State Joint/public Sector Industrial Projects -India

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-215 7-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR STATE JOINT AND PUBLIC SECTOR INDUSTRIAL PROJECTS THROUGH THE INDUSTRIAL DEVELOPMENT BANK OF INDIA January 5, 1978 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as of January 3, 1978) Rs 1.00 = Paise 100 US$1.00 = Rs 8.17 Rs 1.00 = US$0.1224 Rs 1 million US$122,400 (Since September 24, 1975 the Rupee has been officially valued relative to a "basket" of currencies. As these currencies are now float- ing, the US Dollar/Rupee exchange rate is subject to change. Conversions in the Appraisal Report were made at US$1 to Rs 9.00.) FISCAL YEAR April 1 - March 31 ABBREVIATIONS AND ACRONYMS DFC - Development Finance Company GOI - Government of India IDBI - Industrial Development Bank of India SFC - State Financial Corporation SIDC - State Industrial Development Corporation SIIC - State Industrial Investment Corporation  FOR OFFICIAL USE ONLY INDIA LOAN FOR STATE JOINT/PUBLIC SECTOR PROJECTS THROUGH THE INDUSTRIAL DEVELOPMENT BANK OF INDIA LOAN AND PROJECT SUMMARY Borrower: India, acting by its President Beneficiary: Industrial Development Bank of India (IDBI) Amount: US$25.0 million. Terms: Repayable over 17 years, including 3 years grace, at 7.45% interest per annum. The amortization schedule is subject to change to conform sub- stantially to the amortization schedule of sub- loans. Relending Terms: (a) India to IDBI: Repayable in accordance with aggregate maturities of sub-loans, but not exceeding 17 years, including 3 years of grace. Interest rate and commitment charge identical to those to be paid to IBRD by India under the Loan. Exchange risk to be borne by Government of India. (b) IDBI to Investment Enterprises: Repayment dependent on individual subproject but not to exceed 15 years. Interest at not less than 11% per annum for normal lending and not less than 9-1/2% per annum for lending in backward areas. Commitment charge at 1% per annum. Project Description: The project finances the foreign exchange cost of productive medium-scale industrial projects in the state joint/public sector. The project would assist IDBI in carrying out industrial sector investment studies, in strengthening the financial institutions dealing with this sector, namely State Industrial Development/Investment Corporations (SIDC/SIICs), and in developing projects particularly in the less developed States. A major benefit will be to pool private This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - and public capital and establish close working links between public and private sector partners in joint ventures. Better management and speedier implementation of sub-projects is expected to result. The project risks are no greater than can normally be expected with operations of this type. Estimated Commitments and Disbursements: (Fiscal Year) 1978 1979 1980 1981 1982 (US$ Millions) Commitments 5.0 15.0 5.0 - - Disbursements Annual - 5.5 8.0 8.0 4.5 Cumulative - 5.5 13.5 21.5 25.0 Free Limit: The first project of the first six states would be sent to the Bank for approval, as well as all subsequent projects involving IDBI financing of more than US$3 million. Appraisal Report: No. 1736a-IN, dated January 5, 1977.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR STATE JOINT/PUBLIC SECTOR INDUSTRIAL PROJECTS THROUGH THE INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI) 1. I submit the following report and recommendation on a proposed loan to India for the equivalent of US$25 million to help finance the foreign ex- change cost of IDBI's operations in respect of medium-scale industrial projects in the state joint/public sector. The terms of the loan would be an interest rate of 7.45% per annum and repayment not exceeding 17 years, including 3 years of grace. The Government of India (GOI) would on-lend US$24.5 million of the proceeds of the loan to IDBI under the same terms as the proposed loan. IDBI would use these funds to finance loans to sub-borrowers for a maximum of 15 years at interest at not less than 11% per annum for normal lending and not less than 9-1/2% per annum for lending in backward areas. The exchange risk would be borne by GOI. The balance of US$0.5 million of the loan would also be passed on by GOI to IDBI, as a grant, for financing technial assistance. FART I - THE ECONOMY 1/ 2. An economic report, "Economic Situation and Prospects of India" (1529-IN dated April 25, 1977), was distributed to the Executive Directors on May 3, 1977. Country data sheets are attached as Annex I. Background 3. India is exceptional among the Bank Group's member countries for its size and diversity; the country is divided into more than 20 States with a population of some 630 million speaking over 60 languages. Since Independ- ence the trend in growth of GNP has been about 3.5% per annum, or a little over 1% per annum in per capita terms, while over the five years 1971/72 - 1975/76 it fell to as low as 2.5% per annum, in spite of the record harvest of 1975/76. This unsatisfactory performance is only in part the result of the low availability of investable resources: while India's domestic savings effort compares well with other countries at the same average income levels, however, the net transfer of resources from abroad has never been above 3% of GNP, and fell to as little as 0.8% between 1969/70 and 1973/74. More signi- ficant perhaps is the fact that in spite of a marked rise in the investment rate from about 10% in the early 1950's to about 18% over the past fifteen years, the trend in GNP growth has remained about the same. This indicates a marked decline in the efficiency of capital use, as a result of increasing capacity underutilization, long project gestation, and increased emphasis on relatively capital intensive projects and sectors. 1/ Parts I and II of this report are essentially the same as Parts I and II of the President's Report for the Second Foodgrain Storage Project (Report No. P-2135-IN, dated November 3, 1977).  - 2 - 4. Since Independence the growth of the socio-economic infrastructure (transport, education, health services, etc.) has been impressive, but has often been achieved at high cost and has yielded results of variable quality. Many industrial and agricultural investment schemes have been highly success- ful, but others have taken excessively long to be completed and have operated well below full capacity. In some regions of the country, growth and struc- tural change have been rapid and compare favorably with developments in many other parts of the world; in other regions there has been stagnation, and in some, decline. Although national income has increased in most years, there has been no rise in the living standards of the vast mass of rural and urban poor, conservatively estimated at 200 million people with per capita incomes of US$70 per annum. 