to support the establishment of an integrated 600 head purebred piggery, 3,000 head first-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 extension workers 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 monitoring the component’s impact on pastures and grasslands. Established enterprises with cross shareholding 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 County through the construction of facilities for lifting and conveying 83 million m3 of water per year from the Yellow River for rural and urban household consumption,43 industrial and livestock uses, and irrigation. The component involves (i) construction of a pumping station on the right bank of the Yellow 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 long conveyance system; (iii) construction at Xiduancun of a regulating reservoir with a capacity of 24.6 million m3, behind an earth-filled 45-meter (m)-high dam (with crest length of 642.5 m), to store part of the water released from the conveyance system for use during periods when water cannot be supplied directly from the river because of high sediment content; (iv) construction of water treatment plants and expansion of the water reticulation systems in the Yima and Mianchi service 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. 20 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 tunnels will be designed for 7 m3/s to allow for future expansion of the system. The component will directly benefit about 65,000 households in Yima, Mianchi, and three rural villages; provide irrigation 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 the Yellow River, has approved the diversion of water at a maximum rate of 7 m3/s. The water authority concerned, in accordance with the relevant regulations of the PRC (which are consistent with ADB policies), prepared a resettlement action plan (RAP), and the relatively small-scale resettlement of the affected families (367 households) has been substantially completed 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 exchange component of $66.1 million equivalent and a local currency component of $85.2 million equivalent (Table 1). The cost estimate includes physical and price contingencies, taxes and duties, 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 Total Exchange Currency Cost A. Water Supply and Irrigation 20.1 26.7 46.8 B. Horticulture 16.6 31.0 47.6 (1.) Tree Crops 8.1 17.0 25.0 (2.) Vegetables 8.5 14.1 22.6 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 ordinary capital resources (OCR). The loan amount will finance the foreign exchange costs of the Project, with the exception of $1.8 million in foreign exchange costs of the sewage treatment plants and minor PMO operating costs that will be entirely funded by the Government. Interest will be determined in accordance with ADB’s pool-based variable lending rate system for US dollar 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. 21

73. The counterpart local currency requirements will be provided by the provincial, municipal, county, and township level governments through annual budgets, and by project enterprises44 and beneficiaries, who will contribute either in cash or in kind. Loan funds repaid prior to the ADB maturity date will be revolved by the county finance bureaus into the agriculture sector, with a significant portion earmarked for poverty reduction.45 A summary of the financing plan is given in Table 2.

Table 2: Financing Plan ($ million)

Source Foreign Local Total Percentage Exchange Currency

ADB 64.3 – 64.3 42

Local Sources 1.8 85.2 87.0 58

Government 1.8 63.5 65.3 Enterprises - 7.7 7.7 Households (cash) - 1.7 1.7 Households (labor) - 4.5 4.5 Local 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 rates and terms as for the ADB loan. The relevant finance bureau, in turn, will be responsible for channeling 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 Loan proceeds, foreign exchange risks (with the exception of loans to enterprises), and servicing the debt obligations to the Borrower. The onlending interest rates to the endusers (farmers, farmer groups, and enterprises) would be not less than the rate charged by commercial banks for similar loans of similar currency and terms. The repayment periods will be based on the projected cash flow and profitability of each component.

75. The county finance bureaus, through their township financial offices, will onlend to farmers or farmer groups selected by the relevant technical agency (assisted by PADO) at an interest 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 and a repayment period of at least four years, based on the projected payback period of each component. 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. 22 technical bureau (on technical implementation arrangements) and the finance bureau (on terms and conditions of the loan).46

76. For the enterprise + household financing, the Provincial or County Finance Bureau will onlend the ADB funds in US dollars, at an interest rate not lower than the equivalent commercial bank rate, with repayment terms of 10-15 years, depending on projections of profitability, and a grace period of 1-2 years. The enterprises will take the foreign exchange risk and repay the loans in US dollar equivalents. For the water supply and irrigation enterprises, the County Finance Bureau will onlend the ADB funds on the same terms and conditions as the original loan, 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 2001 and will be executed by PGH (Appendix 5). PGH has established a Project Leading Group whose members include a vice governor as chairman, the director of the Henan Provincial Finance Bureau, the director of the Henan Development Planning Commission, and the heads of the provincial line agencies concerned (bureaus of agriculture, forestry, livestock, water conservancy, environment, statistics, and PADO). The Project Leading Group will be responsible for overseeing project implementation, coordinating the various IAs, and resolving policy issues.

78. PGH has established, under the administrative control of PFB, a Project Management Office (PMO) staffed with trained and qualified technical, financial, and management personnel and headed by a director. PMO will (i) compile all feasibility studies pertaining to the project components and subcomponents; (ii) draw up annual work programs and budgets; (iii) apply approved selection criteria47 in preparing lists of households and enterprises that may participate in the horticulture and livestock components; (iv) supervise local and international procurement; (v) supervise Project construction, inspection, and acceptance; (vi) monitor the physical and financial progress of activities; (vii) coordinate and compile progress reporting; and (viii) conduct, in coordination with the IAs, benefit monitoring and evaluation (BME) in conjunction with the provincial PADO. The provincial PMO will be assisted by subordinate PMOs established in the project municipalities and counties. The provincial PMO will also serve as the secretariat for the Project Leading Group.

79. Under PFB guidance, PMO will (i) review the continued financial viability of the activities proposed under the Project and recommend appropriate actions; (ii) approve the loan agreements with participating households and enterprises, ensuring that priority is given to the poorer members of the local communities; (iii) review and approve the annual work program and budget; (iv) ensure that adequate counterpart funding is provided; and (v) coordinate loan repayments by the local governments and, if necessary, withhold annual budgets from defaulting local governments.

80. The IAs for the horticulture and livestock components will be county PMOs with the support 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. 23 enterprises for these components have been preselected according to the agreed upon selection criteria. Substitution of pilot enterprises during project implementation must have prior approval of ADB. The Sanmenxia Huaiba Water Supply Company (SHWSC) established by the Sanmenxia Municipal Government, Yima and Mianchi Water Supply Companies, and Mianchi Irrigation Company established by the Mianchi Water Conservancy Bureau, will be the IAs for the water supply and irrigation component. A dam safety panel of eminent domestic engineers will be formed to oversee dam construction. The project organization is shown schematically in Appendix 5.

2. Procurement

81. Goods and services financed under the ADB loan will be procured in accordance with the 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). Each contract estimated to cost $100,000 or more, but less than $500,000, will be awarded through international 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 awarded through ICB. Civil works contracts valued at less than $2.0 million will be awarded through local competitive bidding (LCB), as they are unlikely to be of interest to foreign contractors because of the relatively small size of the works, the remote location, and the availability of many capable local contractors with a competitive advantage to carry out such labor-intensive works. The procedures used for LCB in Henan Province are acceptable to ADB. Some civil works which are simple and labor-intensive and/or where there is no possibility of competition, may be carried out through force account (FA), or through contracts awarded to village teams composed mostly of eligible farmer beneficiaries (Community Participation in Procurement), where suitable. Prior to loan negotiations, PMO engaged (using counterpart funds) a company acceptable to ADB to assist the IAs in international procurement.

3. Advance Action and Retroactive Financing

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

48 This was reported in the May 2000 issue of ADB Business Opportunities. 24

4. Disbursement

83. Because of numerous small expenditures and FA works involved in implementing the horticulture and livestock components, PFB will establish an imprest account with a local bank acceptable to ADB, and ADB’s statement of expenditures procedures will apply in disbursement of the loan funds. The imprest account will cover procurement of such items as planting materials, small tools, materials for livestock holding pens, and veterinary supplies. The External Debt Management Division of PFB will be authorized to have direct access to the imprest account. The accounting systems and procedures of PFB are satisfactory, and their financial controls and discipline are adequate for the application of the statement of expenditure procedure.

5. Project Accounts, Audits, and Reports

84. PMO will maintain records of all expenditures and prepare consolidated project accounts. PFB will ensure that the accounts are audited annually by auditors acceptable to ADB. The audited reports will be submitted to ADB not later than six months after the end of the fiscal year. PMO, in coordination with the other IAs, will submit consolidated quarterly progress reports 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 actions taken, 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 project implementation, the attainment of objectives and targets, and a critical evaluation of the implementation experience.

6. Implementation Review

85. During inception, further details on the poverty targeting mechanisms will be agreed upon with the Government. ADB and PGH will jointly undertake a special poverty targeting mission after one year of project implementation to ensure that the Project is reaching poor families, and a midterm review of the Project in the third year of implementation. Regular review missions will assess implementation progress and examine the appropriateness of the project design and scope, the effectiveness of poverty targeting arrangements, the criteria for credit assistance, and the implementation arrangements. The reviews will recommend any necessary modifications 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 and achievement of the objectives following ADB’s Handbook for Benefit Monitoring and Evaluation. Sample surveys using the rapid rural appraisal method and household interviews will monitor farmer participation in the activities; their access to extension and training services, agricultural inputs, and other support assistance; and changes in household incomes and off-farm employment. Similar surveys will be carried out to monitor the access of target beneficiaries to dependable 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 irrigation component on the local economy in the service area. Two such surveys will be conducted during project implementation: one in the third year, prior to the midterm review, and another in the 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. The socioeconomic data of the potential beneficiaries collected during project preparation, 25 supplemented by PADO’s database on poverty incidence, will serve as the baseline for the BME. PADO will assist PMO in preparing the annual progress reports, by providing data on poverty reduction. After completion, PGH will evaluate the Project impact in accordance with a schedule 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, and water resources development projects. The organizational and management structures in those projects are similar to those being proposed under the Project, i.e., a leading group and PMOs at the provincial, municipal, and county levels, with technical support and services provided by the concerned line agencies at various levels. PGH’s performance in these projects has been generally satisfactory. Several of the experienced PMO staff will be involved in the proposed Project.

G. Environmental and Social Measures

1. Environmental Measures

88. An environmental impact assessment (EIA) was carried out in accordance with ADB’s Guidelines 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 main environmental concerns relate to the likely impact of the regulating reservoir for the water supply and irrigation component. Measures to address these concerns were identified and incorporated in the project design. Other concerns raised in the SEIA (and a major reason for a Category A rating) related to an agroprocessing component, which was deleted in later processing of the Project because of concerns about project quality.

89. The water supply and irrigation component will include the construction of the Xiduancun reservoir, which will have a surface area of 182 ha at full supply level. It will inundate land that has been heavily modified by long human use: thus, impacts on biological resources will be negligible. 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 unearthed during construction. Sloping land along the reservoir periphery will be shaped and revegetated to minimize landslips. Based on 17 years data, sedimentation will not substantially reduce the volume of active storage for at least 50 years. Downstream impacts are expected to be largely beneficial because the Project will require the relocation of the discharge points from coal industries that have heavily polluted the Jianhe stream passing through the reservoir area. The compensation release past the dam will provide reliable potable water to downstream communities. Spoil from excavation for the water conveyance system and the pump station and settling basins will be deposited on land that is not under productive use, and will not impede natural drainage systems. Spoil sites will be landscaped and revegetated under monitoring supervision by the Henan Environmental Protection Bureau (EPB). Adverse impacts on groundwater levels will be negligible. The impact of pumping on the Yellow River will be negligible 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 removed during subsequent processing, the revised SEIA was not required to be recirculated. 26

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

90. The Project’s horticulture and livestock components are expected to either have comparatively minor environmental impacts, for which mitigation measures have been included in the Project, or actually improve environmental conditions. The horticulture component will be undertaken with strict adherence to soil conservation guidelines. Slopes of cultivated land will not 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 require prior approval from the Institute for the Control of Agrochemicals. The level of support for livestock production in each village will be based on an assessment of grazing land carrying capacity. Grassland management strategies such as rotational grazing, which is already practiced 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 1,603 persons in 367 households (338 households in the regulating reservoir inundation area and 29 households at the pump site on the Yellow River). The magnitude of resettlement is minor by PRC standards. Households in the inundation area will be relocated to four sites around the reservoir and, in most cases, will move less than 1 km from their current dwellings. An updated RAP, prepared in 1999, and consistent with ADB policy, provides a time-bound agenda for relocation and adequate compensation.50 The main concerns are a decrease in the average per capita agricultural land from the present 2.04 mu to 1.38 mu after relocation, and a possible lowering of grain yields on the new land. To avoid a fall in on-farm income, the resettlement plan includes financial and technical support for cultivating high-value, irrigated orchard and vegetable crops on about half of the new agricultural land. Also, the resettled households will be exempted from agricultural and special product taxes for 3-5 years. There will be preferential hiring of resettled adults, including females, in the construction of the dam and associated structures. The living conditions of the resettled households are expected to improve immediately because the housing conditions and amenities such as schools, water supply, and electricity at the resettlement sites are superior to those at the present sites. On-farm incomes are expected to reach or exceed current levels after three years. Support will be provided to maintain 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 preferential access 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 for building materials and roof tiles.

