India - Nangal Fertilizer Project

DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Reort No. P-1172-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR A FERTILIZER PROJECT January 18, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group. authorization. The Bank. Group does not accept responsibility for the accuracy or completeness of the report.  CULRENCY E4UIVALENTS US$1.0( = Rs 7.28 Rs 1 US$0.137 Rs 10 million = US$1,374,000 Rs 1.0 billion = US$137 million *The central rate reported to IMF is Rs 7.28 per US$1. However, the actual rate fluctuates as the Rs is pegged to the British b which has been floating vis-a-vis the US$ since June 23, 1972. Fiscal Year April 1 - March 31  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMNDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR A FERTILIZER PROJECT 1. I submit the following report and recommendation on a proposed credit to India in an amount equivalent to US$58 million on standard IDA terms to help finance the Nangal Fertilizer Expansion Project. PART I - THE ECONOMY 2. The most recent economic report, "Economic Situation and Prospects of India" (SA-32a, dated May 10, 1972), was distributed to the Executive Directors on June 2, 1972. This report estimated that, for the Indian Fiscal Year ending on March 31, 1972, the economy grew at significantly less than 4 percent. For the current year, growth is expected to be even lower, and in- deed there is the prospect that there may not be any growth at all. The prin- cipal factor in the decline this year has been the serious failure of the monsoon. In comparing the rate of economic growth achieved over the past two years with the average of 5 percent per annum experienced during the preceding two years, account should be taken of the fact that the Indian econonv under- went two years of bad weather in a period of sharply falling foreign aid and provided substantial economic aasistance to Bangladesh. 3. Until the beginning of 1972, performance in the industrial sector had been especially disappointing, with a downward trend from a growth rate of 7.1 percent in 1969 to 4.5 percent in 1971. However, the figure for 1971 obscures some improvement which began to take place during the last quarter and which was sustained during the first quarter of 1972. Over these six months industrial production increased by 7.2 percent compared with the same period the year before. But this improvement now has to be qualified, firstly because much of it was confined to the textile industry which re- covered from the effects of a severe shortage of raw cotton, and secondly because recent data indicate that no further increase in industrial output occurred during the latter part of 1972. The factors which have brought about this situation include lack of demand for certain capital goods, shor- tage of imported raw materials, labor unrest, power shortages, as well as managerial difficulties, especially in the steel industry. Cumbersome admiin- istrative procedures in applying industrial policy have also aggravated the situation. These factors have been present in varying degrees almost con- tinuously over the past decade with the result that India's industrial poten- tial has yet to be fully realized. What marks the last three years is the severity of the deceleration in industrial activity notwithstanding the modest reprieve gained in the early part of 1972. The Government of India (GOI) recognizes that fresh initiatives must be taken through industrial policy measures and the Association has recently held discussions in India on a possible role for IDA and the Bank in aiding the Government. It is too early to state any conclusions beyond noting that the GOI is reviewing its approach to industry as a whole and to steel and fertilizer in particular.  - 2 - 4. Agricultural production registered an increase of over 5 per- cent in each of the first two years of the Fourth Plan, with foodgrain production reaching 108 million tons in 1970/71. In 1971/72 foodgrain production was affected by ra-ther indifferent weather, with the result that only an estimated 106 mi:Llion tons were produced. This year weather conditions have been disastrous with a complete failure of the monsoon in both the west and east sides of the country, an unusual occurrence. Mean- ingful estimates have still to be made but clearly production of summer foodgrains will be substantially below last year's level. The current winter crop has also been adversely affected by lack of rain, with the re- sult that India is likely to endure very serious shortages of food over large parts of the country. The Government had hoped that large foodgrain stocks built up between 1968 and 1970 would be adequate to meet require- ments in bad years. But the combined effect of supplying foodgrain to Bangladesh and the severity of the drought this year has led to foodgrain stocks being reduced by about half, to 3-4 million tons at the end of 1972. These stocks are now being depleted at a rate of one million tons a month. The Government has decided to import about two million tons of foodgrains and more may be required if the winter crop does not recover from the ini- tial lack of rain. Other crops have also been affected. Jute and, to a lesser extent, cotton production are expected to be lower, while the short- age of oil seeds may be quite severe with the resulting need for higher im- ports. 