Document of
The World Bank
FOR OFFICIAL USE ONLY
LAl 2'3a-,tJ
Report No. 7091-HU
STAFF APPRAISAL REPORT
THE HUNGARIAN PEOPLE'S REPUBLIC
AGROPROCESSING MODERNIZATION PROJECT
April 11, 1988
Europe, Middle East and North Africa Region
Country Department IVAgriculture Operations
This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
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CURRENCY EQUIVALENTS
US$1 = Forint 46Ft 1 US$0.02
WEIGHTS AND MEASURES
1 liter 0.908 quart1 hectoliter = 100 liters1 hectoliter _ 3.53 cubic feet1 metric ton = 1,102 short tons1 kilogram = 2.2 pounds
ABBREVIATIONS AND ACRONYMS
AGROBER - Agricultural Construction and Engineering FirmAKI - Research Institute of Agricultural Econom-,csBCB - Budapest Credit BankCCB - Commercial and Credit BankEEC - European Economic CommunityHCB - Hungarian Credit BankHUNGEXPO - Agency for Trade Fairs & Export PromotionKOMPLEX - Agroindustrial Equipment Foreign Trading CompanyKOPINT - Institute for Market ResearchMEM - Ministry of AgricultureMT - Ministry of TradeNBH - National Bank of HungaryNPO - National Planning OfficeUHFI - University of Horticultural and Foud Industries
FISCAL YEAR
January 1 - December 31
FOR OFFICIAL USE ONILY
HUNGARY
AGROPROCESSING MODERNIZATION PROJECT
Table of Contents
Chapter Page No.
LOAN AND PROJECT SUM MARY. .. . .i-iv
I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . 1
II. BACKGROUND ON AGROPROCESSING . . . . . . . . . . . .2
A. Sector Overview. . . . . . . . . . . . .* . .2
B. Export Performance . . . . . . . . . . . . . . .3
C. OrganiLation and Firm Size . . . . . . . . . . .5
D. International Competitiveness . . . . . . . . .6
E. Linkage with Government's Reform Program . . . . 6
III. POLICY AND INSTITUTIONAL ISSUES . . . . . . . . . .8
A. Sector and Subsector Development Strategies . .8
B. Trade-Related Issues . . . . . . . . . . .... 11
C. Financial Issues .... . . . . . . .. . .13
D. Institutional Issues . . . . . . . . . . . . . .17
E. Impact of Bank Lending in Agriculture . . . . .19
IV. THE PROJECT . . . . . . . . . . . . . . . . . . .. 20
A. Concept, Design and Objectives . . . . . . . . .20
B. Project Description . . 0 . . .. . .. .. .21
C. Cost and Financing . . . . . . . . . . . . . . .22
D. Procurement . . . . . . . . . . . . .24
E. Bank Loan Allocation and Disbursement . . . . .26
F. Envirormental Impact . . .t . . . . . . . .27
V. PROJECT IMPLEMENTATION . . . . . . .. ..28
A. Organization of Implementation . . . . . . . . .28
B. Intermediary Banks . . . . . . . . . . . . . . . 30
C. Subloan Criteria and Onlending Terms . . . . . .31
D. Technical Assistance and Training . . . . . . .32
E. Reporting and Auditing . . . . . . . . . . . . .35
This report was prepared by Wayne Ringlien (mission leader), Franco Lucca,
Vance Pulley (Bank) and James Tustin (Consultant).
This document ha a restricted diribution and may be used by recipients only In the peorfoman
of their official duties. Its contents may not otherwise be dbclosed wkhout Wordd BDnk authodrtion.
Chapter Page No.
VI. FINANCIAL RESULTS, PRODUCTION AND MARKETS . . . . . . . 36
A. Financial Results.. . . . . . .... . 36
B. Production . . . . . . . . . . . . . . . . . . . . 39C. Marketing and Markets . . . . . . . . .. a .. 40
VII. JUSTIFICATION AND BENEFITS . . . . . . . . . . . . . . . 44
A. Results of Economic Analysis . . . . . . . . . . . 44
B. Major Risks . . . . . . . . . . . . . . . . . . . . 47
VIII. AGREEMENTS AND RECOMMENDATIONS . . . . . . . . . . . . . 47
ANNEXES
1. Export Market Performance for Selected Products
2. Barriers to Entry into EEC Market3. System of Prices, Taxes and Subsidies4. Financial Ratios for Selected US and Hungarian
Agroprocessing and Wood Processing Subsectors for 1986
5. Financial Projections for Poultry, Processed Fruits
and Vegetables, Wine, and Wood Products to 1995
6. Subsector Grading and Quality Control7. Food Industries Research and Development Facility8. Management and Marketing Training9. Issues concerning Feeder Industries10. Detailed Cost Table11. Estimated Disbursement Schedule for Bank Loan
12. Business Plan at EnterpriLe Level13. Swmnary of Projected Financial Statements
- Commercial and Credit Bank- Budapest Credit and Development Bank- Hungarian Credit Bank
14. Active Market_ng Component15. Specific Product-Market Export Prospects16. Selected Documents Available in the Project File
MAPS
IBRD 19989 - Location of Potential Project Enterprises
IBRD 19990 - Location of Raw Material Supply
- I -
HUNGARY
AGROPROCEING MODERMZATION PROJECT
LU and Proi ummt
Barrower. National Bank of Hungary (NBH)
Guarantor Hungarian People's Republic
About 70 agroprocessing and wood processing enterprises
Aimount: US$70 million equivalent
Terum Fifteen years, including three years grace at thestandard variable interest rate.
OkffleadiM Tern= US$64.5 million of the proposed loan would be onlentthrough intermediary banks to state enterprises andcooperatives for a maximum period of 10 years,including a maximum of 3 years grace. NBH will onleudthe loan proceeds to intermediary banks at theprevailing Bank rate plus a 20X mark-up which includesa fee for the foreign exchange risk to be borne by NBH,or at its rediscount rate, whichever is higher. Atpresent, NBI would make the funds available to thebanks at its rediscount rate, which is currently 10.5land therefore higher than the Bank's current interestrate plus a 20S mark-up. US$5.5 million equivalentwill be lent to Government and its agencies forfinancing marketing, training, research anddevelopment, packaging and quality standards andgrading of raw materials and processed products on thesam term as the Bank loan.
Proeot The objective of the project is to increase exportearnings of processed agricultural products,particularly, to the convertible currency market, byimproving their quality and to improve the efficiencyof operations of enterprises in the agroprocessingsector by reducing their unit costs of operations andimproving their productivity. The project would alsosupport training and technical services in order toprepare managers of the enterprises to become directlyinvolved with the marketing and sale of products totheir customers. Based on completed export marketstudies and the results from a workshop on marketingand technology held in Budapest in June 1987,enterprises would develop product and market strategieswhich would indicate the type of investment required bythem over the medium-term for improving product quality
-ii-
and increase market penetration. Equipment tomodernize processing lines, packag4;g, canning,bottling, chilling, freezing and cold storage would bethe major areas for plant improvement under theproject. The improvement of feeder industries whichsupply goods to agroprcoessing plants would also beencouraged under the project. Project componentsinclude institutional strengthening of existing effortsin research and development, grading and settingproduct standards and of new efforts in packagingtechnology and testing of final product quality. TheMi"istry of Trade would establish in Hungexpo anagro-marketing office for export trade promotion andmarketing to provide export and marketing services toenterprises.
Proiect BeneritsarA Risks: The economic benefit would be a restructuring of the
most important agroprocessing enterprises in thecountry toward those products in which Hungary has thebest export market possibilities. The project wouldimprove the marketing and technology of processed foods
and wood which would improve their quality and reducecosLs of production. Agroprocessing enterprises wouldfight to retain their existing markets of productsalready under production, while at the same timedevelop new products and the skills to package andmarket them so that additional agroprocessing productswill be sold on the export market, and thus, increasethe foreign exchange earnings to the country. Theproject faces three sets of risks: (a) at the macrolevel, policy and institutional reforms may lack theintensity and sequencing required for movements towardsa market-oriented system. The risk is being minimizedby the current Government commitment and the ongoing,continuous dialogue between the Bank and Hungarianofficials on policy and institutional reforms; (b) atthe micro level, traditional practices may delay theresponse by managers and employees of productiveenterprises to the freeing of prices and reduction incorporate taxation and subsidies. Supporting servicessuch as export trade promotion, raw material and finalproduct grading system, research and development, andtraining will help to accelerate changes in thebehavior of managers; and (c) at the internationallevel, unfavorable terms of trade and tariff andnon-tariff barriers may limit Hungarian exporters'ability to increase sales abroad. Apart from theimport tariffs and the specific regulation regime underits Common Agricultural Policy, export opportunities tothe Comminity are also limited by the general status ofproduction and imports in the EEC, and in someproducts, the market shares of Hungary are already so
-iii-
high, or the porportion of extra-EEC imports in total
trade is so low, that large incremental exports are
likely to be difficult. But, in spite of these
constraints to trade, Hungary's overall performance in
the EEC market showed improvement between 1980 and
1987. Hungarians can cope with thesu exogenous factors
by imk,roving the quality and servicing of their
products; the signing of a trade agreement, which
is
under active consideration with the EEC, is also
expected to improve access to EEC markets. Finally,
environmental risks of water and air polluW.ion are
reduced as enterprises are finding it more economical
to install pollution control devices rather than pay
the charges, assessed by Government for pollution.
