India - Structural Adjustment Credit Project

DMI TheWo, FOR OFFICIA C,Z oZ 3 t -/A/ ReportNo. P-5678-IN REPORT AND RECOMMENDATION OF THE INTZRNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$250 MILLION AND O: 't PROPOSED STRUCTURAL ADJUSTMENT CREDIT IN AN AMOUNT EQUIVALENT TO SDR 183.8 MILLION TO INDIA November 12, 1991 Ths document has a restricted distribution and may be used by recipients only In the perfomance of their official duties. Its contents may not otherwise be diselosed without World Bank authorization.  CURRENCY EQUIVALENTS Curency unit = Indian Rupee (RS) US$1.00 = Rs 25.84 SDR 1.00 = Rs 35.71 WEIGHTS AND MEASURES Metric System FISCAL YEAR April 1 - March 31 ABBREVIATIONS AND ACRONYMS BIFR Board for Industrial and Financial Reconstruction BSE Bombay Stock Exchange CCFF Compensatory and Contingency Financing Facility CCS Cash Compensatory Support CRR Cash Reserve Ratio DGS&D Directorate General of Supply and Disposals DFI Development Finance Institutions DOD Debt Outstanding and Disbursed EAP Environmental Action Plan NRF National Renewal Fund NRI Non-Resident Indians OGL Open General License PMP Phased Manufacturing Programs RBI Reserve Bank of India REP Replenishment SEB State Electricity Boards SEBI Stock Exchange Board of India SICA Sick Industrial Companies Act SLR Statutory Liquidity Ratio SOE Statement of Expenditures  FOR OFFICIAL USE ONLY INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT LOAN AND CREDIT SUMMARY Borrower: india, acting by its President Executing Agency: Ministry of Finance Amount: IBRD Loan: US$250.0 million IDA credit: SDR 183.8 million (US$250 million equivalent) Terms: IBRD Loan: Repayment over twenty years, including five years' grace, at the standard variable interest rate. IDA credit: Standard (with thirty-five years' maturity). Description: The proposed Structural Adjustment Loan/Crecit would support the initial phase of the Government's program of macroeconomic stabilization and structural reform. In addition to a major fiscal adjustment effort, the main areas covered by the program are: (i) deregulation of domestic industry and promotion of foreign direct investment; (ii) liberalization of the trade regime; (iii) reform of domestic interest rates coupled with measures to strengthen capital markets and institutions; and (iv) initiation of public enterprise reform. Benefits: The adjustment policies being supported by the SAL/SAC in conjunction with an IMF stand-by arrangement, will restore macroeconomic balance and strengthen external creditwoi.thiness. The Government's reform measures would initiate the opening up of the economy and would also alter fundamentally the parameters of public-private interaction in a manner that would promote domestic competition, improve the incentive system, and would foster sustained growth with rising productivity. This document has a restricted distribution and may be used by recipients only in the pOeto; mance of their official duties Its contents may not otherwise be disclosed without World Jank a-ithnrfttion.  ii Risks: Givan the external liquidity situation of India and the extent of adjustment efforts required, the first important risk relates to failure to follow through with the implementation of forceful stabiliza.tion and structural reform measures. The Government's determined and skillful efforts to forge the consensus necessary for sustaining the reform process notwithstanding, social and political reaction to the adverse transitional ronsequences of adjustment (e.g., subsidy reductions, labor retrenchment, and higher inflation) could slow the pace of reform and jeopardize its success. Failure to elicit a strong supply response, either due to lukewarm private investment response and/or to shortages of essential intermediate and capital goods imports, is the second major risk associated with the program. Finally, external developments over which the authorities have limited or no control define the third set of risks (e.g., slow growth of world trade, ur.resolved international trade issues, and inadequate balance of payments support). Disbursements: The proposed loan/credit will be disbursed in two tranches. It is proposed that the first tranche be set at US$300 million, with the remaining US$200 million to be disbursed in the second tranche. The amount of each tranche would be equally divided between the loan and credit. The first tranche would be available upon loan/credit effectiveness. The release of the second tranche, planned for April-May 1992, would be contingent upon satisfactory overall progress in program implementation and the fulfillment of specific conditions.  INDIA STRUCTURAL ADJUSTMENT LOANLCREDIT Table of Contents Pace No. PART I. THE ECONOMY . . . . . . . . . . . . . . . . . . . . . . . . . 1 A. Introduction . . . . . . . . . . . . . . . . . . . . . . . 1 B. Policies in the 1980O . . . . . . . . . . . . . . . . .. 2 C. The 1990-91 Balance of Payments Crisis . . . . . . . . . . 3 PART II. THE ADJUSTMENT PROGRAM . . . . . . . . . . . . . . . . . . . . 4 A. Background ... . . . . . . . . . . . . . . . . . . . . . 4 B. Macroeconomic Framework ... . . . . . . . . . . . . . . 6 C. Industrial Policy Reform .8.. . . . . . . . . . . . . . . a D. Trade Policy Reform ... . . . . . . . . . . . . . . . . 11 E. Reform of the Financial System . . . . . . . . . . . . . . 17 F. Public Enterprise Reform . . . . . . . . . . . . . . . . . 20 G. Social Dimensions of Adjustment . . . . . . . . . . . . . 22 H. Macroeconomic Prospects and External Financing Requirements ... . . . . . . . . . . . . . . . . . . . 24 PART III. THE PROPOSED SAL/SAC .................... . 27 A. Loan/Credit Objectives ... . . . . . . . . . . . . . . . 27 B. Conditions of Effectiveness and Tranche Release . . . . . 27 C. Loan/Credit Administration . . . . . . . . . . . . . . . . 30 D. Monitoring . . . . . . . . . . . . . . . . . . . . . . . . 31 E. Risks .... . . . . . . . . . . . . . . . . . . . . . . 32 PART IV. WORLD BANK STRATEGY AND OPERATIONS . . . . . . . . . . . . . . 32 A. The Bank Group's Role and Strategy . . . . . . . . . . . . 32 B. The Bank's Lending Program . . . . . . . . . . . . . . . . 37 PART V. RELATIONS WITH THE IMF ... . . . . . .... . . . . . . . . 38 PART VI. RECOMMENDATION . . .39 TABLES 1: Summary of Macroeconomi' Projection3 2: Bank Lending, Fiscal Year 1987/91 ANNEXES I: Economic Indicators II: The Government's Letter of Development Policy III: Policy Reform Matrix IV: Status of Bank Group Operations in India V: Supplementary Loan Data Sheet  REPORT AND RECOIOIDATION OF THE PRESIDENT OF TIE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND INTERAXTIONAL DEVELOPMENT AS30CIATION TO THE EXECUTIVE DIRECTORS ON A PROPCSED STRUCTUPULL ADJUSTMENT LOANICREDIT TO INDIA 1. I submit the following report and recommendation on a proposed Structural Adjustment Loan/Credit to the Government of India. The proposed operation would be for the equivalent of US$500 million, equally divided between IERD and IDA. The proposed loan would have a term of twenty years, including a grace period of five years, at the Bank's standard variable interest rate. The proposed credit would be on standard IDA terms with thirty-five years maturity. In parallel with an IMF stand-by arrangement (approved by the Fund's Board on October 31, 1991), the proposed Structural Adjustment Loan/Credit, would support the initial phase of the Government's medium-term program of macroeconomic stabilization and structural reform. PART I. TEE XCONONY' A. Introduction 2. Viewed in the broad perspective of social and developmental goals and objectives that the developing world has pursued irn the past four decades, India's achievements are unique. Since Independence in 1947, the country has eradicated famine and significantly reduced malnutrition, has taken major steps in improving agricultural productivity and output, and has established a diversified industrial base with an internationally recognized scientific culture. The country has established and operated democratic systems and processes which have ensured a remarkable degree of political freedom for the common citizen. These achievements have involved forging a large, extremely poor populace, sharply divided along ethnic, linguistic, and religious lines, into a modern, federated nation state. Driven by the need to build consensus in a highly diverse society, economic policy in Indix has been dominated by goals of interpersonal and interregional equity and national self reliance. 3. In pursuit of its development objectives, however, India relied on an inward-looking and highly interventionist approach to economic management at the level of both aggregate and microeconomic policies. Industrial policy was driven primarily by the objective of attaining self-sufficiency rather than by considerations of efficiency and underlying comparative advantage. At the operational level, the policy assigned a dominant role to the state, which in the process assumed substantial and sometimes exclusive ownership positions in key industries, and regulated virtually every facet of private initiative, including firms' entry, expansion, diversification, and modernization, as well as labor 'The latest Country Economic Memorandu (Report No. 9412-IN), which provides a detailed analysis of the economy's recent performance and prospects, was distributed to the Executive Directors on August 23, 1991.  deployment, asset restructuring or liquidation, on a case-by-case basic. As an integral part of this policy, a highly protective trade regime was built up with numerous quantitative restrictions, high tariffs, and a multiplicity of discretionary import licenses. Over time, the trade regime became intertwined with the fiscal apparatus as the Government's reliance on customs revenues increased. 4. A large number of public en_erprises was established by both Central and State Governments. These were often granted monopolistic positions in key subsectors of infrastructure, manufacturing, services and trade, and were nourished by Government preferences, including easy access to budgetary resources, guaranteed and subsiest!.d credit, and protection from import competition. In the financial sector, the Government has maintAined a dominant ownership position in the banking, mutual funds, and insurance industries following nationalizations in 1969. It has also pre-empted resources, and exerted considerable direct influence on both sides of the balance sheets of financial institutions through differential tax treatment of alternative financial instruments, regulated interest rates, high mandatory reserve requirements, and directed credit at subsidized rates. S. This diriqiste strategy resulted in slow progress toward many of India's development objectives. Growth, in particular, was disappointing in relation to India's relatively high saving and investment rates. Its manufacturing sector and exports, both large at Independence relative to other developing countries, stagnated. Population growth rates remained high, and indicators of the health and educational status of India's population, while showing some progress, remained among the world's lowest. B. Policies in the 1980s 6. A consensus began to build in the late 1970. that India would have to liberalize and increase the efficiency of its economy if it were to meet the challenges of providing gainful employment for a rapidly growing labor force, generating sufficient resources for social programs, and modernizing its infrastructure and industrial capacity to respond effectively to changing global and domestic conditions. This was translated, at the policy level, into a greater emphasis on economic growth as the primary means of poverty alleviation. 7. To this end, the Government took a variety of policy initiatives to stimulate aggregate demand and supply. On the demand side, macroeconomic policy became more expansionary, financed by increased domestic and external borrowing. On the supply side, significant initiatives were launched to improve infrastructure performance, and the scope for private initiative was gradually increased. Constraints on industrial investment, expansion, and diversification were partially relaxed. Price controls were removed in industries such as cement, aluminum, and paper. Licensing restrictions on large and foreign- controlled companies were eased to some extent. Industry-specific deregulation and promotion packages were instituted for industries like electronics and computers, leather, gems and jewelry, some of which experienced spectacular growth in output and/or exports. The private sector was permitted increasing involvement in sectors traditionally reserved for the public sector, on an "Ad h2gc basis, often through creation of "joint sector" concerns. While the trade regime retained its reliance on quantitative restrictions and high tariffs, an active export promotion effort and (after 1985) flexible exchange rate policy  were utilized to reduce the bias against industrial exports. In the financial sector, new instruments were developed to stimulate financial savings. In vied of the Government's tight control over the resources of the banking sector, capital markets and institutions began to grow rapidly, becoming hy the late 1380s a major source of funds to the corporate sector. 8. Viewed in terms of India's historical record, the economy's performance in -:he 1980s was impressive. Real per capita income robe by 40 percent in the 1980s, compared to less than 30 percent over the previous two decades combined, helping to make inroads into India's massive poverty. Manufacturing growth in the 1980s accelerated to over 7 percent per annum after yeara of disappointing performance, and productivity growth rose by 2.9 percent per annum following a long period of stagnation. There were advances in product and process technologies. However, these advances were based to a large extent on relaxed restrictions against foreign collaborations, and progress was uneven. Manufactured exports, sluggish in the 19709 and early 1980s, grew rapidly from the mid-1980s onward, albeit in a fairly narrow range of products. More generally, domestic industrial product markets became more competitive. All of these developments raised hopes that India had achieved a breakthrough onto a higher long-term growth path. C. The 1990-91 Balance of Payments Crisis 9. The severe balance of payments crisis which has beset the Indian economy since mid-1990, has clearly demonstrated the ineffectiveness of a piecemeal approach to economic reform. Alt'hough the crisis was precipitated by the oil shock of 1990, and deepened by the political uncertainty in late 1990 and early 1991, its origins are of a long-term and structural nature, traceable, most directly, to the poor performance of the public sector, and the over-regulation and protection of domestic industry which resulted in a pronounced bias against the expert sector. The Government's recognition of these fundamental causes of the crisis was clearly articulated in the Budget speech of the Minister of Finance on July 24, 1931, and is reflected in the Letter of Development Policy. 