92. Among the households to be resettled, 29 households at the pump site have already been relocated, 19 to a site about 500 m from their original dwellings, and 10 to Mianchi, 23 km away, to join relatives living there. To date, about 125 families, mainly from the dam construction area, have been relocated, although some of the public infrastructure in the new villages is still under construction. About 242 families remain to be resettled, mainly from the tailwater of the regulating reservoir. A survey of the resettlement sites and interviews with people already resettled indicate that conditions at the resettlement sites are a significant improvement 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. 27 arrangements thus far, and indicated that the local resettlement bureau had made regular and frequent visits to monitor conditions in the resettlement areas. Many of those compensated to date have invested in construction equipment (such as trucks), which they anticipate will be needed 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 extensive consultation with all stakeholders. During project planning, public meetings, group interviews in the field, questionnaires, key informant interviews, and public display of project documents were used to solicit public input and feedback. Representatives of the National People’s Congress and 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’s Federation, Brilliant Cause, and Foundation for Poverty Reduction) offered advice on how to effectively tackle poverty reduction in the area. Consultation will continue throughout project implementation through newsletters, technical group formation, development of a market information 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 of fruit trees will produce about 72,600 t of fresh fruit per year (apples, kiwi fruit, and Chinese dates). Annual medicinal plant production on 2,500 ha will be about 2,640 t (gingko leaves and nuts, eucommia leaves and bark), field vegetable production on 2,800 ha will be 176,000 t, and 5,000 sets of greenhouses will produce 21,900 t of vegetables. This component is part of an ongoing development of tree crops and vegetables by farmers in the project area, and will accelerate 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 rapidly since 1990. The rising demand has been met by a rapid increase in production. Fruit production and vegetable production have increased 4.9 and 3.4 times, respectively, since 1990. There is a danger of overproduction in some crops, and falling prices unless quality products are produced. Therefore, the Project has been cautious to promote only selected crops for which extensive 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 to changing market conditions. Market information and projections will be provided to all farmers through the network of PMOs established throughout the project area.

96. The household cattle raising activity will produce 15,580 18-month-old cattle and about 2,375 aged cows per year at full production. The sheep raising activity will produce 108,000 surplus animals per year, with live weight of 5,400 t, and 14,400 aged sheep for slaughter with live weight of 936 t. Raising goats for meat will produce a total of 108,000 surplus animals per year with a total live weight of 6,075 t and 14,400 aged goats with live weight of 720 t. The breeding piggeries will produce 4,600 purebred sows, 20,000 crossbred sows, 25,000 piglets, 28

11,200 porkers, and 1,240 culled sows each year. The Project will assist 2,000 households to purchase crossbred animals for raising porkers. These households will produce about 68,000 animals annually. The pigs will be sold in the local markets for lean pork production. Total annual 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 shortage and unreliable supply result in the poor quality of rural and urban life and constrain agricultural and industrial development. An adequate water supply is necessary to support the growth in the area’s population, which is projected to rise from 290,000 in 2000 to 586,000 by 2022. Of this number, 84,000 will be migrant workers attracted by industrial development dependent on provision of water. Initially 11 percent of the water will be used for rural domestic, irrigation, and livestock uses, but that will rise to 17 percent in 2022 due primarily to an increase in the livestock 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 domestic users initially will consume 13 percent of the supplied water, increasing to 27 percent in 2022 as the population increases. Priority will be given to satisfying all nonindustrial water demands before any industrial demands are met. On the basis of existing industries, industry under development, and additional planned industry, industrial demand will exceed water supply by 25 million m³ in 2022. That excess demand, plus the demand from new industries, will be met by a second-phase development for which part of the conveyance capacity is provided in the project costs, but no benefits are included in the analysis. The water supplied will be readily marketable and 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 for each of the three components. Assumptions underlying the analyses are given in Appendix 7 and the results of the analysis, including sensitivity tests, are summarized in Table 3. The Project is financially and economically viable with a financial internal rate of return (FIRR) of 14 percent and an EIRR of about 17 percent. The Project is relatively robust under sensitivity analysis, but with some differences among the components.

99. The FIRR and EIRR for the horticulture component overall are 16.7 percent and 18.1 percent, respectively. The subcomponent FIRRs range from 14.4 percent for field vegetables to 20.3 percent for greenhouses (assuming half of the greenhouses are of the simple type and half are the standard model). As the component accelerates the assumed without-Project pace of development, it is sensitive to delay, but not excessively so. One year’s delay in benefits reduces the net present value (NPV) by about 30 percent, lowering the FIRR to 12 percent, but still well above the financial cost of capital (FCOC), which is estimated to be about 8 percent. No subcomponent is excessively sensitive to changes in investment or operating costs, but Chinese 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 percent and the EIRR at 19.9 percent, with the FIRRs ranging from about 17.1 percent for cattle breeding to about 21 percent for sheep.

101. The financial returns to the proposed livestock enterprises (purebred piggery and crossbred piggery) are about 13 percent for purebred pigs and 22 percent for crossbred pig breeding. 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 is about 19 percent. The aggregate base EIRR is estimated at just under 22 percent. 29

102. The rates of return show some sensitivity to adverse changes in investment costs or delays in implementation, but substantial sensitivity to changes in prices and operating costs, particularly among the FIRRs of the individual proposals. Maintaining efficiency in operations is a primary consideration for success of the investments, but equally important for all enterprises is 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 satisfactory financial return, provided that consistently efficient management and quality control are implemented. 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 at about 78 percent of the total value of sales at full development). The returns to the crossbreeding piggery investment are more robust than for the purebred breeding unit. A 10 percent reduction in revenues would reduce the base FIRR to about 15 percent and the EIRR would decline from 25 to about 16 percent. As there is substantial cross shareholding in both companies, the overall risk is minimized.

104. For the overall water supply component, the FIRR is estimated at 11.7 percent and the EIRR at 16 percent. The overall figures include the performance of the consolidated water supply and distribution companies and the performance of the 1,300 ha of orchards to be developed in Mianchi’s North Irrigation Area. Separately, the FIRRs for the water companies and irrigated orchard development range between 8 and 14 percent, but cluster around 12 percent. The EIRRs are similarly clustered around 16 percent. The consolidated EIRR for the water and irrigation companies is estimated at 16 percent while the economic return to irrigated orchard development alone is calculated to be about 15 percent. Individually, the EIRR is estimated at 16 percent for Sanmenxia, about 22 percent for the Mianchi Water Distribution Company, 17 percent for the Mianchi Irrigation Company, and 17 percent for the Yima Water Distribution Company. The component FIRRs are sensitive to changes in operating costs, but local authorities can and have adjusted water tariffs to compensate for anticipated increased costs. The sensitivity analysis can be misleading, as increased operating costs of the water distribution companies will trigger an increase in revenues for the bulk water company and, at the 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 much less than with the Project, and the cost of supply would be much higher. Many urban users currently pay 5-10 times the price of water that has been applied in the analysis. The true economic return to the component is therefore likely to be much higher than what is presented here. On the basis of these lower bound estimates for the economic value of water supply benefits, the overall economic return to water supply, distribution, and irrigation company investments 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 total investment costs do not strongly affect returns. These sensitivity results, based on substantial underestimation of the value of water, suggest that the economic viability of the water supply scheme 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 would equate 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 Household Livestock Water Supply Total Project Livestock Enterprises Financial Analysis Base Case IRR 16.7 18.4 18.6 11.7 13.9 Output Prices –10 % IRR 12.0 9.4 9.0 9.7 10.2 SV -18.7 -11.6 -10.9 -18.0 -15.9 Operating Costs +10% IRR 14.4 11.1 11.2 7.8 9.8 SV 40.4 14.4 13.7 9.3 13.1 Investment Costs +10% IRR 15.7 17.0 17.1 10.7 12.7 SV 162.1 150.7 116.6 43.2 39.2 Benefits Delay 1 Year IRR 12.4 10.2 9.3 10.6 10.9 Economic Analysis Base Case IRR 18.1 19.9 21.8 16.0 17.3 Output Prices –10 % IRR 11.0 9.6 13.5 12.2 11.9 SV -8.7 -7.6 -15.9 -10.5 -9.9 Operating Costs +10% IRR 15.5 11.5 15.6 11.0 12.5 SV 24.2 9.4 15.5 8.0 10.9 Investment Costs +10% IRR 17.1 18.3 20.1 14.8 16.0 SV 84.6 72.6 91.4 38.3 31.7 Benefits Delay 1 Year IRR 13.8 10.4 12.1 14.3 13.5 IRR = internal rate of return, SV = switching value.

107. The financial and economic analyses of the water supply and irrigation component do not include the potential benefits of the second phase development, although some of the infrastructure costs are incurred for the second phase. The second phase water supply will increase capacity utilization and the internal rates of return, especially for SHWSC and the Yima Water Distribution Company.

3. Subsidies, Taxes, and Cost Recovery

108. Subsidies associated with the Project consist of agricultural extension and training services provided without cost recovery for the horticulture and livestock components. However, the Project will generate additional tax revenues for the Government, including (i) value-added taxes and import duties on the development costs; (ii) sales taxes in the form of agricultural production tax, value-added tax, development tax, and education tax on component sales revenues; and (iii) corporate income tax on all commercial enterprises in each component. The water supply and irrigation component will ensure cost recovery through approved tariff adjustments, which are based on full cost recovery. Where possible, project loans to end-users will be matched by physical collateral, detailed in legally binding contracts, thus providing incentives for on-time loan repayment. The total cost of the Project, including subsidies, will be recovered through these taxes, tariffs, and repayment of loans by each component. 31

4. Risks

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

110. Each component will produce a wide range of products, primarily for the domestic market, for which marketing arrangements exist and in which incremental project production will be a relatively small addition to total production in the PRC. Extensive market assessment has been 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 similar production increases and make appropriate changes to areas planted and livestock numbers, during project implementation. Farmers will be provided with up-to-date market information to inform their choice of horticulture or livestock options and will be encouraged to diversify production 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 to reduce the risk imposed by reduced market demand due to oversupply and inadequate produce quality:

(i) The Project will not require farmers to follow precisely the production models of the selected tree crops outlined for the project analysis. Rather farmers will be allowed 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 quality of produce that can compete successfully in the market. (iii) Apple trees will be grafted with early-maturing varieties that will produce apples before 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 mature earlier than those of competitors in neighboring provinces and therefore can be sold easily in the Zhengzhou market. Moreover, a controlled atmosphere storage chamber for kiwi fruit (3,000 t) is under construction in Zhengzhou. (v) Gingko leaf production will be coordinated with the Lushan Mingkang Gingko Processing Company that exports gingko extract throughout the PRC and overseas. The gingko production model considers compensatory production of nuts and leaves. (vi) Other products such as Chinese dates and vegetables are not anticipated to meet marketing difficulties, provided product quality is maintained.

112. In the livestock component, risk has been mitigated by recommending that pregnant animals be procured by the Project, to ensure quick returns to farmers. Highly fecund and productive breeds of livestock have been selected to ensure that offspring will command a market 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. 32 the quality of porkers, with lean pigs increasingly commanding a price premium on both local and export markets. The risk of animal diseases, and hence loss to farmers, will be minimized with the provision of veterinary services by the pilot enterprise or livestock bureau. Farmers will be 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 retain their animals longer to reach desirable sales weights.

113. PMO and the relevant government agencies will need to be sufficiently sensitive to the difficult task of effectively targeting poor households. Risks will be minimized by effective monitoring and evaluation arrangements during implementation, especially by relatively independent observers, such as PADO and other poverty-related agencies, and by continuing policy dialogue between ADB and PGH. Poor households will be permitted to enter the Project at a level of debt with which they feel comfortable, and the Project will enable poor households that repay loans on time to take out repeat loans to expand their production. All poor households will be given time to decide on whether to participate or not, will be provided with adequate training and encouraged to join support groups, and will be given the chance to review the experience of other households within the same village or county. Poor farmers are expected to establish a satisfactory credit history as well as build up collateral during the Project, which will enable them to access commercial rural credit for future expansion. Early repayment of loans will enable local governments to establish a revolving fund, part of which may be earmarked for additional poverty assistance.

B. Social Dimensions

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

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

116. Most employment, and highest returns to labor, will be in the horticulture and household livestock components. At full development, the horticulture component will create 30,070 person-years equivalent of annual employment with a total remuneration for labor and net farm income of Y271 million, or an average of Y36 per labor-day,52 reflecting the moderate labor input and high returns from established orchards. The household cattle, goat, and sheep activities 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 imputing household 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. 33

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

VI. ASSURANCES

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

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

(ii) In selecting farmer participants, the assistance of PADO and other poverty agencies will be sought to give priority to the absolute and relative poor members of the local communities. For the horticulture development component, the amount 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 use right contract will include a tenure of up to 50 years for barren upland areas. PGH will select at least 40 percent of intended project beneficiaries with incomes below Y1,000 per year.