Estimated Costs:Local /a Foreign
Total
----------(US$ Million)-
Wine & Fruit Juice 17.8 16.9
34.7
Processed Vegetables & Fruits 11.6 12.2
23.8
Poultry 28.1 28.5
56.6
Wood Processing 11.9 17.0
28.9
Technical Assistance 3.2 5.5
8.7
Marketing 1.3 6.2
7.5
TOTAL 73.9 86.3
160.2
/a Including an estimated US$32.8 million of taxes
and duties.
Financing Plan:
Local ForeiRn Total
----------(US$ Million)-
IBRD - 70.0
70.0
Government 3.2 -
3.2
Commercial Banks 36.8 16.3
53.1
Project Beneficiaries 33.9 -
33.9
TOTAL 73.9 86.3
160.2
- iv -
Estimated Disbwments:
IIRD FY1989 1990 1991 1992 1993 1994
-----------(s(S$ Million)
Anual 8.0 12.0 15.5 15.5 11.0 8.0Cumulative 8.0 20.0 35.5 51.0 62.0 70.0
MAPS: IBRD# 19989IBRD # 19990
Economic Rateof Return Average of 33S per investmaent with ranges between 16S
and 57%
HUNGARY
AGROPROCESSING MODERNIZATION PROJECT
STAFF APPRAISAL REPORT
L INTRODUCTION
1.01 The three agricultural projects in Hungary financed by the World
Bank to date have concentrated mainly on grain production and storage,
livestock production and export marketing, and farm mechanization, with major
emphasis on upgrading deteriorated and obsolete equipment at the farm as well
as the agroprocessirg levels. As part of the macroeconomic dialogue on
economic reform, the Bank is becoming more strategically involved with policy
analysis in the agricultural sector, which is being implemented by the
Ministry of Agriculture (MEM) and its related agencies. The proposed project
grew out of the dialogue to respond to the urgent need for Hungary to expand
its earnings from convertible currency exports of agricultural and
agroprocessed products on an increasingly competitive world market. The
objectives of the project comrlement the restructuring of the industrial
sector which is underway with the assistance of a series of Bank-financed
industrial sector loans, two of which are under implementation.
1.02 The proposed Agroprocessing Modernization Project seeks to increase
the country's foreign exchange earnings by reorientating the operations of
agroprocessing firms, especially the large ones, toward those products which
present the best opportunities on the export market (paras 6.09-6.25), while
at the same time seeking concrete ways in which enterprises can reduce their
costs of production and increase the productivity of capital and labor. In
order for those desirable changes to occur, Government will need to intensify
the implementation of key economic reforms in the critical areas of reduction
of subsidies to loss-making enterprises, trade, investment, wages and credit
as well as permit enterpri¶.e managers increased financiai autonomy and
responsibility for operational matters. At the agroprocessing enterprise
level, it is necessary to introduce modern business planning regarding
product/market strategies, technology, management tools of analysis and
effective organization. Under the project, enterprises are expected to be
responsible for their own profits or losses but will be supported by expanded
and improved services of export trade promotion, training in management and
marketing, grading and quality control of raw materials as well as final
products and research and development.
1.03 The project was appraised in October/November 1987 after two
detailed preparation vmissions (November 1986 and February 1987) which included
the completion of international market studies by country and by product, a
workshop on marketing and technology (June 1987) of international caliber and
the preparation of five subsector strategy reviews in poultry, processed
fruits and vegetables, wine, fruit juices, and wood processing, which were
carried out by a joint expatriate-local venture cf A.L. Little (US) and
Szenxor (Hungary), consulting companies under contract with MEM.
- 2 -
II. BACKGROUND ON AGROPROCESSING
A. Sectoral Overview
2.01 Over the past two decades the Hungarian agroprocessing sector hasplayed an important role in the country's development. The agricultural,
including agroprocessing, and forestry sectors accounted for 20Z of GDP, 22Z
of employment and 30% of convertible currency exports; it is a "hard" currency
sector since it earrs about 30% of all convertible-denominated trade to the
country; and only 18% of all ruble-denominated trade as opposed to
manufacturing which earns the same share of convertible currency, but accounts
for over 75% of ruble-denominated trade. Agriculture, in the mid-to-late
1970s, received a substantial chunk of investment which was associated with
some technical and organizational changes at the enterprise level; it
sustained agricultural growth at 3.7% p.a. from 1970 to 1982. Since 1982,
however, average annual growth in agricultural GDP has slowed considerably.
While a large part of the recent stagnation in agriculture is weather and
external-market determined, the simultaneous occurrence and persistence of
sevreral factors has served to highlight certain critical issues which have to
be faced. They broadly cover three areas of activity:
a) renewal of capital stock for productive subsectors which havesupported significant depletion because of the tight demandmanagement policies adopted since 1979;
b) complicated pricing, taxation and subsidy measures and thecomplex financial influence exercised by government over state
farms and enterprises and, to a lesser extent, over thecooperatives; and
c) need for restructuring of farms and enterprises in order toimprove their efficiency and performance, particularly, withreference to exports.
These broad themes which cover the agricultural sectGr as well as the
agroprocessing sector are being pursued by the Bank as the key discussion
points with Government.
2.02 During the 1970s, the agroprocessing sector continued to produce
traditional goods under the assumption that increasing volumes could
compensate for declining world prices grew at an average rate of 4.5% p.a.
which lagged behind overall industrial growth. This growth rate was partly
attributable to the decision by Government to expand the agroprocessing sector
under the Fifth Five-year Plan (1976-81) in order to increase the country's
capacity to further process primary agricultural production, which had
expanded rapidly during the early 1970s. In 1981-87, however, growth slowed
down in the manufacturing sector (1.6Z p.a.) as well as in the agroprocessing
sector (1.4% p.a.). Severe winters, droughts and the price collapse of some
of Hungary's majoz export products (meat, wheat and vegetable oil) in
international markets contributed to this decline. Wood-processing industries
showed a similar pattern in that this rates of growth was relatively high
- 3 -
(6.21 p.a.) in the 1970s, but fell in the 1980s (-1.0% p.a.) mainly due to a
15% p.a. decline in the prices of sawn wood and plywood, reflecting a major
decline in construction on the domestic as well as their export markets. The
subsectors which stand out as the best performers during the 1980s in the
agroprocessing sector, in terms of annual growth rates greater than the 4%
p.a. were distilling and starch, beer, vegetable oil, and poultry. Declines
were experienced in the five subsectors of: meat, wheat milling, sugar,
confectionaries and wineries.
B. Export Performance
2.03 Hungarian exports of agroprocessed products amounted to about
US$1,200 million both in 1986 and 1987, which was about two-thirds of
agricultural exports; the agricultural sector as a whole accounted for 201 of
total exports from the country. The most important markets for Hungarian
agricultural and agroindustrial products are socialist countries, primarily
the CMEA. These markets account for over 532 of sales revenue in the sector
compared to 40% from sales to developed capitalist countries and 6% from those
to developing countries. Sales revenue from exports of agricultural products
nevertheless represents an important source of convert ble foreign exchange --
251 of the total for the economy. During the 1980s, an average two-thirds of
the foreign exchange earnings generated in the sector were denominated in
convertible currency and about one-third was denominated in roubles.
