India - Cooperative Fertilizer Industry Project

noeumenz of The World Bank FOR OMCAL USE ONLY Report No. P-4346-IN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON TWO PROPOSED LOANS TO INDIA (IN AN AMOUNT OF t150.2 MILLION EQUIVALENT) AND TO THE INDIAN FARMERS FERTILISER COOPERATIVE LIMITED (IN THE AMOUNT OF US$152 MILLION EQUIVALENT) FOR THE COOPERATIVE FERTILIZER INDUSTRY PROJECT June 4, 1986 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 May 30, 1986) US$1.00 = Rs 12.79 Rs 1.00 = US$.0800 Rs 1 million = US$80,000 The US Dollar/Rupee exchange rate is subject to change. Conversions in the Staff Appraisal Report were made at the US$1.00 = is 13 which represents the average exchange rate at the time of the appraisal. FISCAL YEAR Government o, India: April 1 - March 31 IFFCO: July 1 - June 30 Abbreviations and Acronyms FAI - Fertilizer Association of India FICC - Fertilizer Industry Coordination Committee GAIL - Gas Authority of India Ltd GoI - Government of India HBJ Pipeline - Hazira-Bajaipur-Jagdishpur Pipeline IFFCO, the Company - Indian Farmers Fertilizers Cooperative Ltd kv, kw, MW, MWH - kilovolts, kilowatts, Megawatts, Megawatt-hour HARD - Ministry of Agriculture and Rural Development MP - Madhya Pradesh State NFL - National Fertilizers Ltd OECF - Overseas Economic Cooperation Fund, Japan tph, tpd, tpy - Metric tons per hour, per day, per year tyn - Metric tons per year of nutrient UP - Uttar Pradesh State  FOR OMCAL USE ONLY INDIA COOPERATIVE FERTILIZER INDUSTRY PROJECT Loan and Project Summay Borrowers: GOI Loan: India, acting by its President IFFCO Loan: Indian Farmers Pertiliser Cooperative Limited (IFFCO). Guarantor of IFFCO Loan: India, acting by its President. Amount: US$302.2 million equivalent, consisting of: GOI Loan; US$150.2 million; and IFFCO Loan; US$152 million. Terms: GOI and IFFCO loans: 15 years, including 5 years' grace at the standard, variable interest rate. GOI would bear the foreign exchange risk on its Loan and IFFCO would bear the foreign exchange risk on its Loan. OOI would charge IFFCO a Guarantee Fee such that the effective interest rate paid by IFFCO would be 13.75Z, the current rate paid by similar firms in India. Project Description: The project consists of (a) construction and cofiussioning of a greenfield fertilizer manufacturing plant to be owned and operated by IFFCO, one of the two cooperative sector manufacturers of fertilizers in India. The plant would be located at Aonla in the state of Uttar Pradesh; (b) investments at 3 existing IFFCO manufacturing plants at Phulpur, [alol, and Kandla to improve operating efficiencies, reduce energy consumption, improve product quality and output, and lower pollution; (c) a study to develop a performance evaluation and control system for use by GOI for all publicly owned fertilizer plants; and (d) the importation of fertilizer materials. The project faces minimal technological risks as the technologies have been widely used in India. There is a potential risk that the feedstock pipeline-the gas pipeline from Hazira via Bijaipur and Aonla to Jagdishpur (the HBJ Pipeline)--may not be completed in time for the new plant but provi- sion has been made for firing the steam gener- ation units on liquid fuels should gas supplies be delayed. Letters of Intent covering con- struction of the pipeline have been issued and procurement of major items is in progress. This document as arestuicted distbution and may be used by recpients only in the performane of their offi dutiea Its contents may not otherwise be disclosed without World Bank autborizaion.  US$ Millions Estimated Cost Local Foreign Total (a) Aonla Plant 1/ Land and Site Development 8.7 _ 8.7 Civil Works and Building 25.1 18.7 43.8 Equipment, Katerials & Spares 67.5 197.7 265.2 Erection and Commissioning 23.0 4.4 27.4 License, Engineering, Management 29.7 17.3 47.0 Township and Infrastructure 25.1 2.3 27.4 Sub total - Base Cost Estimate 179.1 240.4 419.5 (b) Rehabilitation Component 2/ Phulpur Plant 11.4 10.4 21.8 Kalol Plant 24.9 16.1 41.0 Kandla Plant 10.3 7.2 17.5 Sub total - Base Cost Estimate 46.6 33.7 80.3 Total Base Cost Estimate 225.7 274.1 499.8 Physical Contingencies 7.4 7.4 14.8 Price Contingencies 23.6 27.2 50.8 Total Installed Cost 256.7 308.7 565.4 Working Capital for Aonla 84.2 - 84.2 Interest During Construction 42.6 75.4 118.0 (c) Performance Evaluation and 0.1 0.2 0.3 Control System Study (d) Fertilizer Imports Component - 150.0 150.0 Total Financing Required 383.6 534.3 917.9 1/ Including taxes and excise duties estimated at $13.2 million. 2/ Including customs duty, taxes and excise duties estimated at $18.2 million.  -iil- Financing Plan: US$ Millions Local Foreign Total GOI, Suppliers Credits 169.3 81.3 250.6 IBRD - 302.2 302.2 OECF, Italy, Denmark - 150.8 150.8 IFFCO and Cooperatives 132.5 - 132.5 Local Borrowing 81.8 - 81.8 Total Financing Required 383.6 534.3 917.9 Estimated Disbursements: (US$ Millions) IBRD Fiscal Year FY87 FY88 FY89 FY90 FY91 FY92 Annual 174.3 43.7 50.0 27.6 5.7 0.9 Cumulative 174.3 218.0 268.0 295.6 301.3 302.2 Economic Bate of Return: About 17X for the Aonla component (see text) Appraisal Report: No. 6025-IN, dated June 2, 1986.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON TWO PROPOSED LOANS ONE TO GOI AND ONE TO IFFCO FOR THE COOPERATIVE FERTILIZER INDUSTRY PROJECT 1. I submit the following report and recommendation on two proposed loans; the first to GOI in the amount of $150.2 million (equivalent) to finance a portion of India's fertilizer imports and a study of the peformance evaluation and control mechanisms, and the second to the Indian Farmers Fertiliser Cooperative Ltd (IFFCO) with guarantee by the Government India (GOI) in the amount of US$152.0 million (equivalent) to help finance the construction of a greenfield fertilizer plant at Aonla in the state of Uttar Pradesh, and enhance the operating efficiency of three of its existing plants. GOI would bear the foreign exchange risk in its loan and IFFCO would bear the foreign exchange risk on its loan. PART I - THE ECONOMY 1/ 2. An economic report, "India: Economic Situation and Development Prospects" (6090-IN, dated May 9, 1986), was distributed to the Executive Directors on May 12, 1986. Country data sheets are attached as Annex I. Background 3. India is a large and diverse country with a population of about 760 mil- lion (in mid-1985) and an average per capita income of about US$260. Agriculture continues to dominate the economy, accounting for 36% of CDP, 23Z of exports and about two-thirds of employment. The steady increase in population, which continues at a rate of 2.2% a year, has put increasing pressure on natural resources, in particular cultivable land. By the mid-1960s, nearly all produc- tive land had been brought under cultivation. While irrigation continues to increase total cultivable area, an increasing share of the labor force will have to be absorbed in non-agricultural activities. Industrial development has not progressed rapidly enough to provide employment opportunities for the growing labor force, or to bring about a rapid economic transformation, with sig- nificantly higher productivity and income levels. As a result the long-term growth of per capita income has only averaged about 1.4% p.a. and close to one-half of India's population continues to live below the poverty line. The pervasiveness and intensity of poverty is such that its alleviation has been and remains at the core of India's development strategy. 4. During the 1950s and 1960s, India's economic performance was generally characterized by slow economic growth, moderate inflation and a sustainable 1/ Parts I and II of the report are similar to Parts I and Ir of the President's Report for the Combined Cycle Power Project (No. P-4254-IN), dated March 10, 1986.  -2- external position. GDP rose at about 3.5%, with agriculture and industry grow- ing at 1.8Z and 4.8% respectively; imports increased by 4.6Z and exports by 5.8% a year. India was able to reduce its dependence on foodgrain imports from a peak of 14X of total foodgrain consumption in 1966/67 to 4.5% by 1969/70 through improvements in agricultural production, but progress in poverty alleviation was slow mainly because of continued high population growth. 5. In the early to mid-1970s, in response to a sharp deterioration in India's terms of trade, the Government introduced various polity measures designed to stimulate exports. This resulted in a large increase in export growth to about 7.3% per annum in the 1970. compared with only 2.2% per annum between 1950/51 and 1969/70. While expanding world markets, particularly in the Middle East, contributed to this growth, liberalized access to imported inputs and more effective export incentives played a major role. The success in the export expansion effort coupled with continued import substitution, particularly of foodgrains resulted in a surplus on current account between 1976/77 and 1978/79, which was further enhanced by increased concessional aid flows. India was thus in a relatively favorable position to deal with the increases in inter- national oil prices, the sharp deterioration in the terms of trade and a series of poor harvests. The comfortable foreign exchange position also played a major role in the Government's decision to initiate import liberalization. 