(iii) Prior to the construction of the Huaiba pumping station and the Xiduancun dam and reservoir under the water supply and irrigation component, the affected families will be resettled in other areas and so compensated that they will not suffer a reduction in income, deterioration in their living conditions, or unnecessary social dislocation. Households relocated before project effectiveness will be given priority, thus ensuring that they are adequately compensated and their livelihood restored, before the remaining households are relocated. Land acquisition and resettlement will be carried out in accordance with the agreed upon RAP. The RAP will be publicly available for review, and any concerns or grievances will be adequately addressed.

(iv) The national, provincial, municipal, and county governments and their corporations, in aggregate, will not own more than 49 percent of the shares of any pilot enterprise to be supported under the Project. 34

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

(vi) All activities to be supported under the Project will meet the national environmental standards and EIA procedures which are based on ADB’s Environmental Guidelines for Selected Agriculture and Natural Resources Development Projects and for Selected Infrastructure Projects and no Category A or B subproject will be approved for financing without a comprehensive EIA report reviewed and approved by the Henan EPB.

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

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

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

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

VII. RECOMMENDATION

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

TADAO CHINO President 27 November 2000 35

APPENDIXES Number Title Page Cited on (page, para.)

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

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

3 Project Framework --,67

4 Detailed Cost Estimates --,74

5 Implementation Arrangements, --,80 Organization 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 36 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 and rural development sector in the People’s Republic of China (PRC). All previous World Bank lending to agriculture and rural development used concessional funds under the International Development Association (IDA).

2. The World Bank has successfully supported provincial multicomponent area development projects prepared and implemented by the local governments. Eleven World Bank projects covered Henan Province with a total investment of $250.8 million. Four of them focused on forestry, two on livestock, two on irrigation, two on seed commercialization, and one on agricultural 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 eastern part of Henan (along the Yellow River). HADP comprised an agroprocessing component for 11 plants, horticulture, livestock and some pig farms. After evaluating progress, the World Bank presented HADP to the other provinces as a model project. In contrast to critical ratings by the Ministry of Finance (MOF) of agroprocessing projects in other parts of the PRC (36 percent success rate), the agroprocessing component in Henan Province ($38 million investment) was found to be 80 percent successful, although there are ongoing difficulties in relation to operating funds.

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

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

5. Bilateral projects in Henan have been relatively few. The Japan International Cooperation Agency (JICA) supported a project for the rehabilitation of rice fields ($3 million). A fruit processing project in the province was financed by a Japanese nongovernment organization (NGO). Previously, the United Kingdom (UK) had a $7.1 million duck raising project 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 four of the project counties: Songxian and Yichuan in Luoyang City, Neixiang and Xichuan in Nanyang City. The GTZ project was designed to improve the conditions of water supply and irrigation in the project area. Total project investment was Y12.46 million, of which Y5.85 million was from GTZ, Y4.52 million from the local counterpart fund, and Y2.09 million was the value of local labor. The water supply works were expected to help 7,800 people in the project area to access safe drinking water. The water conservation component, including construction of terraces and dams, and planting of tree crops, will cover 719 ha and 930 households. 37 Appendix 1, page 2

7. Between 1987 and 1998, the Asian Development Bank (ADB) has financed 10 loans (for 8 projects) in the agriculture sector in the PRC with a total investment of $779.6 million, and 53 technical assistance (TA) grants amounting to $31 million. This Project will be ADB’s first in Henan. In the past, the Government’s foremost concern in selecting projects for external assistance was the capacity of the executing agency to repay the loan. In view of this consideration, ADB’s program in agriculture needed to focus on revenue-generating production and agroprocessing projects to justify the Government’s use of funds from the ordinary capital resources (OCR). As a result, ADB financing for agriculture focused on agricultural production and production credit. In the mid-1990s, increased environmental concerns were integrated into the 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 address poverty.

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

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

Origin Loans Technical Assistance and Grants Number Amount Number Amount ($’ million) ($ million) Asian Development 10 779.6 53 31.0 Bank Australia 2 12.0 Canada 3 46.2 European Union 2 13.7 Germany 21 82.9 IFAD 9 214.1 Japan 26 459.3 Norway 1 9.7 United Kingdom 1 6.4 WFP 20 302.3 World 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. 38 Appendix 2, page 1

POVERTY AND SOCIAL DIMENSIONS ANALYSIS, AND SUMMARY RESETTLEMENT ACTION PLAN

A. Introduction

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

B. Socioeconomic Profile of Potential Beneficiaries

2. Demographic features. Agricultural communities in West Henan constitute about 83 percent of the total population, rising to 95 percent in Yichuan and Songxian. Twelve of the 32 counties in the project area are nationally designated poverty counties.1 While 98.4 percent of the 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. Almost 80 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 in Zhengping, Dengfeng, Yuzhou, and Xinmi counties; Manchus, 11 percent of minorities, are concentrated in Nanzhao County; and Mongols, 7 percent of minorities, are concentrated in Neixiang County. The average household size is 4.20, slightly smaller than the province average of 4.59. Average household sizes in counties range from 3.3 in Luoyang to 5.0 in Yichuan. The average family size in Henan Province is 3.86, suggesting that, on average, most families have one additional household occupant (often a grandparent).

3. Settlement pattern and production systems. Population density in West Henan is 463 households per square kilometer (km²), or 1,945 people per km². Households range from 91 per km² in Songxian to 1,101 per km² in Yima. On average, 41 percent of the population live in mountainous 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, crop cultivation on them is officially prohibited.

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

5. Many villages in the hilly areas are difficult to access by road and lack electricity. In addition, 14.8 percent of the households in the project area lack adequate drinking water.2 The average household size in 332 sample families in the project area was 5.47,3 compared with the average 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) and Luanchuan (14 percent). 3 Minority families are exempted from strict family planning targets. 39 Appendix 2, page 2

6. Labor availability and gender issues. The labor force in West Henan is about 8 million people, 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 Henan increased by 22.4 percent. Most new employment in Henan over 1990-1998 was absorbed in the rural areas, although not necessarily in agriculture.

7. The ratio of the male-to-female working population is 52:48. On-farm tasks are typically undertaken equally by men and women with few exceptions, such as men undertaking tree felling and women traditionally raising pigs. Survey data suggest that households relying primarily on their own labor are income maximizers, placing priority on increased economic activity 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 seasonal migration 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 and household tasks, but men increasingly take advantage of greater off-farm employment opportunities. Tree crops, requiring little labor input compared with arable crops except in harvesting, will increase the amount of slack time for both men and women. The result will be increased seasonal migration of male labor and increased farm-based activities, such as cottage industry, vegetable growing, and small livestock raising by women.

9. Current income status. The latest detailed income survey of the project area was undertaken in 19954 (Table A2.1). In 1995, about 36 percent of the horticulture households had incomes in the band immediately above the poverty threshold, corresponding to the international poverty standard. In total, almost 70 percent of the target horticulture households were below or only marginally above the international poverty standard.5 Around 61 percent of target 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 from 1990 to 1998. The growth rates of farmers' income in the project area and Henan Province were 119 percent and 72.4 percent, respectively, during the same period. The disposable income of residents in urban areas in the PRC and Henan increased 66.5 percent and 61.1 percent, respectively, from 1990 to 1998. Despite this growth, the majority of the project beneficiaries have annual incomes below the average rural incomes in the PRC and below the Henan 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 17 percent 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 of livestock 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 Y700 per annum (compared with 29.9 percent in 1995). This suggests that the distribution of poverty among potential beneficiaries remains as in the 1995 survey. 40 Appendix 2, page 3

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

Water Supply Item Horticulture Livestock and Irrigation Total Total Households 185,222 21,000 18,645 218,367 Persons 775,034 89,073 51,277 916,104

Per Capita Income in 1995 (yuan) <400 Households 31,780 1,381 0 33,101 Persons 136,804 5,383 0 142,267

400 – 530 Households 28,814 3,467 0 32,281 Persons 121,660 13,874 0 135,534

531 – 850 Households 66,118 7,905 210 74,233 Persons 280,065 33,301 840 315,000

851 - 1,232 Households 40,799 3,020 2,422 49,041 Persons 164,576 26,261 10,210 201,047

1,232 – 1,578 Households 11,269 2,207 5,404 18,880 Persons 43,421 9,261 21,580 74,262

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

11. Social development. Social development has progressed significantly in Henan and the PRC after the economic reforms. From 1978 to 1998, life expectancy at birth rose from 68.2 to 70.8 years in the PRC, and from 68 to 70 years in Henan. The adult illiteracy rate declined from 22.8 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 incidence of poverty and improving the living standards of the majority of its population. From 1990 to 1998, the input of funds from the central Government to poverty reduction increased almost three times. Using international standards, currently about 106 million people, or around 13.5 percent of the rural population, live in poverty.8 Only 0.8 percent of the urban population live below the poverty line of $1 per day, but consumption requirements are higher and a poverty line of at least $2 per day is more relevant. As a by-product of enterprise and other structural reforms, poverty is reappearing in urban centers and non-income poverty indicators may be more 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 that currently about 34 million inhabitants live in absolute poverty. 41 Appendix 2, page 4

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

14. Particularly vulnerable households such as those of the disabled,10 the elderly, those without 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, undertakes some livelihood training, and provides disaster relief.

15. Poverty incidence in Henan Province. The rate of reduction of rural poverty in Henan has been much higher than in the PRC as a whole. Henan reduced its official rural poverty incidence from 16.5 percent in 1989 to 4.1 percent in 1998. However, the incidence of absolute poverty 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 of the poor in the PRC, and 10 percent of the rural population.11 Between 12 million and 18 million people in Henan are seasonal surplus laborers, and 6 million are employed in industry and services.

16. The provincial government of Henan (PGH) is highly committed to reducing poverty. Of the 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 counties in the project area. In addition, the province, prefectures, and counties raised Y30 million from their own revenue to complement the budget in the poverty counties. Thus, each poverty county has a budget of about Y60 million for poverty reduction.

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

18. The standards for defining poor townships and villages have changed with time. The standards were Y1,280 and Y1,000, respectively, in 1998 current prices. Poor townships and poor villages in Henan were 237 and 2,962, respectively. In 1998, 1.52 million poorest of the poor rural dwellers lived in neither national nor provincial poor counties, and accounted for 47.6 percent of the total poor rural population in the province. The poor population in nonpoor counties 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 Planning Commission showed that out of the Y10 billion special funds for poor counties allocated in 1994, Y2 billion was not properly 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. 42 Appendix 2, page 5

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

20. Of the 22 counties and three other administrative areas or districts currently committed to participating in the Project, 9 are officially designated national poverty counties, but poverty is spread throughout all the project counties, even in the urban areas. About 12 percent of the 12.6 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 100.0 100.0 100.0 Xingyanga 26.5 25.7 14.4 Luoyanga 20.6 13.9 11.2 Zhumadian 14.7 9.7 11.0 Shangqiu 11.8 1.7 3.3 Nanyanga 8.8 9.7 10.1 Puyang 8.8 12.2 7.8 Sanmenxiaa 5.9 2.1 5.2 Pingdingshana 2.9 9.7 9.1 Zhengzhou 0 2.1 4.1 Kaifeng 0 7.6 7.4 Xinxiong 0 4.2 5.2 Anyang 0 0.4 3.0 Kebi 0 0.8 2.5 Jiyuana 0 0 2.5 Zhoukou 0 0 1.4 Jiaozhuo 0 0 1.2 Xuchang 0 0 0.5 a County within the project area. Source: Henan Provincial PADO.

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

22. There is a clear correlation between non-income measures and poverty in the project area (Table A2.3). Poor families have less arable land, consume more than they earn, have 43 Appendix 2, page 6 smaller and poorer quality housing, and are more likely to be illiterate. Accordingly, per capita net 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)

Y700- Y962- Y1,924- Y3,140- > Y6,280 Item Average < Y700 Y962 Y1,924 Y3,140 Y6,280 Per capita net income 1,912.7 550.9 842.4 1,437.0 2,388.9 4,030.3 8,320.1 Per capita arable land (mu) 1.25 0.98 1.01 1.19 1.38 1.48 1.23 Per capita consumption expenditure 1,234.1 799.7 824.7 1,039.1 1,422.9 2,141.4 3,082.3 Per capita housing area (m2) 24.3 17.8 18.6 23.0 26.2 32.8 36.4 Adult illiteracy rate (%) 4.2 7.0 6.8 4.3 3.9 1.4 1.6 Source: 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 the socioeconomic conditions that prevent poor people from creating opportunities for themselves and allow the Government and other stakeholders to include vulnerable groups in the socioeconomic mainstream. Hence, projects with poverty reduction as a strategic development objective need to change the underlying conditions that cause poverty, in addition to including poor people as project beneficiaries.

24. Baseline socioeconomic information and the PGH commitment to poverty reduction have 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 project with poverty as a secondary development objective, at least one third of direct beneficiaries must be poor, or one or more of the project components and 20 percent or more of the total project budget must be designed specifically for the poor. This Project meets these requirements and adds a specific poverty targeting and monitoring mechanism.