10. The basic policy philosophy shaping economic growth in the 1980. combined expansionism on the macro side, with continued interventionism on the micro side. Pervasive Government interventions in the markets for labor, foreign exchange and capital, as well as managerial control, remained a dominant feature of Indian policy management in the 1980s. This led to serious price distortions, inefficiency of resource use and a structural bias against exports. In this environment, the shift in the stance of macro-policy from the conservative management of aggregate demand in the 1960s and 1970. to the fiscal expansionism of 1980s resulted in large and potentially unsustainable accumulations of domestic and foreign debt. As the deficit of the overall public sector rose steadily from 7.4 percent of GDP in 1980/81 to 10.5 percent in 1990/91, total domestic public debt increased from 35.6 percent of GDP in 1980/81 to 56 percent of GDP in 1990/91, while external debt more than tripled to US$70 billion over the same period. The modus-operandi for such large accumulations was repression of the financial system on the domestic side, and increasing reliance on riskier and relatively shorter term debt instruments on the external side. 11. Domestically, the primary burden of financing the Government's debt accumulation fell on the banking sector, particularly commercial banks which were captive holders of the Government's securities and treasury bills through the  Statutory Liquidity Ratio (8LR). Through steady increases in the SLR the government channeled a growing preportion of commercial banks, demand and time liabilities to the public sector. Given India's buoyant private saving, this financing strategy was initially able to meet much of the growing diseaving of the public sector. However, increasingly India's internal imbalances spilled into the external sector accounta. The trade deficit rose from US$4.5 billion in 1984/85 to US$7.3 billion in 1985/86, with the deficit on the current account of the balance of payments rising by over 70 percent to US$6.0 billion. In thc years that followed, the deterioration in the external current account tended to accelerate as the private baving rate stagnated, and as Government imrorts and interest payments on previously acquired debt increased sharply. In the second half of the 1980s as a whole, the deficit on the external current account averaged about 3 percent of GDP despite improvements in India's merchandise terms of trade and buoyant growth of expor.s after 1985. As a result, India's total external debt outstanding and disbursed (DOD) increased from about US$41 billion in 1985/86 to US$70 billion at the end of 1990/91. The ratin of DOD to GDP climbed from 19 percent to 25 percent over the same period. 12. Since the mid-1980s, India has relied Lncreasitigly on borrowings from private markets, and much of this borrowing has been in the form of relatively short-term and potentially volatile instruments buch as two to three year maturity foreign currency bank deposits from non-resident Indians (Ts). Since the BRI bank deposits can be withdrawn on demand (with only a mall penalty), the weight of these deposits and short-term commercial bank debt in the total stock of debt (abuut US$18 billion or 25 percent of total DOD at the end of 1990/91) made India extremely vulnerable to liquidity crises stemming from a loss of private creditor confidence abroad. 13. The many weaknesses in the financing otrategy adopted during the 1980. were revealed abruptly in 1990/91. The increased oil import bill and foreign exchange receipt losses caused by the Gulf crisis came at a time when India's creditworthiness was already under strain. Consequently, the country's access to the international financial market was sharply curtailed. By end 1990, India's foreign exchange reserves had fallen to US$1.2 billion (about two weeks of Lmports). India availed itself of Fund resources, drawing SDR 716.9 million from the Contingency Compensatory Financing Facility (CCFFI and WDR 551.9 million as a first tranche stand-by credit. Despite these infusions, and severe import compression measures, foreign exchange reserves declined by US$1.8 billion in 1990/91 as net borrowing from private creditors fell by US$1.4 billion. Notwithstanding the liquidity pressures, India managed to maintain its impeccable debt servicing record. PART W1. TH. ADUM T PROGRAM A. Backoaound 14. The new minority Government that took office on June 21, 1991 moved swiftly to introduce an impressive set of measures aimed at dealing with the immediate external liquidity crisis, redressing accumulated fiscal imbalances, and equally important, a fundamental restructuring of the economy. On July 1 and 3, the Reserve Bank depreciated the rupee by 23 parcent (in terms of rupee per U.S. dollar). On July 4, the Government announced a trade policy reform package which, together with supplementary measures announced on August 13, 1991,  - s - aims at a significant reduction of quantitative restrictions on imports of intermediate and capital goods, reductions in tariff rates, substantial elimination of state monopoly on exports and imports, and convertibility of the rupee for trade transactions in three-to-five years. On July 24, 1991, the 1991/92 Union budget as well as a "Statement on Industrial Policy" were presented to Parliament. The budget announced the Government's intention to reduce its fiscal deficit by more than two and a half percentage points of GDP in 1991/92, despite the fact that only two-thirds of the fiscal year remained at the time. The new industrial policy aims to drastically reduce administrative control over firms' entry, expansion, and diversification, and to liberalize significantly the foreign investment code, allowing foreign capital ownership of up to 51 percent in selected industries (and up to 100 percent in special cases). Major aspects of these policy initiatives have since been implemented. 15. Discussions with the Government on policy-based lending in support of its stabilization and structural reforms were initiated in January 1991. At that time the Bank indicated that reform measures contained in the 1991/92 budget, and in any related policy statements, could provide an important basis for fast- disbursing assistance. In the context of these initial discussions, the Bank organized an informal donors meeting in April 1991 that was important in mobilizing support for India's emerging program. However, the interim nature of the GovernmenL, and the postponement of the elections caused by the assassination of Mr. Gandhi, created delays in program formulation and presentation of the budget. The discussions, however, accelerated after the new Government assumed office, and urgently requested the World Bank's and IMF'u assistance in support of its adjustment program. 16. In rarallel with a Fund stand-by arrangement2, the Structural Adjustment Loan/Credit represents a prompt response by the Bank to support India's management of the transition to a path of sustained economic growth with external payments viability. It would be the Bank's first policy-be ed loan to India and is facilitated by two important factors. First, the Government has firmly committed itself to economic reform, albeit at a pace that it feels is consistent with India's political and legislative framework. Secondly, the international community is providing major support for India's reform initiatives, as evidenced by the outcome of the India Aid ConsortiLum meeting held in Paris on September 19 and 20, 1991, and the positive response of several major multinational companies to India's liberalized foreign investment regime. The present operation is expected to be followed by a series of policy-based loans/credits in support of further reforms. 17. The thrust of the Government's medium-term adjustment program, as outlined in the Government's Letter of Development Policy (Annex 1I), lies initially in the key inte relateS areas of fiscal and financial stability, and industry, trade, finance and public enterprise reforms. The objectives to be achieved in each area in the near and medium term, as well as specific strategies for their achievement, are articulated in the Letter, and are elaborated upon below. 2The twenty-month arrangement in in the amount of SDR 1,656 million. A second drawing of the CCFF for SDR 166.2 million was approved on July 22, and a third drawing in the amount of SDR 468.9 million was extended on September 12, 1991.  -6 B. Macroeconomic rramework 18. The macroeconomic objectives of the Government are to restore internal and external balance consistent with sustained growth of output and employment, and to facilitate the transition to a less regulated and more efficient economy. Fiscal, monetary and supply-side policies are all being adjusted to effect the necessary mix of expenditure reduction and expenditure switching. Initial priority has been given to easing the country's tight external payments situation and reducing inflation. A credible program of stabilization is also seen as critical to reassure external creditors and to mobilize official external assistance. The basic elements of the Government's macroeconomic strategy include (i) establishing fiscal stability through a combi..ation of expenditure cuts, tax reform, and a streamlining of the public enterprise sector; (ii) a restoration of external payments viability and price stability through vigorous export promotion, a gradual build-up of foreign exchange reserves and tightened monetary policy; and (iii) raising efficiency and productivity growth through the removal of distortion-inducing controls on private sector activity, including a greater reliance on foreign capital and technology. Fiscal Policv 19. Improved fiscal discipline is necessary to lower inflation, reduce demand pressures on the balance of payments and to free resources for investment. Given its role in the recent evolution of India's fiscal imbalances, the chief burden of adjustment is to be borne by the Central Government. Despite the fact that only eight months remained in the fiscal year at the time of its presentation on July 24, the 1991/92 Union Government budget set an ambitious target of reducing the fiscal deficit from over 9 percent of GDP in 1990/91 to 6.5 percent. Since interest payments are projected to rise from 4.3 percent of GDP to 4.7 percent in 1991/92, achieving the Government's 6.5 percent of GDP deficit target requires a contraction of the primary deficit from 4.8 percent of GDP to 1.8 percent. The Union Government deficit is to fall further to 5 percent of GDP in 1992/93, with a target of 4 percent by 1994/95. If these targets are achieved, it is anticipated that the overall public sector deficit (as defined by the saving-investment balance of the consolidated nonfinancial public sector) would decline from 10.5 percent of GDP to 5 percent by the mid-1990s. 20. As indicated in the Government'e Letter of Development Policy, the targeted reduction of the deficit tn the 1991/92 budget will involve a balance between current expenditure cutv and revenue measures, ano will give relative protection to investment and social development outlays. Total expenditures and net lending are targeted to decline from 20.1 percent of GDP to 19.1 percent largely through cuts equivalent to 1.2 percent of GDP in noninterest current expenditures (notably fertilizer and export subsidies), transfers to the state Governments and central public enterprises, and defense spendirng. On the revenue side, Central Government revenue and grants are projected to rise by one percentage point to 12.6 percent of GDP. A significant portion of this revenue increase (equivalent to 0.4 percent of GDP) is to be achieved through the sale of part of Government equity in profitable public enterprises. 21. The dilution of Government ownership in profitable enterprises would have two important benefits besides generating revenues for the budget. It would further the process of public enterprise reform by introducing into the Government-public enterprise relationship a balancing partner and corresponding  - 7 - accountability, and ultimately serve to broaden &nd deepen the operations of the etock exchanges. In conjunction with other measures being taken in the areas of budgetary and public enterprise reform, including reduced loans and transfers to enterprises from the Government, the enhanced autonomy and accountability ehould lead to greater internal reeource generation by tht- :blic enterpriBes. 22. Given the very short time the new Government had for preparing the 1991/92 budget, a major effort will be required to realize its tax revenue projections and to translate overall expenditure reduction targets into specific program cuts. Moreover, some of the revenue measures, while justified at this time because of the priority of stabilization, cannot be relied upon i.9 long-term measures of fiscal adjustment. Thus, additional measures on both the revenue and expenditure side are being formulated. Some measures to further strengthen the fiscal adjustment may be introduced by end-December 1991 with a view to realizing additional net savings equivalent to 0.3 percent of GDP before the end of the 1991/92 fiscal year. 23. Proposals for a comprehensive reform of the tax system, focusing on improving its elasticity, and hence the stability of Government revenues, as well as reducing the distortionary impacts of the current tax system, particularly its dependence on customs' revenues (about 50 percent of Central Government tax revenue in 1990/91), are being examined by a panel of experts, with a view to their introduction in the 1992/93 budget. Substantial additional expenditure savings will be also sought, with likely measures including further cuts in subsidies, curtailment of cost-of-living allowances, a continued decline in budgetary support for public enterprises, and moderation in defense outlays. 