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RESTRICTEDFILE COPY Report No. P-688This report was prepared for use within the Bank and its affiliated organizations.They do not accept responsibility for its accuracy or completeness. The report maynot be published nor may it be quoted as representing their views.INTERNATIONAL BANK POR RECONSTRUCTION AND DEVELOPMENTREPORT AND RECOMMENDATIONOF THEPRESIDENTTO THE.EXECUTIVE DIRECTORSON APROPOSED LOANTO THEUNION. OF LAND IMPROVEMENTASSOCIATIONSFOR ANIRRIGATION PROJECTWITH THE GUARANTEE OF THEREPUBLIC OF KOREAApril 17, 1969Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedREPORT AND RECOMNDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORSON A PROPOSED LOAN TO THE UNION OF LAND IMPROVEMENTASSOCIATIONS (ULIA) WITH THE GUARhNTEE OFTHE REPUBLIC OF KOREA1. I submit the following report and recommendation on a proposedloan in an amount in various currencies equivalent to $45 million to theUnion of Land Improvement Associations (ULIA), to be guaranteed by theRepublic ol Korea.PART I - HISTORICAL2. One of the main objectives of Korea's Second Five Year Plan(1967-71) is to achieve self-sufficiency in foodgrains. Grain importsconstitute a heavy drain on the country's foreign exchange which it canill afford. There is practically no new land which can be put underpaddy cultivation so increased production can be achieved only throughmore intensive use of scarce arable land.3. Following a request from the Minister of Agriculture andForestry for assistance in preparing an irrigation project, intensivestudies iwere undertaken by preliminary IBRD/FAO missions. The projectwas appraised in September/October 1968. The Pyongtaek and Kumgangirrigation schemes are part of the Government's All Weather FarmingProgram for the expansion and rehabilitation of irrigation facilitieswhich aims at increasing fully irrigated paddy land from the present60 percent to 85 percent of the total cultivable area of the countryby 1976.4. Niiegotiations for the proposed loan were held in Washingtonfrom February 14 to 19, 1969. The Borrower, the ULIA, was representedby Yr. E.J. Lim. Mr. B.S. Hann from the Ministry of Agriculture andForestry and Mr. S.Y. Wtlei from the Economic Planning Board representedthe Government.5. The proposed Bank loan would be the second to Korea. In thenext few monzhs I expect to submit an IDA credit for vocational andtechnical education and a second loan to the Korea Development FinanceCorporation (KDFC).- 2 -6. The following is a summary statement of Bank loans and IDAcredits to Korea as of March 31, 1969:Loan or Amount (U.S. $ millicn)Credit No. Year Borrower Purose Bank IDA Undisbursed25 1962 Republic of Korea Railway 13.9 Nil110 1967 Republic of Korea 2nd Railway 11.0 1.2529 1968 KDFC Industry 5.0 4.7S-4 1968 Republic of Korea Highway Studies 3.5 3.0Total (less cancellations) now outstanding O 28.4and held by Bank and IDATotal undisbursed 4.7 4.2 8.97. The projects aro progressing satisfactorily. IFC has invested$700,000 in KDFC and is considering $6 million in equity and loans to twoprojects in Korea, a paper plant and a silk manufacturing plant.PART II - DESCRIPTION OF THE PROPOSED LOAN8. Borrower: Union of Land Improvement Associa-tions (ULIA).Guarantor: Republic of Korea.Amount: Various currencies equivalent to$45 million.Purpose: To provide irrigation to,and enablethe effective utilization of,approx-imately 37,000 hectares of land nearthe western coast of Korea.Amortization: In thirty years including a sevenyear period of grace, thro ugh semi-annual installments beginningJune 15, 1976 and ending June 15,1999.Interest Rate: 6-1/2 percent per annum.Commitment Charge: Three-fourths of one percent per annum.Estimated EconomicReturn on the Project: 14 percent.PART III - THE PROJECT9. An appraisal report entitled "Korea - Pyongtaek-Kumgang Irri-gation Project (PA-6a)" is attached.10. While other sectors of the economy have been growing at consid-erable speed, the agricultural sector has maintained a relatively slowgrowth rate of five percent per annum over the past several years, witha sharp drop last year due to a severe drought. Recognizing the lag ofthe a-ricultural sector and the widening gap between urban and ruralincomes, the Government is determined to step up development in thisarea. Ex-tending irrigation to more areas of the country is part ofthis effort, and the project under consideration is a major element inwhat the Government calls the Au .T;eather Farming Program.11. The proposed Borrower is the Union of Land Improvement Associa-tions (ULIA), a semi-autonomous public organization within the Ministryof Agriculture and Forestry. ULIA was founded in 1940, and through itsmember associations now controls about 43 percent of Korea's total irri-gated area. Its annual budget is almost totaly dependent on Governmentappropriations, either as grants or loans. Under ULIA's guidance andsupervision, a considerable number of small scale reservoir and pump-liftirrigation projects have been completed. In addition, several thousandhectares of tidal flats were successfully reclaimed and a large number ofsmall fragmented areas were irrigated. Although ULIA has a large and tech-nically competent staff, the proposed Bank project is larger and more com-plex than the other irrigation schemes undertaken