25. ADB’s Poverty Reduction Agreement with the central Government will be prepared in 2000. PGH indicated its strong support for the Project’s help to the poor and noted that ADB's new strategy is in line with current Government policy calling for sustained efforts to eradicate absolute poverty. The project area poverty agencies and the Rural and Urban Investigation Teams of the Statistics Bureau will assist the implementing agencies (IAs) to select at least 40 percent of the direct rural and urban beneficiary households with an annual per capita income level below $1 and $2, respectively. The agencies will use the established poverty recording system to monitor the contribution of the Project to poverty reduction. The agencies will prepare an annual progress report to be integrated in the progress report of the Project Management Office (PMO), which can be used for further beneficiary targeting and adjustment of the project design.

26. Generating income and employment. Project components are integrated to benefit the poor. By (i) focusing on labor-intensive production in horticulture and livestock, (ii) assuring a fair mechanism of income distribution between pilot enterprises and households, and (iii) addressing problems in the rural marketing system, the Project will significantly reduce poverty and promote equitable growth on a sustainable basis. The Project will also stimulate rural economic growth (primary objective) and will directly benefit about 0.9 million people in West Henan. 44 Appendix 2, page 7

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

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

29. Financing ongoing poverty reduction. The Project will generate at the county level a sustainable mechanism to finance poverty reduction. By establishing a revolving fund, the Project will enable the county governments to generate additional income that can be targeted for additional poverty reduction projects in agriculture. Early repayments from onlending to end users will be channeled through the Provincial Finance Bureau (PFB) to supplement the budget of PADO and/or the participating technical agencies. For example, the provincial poverty reduction budget for the 99 Henan counties is currently about Y60 million: Y30 million from the central and Y30 million from the local governments. The Project could generate about Y40 million 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 367 households (1,603 people) will need to be resettled. The RAP formulates measures to alleviate adverse impacts in accordance with national and regional laws and regulations and the resettlement policies of ADB. The objective is effective land acquisition and resettlement activities so that the production and livelihood of the affected population can be restored to the pre-project level (if not higher).

31. The pump site works affect Xipo village, Chencun Xiang, Mianchi County, and the whole village has to be relocated. Xipo has 29 households and a population of 130. The average family size is 4.13 persons, and the average farmland is 1.6 mu per person. It is very difficult to get drinking water, and the villagers fetch water 3 km away from the village. Accommodations are poor, and most villagers live in mudbrick and wood houses and caves. In 1996 (before relocation), the average annual household income was Y5,200: Y1,800 - Y3,000 for 4 households, 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 and Chencun 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 per person is Y2,295, 19 percent higher than the average for the countyY1,927.

33. A detailed land acquisition and resettlement design was completed in 1996 and a Resettlement Management Office was set up at Huaiba Water Resources Bureau. The draft resettlement plan was reviewed by ADB consultants (and staff) at least three times since 1996 and has been substantially improved by the time of appraisal. Two of the five planned new resettlement villages have already been set up, and 125 households (496 people) have been 45 45 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 Investigation Guidelines for Reservoir Inundation by Hydropower Projects issued by the Ministry of Water Resources, investigate the physical conditions in the land acquisition area. The social and economic conditions in the affected area of the Project are also to be investigated. (iv) Determine the appropriate rates of compensation for land acquisition and resettlement. (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 have been measured, calculated, and verified according to different categories. The settlers are involved in the measuring process, the results are publicized on the spot, and the settlers concerned acknowledge the results by signing the documents. The results are posted as bulletins, so that the settlers can monitor the calculated property results for the village. The compensation rates and the amount for each household are publicized on bulletin boards, and after verification by the resettlement household concerned, registration cards are filled out for each item and each household. Then the household, production team, village, township, and county sign and stamp the card. One copy is kept in archives, the other copies are kept by the resettlement household concerned, the Relocation Branch. and the Finance Branch of the County Resettlement Office, respectively.

36. The survey shows that 367 households (1,603 people) must be relocated, and production 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. 46 Appendix 2, page 9

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

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

39. The following preferential policies apply to the resettled persons: (i) projects related to industrial and agricultural production in the project area are given priority, and in the recruitment process, the workforce of the resettled and the residents of the relocation destinations are given priority; (ii) agricultural aid, poverty-aid fund, and other social development funds such as transportation, post, education and health services are provided to support the livelihood and production activities of the resettled: (iii) housing construction for the resettled households is exempt 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 adjusted according to the impact after relocation; (v) stone, sand, and roof tiles for the construction of the settlers' new houses are exempt from the mineral resource levy; and (vi) a support fund is set up as a poverty-aid fund for the new settlers in later stages, to ensure that they can make a living even in special circumstances. The settlers from the reservoir area also benefit from the reservoir area maintenance fund and the reservoir area construction fund. The direct compensation for such settlers (land, houses, relocation, and house construction subsidy) totals Y22.3 million. Relocation of public facilities costs Y4.8 million, while other costs are Y1.8 million. Combined with price and physical contingencies, the total resettlement cost is Y27.9 million ($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 205,000 households. The plan is to have at least 40 percent of poor peopleaccording to the international poverty standardamong 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 people within those poor areas identified for each project activity. 47 Appendix 3, page 1

PROJECT FRAMEWORK

Design Summary Targets Means of Verification Risks and Assumptions 1.Project Goal • Promote economic growth • Increased value of • Provincial statistics • Government policies in poor and disadvantaged agricultural outputs • Benefit monitoring are favorable to western areas in Henan • Decreased number of and evaluation (BME) agricultural production Province households living below system and project • Sustainable • Reduce rural poverty the poverty line completion report Government investment in rural infrastructure • Government remains committed to poverty reduction 2. Project Purpose • Increase agricultural • Sustainable incremental • Provincial statistics • Market prices for production and rural annual production of • BME system agricultural products are incomes through integrated - 72,600 tons (t) fruits • Postevaluation stable. agricultural development and 198,275 t reports • Farmers respond • Poverty reduction through vegetables favorably to land and targeted assistance to poor - 2,640 t medicinal water resources rural households leaves, barks, and management nuts technologies. - 17,955 cattle (18-mo • Changes in production surplus and culls), do not adversely affect 122,400 sheep individual workload and (surplus and culls), household labor division 122,400 goats • Appropriate measures (surplus and culls), for mitigation of adverse and 105,440 pigs social and (piglets, porkers, and environmental impacts culled sows) are carried out during - 4,600 purebred sows project implementation & boars, 20,000 • Government supplies crossbred sows credit services to • Provision of 83 million beneficiaries. cubic meters (m3) water supply for rural, urban, and industrial uses • Increased incomes and quality of life for about 900,000 beneficiaries, including 280,000 poor people (>30 percent), amounting to one third of remaining poor people, in the project area 3. Component/Output 3.1 Horticulture Development • Rehabilitation of apple • Developed 3,200 • Project progress • Nursery certification orchards through varietal hectares (ha) for apple, reports and review scheme will be improvements increased annual missions established and properly • Establishment of new fruit production by 38,400 t • Project completion operated orchards, medicinal plant of early-maturing reports • Farmer training plantations, and vegetable varieties • Postevaluation programs will be production under field and • Developed 1,200 ha reports effectively carried out greenhouse conditions Chinese dates, increased production by 4,200 t/year 48 Appendix 3, page 2

Design Summary Targets Means of Verification Risks and Assumptions • Developed 1,400 ha • Orchard farmers are kiwifruit, increased issued land use rights production by 30,000 long enough to provide t/year them incentives for • Developed 1,900 ha investing in land gingko, increased development and production by 1,140 t orchard establishment nuts/year • Adequate credit is • Developed 600 ha provided for investment eucommia, producing and working capital leaf 1,125 t/year and bark 375 t/year • Developed 2,800 ha of field vegetables, producing 176,400 t/year • Developed 5,000 sets of greenhouses, producing 21,875 t/year of vegetables • Total households benefiting about 107,500, with average gross income of Y6,130 ($740) per poor household per year and Y15,360 ($1,850) per less-poor household per year 3.2 Livestock Development • Development of livestock • 9,500 households • Project progress • Farmer training program activities at household level breeding and raising reports and review will be carried out • Development of pilot cattle, producing 15,580 missions effectively livestock enterprises 18-mo. cattle and 2,375 • Project completion • Adequate technical culls per year reports services will be made • 7,200 households • Postevaluation available to monitor the breeding and raising reports feed mix for livestock goats, producing fattening activities 108,000 surplus animals • Adequate credit is and 14,400 culls per provided for investment year and working capital • 7,200 sheep-raising households, producing 108,000 sheep and 14,400 culls per year • 2,000 poor pig-raising households, raising 68,000 pigs • Establishment of 2 breeding piggeries with capacity to produce 4,600 purebred breeding animals, 20,000 crossbred sows, 25,000 piglets, 11,200 porkers, and 1,240 culled sows per annum • About 167,000 beneficiary households with average gross 49 Appendix 3, page 3

Design Summary Targets Means of Verification Risks and Assumptions incomes of Y6,480 ($781) per poor household per year and Y15,710 ($1,892) per less-poor household per year 3.3 Water Supply and Irrigation Component • Development of facilities for • Delivery of 83 million • Project progress • Construction of the dam diversion and conveyance m3 water per annum to reports will be supervised by a of water for rural, urban, benefit 23,000 livestock • Project completion Dam Safety Panel and industrial uses, and 197,500 people in reports • The resettled population involving construction of 22 rural villages, 2 • Postevaluation will be adequately (i) pumping station at towns, 14 small and reports compensated so that Huaiba, medium-size industries, their living conditions (ii) 12.4-kilometer-long 1 thermal power station, are at least as good as conveyance system with and 1,300 ha of fruit those without the Project multistage pumping, orchards • Water tariffs for various (iii) an earth-filled dam with • North irrigation area of users will be set at such 3 24.6 million m capacity, 1,300 ha to benefit levels so as to recover (iv) expansion of water about 6,500 households at least the investment reticulation system in and operation and the service areas, maintenance costs (v) development of irrigation • The reservoir will not facilities, and affect any critical habitat (vi) resettlement of 367 of flora and fauna, or families any cultural relics. • Government will proceed with construction of sewerage treatment system, using local funds. • Adequate credit is available for investment 4. Activities/Inputs $ million • Project progress • Local counterpart funds FX LC Total reports and review will be available on time • Horticulture development 16.6 31.0 47.6 missions and in adequate quantity • Livestock development 11.3 18.7 30.1 • Project completion • Water supply and irrigation 20.1 26.6 46.8 report • Project management 0.4 2.1 2.5 • Project accounts Base Cost 48.4 78.6 127.0 Physical Contingency Price Contingency IDC Commitment Front-end Fee Total

IDC - interest during construction DETAILED COST ESTIMATES

Table A4.1: Components Project Cost Summary

% % Total Yuan Ten Thousand $ million Foreign Base Item Local Foreign Total Local Foreign Total Exchange 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 23.8 Mianchi Water Treatment & Distribution 2,085 1,871 3,955 2.51 2.25 4.77 47.3 3.8 Yima Water Treatment & Distribution 2,211 2,269 4,480 2.66 2.73 5.40 50.7 4.3 Mianchi 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 36.8 B. Horticulture 1. Tree Crops Apples 4,000 2,217 6,217 4.82 2.67 7.49 35.7 5.9 Ginkgo 3,863 1,665 5,528 4.65 2.01 6.66 30.1 5.2 Kiwifruit 3,988 1,805 5,794 4.81 2.18 6.98 31.2 5.5 Eucommia 1,014 428 1,442 1.22 0.52 1.74 29.7 1.4 Chinese 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 19.7 2. Vegetables Greenhouses 5,644 3,711 9,355 6.80 4.47 11.27 39.7 8.9 Irrigated Field Vegetables 6,037 3,331 9,368 7.27 4.01 11.29 35.6 8.9 50 Subtotal Vegetables 11,681 7,042 18,723 14.07 8.48 22.56 37.6 17.8 Subtotal Horticulture 25,762 13,737 39,499 31.04 16.55 47.59 34.8 37.5 C. Livestock Development Household Cattle Production 5,948 3,390 9,338 7.17 4.08 11.25 36.3 8.9 Household Sheep & Goat Production 4,172 2,298 6,470 5.03 2.77 7.80 35.5 6.1 Commercial Pig Breeding 2,764 2,573 5,336 3.33 3.10 6.43 48.2 5.1 Household 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 23.7 D. Project Management 1,771 340 2,111 2.13 0.41 2.54 16.1 2.0 Total 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 5.2 Appendix 4,page1 Price 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 38.5 109.0 Interest During Construction - 9,481 9,481 - 11.4 11 100.0 9.0 Commitment Charges - 627 627 - 0.8 0.8 100.0 0.6 Subtotal 70,709 54,289 124,998 85.19 65.41 150.60 43.4 118.6 Front-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 44 119 Total ADB Financing 0.0 53,352 53,352 0.0 64.3 64.3 100 ADB = Asian Development Bank. Table A4.2: Expenditure Accounts Project Cost Summary

% Item 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 39 Enterprises 1,581 598 2,179 1.9 0.7 2.6 27 Soil 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 35 2. Farm Development Minor Structures /a 11,154 7,387 18,540 13.4 8.9 22.3 40 5