24. Reducing the overall public sector deficit will also require increased financial discipline by the states, and the Central Government intends to play an active role in encouraging desirable fiscal &djustments on the part of the states. Improvements in the fiscal position of states will ease the pressure for increased supporting Central expenditure in eeveral areas. For instance, many important public and social services are the responsibility of the states. Cost recovery for m' s t of these services has been very low and declining as a percentage of the cost of provision, and enhanced cost recovery will be a key to fiscal stability as well as to strengthening the provision of the services concerned. In some caGes, pre-announced cutbacks in Central budgetary support may be sufficient to elicit enhanced cost recovery on the part of the states. The Center's credibility in this effort should be enhanced as it promulgates and implements the difficult adjustment measures neceseary to redress fiscal imbalances in its own budget. Exchance Rate Policy 25. India has pursued a relatively flexible exchange rate policy since the early 1980s, and there has been a gradual but substantial real depreciation of the rupee since 1985/86. However, the crawling depreciation of the rupee in the last few years in the face of growing financial imbalances stimulated considerable adverse speculation against the rupee, and contributed to the country's foreign liquidity problems. The two-step adjustment of the rupee (by 23 percent in terms of rupees per dollar' in early July 1991 would allow for an economy wide re-alignment of prices vis-a-vis the rest of the world, as well as dampen domestic absorption relative to aggregate demand. In order to restore and maintain confidence in the rupee, the Government has indicated that it intends  - 8 - to hold the nominal effective exchange rate atable. However, with inflation in India currently running at a higher rate than in partner countries, some erosion of the real depreciation of the rupee achieved in July is expected. Thus, beyond the immediate period, exchange rate policy will have to be reviewed in the context of more fundamental considerations, including trade reform. In the interim, to ensure that the benefits of the recent exchange rate adjustments are largely protected, tight monetary, and fiscal policies will need to be maintained. Monetary Policy 26. In framing the direction and operating instruments of monetary policy, the authorities are placing considerable emphasis on reducing inflation and supporting the adjustment in the balance of payments. These considerations imply an increased tightening of the stance of monetary policy through reduced growth targets for monetary aggregates, higher interest rates, and tighter quantitative credit controls. As part of the emergency measures adopted in April-June 1991 to control impcrt demand, cash margin requirements on Import letters of credit were substantially raised (from 50 percent to 150-200 percent), the benchmark (minimum) bank lending rate for the non-priority sectors was raised, and a 10 percent incremental cash reserve ratio was imposed on deposits held by commercial banks. 27. By September 1991/92, however, it became evident that monetary aggregates iere expanding at a faster rate than expected, and inflation was accel3rating, with the increase in the wholesale price index reaching an annual rate of 15.7 percent in September. The authorities decided to further tighten the stance of monetary policy, and interest rates were raised again in October. Shorter term deposit rates were raised by 1 to 2 percentage points, while the benchmark minimum lending rate to non-priority sectors was increased by 1.5 percentage points to 20 percent. Priority sector lendir.g rates were also increased by 1 percentage point across the board. A number of important measures were also introduced to contain reserve money expansion, including the withdrawal of several key refinance facilities with the Reserve Bank of India (RBI) and a reduction in the interest paid on incremental cash balances held with the RBI. The RBI also announced a further tightening of the incremental non-food credit-deposit ratio, and the prohibition of any increase in net credit to a number of sectors. Importantly, export refinance and credit were exempted from the new regulations. The reduced availability of domestic credit and higher interest rates would adversely impact investment and the interest component of public expenditures in the first instance. However, the targeted dec line in the Government's recourse to private financial savings should allow for a gradual moderation of the Government's interest bill, and permit a steady increase in the volume of domestic credit to the private sector in support of investment activity. C. InFstrial Policy Refor Maior XI"ues 28. Despite a decade of incremental reforms, India at thei end of the 1980s had one of the most tightly regulated manufacturing sectors ..n the world. The key underlying problems that needed to be addressed through comprehensive industrial policy reform includedt (i) lack of international competitiveness and  - 9 - export orientation in organized-sector firms; (ii) a pervasive high cost structure, due most fundamentally to high tariffs and inefficiency of public sector enterprises; (iii) restrictions on import of new technology; {iv) slow employment growth in the organized sector, with virtual stagnation in organized private manufacturing; and (v) widespread incidence of enterprise failure or "sickness" due to lack of an effective exit policy. Reform Strategy and Xnitiativey 29. The major industrial regulatory reforms recently taken by the Government are designed to create over the next five years an efficient and dynamic industrial sector, subject only to regulations relating to environmental, security and strategic concerns, industrial safety, and unfair trading and monopolistic practices. The new industrial policy, which was placed before Parliament on July 24, introduces a new approach aimed at promoting growth with enhanced international competitiveness. A significant breakthrough has been achieved in the relaxation of administrative and regulatory barriers to entry, expansion, diversification, and modernization by industrial firms. The new industrial policy has eliminated investment licensing requirements for all but eighteen industries, estimated to account for about 20 percent of current manufacturing output. It has drastically reduced the number of industries reserved to the public sector, eliminated restrictions on investments and mergers by larle concerns under the Monopolies and Restrictive Trade Practices Act, and opened up an extensive positive list of industries in which ownership up to 51 percent by foreign companies is freely permitted. At the same time, the mandatory convertibility clause, under which financial institutions had the right to convert a proportion (up to 20 percent) of their loans to the business sector to equity, has been abolished for new projects. 30. Under the new industrial policy, locational approval would still be required for most investments within 25 kilometers of the periphery of cities with more than one million people (23 in all). Because of the delicate balance of payments situation, investors will still need an import license to import capital goods for projects in which the foreign exchange content is over 25 percent of total investment or Rs. 20 million, unless foreign exchange supply is ensured through foreign equity capital. Also, reflecting the acute balance of payments pressure facing the economy, dividend repatriation by companies with up to 51 percent foreign ownership has been linked under the new rules to their export earnings. Nevertheless, the Government recognizes the need for strengthening the incentives for foreign direct investment and will remove the provision linking dividend repatriation to export earnings as soon as the external payments situation improves. Furthermore, the Government recognizes that the all financing requirement on capital goods Imports needs to be modified to allow debt as well as equity financing in order to facilitate financing of large investment projects. Despite the foregoing qualifications, overall, the new industrial policy marks a fundamental break with past practice of capacity planning and entry regulation. 31. Under the adjustment program, the Government will implement further measures aimed at eliminating regulatory barriers to entry. Specifically, it will issue guidelines clarifying that location restrictions on delicensing Included in the new industrial policy are solely for the purpose of addressing environmental, safety, land-use, congestion, urban planning and related concerns, rather than being based on capacity, market size, and other criteria  - 10 - traditionally used in industrial licensing. Concerning capital goods imports for delicensed projects, the limits will be increased by the second tranche release from 25 percent and Re. 20 million to at least 50 percent and Re. 100 million, respectively. These actions will significantly further reduce entry barriers generated by the industrial regulatory system. In this same vein, the Government will put in place a plan for comprehensive deregulation of the steel industry, the most important subsector still subject to price and distribution controls. 32. The Government recognizes that the major restructuring of the Indian economy implied by its agenda of macroeconomic adjustment and structural reform will depend on the formulation of a sociallv accentable exit policy to facilitate the closure or restructuring of sick and loss-making companies in both the private and public sectors. Development of an effective exit policy has been inhibited primarily by the concern to protect existing jobs, largely regardless of cost. The entire regulatory system as it evolved over the years has become highly inimical to exit: onerous procedures for liquidation under the Companies Act; restrictivo regulations governing labor retrenchment and the strong bias in favor of preserving jobs evident in the attitudes of the judiciary and bureaucracy; practices in the financial sector; state and local Governments' refusal to permit closure of plants; restrictions against transfers of land, and intrusion of political considerations. 33. The Government recognizes the necessity of major changes in the legal and regulatory framework as it affects exit, in order to ease the burden of industrial sickness and to enhance flexibility and dynamism in the industrial sector. Large numbers of sick firms are currently a drain on the budget, a threat to the banking system, and an obstacle to the expansion and emergence of more efficient firms and industries. Sick industr.al units absorbed about Re. 70 billion of credit (1.25 percent of GDP) in 1990/91 and accounted for about 10 percent of total commercial bank credit outstanding. The prevailing mechanism for handling sick industrial units in India is their referral to the Board for Industrial and Financial Reconstruction (BIFR). 34. In the past, the BIFR process has been constrained by the restrictiveness of various pieces of legislation governing industrial closure and labor retrenchment. To address these problems, the Government is devising appropriate amendments to the Sic'; Industrial Companies Act of 1985 that would strengthen the BIFR, improve its functioning, and streamline and facilitate its procedures. These amendments will be placed before Parliament prior to second tranche release. More broadly, the Government has established an inter- ministerial Working Group to review existing provisions of various laws governing labor relations, the role of state and local authorities in industrial restructuring, regulations governing the transfer of land, and procedures for liquidation under the Companies Act that unduly constrain industrial exit. Based on the recommendations of this Working Group, the Government will formulate and initiate a satisfactory policy to facilitate adjustment by industrial firms. To provide for the retraining, redeployment, and appropriate compensation where necessary of workers adversely affected by the restructurings, the Government has announced that it will establish a National Renewal Fund (NRF). The detailed scope, structure, financing and operations of the NRF will be specified by December 31, 1991.  - 11 - D. Trade Policy Reform Maior Issues and Reform Obiectives 35. The trade policy reforms undertaken in the 1980e included more generous incentives for manufactured exports, and the relaxation of quantitative restrictions on imports of intermediate goods and capital equipment. At the same time, for essentially fiscal reasons, there was a steady increase in the general level of Customs tariffs. Together with the real depreciation of the exchange rate which started in 1985, the reforms reduced the restrictiveness and overall anti-export bias of the trade regine while reducing import licensing rents and increasing Government revenue. Despite this, about 90 percent of the production of tradeable goods remained protected by nontariff barriers, and many severe impediments remained to competitiveness of the economy and, hence, to the export growth required for long-term external payments viability. 36. These impediments included: (i) a high general level of protection for import substitution manufacturing, and a pronounced anti-export and anti-agriculture bias in the broad structure of incentives; (ii) a large variance in incentive levels within both manufacturing and agriculture, including high effective protection of some industries and low or negative effective protection of others, especially of manufacturing industries using highly protected intermediate inputs and capital equipment; (iii) performance deficiencies resulting from the lack of both import competition and export rivalry in many industries; (iv) high transaction costs associated with the discretionary licensing and other controls of both imports and exports; (v) persistent difficulties in administering the export incentives resulting from the large number and complexity of the schemes, and from the profitability of diversion to the domestic market; (vi) frequent and largely unpredictable changes in the trade regime leading to difficulties in export marketing and to costly risk averting behavior such as the accumulation of above-normal raw material inventories; (vii) severely circumscribed private participation in import and export trade with a corresponding lack of flexibility and generally poor performance by the parastatal trading organizations; and (viii) excessive budgetary dependence on extremely high and largely redundant customs tariffs, whose incentive effects and administration were complicated by large numbers of exemptions and partial exemptions. 