by ULIA, and thereforeLTLIh will appoint supervising consultants, acceptable to the Bank, for theconstruction of the project.12. The project which the Bank is financing is the irrigation oftwo separate land units, Pyongtaek and Kumgang. It also includes thepreparation by consultants of an improved seeds multiplication project.The project under consideration would involve pumping water from riverestuaries into canals to irrigate land in adjacent valleys and on lowerslopes. Construction in the Kumgang area would take about three yearsand that in the Pyongta6karea about five.13. The total cost of the project is estimated at approximately$90 million. The proposed Bank loan is half that amount. Wgater rateswi,ll be set at levels to recover all operating and maintenance costs andat least 40 percent of capital costs over a period of thirty-five years.This approximates the established pattern in Korea. The rates will equalabout one-third of thc incremental family income generated by the projectand will provide ULIA with funds to cover approximately half the annual debtservice on the proposed Bank loan. The balance would come from the Government14. The additional output resulting from the project would be81,000 tons of rice, 38,000 tons of barley, 136,000 tons of vegetablesand lesser amounts of fodder, fruit and other minor crops. At fulldevelopment, the annual gross value of production from the project area- h- is expected to exceed $30 million, more than triple the present level.The net farm income for the average farm family after aU charges isexpected to double to about $600 at full production, an increase of$300 over wqhat the family would have earned without the project. Therate of return to the economy for the project as a wJhole is calculatedat 14 percent.15. All equipment and major civil works contracts would be letafter international competitive bidding. As Korea has a large andhighly competitive construction industry and competes favorably incertain kinds of equipment, it is expected that at least $3.0 millionand possibly as much as $20 million would be disbursed against contractswon by local suppliers. Because of the high priority the Governmentaccords to land improvement, equipment imported for that purpose isexempted from import duties. Accordingly, no preference wil-l be givento local bidders.16. Korea has made remarkable development efforts and its savingsperformance has increased considerably, being presently about 14 percentof GNP. But there is nevertheless a resource gap which can not be metentirely by financing only the foreign exchange costs of projects suit-able for Bank consideration. Many of the projects having a high foreignexchange component, particularly in the industrial sector, are financedwith funds from private and bilateral government sources. In these cir-cumstances, financing of some local expenditures on high priority projectsis justified.17. The proposed project is of high priority and fits into theBank's strategy of upgrading the agricultural sector. The Borrower,with the help of supervising consultants, will be capable of carryingit out efficiently.PART IV - LEGAL INSTRUMENTS AND AUTHORITY18. The draft Loan Agreement between the Bank and the Union ofLand Improvement Associations, the draft Guarantee Agreement betweenthe Republic of Korea and the Bank the Report of the Committee providedfor in Article III, Section 4 (iiij of the Articles of Agreement and thetext of a Resolution approving the proposed Loan are being distributedto the Executive Directors separately.19. The draft Loan And Guarantee Agreement conform substantiallyto the pattern of agreements used for irrigation projects. Under theGuarantee Agreement Korea will take several steps essential for thesuccessful execution of the project, but which are outside the competenceof the ULIA. In particular, Korea will take appropriate steps to ensurethat river waters required for the project are not diverted or utilizedin a manner prejudicial to the efficient execution of the Project. (SeeSection 3.06.)PART V - THE ECONOMY20. An economic report entitled "Current Economic Position andProspects of the Republic of Korea" (in three volumes) No. EAP-4a wascirculated to the Executive Directors on March 14, 1969.21. The performance of the Korean economy continues to be impres-sive. ONP in real terms grew by 9 percent in 1967 and 13 percent in 1968in spite of successive droughts in these years. This is appreciably higherthan the 7 percent growth rate originally planned, largely because of veryhigh growth rates of industrial output of 22 percent and 26 percent in1967 and 1968 respectively. The rate of population growth has slowed downfrom 3 percent to 2.3 percent in the last decade and per capita GNP hasgrown at rates approaching 10 percent, to about $170 equivalent in 1968.22. Merchandise exports increased from an average level of lessthan $90 million in 1962-64 to $320 million in 1967 and to almost $490million in 1968, but imports also expanded rapidly, especially in thelast two years, as a result of the economic expansion, the need forfoodgrains imports and trade liberalization. The deficit on goods andservices account increased therefore to almost $620 million in 1968 from$415 million in 1967 and 4220 million in 1964.23. Agricultural performance in the last two years