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International financing for forestry

Stephen E. McGaughey

Stephen E. McGaughey is Chief, Agricultural Economics Section, Inter-American Development Bank, Washington, D.C. This article is adapted from, a paper presented at the Ninth World Forestry Congress in Mexico City, 1-10 July 1985.

There is a growing awareness in developing countries of the potential contribution and importance of forestry investments to both commercial and social development. While some countries have made a national decision to increase forest-sector financing, many others either do not have the investment resources or have not found the best way to promote the sector. International financing institutions have increased their- funding in recent years, but the amounts are still quite small in comparison with the probable investment requirements. Foresters have not convinced national policy-makers of the sector's importance, and their national institutions are still weak. This article explains what can be done.

WATERSHED MANAGEMENT AREA IN PAKISTAN reforestation needed to check erosion (F. MATTIOLI/FAO)

· The financial requirements of the forest-based sector are increasing because of the rising national and international awareness of its contribution to economic development (World Bank, 1978). At the same time, there are restrictions on the future availability of both official development assistance and national financial resources because of fiscal limits in developed and developing countries.

The total amount of official assistance has grown slowly in the last ten years, with the share going to agriculture and forestry remaining disappointingly low (Organisation for Economic Co-operation and Development, 1984). In this regard, the financial resources supplied to the forest-based sector have expanded only erratically, mainly on the basis of the availability of individual projects and the occasional expansion of national programmes, rather than on that of any concerted effort by national policy-makers and international financial agencies to act. Concurrently, in a slowly growing world economy, countries have been subjected to severe internal adjustment crises stemming from external debt and balance-of-payment problems, inflation, unemployment, and food shortages, adding up to generally limited growth prospects and declining capital budgets.

Because of the unfavourable economic and fiscal climate, international forest-sector policy-makers are now challenged to demonstrate that forest-sector investments compare favourably with competing uses for the limited funds. The experience of the World Bank and the Inter-American Development Bank (IDB) as well as various studies (Sedjo, 1983) demonstrate that both industrial and social forestry investments have favourable rates of economic return. Nevertheless, at present, these forest-sector investments must compete with investments in (non-forest) industry, agriculture and other sectors as well as such current (even emergency) needs as food imports.

Forestry agencies have yet to incorporate an investment project approach in formulating their programmes; they usually organize their activities along functional lines based upon narrow technical objectives of the institutions.

GATHERING DATA ON EUCALYPT PLANTATION better planning can encourage more investment (FAO)

A number of lessons learned from forestry programmes financed by international financial institutions suggest that further steps need to be taken to increase their assistance to the sector. To facilitate international aid, national programmes will also have to be designed to be amenable to existing international financing approaches, which require the preparation and execution of individual investment and technical-assistance projects. More importantly, forestry agencies have yet to incorporate an investment project approach in formulating their programmes; they usually organize their activities along functional lines based upon narrow technical objectives of the institutions, e.g. species research, insect control, national park management or forest resources mensuration.

There are numerous opportunities for increased international financing of national forest-sector programmes, but their realization depends more upon factors under the control of national authorities than on policies of international agencies, because of the pressing limitation on international resources. Regarding international finance, most international and regional institutions have already initiated promotional programmes for the sector. The World Bank dramatically increased its lending to the sector in the late 1970s following the preparation of a sector policy document. The IDB in 1982-83 completed a major study and conference on financing forest-sector development (McGaughey & Gregersen, 1983). The Canadian International Development Agency has recently evaluated its experience in the forest-based sector. The United States Agency for International Development (AID) accelerated its sector activities after the US Congress authorized action in 1979. Other examples can be drawn from initiatives by FAO in social forestry and UNDP's financing of a wide variety of technical-assistance programmes aimed at forest project development.

Despite these many new and significant initiatives, the level of official development assistance to the forest sector remains low. It serves, at best, as a catalytic factor in initiating new programmes or ensuring the continuity of others rather than as a resource to sustain sector development over a long period. Therefore, the bulk of future sector financing will have to come from national public and private sources, complemented by growing international private financing.