5. The structure of the economy has been slow to change. Agriculture remains the dominant sector, with its share of national product declining only gradually from about 50% to 42% over the last twenty years. The share of manufacturing industry has increased only slowly and, since the late 1960s, has remained approximately constant at about 16%. There has, however, been a shift in the composition of manufacturing production, with consumer, inter- mediate, and capital goods now contributing about one third each, compared with an overwhelming preponderance of consumer goods 25 years ago. Recent Trends 6. In March, 1977, a party other than Congress formed a Government for the first time since Independence. The Janata, or People's Party, is a heter- ogenous amalgamation of smaller parties which had never before been able to form a united front. The state of the economy was not a prominent election issue; in fact the economy was generally stronger than at any time in the last ten years. Over the two years 1975/76 and 1976/77, the growth of GDP averaged 5.4% per annum. Agricultural production in 1976/77 did fall by about 3% but only because of a return to a more normal harvest of 111 million tons after the record 121 million ton output in 1975/76. In fact, the 1976/77 figure is the second largest harvest on record. The growth of industrial production accelerated over the past two years from 6.1% in 1975/76 to 9.2% in 1976/77. The volume growth of exports continued its impressive recent performance, and averaged approximately 13% per annum over the past two years. This export growth, together with hardly any increase in import levels, has resulted in dramatic balance of trade improvements with an estimated deficit for 1976/77 of less than US$500 million. In sum, the overall resource position with record foreign exchange and foodgrain reserves, is exceptionally strong, and gives the Government considerable room for manoeuver. 7. In agriculture the bumper crop of 1975/76 was largely due to remark- ably good rainfall, both in amount and distribution, while the good crop in 1976/77 was produced under somewhat less than normal weather conditions. A conspicuous change was the increase in fertilizer use, which rose by about 25% over 1975/76, following marked declines in fertilizer prices. Industrial production benefited from fewer labor disputes, fuller utilization of in- stalled capacity in both private and public sectors, a more liberal import policy, relatively good power availability, and increased demand because of  - 3 - higher consumer incomes, expanded exports and higher public expenditures. Inflation re-emerged in 1976/77 as an important issue of economic management. During 1975/76 the wholesale price index had fallen by 8.5%; but in 1976/77 it rose by 11.6%. The key characteristic of this rise was that it occurred largely in a few agricultural commodities for which prices had dramatically fallen in the previous year. In the twelve months ending September 1977, the increase was less than 5%. The overall price index has shown virtually no trend over the past three years taken together. 8. The balance of payments situation has improved dramatically since the 1973-1975 period. In 1975/76 the trade deficit was $1,530 million, which was more than covered by US$1,560 million in net aid, US$205 million in net purchases of currency from the IMF, and US$559 million in net miscellaneous capital and invisibles (mostly private remittances); indeed, this large aggregate net resource inflow led to a US$794 million increase in foreign exchange reserves, to a level of almost US$2.2 billion. In 1976/77, the balance of payments continued to improve, with exports provisionally esti- mated to have increased by US$1,145 million against an imports increase of only US$85 million, so that the trade balance deficit is now estimated at only US$470 million. The sharply decreased trade deficit, along with a further increase in the net inflow of miscellaneous capital and invisibles from abroad of US$640 million, more than offset the fall of US$350 million in net aid and the US$365 million repurchases of currency from the IMF, and allowed a US$1.5 billion addition to reserves, which reached a level of US$3.7 billion at the end of March 1977. The developments have continued in the current year, with reserves estimated at US$4.8 billion as of October 1977. Development Prospects 9. The favorable economic situation gives the Government the opportun- ity to address the longer-term constraints on growth. The basic task is to raise the overall rate of growth from its historic range of 3% to 4%. In the long run this will require raising more resources for investment. But it will also be important to achieve significantly better utilization of avail- able resources, partly through an immediate boost to industrial demand. 10. In agriculture, the basic problem remains that, despite the record foodgrain crop in 1975/76 and the good crop in 1976/77, the long-term growth rate of foodgrain production has been unacceptably low, less than 3% per annum over the last twenty-five years, and less than 2% since 1967/68. This has meant that only in good years has there been any margin of production to cater to per capita growth in food consumption, and in normal years it has been necessary to import food. There is considerable scope for stepping up growth both by increasing the use of inputs and by raising the productivity of exist- ing capacity. Three promising developments in regard to the first are the sharply higher outlays on irrigation in the Fifth Plan Period along with a renewed determination to increase public investment in irrigation even more in the next plan period beginning March 1978 and to complete existing projects expeditiously; the indications that private investment in tubewells is picking up again after a slowdown in the early 1970's; and the continued recovery of fertilizer demand. With regard to more productive use of existing capacity,  - 4 - there is increased awareness in the Government that the benefits of irrigation projects can be much increased not only through command area development but also through more efficient design and operation of major surface irrigation infrastructure. Also, hopes have been generated for increasing productivity on both irrigated and rainfed farms through a reorganized and improved exten- sion and research system, which has been recently introduced in several States in northern and eastern India. 11. A strong effort to raise agricultural growth is essential, not only to meet food requirements, but also because of the pervasive influence of agriculture on the levels of activity in other sectors of the economy. This effort must also be so structured as to increase the incomes of small and marginal farmers, in order to increase production since they operate 25% of the cultivated land and account for somewhat more than 25% of production, and for welfare reasons, since they make up about 70% of rural population and constitute the majority of those living below the poverty level. 