Farm Labour 1,902 - 1,902 2.3 - 2.3 - 1 Subtotal Farm Development 13,055 7,387 20,442 15.7 8.9 24.6 36 Subtotal Civil Works 28,899 16,045 44,944 34.8 19.3 54.1 36 C. Equipment 3,833 8,067 11,900 4.6 9.7 14.3 68 D. Materials Farm Inputs and Goods /b 16,163 5,314 21,477 19.5 6.4 25.9 25 Planting/Grafting Material 6,128 4,750 10,877 7.4 5.7 13.1 44 Livestock 4,634 5,580 10,214 5.6 6.7 12.3 55 Enterprise 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 37

E. Vehicles 220 220 440 0.3 0.3 0.5 50 Appendix 4,page2 F. Training Staff Training 216 43 259 0.3 0.1 0.3 17 Extension Services 341 - 341 0.4 - 0.4 - Subtotal Training 557 43 601 0.7 0.1 0.7 7 G. PMO Services 480 - 480 0.6 - 0.6 - Total Investment Costs 64,285 40,198 104,483 77.5 48.4 125.9 38 ADB = 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 Project Cost Summary (continued)

% Item Yuan Ten Thousand $ million Foreign Local Foreign Total Local Foreign Total Exchange II. 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 39 Price 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 38 Interest During Construction - 94,808 94,808 - 11.4 11.4 100 Commitment 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 44

Total ADB Financing 0.0 138,680 138,680 0.0 64.3 64.3 100 52 ADB - Asian Development Bank; PMO - Project Management Office Appendix 4,pa g e 3 Table A4.3: Expenditure Accounts, by Component -Totals Including Contingencies ($ million)

Water Supply and Irrigation System Horticulture Huaiba Mianchi Item Water Water Yima Water Mianchi Tree Crops Supply Treatment & Treatment & Irrigation Chinese System Distribution Distribution Company Apples Ginkgo Kiwifruit Eucommia Dates

I. Investment Costs A. Land Acquisition and Resettlement Land Acquisition for Resettlement 0.9 ------Land Acquisition By Enterprises - 0.3 0.2 ------Resettlement Work 2.2 ------Subtotal Land Acquisition and Resettlement 3.1 0.3 0.2 ------B. Civil Works 1. Water Supply Water Supply 21.3 1.7 2.9 1.1 - - - - - Enterprises - 0.3 0.4 0.2 - - - - - Soil Conservation/Afforestation 2.3 0.0 - 0.0 - - - - - Subtotal Water Supply 23.6 2.0 3.3 1.3 - - - - - 2. Farm Development Minor Structures /a - - - 0.2 0.4 0.2 0.2 0.0 0.2 Farm Labour - - - 0.1 0.2 0.2 0.3 0.2 0.1

Subtotal Farm Development - - - 0.2 0.6 0.5 0.4 0.3 0.2 53 Subtotal Civil Works 23.6 2.0 3.3 1.5 0.6 0.5 0.4 0.3 0.2 C. Equipment 6.1 2.7 2.3 2.3 - - - - - D. Materials Farm Inputs and Goods b/ - - - 1.1 2.6 3.0 5.8 0.9 0.7 Planting/Grafting Material - - - 2.0 4.9 3.8 1.4 0.8 1.4 Livestock ------Enterprise Goods & Materials c/ - 0.1 ------Subtotal Materials - 0.1 - 3.1 7.6 6.8 7.2 1.6 2.1 E. Vehicles - 0.0 0.1 ------F. Training Staff Training - - 0.0 ------Extension Services - - - 0.0 0.1 0.0 0.0 0.0 0.0 Subtotal Training - - 0.0 0.0 0.1 0.0 0.0 0.0 0.0 G. PMO Services ------Total Investment Costs 32.8 5.1 5.8 7.0 8.2 7.3 7.7 1.9 2.4 Appendix 4,page4 II. Recurrent Costs H. PMO Staff Salaries & Office Overheads ------Total Recurrent Costs ------Total Project Costs 32.8 5.1 5.8 7.0 8.2 7.3 7.7 1.9 2.4

Taxes 4.0 0.7 0.8 1.0 1.2 1.0 1.1 0.2 0.3 Foreign Exchange 12.9 2.5 3.0 3.7 3.0 2.2 2.4 0.6 0.8 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 A4.3: Expenditure Accounts, by Component -Totals Including Contingencies (continued) ($ million)

Livestock Development Vegetables Household Item Irrigated Household Sheep & Commercial Household Field Cattle Goat Pig Pig Project Greenhouses Vegetables Production Production Breeding Production Management Total

I. Investment Costs A. Land Acquisition and Resettlement Land Acquisition for Resettlement ------0.9 Land Acquisition By Enterprises - - - - 0.2 - - 0.6 Resettlement Work ------2.2 Subtotal Land Acquisition and Resettlement - - - - 0.2 - - 3.7 B. Civil Works 1. Water Supply Water Supply ------26.9 Enterprises - - - - 1.8 - - 2.8 Soil Conservation/Afforestation ------2.3 Subtotal Water Supply - - - - 1.8 - - 32.0 2. Farm Development Minor Structures a/ 9.4 8.3 3.0 1.8 - 0.7 - 24.4 Farm Labour 0.8 0.6 - - - - - 2.5

Subtotal Farm Development 10.2 8.9 3.0 1.8 - 0.7 - 26.9 54 Subtotal Civil Works 10.2 8.9 3.0 1.8 1.8 0.7 - 58.9 C. Equipment 0.5 - - - 1.3 - 0.2 15.5 D. Materials Farm Inputs and Goods b/ 1.6 3.4 4.3 1.6 - 3.5 - 28.5 Planting/Grafting Material ------14.3 Livestock - - 5.0 5.0 2.7 0.7 - 13.5 Enterprise Goods & Materials c/ - - - - 0.7 - - 0.8 Subtotal Materials 1.6 3.4 9.3 6.6 3.4 4.3 - 57.1 E. Vehicles - - - - 0.1 - 0.4 0.6 F. Training Staff Training - - - - 0.0 - 0.3 0.3 Extension Services - 0.1 0.1 0.1 - 0.0 - 0.4 Subtotal Training - 0.1 0.1 0.1 0.0 0.0 0.3 0.8

G. PMO Services ------0.6 0.6 Appendix 4,pa Total Investment Costs 12.3 12.3 12.4 8.5 6.9 5.0 1.5 137.2 II. Recurrent Costs H. PMO Staff Salaries & Office Overheads ------1.2 1.2 Total Recurrent Costs ------1.2 1.2 Total Project Costs 12.3 12.3 12.4 8.5 6.9 5.0 2.8 138.4 g

e 5 Taxes 1.7 1.7 1.7 1.2 0.8 0.7 0.2 18.4 Foreign Exchange 4.9 4.4 4.5 3.1 3.4 1.5 0.4 53.2 PMO = Project Management Office. Table A4.4: Expenditure Accounts Breakdown ($ million)

Physical Base Cont. Costs + Plus Base Cost Physical Contingencies Price Contingencies Total Including Contingencies Price Price Local Local Local Local Cont. on Cont. on Item 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. I. Investment Costs A. Land Acquisition and Resettlement Land Acquisition for Resettlement - 0.8 - 0.8 - 0.0 - 0.0 - 0.0 - 0.0 - 0.9 - 0.9 0.8 0.0 Land Acquisition by Enterprises - 0.6 - 0.6 - 0.0 - 0.0 - 0.0 - 0.0 - 0.6 - 0.6 0.6 0.0 Resettlement 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 0.2 B. 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 1.6 Enterprises 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 0.1 Soil 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 1.8 2. 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 1.2

Farm Labor - 2.3 - 2.3 - 0.1 - 0.1 - 0.1 - 0.1 - 2.5 - 2.5 2.4 0.1 55 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 1.3 Subtotal 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 3.1 C. 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 0.7 D. 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 1.4 Planting/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 0.7 Livestock 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 0.6 Enterprise 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 2.7 E. 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 0.0 F. 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 0.0 Extension 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 0.0 G. 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 6.8 II. 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 0.1 Total Recurrent Costs - 1.1 - 1.1 - 0.1 - 0.1 - 0.1 - 0.1 - 1.2 - 1.2 1.2 0.1 Total 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 Appendix 4,page6

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

Totals Including Contingencies (Yuan ten thousand) Totals Including Contingencies ($ million) 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 - - - 32.8 Mianchi Water Treatment & Distribution 2,170 2,085 - - - 4,255 2.6 2.5 - - - 5.1 Yima Water Treatment & Distribution 2,309 2,526 - - - 4,835 2.8 3.0 - - - 5.8 Mianchi 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 50.7 B. 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 8.2 Ginkgo 1,271 1,550 2,290 621 365 6,098 1.5 1.9 2.8 0.7 0.4 7.3 Kiwifruit 1,474 1,700 2,450 475 275 6,374 1.8 2.0 3.0 0.6 0.3 7.7 Eucommia 360 419 607 126 74 1,586 0.4 0.5 0.7 0.2 0.1 1.9 Chinese Dates 574 586 800 - - 1,959 0.7 0.7 1.0 - - 2.4 56 Subtotal Tree Crops 5,418 6,119 8,835 1,519 953 22,845 6.5 7.4 10.6 1.8 1.1 27.5 2. Vegetables Greenhouses 2,993 3,057 4,176 - - 10,227 3.6 3.7 5.0 - - 12.3 Irrigated 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 - - 24.6 Subtotal Horticulture 11,407 12,235 17,190 1,519 953 43,305 13.7 14.7 20.7 1.8 1.1 52.2 C. Livestock Development Household Cattle Production 2,368 3,049 3,950 886 - 10,253 2.9 3.7 4.8 1.1 - 12.4 Household Sheep & Goat Production 2,069 2,112 2,886 - - 7,067 2.5 2.5 3.5 - - 8.5 Commercial Pig Breeding 3,488 2,258 - - - 5,747 4.2 2.7 - - - 6.9

Household Pig Production 1,221 1,246 1,702 - - 4,169 1.5 1.5 2.1 - - 5.0 Appendix 4,page7 Subtotal Livestock Development 9,146 8,666 8,538 886 - 27,236 11.0 10.4 10.3 1.1 - 32.8 D. Project Management 1,463 199 204 210 216 2,291 1.8 0.2 0.2 0.3 0.3 2.8 Total 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 Table A4.6: Expenditure Accounts, by Years -- Totals Including Contingencies

Totals Including Contingencies (Yuan Ten Thousand) Totals Including Contingencies ($ Million) Item 2000 2001 2002 2003 2004 Total 2000 2001 2002 2003 2004 Total I. Investment Costs A. Land Acquisition and Resettlement Land Acquisition for Resettlement 717 - - - - 717 0.9 ----0.9 Land Acquisition by Enterprises 522 - - - - 522 0.6 ----0.6 Resettlement Work 1,829 - - - - 1,829 2.2 ----2.2 Subtotal Land Acquisition and Resettlement 3,068 - - - - 3,068 3.7 ----3.7 B. Civil Works 1. Water Supply Water Supply 13,076 9,268 - - - 22,344 15.8 11.2 - - - 26.9 Enterprises 2,025 294 - - - 2,319 2.4 0.4 - - - 2.8 Soil 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 - - - 32.0 2. Farm Development Minor Structures a/ 5,933 6,059 8,278 - - 20,269 7.1 7.3 10.0 - - 24.4 Farm 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 - - 26.9 57 Subtotal Civil Works 22,587 17,218 9,119 - - 48,924 27.2 20.7 11.0 - - 58.9 C. Equipment 9,029 3,645 168 - - 12,842 10.9 4.4 0.2 - - 15.5 D. 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 28.5 Planting/Grafting Material 3,483 3,558 4,860 - - 11,901 4.2 4.3 5.9 - - 14.3 Livestock 3,245 4,290 3,640 - - 11,175 3.9 5.2 4.4 - - 13.5 Enterprise 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 57.1 E. Vehicles 410 61 - - - 471 0.5 0.1 - - - 0.6 F. Training Staff Training 224 53 - - - 276 0.3 0.1 - - - 0.3 Extension 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 - - 0.8 G. PMO Services 509- ---5090.6----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 1.3 137.2 II. Recurrent Costs PMO Staff Salaries & Office Overheads 195 199 204 210 216 1,023 0.2 0.2 0.2 0.3 0.3 1.2 Total Recurrent Costs 195 199 204 210 216 1,023 0.2 0.2 0.2 0.3 0.3 1.2 Total 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 Appendix 4,page8

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 A4.7: Components by Financiers ($'000)

($ '000) The Households Asian Development Local Item Government Enterprises Households (Cash) (Labor) Bank Construction Bank Total (Excl. Duties & Amount % Amount % Amount % Amount % Amount % Amount % Amount % For. Exch. Taxes) Taxes