6. Towards the end of the 1970s, India again faced considerable domestic difficulties. In 1979/80 it experienced one of the country's worst droughts which caused a large reduction in agricultural production. In addition, industrial production, plagued by labor unrest and a vicious circle of supply shortages (coal, power and transportation), failed to expand. These events coincided with a second round of international oil price increases. As a result, the current account reverted to a deficit position and the remarkable price stability that the Indian economy enjoyed after 1975 came to an abrupt end. The Government responded by mounting an adjustment program, which was embodied in the Sixth Five Year Plan (1980/81 - 1984/85). The program aimed at raising the GDP growth rate from its historical level of 3.6% to 5.2% per annum while adjusting the country's external balance to the adverse price developments in world markets. The major elements of the program were alleviation of infrastructure and supply constraints, increased energy independence, improved efficiency in resource use, promotion of exports and efficient import substitution. Economic Performance Under the Sixth Plan 7. Overall the Government's adjustment program has been effective despite the severe drought in 1982/83 and a worsening of the external environment in the early 1980s. During the Sixth Plan period, GDP grew by 5.1% per annum, I/ well above India's long-term growth rate of 3.6%. However, overall growth during the 1/ Actual GDP growth rate during the 1979/80-1984/85 period was 5.1% per annum. However, this figure overstates the trend in recent years because of the relatively low base year (1979/80). The 4.5% GDP growth per annum and 3.3% annual agricultural growth between 1980/81-1983/84 (two "normal" years) are more representative of the growth rates during the period.  -3- first half of the 1980s has not been steady, mainly because of the effect of uneven rainfall on agricultural production. In 1980/81 and 1981/82, the economy substantially recovered from the 1979 drought, with real CDP growing by 7.6% and 5.3Z, respectively. The recovery was particularly robust in agriculture where normal weather helped output to rise by more than 15% in 1980/81 and 5.5% in 1981/82. A severe drought in mid-1982 brought the economic recovery to a halt. Agricultural output declined by 4%, which in turn reduced GDP growth to only 1.8%, and put further strains on the balance of payments and domestic resource situation. The timely implementation of various economic policies relating to foodgrain imporLs, procurement and distribution, and the increased allocation of power to irrigation pumps mitigated the adverse effects of the poor monsoon. An excellent monsoon combined with satisfactory performance of the infrastructure sectors, in particular coal and transport, led to a recovery of the economy in 1983/84. Agricultural output rose by 9%, industrial output by 4.5Z and overall GDP by 7.4Z. The power sector, however, emerged again as a constraint on higher growth, especially in industry. In 1984/85, despite a mediocre monsoon and difficult political circumstances, the aggregate growth of the economy estimated to be 3.6%. 8. During the Sixth Plan period, foodgrain production continued to grow at an average annual rate of 2.6Z a year-sufficient to maintain a broad balance between supply and steadily increasing domestic demand. The progress achieved is an indication of the effectiveness of programs to expand irrigation, strengthen extension and encourage efficient use of other agricultural inputs which are being implemented. Bountiful harvests have led to record foodgrain stocks in recent years. Over the past year, Government held stocks have increased by more than 40%. Maintenance of ample, balanced operating stocks to ensure smooth operation and even expansion of the public distribution system remains a top priority of Indian agricultural policy. Yet, the financial cost of foodgrain storage and subsidies represent a rapidly growing burden on the budget. 9. Growth of the industrial sector during the Sixth Plan period was slow and uneven. Industrial growth averaged about 3.4Z a year--below the growth rates achieved in the 1960s and 1970s. An inadequate policy environment, coupled with depressed domestic demand, power and raw material shortages, as well as labor unrest are the main causes for the slower than anticipated growth of the industrial sector. After the severe drought in 1979/80, manufacturing output grew at 1.7% in 1980/81 and 3.3% 1981/82. The drought in 1982/83, which led to widespread shortfalls of agro-based raw materials and a sharp drop in the demand for consumer durables, combined with a prolonged textile strike in Bombay, reduced the growth of industrial output to 1.7% in that year. Following the excellent monsoon in 1983184, industrial output gained momentum and grew by 5.0%. Preliminary estimates place ths growth of the manufacturing sector at about 5.5% in 1984/85. 10. The performance of the infrastructure sectors was mixed under the Sixth Plan. While electric power generation, coal production and railway traffic grew by 8.7%, 6% and 2.5% a year respectively, oil and gas production increased by 22.6%. The rapid expansion of domestic oil production is largely the result of India's oil development program. Backed by substantial financial commitment, performance under the program has been excellent with real investment and oil production levels running well ahead of Plan targets. In 1984/85 domestic oil  -4- production is estimated to have reached 29.4 million tons. While the gap between domestic consumption of petroleum and production remains large, India's dependence on oil imports dropped from 63% of consumption in 1979/80 to 30% in 1984/85. About two-thirds of current output comes from offshore fields around Bombay High. As most of these fields have now reached their mature stage, further increases in domestic oil production will have to come mainly from new discoveries. 11. India's economy reverted from a situation of a resource surplus in the late 1970s to an aggregate resource deficit during the Sixth Plan period. The gap between gross investment and national savings increased from negligible levels to an average of 2.1Z of GDP in 1980-85. Gross domestic capital forma- tion increased from an average of 22.6% of GDP in 1975-80 to 24.7% in 1980-85 while gross national savings remained constant at an average of 22.6% of GDP in both periods. The increase in capital formation mainly resulted from an increase in the public investment rate, but it was largely a financial rather than a real phenomenon since prices of investment goods increased considerably faster than the general price level. 12. The basic thrust of fiscal policy during the Sixth Plan was to provide sufficient resources for growth and planned investment while maintaining infla- tion under control. However, the Sixth Plan period was characterized by sig- nificant budgetary resource constraints. Despite massive additional resource mobilization efforts, public sector deficits exceeded 7% of GDP as compared to only 4-5% of GDP during the mid-1970s. The shortfall was met by additional market borrowings, both domestically and from abroad and by deficit financing. Major reasons behind the large deficits were continued losses by most departmentally-run undertakings, unsatisfactory performance of the two major non-departmental undertakings of the States (the State Electricity Boards and the State Road Transport Corporations), and the increasing importance of sub- sidies which are estimated to have reached 2.8% of GDP in 1984/85. Of these, fertilizer subsidy accounted for more than 0.8% of GDP, and food subsidies nearly 0.5% of GDP. 13. Developments in the savings-investment balances were mirrored in the balance of payments. Thus, India's current account balance, which had recorded surpluses between 1976/77 and 1978/79, reverted to deficits averaging US$3.5 billion and 2.1% of GDP during 1980-85. Several developments contributed to these relatively large deficits. First, the terms of trade deteriorated sharply in 1979/80 due to the second round of oil price increases and continued to move against India during the first three years of the 1980s. Second, a more liberal import policy towards industrial inputs was pursued. Third, net invisibles declined as travel receipts fell off, workers' remittances stagnated (reflecting slower development activity in the Middle East), and payment of interest on higher levels of foreign debt increased. Fourth, export growth was sluggish partly due to growing domestic demand, and, perhaps most significantly, due to depressed foreign markets and prices. Faced with a growing need for external capital inflows and stagnation in the availability of concessional assistance, india drew SDR 3.9 billion from the Extended Fund Facility of the IMF and borrowed significant amounts on commercial terms from the Euro-dollar market and increased the use of suppliers' and export credits.  -5- 14. Price performance during the Sixth Plan period has been mixed. The overall improvement in economic Derformance in the early 1980s, combined with more restrictive monetary policies in 1981/82 and 1982/83, resulted in a sharp decline in the rate of inflation. The growth rate of wholesale prices declined from 182 in 1980/81 to only 2.6% in 1982/83. The lagged effects of shortages of foodgrains in 1982/83 and of other agricultural products and industrial goods in 1983/84 coupled with a rise in the domestic cost of imports and rapid liquidity growth, gave a boost to inflationary pressures towards the end of 1983/84. The annual average growth of wholesale prices rose to over 9% in 1983/84, and the rate of growth of consumer prices exceeded 12%. In SepLember 1984, the Government took a number of measures to dampen pressure on prices including increased imports of important agricultural commodities (sugar, jute, coconut oil and others), releases of sugar stocks for distribution through fair price shops, and a reduction in wheat prices for flour mills. These measures, together with a decline in cereal prices as a result of the bumper crop in 1983/84 and a generally restrictive budgetary policy, led to a slowdown in the rate of increase of wholesale prices to about 7.1% in 1984/85. 15. Developments in the Indian economy during the Sixth Plan underscore the progress that has been made in recent years towards accelerated GDP growth, external adjustment, and increased investment. The experience of recent years illustrates that India has the capacity to grow and develop at a more rapid pace. It is a tribute both to the fundamental soundness of key policies and programs, particularly in agriculture, and to the strength and effectiveness of public administration, that neither the serious political disturbances in Punjab, nor the assassination of Prime Minister Indira Gandhi, resulted in significant disruptions to the performance of the economy in the last year of the Sixth Plan. But the results during the Plan period also highlight the disappointing performance of industry, the continuing shortfalls in electric power generation, the rising public sector deficits, the importance of regaining and sustaining momentum in export growth and the need for continued prudent economic management so as to avoid a resurgence of inflation while generating adequate resources for development. This mixture of achievements and challenges provides the context for an assessment of development prospects and policies. Development Prospects and Policies 16. To deal effectively with its dual challenges of alleviating pervasive poverty and expanding employment opportunities for a growing labor force, the Seventh Plan aims at sustaining an annual rate of growth of GDP of at least 5Z. The Seventh Plan lays down the development strategy for 1985/86-1989/90, and continues the emphasis on agriculture, energy development, export promotion, domestic import substitution where economically justifiable and the removal of infrastructural bottlenecks. 17. Achieving a GDP growth of around 5% a year will place heavy demands on policy adjustment and entail major challenges. India will need to: (a) maintain the recent higher rate of expansion of agricultural production; (b) accelerate industrial production and export growth through policy changes which enhance competition and efficiency; (c) expand supply capacities in the economy by improving basic infrastructure services and the availability of energy; (d) improve the efficiency with which resources are used, including  -6- particularly the existing capital stock in infrastructure and industry; and (e) further improve the already high resource mobilization effort. 18. Agriculture. Despite an impressive performance under the Sixth Plan, Indian agriculture faces many chaLlenges in the second half of the decade. As possibilities for extending cultivated acreage shrink, agricultural growth will depend on finding new ways of increasing the productivity of land through fur- ther development of irrigation, better water management, more intensive use of new technology, efficient delivery of inputs and services, and appropriate pricing policies. High priority must be given to the expansion of the country's irrigable area through completion of ongoing irrigation projects, as well as selective investment in new undertakings. Besides creating new irrigation potential, the efficiency of irrigated farming will have to be enhanced through the improvement of water management practices in existing irrigation systems. Greater emphasis should al3o be given to obtaining higher yields under rainfed and dryland farming conditions. Finally, even greater efforts must be made to build and strengthen institutions to ensure the efficient delivery of agricul- tural services, input supplies, credit and technology. 19. Industry and Trade. Prospects for raising India's GDP growth rate will, to a large extent, depend on more rapid industrial production and export growth to be attained through improved productivity and efficiency. A key requirement will be greater competitive pressure on industry than has been the case in the past. The size and domestic orientation of the Indian economy make it necessary that this competitive pressure come mainly from within the domestic economy. An important complement, however, will be greater exposure to foreign trade to stimulate domestic competition as well as to induce technological innovation and modernization. 20. To increase domestic competition, domestic policies will need to allow freer entry and exit of firms in the industrial sector and greater reliance on market price signals. While the Government has taken various initiatives in the above directions during the past several years, the most significant were announced in the context of the 1985/86 Budget. These include the broadening of licensing categories for certain industries, delicensing for others, increases in the size limits for MRTP 1/ and small-scale industries, reductions in the incentive for small-scale industries to stay small and various initiatives to stimulate efficient indigenization of 'sunrise' industries (energy exploration equipment, computers, telecommunication equipment, motor vehicles and parts, general electronics). These are significant advances that need to be sustained in future years. 21. Changes in external trade policy will also be required to stimulate export growth which is essential riot only for current financing of imports, but to enhance borrowing capacity, to service debt, to provide an impetus to the economy from the demand side, and to expose entrepreneurs to the quality- consciousness of competitive external markets. While some changes have been recently introduced, there remains a need to: (a) provide greater access to imported inputs and capital goods through continued import liberalization; 1/ Monopolies and Restrictive Trade Practices Act, 1969.  -7- (b) review tariffs, eliminating anomalies and lowering their overall level; and (c) modify trade policies in such a way that the net impact of incentives is more neutral between exports and import substitution. 22. Infrastructure Sectors. Investments in these sectors currently con- stitute about one-third of total investment in India, and the efficiency with which these investments are managed has an important bearing on the efficiency of total investment and the growth rate of the entire economy. There is sub- stantial evidence that better plaanming and management of public investments in power, coal, railways and irrigation could improve returns and lower the current capital-output ratios. For example, more efficient use of investment could be achieved by better water management in irrigation projects, improved load 'ac- tors in thermal power generatior., better capacity utilization in the fertilizer industry and improved efficiency in railway transport. 23. Resource Mobilization. India's gross national savings rate (22.6% in 1980-85) is already high for a country at India's level of income. Nevertheless, the investment required to sustain the relatively high GDP growth rates realized during the Sixth Plan period--while holding foreign savings as a share of GDP at prudent levels-will require some further increase in the aggregate savings rate especially in public savings. Because there will con- tinue to be well-founded demands for expansion of current and capital expendi- tures in the public sector, the burden for a reduction in the savings investmant gap has to be put on the revenue side. Increasing tax rates beyond their cur- rent high levels would be counter productive. Thus, economically efficient pricing policies in public enterprises, supported by improvements in their operational efficiency, are to be preferred over tax increases as vehicles for increased public resource mobilization. The sheer size of past and present public enterprise investment indicates that if proper returns were made even only a part of them, an increase in revenues of about 3% of GDP would be attainable. In a number of sectors, e.g. thermal power, railways, and fertilizer, concerted efforts are being made--with Bank assistance-to increase efficiency and reduce costs. These efforts need to be improved and expanded into new areas. 24. Balance of Payments. A policy of sustained GDP growth of 5Z per annum will need to be complemented by measures which assure a viable balance of pay- ments position. Acceleration of industrial growth will lead to a substantial increase in import requirements, even after allowing for continued import sub- stitution of key bulk comodity items. Bank staff estimates place the export volume growth necessary to support these growing import requirements without excessive increases in external borrowing at about 8% a year over the Seventh Plan period. Prospects for India to attain the needed higher export growth rates appear to be reasonably good because India's share in total world exports in value terms is only about 0.4%, leaving ample room for growth. Furthermore, India's exports are relatively less sensitive to fluctuations in demand in the OECD industrial countries because exports are well diversified with respect to both products and markets. Nevertheless, success in India's export drive will depend heavily on changes in domestic policy to improve the supply and profitability of exports. 