5. In the present situation, the generally favorable trend in agricultural production over the past several years should not be over- looked. Even if this yearl"s f'oodgrain crop should be between 95 and 100 million tons, it would still be significantly above that obtained in the last serious drought year, 1965/66, when production reached only 72 million tons. This would indicate that the considerable investments in irrigation facilities, fertilizer, and other agricultural inputs have had the effect of reducing the impact of droughts. If yields this year remain high on irri- gated land in spite of adverse weather conditions, and reports of good crops in the Pumjab and Haryana are favorable indications, this will confirm the success of the new technology and highlight the need to broaden its use within India. 6. The wholesale price index increased at a rate of 7.5 percent be- tween April 1972 and August 1972. An important factor has been the rapid increase of food prices, which went up by 13 percent over this period re- flecting expected foodgrain shortages. In an effort to control inflation, the Government has limited the overdraft facilities available to State governments, previously a source of deficit spending, and is considering measures to control more effectively the level of foodgrain prices, but such steps are likely to be offset by the relief programs necessitated by the drought. 7. India's net reserve position at the end of August was US$1,180 million or the equivalent of 38 percent of annual imports, plus debt ser- vice payments. Reserves have fallen by nearly US$100 million since March 1972. Further pressure on the country's declining reserves from foodgrain  -3- imports is inevitable. On the export side, recent estimates indicate a 10 percent increase in exports between April and August this year, as compared with the corresponding period last year. But overall, the rate of growth of exports has been slow in the recent past while uncertainty surrounds future levels of net aid. In the circumstances, India should clearly continue to receive substantial aid from IDA. 8. A draft document setting out the approach to the Fifth Plan for the period 1974/75 to 1978/79 has already been approved by the Planning Commission and is now under review by the cabinet. Economic self-reliance and the elimination of poverty are held to be the major tasks of the Fifth Plan. In the light of the experience of the Fourth Plan, considerable effort will be required to achieve the 5.5 percent annual growth which is the target for the Fifth Plan period. 9. A country data sheet is attached as Annex I. PART II - BANK GROUP OPERATIONS IN INDIA 10. Since 1949 the Bank has made 40 loans and 46 development credits to India totalling US$1,110 million and US$1,956 million (both net of can- cellation), respectively. Of these amounts, US$554 million has been re- paid and US$772 million is still undisbursed. Annex II contains a summary statement of disbursements as of December 31, 1972, and notes on the status of currently active loans and credits. 11. Since 1957 IFC has made 13 commitments in India totalling US$42.3 million of which US$4.3 million has been repaid, US$7.0 million sold and US$6.0 million cancelled. Of the balance of US$25.0 mil1ion, US$16.9 million represents loans and US$8.1 million equity. A summary statement of IFC operations as of December 31, 1972, is also included in Annex II (page 2). 12. The emphasis of Bank Group assistance to India in recent years has been on agriculture and agriculture-related projects. This reflects the importance of agriculture, which contributes about 50 percent of India's GNP, and the corresponding investment priorities of the Government. In addition to the Agricultural Universities project, which was signed on November 10, and the present proposal, projects in agricultural credit, in agro-industries, and in agricultural markets are expected to be ready for consideration by the Executive Directors this fiscal year. 13. While the emphasis of Bank Group assistance will be on agricul- ture, lending to industry will also be a prominent feature of the program for this fiscal year. Assistance to the industrial sector will concentrate on the support of development finance institutions through a credit for the Industrial Development Bank of India, which was approved on January 9, and a proposed tenth loan to the Industrial Credit and Investment Corpora- tion of India. Industry will further benefit from an eighth Industrial Imports credit which will be submitted later. Assistance to infrastructure  - 4 - will be proposed through further projects for power transmission, tele- communications and urban development. India's large cities, particularly Bombay and Calcutta, require major investment in public services to keep up with the growth of their populations; accordingly, a Bombay water sup- ply and sewerage project and an urban development project in Calcutta are also included in this year's program. PART III - THE FERTILIZER SECTOR AN) THE PFOJECT 14. Increased fertilizer production is an essential part of India's program to increase agricultural production. The output of foodgrains, particularly the high-yielding varieties of wheat and rice, is a function of the overall fertilizer application rate, which in India is very low. 15. Since 1964, nitrogen production and consumption have increased at average annual rates of about 20 percent and 22 percent, respectively, but production still lags far behind consumption. In 1971/72 some 820,000 tons of nitrogen, almost half of total consuoption, was imported, at a total estimated foreign exchange cost of at least $120 million. 