REPORT

VIETNAM SUGAR CASE

EXECUTIVE

SUMMARY

GENERAL INFO Vietnam

Area: 331,114 sq. km. 21% arable 28% forest and woodland 51% other Population (2011): 90 million. Annual population growth rate (2011): 1.077%. Deaths/1,000 live births Life expectancy--73 yrs. GDP: (2010) $102 billion; (2011, first 9 months) $81 billion. Industry and construction (41.09% of GDP, 2010) mining and quarrying, manufacturing, electricity, gas, crude oil, water supply, cement, coal, and steel. Services (38.33% of GDP, 2010) tourism, wholesale and retail, hotel and restaurant, transport storage, telecommunications Agriculture, forestry, and fisheries (20.58% of GDP, 2010) rice, coffee, cashews, maize, pepper (spice), sweet potato, pork, peanuts Real GDP growth rate: (2010) 6.8%; (2011, first 9 months) 5.76%. Per capita income (2010): U.S. $1,168. External debt (2010): 42.2% of GDP, $32.50 billion. Source: www.state.gov

This report discusses IFC project risks for financing $90 million sugar mill in northern Vietnam, try to answer the main question: Will IFC finance the project, taking into consideration of projects commercial viability/attractiveness impact assessment, risks face to project and gives some recommendations. It also summarizes the findings of research and recommends the IFC to approve the loan. Vietnam is country where sugar consumption is about two times higher than the volume of production. At the same time, north of country is not developed as south which is the one of main concern of the government.

The Tate & Lyle Group operates in over 50 countries with a turnover of over 4 billion. In 1998 Tate & Lyle asked the International Finance Corporation (IFC) to consider lending up to $45 million (IFC A loan-20 mln, IFC B loan-25 mln) to finance a $90 million sugar mill in Northern Vietnam. Result of analysis shown there are many critical factors, which make the project attractive (expanding population, low current sugar consumption, import of sugar, governmental support, need to develop the northern part of the country). Analysis show that development of sugar mill in Northern Vietnam will improve social situation in the Vietnam as well. From the economic perspective of the project, Economic Rate of Return (ERR) is about 19%, which is much more high than IFC threshold value of 10%. And this calculation includes cash flows of employees, cane growers, truck haulers, profit tax, import tariff loses and inflation as well. Beside on this calculated IRR for the project is about 18%.

INTRODUCTION
In September 1998 Tate & Lyle asked the International Finance Corporation (IFC) to consider lending up to $45 million (IFC A loan-20 mln, IFC B loan-25 mln)1 to finance a $90 million sugar mill in Northern Vietnam. To make decision the IFC agricultural unit has been conducting a research investigating the following questions:

The projects commercial viability and attractiveness from the sponsors perspective. The assessment of projects development impact. The major risks facing the project.
COMMERCIAL VIABILITY/ ATTRACTIVENESS

PROJECT

The project considers construction and operation of sugar mill in Northern Vietnam. The Company has been established as a foreign joint venture. The Sponsors intend to capitalize on the rapid growth in domestic demand for sugar forecast for the country. The most critical factors, which make the project attractive, are: Expanding population. Low current sugar consumption. 9kg/person expected to grow to 14 kg by 2005 Deficit sugar country imports sugar Domestic demand (700,000 tons in 1997) vs. Domestic supply (360,000 tons) Strong quotas/high tariffs system profitable domestic production. The trade restrictions, which protects the industry from world prices and on average raised domestic prices well above world prices2; Government support, as it is considered strategically important project for the country:

1 Through B Loan, IFC offers financial institutions the opportunity to lend to IFC-financed projects. These loans are a key part of IFC's efforts to mobilize additional private sector financing in developing countries. Participants in IFC's B Loans share the advantages, including preferred creditor access to foreign exchange in the event of a foreign currency crisis in a particular country. Where applicable, participant banks are also exempted from the mandatory country-risk provisioning requirements that regulatory authorities may impose if these banks were to lend directly to projects in developing countries. An A loan is governed by a Participation Agreement (loan is from IFC account). As in a B loan, IFC remains the lender of record for the entire A Loan. A participant shares all project risks with IFC and has the same benefits of a traditional B Loan participant (www.ifc.org) 2 However, the surge in production toward the end of the investment period can make Vietnam close to
self-sufficient in sugar production, and market saturation can cause prices to fall close to world prices.