25. Even assuming favorable export performance, India will continue to need substantial external capital flows to augment its own resources for the foresee-  -8- able future. Even with 8% export growth, the 5% GDP growth implies an increase in gross capital inflows from US$17.5 billion to US$34.5 billion between the Sixth and Seventh Plan periods. In the past, the bulk of this financing was provided in the form uf official development assistance. In more recent years the availability of concessional assistance to India has declined. Total bilateral grants and concessional loans declined from a level of about US$1.3 billion per annum over the years 1979/80-1981/82 to US$1 billion in 1983/84. Moreover, there was a large deterioration in the terms of aid from multilateral sources. For example, while total lending from the Bank Group continued to increase in nominal terms, the grant element declined from 71Z to 41Z as new commitments of IDA declined from a peak of $1,535 million in FY80 to $673 million in FY85 and about $640 million in FY86. 26. In the event that official develnpment assistance does not increase significantly from recent levels, nearly the full additional financing required would have to be provided from additional non-concessional borrowing from offi- cial and commercial sources. Thi- -ill increase India's debt service ratio from the present level of 15.5% to 21.6% by 1989/90. Provided India can in fact, expand export earnings along the lines described earlier, and provided India's past record of prudent borrowing and debt management continues, the country should be able to raise the projected amounts. While its foreign resource requirements would be manageable, the increase in its external debt exposure would leave it with little cushion to deal with unfavorable eventualities and with the risks of policy change. 27. In the short term, a relatively large level of external borrowing, including an increased emphasis on commercial borrowing, will be necessary to cope with the balance of payments consequences of the growth strategy described earlier. Althcugh India is currently in a position to increase borrowing on commercial terms from the very low levels of the past, there are, of course, limits beyond which India will choose to sacrifice growth objectives rather than accept debt on unfavorable or unmanageable terms. While therefore a greater volume of both official concessional and non-concessional assistance is warranted, concessional assistance, in particular, will be invaluable in moderating the build-up in India's debt service burden. Apart from the quan- titative arguments for concessional aid, there remains the imperative to assist India in addressing the problems of pervasive poverty. While Ini.;a is now better placed than other poor countries to tackle its development problems, the mobilization of additional resources to address poverty problems is heavily constrained. Concessional assistance can also play a very important role in relieving this constraint. 28. Summary. India has demonstrated that it can sustain a rate of growth closer to 5.0Z per annum than to the long-run trend of 3.6% per annum. If the rate of population growth can be brought to below 2.0% per annum, a 5.0% growth rate would mean a doubling of the trend rate of growth of per capita income of 1.4% per annum. Success in these efforts would make a significant difference to the prospects of easing poverty in India. Development prospects over the next few years will hinge on the extent to which the economy can be brought into both internal and external balance, while at the same time achieving more rapid growth than in the past. This will require the continuation of the current development strategy which assigns high priority to export promotion, public  -9- finance discipline, improvement of economic efficiency, and investment in infrastructure, supported by adequate flows of external borrowing and aid. PART II - BANK GROUP OPERATIONS IN INDIA 29. Since 1949, the Bank Group has made 93 loans and 183 development credits to India totalling US$8,735 million and US$13,809 million (both net of cancellation), respectively. Of these amounts, US$1,633 million has been repaid, and US$8,743 million was still undisbursed as of March 31, 1986. Bank Group disbursements to India in the current fiscal year through March 31, 1986 totalled US$1,003 million, representing an increase of about 28 percent over the same period last year. Annex II contains a summary statement of disbursements as of March 31, 1986. 30. Since 1959, IFC has made 36 commitments in Lidia totalling US$310 million, of which a total of US$186 million has been repaid, sold, ter- minated or cancelled. Of the balance of US$124 million, USt118 million repre- sents loans and US$6 million equity. A suimmary statement of IFC disbursements as of March 31, 1986, is also included in Annex II (page 5). 31. The thrust of Bank Group assistance to India has been consistent with the country's d-velopment objectives in its support of agriculture, energy and infrastructure. Of particular importance have been investments in irrigation, extension and on-farm development dRsigned to increase agricultural productivity, and efforts to improve the availability of basic agricultural inputs to farmers through credit, fertilizer, marketing, storage, and seed projects. Major elements of the lending program have also been directed at helping to meet the energy needs of the economy while curbing the growth of oil imports, and to ease the infrastructure bottlenecks which have hampered economic growth in India, particularly through power generation and distribution, and railways and telecommunications projects. The Bank Group has also provided financing for a broad range of medium- and small-scale industrial enterprises, primarily in the private sector, through its support of development finance institutions. Recognizing the importance of improving the ability to satisfy the essential needs of urban and rural populations, the Bank Group has supported nutrition and family planning programs, a rural roads project, as well as water supply and sewerage and other urban infrastructure projects. 32. This pattern of assistance remains highly relevant, and consonant with Government priorities, as reflected in the the Seventh Plan. First, high priority will continue to be given to GOI's agricultural program. While India has made significant progress in agriculture, productivity growth will have to be sustained to improve the balance between food demand and supply and to con- tribute to poverty alleviation and employment. Thus, the Bank Group will con- tinue to support irrigation, fertilizer production and distribution, and agricultural extension, research and credit. Second, alongside GOI's efforts in promoting greater efficiency and faster development of the industrial sector, increased assistance will be provided for industrial development. Third, in line with the stress which the Seventh Plan gives to the expansion and more efficient use of basic infrastructure capacity and to the development of India's indigenous hydrocarbon resources, the Bank Group will continue to provide sub- stantial support to the development of the energy, transport and telecommunica- tions sectors to alleviate critical shortages which constrain output in both  -10- the agricultural and industrial sectors. Fourth, support of urban development and other GOI basic social services programs for the poor will also continue in light of the growth in population which, despite successes in lowering birth and death rates, still increases by about 16 million each year. 33. The need for a substantial net transfer of external resources in support of the development of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. Thanks in part to the response of the aid coummnity, India successfully adjusted to the changed world price si nation of the mid-1970s. However, India continues to require a substantial levei uo foreign assistance both to offset the overall deterioration in the world trade environment, and to sustain the relatively higher investment and growth rates achieved during the Sixth Plan period. As in the past, Bank Group assistance for projects in India should aim to include the financing of local expenditures. India imports relatively few capital goods because of the capacity and competitiveness of the domestic capital goods industry. Consequently, the foreign exchange component tends to be small in most projects. This is particularly the case in such high-priority sectors as agriculture and irrigation. 