Sources and requirements

The diagram on page 9 depicts the relationship between (1) public and private (direct and indirect) sources of financing, whether of national or international origin; (2) selected major categories of forestry and forest industry investments (including components of larger projects such as hydroelectric or agricultural projects); and (3) the financing mechanisms that are used in channelling resources from public and private sources to the investment projects. The mechanisms include a full range of indirect and direct ways of transferring resources, with or without cost, to the beneficiary (Gregersen & McGaughey, 1985).

Funds come from public or private, domestic or international sources; some move initially from public sources, through private inter mediaries, on through to the final investment project. In this article, issues and the constraints on increasing the funding of international public financial sources are given most emphasis.

In several recent studies, attempts have been made to quantify the investment costs of forest-sector development strategies by region and by country. If traditional commercial forest-industry investments and industrial plantations are included, the costs tend to be very large in relation to the supply of existing international and national funds. For example, the IDB estimated that in Latin America, investments of about US$8 000 million annually would be required just to cover the most significant investment opportunities in forest industry and industrial plantations through the year 2000 (McGaughey & Gregersen, 1983). Spears and Ayensu (1984) recently estimated that the total annual worldwide costs of plantation and conservation forestry investments (excluding forest industry) for the period 19862000 would be $5 300 million, of which it is estimated that one-third needs to be in the form of official development assistance. This assumes an across-the-board national commitment to watershed rehabilitation, biological conservation, fuelwood plantations, industrial forestry, forestry research, and education and training; and, therefore, this figure should be treated as an upper limit of the future volume of financing.

PINE NURSERY IN BURMA to meet fuelwood demands (F. BOTTS/FAO)

LOCAL WOOD PRODUCTS IN HAITI the forestry sector needs investment (J. LAGLEY)

The dollar amounts discussed in both reports tend to be large in comparison with the number of investment projects that are at present available for implementation by international financial agencies and with the total volume of lending likely to be disbursed during the next five to ten years. However, there is still a margin to increase the annual funding from its current levels. At present, the World Bank commits about $150 million and the regional development banks no more than about $75 million to $100 million a year to the sector. At the most, average annual new loan commitments of $300 million to $400 million for forestry and forest industry by financial institutions and bilateral agencies should be considered optimistic figures.

Priorities and programmes

Beginning in the 1960s, but continuing actively today, multilateral and bilateral institutions have financed commercial forestry and forest industry investments. These projects meet traditional criteria of financial viability and often are integrated forest industries and plantations or industrial processing facilities exploiting existing natural forest resources. At present, traditional forest industry investments are likely to be important for those countries suffering serious balance-of-payments problems that have already established a significant forest resource and are able to compete in international markets with a competitive cost structure.

There have been changes in the forest-sector programmes of international financial institutions, which are reflected in their technical-assistance programmes. A notable feature has been the introduction, since the early 1980s, of social and environmental forestry investments. Accompanying the emphasis on rural development, social forestry elements were introduced as project components. FAO introduced the term "forestry for local community development", and later the use of the term "social forestry" became widespread. Worldwide, the World Bank undertook a substantial volume of social-forestry lending. Regionally, the Asian Development Bank and the IDB have approved several social-forestry elements as a part of rural development projects, as well as separate social-forestry projects. AID has been especially active in supporting social-forestry programmes.

With the advent of the energy crisis, wood-based energy became more valuable for the rural poor, for industry and in urban household use. International financial agencies responded by including fuelwood production projects in integrated rural development projects, and later these were introduced as major elements of national forestry programmes. Likewise, the availability of cheap hydroelectric generation sources in some regions, especially Latin America, brought to the forefront the need to protect valuable watersheds. This produced a ready economic justification for including forestry conservation in national energy programmes. More recently, the recurrence of food scarcities in Africa has increased the desirability of introducing multipurpose forestry plantations providing conservation, animal fodder and local fuelwood supplies as components of national agricultural programmes.

In brief, international institutions now appear more disposed to finance a variety of forest-sector investments in response to rapidly changing circumstances, even in the face of serious constraints on the expansion of international financing. But within the international institutions themselves, the forest sector has always had difficulty in competing for limited resources with other (apparently) more urgent needs such as agricultural and food production.