12. The industrial sector is poised for growth, as serious constraints on the supply side have been removed by the improved situation, particularly with respect to coal and imported raw materials and components; however, the power supply situation is once more somewhat worrisome (paragraph 13 below). There has been a progressive liberalization of controls and the 1976/77 Central Budget announced a reduction of some taxes on private industry. In many cases management of public enterprises has improved, as is reflected in their markedly higher production and profitability as a group. In the medium term it is the demand for industrial output that will determine industrial growth. In certain industries, export demand will provide a strong pull on production; this is true, for example, for certain chemicals including dye- stuffs and crude drugs, some electrical equipment, processed agricultural products, vehicles and automobile ancillaries. But the impact of increased exports on overall industrial demand will grow only slowly given the current low share of exports in sales. If the higher growth and productivity in agriculture discussed earlier were to materialize, it would provide a sig- nificant stimulus to industry. It is difficult to specify the linkages explicitly; but because of the large share that agriculture holds in GNP, the coefficients do not have to be large for agricultural growth and the concomitant growth in demand for industrially produced inputs and mass con- sumption goods to boost overall industrial demand significantly. A higher public deficit and increased public investments are the instruments most directly under Government control, and also those that can increase demand for industrial products most immediately. While the first budget of the new government projects a relatively small deficit, it does maintain a 20-22% increase in spending over the likely outlay in 1976/77. The projected deficit is contingent on the utilization of foreign exchange reserves; to the extent they are not utilized though increased imports, the deficit will increase. 13. The general improvement in the supply of energy augurs well for India's ability to meet the needs of a more rapidly growing economy. Organ- izational and transportation problems in the coal industry have largely been overcome, production is sufficient to meet demand, stocks are comfortable, and the industry has good prospects for meeting both domestic and export  - 5 - demand. However, the supply of electricity continues to be a concern, since the power situation is not uniformly good. Power shortages affect a number of the more industrialized states, particularly Maharashtra in the west and Punjab and Haryana in the north, and as a result, there is a continued con- straint on the expansion of industry. This is despite a number of favorable factors: greatly improved capacity utilization in thermal power stations; more efficient exchange of power between states; accelerated implementation of power projects; and somewhat improved availability of finance for power investment. The underlying reason for the weak power supply position is that capacity shortages continue despite the improved investment program. In the short-term, the situation may improve somewhat if, as was hoped, reservoir replenishment was better than average during the last stages of the monsoon. The prospects for the oil and gas sector have been further improved by new finds of oil and gas near the large offshore Bombay High field. Crude oil from Bombay High was brought to shore for the first time in May 1976; produc- tion reached an annual rate of 2 million tons by March 1977, and will rise to a level of 12-13 million tons by 1984/85. Although India will continue to import crude at or somewhat above the current level, much of the foreign exchange burden of rapidly rising imports will be avoided by the development of these resources. Prospects are also bright for further discoveries off- shore, given the current high level of exploration activity. 14. Underlying all other development issues is that of population. Although India's population growth rate of a little over 2% is not high in comparison with most LDCs, the size of the absolute increment - 13 million annually - is daunting. It appears, however, that population growth may have passed its peak in the 1960's, and it is expected to continue to slow down, both because the birth rate will continue to decline and because the death rate will not fall as steeply as in the past. It is apparent that India's family planning efforts suffered a setback following the end of the recent emergency period, and acceptor rates are at very low levels currently. How- ever, the new Government has announced its commitment to a voluntary family planning program and has maintained ambitious performance targets. Although it will take some time, adoption of family planning practices is expected to increase to higher levels. Over the longer term, with a sustained family planning effort, it should be possible to lower the population growth rate to 1.1% per annum by the end of the century. Our "best guess" projection of India's population by 2000 is 890 million. Many of the benefits of family planning policy will only be felt beyond the turn of the century, but the decline in fertility will bring about an early change in the age structure of the population. The school age group will grow more slowly or not at all after 1981 thereby reducing the pressures on the primary and secondary edu- cation system. The labor force, however, will continue to grow at a fast rate until the end of the century. 15. India's balance of payments position should be comfortable for the next few years. The combination of past global inflation and increased ex- ports have reduced the proportion of export earnings needed for debt service from 30% in 1970/71 to 16% in 1976/77. The ratio is not likely to rise above this level in the next few years. Given continuing favorable policies, the volume of exports should grow by at least 7% to 10% annually in the near  - 6 - future; and import needs for fertilizer, POL and foodgrains will continue to require a diminishing proportion of available foreign exchange. The large inflow of private remittances shows no immediate signs of declining and should continue to bolster the foreign exchange position in the medium term. Imports, including a variety of capital goods, have already been liberalized signifi- cantly. Increased public investment and a revival of the domestic economy is likely to generate substantial additional import demand. However, this should be quite manageable, given the currently comfortable foreign exchange position, continued export effort, and maintenance of the current real level of net aid. The present situation presents an opportunity to raise the level of investment and, consequently, reach a more satisfactory level of long terni growth. PART II - BANK GROUP OPERATIONS IN INDIA 16. Since 1949, the Bank Group has made 52 loans and 93 development credits to India totalling US$1,992 million and US$4,991 million (both net of cancellation), respectively. Of these amounts, US$859 million has been repaid, and US$2,105 million was still undisbursed as of November 30, 1977. Annex II contains a summary statement of disbursements as of November 30, 1977, and notes on the execution of ongoing projects. 