A. Water Supply and Irrigation System Huaiba Water Supply System 11,930.7 36.4 ----1,914.7 5.8 12,897.1 39.4 6,024.2 18.4 32,766.6 23.7 12,897.1 15,889.7 3,979.8 Mianchi Water Treatment & Distribution 2,315.0 45.2 ----13.2 0.3 1,835.0 35.8 963.8 18.8 5,127.0 3.7 2,455.5 1,972.9 698.7 Yima Water Treatment & Distribution 2,971.2 51.0 ------1,992.8 34.2 861.5 14.8 5,825.5 4.2 2,980.8 2,022.1 822.5 Mianchi Irrigation Company 3,157.1 45.4 - - 43.9 0.6 76.3 1.1 3,677.0 52.9 - - 6,954.2 5.0 3,677.0 2,255.2 1,022.0 Subtotal Water Supply and Irrigation System 20,374.0 40.2 - - 43.9 0.1 2,004.1 4.0 20,401.9 40.3 7,849.5 15.5 50,673.3 36.6 22,010.3 22,139.9 6,523.0 B. Horticulture 1. Tree Crops Apples 4,980.4 60.5 - - 108.0 1.3 182.1 2.2 2,956.0 35.9 - - 8,226.5 5.9 2,956.0 4,113.7 1,156.8 Ginkgo 4,686.0 63.8 - - 215.4 2.9 216.3 2.9 2,228.9 30.3 - - 7,346.5 5.3 2,228.9 4,090.5 1,027.1 Kiwifruit 4,858.8 63.3 - - 175.4 2.3 238.9 3.1 2,405.9 31.3 - - 7,679.0 5.5 2,405.9 4,199.9 1,073.2 Eucommia 1,070.7 56.0 - - 68.8 3.6 199.1 10.4 572.8 30.0 - - 1,911.4 1.4 572.8 1,094.7 243.9 Chinese Dates 1,479.8 62.7 - - 42.2 1.8 68.3 2.9 770.5 32.6 - - 2,360.8 1.7 770.5 1,261.7 328.6 Subtotal Tree Crops 17,075.7 62.0 - - 609.8 2.2 904.6 3.3 8,934.2 32.5 - - 27,524.2 19.9 8,934.2 14,760.5 3,829.6 2. Vegetables Greenhouses 6,550.6 53.2 - - 123.6 1.0 714.3 5.8 4,933.3 40.0 - - 12,321.8 8.9 4,933.3 5,713.5 1,675.0 Irrigated Field Vegetables 3,179.2 25.8 4,159.4 33.7 289.5 2.3 271.6 2.2 4,428.3 35.9 - - 12,328.1 8.9 4,428.3 6,204.2 1,695.6 Subtotal Vegetables 9,729.8 39.5 4,159.4 16.9 413.1 1.7 985.9 4.0 9,361.6 38.0 - - 24,649.9 17.8 9,361.6 11,917.7 3,370.6 Subtotal Horticulture 26,805.5 51.4 4,159.4 8.0 1,022.9 2.0 1,890.5 3.6 18,295.7 35.1 - - 52,174.1 37.7 18,295.7 26,678.1 7,200.2 C. Livestock Development 58 Household Cattle Production 7,281.9 58.9 - - 267.0 2.2 279.3 2.3 4,525.3 36.6 - - 12,353.5 8.9 4,525.3 6,084.6 1,743.6 Household Sheep & Goat Production 5,056.2 59.4 - - 121.2 1.4 282.2 3.3 3,054.9 35.9 - - 8,514.5 6.2 3,054.9 4,279.8 1,179.8 Commercial Pig Breeding 0.0 - 3,544.8 51.2 ----3,378.7 48.8 - - 6,923.5 5.0 3,378.7 2,723.9 820.9 TotHousehold Pig Production 3,254.4 64.8 - - 205.5 4.1 39.2 0.8 1,523.8 30.3 - - 5,022.8 3.6 1,523.8 2,777.2 721.8 Subtotal Livestock Development 15,592.5 47.5 3,544.8 10.8 593.6 1.8 600.6 1.8 12,482.8 38.0 - - 32,814.3 23.7 12,482.8 15,865.5 4,466.1 D. Project Management 2,541.8 92.1 ------218.1 7.9 - - 2,759.8 2.0 440.8 2,136.2 182.8 65,313.8 47.2 7,704.2 5.6 1,660.4 1.2 4,495.2 3.2 51,398.4 37.1 7,849.5 5.7 138,421.5 100.0 53,229.6 66,819.8 18,372.1 Appendix 4,page9 TableA4.8: Disbursements, by Semesters, and Government Cash Flow ($ million)

Financing Available Net of Retroactive Financing a/ Costs to be Financed Asian Financial Charges Households Households Development Construction Interest The Government Enterprises (Cash) (Labour) Bank Bank Project During 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 -22,779.1 2 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 -38,394.5 3 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 -46,972.7 4 976.0 208.7 874.0 8,711.8 1,606.0 12,376.5 21,741.9 686.5 111.8 22,540.2 -9,365.3 -56,338.0 5 976.0 208.7 874.0 8,711.8 1,606.0 12,376.5 16,279.2 963.5 79.1 17,321.8 -3,902.7 -60,240.6 6 849.0 302.4 523.6 5,742.5 0.0 7,417.5 16,279.2 1,240.5 46.4 17,566.1 -8,861.7 -69,102.3 7 849.0 302.4 523.6 5,742.5 0.0 7,417.5 1,647.9 1,423.1 24.9 3,095.9 5,769.6 -63,332.7 8 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 -64,526.2 9 0.0 118.6 0.0 335.9 0.0 454.4 762.6 1,616.3 2.1 2,381.1 -308.2 -64,834.4 10 0.0 52.0 0.0 112.7 0.0 164.7 762.6 1,627.0 0.8 2,390.5 -597.9 -65,432.3 11 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 financing 59 c Excluding interest during construction and charges.

Table A4.9: Allocation of Loan Proceeds Asian Development Bank ($'000)

Suggested Allocation of Loan Proceeds Loan Amounts ($'000) Item Loan Disbursement Total Project Cost Average Disbursement (%) Unallocated Allocated Amount % Foreign Local Total Foreign Local Total Total Foreign Local Total Foreign 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 - 20,763.1 3. 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 - 7,723.9 4. 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 - 20,282.6 5. Training b/ 53.3 7.0 55.9 741.3 797.2 100.0 - 7.0 55.9 2.7 - 2.7 53.3 - 53.3 Unallocated 2,575.5 ------Total 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). Appendix 4,page10 b ADB-financed overseas training/study tours for staff of the Project Management Office. 60 Appendix 5, page 1

IMPLEMENTATION ARRANGEMENTS, ORGANIZATION CHART, AND IMPLEMENTATION SCHEDULE

A. Project Leading Group

1. The Provincial Government of Henan (PGH) has set up a West Henan Economic Development Leading Group to provide policy guidance, supervision, and coordination for the Project implementation. A vice governor heads the Leading Group, with directors of the Henan Development Planning Commission and Provincial Finance Bureau (PFB) as deputies. Directors of the Provincial Poverty Alleviation and Development Office (PADO) and other provincial rural and urban poverty-related agencies including the Statistics Bureau, Environmental Protection Bureau, and sector bureaus of agriculture (BA), livestock (BL), water conservancy, 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 8 professional staff will be responsible for supervision and management of project implementation. 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 already established their own leading groups and PMOs. The number of professional and technical staff involved in the lower level PMOs is estimated to be 5-8 at each office. The PMOs will be assisted 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 a pilot basis, but most of the IAs will be either a township finance office or a township BA, BF or BL, with the choice determined by the local government involved. These “ultimate” borrowers would 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, and medicinal plants (eucommia and gingko), the Forestry Bureau will be the IA.

6. Vegetables component. The agriculture component comprising 2,800 hectares (ha) of field vegetables and 5,000 greenhouses will be implemented by the Agriculture Bureau. Part of 61 Appendix 5, page 2 the field vegetable component may be implemented with the support of the Jiyuan Vegetable Seeds Company Ltd.

7. Livestock component. County/township livestock bureaus will be responsible for organizing implementation of beef, sheep, and goat production. The proposed breeding farm for purebred 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 be implemented by the Jiyuan Dazhong Livestock Industry Company Limited, a limited liability company already successfully operating pig and poultry production enterprises.

8. Water supply and irrigation component. The Sanmenxia Huaiba Water Supply Company has been set up to construct, operate, and maintain the Huaiba Water Supply Scheme. This commercial enterprise will sell bulk water to (i) Yima and Mianchi Water Supply Companies, which will construct, operate, and maintain water supply networks and treatment facilities in Yima City and Mianchi County at commercial tariffs; and (ii) Mianchi Irrigation Company, a commercial enterprise under the jurisdiction of the County Water Conservancy Bureau, which will construct, operate, and maintain the irrigation distribution system and collect water fees from the farmer beneficiaries.

D. Financial Management

9. MOF will be the principal Borrower. MOF will onlend the funds at the same interest rate and conditions (about 6.46 percent interest, 25 years maturity, 5 years grace period, 0.75 percent commitment fee, and 1.0 percent front-end fee) to PFB. PFB will open a separate account for the Project through which the funds for implementation will be channeled to the finance bureaus at the prefecture/city and county levels of the project area. With the exception of onlending to the pilot enterprises and water supply and irrigation companies, the county/municipal finance bureau will take the foreign exchange risk. These bureaus will relend the funds to the farm enterprises and participating households on terms and conditions that will vary according to the profitability of the activities and ability to repay the loans, according to draft loan 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 less than commercial bank lending,1 the local government level will provide funds to end users in three modalities. First, to farmers, funds will be provided in local currency through township financial offices, at interest rates not lower than commercial bank rates for equivalent loans, with at least 4-year maturity and grace period of 1-2 years. Wherever possible, loans will be secured by fixed assets collateral under a formal loan agreement. However, it is accepted that poor farm households have extremely limited fixed assets of any value, so emphasis will be on careful selection of participants and group pressure, where appropriate. Second, to the water supply and irrigation companies, funds will be provided at the same terms and conditions as the ADB funds, although these companies will take the foreign exchange risk. Third, the pilot enterprises will be expected to take the foreign exchange risk and will receive funds from the relevant finance 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) than farmers, 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 the horticulture 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. 62 Appendix 5, page 3 local funding amounting to about $65.3 million is needed. PFB will ensure that the relevant municipality and/or county government is prepared to commit the necessary amount of counterpart funding (up to $3 million - $5 million per county), to be released through the normal local government budget mechanisms. Counties that have excessive exposure to foreign currency 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 for the ADB funds. PFB will process loan withdrawal applications, following preparation by the provincial PMO and certification by the provincial PMO that the relevant works or procurement have been carried out to an acceptable standard. PFB will authorize the release of funds to bank 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). ADB funds advanced to the special account will be reimbursed under ADB’s statement of expenditure procedure.

E. Procurement

13. Generally the relevant level of the PMO will be responsible for procurement of goods and materials, which will then be distributed to either groups of farmers or individual farm households. 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 items that can be procured locally, the county PMOs will be responsible. The PMO will also be responsible for procurement of training services, inspection/acceptance surveys, and technical advice to farmers. The main exceptions to this arrangement will be procurement for the water supply and irrigation component, which will be undertaken by the relevant water supply company, and procurement by pilot enterprises.