37. As indicated in the Letter of Development Policy, the Government has the following six medium-term objectives for trade policy reform: (i) the removal of most licensing and other nontariff barriers to all imports, with initial focus on intermediate and capital goods; (ii) the broadening and simplification of export incentives and the removal of licensing and other restrictions on exports; (iii) the abolition of most of the legal monopolies for parastatals involved in the export and import of key products, and the removal of restrictions on private importers and exporters; (iv) drastic simplification and increased transparency of the trade regime; (v) substantial reductions in the maximum and average levels and in the variability of customs tariffs; and (vi) a foreign evzhange system free of all allocative restrictions affecting trade transactions.  - 12 - The Reform Aaenda 38. In order to pursue these medium term objectives, the Government has adjusted the exchange rate, introduced a new "Eximscrip" scheme linking imports to exports, and has commenced a process of reform aimed at removing administrative barriers to imports, improving the export incentive system and removing administrative barriers to exports, reducing tariff rates and simplifying the overall structure of the tariff schedule. 39. Exchance rate adjustment. As noted earlier, the depreciation achieved during the first half of 1991 is substantial. Hence, it will increase the profitability of exports, and will have made many import controls and tariffs redundant. It will, therefore, facilitate the removal of import controls and initial reductions of tariffs without much immediate Impact on either the volume of imports or domestic production. 40. The Eximscrin scheme. This scheme simultaneously replaces and broadens a previous "replenishment" (REP) import license scheme for exports, and restricts a broad category of imports to a policy-determined fraction (presently 30 percent in most cases) of export earnings. It effectively removes discretionary import licensing for a large category of intermediate inputs and for some capital goods, and represents a major simplification of the trade regime. The Eximscrip, like the REP license which preceded it, is freely tradeable, with its price (the "premium") determined by the supply of scrip generated by exports and the demand generated by manufacturers wishing to use the scrip to import inputs needed for their exportr, or domestic production. The premium (currently about 30 percent of the value of exports) provides an incentive to exporters and at the same time is an efficient means of rationing the foreign exchange available for imports. The scheme also provides a convenient mechanism for further liberalization of the import regime, which can be achieved by allowing products subject to import licensing to be freely importable with the use of the scrip. However, compared with equilibration through the exchange rate, the Eximscrip scheme emphasizes adjustment through import compression more than by export expansion. This is because the cost of imports is increased by the full amount of the market premium, whereas exports only benefit by the premium times the replenishment rate. Moreover, if the scheme were to remain in place for very long, and especially if the premium is high, there is a serious danger that pressures would build up from both importers and exporters for special treatment and exemptions. Given the crucial importance of exports, and the basic policy objective of substantially reducing anti-export blas and of moving to a greatly simplified and leos discretionary trade regime, the Government considers the Eximacrip scheme to be a transitional mechanism and intends to integrate it with OGL (open General License) as soon as is feasible, and in any event no later than mid-1995. 41. Removal of nontariff barriers to imports. As part of its efforts to manage the acute balance of payments situation, beginning late last year, the Reserve Bank introduced foreign exchange controls including cash margins for imports, a queuing system for letter of credit applications, and foreign financing requirements for imports of capital goods. Initially, as well as restraining imports, these restrictions had an indirect negative impact on a number of export industries. These effects have now been largely mitigated by special provisions for export-related imports. As a first priority, the Government will continue to remove remaining impediments to export-related imports and by the second tranche release, it will have removed all the emergency  - 13 - restrictions listed above. With respect to the import licensing system for intermediate inputs, a substantial number of items was removed from discretionary import licensing with the introduction of the Eximscrip scheme and through subsequent actions. Further intermediate items will be removed from the restricted list. By second tranche release, the proportion of domestic production protected by the restricted list would have been reduced by at least two-thirds, when compared to the pre-reform situation. 42. "Phased Manufacturing Programs" (PMPs) under which manufacturing firms are obliged to commit themselves to incorporate specified locally produced materials, ccmponents, and parts in their finished products, were used with increasing frequencl during the 1980s and became an important nontariff barrier to imports. In July 1991, as part of the new industrial policy, it was announced that there would be no further PMPs for new projects, and in October 1991 some initial steps were taken to remove constraints on firms already operating under PMPs. When this latter process ip completed, all decisions on the sourcing of inputs will be left to individual firms subject only to any remaining controls on imports inputs and tariffs. 43. Under existing policies a number of products are exclusively or principally imported by public sector organizations ("canalizing agencies"). The scheme for REP import licenses linked to exports and the Eximacrip scheme which has now replaced it have diluted these arrangements by allowing private imports of some canalized products. The Government intends to reduce substantially the role of the state monopoly agencies and to increase the private role in importing in the following ways. First, following the decanalization of a number of minor items in August 1991, all remaining canalized imports will be decanalized with the exception of petroleum products, fertilizers, oilseeds, cereals, certain fatty acids, and other goods on the grounds of security. Second, dual pricing will be eliminated with respect to products which can be imported by the parastatal agencies with the use of official foreign exchange, but if imported by others require the pricr purchase of Eximscrip. Thus, either the parastatal agencies will also be required to use Eximscrip, or the discrimination in favor of the agencies will be eliminated by a program of progressive reduction and eventual elimination of official foreign exchange allocated to them for these imports. 44. Aside from the emergency RBI measures, imports of capital goods are subject to two types of restrictions: (i) the import licensing system administered by the Ministry of Commerce; and (ii) a requirement for approval from the Ministry of Industry for projects involving imports of capital goods. As noted above, the authorities intend to remove the RBI's foreign financing restrictions by second tranche release. As regards the import licensing system, policies for capital goods are based on a list of restricted items for which import licenses are required and a more extensive OGL list of machines and equipment for whicrh import licenses are not required. However, licenses are required for the large category of machines and equipment which are not found on either list. Some liberalization of this system was previously introduced by allowing individual firms to use REP licenses to import otherwise restricted machines, and this provision was broadened with the introduction of the Eximscrip scheme. Furthez liberalization of capital goods imports will be implemented. By second tranche release, the import of all unlisted capital goods will be allowed by the Eximscrip route, and the capital goods restricted list would be reduced by an extent corresponding to at least 50 percent of the domestic  - 14 - production of items on this list. This will represent substantial progress towards the medium term objective of delicensing all capital goods except those which will remain restricted for health, environment and security reasons. Finally, with respect to the Ministry of Industry's clearance requlirement for capital goods imports, the restriction on imports has been relaxed by allowing automatic clearance when the required foreign exchange is provided by foreign equity. Moreover, as described In paragraph 31, a significant increase in the ceiling value below which clearance will not be required will be effected. 45. In order to reinforce industrial licensing and to prevent traders from benefiting from the scarcity premia inherent in import licensing, a basic principle of import policies has been that only "actual users", i.e., individuals and firms which use imported intermediate materials and capital equipment for further production, are permitted to import. The policy is based on the presumption that there will be no imports of consumer goods. The pcrlicy greatly reduces the flexibility and efficiency of the importing process, discriminates against firms requiring imports in small quantities, raises industrial costs, and more generally constitutes a separate nontariff barrier to imports. Given the abolition of most industrial licensing and the intention to remove most import licensing of intermediate and capital goods as well, the policy has lost its original rationale. Recognizing this, and also the economic costs, the Government has removed the "Actual User" requirement for the imports of many items, and will abolish the general policy. 46. Indian Import-Export policies are generally recognized to be extremely complex and often obscure, and for both reasons their administration involves a high degree of discretionary decision making. Frequent changes further increase the difficulty of understanding the policy and the time and energy required of businessmen who must work with it. In recognition of these problems, the Government has issued a computerized list, which will be continuously updated, of each product's import licensing status according to the Harmonized System of customs classification. At present, the tariff rate applicable to many products is not readily apparent, owing to the need to check whether an exemption applies, and if so at what rate. In the near future, the computerized list will be extended to include the applicable tariff. This will provide a much more efficient and transparent tool for customs administration and for the business community. 47. The Government also intends to simplify the import policy by moving to a negative list principle. Any intermediate or capital equipment item not on a restricted, canalized or OGL list will be importable with the purchase of Eximecrip. With a few exceptions, however, the import of consumer goods will continue to be banned for the time being. Eventually, as regards intermediate and capital goods, when Eximscrip and OGL are merged, there will only remain a short list of "sensitive" canalized products and products restricted for health and security reasons. All other intermediate and capital goods will be freely importable without the need for an import license (although capital goods imports will still be subject to the project-related restriction described above). 48. The purchasing organization for the Central Indian Government (the Directorate General of Supplies and Disposals), which also makes some purchases on behalf of state Governments, gives purchase preferences to domestic suppliers over imports. This purchase preference comes on top of already generally very high tariffs and also the Eximscrip premium in the case of products which must  - 15 - be imported by this route. Recognizing that this additional protection of domestic suppliers is excessive, the Government intends to abolish this preference. 49. The reforms described above will constitute a major liberalization of the import regime in the medium term. However, more will remain tc be done and the Government needs to consider its reform strategy for the remaining areas of quantitative restrictions. In this regard a major issue will be the liberalization of imports of consumer goods, which account for about half of domestic manufacturing output. This will become all the more urgent as imports of intermediate and capital goods are freed and tariffs on them are reduced. Although domestic competition in many industries reduces, or eliminates, the potentially available processing margins in the presence of import bans or high levels of protection, there remains a risk that new investment will be attracted into high cost and inefficient areas, which will make subsequent import liberalization more difficult. The Government is aware of these and other economic tonsiderations dictating the extension of trade reform to include consumer goods. However, currently, because of political sensitivity and balance of payments constraints, it does not consider this aspect of trade reform a priority area. 50. Exnort incentives and removal of administrative barriers to exports. India has a large set of complex export incentive schemes (before the recent reforms, there were eleven separate general schemes plus other product-specific schemes). These have been introduced to make exporting attractive in view of the security and profitability of domestic markets resulting from almost complete protection against competing imports, and to offset or bypass the high costs of many intermediate inputs and machines. The system of cash compensatory support (CCS) for exports was abolished along with the devaluation of the rupee in July 1991, and preferential interest rates for exporters were also removed. The removal of these two incentives has been compensated, however, by the replacement of the REP license scheme with the much broader and simpler Eximscrip scheme and with measures which are intended to make the advance license scheme for duty-free imports by exporters much more comprehensive, automatic and expeditious. The attractiveness of the "100 percent EOU" (bonded warehouse) scheme and of the export processing zones has also been increased by allowing sales in the domestic market equivalent to 25 percent of total sales. These sales are subject to a special excise tax which is equivalent to half the normal import duty rate and in most cases are not subject to normal import controls; among other things, consumer goods, the import of which would normally be banned, can be "exported" into the domestic market in this way. Overall, these changes have considerably simplified the export incentive regime, and the Government expects that they will reinforce the change in the exchange rate in bringing a new impetus to exports. 