Need to develop the northern part of the country Besides the aim to meet demands for sugar through domestic production, other implicit objectives of the program appeared to include employment creation, skills development in the regional labor force, a contribution to the reduction of hunger and poverty in rural areas, and industrialization of the rural economy. Tax advantages, if IFC will approve the project. The concentration of sugar production in Vietnam is too low, and does not allow companies to exploit economies of scale (See Chart 1). The new mill will achieve economies of scale in milling, because they use better technology in milling, educate farmers in better farming methods and are able to set up longer term contracts with farmers for sugar cane supply. The latter means low cost price and additional revenues. The process of investment analysis in capital budgeting requires analyzing the project to check for expected returns.

First, the calculated IRR3 for the project is about 18%. Directly comparing it with organization's cost of capital, we will see that project covers its cost of capital. Second, NPV stands for net present value and signifies the net benefits from an investment in terms of money whereas IRR stands for internal rate of return and signifies the rate of return on an investment. Besides, the economic rate of return (ERR) is about 19,19% for this project, which is much more high than IFC threshold value of 10%.

PROJECT

IMPACT ANALYSIS

ERR

In order to have a complete and objective picture, it should be taken into consideration the impact level of the project on interested parties/stakeholders also. Developmental benefits include direct employment of an estimated 725 mill workers (premiums and approximately twice higher salaries). As the price of the sugar produced by NATL would include tarifs and taxes, both imported and domestic sugar prices will be equalize. High quality of national production to some extent can be more attractive for the consumers and hence be rather competetive in the market. Researches show that the revenues from sugar cane will exceed the ones that farmers gain from alternative crops. The farmers on the second year will spend only 10% of total revenue on haulage and 43% on Labor and Fertilizer. NATL needs 300 trucks for cane delivery. Under pressure of government preference will be given to locals while signing trucking contracts. The truckers will probably be truckowning farmers who will deliver cane part-time with their main work or probably they will not have their own trucks but will be able to borrow money to buy used trucks. Competitors Local residents grow their own sugar cane for their own consumption or for small handicraft mills that are less effective: 50% of extraction vs 90% of modern mills. NATL can buy the can from these farmers paying them much more than they

3 The IRR is the interest rate that makes the net present value of all cash flow equal to zero. In financial
analysis terms, the IRR can be defined a discount rate at which the present value of a series of investments is equal to the present value of the returns on those investments.

would gain from processing it thereby supporting farmers. It can bring closure of small mills will displace mill workers, which may generate political barriers. The project has been rated environmental category B under IFC's environmental review procedure (www.ifc.org). Infrastructural development will connect neighboring regions thereby rase speed and quality of trade as well as facilitate the delivery of cane to the mill. But to this end government has to make investment of $800.000 which is not done yet. Before this the farmers will have to use existing bridges and roads, which raise the costs of transportation. As an investment company NATL will have to pay 25% of profit tax after 5 years since the first profit, 10% of value added tax and 30% tariff for equalizing to the tariff that Vietnamese companies pay for imported sugar. This will increase budget of Vietnam and will help to solve social problems that the government faces with. It was also estimated Economic Rate of Return (ERR). In this calculation are included cash flows of employees, can growers, truck haulers, profit tax, import tariff loses and inflation as well. The value of ERR is estimated on 19.19% level. The IFC Threshold Value of ERR is 10%.