14. Procurement of goods and services will be undertaken in accordance with ADB's Guidelines for Procurement. ADB’s domestic preference scheme will apply in procurement. 63 Appendix 5, page 4

ADB has approved advance procurement action and retroactive financing for certain items in the 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 penalties would be imposed for any proven case of corruption during implementation. PMO will make appropriate arrangements for independent inspection and auditing to ensure that the Project has 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 of selected commercial enterprises connected to household production models. These guidelines provide criteria for selecting enterprises. The guidelines seek: (i) consistency with overall project objectives; (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 to agricultural households of the project area of West Henan, with priority given to proposals that utilize the outputs of the Project’s agricultural components. (ii) Priority will be given to proposals that benefit poor households and/or are effective in creating off-farm employment in terms of investment cost per new job and 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 solid wastes. (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, then the following will apply to that enterprise and its principal sponsor, but if it involves the expansion of an existing enterprise, the following will apply to the whole enterprise:

(i) Borrowers must be small and medium-size shareholding enterprises with at least a controlling 51 percent of the shares held by PRC entities that are neither directly 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 the portion of long-term loans due for payment within one year, should not be less than 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 the projected level of full production is achieved. (iv) Sponsors must have a good track record in general, financial, commercial, processing and marketing management. 64 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 Maintenance B. Livestock Development (i) Household Livestock Units Establishment (ii) Livestock Enterprises Establishment (iii) Livestock Maintenance C. Water Supply and Irrigation Development (i) Huaiba Scheme Construction

(ii) Water Supply and Irrigation Distribution System D. Project Management Appendix 6, page 1 65

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 Procurement Mode a I. Water Supply A. Huaiba WSC 1 No. 2 tunnel 0.723 0.340 LCB 2 Access road, Wu Huai 0.453 0.213 FA 3 Access road, Cao Huai #1 0.678 0.319 LCB 4 Access road, Cao Huai #2 0.746 0.351 LCB 5 Power transmission line, 110kV and communication line 0.672 0.538 FA/IS 6 Transmission substations 0.761 0.609 FA/IS 7 Transmission line, 10kV, to reservoir 0.502 0.401 FA/IS 8 Communications system 0.054 0.044 DP 9 Water supply system for construction 0.057 0.027 FA 10 Construction tunnel 0.055 0.026 FA 11 Office building 0.327 0.154 LCB 12 Steel gate, No. 1 intake pumping station 0.308 0.246 IS 13 Pumps (pump stations No 2, 3, 4) 0.281 0.225 IS 14 Electrical equipment/control (pump stations No 2, 3, 4) 0.257 0.206 IS 15 Electrical motors (pump stations 2, 3, 4) 0.440 0.352 IS 16 Special vehicles 0.190 0.158 IS B. Mianchi WDC 1 Auxiliary works (gatehouse, office, 0.215 0.101 LCB garage, fence, gate, access road) C. Yima WDC 1 Auxiliary works (Treatment plant, gate 0.581 0.273 LCB house, dormitory, works outside plant) D. Mianchi Irrigation Co. 1 Office and temporary buildings 0.099 0.047 LCB Subtotal 7.399 4.627 II. Agriculture Enterprises A. Crossbred Pigs 1 Office 0.052 0.014 LCB B. Purebred Pigs 2 Enclosure and road 0.026 0.007 LCB Subtotal 0.078 0.020 III. Agriculture Materials A. Horticulture (small items summary) 3.919 1.763 DP Subtotal 3.919 1.763 TOTAL 11.396 6.411 a. DP = direct purchase, FA = force account/small contract, ICB = international competitive bidding, IS = international shopping, LCB = local competitive bidding. 66 Appendix 6, page 2 Table A6.2: Indicative Procurement Packages beyond Retroactive Financing

Package Amount Procurement ($ million) (Y million) Mode a I. Water Supply A. Huaiba WSC 1 No. 3 tunnel, contract 1 0.624 5.177 LCB 2 No. 3 tunnel, contract 2 0.893 7.413 LCB 3 No. 4 tunnel & No.3 siphon and aqueduct 0.994 8.254 LCB 4 Xiduancun reservoir-dam 5.701 47.321 ICB 5 Discharge tunnel, metal and electrical work 0.992 8.230 LCB 6 Conveyance tunnel and pumping station 0.711 5.898 LCB 7 Excavation and backfill 0.416 3.449 FA 8 Pipe installation 0.779 6.470 LCB 9 Ditch crossing and siphons 0.989 8.212 LCB 10 Steel pipes and installation 0.537 4.455 ICB 11 Concrete pipe and installation 1.271 10.550 LCB 12 Pipe material, steel plate 0.293 2.430 FA 13 Office building 0.435 3.606 LCB 14 Power transmission line 0.665 5.520 IS 15 Equipment (fire prevention, maintenance) 0.474 3.938 DP 16 Special vehicles Huaiba 0.142 1.180 IS Mianchi 0.021 0.176 IS Yima 0.053 0.441 IS B. Mianchi WDC 1 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 FA 4 Water purification equipment 0.315 2.611 IS C. Yima WDC 1 Water treatment plant 1.380 11.458 LCB (2 contracts) 2 Water distribution network 0.979 8.123 LCB 3 Auxiliary works office, misc. 0.189 1.569 LCB 4 Water purification equipment 0.560 4.648 IS/ICB D. Mianchi Irrigation Co. 1 Pumping stations, main and trunk pipes 0.965 8.007 LCB (2 contracts) 2 Metal works 1.504 12.480 ICB 3 Electrical equipment 0.830 6.888 ICB Subtotal 25.826 214.356 II. Agriculture Enterprises A. Crossbred Pigs 1 Civil works 1.024 8.500 LCB 2 Equipment 0.794 6.590 IS/ICB 3 Light truck 0.026 0.214 IS/ICB 4 Livestock, local breeds 1.655 13.737 DP 5 Inputs 0.324 2.688 DP B. Purebred Pigs 1 Civil works 0.908 7.539 LCB 2 Equipment 0.477 3.961 IS/ICB 3 Light truck 0.024 0.200 IS/ICB 4 Livestock, local breeds 0.028 0.231 DP 5 Livestock, foreign breeds 0.072 0.595 IS 6 Inputs 0.664 5.511 DP Subtotal 5.996 49.766 TOTAL 31.822 264.122 a. DP = direct purchase, FA = force account/small contract, ICB = international competitive bidding, IS = international shopping, LCB = local competitive bidding. Appendix 7, page 1 67

FINANCIAL AND ECONOMIC ANALYSES

A. Review of Proposed Horticultural Activities

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

Table A7.1: Horticultural Yields with the Project

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

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

Other Civil Works Planting Goods & Working Crop Labor & Equipment Material Materials Capital Total Apples 484 950 11,730 3,750 2,797 19,711 Gingko 968 950 15,272 2,600 10,456 30,245 Kiwifruit 1,451 17,750 7,728 5,750 12,797 45,476 Dates 484 950 8,625 2,450 2,450 14,959 Eucommia 2,419 950 17,250 3,975 14,828 39,421 Ratoon Eucommia 3,225 3,450 2,575 885 10,135 Plantation Simple 840 8,150 1,600 677 11,267 Greenhouse Standard 1,590 20,450 1,600 1,549 26,689 Greenhouse Field 1,650 22,500 450 8,856 33,456 Vegetables

2. Summary of results. At full development (9-10 years from the start of the Project), the proposed horticultural plantings have the potential to achieve sooner than would otherwise be possible in the project area an additional annual production of 38,400 tons (t) of early-maturing Appendix 7, page 2 68 apples, approximately 1,140 t of ginkgo fruit, 30,000 t of kiwifruit, 4,200 t of Chinese dates, an average 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) to about 17 percent (for apples and dates) to 20 percent (for greenhouses). Estimated benefits per household are summarized in Table A7.3. The sensitivity of these base results to adverse changes in output prices, operating costs, investment costs, and delays in benefits is presented in Table A7.4.

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

5. In economic terms, the proposed activities produce satisfactory returns, although these returns 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, and eucommia are calculated to be about 14 percent each. At 27 percent, dates have a relatively high economic return primarily because, in the farm model, production and land taxes represent a high share of the financial costs of production. Following grafting, the maintenance input and labor costs of a stand are low compared with those for other tree crops. Greenhouse and field vegetable production generate economic returns approaching 26 and 22 percent. Farmers can, of course, reduce the risks pertaining to revenues derived from horticulture by diversifying their tree crop holdings. Households participating in field vegetable development may also secure seasonal stability in revenues by negotiating purchase contracts with vegetable processing enterprises.

Table A7.3: Estimated Household Benefits from Horticulture

Area/ Average Total Average Total House- Total Net Net Net Gross Gross Gross Horticulture Area hold hh Income Income Income Income Income Income Crop (ha) (ha/hh) (‘000) (Y/ha)a (Y/hh) (Y’000) (Y/ha)b (Y/hh) (Y’000) Apples 3,200 0.20 16.0 7,793 1,559 24,936 10,485 2,097 33,553 Gingko 1,900 0.07 28.5 11,174 745 21,231 7,694 513 14,619 Kiwifruit 1,400 0.20 7.0 23,392 4,678 32,748 26,842 5,368 37,578 Eucommia 600 0.20 3.0 10,807 2,161 6,484 7,926 1,585 4,755 Chinese date 1,200 0.20 6.0 2,384 477 2,861 6,678 1,336 8,014 Greenhouses 167 0.03 5.0 102,209 3,407 17,035 223,709 7,457 37,285 Field 2,800 0.07 42.0 3,977 265 11,136 18,227 1,215 51,036 Vegetables Huaiba 1,300 0.20 6.5 7,793 1,559 10,130 10,485 2,097 13,631 Orchard TOTAL 12,567 114 126,562 200,472 Weighted Av. 10,071 1,110 15,953 1,759 Horticulture Weighted Av. 10,241 1,469 11,682 1,674 Tree Crops Weighted Av. 9,496 599 29,771 1,879 Vegetables hh = households. a Full development incremental gross margin after imputing labor costs. b Incremental gross margin after taxes and before imputing labor costs. Appendix 7, page 3 69

Table A7.4: Sensitivity of Returns to Horticulturea

Apple Gingko Kiwi- Chinese Green- Field Whole fruit Date Eucommia houses Veg. Component Financial Analysis 1. Base case IRR 17.2% 15.1% 16.2% 17.2% 18.4% 20.3% 14.4% 16.7% Yuan ‘000 NPV 14,879 18,941 32,352 3,143 5,200 34,041 10,453 119,008 2. Output IRR 13.9% 11.4% 12.5% 6.4% 12.1% 15.9% 3.5% 12.0% prices – 10 NPV 9,387 8,338 17,222 -430 2,089 24,655 -5,917 55,344 percent SV -27.1% -17.8% -21.4% -8.8% -16.6% -36.1% -6.4% -18.7% 3. Operating IRR 16.3% 14.7% 15.4% 9.6% 16.9% 17.4% 5.0% 14.4% costs + 10 NPV 12,630 18,422 29,385 462 4,532 28,235 -4,102 89,564 percent SV 66.3% 360.8% 110.1% 11.7% 76.9% 58.5% 7.2% 40.4% 4. Investment IRR 15.8% 14.6% 15.7% 15.7% 17.6% 18.3% 13.1% 15.7% costs + 10 NPV 13,300 18,230 31,482 2,858 5,001 31,708 9,140 111,719 percent SV 93.8% 265.7% 368.0% 110.4% 259.9% 144.1% 79.2% 162.1% 5. Delay of 1 IRR 14.6% 14.0% 14.4% 4.6% 19.1% 12.7% 7.3% 12.4% year NPV 11,252 16,740 26,812 -2,004 5,502 19,872 -2,074 76,100 Economic Analysis 1. Base case IRR 14.6% 14.7% 16.8% 27.1% 14.5% 25.9% 21.9% 18.1% Yuan ‘000 NPV 3,572 5,822 15,047 3,938 1,311 17,433 12,487 59,610 2. Output IRR 10.8% 10.9% 5.6% 16.3% 9.5% 19.6% 11.4% 11.0% prices – 10 NPV -1,578 -2,310 -13,827 1,056 -1,480 10,222 -800 -8,717 percent SV -7.2% -7.4% -5.2% -13.7% -4.5% -24.2% -9.4% -8.7% 3. Operating IRR 13.0% 13.7% 16.1% 18.9% 15.2% 21.5% 13.5% 15.5% costs + 10 NPV 1,282 3,569 12,644 1,751 1,651 12,195 1,855 34,946 percent SV 15.9% 26.3% 63.1% 19.1% -37.9% 33.3% 11.8% 24.2% 4. Investment IRR 14.1% 14.3% 16.4% 24.8% 14.0% 22.8% 20.1% 17.1% costs + 10 NPV 2,979 5,080 14,106 3,637 1,089 14,599 11,081 52,572 percent SV 59.9% 77.3% 155.7% 130.1% 58.9% 61.5% 88.2% 84.6% 5. Delay of 1 IRR 12.5% 13.9% 15.1% 13.8% 15.0% 15.3% 11.2% 13.8% year NPV 635 4,118 9,851 850 1,481 6,455 -1,749 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 in raising cattle, and 2,000 in raising porkers. The budgets for livestock activities have incorporated the costs of annual animal mortality (and replacement outside normal culling) that should be expected for households that are new to the activities (or new to the demands of meeting certain levels of product quality), and that should be expected even in the presence of excellent veterinary care. Table A7.5 summarizes the estimated investment cost per household for each activity.

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

Civil Works Breeding Other Goods Working Livestock Labor & Equipment Animals & Materials Capital Total Meat Goats 150 800 3,000 60 1,025 5,035 Sheep 150 800 3,000 60 1,116 5,126 Cattle 225 2,206 4,000 380 3,018 9,829 Pigs 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 and about 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 70 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 to purchase crossbred pigs for raising porkers. These households will produce about 68,000 animals annually. The local markets will absorb all annual meat production. Table A7.6 shows estimated benefits per household, by activity.

8. The base FIRRs for meat goats, sheep, cattle, and pig raising investments are estimated to be about 18, 21, 17, and 20 percent, respectively. Together, these activities generate a return of about 18 percent (Table A7.7). The meat goats, sheep, and cattle raising investments indicate relatively moderate risk. The porker production entails greater risk, which is mitigated by the company + household model, where the enterprise guarantees minimum protection prices. Household porker production also operates on a rather narrow margin. At full development, operating costs represent approximately 93 percent of the value of sales, chiefly due 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, beef production by households in the PRC may be marginally profitable in areas with inadequate feed supply. For the selected communities in Henan, with access to productive grassland, raising cattle should provide adequate financial returns. Households can also manage risks by raising different types of livestock.