There has also been a general lack of knowledge about forestry investments, and even a certain unfounded prejudice against them. A further problem is that project loan officers are unfamiliar with the design, operation and management of forestry investments. With the exception of forest industry investment projects, which have ready national or international markets, forest-sector investments are thought to have long gestation periods, providing returns that are too far in the future. Moreover, forestry projects (especially plantations) usually have high foreign-exchange costs, whereas most multilateral and bilateral institutions were conceived originally to be mechanisms for transferring limited foreign exchange to developing countries. Nevertheless, international agencies have heavily and traditionally financed irrigation projects that typically have low rates of return, long gestation periods, and subsidies for the beneficiaries.

What it costs not to invest

For the past two decades, most national governments and aid agencies have been so preoccupied with the enormity of trying to feed the Third World's exploding population that more than 95 percent of all aid-agency agricultural investment has been channelled into projects that have short-term food production as their basic objective. Investments in agriculture, education, human nutrition, health and the like have invariably taken precedence over the need for protection of the basic land and natural resources on which human survival will ultimately depend. For example, forestry conservation investment by the development banks over the last decade amounted to less than 1 percent of their total investment.

Past failures by both national government and the international community adequately to invest in forest conservation' in watershed rehabilitation, and in antidesertification, soil-erosion control and other environmental protection measures have had an extremely high economic and social cost.

Some of the decline in agricultural productivity, the food shortages, the human suffering and the environmental damage that developing countries are facing today could have been avoided through greater political commitment in the past to investment in natural-resource conservation.

To quote from a recent World Environmental Commission report:

Long range programmes that would have helped to tackle the underlying problems have received comparatively little support. The antidesertitication programme adopted by the UN in 1977, for example, was largely ignored by donor and recipient governments alike. That programme, it is interesting to note, was estimated to cost US$4.5 billions per annum to the year 2000 for the entire globe. A breakdown of this figure reveals that the estimated cost for Ethiopia was US$50 million per year to the year 2000. Neither the political will nor the money could be found to implement this programme, however. Yet, eight years later, faced with a human drama beyond precedent, the world community has had to find an estimated US$400 million for crisis-response measures to date for Ethiopia alone, and this figure will undoubtedly exceed US$500 million before the next harvest. It will go well beyond that if the harvest fails again. The arithmetic of prevention is almost always persuasive; somehow we have to invent a politics of prevention that can match the politics of crises.

From "Deforestation issues in developing countries: the case for an accelerated investment programme", a paper presented at the Twelfth Commonwealth Conference in Victoria, B.C., Canada, in September 1985 by John Spears, Forestry Adviser to the World Bank.

Disbursement periods for forestry loan components should be in the order of eight to ten years; currently, in international agencies, they are around five years.

Similar difficulties in convincing national policy-makers have occurred. (Of course, there are important exceptions in Brazil, Chile. India, Malaysia and the Republic of Korea, to cite some examples.) Foresters struggle to sell their programmes, with limited success, despite the large potential contribution of the sector, the wide extent of resource conservation problems and the meagre financing that has gone to the sector so far.

To overcome these difficulties, the national forestry-financing question has to be treated by forestry agencies in terms of two problems. The first is to demonstrate to national policy-makers the feasibility and the considerable contribution that such investments make to national development. This can be well documented with the rates of return obtained for forestry investments of the World Bank and the regional development banks. Additionally, the multiple benefits of forestry to national economic and social development, in terms of foreign exchange, energy supplies, food, fodder, income and employment, need to be demonstrated to national finance and planning officials.

The second problem at the national level is to design workable financial transfer mechanisms for forestry investments. These range from direct financial subsidies to forest operators, long-term commercial credit, and direct grants of seedlings and planting and harvesting equipment to individual foresters. Experience has shown that there is no single formula for structuring financial incentives; each country has to design them on the basis of the characteristics of its own financial and fiscal system and local capital markets. Important examples are Chile's highly successful direct subsidies; Brazilian tax "holidays that have produced large plantation investments; and the Republic of Korea's national programme of subsidized credit that worked effectively. Generally, however, subsidized forestry credit programmes have not worked well in most other countries.

Nevertheless, progress has been made by international financial institutions in supporting forest-sector development. A decade ago it was extremely difficult to have forestry projects taken seriously by the financial agencies; now forestry has become a legitimate activity in all institutions. The issue at the international level is whether forestry financing will remain relatively small, subject to doubtful priority in comparison with other sectors, and whether a secure uniform flow of international resources will be made available to promote incipient national forestry programmes.