17. Since 1957, IFC has made 14 commitments in India totalling US$58.4 million, of which US$13.8 million has been repaid, US$7.6 million sold and US$6.9 million cancelled. Of the balance of US$30.1 million, US$23.6 mil- lion represents loans and US$6.5 million equity. A summary statement of IFC operations as of November 30, 1977, is also included in Annex II (page 2). 18. In recent years, the emphasis of Bank Group lending has been on agriculture. The Bank Group has been particularly active in supporting minor irrigation and other on-farm investments through agricultural credit opera- tions. Major irrigation, marketing, seed development, and dairying are other agricultural activities supported by the Bank Group. Also, the Bank Group has been active in financing the expansion of output in the fertilizer sector and, through its sizeable assistance to development finance institutions, in a wide range of geographically scattered medium- and small-scale industrial enterprises. IDA financing of industrial raw materials and components for selected priority sectors has been instrumental in facilitating better capac- ity utilization in industry. The Bank Group has also been active in support- ing infrastructure development for power, telecommunications, and railways. Family planning, education, water supply development, and urban investments have also received Bank Group support in recent years. 19. The direction of assistance under the Bank/IDA program has been consistent with India's needs and the Government's priorities. The emphasis of the program on agriculture, industry, power, urban development and water supply remains highly relevant. Projects designed to foster agricultural production through the provision of essential inputs such as credit for on-farm investments, command area development of existing irrigation schemes, intensification and streamlining of extension systems, and seed production  - 7 - form an important aspect of the Bank Group's program for the next several years. Special emphasis will be given to projects benefitting small farmers. Projects supporting water supply, sewerage, and urban development also form an integral part of the Bank's lending strategy to India for the next several years. Lending in support of infrastructure and industrial investments will focus on agriculture-, export- and energy-related projects. 20. The need for a substantial net transfer of external resources in support of India's economy has been a recurrent theme of Bank economic re- ports and of the discussions within the India Consortium. Thanks in large part to the response of the aid community, India has successfully adjusted to the changed world price situation. However, the basic need for readily usable foreign exchange assistance, to augment domestic resources, assure effective utilization of existing capacity, stimulate investment and acceler- ate economic growth, remains. As in the past, Bank Group assistance for projects in India should include, as appropriate, the financing of local expenditures. India imports relatively few capital goods because of the capacity of the domestic capital goods industry. The import component of projects tends to be especially low in such high-priority areas as agriculture, education, and family planning. For the Bank Group to be able to make an appropriate contribution to the financing of projects in these sectors, it is important to cover a proportion of local expenditures. 21. It is clear from the review of the Indian economy that as much as possible of India's external capital requirements should be provided on con- cessionary terms. Accordingly, the bulk of the Bank Group assistance to India has been, and should continue to be, provided from IDA. However, the amount of IDA funds that can reasonably be allocated to India remains small in relation to India's needs for external support, and some Bank lending to India, for which the country is creditworthy, is appropriate. As of November 30, 1977, outstanding loans to India totaled US$1,165 million, of which US$474 million remained to be disbursed, leaving a net amount outstand- ing of US$699 million. 22. Of the external assistance received by India, the proportion con- tributed by the Bank Group has grown significantly. In 1969/70, the Bank Group accounted for 34% of total commitments, 13% of gross disbursements, and 12% of net disbursements as compared with an estimated 58%, 24% and 29%, respectively, in 1975/76. On March 31, 1976, India's outstanding and disbursed external public debt was US$13.1 billion, of which the Bank Group's share was 25%. The Bank Group's share is expected to remain around this level in the future. Because Bank Group assistance to India is predominantly in the form of IDA credits, debt service to the Bank Group will rise slowly. In 1975/76, about 15% of India's total debt service payments were to the Bank Group.  PART III - INDUSTRIAL SECTOR Structure 23. India's industrial output has grown on average by onily about 3.5% per annum since 1965 and manufacturing presently accounts for 16% of NDP, as against 14% in 1960/61. 1/ Within the manufacturing sector, there have been gradual changes in structure which reflect the Government's priorities. Consumer goods industries now contribute less to value added than formerly. For example, the food processing and textile industries' combined share has fallen from 43% in 1960/61 to 28% in 1974/75. Over the same period, the share of "basic" industries, (defined to include basic metals industries, chemicals and fertilizers), together with the engineering industry, increased from roughly 40% of value added in manufacturing to somewhat more than 50%. 