34. India's poverty and needs are such that whenever possible, external capital requirements should be provided on concessional terms. Accordingly, the bulk of the Bank Group assistance to India in the past was provided from IDA. However, IDA lending to India is declining from a peak of US$1.5 billion in FY80, mostly due to funding constraints related to IDA. The amount of IDA funds available to India is likely to remain small in relation to India's needs for external support. Thus, this requirement for additional assistance will have to be met, in part, through larger Bank lending. Given its development prospects and policies, India is judged creditworthy for Bank lending to supple- ment IDA assistance. A continuation of efforts already underway to achieve growth in productive capacity, trade expansion, higher levels of savings, foodgrains self-sufficiency and a reduction in the rate of population growth should result in continued economic growth and improvement in the balance of payments. India's debt service ratio is estimated at about 15.2% in 1984/85. This ratio is projected to rise to around 20% by 1989/90, mainly due to the hardening structure of India's debt; and to increase slightly over this level through the mid-1990's. Although the projected debt service ratios are con- siderably above historical levels, they are still manageable and will not adver- sely affect India's creditworthiness. 35. Of the external assistance received by India, the proportion contributed by the Bank Group has grown significantly. In 1970/71, the Bank Group accounted for 22% of total commitments, 11% of gross disbursements, and 10% of net disbur- sements as compared with 68Z, 38Z and 47%, respectively, in 1984/85. In 1984/85, about 26.3Z of India's total debt service payments were to the Bank Group. On March 31, 1985, India's outstanding and disbursed external public debt was estimated to be about US$26.5 billion, of which the Bank Group's share was US$11.1 billion or 42% (IDA's US$8.9 billion and IBRD's US$2.2 billion). As of March 31, 1986 outstanding loans and credits to India held by the Bank totalled US$20,911 million, of which US$8,743 million remain to be disbursed, leaving a net amount outstanding of US$12,168 million.  -11- PART III - THE FERTILIZER SECTOR Background 36. India's fertilizer industry accounts for about 4% of the total output of the organized industrial sector, and in 1984/85, represented about 0.6% of GDP at factor cost. The subsector employs about 79,000 people, representing about 0.7Z of total employment in the sector. The industry comprises 42 manufacturing plants owned and operated by 27 producers. Twenty-two of the plants are owned wholly or partly by GOI, sixteen plants are owned by private sector groups and the remaining four are owned and operated by cooperative sector companies including the Indian Farmers Fertiliser Cooperative, Ltd. (IFFCO). Plant capacity utilization rates, though increasing, vary widely. Average capacity utilization of publicly owned plants has increased from 41% in 1980/81 to 60% in 1984/85. Average capacity utilization of privately owned plants for the same period has increased from 612 to 91%, while in the cooperative sector, utilization rates have consistently remained near or above 100%. The Indian Fertilizer Market 37. Supply and Demand. Increased fertilizer use is central to India's efforts to increase agricultural output. Indigenous production capacity of both nitrogenous and phosphatic fertilizers has grown from 148,000 metric tons of nutrient per year (tyn) in 1952 to its current level of 6.9 million tyn, of which 75X (5.2 million tyn) is nitrogenous fertilizer production capacity. Both the production techno'logies and plant design capacities have changed over the period and have generally followed international trends towards more energy-efficient, larger capacity manufacturing facilities. Plant locational decisions have been made in the light of regional supply/demand requirements, raw materials sources, and infrastructure considerations. Feedstock choice for nitrogen fertilizer initially favored naphtha, then fuel oil and, still later, coal so as to decrease the country's dependences on imported hydrocarbons. Following the discovery of large quantities of natural gas near Bombay, most of the new nitrogen plants have been, and will be based on this feedstock. India is currently the fourth largest fertilizer producer in the world, after the USA, USSR, and China. 38. In spite of this impressive build-up of production capacity, the country, today, faces a supply gap of some 3.0 million tyn at an FOB cost of about US$750 million. While fertilizer consumption has grown at an average rate of 14% per annum over the past 25 years, there is considerable potential for continued strong growth. Application rates in India, which average 36.6 kg of nutrient per hectare, are low in comparison to other developing countries l/ and there are widespread disparities in fertilizer usage among 1/ Comparable figures for Mexico, Brazil, and China are 67 kg/ha, 79 kg/ha, and 150 kg/ha respectively.  -12- states within India. While the Punjab averages 149 kg/ha, some other states use as little as 12 kg/ha. By 1991, in spite of the planned increased production capacity, demand is expected to outstrip supply by at least 1.2 million tyn and, depending on various assumptions as to growth rates, the gap could again be as high as 3.7 million tyn by 1994/95. India's Fertilizer Investment Strategy 39. Given the expected shortfall in domestic production and the large quantities of natural gas available from newly discovered fields, the prin- cipal thrust of India's investment program in fertilizers is to expand nitrogen production through the construction of 10 large ammonia/urea plants. Four have been completed; two are under construction; the seventh (the proposed Aonla plant) is now at an initial stage of implementation; and a further three are planned to be owned and operated in the private sector. All will use natural gas from the Bombay High and South Bassein offshore fields as feedstock and most will use common process technologies. 40. In addition to establishing new facilities, GOI is keenly aware that, in order to mitigate the cost of imports, the utilization of existing capacity must be improved. In consultation with the Bank, GOI has in progress a comprehensive program of plant-by-plant studies particularly focussing on some of the public sector-owned manufacturing facilities to determine technical rehabilitation measures that would permit higher capacity utilization and energy conservation to reduce operating costs, and to iden- tify uneconomic units for closure. Previous Bank Group Operations 41. The Bank Group has supported the fertilizer industry in India through twelve projects with a total financial contribution of about $1.1 billion. The financing has been through IDA for seven projects, IFC for three projects, and IBRD for two projects. These projects aimed primarily at expanding and balancing the expansion of capacity in the public sector. According to their project completion reports, three (Cochin, Cr. 624-IN; Gorakhpur, Cr. 279-IN; and Nangal Cr. 357-IN) experienced completion delays due to delays in finalizing engineering arrangements, late delivery of equipment, and/or poor management. A Project Completion Report (SEC M83-69, June 22 1983) on the Bank-financed Phulpur project owned by IFFCO pointed out the need for improved implementation, monitoring and management systems; prompt Government decision-making; and greater selectivity in the use of engineering technologies and equipment. A report being issued by the Operations Evaluation Department (Sustainability of Projects-Review of Experience in the Fertilizer Subsector) on all projects in the sector con- cludes that the transfer of technology is an ongoing process, and that the Bank Group has an important role to play. It cautions against using too optimistic estimates of plant construction times and points to the need for project sponsors to be selective in choosing domestic suppliers of services and equipment. The proposed project has been prepared with these lessons in mind. All legal covenants in the earlier projects were and/or are being met.  -13- Fertilizer Prices and Subsidies 42. Both the retail and ex-factory fertilizer prices are administered by the Government. The ex-factory or so-called "retention" price is set accord- ing to a formula that, on a plant-by-plant basis, will enable the producing unit to earn a 12Z post-tax return on capital employed when operating at 80% capacity utilization and at certain agreed input consumption norms. Urea 1/ retention prices for the various plants vary widely and currently range from a low of US$128/ton to a high of US$377/ton, depending on technology and feedstock used, plant age, cost of feedstock and other factors. The weighted average retention price for all plants during 1984/85 was US$238/ton, which, with the cost of freight and distribution margins, brought the average farmgate cost of domestic urea to US$263/ton. While the retention price system has certain advantages, it does not strongly encourage producers to improve the efficiency of the production--since it allows them to recover most costs--and, being separately calculated for each plant, does not gener- ate the necessary element of competition among manufacturers. As part of. the initiatives being undertaken by the Government at this time, there is a major review of the retention pricing mechanism to ensure that the pricing mechanism stimulates competition among producers using similar technology, feedstock and equipment and to encourage lower operating costs. Support for these measures is built into this project (see para. 53). 