2.04 The apparent contradiction between the large market share held by
the CMEA and high proportion of convertible currency-denominated trade in
agriculture is explained by the fact that a portion of Hungary's exports to
the CMEA are denominated in dollars rather than transferable rubles. Although
the proportion of total Hungarian exports to the CMEA that are denominated and
cleared in convertible currency was only 20% in 1985, the corresponding
proportion for agriculture was 462. In 1986, data shows substantial
deterioration for Hungary with only 331 of agricultural trade with socialist
countries denominated in convertible currency. One notable contributor to the
trend was the poultry subsector which received much less favorable treatment
on exports to other CMEA countries in 1986.
2.05 Although agroprocessed exports stagnated from 1983-85, they have
expanded at an impressive average annual rate of 4.81 during the period
1979-1986. This exceeded the rate of growth in total exports, which was only
2.61 p.a. Agricultural exports enjoy large subsidies from the Government --
as much as 341 in 1987 for sales to non-CMEA markets and perhaps even higher
on sales to the CMEA, depending on the domestic price which Hungarian export
enterprises could receive for their products.
2.06 The most important agroprocessing export commodities are processed
meat products including poultry, which accounted for about one half of sales
of agroprocessed exports in 1986. Sizeable, but considerably lower
contributions to exports were made by beverages, tobacco and other products
(201), canned fruit3, vegetables and spices (191) and vegetable oil (91).
Baking, milling, sugar, confectionaries and sweets represented only negligible
components of agroprocessing exports. As for the products covered by the
proposed project, Table 1 below shows that these groups accounted for US$ 693
million equivalent in 1986.
Table 1: EXPORT VALUE OF SELECTED PRODUCT GROUPSIN AGkOPROCESSING AND WOOD-PROCESSN!¢G
Total S growth/decline
Product Group 1984 1985 1986 between 1084-86
---- (in US$ '000)----
Poultry and Products 203.3 201.8 243.4 19.7
Wine 187.2 193.7 149.4 -20.1
Processed Fruits 68.1 79.5 93.9 37.9
Processed Vegetables 93.0 119.1 139.9 50.4
Pulp Wood 31.4 35.2 39.1 24.5
Parquet Flooring 7.2 7.4 9.9 37.5
Sawn Wood 7.6 7.1 8.4 10.5
Plywood, Veneers, Logs 5.3 6.1 8.9 67.8
for ProcessingTOTAL 603.0 649.5 692.9 14.9
Source: Hungarian Trade Yearbook, Budapest 1984-86.
2.07 All of these product groups showed impressive increases in foreign
exchange earnings between 1984 and 1987 except wine, which declined by 20X
between 1984 and 1986 due to poor harvests in 1985-86 and a sobriety campaign
initiated in the Soviet Union, Hungary's largest market for wine exports.
2.08 On the non-CMEA markets, forty-two percent of the value of the listed
products represented exports to the EEC, 24S to other industrial markets aad
34S elsewhere, mainly the Middle East and North Africa. Given the small size
of Hungary's economy, it has basically no influence on the pricing structure
abroad and has to content itself with the role of a price taker.
Nevertheless, Hungary's overall performance in the EEC market showed
improvement between 1980 and 1987, and Government is actively negotiating a
trade agreement with the EEC Commission (para. 3.12). This includes Hungary's
principal export items of fresh, chilled and frozen meats and meat products.
Other products such as canned meat, aad vegetable oil did less well but were
able to maintain their market share. Despite this performance, Hungarian
foreign trading organizations have not been innovative or risk-taking in the
export of agroprocessed products as they tend to sell products through
exclusive rights to a foreign agent under long-term contracts, and in this
sense, become order takers rather than aggressive marketers. Although the
proposed project encompasses all enterprises in agroindustry which satisfy the
onlending criteria, 5 subsectors have been targeted on the basis of their
share of exports, recent performance in this area, or their potential for
significantly increasing sales to convertible currency markets. The export
performance of these subsectors viz., poultry, processed fruits & vegetables,
-5-
wine, fruit juices, and wood processed products is reviewed individually in
Annex 1.
C. Orianization and Firm Size
QCganization
2.09 The government began decentralizing the food industry in the early
1980s by breaking up 10 subsectoral trusts which had maintained wiie-ranging
authority over member firms' decisions in such strategic areas as production,
export and investment, and by introducing enterprise management reforms in
1985. The primary goal of these reforms was to improve firms' efficiency and
profitability by increasing their financial responsibility and managerial
independence. Only the grain and dairy subsectors continue to retain the
trust form of organization. There are 1,375 individual enterprises involved
in food processing, including a large number of state farms and cooperatives
which carry out some processing of primary production, a few small private
firms, and 199 large, state-owned agroprocessing firms, which represent about
80% of production. The structure of the wood processing industry is rather
distinct from agroprocessing firms with more enterprises (68%) organized as
cooperatives and most falling under the regulatory framework of the Ministry
of Industry rather than MEM.
Firm Size
2.10 High concentration of production exists in both agroprocessing and
Hungarian industry as a whole, with large agricultural enterprises employing
more than 300 workers representing more than 95% of the gross value of
production in 1984. Although the number of large enterprises within the
industrial sector has remained basically constant (56%), the number of firms
employing more than 300 workers within the agroprocessing sector increased
dramatically from 36% in 1965 to 85% in 1984.
2.11 Moderate to significant economies of scale exist in canning and
poultry, the two project subsectors where size significantly exceeds industry
norms on a per plant basis. Wood processing firms, which are predominantly
cooperatives, on average tend to be significantly smaller and fall below the
norm for Hungarian industry. The possible inefficiencies associated with a
high degree of concentration in Hungarian agroindustry result from their link
to non-competitive behavior and high cost production structures. The lack of
competition in the past is likely to have contributed to the sector's low
productivity performance and reduced growth below its potential. The success
of the tax reform and other measures in decentralizing the economy and
strengthening profit orientation will be determined to a large extent by the
government's willingness to reduce the degree of industrial concentration and
thereby increase competition among firms. The dismantling of the trusts will
reduce barriers to entry and exit in agroprocessing. Tne promulgation in
January 1988 of the new law allowing the establishment of limited liability
corporations should also ease the entry of small and medium sized enterprises,
including agroprocessing, into industrial and agricultural activities. A Law
of Association has also been promulgated which permits the establishment of
joint ventures between cooperatives and/or private individuals, foreign
companies and state enterprises.
- 6 -
D. International Competitiveness
2.12 As about half of Hungary's GNP is derived from foreign trade, all
sectors must attempt to contribute to the overall trade balance by exploiting
international comparative advantages which are inherent in Hungary's current
level of technology in transforming products and in factor endowments. In
addition, the Hungarians need to compensate for shortcomings by selling in
competitive areas through aggressive and penetrating marketing methods and
techniques. Based on average domestic resource costs (DRCs) estimated for
1981, 1983 and 1986, those project product groups, currently being produced
and exported, which are most competitive on the international market are fruit
juices, wood products, cherries and apricots. The least competitive project
product groups are vegetables and broilers. Increased export earnings from
poultry sales will depend on the development of new products derived from
chicken such as fresh and chilled poultry including ducks and turkey, and
poultry parts. Vegetable exports will largely depend on ef' ttve demand from
convertible currency markets and on the response of agroprotl -ing enterprise
managers to produce higher quality products, which are packaged to take
advantage of market niches.
E. Linkage with Goverment's Reform o
2.13 In support if a comprehensive five-year industry policy reform
program in an environment of increased fiscal austerity, a series of
industrial restructuring projects financed by the Bank have been initiated in
Hungary to improve industrial efficiency through increased competition,
enhanced reliance on market forces and increased enterprise autonomy. Because
of the importance of industry in the Hungarian economy and the "systemic"
nature of the policy changes, the reforms being implemented have also
important implications for the agricultural and, especially, the
agroprocessing sectors. Of the eleven policy areas being discussed with
Government under the ongoing industrial restructuring loans 1/ from the Bank,
and in the current dialogue between the Bank and Government, five are
particularly relevant for the agricultural and agroprocessing sectors.
(a) Entry and liquidation of enterprises--to encourage competition
and encourage the mobility of productive resources. Action on
these lines, which has already occurred in 1986 in the case of
meat, with the breakup of marketing and trade monopolies, is the
fundamental policy reform required for the creation of a
business environment and the provision of incentives to managers
of enterprises, to maintain their market shares, to expand new
product lines and to improve enterprise profitability in the
medium-term.
(b) Improved pricing, incentive and taxation policies to (i) promote
market-based allocation of resources through price deregulation,
and (ii) rationalize the taxes and subsidies system to improve
1/ See the SAR for the Hungary Second Industrial Restructuring Project,
Report No. 6643-HU, Table 3.1, May 15, 1987.
