Report and Recommendation of the President to the Board of Directors Project Number: 38662 November 2009 Proposed Loan and Administration of Grants People’s Republic of China: Shanxi Integrated Agricultural Development Project CURRENCY EQUIVALENTS (as of 15 November 2009) Currency Unit – yuan (CNY) CNY1.00 = $0.1465 $1.00 = CNY6.8263 ABBREVIATIONS ACWF – All China Women's Federation ADB – Asian Development Bank CFB – county finance bureau ChinaGAP – China good agriculture practices EIRR – economic internal rate of return FIRR – financial internal rate of return GDCF – Gender and Development Cooperation Fund IPM – integrated pest management MFB – municipal finance bureau MOF – Ministry of Finance PADO – Poverty Alleviation and Development Office PCR – project completion report PIU – project implementation unit PMO – project management office PPMS – project performance management system PRC – People’s Republic of China RCC – rural credit cooperative SFD – Shanxi Finance Department SPG – Shanxi provincial government TFS – township finance station TSA – technical support agency WRB – water resources bureau WACC – weighted average cost of capital WFPF – Water Financing Partnership Facility WEIGHTS AND MEASURES ha – hectare km2 – square kilometer m3 – cubic meter mu – Chinese unit of land (1 mu = 667 m2 or 15 mu = 1 ha) NOTES (i) The fiscal year (FY) of the Government and its agencies ends on 31 December. (ii) In this report, "$" refers to US dollars. Vice President C. Lawrence Greenwood, Jr., Operations 2 Director General K. Gerhaeusser, East Asia Department (EARD) Director K. Kannan, Agriculture, Environment, and Natural Resources Division, EARD Team leader A. Siddiq, Principal Natural Resources Economist, EARD Team members L. Medina, Project Officer, EARD X. Peng, Lead Professional (Counsel), Office of the General Counsel F. Radstake, Environment Specialist, EARD M. Vorpahl, Social Development Specialist, EARD F. Wang, Financial Management Officer, PRC Resident Mission, EARD M. Watanabe, Young Professional, EARD H. Wilkinson, Senior Finance Specialist (Microfinance), EARD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area. CONTENTS Page LOAN AND PROJECT SUMMARY i MAP I. THE PROPOSAL 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Performance Indicators and Analysis 1 B. Analysis of Key Problems and Opportunities 2 III. THE PROPOSED PROJECT 8 A. Impact and Outcome 8 B. Outputs 8 C. Special Features 13 D. Project Investment Plan 14 E. Financing Plan 14 F. Implementation Arrangements 16 IV. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 20 A. Farm Investments and Incomes 20 B. Financial Analysis of Agro-Enterprises 20 C. Economic Benefits 21 D. Environmental Benefits and Impacts 21 E. Employment Generation 21 F. Poverty Impact 22 G. Gender and Development 22 H. Resettlement 23 I. Risks and Mitigation Measures 23 V. ASSURANCES 23 VI. RECOMMENDATION 24 APPENDIXES 1. Design and Monitoring Framework 25 2. Sector Analysis 29 3. External Assistance 33 4. Criteria to Select Project Counties, Sites, and Activities 34 5. Distribution of Project Activities by Municipalities and Counties 36 6. Eligibility Criteria for Participating Agro-Enterprises 38 7. Climate Change Adaptation through Groundwater Management 39 8. Women's Economic Empowerment Pilot Project 40 9. Detailed Cost Estimates 41 10. Flow of Funds 42 11. Implementation Schedule 44 12. Procurement Plan 45 13. Summary of Consulting Services 49 14. Financial and Economic Analyses 50 15. Environmental Analysis 57 16. Summary Poverty Reduction and Social Strategy 60 17. Gender Action Plan 62 SUPPLEMENTARY APPENDIXES (available on request) A. Shanxi Agriculture Sector Analysis B. Farm Investment and Income Analysis C. Past Experience and Lessons D. Financial Due Diligence of Participating Agro-Enterprises E. Climate Change Adaptation through Groundwater Management F. Women's Economic Empowerment Pilot Project G. Institutional Analysis H. Detailed Description of Project Components and Activities I. Financial Management Assessment of Executing and Implementing Agencies J. Detailed Economic Analysis K. Summary Initial Environmental Examination L. Environmental Due Diligence of Participating Agro-Enterprises LOAN AND PROJECT SUMMARY Borrower People's Republic of China (PRC) Classification Targeting classification: Targeted intervention—household Sector (subsector): Agriculture and natural resources (agricultural production and markets) Themes (subthemes): Environmental sustainability (natural resources conservation, climate change adaptation), economic growth (promoting economic efficiency and enabling business environment), private