51. While the Government operates a variety of export incentive schemes, mainly focussed on manufacturing, it also implements a complex set of export controls which are applied to most agricultural and mineral commodities, as well as to a number of manufactured products. These controls (which currently apply to about 190 products or product groups) include export bans, export licensing requirements, minimum export prices, and canalization by public sector agencies. They prevent or reduce the exports of the products affected and the responsiveness of their supply to changes in world prices and the exchange rate. The Government intends to remove all these controls with the exception of a satisfactory negative list. An understanding with the Government has been  - 16 - reached on considerations for formulating such a list. These reforms will also mean that private intermediaries will have an increased and less restricted role in India's export trade. 52. Tariff reduction and nimglification. Indian tariffs are extremely high by international standards. The median rate exceeds 100 percent, and for nonpetroleum imports in 1990/91 the average collectlon rate. which reflects the large numbers of exemptions and partial exemptions, was 63 percent. For a wide range of domeotically produced products these rates are prohibitive, in the sense that domestic prices are well below the duty inclusive prices of imports, so that even in the absence of quantitative import controls no import competition would be possible. Largely due to numeroua exemptions, tariff rates are also widely dispersed, with the result that there is also a wide variation in 'he tariff protection available to different productive activities. For these reasone, as tariffs become the main instruments of protection with the removal of quantitative controls, a basic Government objective is to reduce the level of tariffs and to simplify their structure. However, customs revenue (mainly collected from imports of products and product varieties which are not produced domestically) accounts for a very large share of the Central Government's tax revenue (about 50 percent in 1990/91). Consequently, tariff reduction and simplification have to be accompanied by more general tax and fiscal reforms and to be compatible with the Government's targets for budget deficit reduction and for the restoration of foreign exchange reserves. Tariff reduction also needs to be coordinated with the removal of import controls, otherwise reductions for products which remain subject to licensing will simply transfer revenue from the Government to the license holders without much or any benefit for consumers or for increased productive efficiency. 53. Recent changes in tariffs recognize these considerations but principally emphasize the need for tax revenue which is particularly urgent in the short run. For fiscal reasons, tariffs were substantially increased across the board in December 1990. Some of these increases were rolled back in July 1991, but tariffs are generally 5 to 10 percentage points above their previous levels. This is despite a reduction of 5 percentage points in most machinery tariffs to 80 percent, and the introduction of a maximum rate for ad valorem tariffs of 150 percent. This maximum does not apply to specific tariffs, some of which considerably exceed the equivalent of 150 percent ad valorem. 54. A committee has been appointed to formulate proposals for comprehensive tariff reform over the next five years. The committee has been asked to recommend ways and means for progressively reducing the maximum and average levels of tariffs, minimizing the use of specific tariffs, and simplifying the tariff structure with a view to substantially reducing the incidence of exemptions and partial exemptions. The committee will also recommend alternative revenue sources to compensate for revenue reductions which may follow from lower tariffs. On the basis of this review, the Government will have adopted a medium term plan to meet these objectives, and a substantial initial reduction in the maximum customs tariff will be introduced in the 1992/93 budget. This initial reduction is expected to have a quite limited impact on domestic production, but as the maximum level declines further in subsequent years it will put increasing competitive pressures on domestic Industries. 5S. In axy, the reforms contained in the adjustment program supported by the SAL/SAC will initiate liberalization of India's trade regime. The  - 17 - measures that have already been taken by the authorAties provide a firm basis for further liberalizati2n and progress towards the Government's medium term objectives. However, the pace of further liberalization will be dictated to a large extent by the extremely tight balance of payments situation and the need to reduce the fiscal deficit. Imports have been severely repressed during the recent past, and there is likely to be substantial pent up demand. The likely surge in imports in response to liberalization highlights the urgency of bringing about a rapid and robust recovery of exports through changes in the incentive regime and new investment. 56. As a result of the trade reforms in the adjustment program, it is expected that the share of the domestic production of internationally tradeable goodb (including foodstuffs, coal and petroleum products) free of nontariff barriers will have increased from about 10 percent to about 35 percent. Nearly all manufactured intermediate items will be freely importable subject only to tariffs and the prior purchase of Eximscrip in some cases. Likewise, current Reserve Bank foreign financing requirements are, in most cases, free of detailed import licensing requirements, even though clearances will still be needed for larger projects. 57. As well as the removal of import licensing, on completion of the SAL/SAC-supported reforms, the import process will have become much more flexible and competitive as a result of the removal of parastatal import monopolies and the abolition of the rules which currently inhibit or prevent the activities of private importers. on the export side most controls will also have been removed. It is expected that the new maximum level for tariffs will eliminate a substantial number of clearly excessive tariff rates and will send a clear signal as to the Government's intentions on tariff reduction in the subsequent four to five years. After taking into account these changes and the reforms of the export incentive regime which have already been implemented, the trade regime will be considerably more transparent, and discretionary decision making, while by no means eliminated, will have a much reduced role. This in turn will reduce uncertainty and transaction costs for the business community. S. Reform of the Financial System Backaround 58. Since independence India has witnessed the development of a deep and well-diversified financial system with a broad variety of banking and capital market institutions and instruments. In terms of depth, i.e., broad money to GDP ratio, the banking sector ranks in the top quarter of developing countries, and is institutionally specialized between commercial banking and term lending institutions. The country's capital market is deep and sophisticated and has found investors particularly receptive in recent years. With a market capitalization of US$39 bil'lion as of end-1991, the Bombay Stock Exchange (SOB) (the largest of India's nineteen stock exchanges, accounting for 70 percent of total capitalization and turnover), is the nineteenth largest in the world. In terms of investor base, i.e., numbers of individual shareholders, the Indian market io the third largest in the world, behind only those in the United States and Japan. Throughout the 1980s, the equity market witnessed rapid growth in all aspects, including the number of companies listed, the trading volume, as well as the amount of fresh capital raised. Furthermore, the country's large and  - 18 - rapidly growing bond market has become an important source of debt capital to both the public as well as the private corporate sector. S9. The Government's control of the financial system is, however, excessive, and it has maintained a domir.ant ownership position in commercial banking, insurance, and development finance since nationalizing many institutions in these areas in 1969. Moreover, it has exerted considerable direct influence over the operation of capital markets, including pricing of new issues, margin trading, and corporate take-over activity. Commercial banking is overwhelmingly dominated by twenty large public sector scheduled commercial banks which account for over 90 percent of total commercial bank assets. Term lending business is even more dominated by development finance institi ins (DFIs) created by the state to provide term credit to acriculture, industr, axports, and housing. The Government's dominance of the financial system has er.iblad it to achieve multiple objectives including mobilization of resources, integration of the rural population into the financial mainstream, enhancement of availability of long- term loans to all levels of industry and agriculture, and increa.ed access to credit to small industrialists, farmers and weaker sections of society. 60. These notable achievements have, however, been accompanied by some serious emerging imbalances. First, mandatory investments in illiquid and low yielding Government securities through the statutory liquidity ratio (SLR) recuirements have pre-empted an increasingly large proportion of bank assets, and have limited the scope for proper asset management. In addition, high cash reserve ratios (CRRs), well in excess of prudential norms, have also been used to further divert resources from the banks. Second, directed lending to the priority sector consisting of agriculture, small-scale industry and small trade, at subsidized rates have eroded bank profitability and resulted in the build up of a large stock of non-performing assets. Third, the role of private sector in the banking industry is marginal and, along with other barriers to entry and exit, has severely limited competition. Fourth, the standard of prudential regulation and supervision of financial institutions, particularly in the capital markets, is inadequate and needs to be strengthened to ensure an orderly growth of the system. Reform Strateav and Recent Initiatives 61. As outlined in the Letter of Development Policy, the thrust of the Gc.;ernment's medium-term reform strategy for the financial system would be to effect a transition to a market-based system operating within a sound prudential regulatory and supervisory framework. Some important steps in this direction have already been taken. All regulated deposit rates have been increased in several stages, term lending rates for non-priority sector loans have been liberalized, with both the development finance instititions (DFIs) and commercial banks receiving the freedom to set rates according to market conditions and borrowers' creditworthiness (subject to a floor of 15 percent for DFIs and 20 percent for commercial banks). In addition, money market instruments such as certificate of deposits, 182-day Treasury Bills, commercial bills, and commercial paper have been introduced, and a high level committee (the Narasimham Committee) has been established to review the structure and overall functioning of the financial system, including the scope and form of targeted credit schemes, and to advise the Government on reforms by mid-November 1991.  - 19 - 62. Measures have also been taken to strengthen capiti1 markets: interest rates for debentures (except for tax-free bonds for the public sector) have been freed; the coupon rate on government long-term bonds has been raised; and two Committees (the Pherwani and Dave Committees) have been established to respectively: (i) review the need for establishing new stock exchanges and to improve the wo king of existing ones; and (ii) review the existing regulatory framework for the mutual funds industry with a view to preparing draft leg-slation for regulation of mutual funds and other offshore funds, including such funds which may be set up in the joint/private sector. The report of the Pherwani Committee has already been submittod to the Government, and the Dave Committee's report will be completed in the next few months. 63. Building upon the prootess already achieved, the strategy to bring about the transition toward a market-based system relies on the promotion of a healthy competitive environment coupled with greater autonomy for banks in their lending and asset management decisions. This strategy requires actions in the following four areas: (i) reducing the level of directed investments via SLR; (ii) reducing the scope of targeted credits; (iii) establishing a level playing field among banks and development financial institutions regarding their funding sources. and tax treatment of financial instruments; and (iv) promoting greater private sector participation in the banking and mutual funds industry. In addition, to ensure the soundness of financial institutions, increasing autonomy should be accompanied by prudential regulations and an accounting framework that conform with international norms. 64. In the area of capital market development where India's financial system is distinguished by its depth, number of stock exchanges, and investor base, the key concerns are: (i) the lack of liquidity particularly in small stock exchanges outside the principal metropolitan areas; (ii) the lack of infrastructural facilities and outdated trading and settlement systems; and (iii) an inadequate regulatory and supervisory framework to safeguard investors' interests and promote the orderly growth of the market. 