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

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

Total Net Total Net Gross Gross Animals/ Total Income Income Income Income Livestock Head household Households (Y/hh)a (Y’000) (Y/hh)b (Y’000) Cattle 19,000 2 9,500 1,522 14,457 2,422 23,007 Sheep/Goats 144,000 10 14,400 926 13,330 1,646 23,698 Pigs 4,000 2 2,000 1,818 3,636 2,328 4,656 TOTAL 167,000 25,900 1,213 31,423 1,983 51,361 a 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 household activity. The calculations are based on the incremental cash flows implied by the presented activity budgets, assuming that household borrowing through the Project has a nominal interest rate 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 be deferred and capitalized into total amounts of debt held, financing for operations are part of long-term debt, and households self-finance the next period’s input costs from the current period’s retained earnings as soon as it is feasible. 71 Appendix 7, page 5

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

Whole Pigs Goats Sheep Cattle Component Financial Analysis Base Case IRR 20.1% 18.4% 20.7% 17.1% 18.4% Yuan ‘000 NPV 4,991 7,860 10,190 17,514 40,556 Output Prices – 10 percent IRR -3.9% 9.9% 11.7% 11.5% 9.4% NPV -5,531 1,501 3,029 6,606 5,605 SV -4.7% -12.3% -14.2% -16.1% -11.6% Operating Costs + 10 percent IRR -2.1% 11.6% 13.5% 12.9% 11.1% NPV -4,700 2,837 4,598 9,590 12,326 SV 5.1% 15.6% 18.2% 21.9% 14.4% Investment Costs + 10 percent IRR 18.3% 16.9% 19.1% 15.8% 17.0% NPV 4,659 7,310 9,640 16,281 37,890 SV 148.6% 141.7% 184.9% 141.2% 150.7% Delay of 1 Year IRR 5.9% 10.4% 11.4% 11.5% 10.2% NPV -2,803 3,149 4,886 10,061 15,293 Economic Analysis Base Case IRR 15.5% 20.8% 23.1% 19.3% 19.9% Yuan ‘000 NPV 1,116 4,418 5,931 9,542 21,006 Output Prices – 10 percent IRR -5.1% 10.9% 12.6% 12.8% 9.6% NPV -7,183 -575 323 1,076 -6,359 SV -1.3% -8.8% -10.6% -11.3% -7.6% Operating Costs + 10 percent IRR -4.0% 12.9% 14.8% 14.6% 11.5% NPV -6,714 465 1,515 3,358 -1,375 SV 1.4% 11.2% 13.4% 15.5% 9.4% Investment Costs + 10 percent IRR 14.2% 19.0% 21.1% 17.8% 18.3% NPV 759 3,819 5,332 8,214 18,123 SV 30.5% 73.5% 97.7% 71.7% 72.6% Delay of 1 Year IRR 4.7% 11.0% 11.9% 12.4% 10.4% NPV -7,776 -932 -77 710 -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 grainas is the case for gingko, kiwifruit and eucommiaand there is loss of income in the period prior to the maturity of a tree crop, the calculations for total household debt financing and cash flows have considered amounts of credit for financing operating expenses that would keep the welfare of households about the same as without the Project. The scheduling of repayments for these investment loans are worked out with the assumption that household borrowings for operating expenses in the period prior to a sufficient tree crop harvest are such as to allow households, in the absence of adequate savings, to avoid becoming temporarily poorer while participating in the Project.

13. Of the horticultural activities, apples, Chinese dates, ratooned eucommia, greenhouses and field vegetables appear to be best able to accommodate repayment of credits within seven years, or less, including two to three years grace. Apple financing appears feasible with three years grace and a repayment period of four years. Eucommia development with ratooning could sustain repayment within four years following three years’ grace. The grafting of Chinese dates could be financed with repayments over three years following two years’ grace. The greenhouses and field vegetables should repay credits within three to four years, including two years grace. Kiwifruit and gingko development, however, appear difficult to finance within comparable periods of time due to the relatively long periods before maturity. One way to improve the situation is to have households contribute more cash for the investments, but this could conflict with the Project’s poverty reduction objectives. The preferred response is to accord considerable flexibility in the amount and scheduling of credit repayments for these investments, as provided under the Project. Alternatively, some grant financing from local sources might be available. Appendix 7, page 6 72

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

D. Review of Enterprises

15. Apart from the Huaiba water supply companies (see next section), the Project would partially finance the investments of two livestock enterprises: a crossbred piggery and a purebred piggery. One piggery, located at Jiyuan, would produce crossbred pigs for breeding porkers. 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 crossbred piggery and purebred piggery investments are estimated at 22 and 13 percent. The corresponding EIRRs for these activities are estimated at 25 and 15 percent. In aggregate, the estimated base FIRR for the three livestock enterprise investments is about 19 percent. Their aggregate base EIRR is estimated at about 22 percent.

17. Purebred pig breeding, with an FIRR of about 13 percent, can provide a satisfactory financial return – provided that consistently efficient management and quality control can be implemented. The returns to the crossbreeding piggery investment can be more easily accommodated than those for the purebred breeding unit. A reduction in revenues of 10 percent drops the base FIRR to about 11 percent, while the EIRR would decline from 25 to about 16 percent. In contrast to the purebred piggery these returns hold up well under other combinations of varied costs and income. As there is substantial cross shareholding in these enterprises, the overall result for the whole component is more significant and shows a robust result (Table A7.8).

Table A7.8: Sensitivity of Returns to Livestock Enterprisesa

Financial Analysis Economic Analysis Item Crossbred Purebred Whole Crossbred Purebred Whole Piggery Piggery Component Piggery Piggery Component

1. Base case IRR 21.7% 13.0% 18.6% 25.0% 15.1% 21.8% Yuan ‘000 NPV 23,502 1,231 24,733 29,609 3,248 32,856 2. Output prices IRR 10.9% 5.4% 9.0% 16.2% 7.6% 13.5% – 10 percent NPV -2,324 -7,508 -9,832 9,080 -4,221 4,859 SV -12.3% -6.9% -10.9% -14.4% -9.4% -15.9% 3. Operating IRR 13.3% 7.2% 11.2% 18.4% 9.4% 15.6% costs + 10 NPV 2,858 -5,767 -2,909 14,311 -2,590 11,721 percent SV 15.3% 8.6% 13.7% 19.3% 5.7% 15.5% 4. Investment IRR 19.9% 11.7% 17.1% 23.2% 13.7% 20.1% costs + 10 NPV 20,671 -387 20,284 27,339 1,942 29,281 percent SV 153.2% 50.8% 116.6% 130.1% 24.7% 91.4% 5. Delay of 1 IRR 10.4% 6.9% 9.3% 13.7% 8.3% 12.1% Year NPV -6,297 -8,852 -15,149 5,922 -5,370 552 a 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). Appendix 7, page 7 73

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 the conveyance system will be constructed to allow for the proposed expansion of the water supply in Phase 2 to 7 m3/s. The base case evaluation reviewed here does not incorporate any benefits of this second phase of construction. The evaluation reflects estimated losses of 5 percent in the 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 and provincial 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, 30 l/person/day for general urban public use, 75 l/person/day for rural domestic users, and 50 l/animal/day for rural livestock. Consumption levels are expected to reach these averages within five years after water supplies are made available. Industrial demand in 2001 is based on existing enterprises plus identified industries either planned or now under construction. The total annual demand is expected to exceed supply by 10 percent in 2001. As there will be excess demand, the evaluation assumes that all nonindustrial water demands will be met before any industrial demands: i.e., all of the excess demand will be industrial.

20. The analysis calculates a return to irrigation development based on the establishment of 1,300 ha of orchards following the expansion of water supplies. To approximate the net benefits of horticultural development of this area, the analysis assumes plantings of kiwifruit as a representative crop.

21. The financial analysis uses revised investment costs and cost estimates for resettlement works. Using tariff information provided by the Sanmenxia authorities, the FIRR for the proposed investment in the Sanmenxia Water Supply Company is about 11 percent. The FIRRs for investments in the Mianchi and Yima Water Distribution Companies are estimated at 12 and 8 percent, respectively. The overall FIRR for the development of water supplies is about 11 percent. At approximately 14 percent, the returns to orchard development are comparable with those to the horticulture component. The overall FIRR for the water supply component is estimated at just under 12 percent.

22. Table A7.9 summarizes the results of sensitivity analysis for this component. The Yima Water Distribution Company has lower returns and greater sensitivity than the Mianchi Water Distribution Company due to the priority given to nonindustrial uses and Mianchi’s faster population growth. The second phase development, however, should improve Yima’s performance. Appendix 7, page 8 74

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

San- Mianchi Yima Total Mianchi Total Whole menxia Water Water Water Irrigation Water & Irrigated Comp- Water Supply Supply Supply Company Irrigation Orchard onent Financial Analysis Base case IRR 10.6% 11.9% 8.0% 10.6% 9.4% 10.6% 14.5% 11.7% (Y’000) NPV 75,177 2,417 -17 77,577 508 78,085 80,813 158,898 Output IRR 8.4% 8.0% 1.9% 8.3% 7.6% 8.3% 13.5% 9.7% prices – 10 NPV 10,791 -16 -3,161 7,614 -156 7,458 63,752 71,210 percent SV -11.7% -9.9% 0.0% -11.0% -7.8% -11.0% -44.3% -18.0% Operating IRR 8.5% N/A N/A 5.1% N/A 4.9% 13.7% 7.8% costs + 10 NPV 13,541 -31,008 -56,223 -73,690 -6,346 -80,035 70,344 -9,692 percent SV 12.2% 1.0% 0.0% 5.3% 0.7% 5.1% 77.4% 9.3% Investment IRR 9.5% 10.5% 6.5% 9.4% 8.2% 9.4% 13.9% 10.7% Costs + 10 NPV 45,318 1,667 -1,018 45,968 75 46,042 76,149 122,192 percent SV 25.0% 31.7% 0.0% 24.4% 10.8% 24.2% 173.0% 43.2% Delay of 1 IRR 9.3% 9.2% 5.2% 9.2% 7.8% 9.2% 14.5% 10.6% Year NPV 38,427 833 -1,992 37,268 -100 37,168 80,813 117,981 Economic Analysis Base Case IRR 16.1% 22.4% 17.2% 16.2% 17.1% 16.2% 15.3% 16.0% Y ‘000 NPV 71,489 4,417 2,301 78,207 1,346 79,553 26,384 105,938 Output IRR 11.8% 15.0% 6.4% 11.8% 14.3% 11.9% 13.1% 12.2% Prices – 10 NPV -2,449 1,180 -1,873 -3,142 598 -2,545 8,261 5,716 percent SV -9.6% -13.6% -5.5% -9.6% -18.0% -9.6% -14.5% -10.5% Operating IRR 13.5% N/A N/A 9.6% N/A 9.3% 14.4% 11.0% Costs + 10 NPV 25,900 -22,675 -41,691 -38,466 -5,883 -44,349 18,897 -25,452 percent SV 16.0% 1.6% 0.5% 6.7% 1.9% 6.4% 35.3% 8.0% Investment IRR 14.7% 20.3% 15.1% 14.8% 15.5% 14.8% 14.7% 14.8% Costs + 10 NPV 50,074 3,816 1,500 55,390 998 56,388 22,745 79,133 percent SV 32.8% 73.3% 28.4% 33.7% 38.7% 33.7% 71.8% 38.3% Delay of 1 IRR 13.9% 17.0% 11.9% 13.9% 13.5% 13.9% 15.3% 14.3% Year NPV 35,358 2,519 -39 37,838 468 38,306 26,384 64,690 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). N/A indicates that the IRR cannot be calculated.

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

24. The estimated base EIRRs for the water companies should be regarded as lower bounds as the economic value of the water supplied in the analysis was assumed to be no less than its total financial value, which is related to the cost of its supply. In the future without the Project, 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 is therefore likely to be much higher than presented here. Sensitivity results, based on a conservative economic value of water, suggest that the economic viability of the water supply scheme is assured.

F. Overall Project Performance

25. The base FIRR for the entire Project is estimated at about 14 percent. Component FIRRs range from 12 percent to about 19 percent. The corresponding EIRR for the Project is Appendix 7, page 9 75 estimated at about 17 percent, with a range in returns to subcomponents similar to those calculated for the financial analysis. Sensitivity analysis (Table A7.10) shows that the Project in aggregate is moderately sensitive to adverse changes in output values and operating costs, with livestock among the most sensitive. The Project, however, has a large number of subcomponents, covering a wide range of products. This diversity should reduce the probability of simultaneous adverse price and cost movements that would jeopardize the overall economic viability of the Project.

Table A7.10: Sensitivity of Total Project Returnsa

Operating Investment Item Base Case Output -10% Costs +10% Costs +10% 1 Year Delay Financial IRR 13.9% 10.2% 9.8% 12.7% 10.9% NPV 372,427 136,656 106,716 321,142 219,365 SV - -15.9% 13.1% 39.2% - Economic IRR 17.3% 11.9% 12.5% 16.0% 13.5% NPV 219,410 -4,500 19,839 179,109 78,809 SV - -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).