43. The farmgate price for the different types of fertilizers is uniform throughout India and is set at levels that ensure that farmers have suffi- cient incentives to increase fertilizer usage and therefore crop outputs. GOI has maintained farmgate prices practically constant for a number of years in keeping with its policy of stimulating agricultural production through increased fertilizer application. The current price of urea, at US$181/ton is about 30Z below the current average farmgate cost of domestically produced fertilizer of US$263/ton--implying a substantial budget subsidy. The incen- tive to farmers to use fertilizer obviously depends not only on fertilizer prices, but also on crop prices and on crop response rates. At current levels, the use of fertilizer is profitable for Indian farmers and a study of prices, crop response rates and fertilizer usage is currently underway. 44. The Fertilizer Subsidy. Since current average retention prices are above retail prices, a Government budget subsidy is required to sustain the producer margins. The overall cost of the subsidy has risen rapidly during the 1980s, largely because of sharp increases in the retention prices for many existing fertilizer plants 2/ and the coming on stream of new plants with above average retention prices. In 1979/80, the total fertilizer budget subsidy amounted to US$745 million. By 1984/85, the subsidy had reached 1/ Urea is the most common form of nitrogenous fertilizer sold in India. 2/ A major factor in the rising retention prices was higher energy costs, which constitute 50% of the production costs of urea. These rose dramati- cally between 1979 and 1985. Natural gas prices increased 1290%, naphtha 155% and power 75%.  -14- US$1440 million and is expected to exceed US$1.5 billion in 1985/86. However, not all of this subsidy represents a net outflow of funds from the Covernment's budget. Currently, about half of the subsidy related to domes- tically produced nitrogenous fertilizer is actually transferred to gas and energy suppliers as payments under the retention price for energy and feedstock costs are higher than international energy prices or compensates for duties and taxes charged on capital equipment (which are reflected in the capital costs of existing fertilizer plants). 45. The level of total economic 1/ subsidy is also substantial and amounted to US$1.1 billion or US$87/ton in 1984/85 - virtually all of which was attributable to users since, on average, the retention price closely matched the economic cost of fertilizer during that year. If, longer term, international prices (FOB Europe) tend toward a projected equilibrium level of around US$190/ton by 1990 and if there is no further increase in farmgate or retention prices, the economic subsidy would increase to around US$115 per ton and the need to progressively reduce the cost of the overall subsidy to the levels implied in its public statements will require concerted action by GOI to both reduce producer prices and increase user prices. Apart from the political ramifications of substantial and repeated user price increases, the disincentive effects on fertilizer use will clearly have to be taken into account and, in addition, production costs will have to be reduced. 46. The Government has recognized the need to reduce the burden of the subsidy and has already undertaken a number of major steps. First it has committed itself publicly to reduce the subsidy--the Long Term Fiscal Policy (LTFP) Statement issued recently calls for a reduction in the total food and fertilizer subsidy from 1.4Z of GDP in 1984/85 to an average of 1.1 over the Plan period (1985/86 - 1989/90), a goal that implies a substantial reduction in fertilizer subsidies. Second, it has recently (February 1986) increased the retail price of urea by 10Z--the immediate effect of which is to reduce the budget subsidy by about 20Z below what it would have been without this increase. Third, it has nearly completed two major studies, one which examines the need for changes in the retention price system to more ade- quately reflect market conditions, and the other examines all aspects of the price/subsidy question with reference to crop prices and input/output ratios. The results of both of these reports are expected later in 1986 and will provide the framework for the actions to be taken over the next few years to meet the LTFP goal. GOI would review the conclusions of the reports with the Bank and, in implementing the recommendations, take the Bank's views into account. Finally it has agreed, in the context of the proposed project that, in order to meet the subsidy-reduction targets implied in the LTFP, it will have to meet a series of successively more stringent performance targets for 1/ The economic subsidy in India's situation of being a net importer of fertilizers, consists of two components: first, a user subsidy that is the difference between the farmgate price and the delivered cost of imports; and second, a producer subsidy that is the difference between the delivered cost of imports and the delivered cost of domestically produced fertilizer.  -15- all fertilizer plants and the distribution system. The year-by-year targets are outlined in Annex V of this report. Rationale for Bank Involvement 47. The Bank Group's principal objective in the past has been to support India's strategy for increasing domestic production of basic commodities such as fertilizer in which India has a comparative production advantage. It has played a central role in helping to build domestic capacity, and in helping individual plants optimize design and technology choice and avoid delays in implementation and commissioning. Through assistance from foreign licensors and equipment suppliers, domestic engineering and contracting firms have been able to build their capabilities to a point where domestic replication of new generation, large scale fertilizer plants is feasible. Over the next 5-6 years the Bank envisages a series of three projects, including the proposed project, that adds a focus on rehabilitation of additional existing plants and upgrading of the fertilizer distribution network, while maintaining a dialogue with, and supporting the Government in its efforts to reduce fer- tilizer costs and the level of subsidies. If the Government is to achieve the ambitious targets it has set for itself in terms of subsidy reduction, considerable adjustment costs will be incurred over the next five years as plants invest in upgraded production and energy efficiency and distribution facilities. Many of these measures are the result of the Bank's dialogue with the Government and the fertilizer industry, and the Bank is supporting GOI's efforts in taking these initiatives by including in the project a $150 million imports component that first, partially meets GOI's immediate requirements for fertilizer imports to bridge the domestic production shortfall, and second, in the medium term, frees up that amount of GOI funds to make the efficiency investments required to meet the targets--investments which, individually, would be too small for inclusion in a cost-effective IBRD project. PART IV - THE PROJECT 48. The project was appraised in July 1985. Negotiations were held in Washington in April/May 1986 with the Indian delegation coordinated by Mr. V. K. Malhotra of the Government's Department of Economic Affairs, Ministry of Finance. The Staff Appraisal Report (No. 6025-IN) dated June 2 is being circulated separately. A supplementary data sheet is attached as Annex III. Project Objectives and Description 49. The main objectives of the proposed project are to expand domestic nitrogenous fertilizer production capacity, thereby lessening India's depend- ence on imports, and to improve the operational efficiency of existing plants in the cooperative sector. The resulting reduction in fertilizer imports also lessens the burden on India's internal transportation system and increased domestic production capacity also reduces the chances of supply interruptions at critical times due to shipping, port, and/or transportation congestion or delays--thus enabling farmers to more efficiently prepare their crops. The focus of the proposed project is consistent with the Bank's strategy for the industrial sector which is to give encouragement and finan-  -16- cial support to such industrial and other policy shifts as are now being considered and to provide project assistance for those initiatives designed to improve the competitive position of those entities engaged in raising productivity and reducing unit costs. 