-7-
cost efficiency and remove in:entive distortions. Since January
1988, the proportion of on-farm producers prices that are in the
fixed category of the Materials and Pricing Board was reduced
from 50% to about 10% and consumer food prices from 55% to 252;
all subsidies for agricultural inputs except fertilizer have
been eliminated. Furthermore, comprehensive economy-wide tax
reforms are being introduced. The impending standardization of
income taxation and the introduction of the value-added tax
would directly have positive effects on the profitability of
efficiently managed agricultural enterprises, but have negative
effects on loss-making enterprises. The elimination of all
subsidies on commercial inputs, except fertilizer, may also
increase the cost pressure on agricultural enterprises but the
government hopes that the reduction (and, in several cases, the
elimination) of consumer subsidies would compensate for these
disincentive effects. In any case, further decontrol of prices
(away from cost plus pricing) is likely to improve the business
climate for enterprise performance. The impact of these changes
is analyzed in paras. 3.17 - 3.20.
(c) Liberalization of foreign trade in 1988, now permits interested
enterprises to acquire direct foreign trading rights either on
an individual basis or through joint trading houses formed by
two or more enterprises. Enterprises are rewarded with positive
incentives for exports to the convertible currency market such
as export subsidies, tax rebates, and duty drawbacks. But there
are virtually no commensurate penalties for enterprise managers
to pay, such as bankruptcy or loss of management positions
within enterprises if the enterprise stays with the CMEA markets
even when threatened with future losses. This inertia of
enterprise managers has left convertible currency trade
promotion in the hands of foreign trading companies which do not
control product supply and act only as marketing agents of
enterprises. While these problems are particularly pronounced
in the agroprocessing sector, they are present in other
sectors. The Bank is addressing these issues under a
macro-economic dialogue with the Hungarians which includes:
(a) e medium-term program to phase out all forms of support to
ineftAcient or loss-making enterprises; and (b) an export
promotion program which would provide additional incentives to
exporters such as devaluation of the forint against convertible
currencies, access to direct foreign trading rights, and import
competition.
(d) Wage regulations continue to be tightly controlled by
Government, based on the view that strict demand management is
one of the key actions required by economic managers for growth
and stability. Currently, wage regulation in the agricultural
and agroprocessing sectors differs from the other sectors and
the rest of the economy which is set at an overall rate of 32 in
wage increases for 1988; these sectors will tie wage increases
to improvement in productivity and any increases in excess of
such improvement will meet with prohibitive taxes.
(e) Increasing financial autonomy of enterprises and the
corresponding decline of the traditional practice of assigning
production quotas without regard to cost constitutes two of the
most critical areas for renewed growth and development of those
enterprises which are, particularly, inte nationallycompetitive. Financial discipline of enterprise is to be
strengthen by the threat of bankruptcy and management's greater
accountability for its profits and losses. While the
establishment of a commercial banking system in 1987 is evidence
of movement toward improving the financial institutionalenvironment, Government continues to exercise a strict control
over credit policy and foreign exchange through the NBH. Under
its macro-economic dialogue with the Bank, the Hungariara are
making progress on permitting enterprises to have greater access
to foreign exchange than previously was the case and are
committed to introducing reforms in the banking system which
would gradually shift greater responsibility to the commercial
banks for the management of their operations without the current
influence exercised by the NBH. These issues are being
discussed under the proposed Industrial Sector Adjustment Loan.
Efforts under the project will, essentially, help deepen these economic
restructuring efforts in the agroprocessing sector.
M. POLICY AND ThTSTITUTIONAL REFORMS
A. Sector and Selected Subsector Development Strategies
Sector
3.01 The strategy for developing the agricultural and agroprocessing
sectors falls within the objectives of the Seventh Five-year Development Plan
and the efforts under the industrial restructuring program with consideration
given to the special characteristics, roles and problems facing agriculture.
In addition to contributing to economic growth and export earnings,
agriculture has played a critical role in income dittribution and reducing the
population and employment pressure on the large cities. Development strategy
in agriculture and agroprocessing is based on four fundamental sets of
policies and actions:
(a) liberalization and support of trade with the convertible
currency markets;
(b) improvement of the incentive system facing enterprise managers
in terms of prices, taxes and subsidies;
(c) identification and implementation of those actions in the areas
of the production, processing, marketing chain which reduce
costs, promote efficiency and emphasize products which have the
best export market prospects at internationally competitive
prices; and
(d) introduction of management-labor systems in agriculture and
agroprocessing enterprises which provide more effective use of
land, particularly of the cooperatives, and use of capital for
meeting specific production targets based on market forces.
- 9 -
These four policy areas are the focus of the Bank's discussions with
Government on agricultural and agroprocessing policy, and are being followed
up with Government.
Selected Subsectors
3.02 Poultry. The poultry br, .ch of agroindustry is not internationally
competitive at present. Subsidies of about US$108 million equivalent, 30X of
gross production value, were provided in 1986 to enable processors to maintain
exports and domestic sales at current depressed price levels in the face of
negative value added which totalled US$34 million. International
broilerprices have fallen substantially since 1983. Nevertheless, major
indicators of efficiency of the poultry show Hungary lagging behind its major
competitors in world markets.
3.03 Improving feed formulation is a prerequisite to achieving
competitiveness for poultry. Average feed conversion ratios are below and
mortality rates, and days to slaughter recorded in Hungary are substantially
above those recorded for the United States. The two most critical factors
contributing to this poor performance are inadequate supply of high protein
soymeal required for feeds and government maintenance of high prices on
imported protein in order to conserve foreign exchange and promote domestic
production. The artificially high price of soymeal results in inefficient
substitution of grain for soymeal in feeds which lowers protein content. The
government maintains a defacto quota on imports through import licensing and
control over foreign exchange. The total soymeal deficit for the country in
1987 is estimated at 100,000 tons, appoximately 20% of imports. Increasing
soymeal imports and the supply available to poultry producers at lower prices
are essential at least in the short- to medium-term if Hungary is to improve
production efficiency and profitability and reduce the budgetary drain caused
by the subsidies. Otherwise, current levels of poultry production should be
reduced in line with appropriate feed supplies. In the longer term, the new
IFC-financed, lysine facility scheduled for full development by 1992 and
increasing domestic production would help reduce import requirements, but the
economic viability of domestic soybean production is yet to be proven. Local
costs of soymeal prnduction are currently 15-20% higher than importing. High
mortality rates in Hungary can also be improved through better veterinary
practices and better care during transport to the processor.
3.04 Processed Fruits and Vegetables. As in the case of poultr
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3.05 The most important cause of the first two constraints is the weakness
of domestic feeder industries which provide glass, jars* cans, packaging,
additives and other ingredients for processed products. This issue is not
exclusive to this branch, but affects wine and many other agroprocessed
exports. Two problems with packaging are evident throughout the food
processing industry; poor quality and unreliable supply. The latter causes
enterprises to hold large inventories in order to guarantee that production
schedules and supply contracts can be met, but this imposes high financial
costs and efficiency losses. The poor quality of packaging also affects the
pos.tioning of Hungarian products in international markets and results in a
lower price, irrespective of the quality of the contents of the product. This
leads many importers of Hungarian products in convertible markets to provide
their own labels and packaging and implement expensive quality control
measures at the Hungarian factory, thus raising their transaction costs.
Although the import of labels and other packaging material does not result in
an outflow of foreign exchange, it reduces the domestic value added and
incremental foreign exchange earned by the branch due to lower net prices paid
by importers. It also contributes to the very high import content for these
products.
3.06 Two steps are necessary to improve this situation; first, greater
competition among enterprises in feeder industries is needed so as to improve
the quality and supply of products and services they provide to agroindustry;
second, modernization of these industries is required to upgrade industrial
design, graphics, and domestic content of convertible currency exports. These
steps are particularly pertinent to this project in respect of the feeder
industries involved in the production of glass bottle, jars, metal cans and
lids, cardboard and other laminated and coated paper containers and printed
labels and aluminum foils. The four largest processed fruits and vegetables
plants operate their own can manufacturing departments to overcome the
problems of reliability of supply and they supply cans to the smaller
processing plants, but suffer from underinvestment, fully depreciated
equipment, and inefficient management.