PROJECT RISKS
The most important risk that the project may face is the Supply Risk. It includes: Cane supply/feedstock risk: To function on its full capacity about 22000 farmers should supply the company. And to mitigate the cane supply risk NATL will encourage local farmer to convert to cane. The payment mechanisms also increase the risk of supply, because farmers want to get their money in whole, in one payment. Also it was estimated that growing sugar cane is more favorable, which is a good argument to believe that many farmers will convert to the sugar cane. According to interviews the big part of Vietnamese farmers are going to convert to the sugar cane. Anyway, farmers for many decades supply local sugar companies, and it will take some time from NATL to convince farmers to change their habit. Transportation risk: During the harvesting season, which lasts six months, the project will need 300 trucks. And this contains several risks:

Bad transportation infrastructure of the region, and the fact that Vietnamese government did not keep it promise to build the roads and bridges wholly. It means, trucks will need to be repaired frequently; as well the fuel consumption will rise, which is additional burden for the farmers. Second, which is very actual in case of bad transportation infrastructure, is that cane deteriorates very fast. It means that cane should be transported as fast as possible. This implies the existence of trucks, but many farmers do not have their own trucks, and they have to find additional money to buy or rent trucks. But for the farmers it is significant expenditure.

Considering the fact that agriculture accounted for the nearly half on the Vietnams income, the success of the project is very important for the Vietnamese government, not

only from the perspective of the development of the region and the country at whole, but also to show foreign investors that Vietnam is the safe place to invest in. Sponsors risk could be neglected because of the reputation of the sponsor company4. Relationship between Sugar, Oil and Corn prices. Figure 3 shows there are a likely linear relationship between sugar, corn and oil prices. This is not surprising from first look, because oil is used during the production process of sugar and every fluctuation of oil price lead to change of sugar price. According to Robert Wisner (Professor of Economics and Energy Economist, Ag Marketing Resources Center Iowa State University) The main factor is the growing importance of fuel ethanol as a percentage of total demand for U.S. corn. With the current large size of the ethanol industry, corn prices have become closely related to crude petroleum and gasoline prices because corn is now a major energy crop 5. On the other hand Ethanol has not been the only factor influencing corn prices, which shows recent analysis6. Armenia - Vietnam sugar industry outlook Armenia looks like Vietnam in terms of sugar import. Sugar consumption per person in Armenia was 29.5 kg in 2005 and it reached to 35 kg in 2007, which is proportional to developed countries rate. At the same time, recent five years Armenia imports more than 80 000 MT sugar each year, while Vietnam imports more than 35000MT sugar 7. The economic structure of both countries are also similar each other (see Figure 1). Anyway Armenia has close borders, which has direct influence on sugar cost prices. In 2007 new sugar fabric was established in Armenia, which considered working on the raw-material from Brazil. The investor wanted to encourage rural people to switch to sugar beet. Unfortunately, today the factory doesnt operate, due to raw materials high prices. Also local farmers are not familiar with the factory suggestions/payment options to grow local beet. This is the same challenge faced to IFC project in Vietnam.

RECOMMENDATIONS
Taking into account the results of research, we can conclude that overall risk of project is below the moderate level and IFC can finance the project. The project implementation provides wide range of high social benefits, including employment creation, skills development in the regional labor force, a contribution to the reduction of hunger and poverty in rural areas, and industrialization of the rural economy.
4 The Tate & Lyle company was established in 1921 and it has been building sugar mills all around the
world for years. The Tate & Lyle Group operates in over 50 countries with a turnover of over 4 billion (Tate & Lyle Annul Report 1998).

5 R. Wisner; AgMRC Renewable Energy Newsletter August 2009, Iowa State University
6 THE RENEWABLE FUELS FOUNDATION; ANALYSIS OF CORN, COMMODITY, AND CONSUMER FOOD PRICES, 2011

7 www.indexmundi.com

It is reasonable to finance project as the ERR indicator shows that both social and financial benefits are sufficient.

ANNEXES
Exhibit 1: IFC

Source www.ifc.org

Chart 1: Milling costs reflecting economies of scale in production

Source: Centre for International Economics (2001)

The fact that there are many smallholders involved in sugar production in Vietnam increases transaction and coordination costs, and reduces scale economies. Thus Vietnamese sugar production is not efficient compared with leading cane producers . Exhibit 2 Relationship between Sugar, Oil and Corn prices

Note: Prices for Sugar and Corn reduced 10 times. Source: Case materials

Figure 1

Source: Global Finance, Nov. 2010