50. The project would include (i) construction of a natural gas-based plant to produce 423,000 metric tons per year (tpy) of amonia in order to produce 690,000 tpy of urea, together with related offsite and utility facilities at Aonla in the State of Uttar Pradesh; (ii) rehabilitation of three existing plants in the cooperative sector to increase production and energy efficiencies; (iii) the preparation of a study for a management per- formance control, signalling and incentive scheme for India's public sector plants similar to that used in other countries; and (iv) imports of finished fertilizers and raw materials required for the manufacture of fertilizers in the early years prior to the start-up of the proposed Aonla manufacturing plant. The Bank would lend a total of US$152 million to IFFCO (the IFFCO loan) for the Aonla and rehabilitation components and US$150.2 million to GOI (the GOI loan) for the imports component (US$150.0 million) and for carrying out the study (US$200,000). Detailed Features 51. The Aonla component, for which the Bank would provide US$112 million, consists of (a) a single-train 1350 tons per day (tpd) amonia unit; (b) two 1100 tpd urea units; (c) integrated power and steam generation facilities; (d) cooling water and effluent treatment facilities; (e) storage for about 10,000 tons of refrigerated aimmonia and about 45,000 tons of bulk urea, and associated bagging facilities; (f) other related offsites; and (g) infrastructures, including a township with about 1000 housing units. The annonia unit employs technology from Haldor Topsoe A/S (Denmark) and both the design and capacity is the same as that used in the Bank-financed Madhya Pradesh Fertilizer project (Ln. 2415-IN). The two urea units use the ammonia-stripping technology offered by Snamprogetti (Italy) and the design and size is similar to that used successfully in several other plants in India. 52. The rehabilitation component, for which the Bank would provide US$40 million, consists of investments at three existing plants: at Phulpur, investments would include replacement of furnace tubing, larger coal grinding mills and other measures to be identified by an "end-to-end" energy audit and engineering study to be carried out under the project; at Kalol, major upgrades are required to the plant which was commissioned in 1975, including rehabilitation of the urea plant, modifications to the primary reformers, replacement of heat exchangers, purchase of better inspection equipment, and additional ammonia storage; and at the Kandla plant, modifications would include retrofitting of two of the process trains with improved reactors, additional storage and product bagging facilities, and supplementary seawater desalination units. 53. The performance evaluation and control system cimponent, for which the Bank would provide US$200,000, would, as an important institution- building element, further develop the management information system now being  -17- implemented by the Department of Fertilizers and would incorporate: (i) periodic evaluation of individual company and plant financial performance; (ii) a signalling system to highlight variations from estab- lished performance standards; (iii) a control mechanism to monitor progress of corrective actions being taken; and (iv) a management performance incen- tive scheme to foster improved plant operatiors. The terms of reference of the study to design the new system which would comence no later than November 1, 1986 and be carried out by June 30, 1987, will be agreed by June 30, 1986. 54. Fertilizer and associated raw material imports to the value of US150 million, would also be financed under the project to support GOI's efforts to increase production efficiency, improve pricing policy and reduce the subsidy. India is currently importing about US$500-750 million of fer- tilizers each year to make up the shortfall in domestic production so this import component will still only finance about 12X of imports for a two-year period. However it will free up an equivalent amount of resources to make investments needed to raise the efficiency of production and distribution. Project Implementation 55. The Aonla component of the project would be constructed, owned and operated by the Indian Farmers Fertiliser Cooperative Ltd. (IFFCO), a company established in 1967. The company is well managed, has satisfactory internal and external audit arrangements, management systems and capital structure. It employs approximately 5000 staff of whom nearly 2000 are professionally qualified. The in-house training systems are extensive and appropriate to the needs of the organization. The Board of 31 Members has delegated suffi- cient powers to the management to carry out its mandate effectively. Consequently it is considered that there would be little, if any, managerial risk in having IFFCO implement the project. Preparations for the Aonla plant are complete and, as of March 1986, the engineering, procurement and con- struction activities on the process units were 74Z, 441 and 141 complete respectively (in physical terms). Detailed engineering will be completed and most major equipment orders placed by mid 1986. The Aonla plant is expected to be completed by October 1988, although for purposes of financial and economic analysis, a more conservative, and typical profile has been assured with a completion date of December 31, 1989. 56. IFFOO will also undertake the rehabilitation component. The many sub-components (about 29 separate improvements are envisaged) are each expected to take from one to three years to complete, and all would be com- pleted by end 1990. The standard six-year disbursement profile has been assumeu in preparing the project economic estimates because of the possible difficulties of managing a large number of sub-projects simultaneously in three different plant locations. The final selection of design and engineer- ing requirements, although not yet definitive, is to be agreed between IFFCO and the Bank and will be based on proven technology: most will involve the installation of packaged units of standard designs. GOI confirmed, during negotiations, that it expected that all necessary approvals would be provided by December 31, 1986 and IFFCO would, by December 31, 1986, furnish to the  -18- Bank for its approval a detailed plan for the management and execution of the rehabilitation component. 57. The study of performance evaluation and control systems would be undertaken by internationally recruited consultants under the direction and responsibility of the Department of Fertilizers. Costs are based on an estimate of 15 man-months at US$10,000 per man-month, plus computer costs and local expenditures. The Mines and Minerals Trading Corporation, a government entity would implement the imports component as part of its ongoing respon- sibility for importing the country's total fertilizer requirements. Marketing 58. Close to 80% of the Aonla plant's urea production is expected to be consumed in UP - the state where both the Aonla and the Phulpur plants are located. IFFCO has established a solid, extensive, and competitive marketing position in this the major fertilizer consuming state in India. It is actively involved in extension efforts that are also supported by the Bank and, as a result, no new market development or seeding initiatives are required under the proposed project. Environment 59. The Aonla plant is located in a sparsely populated, non-fertile area. The plant has been designed and will be operated to meet the liquid effluent and gaseous emissions tolerances/limits according to Indian standards which are comparable to those applied to similar facilities in industrialized countries and which are considered satisfactory by the Bank. These design criteria have been incorporated in the contracts between IFFCO and its process consultants and form an integral part of the process guarantees to be met by them without limit to their liabilities. For the rehabilitation component, a number of the investments proposed at the three plants are intended to reduce effluents and treat pollutants in order to comply with, or improve on these same standards. Gas Supply and Infrastructure 60. Natural gas for the Aonla plant will be transported from the Bombay High/South Bassein offshore gas fields via the HBJ pipeline as shown on Map 19363 attached. GOI has confirmed the timely availability of adequate gas supplies for the Aonla plant and procurement of major items (including pipe) for the HBJ pipeline is in progress. GOI has signed a contract with the successful bidder for the construction of the pipeline and mobilization of the construction teams has commenced. GOI would ensure adequate supplies of gas to the project by no later than July 31, 1987. IFFCO and the Gas Authority of India Ltd. (GAIL) would be required to conclude by June 30, 1987 a formal gas supply agreement that would be acceptable to the Bank. The supply of gas to Aonla is a key component of the project and, in case of unforeseen delays in construction or commissioning of the pipeline, provision has been made to fire the steam generation units with liquid fuels (see para. 70 below).  -19- 61. Power for the Aonla component will be supplied, in part, from captive power generation units and from a new twin 132kv transmission line from the ezisting UP power grid to the project. The UP State Electricity Board has sanctioned the required 8mw of power for the plant and provided assurances that the state grid has adequate resources to provide the entire power requirements of the complex on a temporary basis if necessary. Local surface water sources are inadequate to supply the estimated 40,000 cubic meters per day required of the project. Groundwater studies have indicated, however, that a series of 15-16 tubewells, appropriately spaced, would meet the plant and township needs without adversely affecting surrounding wells. Project Costs and Financing 62. The financing required for the project, including contingencies, interest during construction, working capital, and the fertilizer imports component is US$917.9 million, of which about US$534 million is in foreign exchange. Taxes and duties included in the total cost amount to US$31.4 million. Physical contingencies have been calculated at 2% and 10Z of the base costs of the Aonla and rehabilitation components, respectively, and price contingencies have been calculated on the basis of escalations of 5% for 1986, 62 for 1987 and 7X for 1988 and beyond. The proposed Bank loans totalling $302.2 million would finance about 18% of the costs of the Aonla component, 30% of the costs of the rehabilitation component, 66Z of the costs of the study on performance evaluation and control systems, and 100Z of the costs of fertilizer imports. The proposed loans to GOI and to IFFCO, with GOI guarantee, would be for 15 years with a five-year grace period, at the standard, variable rate. For the IFFCO loan, GOI would, in addition, charge IFFCO a Guarantee Fee such that, together with IFFCO's cost of covering the foreign exchange risk, the resulting effective interest cost on the Bank funds to IFFCO would approximate the standard rate applicable for similar industrial type loans in India (currently 13.75%). 