has been dis-appointing; the 1968 output remained at the low level of 1967 which was6 percent below 1966. While poor weather undoubtedly was the majorreason, a slowdown in land development and the use of agricultural inputshas been noticeable. The irrigation project for which the proposed loanwould be made will help to rectify this situation and alleviate the impactof possible future droughts on agricultural production. Therefore, it hashigh priority among proposed Bank Group operations in Korea.24. Private savings, which had slowed down somewhat in 1967 due tothe low level of agricultural income and increased private consumption,regained some strength in 1968. Public savings rose substantially owingto a sharp increase in tax revenue, following a tax reform and furtherimprovement of the tax administration. Total gross domestic savingsstayed at a level of 13.5 percent of GNP in 1968, but are expected togo up to about 15 percent of GNP in 1969 on the assumption that privatesavings would further recover to about 10.5 percent of GNP and publicsavings remain at the present level of about 4.5 percent of GNP.25. Gross capital formation amounted to 24 percent of GNP in 1968.As investment increased more rapidly than domestic savings, the resourcegap, which has been widening since 1966, reached close to 11 percent ofGNP in 1968. Capital inflow from abroad filled this gap; however, theshare of official vrants declined and that of loans, especially of short-term commercial loans, increased sharply. Gross investment at currentprices is expected to reach a level of close to txbn 500 billion (US$ 1.8billion) in 1969 or almost 26 percent of GNP. This would result in a- 6 -resource gap of between 10 percent and 11 percent of GNP or roughlylWon 200 billion (US$ 720 million) to be financed by the inflow ofcapital from abroad. Investment as a proportion of GNP is forecastto remain at the level of roughly 26 percent in 1970 and 1971, whiledomestic savings may go up to 16 percent of GNP in 1971 but hardlyvery much farther. This would still leave a resource gap of between9 and 10 percent of GNP in 1971 to be filled by external borrowing.26. Korea has incurred during the last two years a ratherlarge amount of short-term debt. As a result the debt service ratioincreased from 2.6 percent in 1966 to 7.4 percent in 1968. If itemsnow on order are delivered on schedule service on public and privatedebt will reach 20 percent or more in 1970, not counting any provisionfor the service of new debt. In these circumstances the projected rateof investments at present appears to be unreasonably high. Korea cannotrealistically expect to fill the estimated resource gap with borrowingson long and concessionary terms, so that tho ambitious level of invest-ments would add further to the already heavy external debt burden. Aslower growth of exports in the future and a possible decline of receiptsfrom Vietnam will accentuate the problem of debt service in the comingyears, and this will have to be taken into account in reviewing the futureinvestment targets.27. In present circumstances it is imperative that the Governmentcontrol the accumulation of short- and medium-term debt. The Governmentcurrently exercises reasonable control over the level of Government-guaranteed loans; however, the degree of control over commercial bank-guaranteed loans is inadequate and should be extended. Measures tocontrol the inflow of further short- and medium-term capital includean agreement with the International Monetary Fund which would limitnew commitments of short- and medium-term loans to more prudent pro-portions.28. The Government has been informed of our doubts regarding thesize of the proposed investment program, which includes a number ofprojects which could be postponed or scaled dowqn without seriouslyaffecting future growth rates. Similarly, private borrowing abroadand private investment could be restrained by applying cost benefitanalysis more strictly in the selection of projects using foreignexchange and budgetary funds. Given the generally sensible economicpolicies followed by the Korean Government in recent years, it isreasonable to expect that the Government will take the necessary actionto control the growth of the country's external debt burden while keepingfuture investments at the level necessary to maintain further rapid eco-nomic growth.29. Considering the good export and savings performance of theKorean economy, Korea can be regarded as creditworthy for this loan.- 7 -PlAT VI - COMPLIANCE WITH ARTICLES OF AGREEIENT30. I am satisfied that the proposed loan would comply wqith theArticles of i-igreement of the Bank.PART VII - RECOMMENDATION31. I recommend that the Executive Directors approve the proposedloan.Robert S. IIcNamaraPresidentAttachmentWashington, D.C.April 17, 1969

Report and recommendation of the president to the executive directors on a proposed loan to the union of land improvement associations for an irrigation project with the guarantee of the Republic of Korea

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Report and recommendation of the president to the executive directors on a proposed loan to the union of land improvement associations for an irrigation project with the guarantee of the Republic of Korea

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