Report and Recommendation of the President to the Board of Directors ______________________________________________________________________________ Project Number: 40684 March 2011 Proposed Loan and Administration of Grant People's Republic of China: Forestry and Ecological Restoration Project in Three Northwest Provinces CURRENCY EQUIVALENTS (as of 2 March 2011) Currency Unit – yuan (CNY) CNY1.00 = $0.152 $1.00 = CNY6.57 ABBREVIATIONS ADB – Asian Development Bank FIRR – financial internal rate of return GEF – Global Environment Facility IEM – integrated ecosystem management PRC – People’s Republic of China SFF – state forest farm WEIGHTS AND MEASURES ha – hectare km2 – square kilometer m3 – cubic meter t – ton NOTES (i) The fiscal year (FY) of the government and its agencies ends on 31 December. (ii) In this report, "$" refers to US dollars. Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General K. Gerhaeusser, East Asia Department (EARD) Team leader R. Renfro, Officer-in-Charge, Environment, Natural Resources, and Agriculture Division/Lead Natural Resources Economist, EARD Team members L. Medina, Project Officer, EARD R. O'Sullivan, Principal Counsel, Office of the General Counsel F. Radstake, Senior Environment Specialist, EARD A. San Pedro, Associate Project Analyst, EARD M. Vorpahl, Social Development Specialist, 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 PROJECT AT A GLANCE I. THE PROPOSAL 1 II. THE PROJECT 1 A. Rationale 1 B. Impact and Outcome 4 C. Outputs 4 D. Investment and Financing Plans 5 E. Implementation Arrangements 7 III. DUE DILIGENCE 8 A. Economic and Financial 8 B. Governance 8 C. Poverty and Social 8 D. Safeguards 9 E. Risks and Mitigation Measures 9 IV. ASSURANCES 10 V. RECOMMENDATION 10 APPENDIXES 1. Design and Monitoring Framework 11 2. List of Linked Documents 14 I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on (i) a proposed loan, and (ii) a proposed administration of a grant to be provided by the Global Environment Facility (GEF), both to the People’s Republic of China (PRC) for the Forestry and Ecological Restoration Project in Three Northwest Provinces. The design and monitoring framework is in Appendix 1. 2. To support the national and provincial government development policies and plans, the project will help the State Forestry Administration (SFA); and the Gansu and Shaanxi provinces, and the Xinjiang Uygur Autonomous Region (Xinjiang) improve the productivity of the forestry sector, demonstrate an integrated ecosystem management (IEM) forest-development approach, and introduce forest carbon-sequestration and climate change-mitigation measures. The Asian Development Bank (ADB) provided project preparatory technical assistance ($800,000, approved in December 2007).1 Key outputs of the project will include (i) economic tree crop development on about 38,000 hectares (ha) of barren and low-yielding forest lands that will benefit about 207,000 households; (ii) ecological or natural forestry development on about 300,000 ha, including replanting of about 4,700 ha; and (iii) project management support. II. THE PROJECT A. Rationale 3. The rapid development of the PRC through agricultural expansion, industrialization, and urbanization is attributed to the initial impetus from land reforms and the resulting increase in agriculture output and productivity. As the rural economy transitioned from the centrally planned collective and commune systems to market-based management with price and profit incentives and improved property rights, infrastructure and financial services significantly raised income levels and reduced poverty. Rural poverty still persists for a range of reasons, including the small fragmented nature of land plots and the significant influence of the forest sector and the forest lands under its purview. Forest resource management was transferred from the private sector into collectives during 1950–1956, and from 1988 there has been an ongoing movement toward increased integration with market-based decision making through the allocation of forest user certificates to contracted households. 4. The total forest area in the PRC is about 175 million ha and it supports a standing tree stock volume of about 13.6 billion cubic meters (m3). On a per capita basis, the PRC falls far below international standards, with a per capita forest area of about 0.13 ha compared with the international average of about 0.65 ha per capita. The standing stock volume of 10 m3 per capita compares to a global average of 66 m3. The PRC is a net importer of timber products. Land classified as forest land accounts for 285 million ha; however, only 60% or 169 million ha is forested. Forest land is typically of three types in the PRC: (i) ecological or natural forests, (ii) timber plantations, and (iii) economic tree crops comprising fruit and nut orchards. Of the forest land, 115.8 million