65. Under the adjustment program, the Government would formulate and implement further reforms of the financial sector over the coming months, in addition to actions already taken (paragraphs 61-62). As detailed in the policy matrix (Annex III), these measures would include: (i) a phased reduction, beginning in Fiscal Year 1992/93, in the pre-emption of bank credit through the statutory liquidity ratio (currently at 38.5 percent), consistent with the reduction in the central Government fiscal deficit, and with the overall imprc,vement in the management of Government's domestic stock of debt; (ii) a substantial reduction in the amount of subsidies associated with priority lending schemes through a more stringent definition of groups eligible for the subsidy, and adjustment in associated interest rates; (iii) fostering competition, initially by allowing private sector participation in the mutual funds industry; (iv) improving the trading mechanism of stock exchanges, 5.ncluding a system of national clearing and settlement and setting up a central depository trust; and (v) strengthening the prudential regulation and supervision of capital markets by presenting legislation to Parliament to empower the Stock Exchange Board of India (SEBI) to operate as an independent regulatory body. 66. These measures would form the basis for proceeding to the next phases of the reform which, along with the progress achieved in reestablishing macroeconomic balance, would aim to strengthen banks' asset portfolios and their  - 20 - capital base, deregulate term deposit rates, develop a sound regulatory and accounting framework, improve liquidity in the Government'8s secondary-debt markets, and facilitate entry in the banking sector. In Eupport of these measures, the authorities have requested the Bank's assistance initially in the form of a financial sector adjustment loan. F. M1bic VrtsrprLse Reolrm 67. Public enterprise involvement in most sectors of the economy has formed a central element of Indialo development strategy. The central and the state governments have established over 1,000 public enterprises (244 at the central level), holding monopoly pooitions in many critical basic industries, such as steel, oil and gas, coal, powsr, and petrochemicals, and in services such as railway transport and telecommunications. Over the years, the public sector has spread into diverse activities--such as hotels and construction--often far removed from the "commanding heights" of the economy which had been its original rationale. Public enterprises account for the bulk of organized-sector employment in the Indian economy: 95 percert in electricity and other utilities, 98 percent in transport and communications, 95 percent in mining, and 30 percent in manufacturing in 1989. 68. The fundamental concerns underlying the reform of public enterprises in India relate, first, to their extremely low financial returns, rigid and distorted managerial incentive structures, excess staffing, heavy reliance on budgetary resources for inveotments and operations, and, second, to the high cost structure that their inefficiency imposes on the rest of the manufacturing sector, with consequent adverse implications for international competitiveness. Of the 244 central public enterprises (CPUs), ninety-eight were loss-making in 1989/90, with aggregate losses of about Ro. 19.6 billion and, of these, forn-y- seven were considered chronically sick, haviuig made cash losses continuously for at least five years and with negative not worth. Including the profitable petroleum/petrochemical companies, the aggregate net return, i.e., after tax and interest, on capital employed, has averaged only about 2.5 percent per year in the 1980., significantly lower than the average subsidized cost of debt of about 10 to 12 percent per year, depending on the source of funds. 69. The reasons underlying the poor financial returns earned on public investments are various, including: overmanning amounting to about 25 to 33 percent; lack of managerial autonomy and accountability; adverse incentives due to explicit Government guarantees and availability of fundsl and the conflicting multiple objectives to which public enterprises have been tradltionally subjected. As an instrument of public policy, public enterprises have been expected to promote industrialization, generate employment, assist the development of small-scale and ancillary industries, redistribute income and wealth, encourage balanced regional development and stimulate import substitution. These objectives, combined with lack of autonomy or accountability, have made it very difficult to follow consistent commercial strategies geared to efficiency enhancement and balanced growth.  - 21 - RjJ e2mta,teav and Recent Initiatives 70. The Government's program dealing with the public enterprise sector addresses the most pressing areas for reform: stopp_ng the drain on the budget; creating competitive preasures for Improved performance; restructuring or closing chronic loss makers; arresting the expansion of the sector; and tapping private finance and initiative. These measures begin a medium-term program of change which will address deep-seated institutional problems and further rationalize the scope of the sector through closure, restructuring, or divestiture. 71. As a first step toward this strategy, the Government has reduced the industries roserved for the public sector from eighteen to eight, all of which Involve strategic considerations or resource extraction. This move, combined with measures introduced under the new industrial policy to ease restrictions on private entry, will increase competitive pressure on many public enterprises. In addition, a number of subsidized prices have been raised (e.g., fertilizer), an important step toward freeing markets. At the same time, the Government has moved to harden the budgets of CPEs by cutting non-plan loans and transfers by 25 percent in the fiscal year 1991/92 budget and by reducing budgetary support for plan investment by 10 percent. Finally, the Government will sell 20 percent of equity in selected profit-making CPEs to mutual funds and other financial institutions as an initial step toward longer-term divestiture. 72. The measures taken by the Government mark a promising first step in the reform of public enterprise sector. Further elements in this process under the adjustment program include the following: 73. Rationalization of the scoRe of the public sector. This involves, first, prevention of further proliferation of public enterprises. The existing portfolio of CPEs will also be reviewed from this perspective, leading to shedding of inessential components. The Government's existing policy of refusing to take over sick private firms will be continued and strengthened. 74. Phalino out budaetarv sunnort for CPEs. In order to "harden" the budget constraint faced by CPEs, the Government intends to phase out budgetary support and loan guarantees for CPEs, except in energy, transport, and other infrastructure. These measures will force CPEs to compete for funds on an equal basis with the private sector. Specifically, supported by the SAL/SAC, the Government will put in place a program for phased elimination of budgetary transfers and loans to sick CPEs, except in infrastructure, by the end of 1994/95. Over the same time period, budgetary plan support for non-infrastructural public enterprise investments also will be ended. Government loan guarantees for CPS borrowings will be limited to essential infrastructure, oil and mineral resource extraction, and strategic-related activities. 75. Disinvestment of Government eouitv in oublic enterprises. This is intended to further both fiscal and efficiency objectives. Proceeds from sales of CPE equity will temporarily ease the burden of fiscal adjustment. It is also hoped that partial private ownership will provide a better climate for CPEs to improve efficiency. The initial program to sell 20 percent of the equity of selected CPEs to mutual funds and other financial entities will be completed by March 1992. The divested equity will then be resold to the general public in a manner that promotes confidence in the divestiture process and avoids disruption of capital markets. Building on the 20 percent disinvestment, a program to raise  - 22 - the private equity share to 49 percent in profitable CPEs within three years will be promulgated by the Government. 76. Development of a viable exit Policy for *3ublic enternrises. The Government will take a two-pronged approach to exit policy for public enterprises. In the case of CPEs that are patently unviable, the Government will develop a program for expeditious closure, with suitable provisions to alleviate the burden on displaced workers. The Bank intends to support such measures as part of a project dealing with the social dimensions of adjustmert. Other public enterprises facing financial difficulties will be referred autc- tically to BIFR for assessment of their prospects for return to viability, and subsequent rehabilitation or winding up.3 An essential part of a viable exit policy for public enterprises is an effective safety net to provide compensation and transitional support to displaced public enterprise workers. G. Social Dimensions of Adiustment 77. The Government's agenda for stabilization and reform carries a risk of significant transitional costs. These costs include potential losses of output, employment and consumption due to the deflationary impact of fiscal consolidation, and frictions in the process by which productive resources move between alternative uses in response to changes in economic incentives. The slowdown in growth anticipated for the next year or two is likely to lead to a stagnation in per capita real incomes, and some segments of the populat'^n may experience a significant fall in living standards. The main losers are likely to be the small minority of the population that benefitted from the rents created by the previous restrictive and distorted economic environment. However, a large proportion of India's population continues to be subject to malnutrition and ill- health, and does not have the educational skills and access to means of production that will enable it to participate fully and benefit from the growth process. For this group, government expenditure restraint as well as the restructuring steps envis.aged above may prove particularly costly. In the short term, some urban poor, particularly the unemployed and underemployed, and displaced workers are also likely to be adversely affected by the adjustment program. Urban wages for unskilled and semi-skilled labor in particular would probably decline in real terms as Government expenditures are reduced, and the liberalization of firm exit and international trade lead to job losses in inefficient public and private enterprises. 78. Industrial reservations, labor and labor-management regulations, and protection from foreign trade have all militated against competition in Indian industry and, hence, against employment creation. The proposed reforms in trade, industry, taxation and finance will therefore have beneficial effects upon employment and income. Importantly, the relative price changes stemming from structural reform and the increased availability of imports are likely to improve rural welfare, thus spreading the benefits of adjustment widely. However, distribution of the gains from restored growth is unlikely to be even, and poverty and economic hardship will remain difficult problems, particularly for 3Improvements in the BIFR process itself, now being prepared by the Government, also will be necessary to make this an effective, smooth, and reasonably expeditious exit mechanism for public enterprises.  - 23 - traditionally vulnerable groups such as scheduled tribes and castes, and women ia rural areas, whose access to productive assets is constrained, and who are faced with disease, unemployment and hunger for significant portions of the year. The reform of the public sector enterprises may also lead to some reduction in services as well as higher tariffs, particularly for water and electricity. These changes will be particularly difficult for low-income unemployed and under- employed urban households, and for redeployed workers during the transition. 79. Although specific measures will be required to alleviate the burden of some of these changes, the Government's effort to moderate the costs of the adjustment program is concerned primarily with creating employment opportunities. Generation of employment opportunities is being pursued along several policy avenues. Short-term interventions are being devised to create jobs through priority public works and food-for-work programs, and to retrain redeployed workers. However, ir the medium term, the principal concern would be to continue capital deepening, as well as improvements in capital and labor productivity. Strengthening structural reforms, particularly of trade, tax and regulatory policies that affect the level and efficiency of investment, would be critical. Finally, the Government intends to promote labor-intensive activities, consistent with India's comparative advantage, and which would offer scope for increasing job opportunities that match available skills, particularly in manufacturing. 80. The Government's adjustment effort would also work through its expenditure programs to make a substantial improvement in the delivery of social services and the establishment of basic infrastructure. In the context of a shrinking budget, Government is refocusing social expenditures, particularly in health and education, towards the poor. Additionally, cost-effective compensatory programs, particularly in the areas of nutrition and employment, are being strengthened and broadened. Recurrent expenditures for equipment, materials, and other supporting inputs in health, education and other basic needs will also be increased. In the Government's development budget, investment programs in social development are being more carefully targeted to increase the access of poorer groups to services that improve their productivity and participation in economic growth. 81. The Government recognizes that, in addition to the risks of adverse economic shocks and an inadequate private investment response, the adjustment program faces the risk of successful opposition from groups who may perceive that they are being asked to bear a disproportionate share of the costs of the program. Retrenched workers and sectors facing zeduced rents, subsidies and/or higher user-fees could play a vocal role in striving to delay or defeat reforms intended to improve budgetary management. The Government hopes to forestall such socio-political risks by balancing and timing higher service costs with improved service provision, mitigating transitional unemployment through achieving overall economic growth, providing generous compensation benefits to redeployees, and implementing retraining and temporary job creation programs under a national social security fund (the National Renewal Fund) proposed in the 1991/92 Union Government budget.  - 24 - U. Macroeconomic Prosoects and External Financing Requirements Evolution of the Economy 82. If the fiscal adjustment and structural reforms outlined for the next few years are implemented fully, the medium term prospects for India's achievement of growth rates surpassing those of the second half of the 1980s, along with restored internal and external financial balance, would be very good. The stabilization measures taken thus far, including a severe compression of imports, tight credit policies, and the exchange rate adjustment of the rupee, have been successful in addressing the immediate problems of strengthening external confidence and restoring foreign exchange reserves. In conjunction with an amnesty scheme for remittances from abroad, and a new issue of convertible bonds for non-resident Indians, these measures contributed to a recovery of foreign exchange reserves from their low level of US$1.1 billion at the end of June 1991 to about US$2.1 billion on November 1, 1991. 83. Staff projections of key indicators of macroeconomic performance over the next several years are shown in Table 1. For 1991/92 as a whole, GDP Srowth is likely to fall in the range of 2 to 2.5 percent, with significant declines in both private and public investment. However, as Table 1 shows, private investment should rebound in 1992/93 to about the level of the latter 19809, as the foreign exchange situation eases, and credit and import restrictions are relaxed. Public investment, on the other hand, would probably decline in real terms in both 1991/92 and 1992/93, reflecting the restructuring and rationalizing of public sector activity. Nevertheless, the projected recovery of private investment activity should be sufficient to set the stage for a recovery of growth in 1992/93. 84. over the medium term, the substantial contraction of the public sector required by the adjustment program would reduce the extent of public sector pre- emption of financial resources, and further improve the prospects for a strengthening of private investment. As a share of GDP, private investment would increase steadily to about 16 to 17 percent of GDP by 1999/2000. Although public investment would decline in real terms during the first few years of the adjustment process, this would ultimately be reversed in order to allow for essential infrastructure investments. As a share of GDP, public investment would recover from a low of 8.7 percent in 1993/94 to about 10 percent by the end of the decade. 85. In view of the need to restrain domestic absorption during the program period, export growth would be an important stimulus to growth of output and employment. The structural reforms under implementation and envisaged by the Government of India would generate greater internal and external competition. This would help raise the efficiency of both new and existing investments, particularly in the private sector. Therofore, as the composition of aggregate investment changes in favor of private investment, productivity of the economy as a whole would begin to rise. Reform of the trade regime through the elimination of qaantitative restrictions and substantial reductions in tariff rates, together with a significantly depreciated real exchange rate and domestic deregulation of the industrial sector, should render India's exports much more competitive internationally. Thus, export growth in real US$ terms, which is Likely to fall below 2 percent in 1991/92, is projected to exceed 10 percent beginning in 1992/93.  Table 1 Summary of Macroeconomic Projections Estimate Projections 1990191 1991192 1992/93 1993194 1994195 1995196 199912000 Growth, investment and inflation (2) GDP growth 5.0 2.1 3.0 3.6 4.0 5.3 6.1 GDP growth per capita 2.6 0.2 1.1 1.7 2.1 3.3 4.3 Gross domestic saving/GDP 20.4 19.8 20.6 21.3 22.5 23.5 26.3 Gross domestic investment/GDP 23.2 21.7 22.1 22.6 23.4 24.1 26.5 Private investment 12.6 11.8 13.0 13.8 14.2 14.9 16.6 Public investment 10.6 9.9 9.1 8.7 9.2 9.2 9.9 Inflation rate (GDP deflator) 10.1 11.0 7.0 6.5 6.0 5.5 5.5 Public sector balance (2 of GDP) Central government fiscal deficit 9.0 6.5 5.0 4.5 4.0 4.0 4.0 Public sector deficitSl 10.5 8.0 6.5 5.5 5.0 5.0 5.0 External sector Export growth (in real US$, 2) 5.0 1.2 10.4 10.9 11.0 10.4 8.6 Import growth (in real US$, Y) 2.2 -3.2 4.1 5.1 4.7 5.8 6.2 Current account balance (US$ m.) -9829 -6303 -5598 -5300 -4584 -4154 -3512 Current account/GDP (Z) -3.5 -2.6 -2.4 -2.1 -1.7 -1.5 -0.9 Foreign exchange reserves (US$ m.) 2338 2550 3166 4395 5610 5970 18010 Reserves in months of imports 1.0 1.3 1.5 1.8 2.1 2.0 3.7 Exceptional financing (US$ m.) 3549 3681 2850 2600 2050 500 0 Total external debt (US$ m.) 70122 74755 81083 86822 91426 94247 111216 Total external debt1GDP (Z) 24.7 31.4 34.3 34.8 34.4 33.3 28.9 Debt service/exports () bl 28.8 27.7 26.6 25.7 26.8 27.5 18.0 a/ Refers to saving-investment gap of the consolidated public sector, which includes the Central and State Governments, and nonfinancial public enterprises. b/ Exports of goods and nonfactor services, including workers' remittances.  - 26 - 86. Strengthening the price competitiveness of India's exports will require effective containment of inflation. Prompt action to further tighten monetary policy in October has already helped to slow the pace of price inflation in 1991/92, and the current restrictive stance of monetary policy should be sufficient to keep the overall increase in prices (as measured by the GDP deflator) in 1991/92 to about 11 percent as compared to 10 percent in 1990/91. As the fiscal correction and other adjustment measures take hold, inflation should fall rapidly to international levels by the mid-1990s. This should allow India to maintain the competitiveness of its exports without excessive recourse to exchange rate adjustments. 87. Despite the slowdown in export growth, the current account deficit in 1991/92 is projected to decline from US$9.8 billion (3.5 percent) in 1990/91 to US$6.3 billion (2.6 percent). Given the current level of foreign reserves, such an outcome would allow for a build-up of foreign exchange reserves by the end of the year to about US$2.6 billion. As export growth strengthens in 1992/93, the current account deficit snould fall further to about US$5.6 billion (2.5 percent of GDP), and India's external payments situation and creditworthiness would improve. However, the extent of further foreign exchange reserve accumulation in 1992/93 would be somewhat constrained by the substantial import requirements of the restructuring effort and the prudence of limiting India's commercial borrowing. 88. With further improvements in export performance, both the current account deficit ratio to GDP and external debt service ratio would decline over the remainder of the decade, falling to about 1 percent and 18 percent respectively by 1999/2000. However, restoring stability to India's capital account would be a gradual process, and the economy would remain vulnerable to adverse external shocks or policy slippage over the next few years. As Table 1 shows, primarily as a result of the substantial recent exchange rate adjustment, India's external debt to GDP ratio would rise from around 25 percent in 1990/91 to about 35 percent in 1993/94. Moreover, during the mid-1990s, there would be a temporary increase in the proportion of foreign exchange receipts preempted by external debt service due to repayments of debt contracted during the 1980s, as well as repurchases in respect of the recent IMF drawings. In spite of these increasing claims, India's external liquidity position should improve steadily with foreign exchange reserves rising to two months of imports by 1995/96, and to 3.7 months of imports by the end of 1999/2000. External Financing Reauirements 89. The large annual repayments associated with India's external debt (estimated at US$70 billion at the end of March 1991), and the continuing need to rebuild foreign exchange reserves indicate that exceptional balance of payments support would be needed in both the near and medium term. Table 1 shows that aespite the large projected current account adjustment the exceptional financing requirement in 1991/92, over and above likely inflows of project aid, commercial borrowing, and non-resident Indian (NRI) deposits, is projected to be US$3.7 billion. Some of this exceptional financing has already taken place, including fast disbursing loans from the ADB, Japan, IBRD and IMF, and a gold- backed transaction. Most of the remaining financing is assumed to be provided by further drawings from the IMF and disbursements from the first tranches of the proposed SAL/SAC and a planned Financial Sector Loan from the Bank. Donors  - 27 - responded positively to the request for exceptional financing during the recent Aid Consortium meeting, with about US$6.7 billion in overall pledges (US$4.5 billion from multilateral and US$2.3 billion from bilateral sources), an increase of around 6 percent from last year's level. Equally important, pledges of quick disbursing balance of payments assistance amounted to US$2.3 billion, of which US$700 million was from bilateral donors. Of the latter, some US$300 million remains to be disbursed in 1991/92. Several donors have indicated interest in associating their fast-disbursing assistance with the proposed Structural Adjustment Loan/Credit. Germany has agreed to provide co-financing in the amount of DM 45 million with the proposed operation. 90. In the absence of any major external shock or disruption to doimestic production, India's exceptional financing requirements should decline gradually, beginning in 1992/93. However, the need to rebuild reserves and the bunching of repayment obligations indicate that India would require continued substantial exceptional financing through 1994/95. Specifically, in each of the next three years, India would require exceptional financing from multilateral donors of an average of about US$2 billion per annum. Bilateral donors would need to provide about US$500 million of fast disbursing assistance in each year to supplement these resources. PART 1II. TRE PROPOSgD SAL/SAC A. LoanlCredit Obiectives 91. The proposed structural adjustment loan and credit is for the equiva- lent of US$500 million, equally divided between IBRD and IDA. It is proposed that the first tranche be US$300 million, and that the remainder be disbursed in the second tranche. The amount of each tranche is also proposed to be equally divided between the lc-an and credit. It would support the initial phase of the Government's program of macroeconomic stabilization and structural reform. In addition to a major fiscal adjustment effort, the main areas covered by the program are: (L) deregulation of domestic industry and promotion of foreign direct investment; (ii) liberalization of the trade regime; (iii) reform of domestic interest rates coupled with measures to strengthen capital markets and institutions; and (iv) initiation of public enterprise reforms. B. Cogditions of Effectiveness and Tranche Release 92. The first tranche would be available upon loan/credit effectiveness. The release of the second tranche, planned for April-May 1992, would be contingent upon satisfactory overall progress on program implementation and the implementation of specific conditions detailed in the policy matrix (Annex III), and summarized below (paragraph 93). As part of the Bank's/Association's continuing policy dialogue with the Government, it will monitor the Government's macroeconomic program, articulated in its Letter of Development Policy, to ensure that it remains fully consistent with the implementation of structural adjustment reforms.  - 28 - Second Tranche Release 93. The second tranche would be released after the Government has provided the Bank/IDA with satisfactory evidence that: * guidelines have been issued that industrial licensing decisions on grounds of location will be based solely on environmental, safety, land-use, congestion, urban planning and related concerns; 0 the 25 percent and Rs. 20 million limits on automatic approval for capital goods imports have been raised to 50 percent and Rs. 100 million respectively; 6 a satisfactory plan of action has been adopted to deregulate and decontrol the steel industry, including, inter alia, removal of price and distribution control. * amendments to the Sick Industrial Companies Act of 1985 have been prepared and submitted to Parliament to institute more appropriate criteria for sickness, strengthen the Board for Industrial and Financial Reconstruction (BIFR), improve its functioning; and streamline and facilitate procedures under BIFRs = the objectives, scope, structure, operations, sources and methods of funding, criteria and mechanisms for providing support to workers, nature and amounts of such support, and other details of the National Renewal Fund have been specified; * based on the review and recommendations of the inter-ministerial Working Group a satisfactory policy has been formulated to facilitate adjustment by industrial firms taking into account the need for adequate safeguards for workers, programs for re-deployment and retraining, and appropriate compensation where necessary. * all RBI restrictions related to cash margins, queuing system for L/Ce, and capital goods financing requirements have been eliminated; * intermediate goods on the restricted list (Appendix 2B of the Import and Export Policy, 1990-93) corresponding to at least two-thirds the protected domestic production have been moved to be freely importable by Eximacrip or on OGL. However, consumer goods will continue to be restricted and will remain on Appendix 2B of the Imprt and Export Policy, 1990-93. Certain products will also continue to be restricted for health, environmental and security reasons; * implementation of a satisfactory program of reductions and elimination in the official foreign exchange allocated to the public sector agencies in connection with the phasing out of dual pricing of previously decanallzed items, and decanalization of all remaining canalized products except petroleum products, fertilizers, oilseeds, cereals, certain fatty acids and acid oils, and other acceptable