16. Projections of demand and supply through the end of the decade show a continuing deficit, even assuming optimistic start-up schedules for new projects and high capacity utilization for all plants. The pro- jections used by IDA assume that nitrogen consumption will grow about 20 percent compounded annually to 1974 and about 12 percent thereafter, leading to total consu.mption of some 14.6 million tons by 1979 (compared with 1.9 million tons for 1972). During the same period, supply is projected to increase to about 3.9 million tons from a current level of about 1.0 million tons. 17. The projected deficit is particularly large in northern India, where the project will be located. Fertilizer consumption per unit of cropped acre in the Punjab is over three times as great as for India as a whole. According to current; estimates, a shortage equivalent to the production of at least two additional large plants will persist in northern TLnia rit the end of the decade, even with the proposed Nangal urea project in full operation. 18. The Bank Group has recently been active in the fertilizer field in India. IDA has made two Credits, for expansions by the Fertilisers and Chemicals (Travancore) Ltcl. (FACT) in Cochin and by the Gorakhpur Unit of the Fertilizer Corporation of India (FCI). These have experienced some initial delays but project implementation is now proceeding at a satisfac- tory rate. IFC has participated in two private sector fertilizer projects: Indian Explosives Ltd., in Kanpur, Uttar Pradesh, and Zuari-Agro-Chemicals Ltd., in Goa. Indian Explosives is already operating, and Zuari Agro is about to commence operations. In addition, the Bank Group is now considering twc other fertilizer projects FCI Trombay, near Bombay, and Tata Chemicals,  -5- in Gujarat State. 19. The proposed credit would help finance the modification and ex- pansion of FCI's Nangal Unit. Located in the State of Punjab in northern India, the existing Nangal plant has an annual design capacity of 80,000 tons per year of nitrogen in the form of calcium ammonium nitrate (CAN) fertilizer and 14 tons per year of heavy water as by-product. The expan- sion project would provide capacity for producing an additional 152,000 tons per year of nitrogen in the form of urea, now the most popular fer- tilizer in India and in most other countries. It would also replace the power- intensive electrolysis section of the existing, fully depreciated ammonia plant, thus permitting release of a large amount of hydroelectric power for more economic uses in the area; the manufacture of heavy water would be discontinued but other existing production (CAN) and off-site facilities would be retained. The feedstock for the new (as well as the existing) fertilizer production facilities would be heavy fuel oil, of which in pre- sent circumstances India has relatively large quantities, but crude oil could be used as an alternative, if desired. 20. The Nangal Unit began operations in 1961 and has been FCIfs most profitable plant, not only because it has been operated efficiently but also because of the low price it pays for power, a price only about one- fourth of the opportunity cost of power. The plant operated consistently at close to full capacity until power shortages arose about two years ago. These have reduced fertilizer output at Nangal by about 30 percent. The power shortages are likely to continue and are an added reason for shutting down the existing electrolysis plant. 21. The plant designs and proposed capacities for the project reflect efficient and commercially proven technology. FCI will act as overall prime contractor for the project, with major parts of the design, procurement and erection supervision of the ammonia plant and the urea plant subcontracted to Fr. Uhde (Federal Republic of Germany) and to Montedison (Italy), respectively It is expected that the project will start commercial production after a con- struction period of 34 mt. Uhde and Montedison-will have major responaibilities for execution of the project, in order to help ensure its completion within the proposed budget and time schedule. A Project Manager has been appointed, and his responsibilities -- together with a detailed project implementation plan -- have been defined and are acceptable to the Association. 22. The cost of the project is estimated at about US$106 million equivalent, including interest during construction, with a maximum foreign exchange component of about US$58 million. The cost of equipment is es- timated at US$44.5 million equivalent, the remainder being the cost of en- gineering, design, project management, freight and handling, civil works, duties and taxes, and contingencies. The proposed credit would be dis- bursed primarily against expenditures for equipment subject to international competitive bidding (US$42.2 million), with Indian suppliers receiving a 15 percent preference. (The prevailing import duty on equipment is now 30 per- cent.) It is expected that Indian bidders will win about 10 percent of such contracts. Another US$2.5 million would be disbursed for proprietary items  - 6 - required for standardization, and US$7.5 million toward the costs of en- gineering, design, erection and cormmissioning. A small amount of non- critical equipment (about 4 percent of the total) would be reserved for domestic suppliers and financed out of GOI funds. 