3.07 Over staffing in his branch has resulted from industry attempts to
satisfy peak labor demands with full time employees and growth in
administrative staff has not been commensurate with increased quality or
volume of output. The modernization of plant and equipment and reorganization
of production expected to take place through this project will, if successful,
likely exacerbate the problems of redundant labor. Enterprises will,
therefore, need to carry out a manpower assessment and make a medium-term
training and employment plan as part of the business plan attached to their
subloan application.
3.08 Wine. Unlike canning and preserving, 95% of packaging materials in
this branch are procured domestically. This situation is facilitated by the
fact that 85% value of wine is shipped to convertible markets in bulk, and
packaging requirements for such products are less rigorous than for bottled
wine. The steps outlined earlier for improving the quality and services of
feeder industries including glass bottles, labels, boxes, and corks are also
essential if this branch is to launch a successful effort to market higher
value bottled wines and champagnes in convertible currency markets.
3.09 As in the case of processed fruits and vegetables, improving feeder
industry is a necessary, though insufficient, condition for achieving
competitiveness in these product lines. In addition, new investment will be
- 11 -
needed to modernize physical and chemical wine treatment methods including
heat and filtration. An estimated 50% of equipment in the industry is
fully
depreciated. Investment is also needed to expand storage capacity
and upgrade
its standards. Current capacity is insufficient and almost two-thirds
fails
to meet western hygienic standards. Improvements in quality control and
laboratory testing facilities are also needed. Enterprises will be
required
to submit a qualification statement from MONIMPEX, the relevant FTO,
to the
lending commercial bank confirming that the enterprise has equipment
in place,
or that it will be procured under the subloan, in order to carry out
necessary
quality control tests on both raw materials used in processing and
the
finished product itself.
3.10 The final area in which greater attention and financing is
needed is
marketing. Again, while this concern applies to all branches included
under
the project, the issue is highlighted in this branch since bottled wines
are
not currently marketed in convertible markets to any great extent.
Enterprises and the responsible foreign trading organizations must therefore
make a strong commitment in terms of human and financial resources to
undertake an aggressive product promotion campaign to launch Hungarian bottled
wine in the convertible currency markets (paras. 6.15-6.16).
3.11 Wood Processing. The problems facing wood products are somewhat
different from the agroprocessed products. Principally, there is a
strong
demand on the international market for wood products, particularly for
the
hard woods which are indigenous to Hungary, despite the heavy felling
program
for the last ten years. The most important issue is to maximize the
return
from production and exports by better processing and marketing and by ensuring
that each product is sold in the best market. The main export items are
sawn
timber for packaging and for furniture structures, fiber board supply and
both
traditional and panel parquet. There are some fifty companies with direct
export licenses; virtually all of them are in need of replacement equipment
with modern technology which would ensure less waste and greater efficiency
in
the manufacturing process.
B. Trade-Related Issues
EEC Barriers to Entry
3.12 The barriers to entry faced by Hungary in its export markets
(especially the EEC) are comprised of tariffs and quantitative restrictions,
as well as of non-tariff barriers (e.g., legal, hygienic requirements).
In
general, the EEC, which receives about 402 of agroprocessed exports, imposes
an average 107 tariff on raw materials and 257 on processed goods. Hungary
must compete with other more favored exporting countries (ACP members,
countries of the Mediterranean rim), but in the type of temperate climate
exports Hungary produces, it does not face more restriction than any of its
competitors. But since 1980, world growing supplies of agroprocessed products
and tightening demand have created a buyer's market. Hungarians can cope
with
those exogenous factors through the improvement in the quality and servicing
of their products on export markets and signing of a trade agreement with
the
EEC, which is under active discussions between the Hungarians and the
representatives of the EEC and is expected to improve the Hungarian position
on the EEC market. The trade agreement is expected to halt discrimination
against Hungarian exports by EEC countries and develop understandings between
Hungary and EEC on a series of important products, which include agroprocessed
goods. EEC trade restrictions will continue to constrain Hungarian exports
to
the Community, but exporters are finding ways to find the niches for
- 12 -
agroprocessed products by evidence of export improvement in the EEC between
1980 and 1987. See Annex 2 for greater detail on barriers to entry into the
EEC for Hungarian agroprocessed goods.
Lack of Trade Promotion Services
3.13 Government-controlled Foreign Trading Organizations (FTO) manage all
product flows to the CMEA market and, until recently, controlled virtually all
export sales of agroprocessed goods to convertible currency markets. They
work through well-established agents and basically take orders which are
conveyed back to the processing plants. HUNGEXPO is an autonomous agency of
the Ministry of Trade MT and is responsible for trade fairs and the "Gutes aus
Ungarn" program, which is an advertising program under which high quality
goods are labelled and sold in the West German market. The Chamber of
Commerce invites and entertains foreign businessmen to Hungary and attempts to
develop general trade contacts abroad through a series of programs. KOPINT is
a market research institute which undertakes market studies on a contract
basis for paying clients. The commercial and agricultural attaches located at
Hungarian Embassies throughout the world attempt to carry out irregular
promotional efforts on behalf of Hungarian producers.
3.14 To initiate a breakthrough for Hungarian products, enterprises must
start the process of developing a marketing capability within those individual
enterprises that have achieved sufficient economies of scale in their
operations to justify direct marketing overseas, and to support those efforts
through an enhanced and more focussed infrastructure of public services
offering current market related information and analysis, as well as trade
related activities. 1/
Accomplshments in Trade Activities
3.15 While the country is facing important challenges in export
competition and requires strategic planning and action at the government level
as well as the enterprise level, it has undertaken over the last three years
several measures which indicate an acknowledgement of trade, constraints and
an apparent willingness to take the following actions:
(a) eliminate the trusts which handled resource allocation marketing
and sales of poultry, wine, and fruits and vegetables in the
early 1980s and abolished restrictions affecting exports;
1/ Hungary's lack of market intelligence, its primarily consignment-orientedtrading and the lack in flexibility of response to chenging world market
conditions represent another set of difficult constraints to overcome. They
arose out of: (i) traditional trading approach which seeks, mostly on an
ad-hoc 'Masis to provide the products they have been used to providing through
traditional channels; (ii) use of importing agents, foreign trading companies
ar.d trusts (the last ones being trading and market monopolies) which acted
more as "common agents" or passive sellers with little incentive to actively
search for new market prospects or niches; (iii) relative isolation of
producing agents from export markets; and (iv) pricing, subsidy and taxation
signals set by the state which often do not reflect world market signals and,
jointly with an inadequate accounting system, distorted the "true"profitability of firms thus providing opportunities for uneconomic investments.
- 13 -
(b) completed market studies of project product groups by
internationally known firms and through the Hungarian Chamber of
Commerce and organized a workshop with Bank assistance on
marketing and technology of project products in June 1987 in
Budapest;
(c) granted subsidies on export-oriented investments and direct
subsidies for selected agroprocessing and wood processing
exports to convertible currency markets together with an
improved automatic duty drawback system in order for Hungarian
goods to compete on world markets, particularly the EEC market;
and
(d) reduced import tariffs and eliminated many quantitative
restrictions on project products coming into Hungary in line
with GATT regulations.
C. Finaniagd Issues
3.16 In line with the economic reform program, Hungarian authorities
launched a program in January 1988 of changes in the way enterprises calculate
their prices to wholesalers and retailers and the way Government grants
subsidies. In general, prices to producers and consumers were liberalized and
a new set of taxes - value added, personal income and linear profit tax
replaced several other taxes. Current subsidies being transferred to the
agricultural and agroprocessing sectors are scheduled to be significantly
reduced over the medium-term. Despite these important changes in the current
system, the degree of change in prices and subsidies will depend directly on
the new tax system at the enterprise level. The details of those policy
changes can be found in Annex 3.
Impact of Reforms on Project Subsectors
3.17 Although the overall impact of the various price, tax and subsidy
changes is expected to be revenue neutral for much of agriculture, the impact
on project subsectors such as wine, soft drinks, and to a lesser extent,
poultry is expected by the government to be positive. For six enterprises
examined in the wine subsector, total sales revenue is expected to rise by 52
over 1986 baseline measures after 10-152 domestic price increases are offset
somewhat by reductions in consumer demand. The recent (November 1987)
devaluation against the dollar (42) and rising sales revenue should permit a
immediate reduction in subsidies. The most significant benefit for wine
enterprises stemming from the reform program is the reduction in the corporate
tax rate from 47% to 40%. This change, along with the other measures
affecting pricing, would result Ln an estimated 53% increase in net after tax
profits of the subsector.