24. About two-thirds of manufactured output is estimated to come from registered plants, which are predominantly medium- and large-scale. The more labor-intensive small scale sector, which accounts for the balance of indus- trial output, employs two-thirds of the industrial labor force. The Govern- ment sector dominates mining and power generation and, to an increasing extent, the "basic" industries within the manufacturing sector. Nonetheless, accord- ing to the 1970 Annual Survey of Industry, almost 80% of value added in indus- try and mining originated in the private sector. While in 1974/75, the last year for which statistics were available, public sector enterprises accounted for about 15% of manufacturing value-added (22% of value added from the larger, registered sector) in certain sectors such as steel, petrochemicals and heavy electrical equipment all or almost all the enterprises in the sector are government owned. Within the private sector, textiles, chemicals and engi- neering goods continue to be dominant with food processing, paper and tobacco making important contributions to manufacturing value-added. The Environment for Industry 25. Over the last fifteen years, both supply and demand factors have hindered industrial growth. Supply constraints have perhaps been more per- sistent. Through much of this period shortage of foreign exchange constrained the availability of essential intermediate inputs not manufactured in India, and affected the supply of inputs, such as steel, at times when domestic pro- duction was unable to match demand. Equally the unpredictable effect of the monsoon on the supply of agricultural raw materials, such as cotton, has con- strained industrial growth. Moreover, agricultural supply bottlenecks have tended to coincide with power shortages, since hydro supply is also dependent on the monsoon. 26. However, when these supply constraints have not been binding, demand tended to fall short of production capacities. The principal opportunities 1/ If industry is more broadly defined to include the remainder of the secondary sector - utilities and construction - then value added in industry constitutes about 23% of NDP.  - 9 - for simple import substitution were largely exhausted by the mid-1960s. Exports have recently contributed to growth, but they still constitute a very small part of total production. The relatively slow growth trend of agriculture of little more than 2% since 1967/68 restricted demand for con- sumer goods. Finally, both public and private real investment has been stagnant, although public sector investment is now increasing and may provide a much needed boost to demand. Industrial Policies 27. The Government has placed central emphasis on rapid industrializa- tion and national self-sufficiency as the keys to development. At the same time, the Government has sought to curb the concentration of economic power through expanded public ownership, restrictions on the growth of "large houses" and "dominant undertakings"; reservation of many products to the small-scale sector as well as special assistance to it; and finally support for development in backward regions. The aim of self-sufficiency has largely manifested itself in the pursuit of import substitution as well as curbs on foreign-owned firms and other forms of foreign involvement in industry. 28. The main instruments of industrial policy have been central licen- sing of investment and imports, physical allocation of scarce, domestically produced raw materials and controls on industrial prices. This system has itself tended to conflict with other aims, especially that of curbing econo- mic concentration, since large firms are much better able to bear the over- head costs of dealing with a centralized bureaucracy. Controls have also restricted the ability of firms to respond to changed opportunities, especially in overseas markets, and thus hampered exports. Price controls appear to have had an adverse effect on investment and modernization in such critical indus- tries as cotton textiles, sugar, and cement. 29. In the last two years, there have been a number of important devel- opments in industrial policy. In the face of poor industrial performance the Government recognized that existing capacity must be utilized more efficiently and took steps to require public sector enterprises to meet more commercially oriented criteria for output, price and profitability. Increased emphasis was placed on exporting and a number of measures were taken to boost industrial growth, including liberalization of licensing procedures, relaxation of import and other controls, fiscal incentives and more emphasis on industrial modernization. 30. With the recent change in government, however, strategy for the industrial sector is again under review. It is clear that policies relating to, for example, larger private sector undertakings and foreign investment in Indian industry are being actively debated within the Government. One of the elements of strategy that has now emerged is the emphasis to be placed on small scale enterprises, and on the development of industry in rural areas. The industrial priorities of the new Government are expected to crystallize in the process of the preparation of a rolling five year plan. The new plan is to be initiated in March 1978.  - 10 - Recent Performance and Prospects 31. Industrial production as a whole grew by just over 9% in 1976/77 over that in 1975/76, which had registered a significant improvement over 1974/75's performance. Early indications suggest this healthy performance is continuing in 1977/78, if not at the very high rate of 1976/77. Although there are a few physical bottlenecks -- particularly in power and cement -- the supply conditions are favorable for sustained growth in industrial pro- duction. Continued high industrial growth depends largely on the demand for industrial output. To stimulate demand, the Government of India is taking a variety of positive steps, the most direct of which is accelerating public investment. The Role of the State Joint/Public Industrial Sector 32. There is considerable opportunity for investment at the state level, particularly in the less developed states, in economically efficient state- sponsored projects in the joint/public sector. A joint sector unit is defined as an undertaking in which the state holds at least 26% of the equity, with a private entrepreneur holding up to 25%, and the balance being held by the public at large. In the 1960s GOI looked upon the joint sector concept as an instrument for curbing the concentration of economic power by restricting the growth of "large houses." The concept, however, has been evolving, and since about 1970 state governments have had the active support of the Center in using the joint sector as a promotional tool to attract private investment, particularly in the development of natural resources. In addition, joint/ public undertakings have been established in a wide variety of manufacturing subsectors, including fertilizers, petro-chemicals, and engineering. Despite the emphasis the states have given to joint sector projects, the sector is small, and probably accounts for somewhat less than 5% of industrial value added. The main institutions employed in promoting this sector are the IDBI and State Industrial Development/Investment Corporations (SIDC/SIICs). IDBI provides finance for projects directly and gives technical assistance to SIDC/SIICs. IDBI started financing state joint/public sector projects in 1970 and had financed 120 projects in this category by June 1977. The SIDCs/ SIICs are the institutions at the state level responsible for promot- ing industrial development through the joint sector by identifying, preparing and implementing high priority projects. SIDC/SIICs almost always are the institutions that hold the state governments' equity. The first SIDC was established in Bihar in 1960. Since then all states have followed suit and there are 21 SIDC/SIICs throughout the country intended to serve as catalysts in the industrialization process. Although SIDC/SIICs, on behalf of state governments, sometimes implement projects on their own, holding more than 50% of equity, in most cases state-sponsored projects are implemented in the joint sector. 