International financing issues

Loan conditions The first issue concerns the loan conditions of the financing institutions. Current lending regulations of international and regional multilateral banks are not fully suited to financing forestry development. This is particularly the case in the absence of national public financing and incentives in amounts and conditions consistent with the characteristics of forest-sector projects.

The lending terms of international agencies that potentially affect forestry investments are (1) the rate of interest; (2) the grace period; (3) the disbursement period; (4) the foreign exchange content; and (5) the repayment period. If the government guarantees global loans and then private banks on lend to groups or individual borrowers, or, alternatively, if the government provides direct project financing or in-kind project contributions, the critical terms affecting forestry projects are the grace and disbursement periods and the foreign-exchange content. As long as financing is available, the rate of interest, except at very high real levels, appears less limiting for project success.

The disbursement periods for forestry loan components should be in the order of eight to ten years; currently, in international agencies, they are around five years. In other sectors where the production cycle is relatively long, such as livestock, international lending agencies have used multistage global credit loans to sustain the activity. This procedure, although less than optimal, might be used for forestry when disbursement periods of eight years and longer are common. To date, international and regional institutions have been unwilling to incorporate the long disbursement periods, even for other subsectors like irrigation or livestock.

The other critical element is the, foreign-exchange content of the forestry loan or subloan. In the past, international and regional banks; financed only the foreign-exchange costs of a project, which restricted government interest in natural-resource investments. But this has, been changing. The IDB applies pre-established percentages of! project costs, which are then financed with foreign exchange, and, they may exceed the foreign-exchange outlays. This means that any project with a low true foreign-exchange component (such as forestry) would be attractive to national financial authorities since there is an element of free foreign exchange made available from the loan. This is an added stimulus to governments to supply financial incentives to forestry, to compensate for the projects cash-flow deficiencies.

International regional financial institutions should give far greater attention to helping countries design effective financial incentives, especially for plantations and other forestry projects.

Instruments A second important issue is whether international institutions can introduce new financing instruments for the forest sector. Among the possibilities are (1) joint (co- or associated) financing schemes; (2) the establishment of guarantee funds to reduce risk; (3) insurance schemes sponsored by national governments; and (4) sector and global loan programmes, integrating industry and resource financing. Co-financing schemes have been widely studied by international financial agencies as a tool to increase the leverage of public funds. Co-financing might include joint financing among several international or regional multilateral banks; or private commercial banks, or regional or national export-finance agencies; or bilateral development funds. In forestry projects such arrangements could be made to extend a project's cash flow by modifying the repayment, grace, and disbursement periods.

Guarantee funds might be established to reduce the risk to national financial intermediaries when they finance private forest plantations. These funds could be set up as reserves to cover loan defaults and other related losses. Multilateral and bilateral agencies have recently used guarantee funds to promote small-business loans, and they appear to be promising instruments for a limited category of forestry investment projects. They are not needed when governments provide direct financing to project beneficiaries.

Insurance against fire, insects, flood and similar losses might be provided at the national level to reduce project risks. Crop insurance programmes usually have a large government subsidy element; forest insurance would likely have a similar cost structure.

Sector, global and economic adjustment loans have been employed by multilateral and bilateral agencies to finance agricultural and industrial development. Global loans are used to channel funds through financial intermediaries to private subborrowers. In a sector or economic adjustment loan, a sector investment programme is financed by a series of disbursements that are conditional on progress achieved in the total investment schedule and public policies, rather than on individual projects. The sector loan usually contains complementary financing and a technical-assistance package to supply inputs to the sector investment programme. The sectoral approach might be used advantageously in countries that have already established a capacity to identify, prepare and execute several investment projects simultaneously.

Coordination A third important international financing issue concerns the need for better combining of international loan conditions and terms with national financing incentives for forestry investments. Elsewhere, it has been suggested that it is a necessity to provide public financial incentives to ensure an adequate volume of forestry investments (Gregersen & McGaughey, 1985). This has also been clearly demonstrated in several countries where financial incentives were used to expand significantly the national industrial plantation programme and provide a base for a competitive and diversified national forest industry or for a secure national fuelwood supply. The successful programmes of Brazil, Chile and the Republic of Korea have been cited frequently.

