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Hungary: Agroprocessing Modernization Project (Loan 2936-HU)

The Hungary Agroprocessing Modernization project, supported by Loan 2936-HU for US$70 million equivalent, was approved in FY88. The loan closed on schedule in FY94, after US$21.9 million was canceled at the Borrower's request because the funds were no longer needed. The Implementation Completion Report (ICR) was prepared by the Europe and Central Asia Regional Office. The Borrower's assessment of the project is appended to the ICR.

The overriding objective of the project was to increase export earnings from processed agricultural and forestry products by improving facilities, operations, management and marketing. Participating commercial banks were to lend US$60 million to state-owned enterprises for investments directed exclusively at increasing exports. The balance of the loan was for technical assistance, training and studies to improve export-oriented institutions, including the development of a center to provide information on foreign markets and help to improve the packaging of export products. The project was carefully prepared. It identified key constraints on agroindustrial exporting and developed a good program for dealing with them.

After the collapse of Communism in Eastern Europe, Hungary's new government launched a program of economic liberalization, including privatization of state-owned assets. These changes also led the government to transform the project's objectives. Although the basic objective to increase export earnings as stipulated in the project description in the loan agreement was never revised, the five amendments to the loan enabled banks to make loans to private firms whose activities had nothing to do with exporting. By FY90, project funds were supporting the conversion of public enterprises into private firms and providing term and working capital_then in short supply_to new firms. By 1993 the demand for project funds had dried up as other donors made credit available on more favorable terms. Exporting also dropped out of the de facto new project after many of Hungary's export markets disappeared following the collapse of the Soviet Bloc. Hungary's lack of knowledge about international markets and attractive export products constrained exporting to other countries.

The project's new objectives were partially achieved. Under the loan, US$48 million equivalent disbursed of which US$45 million went to 56 subloans. The loan agreement, as amended, stipulated that the financial rate of return to these subloans should be at least 18 percent per year. The ICR does not provide average financial or economic rates of return to the subloans. It does state that US$10 million equivalent went to six enterprises that are now bankrupt. The ICR also states that about 30 percent of the US$45 million in subloans went to loss-making firms. Thus, it seems that 70 percent of the funds lent as subloans had financial rates of return greater than zero. The original objectives were not completely ignored: US$3 million aided export-support institutions in the public sector, mostly before 1990. Some of these institutions still exist, although the government has not developed a plan for their future operation.

The ICR assesses project outcome as satisfactory. It argues that although the objectives of the original exportsupport project were achieved to "only a limited extent," the new objectives (called modifications in the ICR) in the form of financial support to the development of private enterprises were achieved to a greater degree and on balance the outcome was satisfactory. OED disagrees, rating outcome as marginally unsatisfactory because of the seemingly overall weak financial and economic performance of the subloans. In discussing project outcome, the ICR stresses success in reducing subsidies to agriculture from 8 percent of GDP to 2 percent. The loan, however, was not policy-based and subsidy reform was not a basic project objective. There is neither covenant nor reference to reducing subsidies in the loan-agreement and its amendments. The agreement to reduce agricultural subsidization is found only in a side-letter agreed at negotiations. The subsidy-reduction was made independently of the project, and had no bearing on the project outcome. OED agrees with the ICR in rating sustainability as likely, and institutional development (at least in the private sector) as substantial. The ICR rates Bank performance as satisfactory. OED agrees but notes that the Bank never acknowledged that the objectives of the loan had changed.

The project experience suggests the following lessons: (i) successful restructuring of medium and large state-owned enterprises cannot be accomplished without sweeping reforms that address questions of enterprise ownership and regulation; and (ii) in situations of rapid economic change, there is need for close follow-up and frequent assessment of the overall economic situation, so as to quickly adapt the project to changing circumstances.

The ICR is unsatisfactory. Information on the achievement of objectives is incomplete. It fails to clearly distinguish between the objectives of the original project and the very different objectives of the de facto new project and does not evaluate the project experience accordingly. An audit is planned.

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