3.18 In the fruit juice subsector, aggregate sales revenue for 5
enterprises studied is expected to increase by about 52 as a result of the
reforms, but domestic demand is expected to contract sharply with the
application of the VAT tax on these products. The reduction in corporate
taxation from 561 to 502 is, again, expected to be the most significant factor
affecting profitability for these products. Application of this lower rate
along with the assumptions on sales revenue are expected to result in a net
increase in after-tax profits by about US$ 0.8 million.
- 14 -
3.19 The benefits for the poultry subsector would increase net, after-tax
profits by 40X. This is primarily the result ot increasing sales revenue
due
to price liberalization and the devaluation against convert'tble currencies.
These results will depend on the ability of the industry to avoid an
overall
increase in production cost due to the planned increase in the price
of corn
and the expected increase in wages. Total subsidies to the industry can
be
reduced by about 2.52 as a result, in part, of the devaluation.
3.20 The reforms are expected to have a neutral impact on the processed
fruits and vegetables subsector, which would increase after-tax subsector
profit by about 42. Total sales revenue will increase slightly due to the
combined effects of higher domestic revenues and devaluation against
convertible currencies and revaluation against the rouble. Higher prices
that
will be demanded by small producers of fruits and vegetables whose marketed
sales make them liable to taxes and will likely be passed on to processors
who
will face higher costs of production. If they are not compensated, small
producers can be expected to reduce output or resort to other non-taxable
forms of exchange.
Financi Performnance of Agrorocessng Enterprises
3.21 Improvement in the management of corporate assets and in the capital
structure of enterprises is essential to increase efficiency and profitability
in agroprocessing in Hungary; progress in this area is expected to yield
substantial financial and economic benefits. At present, financial
management
of corporate assets is hampered by frequent underutilization of production
capacity, excessive build up of inventories of raw materials and finished
products, and excessive delays in collecting accounts receivables and
in
paying suppliers. Further, inadequate use of financial leverage for
investment financing limits the availability of financial resources to
agroprocessing enterprises and results in an excessive recourse to government
financing in the fcrm of subsidies.
3.22 A comparative analysis recently carried out with the assistance of
NBH and MEM on financial performance of enterprises operating in the same
subsectors in Hungary and in the U.S. clearly indicates these deficiencies
in
Hungarian agroindustries. The exercise is based on the comparison of 14 key
business ratios as derived from subsectoral aggregate financial statements
provided by the Hungarian authorities and on a set of Dun and Bradstreet
median financial indicators, which represent standard industry norms.
3.23 The fourteen business ratios are categorized into three major groups
as follows:
(a) Solvency or Liquidity Ratios which provide a significant measure
for evaluating a company's ability to meet short-term and
long-term obligations;
(b) Efficiency Ratios which indicate how effectively a company uses
and controls its assets; and
(c) Profitability ratios showing how successfully a business is
earning a return on its assets and to its owners.
- 15 -
3.24 As indicated by Table 2, the comparative analysis of the six
most
significant ratios provide a valuable insight into the Hungarian
agroprocessing and wood processing subsector. Detailed financial ratios,
can
be seen in Annex 4.
Table 2: HUNGARIAN AGROINDUSTRY BUSINESS RATIOS
Solvency Ratias Efficiency Ratios Profitability
Ratio
Current Total Liabilities/ Collection Sales/Inventory Assets/ Return
on
Ratio Networth X Period (Days) Turnover Sales X
Assets S
X (Days) X
POUJLTRYNorm 1.8 129.9
18.6 21.6 21.9 7.7
Hungarian 1.8 95.1 45.2 6.2 63.7
3.7
FRUITS AND VECETARLESNorm 1.6 147.4
23.3 4.9 50.3 5.1
Hungarian 1.8 97.6 58.9 2.2 107.6
3.8
Norm 1.8 93.9 51.4 1.6 133.3
1.0
Hungarian 1.8 88.8 51.1 2.0 113.7
2.3
WOOD PROCE5SINCNorm 0.8 67.1
92.3 7.2 161.0 0.3
Hungarian 3.3 20.7 40.3 4.2 106.1
5.7
Source: Dun and Bradstreet, IndustrX Norms and Key Business Ratios. 1986
and Mission Estimates.
3.25 The solvency ratio analysis indicates that the financial performance
of Hungarian agroindustrial enterprises compares well with the subsector
norms; but a large number of Hungarian firms in poultry, fruits and
vegetables, and wood processing are underleveraged with regard to
their
long-term borrowings position as indicated by the comparison of the
total
liabilities to net worth ratios. These show that on average in the
po-altry
and processed fruits and vegetables subsectors, Hungarian enterprises
use
about 40t less long-term borrowings than similar American enterprises
and in
the wood processing sector about 302 less. It is important that
financing of
investment of Hungarian agroprocessing enterprises should be done increasingly
through long-term borrowings instead of subsidies or equity capital.
This
would decrease the burden on Government funds and probably result in more
funds made available to enterprises for restructuring their assets.
It would
also improve capacity utilization and financial responsibility of
agroprocessing enterprises.
3.26 The comparison also shows that poultry and wood processing
enterprises make use of short-term borrowings less than their peer
enterprises
in the US as excessive financing of inventories often occurs through
a
Government-financed, quasi-equity facility. This transfer of long-term
funds
for current expenditures results in an unnecessary financial burden
for the
Government and excessive build-up of working capital. The latter
is normally
financed through short-term borrowings, which also oblige enterprises to
be
more financially responsible for their operations.
3.27 The efficiency ratios show significant deviations of financial
performance of Hungarian enterprises from the industry's norms. First,
slow
- 16 -
collection of receivables which is a problem especially in the poultry and
canning subsectors where the collection period is about 2.5 times longer than
the norm. This excessive delay results in significant financial cost on
account of lost interest to the companies and in liquidity shortages. The
excessive delays in collecting accounts receivables by enterprises and delays
in timely paying of accounts payables is, in fact, due to the current system
of cross-subsidizatien among enterprises. Primary producers are not timely
paid by agroprocessors who in turn are not paid in time by wholesalers and
retailers. This practice makes it difficult if not impossible, to charge
financial costs to those enterprises that actually incur them. Efforts should
be made throughout the industry to reduce the payments collection periods.This would permit better identification of corporate profitability and result
in decreased Government subsidies.
3.28 Second, the sales to inventory ratio, which is a useful inventory
control measurement tool to prevent excessive build up or ' sufficientinventory stocks, indicates an extremely low inventory tu. "er in the entire
agroprocessing sector in Hungary with the exception of the wine processing.
The situation is particularly anomalous in the poultry subsector where the
inventory turnover is about 4 times below the norm. It is also problematic in
fruits and vegetables, and wood processing with a turnover about half of the
norm. Extremely high inventories are usually the result of conservative or
inadequate sales management. A more aggressive sales and marketing policy and
a more conservative policy of inventory accumulations is required in order toreduce financial costs to the sector.
3.29 Third, the analysis of total assets-to-sales ratio indicates that
processed fruits and vegetables and poultry enterprises are undertrading or
not generating sufficient sales to warrant the assets invested. A more
aggressive sales policy and reorientation of investment is needed in order to
achieve a more efficient utilization of capacity. The sales-to-net working
capital ratio indicates that a company is overtrading or conversely carrying
more liquid assets than needed for its volume. In the case of Hungarian
agroprocessing enterprises, this ratio indicates excessive use of working
capital per unit of sales and that, therefore, a drastic reduction in the net
working capital position is required, especially in the case of the processed
fruits and vegetables and poultry subsectors. The accounts payable-to-sales
ratio indicates a problem only in the case of the Poultry subsector showing
that firms throughout the subsector may be using suppliers to help finance
operations.
3.30 Finally, profitability ratios indicate that the return on assets and
on net worth of the processed fruits and vegetables and poultry subsectors are
much below average performance. This is attributed to excessivecapitalization, and hence, the value of fixed assets is out of proport£on to
the processing activities undertaken. In general, Agroprocessing enterprises
in Hungery have a tendency to employ substantially more asset and inventoryvalue per unit of production and to use less borrowed capital than do similar
firms operating efficiently in a market-oriented economy.