ha (66%) is natural forest and 53.3 million ha (34%) is plantation forestry (timber and economic tree crops). The extent of forest located on nonforest land is only 6 million ha. The area of degraded and barren forest land totals about 116 million ha and has mostly been left out of the modernization of the rural PRC that focused on agricultural land. Within the western PRC, most of this land still supports traditional low-yielding and low-value cropping systems built around wheat and corn rotations, or is steep gully sidings and desert periphery that are barren or wastelands. The scale of the forest sector has continued to grow, with the 1 ADB. 2007. Technical Assistance to the People’s Republic of China for Preparing the Silk Road Ecosystem Restoration Project. Manila. 2 forest cover increasing from less than 9% in 1949 to about 18% in 2007. This growth in forest cover has averaged about 4 million ha per year since 2000 and is in direct contrast with the global average of progressive forest cover loss, amounting to nearly 7.3 million ha per year over the same period. However, this impressive expansion of forest cover does not reveal the current low quality of forest structure, including the thin forest density and lack of biodiversity in the PRC forests. The sector target for forest cover is expected to reach 20% by 2010 with a further increase to 23% by 2020, requiring an additional 29 million ha to be forested during the project period through 2020. The project will contribute less than 1% of the proposed policy target. Within the rural landscape, the forestry sector has lagged behind in reforms and has been slow to respond to market-oriented policy priorities. Policy analyses demonstrate the need for reform with basically two categories of issues: (i) management of publicly owned forests, and (ii) the role of government in guiding managers of privately operated forest land and forest enterprises to support sector growth. 5. The drylands of the western PRC cover about 40% of the country and contain some of the most severely degraded land in the world. The proposed project area covers about 165,000 square kilometers (km2), incorporating 18 districts and 55 counties selected from some of the worst-affected and poorer parts of Gansu, Shaanxi, and Xinjiang. This area includes three distinct ecological zones: the loess plateau, the central mountain region, and the oases in Xinjiang. The ancient Silk Road ran through this area, starting near Xian and running northwest through Gansu and Xinjiang. The loess plateau in the PRC is characterized by fine, wind-blown soil that is very deep (up to about 200 meters in places) and highly prone to erosion. Much of the area of eastern Gansu and Shaanxi lies on the loess plateau. Agriculture is predominantly rain fed, producing relatively low-value and low-yielding annual crops, such as wheat and corn. The central mountain region includes the Qian mountains in Xinjiang, the Qilian mountains in Gansu, and the Qinling mountains in Shaanxi. It contains several nature and forest reserves that provide important habitats for endangered and protected species. The third zone, the desert oases in Xinjiang, is home to the majority of rural people and agricultural activities, but makes up only 4% of Xinjiang’s territory. The oases require irrigation for agriculture and their desert climate features harsh winters and summers of extreme heat and high winds. To improve economic prospects and living conditions in this region, the establishment of shelter belts to prevent the shifting of the desert sands, and the construction of water management infrastructure (e.g., canals, wells, and high-efficiency irrigation), are vital. Oasis farming of grapes, melons, cotton, and wheat forms the core of local agricultural activities. 6. Between 1980 and 2006, the combined population of Gansu, Shaanxi, and Xinjiang increased from about 60 million to about 84 million, or by about 40%. The population of ethnic minorities therein grew from about 9.2 million to about 15.2 million, or by about 65%, over the same period. Land degradation is a critical environmental problem in all three project areas, seriously affecting about 274,600 km2 of land in Gansu (about 65% of its total area), about 30,000 km2 in Shaanxi (about 14.5% of its province), and about 1.1 million km2 of Xinjiang (about 64% of its total area). The economic cost of land degradation is estimated at about CNY3.1 billion in Gansu (about 15.9% of provincial gross domestic product), and about CNY11.6 billion in Shaanxi (about 3.6% of provincial gross domestic product). About 64% of the population in the three provinces lives in rural areas. In 2006, the average annual urban income in the project area was CNY9,103 ($1,097 equivalent), while the average annual per capita rural income was only CNY2,377 ($286), less than the poverty line defined as $1.25 per day.