33. Most state joint/public sector projects are either under construc- tion or just starting up so it is difficult to evaluate their performance. However, an analysis was made of projects in three states (Gujarat, Andhra Pradesh and Madhya Pradesh) in different stages of industrial development. In 1976, there were 12 operating state joint/public sector projects (2 in  - 11 - Gujarat, 2 in Madhya Pradesh, and 8 in Andhra Pradesh), of which 5 were operating profitably, 3 were making losses and 4 had started operations only in 1975 or thereafter. Moreover, a comparison of 10 state government spon- sored projects from different states with 8 private sector projects in the same industries which had been in existence for comparable periods of time shows that generally the performance of these projects has been similar. 34. There are a number of advantages to implementing projects through the joint sector. Private entrepreneurs and state governments have comple- mentary functions in promoting project implementation and administration, particularly in the relatively less developed states, which generally need to attract entrepreneurs from industrialized states. Private entrepreneurs reduce their financial risks through joint undertakings with the state gov- ernments and, in general, relationships with the government are facilitated. Conversely, participation of private entrepreneurs in joint projects allows state governments to take advantage of managerial skills, operational knowhow and manpower of the private sector. Mobilization of private resources for investment also enables SIDC/SIICs to allocate scarce public funds over a larger number of projects. A possible deterrent to greater private sector participation in the joint sector is believed to be the concern that in important matters affecting the project State governments, holding a larger share of the equity than the private partner, may use their power to effect decisions inimical to the interests of the private investor. IDBI involve- ment in appraisal and supervision of these projects should greatly ease such concern. Previous Bank Group Support 35. The proposed project would complement Bank Group lines of credit to the Industrial Credit and Investment Corporation of India (ICICI) and through IDBI to State Financial Corporations (SFCs), both of which are pri- marily designed to assist the private industrial sector. The Bank has made twelve loans to ICICI. The most recent, Loan 1475-IN made in 1977, conti- nues to take advantage of ICICI as an efficient channel for financing the foreign exchange costs of high priority industrial projects. Our experience with the ICICI projects has been consistently satisfactory. The proposed project would represent the fourth Bank Group operation involving IDBI. Two previous operations (Credit 356-IN in 1973 and Loan 1260-In in 1976) for a total US$65 million channel funds through IDBI to 18 SFCs. These two credit lines provide assistance in financing the import component of sound indus- trial projects in the small- and medium-scale private sector. They also provide for upgrading of SFC capabilities. Credit 356-IN was fully committed by June 1976 and Loan 1260-IN continues the pursuit of the objectives sought under the first credit for a two-year period through 1978. The first project got off to a slow start, mainly due to the weakness of SFCs. However, SFC upgrading programs have had a positive impact on the progress of both pro- jects which is now satisfactory. IDBI was also one of the channels, for US$28 million out of US$105 million, under a 1976 IDA Credit for fertil- izer industry modernization (Cr. 598-IN).  - 12 - PART IV - THE PROJECT 36. The proposed project was appraised in November/December 1976. A supplementary Project Data Sheet is attached as Annex III. A report entitled "India -- Appraisal of a Loan to Finance State Joint/Public Industrial Sector Projects through the Industrial Development Bank of India" dated January 5, 1978, Report No. 1736a-IN, is being circulated separately to the Executive Directors. Negotiations were held in Washington in December 1977. GOI and IDBI were represented by a delegation headed by Mr. D. K. Chatterjee, Director. 37. The basic purpose of the proposed loan is to assist the develop- ment of industries in the state joint/public sector, to which the Government attaches priority. It would do so by financing the foreign exchange cost of productive medium-scale projects in this sector. The project also concen- trates on strengthening the financial institutions dealing with this sector, namely IDBI and state industrial development/investment corporations (SIDC/ SIICs), by enhancing the ability of these institutions to plan and promote industrial development. The projects to be financed under the project would be medium sized industrial projects (those involving fixed assets excluding land in the range of Rs 10 million to 200 million) sponsored by state govern- ments and SIDC/SIICs. The loan would be restricted to financing projects sponsored as state public sector (i.e., 51% equity or more held by the state government or SIDC/SIIC), or joint sector (i.e., more than 25% but not more than 51% equity held by the state government or SIDC/SIIC and about 25% held by a private party with the balance by the public at large). Also, $500,000 of the proposed loan would be allocated to a Technical Assistance Fund which would enable IDBI to engage consultants to assist state government agencies in executing industrial sector investment studies. Priority would be given to the less developed states which are short of the necessary technical man- power to carry out such studies. Industrial Development Bank of India (IDBI) 38. IDBI would be responsible for implementing the project and would, in particular, be responsible for the appraisal and supervision of sub- projects, preparation and supervising implementation of upgrading programs for SIDC/SIICs, and supervising the preparation of state industrial invest- ment studies. IDBI is the largest industrial development bank in India and also the apex institution for all other industrial financial intermediaries. Established in 1964, it was a fully owned subsidiary of the Reserve Bank of India until 1976. As a result of legislation enacted in 1976, important changes took place in IDBI. The organizational relationship between IDBI and the Reserve Bank was severed and IDBI's ownership was transferred to GOI. Also, IDBI's role as an apex institution for industrial financing was strengthened by making it responsible for coordinating industrial investment activities of other financial institutions. In 1976, GOI appointed IDBI to administer industrial modernization programs launched by GOI to improve effi- ciency in selected industries. IDBI has also taken up refinance schemes for SIDC/SIICs to augment their resources and assisted in upgrading their capa- bilities as industrial financing institutions.  - 13 - 39. In view of its increased responsibilities and work load, IDBI is taking measures to ensure continued operational efficiency, adequate staffing and viable finances. IDBI is in particular strengthening the staff of its Loan Departments, responsible for appraising and following up subprojects, and of its SFC/SIDC Department, responsible for monitoring the activities of these institutions and ensuring that upgrading programs are effectively carried out. IDBI's appraisal and follow-up standards and its procurement and disbursement procedures are adequate. IDBI ensures that all capital expenditures for projects it finances are technically and economically jus- tified. Disbursements are usually made in installments according to the progress of the projects. 40. IDBI is now the largest single institutional source of industrial finance in India, accounting for approximately 5% of the annual total indus- trial investment. Its activities include direct loans, rediscounting com- mercial bills, refinancing loans made by the SFCs, SIDC/SIICs and commercial banks, providing export finance, underwriting, equity investment and guarantee operations. As of June 30, 1977, the total effective financial assistance sanctioned by IDBI was Rs 24.5 billion (US$2.7 billion). About one third of the total (Rs 7.2 billion) was for direct financial assistance to develop industry. The balance consisted of rediscounted bills (29%), refinance (26%), export finance (9%), and subscription to shares and bonds of financial insti- tutions (4%). IDBI's operations have expanded rapidly in recent years. Total annual assistance sanctioned reached Rs 7.7 billion (US$855 million) in 1976/ 77 compared to Rs 1.4 billion (US$156 million) in 1970/71. Direct loans accounted for Rs 2.4 billion (US$226 million) or about 30% of the total assistance approved in 1976/77. 41. IDBI's total assets as of June 30, 1977 were Rs 11 billion, its longterm debt/equity ratio 10.6:1, and its profitability 1.9% on average total assets. IDBI's financial situation is satisfactory. Arrears on IDBI's direct loan portfolio have increased over the past few years largely as a reflection of the difficult economic circumstances in 1972-1975. But, the improving economic situation, combined with IDBI's improved follow-up, has helped to slow down the upward trend in arrears. The total principal out- standing on loans affected by arrears has improved from 50% of its total portfolio as of December 31, 1974 to 40% as of June 30, 1977. 42. IDBI's interest rates for direct loans are 9.5% for units in back- ward areas and 11.0% in other cases. With long run inflation estimated at about 8% per annum, IDBI should be lending at positive real rates of in- terest of 1.5% to 3%. State Industrial Development/Investment Corporations (SIDC/SIICs) 43. At the state level, the SIDC/SIICs are responsible for promoting industrial development mainly through provision of finance and by identifying, preparing and implementing high priority projects. The State Financial Cor- porations (SFCs) are the other important category of state sponsored devel- opment institutions in the industrial sector; they essentially deal with the large number of small scale enterprises, almost all of which are privately owned.  - 14 - 44. All SIDC/SIICs are wholly owned by the state governments. They have been incorporated under the Companies Act, as public or private limited companies. Their Articles of Association or their Statutes authorize them to undertake a wide range of functions, which is appropriate in view of their objective to promote industry at the state level. Their functions are: granting of financial assistance (equity and loans); identification, promo- tion and management of industrial projects; setting up of industrial estates; selection and training of entrepreneurs; and the provision of technical assistance. There is considerable diversity of operations from state to state, as well as difference in emphasis, arising out of the degree of industrialization achieved, the institutional network existing and the particular local needs. 45. The bulk of the resources available to the SIDC/SIICs, taken as a group, comes from state governments; about 40% is in the form of equity and about 20% in the form of loans. The balance comes from bonds placed in the open market. In recent years, SIDC/SIICs have disbursed about one-quarter of the amount disbursed by the State Financial Corporations (SFCs), the other important category of state sponsored development institutions. The SFCs generally deal with the smaller enterprises, almost all of which are privately owned, and SFCs are able to enhance their resources with refinance from IDBI. The SIDC/SIICs became eligible for IDBI's refinance facilities only recently (1976). The operating results of the SIDC/SIICs show considerable variation but in general, and as might be expected, those in the industrialized states have greater resources at their disposal and earn higher profits than most others. While some SIDCs have adequate finances and procedures, many SIDCs need to improve their finances, their financial reporting and planning, their capacity to identify and select suitable project and, in general, their opera- tions and procedures. 46. Most SIDC/SIICs need to be substantially upgraded to enhance their ability to contribute to state-sponsored industrial development. With this in mind, IDBI decided in July 1976 to strengthen its relationship with SIDC/ SIICs so as to have a greater impact on their institutional development and to make SIDC/SIICs eligible for IDBI refinance facilities. In addition, IDBI will subscribe to SIDC/SIICs' share capital, and more closely monitor their activities. IDBI plans to provide for the appointment of an IDBI nominee to the SIDC/SIIC's Boards and to inspect their operations and accounts. Under the project, IDBI will help implement upgrading programs for each SIDC/SIIC. The upgrading programs, prepared in connection with the proposed loan, should help in particular to: (i) improve the SIDC/SIICs' promotional role in the state joint/public sector, (ii) clarify the division of responsibilities between the SIDC/SIICs and the consulting firms/agencies entrusted to under- take feasibility reports, market surveys, etc., and (iii) improve SIDC/SIICs' capability to identify and select suitable projects and suitable private partners for joint sector enterprises. Projects sponsored by SIDC/SIICs would not be eligible for financing under the loan in cases where an SIDC/ SIIC was failing to make a reasonable effort to fulfill its upgrading pro- -ram (Section 2.02 of Loan Agreement).  - 15 - Project Pipeline 47. The states have presented a pipeline of 218 state joint/public sector investment proposals of medium size totalling Rs 12 billion ($1,333 million equivalent) with foreign exchange requirements of Rs 2.2 billion ($244 million equivalent). However, many of these projects are not at a bankable stage and others may not be economically viable. It would be IDBI's function to screen this pipeline and select high priority projects (approxi- mately 15 to 20) requiring foreign exchange. IDBI's appraisal capability and the sectoral studies to be undertaken in conjunction with the proposed loan would help ensure selection of high priority, well prepared projects. Given that the proposed operation would be the first along these lines, a modest- sized loan has been proposed. 48. Nine-tenths of the proposals in the pipeline are in the joint sector. The emphasis is on chemical projects (about one-third) and the remainder covers a wide variety of industries, many of which involve improved utilization of natural resources. The majority of these industries require capital intensive technology. Investment cost per job is roughly estimated at about $30,000. Projects financed under the proposed loan would stimulate a variety of other industries to utilize the intermediate goods produced as well as to develop ancillary and service functions, thus enhancing the employment effect. The geographical distribution shows that only about 30% of the proposals came from the four more developed industrial states of Maharashtra, West Bengal, Tamil Nadu and Gujarat. The less industrialized states will be the major beneficiaries of the institution building program, and it is expected that this will pave the way to increasing investment in these States. Features of the Proposed Loan 49. The IBRD loan of $25 million would be made to GOI at annual interest of 7.45%. GOI would directly on-lend US$24.5 million of these funds at the same terms to IDBI, which in turn would on-lend them at a spread of at least 2% on the average, for periods not exceeding 15 years, to industrial units sponsored by state governments to meet the foreign cost of capital goods and services. GOI would bear the exchange risk. Procurement and disbursement would follow the normal DFC-type pattern. As with other loans to development finance companies, eligible enterprises would be broadly defined and include manufacturing, agro-industries and mining. The loan would be repaid according to a composite amortization schedule which would reflect the repayment terms of the subloans and which will not exceed 17 years including three years of grace. IDBI has prepared a statement of strategy acceptable to IBRD for the next 2 to 3 years for financing the target group from the proposed loan. GOI would pass on to IDBI also the US$0.5 million balance of the loan, but as a grant, to finance the Technical Assistance Fund (para 37 above). This part of the loan would be disbursed against 100% of local as well as foreign expenditures. 50. In order to provide the Bank with an early assessment of project preparation and appraisal work, the first project from the first six states would be sent to the Bank for prior review and approval. In addition, all  - 16 - subsequent projects for which IDBI would make loans of more than $3 million from the proposed loan would require the Bank's prior review (Section 2.02 of the Loan Agreement). With this arrangement, about 50% by number, and 70% by amount of the projects financed under the credit would be reviewed for prior approval. Further, in order to guard against the possibilities of the proposed loan being used to assist only a few large firms, an upper limit of $4 million is proposed on the amount that IDBI can provide for any single project. Project Risks 51. The short term objective of the project is to supporl: sound and well prepared investment schemes in the joint sector. There is little risk in a country with the size of India that there will not be enough sound projects to utilize the proceeds of the proposed loan. The longer term ob- jectives of the project are to strengthen SIDCs/SIICs and to lay the basis for state level industrial planning and project promotion. This will be a slow and difficult task, but one that needs to be tackled and one which IDBI is well equipped to handle. PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. The draft Loan Agreement between India and the Bank and the draft Project Agreement between the Bank and the Industrial Development Bank of India, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank are being distributed to the Executive Directors separately. 53. Features of the draft Loan Agreement of special interest are referred to in paragraphs 37, 46 and 50 of this report and are set forth in Section III of Annex III of this report. There are no special conditions of effectiveness of the Loan. 54. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President January 5, 1977 Attachments  ANNEX I INDIA - SOCIAL INDICATORS DATA SHEET Page 1 of 4 LAND AREA (THOU KM2) -----4-------------------------- --- --------------- INDIA REFERENCE COUNTRIES (1970) TOTAL 3260.5 MOST RECENT AGRIC. 1780.7 1960 1970 ESTIMATE INDONESIA PHILIPPINES BRAZIL** GNP PER CAPITA (USS) 60.0* 100.0* 1so.o/a* 130.0* 230.0* 550.0* POPULATION AND VITAL STATISTICS POPULATION (MID-YRR MILLION) 434.9 547.6 620.4/a 117.6 36.9 92.8 POPULATION DENSITY PER SQUARE KM. 133.0 167.0 189.0/a 62.0 123.0 11.0 PER SQ. KM. AGRICULTURAL LAND 252.0 308.0 348.071 414.0 375.0 49.0 VITAL STATISTICS CRUDE BIRTH RATE (/THOU, AV) 43.2 41.0 37.0 45.9 44.2 36.4 CRUDE DEATH RATE (/THOU,AV) 23.9 19.0 17.0 20.6 13.2 9.9 INFANT MoRTALITY RATE (/THOU) 139.0/a .. 130.0 . 80.0 110.0 LIFE EXPECTANCY AT BIRTH (YRS) 41.7 47.2 49.5 .. 55.6 3 4 GROSS REPRODUCTION PYTE 3.2 2.9 2.8 3.2 3.3 2.6 POPULATION GROWTH RATE (%) TOTAL 2.0 2.3 2.2 2.0 3.0 2.9 URBAN 2.5/b 3.2 3.1 3.7 /a 4.0 5.0 URBAN POPULATION (% OF TOTAL) 17.9 19.9 20.6 17.5 /b 27.6 56.0 AGE STRUCTURE (PERCENT) 0 TO 14 YEARS 41.0 41.6 40.1 /b 44.0 45.6 42.0 15 TO 64 YEARS 55.9 55.3 56.7 7`7 53.5 51.6 55.0 65 YEARS AND OVER 3.1 3.1 3.2 7FS 2.5 2.8 3.0 AGE DEPENDENCY RATIO 0.8 0.8 0.8 0.9 0.9 0.B ECONOMIC DEPENDENCY RATIO 1.1/c 1,1/a 12 /C .. 1.5 1.5 FAMILY PLANNING ACCEPTORS (CUMULATIVE, THOU) 71.0 145B5.0 37658.0 259.3 354.0 250.0 USERS (% OF MARRIED WOMEN) . .. 18.7 . 2.0 1.6 EMPLOYMENT TOTAL LABOR FORCE (THOUSAND) 175000.0 218000.0 248000.0 /a . . 12400.0 29400.0 LABOR FORCE IN AGRICULTURE (%) 71.0 69.0 68.0 ss.o /a 40.4 UNEMPLOYED (% OF LABOR FORCE) 1.0/a .d 1.7 . 7.6 7.5 INCM