3.31 Under the revised income regulation system, most enterprises willhave to increase their self financing capacity by a more efficient management
of their assets, especially current assets. This could be done through the
- 17 -
use of computerized corporate medium- and long-term planning to foresee
financial, technical, managerial and marketing improvements needed to improve
overall profitability. Commercial banks making subloans, for investment and
working capital, to agroindustrial enterprises need to see that medium- and
long-term restructuring planning is prepared at the company level as a
condition of subloan eligibility. Banks would have the obligation to ensure
that, in all cases, corporate plans of agroprocessing enterprises indicate
measures to improve their management of current assets. To achieve an
improved financial position, sub-borrowers would also need to improve their
capital structure by bringing about a more balanced total liabilities to net
worth position.
3.32 As a general rule, commercial banks would have to be assured prior
to subloan approval that improvement in the following ratios over the
medium-term be achieved up to the norm levels as a measure of acceptable
financial performance; current ratio, current liabilities to networth,
collection period, sales to inventory, assets to sales, and return on assets.
In addition, a computerized c)rporate plan would be submitted when applying
for a subloan, the plan would be periodically reviewed for performance by the
commercial banks. In addition, Annex 5 provictes a subsectoral example of
projections of financial statements of agroprocessing and wood processing
categories. Commercial banks would have to see that a similar methodology is
applied in the preparation of corporate medium-term planning of
sub-borrowers.
D. Istitutional Issues
3.33 Apart from the upgrading of vital supports of export trade promotion
and marketing which government and specialized agencies would render to
enterprises exporting to the convertible currency, enterprises are also in
critical need of the following institutional assistance: (a) grading and
quality control of raw material and final products; (b) training in management
and marketing of agrprocessed products; and (c) research and development of
new products, food technology and use of food processing machinery.
Grading and .ualitY Control
3.34 A major factor relevant for increasing earnings on western markets
is not the volume of raw material but its quality which requires the setting
and enforcement of industry standards at the raw material and final product
level. The introduction of an enforceable grading system based on uniform
standards on which processing firms can justify differential payment to
producers as a function of the quality of raw materials would increase the
supply of higher quality raw material, reduce losses at the processing -nt,
and improve the quality of the processed product. Likewise, agroprocessing
firms have not been sufficiently concerned with the quality of product
presentation, particularly regarding container labeling and packaging. Until
recently, Hungarian agroprocessing firms could sell low quality products
presented poorly on the domestic and the CMEA markets, but with their sights
now set on the sophisticated western markets and the Soviet market demanding
better quality products, firms are beginning to pay greater attention to the
overall presentation of their products in line with the competition.
- 18 -
3.35 The Hungarian food law is currently under review and revision by
Government; it is vague in its application and confusing to administer since
several government agencies -- Ministries of Agriculture, Trade and Health as
well as the Bureau of Standards and the University of Horticultural and Food
Industries -- are assigned tasks without sufficient clarity regarding
authority or enforcement of the law at the industry and enterprise levels.
Moreover, with prices officially prescribed by Government in the past, the
rewarding of volume production and the regulatory environment under which the
economy generated, there was little incentives f.,r managers to excel in
quality of product. It is still a widespread practice, particularly in the
processed fruits and vegetable industry, to ignore established quality
standards and accept all raw materials that are offered, which result in an
overall low average product quality. Revised grading system and quality
control standards are needed and should be based on existing western European
and U.S. practices both at the raw material and final product levels
(Annex 6).
Research and Development
3.36 The University of Horticulture and Food Industries (UHFI) is charged
with the responsibility of undertaking R&D for the food industry in general
and for specific enterprises on a contract basis. It seeks to achieve the
development of new products for export, improvements in production efficiency,
quality assurance and better utilization of by-products. The University has
proposed a series of programs for the project products, but requires a broader
view of its role in that research findings and quality control practices
actually reach the factory-floor. It needs to initiate a comprehensive
program on quality improvement in product packaging wh
4ch would integrate
handling, transport and processing line technologies in the development of
improved product presentation to final buyers. Unfcrtunately, as in the case
of agricultural research, other than the transfer of technology spread by the
technical production units, final users of the research have initially no
input into the setting of priorities and design of the work. Therefore,
priority setting of UHFI should be a result of structured meetings with MEM,
MT and various industry groups (Annex 7). R&D is also required in packaging
standards, technology and design if Hungarian products are to increase their
international competitiveness.
Traing in Management and Marketing
3.37 The University of Horticulture and Food Industries (UHFI) has
proposed a training program for management and marketing specific to the
project that would aim at training personnel from foreign trading
organizations, commercial and agricultural attaches, commercial banks, and
ministries of agriculture, trade and industry. They would organize special
training programs for the different levels of enterprise managers on a case
study method. Marketing candidates would be placed in a foreign branch of a
trading office or supermarket chain store which carries on business in
Hungary. In order to improve its own capacity for training, UHFI would send
its staff abroad for study and research and bring expatriates regularly to
Budapest as guest lecturers. A key to the success of the program will be the
development of the international cooperation with management training
institutes in other countries and the exchange of staff that this will allow
(Annex 8).
- 19 -
Feeder Industries
3.38 The lack of quality and timely availability of jars, bottles,
lids,
cans, boxes, labels, printing and other goods and services needed
by the food
industry is one of the fundamental constraints to growth of food exports
and
profitability of enterprises. The food industry should set its own
standards
for the packaging the) procure from the feeder industries, and set up
a
program, with their suppliers on a one-to-one basis for quality improvement.
Government would be expected to assist these feeder industries which
have
particular problems in meeting the quality, variety and timeliness
requirements of agroprocessing enterprise as they target specific customers
in
convertible currency markets. One of the major constraints for expanding
exports of processed fruit and vegetables and wine is the lack of appropriate
glass containers delivered in a timely manner by the current monopoly
enterprise which controls the four glass contair%.L plants in the country.
Another constraint is the lack of specialized ma, :aufacturing companies
which use modern technology to produce modern style tans for exports (Annex
9>
E. Impact of Bank Lendin in Agriculture
3.39 The Grain Storage and Farm Mechanization Project (1983, Ln.
2316) was
the first Bank operation in Hungary and has been followed in the agricultural
sector by two other projects, the Integrated Livestock Industry Project
(1985,
Ln. 2510) and the Crop Production Improvement Project (1986, Ln. 2738).
The
Grain Storage Project was successfully closed on December 31, 1986 and
contributed to the replacement of obsolete, deteriorated grain storage
facilities and on-farm equipment such as combine harvesters, tractors,
etc.
with modern equipment, embodying new technology. It also introduced
the
Hungarians to cost effective storage facilities in terms of both construction
and operating costs and helped trained operators of storage facilities
in
efficient storage and handling practices. Under the first Bank project, the
project preparation system used by Bank staff was initially transferred
to
Hungarian counterparts in the agricultural sector and the door was slightly
opened for exchange of views on agricultural policies, particularly
in the
area of prices, taxes and subsidies. Under the initiative and guidance
of
Bank staff, the Hungarians began a series of economic, technical
and financial
studies which formed the basis of an increasingly relevant dialogue
regarding
current government strategies in agriculture. The Livestock project
is
assisting the Hungarians to modernize the production and marketing system
for
beef, sheep, pork, milk and products and lamb/mutton, and includes
improvements in institutions and practices in input supply, on-farm
development, slaughterhouse rehabilitation and export marketing. Within an
overall Government program to gradually liberalize the economy, discussions
between the bank and authorities under the project resulted in a
complete
review of their price policy and led to increases in milk prices
to consumera
and the eventual breakup of the Meat Trust in January 1987; both actions
proved to be important and were subsequently followed by further
price
liberalization (para 6.05) and export trade liberalization (para 3.15).
The
project was innovative as it focussed on improvements in export marketing
with
particular reference to changing the traditional ways of thinking
about how
livestock products are sold on foreign markets. In response to this project,
MEM reorgan! -A itself to place production and marketing activities under one
deputy minister whereas these two functions had been managed earlier
under
different deputy ministers. More recently, the Crop Production project
is
funding high-efficiency farm machinery and construction equipment for land
improvement. In line with the need for high levels of fertilizer, liquid
- 20 -
fertilizer plants are expected to be constructed or rehabilitated. However,
demand appears slow for these funds and a reduced construction plan is
envisaged compared to appraisal estimates. The project has also introduced a
computerized management information system at the Papa State farm level as a
pilot exercise and is expanding the traIning of agricultural extension agents
in farm management techniques and practices. Since the commencement of Bank
involvement in the sector, the Hungarians have made significant reforms in
agricultural policy particularly in prices and tax liberalization. They have
reduced the amount to be sold in the category of fixed prices to farmers from
50% to 10% and the amount to be sold to consumer food goods in the category of
fixed prices from 55Z to 25X. Enterprises management is now largely
responsible to the workers and not to MEM and agroprocessing enterprises have
directly exported about 15% of food products to convertible currency markets
without going through the traditional FTOs.