sector development (public–private partnerships, gender equity) Environment Assessment Category B. An initial environmental examination was undertaken. Project The Project will provide credit and training to about 66,000 farm Description households in 26 counties of five municipalities in central and southern Shanxi. Of these, 11 are poverty counties and 12 are on the priority list for treatment of accelerated soil erosion in the PRC. The Project comprises four components (i) transition to high-value farm production by adopting technologies and practices that ensure environmental sustainability and increase farm income; (ii) strengthening of farm–market linkages by supporting on-farm and industrial agroprocessing and marketing of high-value products; (iii) capacity-building and training of farmers, farmer associations, and technical support agencies to support high-value production and processing of farm products; and (iv) project management to support efficient project implementation. To keep project implementation manageable, each participating county will take up two of the three activities in the first component—perennial crops, annual crops, and livestock. Structured criteria were used to select project counties, sites, and activities. Most project counties have a variety of marketing channels with varying degrees of efficiency. Under the Project, the participating farmers will make the transition to high-value production systems and connect to the value chain for the first time. By involving 24 agro-enterprises, the Project will support beneficiary households to establish production bases, expand their on-farm processing capacity, and connect with agro- enterprises through formal contractual arrangements. Participating agro- enterprises will provide subloan guarantees to contracted farmers. To minimize postharvest losses and improve storage-life, the Project will support on-farm processing and farmer-managed drying rooms. Five agro-enterprises will receive credit to increase storage capacity and processing operations. The Project will build the capacity of farmers, their associations, and staff of technical support agencies (TSAs) to adopt high-value and environmentally sustainable production systems that will increase farmer incomes and farm productivity, and improve food safety and quality. ADB's Multi-Donor Trust Fund under the Water Financing Partnership Facility (WFPF) and the Gender and Development Cooperation Fund (GDCF) will provide grants to pilot-test creative interventions. The WFPF- funded activities will demonstrate the viability of more productive and ii efficient irrigation techniques, and support farmers to adapt to climate change impacts. Poor farmers will be provided with subsidies to adopt water-saving technologies to showcase the efficiency and economic benefits of such interventions. Skills training will help farmers reduce dependence on increasingly scarce water resources. The GDCF grant will facilitate women’s economic empowerment by (i) setting up a revolving fund for microfinance; (ii) organizing self-help groups linked to existing farmer associations to access markets; (iii) providing training on technical, marketing, alternative income-generation activities, and leadership; and (iv) building capacity to ensure sustainability of these activities. Rationale Shanxi has only about 3.8 million hectares of dependable arable land—of modest quality and productivity—for its 23 million rural population. Low rainfall, high evaporation, frequent natural disasters, and soil erosion lead to instability in agricultural production. After about 30 years of reforms, the agricultural service system, farmers' technical capacity, and women’s economic participation have improved. However, the nature of extensive and scattered small-scale agriculture has not changed significantly. Most farmers continue to practice traditional agriculture mainly growing wheat and maize that generate low incomes and require extensive use of water and agrochemicals. Similarly, the patterns of free-range livestock grazing and untreated disposal of animal waste adds to soil and water pollution. This agricultural system is unsustainable and damaging to the environment, and keeps most farmers in poverty. Most farmers also remain largely unorganized and cannot take full advantage of market and rural finance opportunities. In addition, women’s participation remains marginal, and their social and economic rights are usually ignored. One of the main constraints to converting traditional farming to high-value farming is access to formal credit. The agricultural lending institutions have (i) a limited range