63. The additional debt financing requirement of US$330.8 million woulU be financed, in part, by the Overseas Economic Cooperation Fund of Japan (OECF) in an amount of $126.8 million equivalent, by DANIDA, an agency of the Danish Government, (US$6 million equivalent), and by the Italian Government (US$18 million equivalent). Local borrowings and GOI would provide the remaining debt requirements. Equity funds in the amount of US$284.9 million would be provided by GOI, by the shareholder cooperatives and from IFFCO's internal resources, including internal cash generation of the project itself. Under the terms of the GOI guarantee agreement, GOI would promptly provide IFFCO with any additional funds and facilities required to complete the project and cover any possible cost overruns. Procurement and Disbursement 64. Equipment financed by the Bank loan for the project would be procured primarily through international competitive bidding (ICB). Procurement through limited international bidding (LIB) procedures would be permissible for equipment from specialist suppliers and proprietary to the process design (US$5 million) and small items under contracts each with an estimated value of not more than US$200,000 (totalling about US$8.5 million) from qualified  -20- local suppliers from at least three eligible countries; and also for specialist erection/comissioning services supplied by vendors (about US$3.5 million) and engineering and consulting services (about US$13.5 million). For purposes of bid evaluation under ICB procedures, qualified local sup- pliers will receive a margin of preference of the lower of either 15%, or the generally applicable duty for such goods. Prior Bank approval would be required before awarding all contracts over US$500,0oo (estimated to cover 70% of the loan amount). Imports of fertilizers would also be procured in economic shipping quantities in accordance with the Bank's LCB procedures. 65. The proposed loan would be disbursed against: (i) 100% of foreign (CIF) or locally manufactured (ex-factory) costs for equipment, materials and spare parts and 70% of other costs for items procured locally; (ii) 100% of the costs of engineering and commissioning services by equipment suppliers; (iii) 100% of foreign and 70Z of local costs for specialist transportation services and for civil works and erection services within supply and erect contracts, both let under ICB; (iv) 100% of the foreign cost of the study and consultancy services for the rehabilitation component; and (v) 100% of the foreign cost of imported fertilizers, net of duties and taxes. Disbursements will be made under Statements of Expenditure for payments relating to con- tracts with a value below US$500,000. Retroactive financing in the amount not to exceed US$11.2 million for procurement of long lead time items would be provided for eligible expenditures made after July 31, 1985. Financial Evaluation of IFFCO 66. Largely because of high capacity utilization of existing plants and sound management, IFFCO's financial position is strong. It has earned ade- quate returns and its financial ratios are better than the standard bench- marks considered prudent for the industry. Profits are expected to rise rapidly once the Aonla plant comes on stream. Capacity utilization from year 1991 is expected to be 95% or better. In order to ensure IFFCO's continued financial soundness, IFFCO would (i) maintain its debt-equity ratio at a level not greater than 60:40; (ii) maintain a ratio of current assets to current liabilities of at least 1.2:1 after completion of the project; (iii) not incur any additional debt if its projected debt service coverage ratio would be less than 1.3; (iv) not make additional investments in fixed assets during implementation of the project in excess of an aggregate US$80,000,000 equivalent (representing mostly projects already under execution); and (v) not prepay any debt or declare any dividends if such action would result in the current ratio falling below 1.4:1. The financial rate of return (FRR) of the project is an acceptable 12% which is lower than the economic rate of return of about 17%, primarily because the projected urea retention prices are lower than their projected economic values and domestic energy prices are projected to be above their projected economic values (para.69 below). Audits and Accounts 67. IFFCO would also submit, in a form satisfactory to the Bank (a) its annual audited financial reports within nine months from the end of its financial year, (b) monthly construction progress reports until commissioning of all components is completed, and (c) not later than 30 days after the end  -21- of each quarter, quarterly financial statements for IFFCO. As is usual practice, IFFCO would also prepare a project completion report. GOI, for its part, would provide a quarterly report on the implementation of the fer- tilizer imports program and the study in a form satisfactory to the Bank. Benefits and Risks 68. The project will ireate about 1200 permanent jobs and an additional 3000 jobs at the peak construction phase of the plant at Aonla. Local engineering firms involved in the project will gain valuable experience and know-how, a?' the project will have significant backward linkages into the industrial sCLor, creating additional jobs and investments. 69. The economic rate of return (ERR) of the Aonla component is about 17%, based on projected equilibrium international fertilizer and energy prices and completion of the plant in a conservatively estimated 63 months. The rate is sensitive to changes in product prices, and, to a lesser extent, to operating costs. A 10Z drop in fertilizer prices would reduce the ERR to 14.8Z. A one year delay in start-up or a 20% increase in capital costs would reduce the ERR to 14.8% or 14.2Z, respectively-rates that are still acceptable. A reduction of 30Z in projected energy costs (equivalent to a long term oil price of US$13.00 per barrel) would increase the ERR to 20% if fertilizer prices remained at currently projected levels. Some of the rehabilitation sub-projects have directly measurable ERR's that range from 22-44%. Others do not, however, and no overall ERR has been calculated for the rehabilitation component. 70. The major potential risk faced by the project initially concerns the possible delay in receipt of gas from the EBW pipeline. To compensate for this possibility, conservative assumptions have been used by the Bank in the preparation of the project by estimating a plant start-up date of January 1990-which is two years after the planned pipeline completion date to Aonla. In addition provision has been made to fire the steam generation boilers with liquid fuels to cover short term delays in pipeline commissioning-up to 4-6 months. Second, a significant drop in the long-term international price of fertilizers, possibly as a result of a long-term decline in world-wide energy prices would affect the economic attractiveness of the project as shown in para 69 above, and the possibility of lower international fertilizer prices cannot be ruled out in today's volatile energy market. Should international fertilizer prices stay depressed, then on strictly economic gr3unds, the Government would be better off importing fertilizer than investing in domes- tic production capacity. Nevertheless, reliance, except possibly at the margin, on imports in a volatile mar.tet is not an appropriate development objective for India with its abundant gas resources and growing fertilizer demand.  -22- PART V - RECOMMEADATION 71. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank, and recommend that the Ezecutive Directors approve the proposed loans. A. W. Clausen President Washington, D.C. June 4, 1986  ANNEX 1 I ha L.g Pag 1 of 6 mu: cmu ucaur DlSuu13 ^ aguaLk. 136311 SLII 130016 li l KN * O AM taM- u. U) TOTAL 2267.6 3361.6 2367.6 . AOUCUEeR*1 1763.5 1760.5 1811.4 N I CA C .. .- 240.0 276.3 1011.1 CUILo SO 0or oL QOIvzLII) 79.0 :13*0 151.0 2 5.? 566.. iuwr&mu m rna IUcewu POPUIATIKO, nMD-TUl CT03M) 4549.0 567569.0 733248,0 133* IWULATIOU 3 OF IOTA?.) 11.0 19.6 24.4 22.2 25.9) OPUSATIxow It1* 200 CuLL) 694.4 As* MWUATK (EILL) 1700.0 OUUATIOV 3 N1 1.6 . MR 30. IN. 122.2 166.6 223.0 173.8 366.9 331 3 IN. AGRI. LAND 244.6 307.5 395.6 353.3 1591.2 P0WMAINA1 AMg STUICIS (1) 0-14 1us A0.L 42.7 39.5 36.3 32.2 1544 Yu 54.4 56.1 36.5 59. 57.7 *5 no ADftN 1.6 3.0 3.9 4.3 3.5 POPMATZ oROT RhTn (2) TOTAL 1.l$ 2.3 2.2 2.0 2.3 03211 2.5 3.3 3. 4.1 4.1 5i3i- 113T 11 Tt CMI 1TO05) 47.7 61.5 3.9 27.5 30.1