IV. THE PROJECT
A. Concept. Desiga and Objectives
4.01 In parallel with the ongoing restructuring of the industrial sector,
the concept underlying the proposed project is to realign, over time, the
production mix of the agroprocessing sector in line with expected effective
market demand, particularly, on the convertible currency market. The Project
seeks to achieve a breakthrough in motivating agroprocessing managers towards
efficiency, exports and profitability by internalizing the commitment of
managers of enterprises to produce improved product quality and to engage in
direct marketing to the large supermarket chains and other large buyers in
Western Europe and other selected parts of the world. Individual anterprises
are expected: (a) to develop clear product and market strategies, (h) to
reduce costs of production, (c) to improve product quality through better and
more efficient technologies in product processing, and (d) to impose methods
of enterprise management which fulfill modern standards such as those
practiced in comparable model countries like Denmark and Holland. These
developments are expected to be accompanied by greater financial autonomy and
by greater independence from the Ministry of Agriculture in terms of capacity
and freedom to take and to carry out major decisions on investment, product
selection, pricing and medium-term, business planning.
4.02 The Project was originally designed by MEM to include a number of
pre-selected firms in the subsectors of poultry, processed fruits and
vegetables, wine and fruti juices, and wood products. In the judgement of MEM
and NBH, these firms were in need of rehabilitation of their capital stock and
reorganization of their product lines in order to take advantage of presumed
current and potential export opportunities in the convertible currency
markets. It became apparent during project preparation that, due to the
difficulty of market access and the weak overall financial structure of some
of these enterprises, all firms should be required to meet a series of lending
criteria which would include, in addition to the financial analysis of the
project investment, assessment and improvement of the financial structure of
the enterprise, its organization and management, its technology, and its
country specific marketing strategy. In addition, in January 1987 a new
commercial banking system was established, which provides for competition
among the banks and requires them to take responsibility for subloan
decisions. The project was redesigned from financing a possible list of
enterprises selected by MEM to a credit line, open to all agroprocessing
- 21 -
enterprises which qualify under the criteria set by the commercial banks.
This expansion of the project scope challenges the preselected firms to
improve their plans for the future in line with market signals and permits
only the best firms with a viable investment package to support such
development to be included in the Project.
4.03 The Project seeks to enhance international competitiveness of
Hungarian agroprocessed exports and increase the efficiency of production and
effectiveness of marketing of agroprocessed products. The specific objectives
of the Project are to:
(a) increase earnings of processed agricultural and forestry
exports, particularly to the convertible currency market, by
improving the quality and marketing of exports;
(b) improve the efficiency of operations of enterprises in the
agroprocessing sector by reducing their unit costs of operations
and improving their productivity; and
(c) create a more effective business climate in the agroprocessing
subsector in line with macro economic price and tax reforms.
These objectives directly support the macro-economic goals of the Government,
which are to achieve a balance in its foreign payments account by increasing
exports and greater efficiency in the production of agricultural and
agroprocessed goods.
B. Project Description
4.04 The Project would provide funds through the intermediary banks to
about 70 agroprocessing enterprises to modernize their facilities and to
incorporate improved management. marketing and technology into the
operations. Each enterprise requesting subloans would prepare, with the help
of qualified consultants, a medium-term business plan which would include
country-specific product and market strategies, the appropriate equipment
technology, modern management practices and a responsive organizational
structure; an environmental impact assessment would also be included with each
subloan application. Modern, up-to-date equipment for packaging, canning,
bottling, chilling, freezing and cold storage of food and wood products would
be the major areas for plant improvement. Computer software and consultant
services would also be financed for those firms which want to install
inventory control systems, cost accounting, including management information
systems and other operations requiring automation.
4.05 The project selected subsectors are poultry, processed fruits and
vegetables, wine and fruit juices and wood processing. Apart from meat
products which are covered under an ongoing bank-financed project, those
subsectors offer the greatest possibilities for increasing earnings from
exports. Improving competitiveness of poultry production through targeted
financing under the Agroindustry Modernization project is critical given the
importance of these products among agroindustrial exports (approximately, 20%
of total) and the fiscal drain caused by subsidies. There is an identified
need to modernize plant and equipment of processing operations and improve
- aZ -
their capacity to produce higher value products such as cut chicken,
turkey,
and other products suitable for export to convertible currency markets.
Major
constraints on achieving competitiveness relate to shortcomings at the breeder
and grow-out stage. Feed formulation, poultry management, the quality
of
day-old chicks, lack of modern equipment and competition at the hatchery
stage, as well as the genetic qualities of breeding stock are issues that
must
be addressed in the context of financing for the subsector. The project
would
provide funds ror investment in the poultry breeder industry currently
held by
two enterprises and for rehabilitation of grow-out farms. Processed fruits
and vegetables receive large subsidies from Government due to high costs
of
production and low prices received from the USSR. Major restructuring
of the
existing enterprises as well as the feeder industries supplying
glass
containers and cans is urgently needed in order to become more -ompetitive
on
Western markets.
4.06 Hungary's production of wine is divided into three broad
groups; bulk
wine, bottled wine, and sparkling wine. Only bulk wine can be characterized
as marginally competitive in convertible currency markets at present. Value
added in this branch was slightly positive in 1986 (US$4 million equivalent).
Several constraints facing the wine industry relate to packaging, processing,
storage, quality control and marketing must be addressed if Hungary is
to
increase its convertible currency earnings in this branch and increase
value
added in production. Unlike the other subsectors, wood products
enjoy a
strong demand, particularly the hard wood, which is indigenous to
Hungary.
Enterprises are in need of rehabilitated factories along the lines of those
high value added products indicated by market studies carried out during
project preparation (para. 6.22).
4.07 The Project would upgrade support services to enterprises,
in terms
of: (a) export trade promotion and marketing; (b) training in management
and
marketing; (c) grading and quality control of raw materials and final
products; and (d) research and development. It would also seek to create
restructuring of the glass container industry and can manufacturing so
as to
assist agroprocessing enterprise to improve its competitive position
on export
markets with more attractive and appropriate jars, bottles and cans.
C. Cost and Financing
4.08 The total financing required for the Project is estimated at
US$160
million, of which US$86 million (54X) would be in foreign exchange, as
shown
in Table 3:
- 23 -
Table 3: PROJECT COST ESTIMATE
HUNGARYAGROPROCESSING MODERNIZATION PROJECT
PROjECT COST SUMIARY
(FT '0001 (USS '000\ S Total
------------------------ ^----------- --------------------------- I Foreign Base
Local Forsign Total Local Foreign Total Exchange Costs
_=c=======z= ===:-===== =:::=:===:=z =======: ==
=::==:::=::= =:::
A. MINE AND JUICE 660,854.9 712.012.3 1.372,867.2 14,045.3 15,132.6 29.177.8
52 22
8. PROCESSED VEGETABLES AND FRUITS 281.091.7 513,761.7 794,853.4 5,974.1 10,919. 1 16,893.2
65 12
C. POULTRY 1,046,008.5 1,240, 191.3 2,286. 199.9 22,231.0 26. 358. 1
48 589. 1 54 36
0. FORESTRY 446,366.9 707.515.3 1.153,882.3 9.486.7 15,037.0 24.523.7
61 18
E. TECHNICAL ASSISTANCE 259. 592.4 188, 084.4 457. 676.8 5, 729.7 3,997.4
9, 727. 1 41 7
F. NARKETING 49,392.0 260.610.0 310,002.0 1,049. 7 5,538.8 6,588.5
84 5
Total BASELINE COSTS 2. 753.306.4 3.622, 175. 1 6.375.4U1.5 58,516.6 76,982.9 135,499.5
57 100
Physical Contirgencies 269.619.7 328,529.0 598, 148.7 5,730.3 6,982.3 12,712.6
55 9
Price Contingencies 453,930.7 111.645. 1 565. 575.8 9.647.5 2,372.8 12,020.3
20 9
Total PROJECT COSTS 3.476,856.9 4.062. 349. 1 7,539. 206.0 73. 894. 4 86. 338.0
160,232.4 54 118
January 19. 1988 21:42
4.09 The base costs were derived from feasibility studies and adjusted
by
the appraisal mission to prices of March 1988 at the exchange rate of US$1 =
FT 46. The cost estimates