It is clear that forestry incentives (subsidies) are essential because of the special nature of forestry (and other natural-resource) investments. First, forestry investments have important external economies (economists' jargon for benefits that extend outside the investment project and may benefit other people besides the individual investor) such as soil conservation, flood control, and ecological protection. Second, there are great uncertainties about future revenues from the investments. Third, the cash flow of forestry investments. with relatively extended initial periods of cash deficits (negative cash flows), requires special long-term financing, even if the economic and financial rates of return are satisfactory.

BOTANY STUDENT IN NIGERIA investment also needed for education (UN/FAO)

The essential point is that international financing, even with favourable project rates of return, is not likely to succeed unless either national financial incentives make up for the inappropriate international loan conditions or the international loan conditions are changed to meet the project's financial structure. There are many examples of lines of international credit that have gone unused because national incentives were not appropriate. Therefore, international and regional financial institutions should give far greater attention to helping countries design effective financial incentives, especially for tree plantations and other forestry projects that have long payoff periods and high degrees of risk and uncertainty affecting their returns.

Guidelines for future financing

The forest sector can contribute significantly to the social and economic goals of developing countries, even those suffering severe short-term economic, external, and internal crises. Several countries have already shown that if high national priority is assigned to the forest sector, both in its commercial and social aspects, forest plantation areas and yields can be increased sharply in less than a decade. But this process, because of the nature of forestry investments, must be stimulated by direct public subsidies, especially financial grants or tax write-offs. While direct subsidies are often successful in stimulating tree plantations of all kinds, they are essential if international financing, under present loan terms and conditions, is to be increased and used judiciously. Conditions and terms for international financing need to be revised to provide for the extension of disbursement periods appropriate for forestry investments. Failing this, national governments will have to increase the volume of sector subsidies to cover operating cash shortfalls. International financing should be increased particularly for agroforestry and conservation purposes.

Even if international financing institutions modify their lending conditions, national authorities will have to examine ways of increasing national financial incentives to forestry. In the face of severe fiscal constraints, this will require careful use of existing funds and a combination of incentives (grants, credits, in-kind contributions, tax write-offs) that maximize the increase in forest resources for the funds that are committed. For example, it has been widely commented that some countries have supplied forestry subsidies above amounts that would have been needed to obtain the resulting forestation rate. While this proposition is difficult to demonstrate, the small extra costs of subsidies have probably been tolerable within the public fiscal budget of most countries. There is little experience in helping countries design optimum forestry-subsidy programmes (i.e. those that keep costs low and are effective and sustainable under current and medium-term fiscal constraints). It is recommended that international financial and technical-assistance institutions provide specialized assistance to developing countries to design improved financial incentives for the sector.

A further requirement for immediate action is the provision of institutional support to forestry agencies, in two fields - research and training, and investment project formulation. FAO and the International Union of Forestry Research Organizations have reviewed proposals for organizing forestry research and establishing regional and international networks of research institutions. Most proposals have substantial merit but, to date, there has been a lack of initiative to organize and finance such arrangements. There is an absence of support for forestry project formulation; especially lacking is training for foresters to identify and prepare projects that might be candidates for international finance. These two areas of technical assistance deserve high-priority action by financial agencies.


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GREGERSEN, HANS M. & MCGAUGHEY, STEPHEN E. 1985 Improving policies and financing mechanisms for forestry development. Washington, D.C.. Inter-American Development Bank.

MCGAUGHEY, STEPHEN E. & GREGERSEN, HANS M., eds. 1983 Forest-based development in Latin America. Washington, D.C., Inter-American Development Bank.

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. 1984 Development cooperation: 1984 review. Paris.

SEDJO, ROGER A. 1983 The comparative economies of plantation forestry: a global assessment. Washington, D.C., Resources for the Future.

SPEARS, JOHN & AYENSU, EDWARD S. 1984 Global Possible Conference: sectoral policy on
forestry. Washington, D.C., World Resources Institute.

WORLD BANK. 1978 Forestry sector policy paper. Washington, D.C.

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