23. The proceeds of the proposed credit (US$58 million) would be passed on by GOI to ECI as long-term debt, at 8.5 percent interest for 15 years, including 5 years of grace. GOI would provide the remaining US$48 million equivalent as equity, and would also provide any overrun financing required, at least half as equity. Thus, about 55 percent of the financing for the project would be provided to FCI in the form of debt and 45 percent in equity. This is slightly higher than the usual propor- tion of debt for financing new FCI projects; but the Nangal plant has no outstanding long-term debt, and the debt:equity ratio of the plant after expansion will not exceed 35:65, a satisfactory level which will allow Nangal always to have a debt service coverage of better than 2.2:1. The financial return on the project would be about 18 percent before taxes and 14 percent after taxes. 24. The project's retw-ns are satisfactory. Using a conservative urea import price of US$65 per ton, c.i.f. India, the economic rate of return of the project is about 15 percent. This is quite good for a fer- tilizer plant in India, since Indian producers do not have access to natural gas, a relatively low-cost and convenient feedstock. If revenues and costs of the project were considered on an incremental basis, thereby including in the economic analysis of the project the shutting down of the electro- lysis section of the existing plant and the release of hydroelectric power for more econornic uses, the economic return would becone about 22 percent. 25. FCI is the largest fertilizer producer in India; at present it accounts for 30 percent of Indiats nitrogen and 10 percent of phosphate capacity. The project forms part of an ambitious expansion program in- volving nine plants now under construction and three in an advanced planning stage. This program will, by 1980, increase nitrogenous and phosphatic fer- tilizer production 5.4 and 9.3 times respectively over 1970 levels. While projects have been financed on a conservative 1 to 1 debt to equity ratio, FI's earnings record has been unsatisfactory (about 1.5 percent return on capital in recent years), due mainly to operating problems in existing plants and serious delays in plant construction. In the next two years annual losses of about Rs 20 million are expected because of continuing pro- duction difficulties and the expected start-up losses of three large fer- tilizer plants which are more than two years behind schedule. During that period, EI may need Government assistance to service its debt. Thereafter FCI's financial situation should show substantial improvement, provided it gives priority to bringing new plants into operation more quickly and to increasing overall utilization of existing capacity. 26. The Government and FCI agree that priority should be given to achieving maximum use of existing capacity and commissioning projects under construction. Careful examination of FCI's further expansion plans  -7- is needed to bring them better into line with FCl's resources: managerial, technical and financial. The method of carrying out the Nangal expansion project and also the subsequent expansion at Trombay are examples showing how further investments can be taken up reasonably, notwithstanding these constraints. The Government is presently preparing the fertilizer invest- ment program for the Fifth Five Year Plan (1974/75 - 1978/79). In addition to feasibility studies of specific project proposals, studies to determine organizational constraints are being undertaken by the Planning Commission. The Bank has recently been asked to review the investment program and to comment on it. This review will present an opportunity to discuss the specific steps which FCI and the Government are proposing to overcome FCI's present difficulties. Furtihermore, this review is expected to lead to the identification of future fertilizer projects suitable for Bank Group assis- tance. 27. Annex III provides a Project and Credit Summary. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 28. The draft Development Credit Agreement between India and the International Development Association, the draft Project Agreement between FCI and the Association, the Recommendation of the Committee provided for in Article V, Section 1(d) of the Articles of Agreement and the Text of the Resolution approving the proposed Development Credit are being distributed to the Executive Directors separately. The draft agreements generally con- form to the pattern of the earlier agreements for the Cochin and Gorakhpur fertilizer projects in India. 29. I am satisfied that the proposed credit will comply with the Articlesof Agreement of the Association. PART V - RECOMMENDATIONS 30. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President by J. Burke Knapp Attachments January 17, 1973   ANIIIEX I COUNTRY DATA - TNDIA AREA POPULATION DENSITY 3,268,580 km2 560 million (mid-1972) 172 per km2 Rate of growth: 2.23% (from 1961 to 1971) 31lf per km2 Of arable land POPUJLATION CNARACTERISTICS (1971) HEALT Populat ion per physician (1971) 4,010 (eat) Crlde Birth Rate (per 1,000) 38 (eat) Population per hospital. bed (1968/69) 1,826 Cs-de Death Rate (per 1,000) 16 (eat) Infant. Mortality (per 1,000 live births) 100-120 (est) INCOME DISTRIBUTION (1967/68) DISTRIBUTION OF LAND OWNERSHIP (1954/55) % of consamptioo, lowest quintils rural 8% (est) urban 7% (est) % owned by top 7% owners 52% (eat) % of consumption, highest quintile s-ral 41% (est) urban 44% (est) % owned by smallest 25% of owners 1% (est) AICCES TO PIPFD WATER (1971) ACCESS TO ELECTRICITY (1971) 8 of npulatlon - urban 70% (est) % of population - urban 100 (est) % of population - rural 5% (est) % of population - rural 25 (eat) NUTRITION (19i0-69) EDUCATTON Calorie intake as % of requirements 83 (est) Adult literacy rate % 41