products. In the case of the products for which  - 29 - private importers must use Eximscrip, either require the canalizing agency to also use Eximecrip from the date of decanal-zation or announce a satisfactory program of progressive reductions and eliminat;on of official foreign exchange to the public sector agencies in order to pl:-e out dual pricing; O permitting all unlisted capital goods to be imported with Eximecrip whether or not the Eximecrip is earned by the exports of the importing firm. Remove a substantial proportion of capital goods (corresponding to at least 50 percent of protected domestic production) from the capitaL goods restricted list (Appendix 1A of the Import and Export Policy, 1990-93). Production from which protection by import licensing is removed will not include capital goods the import of which remains restricted for health, environmental or security reasons; O the "Actual User" requirement for imports has been abolished; 0 the Limited Permissible List (Appendix 3 of the Import and Export Policy, 1990-93) has been abolished and announcement is made that all products not on Restricted Lists, the Canalized Lists, or the OGL lists are importable with the use of Eximscrip; 8 the purchase preference given by The Directorate General of Supply and Disposals (DGS&D) to domestic suppliers over the duty paid price of imports has been abolished; * all export licensing, canalization and minimum export prices except for a satisfactory negative list have been removed; * completion of the customs tariff review and adoption of a satisfactory medium term plan to reduce tariff rates with a substantial initial reduction of the maximum customs tariff introduced in the 1992/93 budget; * the Statutory Liquidity Ratio required to be maintained by the scheduled commercial banks has been reduced consistently with reduction of the fiscal deficit of the Central Government; * based on the recommendations of the Narasimham Committee, a satisfactory program of action to reduce interest subsidies in areas of directed credit has been formulated; 0 legislation to give SEBI statutory status in order to operate as an independent regulatory body, including power to investigate with due diligence, has been presented to Parliament; 0 a satisfactory program of action to reform the trading mechanism of stock exchanges, including a system of national clearing and settlement and setting up a central depository trust has been adopted; * based on the recommendation of Dave Committee, a satisfactory program of action for setting up of mutual funds in the private sector, has been formulated and adopted; O implementation of the initial phase of a satisfactory phased action plan to eliminate within three years (i.e., by the end of fiscal year  - 30 - 1994/95) budgetary transfers and loans to sick central public enterprises and budgetary plan support (loans and equity) for public enterprise investments except in energy, transport, and other infrastructure. Under the action plan, Government guarantees of central public enterprise borrowings will be limited to essential infrastructure, exploitation of oil and mineral reserves, and strategic-related activities; * in the case of units that are patently unviable, the Government has formed a satisfactory action program to initiate restructuring and closure procedures; 4 the Government has taken actions to ensure that, exccept for central public enterprises already determined to be potentially unviable by the Government (see previous item) all public enterprises that are sick according to the criteria specified in the Sick Industrial Companies Act (SICA) henceforth will automatically be referred to the Board for Industrial and Financial Reconstruction (BIFR) for assessment of their prospects and subsequent winding up or rehabilitation, and all such sick central public enterprises have been referred to BIFR; * the detailed program for disinvestment of 20 percent of equity in selected public enterprises, to yield Rs. 25 billion has been finalized and approved by the Government and implementation of the program has been completed by the end of 1991/92; and * building on the 20 percent disinvestment, an action program to progressively increase the private equity share in profitable central public enterprises to 49 percent within three years has been promulgated by the Government, along with a list of the companies concerned and a timetable for implementation. These conditions are expected to have been met by April-May 1992. C. Loan/Credit Administration Procurement 94. The proposed loan and credit totalling US$500 million would finance 100 percent of the c.i.f. costs of general imports, excluding inter a/ia luxury goods, military equipment and environmentally hazardous products. Imports valued at US$5 million and above by both public and private sector entities would be procured in accordance with simplified ICB procedures except for certain commodities which are traded in international markets. For a list of these commodities agreed with the Bank/Association, other procedures acceptable to the Bank/Association may be used. Imports valued at below US$5 million by public sector entities would be procured using their own procurement procedures. The specific import procedures followed by many public sector organizations have been reviewed in connection with recent Bank/Association operations and determined to be satisfactory. The procedures used by others would be reviewed before their imports would become eligible under the loan. Imports valued at below US$5 million by private sector firms would follow established commercial practice. The Bank/Association is reviewing the procedures used by a sample of potential private sector importers to ensure that they are satisfactory.  - 31 - Contracts for imports valued at less than US$100,000 would be ineligible for Bank/Association financing. Procurement will be coordinated by the Ministry of Finance under arrangements acceptable to the Bank/IDA. Disbursement 95. The proceeds of the proposed loan and credit would be disbursed against the foreign costs of general imports based on a standard negative list which includes, inter alia, luxury goods, military equipment and environmentally hazardous products. Both private and public sector imports would be eligible for financing. Retroactive financing up to US$100 million equivalent (i.e., US$50 million equivalent each under the loan and credit) would be provided to reimburse expenditures for eligible imports incurred after July 31, 1991. To facilitate disbursements, Special Accounts would be established in the Reserve Bank of India with an authorized allocation of US$100 million equivalent under the loan and US$100 million equivalent under the credit which, in total, is equal to the estimated average disbursements during a five-month period. Disbursements would be administered by the Ministry of Finance in coordination with the Reserve Bank of India. Withdrawal applications for reimbursement of expenditures under each contract valued less than US$5 million equivalent may be submitted under Statement of Expenditures (SOE) procedures. Withdrawal applications for all other expenditures would be fully documented. Documentation in support of SOEs would be retained by the Ministry of Finance. The proposed loan and credit are expected to be disbursed over a period of one year. The closing date would be December 31, 1992. Accounts and Audits 96. RBI would maintain accounts and supporting documentation in respect of the project. Audits would be carried out by independent auditors acceptable to the Bank/Association within six months of the closing of the GOI fiscal year (March 31) in which disbursements under the loan/credit are made. D. Monitorina 97. The adjustment program is being coordinated by the Department of Economic Affairs, Ministry of Finance. The proposed operation requires monitoring of the consistency of macroeconomic framework, as outlined in the Letter of Development Policy, and the implementation of specific actions detailed in paragraph 98. The monitoring of macroeconomic performance in particular will be closely coordinated with the IMF. The Bank/Association will also monitor the implementation and progress of reform actions through a mid-term consultation to be held prior to end-January 1992. In addition to serving as a catalyst to promote greater coordination among the various line ministries to which the SAL/SAC program relates, the review would prcvide a forum to discuss with the authorities the recommendations of several high level committees established by the Government and their incorporation, to the extent appropriate, in the 1992/93 Budget.  - 32 - E. Risks 98. Given the external liquidity situation in India and the extent of the adjustment effort required, there are significant downward risks. Failure to follow through with the implementation of forceful stabilization measures and reforms is the first important risk. The reform process will change the complex system of rents and patronage which has been estaolished over the last four decades and thus will affect the minority government's constituencies. The government's management of the politics of reform has consisted of stimulating public debate to forge the consensus necessary to sustain the process of reform. It has articulated, quite convincingly, the urgent need for reforms and actively sought the cooperation of political parties and various interest groups, including organized labor. Nevertheless, social/political reaction to the adverse transitional consequences of the adjustment program (e.g., labor retrenchment, subsidy reductions, and higher user fees and other administered prices which could fuel inflation in the short run) could slow the pace of reform and jeopardize its sustainability. 99. Absence of a strong supply response due to the sheer lack of essential intermediate and capital goods imports, is the second major risk associated with the program. The very severe import compression policy that has been pursued over the past several months has already restrained production and investment plans of many firms. It is well recognized that this policy has to be reversed very soon to avoid the danger of a slump in the manufacturing sector in particular. The recent improvement in the foreign exchange reserves makes feasible relaxing the import compression. Yet, the provision of imports at satisfactory levels hinges crucially on strong export performance and availability of adequate external financial assistance. 100. The third set of risks relates to both domestic and external factors over which the authorities have limited or no control. Domestically, the response of private investment will be critical to the success of the program. While the business community has so far been supportive of reform initiatives, the risk that a prolonged stabilization effort may hold back investment responses should not be underestimated. Externally, slow growth of world trade and unresolved international trade issues may lessen the prospect for a rapid export expansion in the medium term. Finally, inadequate transitional balance of payments support would undermine domestic political support for reforms, and technically complicate the implementation of the adjustment program. PART IV. WORLD BANK STRATEGY AND OPERATIONS A. The Dank Group's Role and Stratoav 101. The Bank's strategy for assisting India gives highest priority to supporting India's efforts to restore macroeconomic equilibrium, accelerate structural reforms (especially in the areas of industry, trade, finance and public enterprises), and regain access to private credit markets abroad. These reforms, are essential to improving the efficiency, productivity and competitiveness of the economy to achieve the export growth necessary to strengthen India's creditworthiness and to support the future growth and development of the economy.  - 33 - 102. To these ends the Bank's operational strategy emphasizesi (i) country economic and sector work and policy dialogue with a sharpened focus on macroeconomic and structural reform issues; (ii) policy-based lending, beginning with the SAL/SAC and to be followed by a series of sector adjustment operations, in support of India's stabilization and economic reform program; (iii) investment and sector lending in support of efficiency-improving sectoral reforms and institutional development in agriculture, infrastricture, human resources and poverty alleviation; (iv) increased emphasis on private sector development (in close cooperation with IFC) and an orderly retrenchment of the public sector as essential elements of the adjustment program; (v) increased emphasis on aid coordination and cofinancing to shape the financing plan for the adjustment program and to rebuild and strengthen India's external financial structure; and (vi) careful management of the Bank's risk and exposure in view of India's weakened creditworthiness. Economic and Sector Work 103. The Bank,s economic and sector work gives highest priority to providing the macroeconomic and structural reform analysis needed for underpinning adjustment lending and policy dialogue in support of sustainable growth and development. Among the areas to be emphasized are sequencing and transitional aspects of reforms; public finance issues, including expenditure policies and state and local government finances; progress in poverty alleviation and employment creation; and energy and forestry sector reviews. In addition, special attention will be devoted to external debt management policies and practices. Policy-Based Lending 104. The proposed SAL/SAC represents the first stage of the Bank's support for the adjustment program and will be followed by a series of sector adjustment loans designed to support subsequent stages of the reform effort. The Bank is particularly well-positioned, by virtue of recently completed economic and sector work, to develop follow-up policy-based loans to deepen the reform program in the areas emphasized in the SAL/SAC (finance, trade reform, industrial regulation, and ptolic enterprise reform). Lending for adjustments in agricultural sector policy (including urgently needed reforms of the agricultural credit and pricing systems) and energy policy is also under consideration. The Bank's policy dialogue, in close coordination with an expanded program of IFC activities, aims at making private sector development and orderly public sector retrenchment dominant elements of the adjustment program. In addition, fast disbursing IDA lending in support of programs to address the social dimensions of adjustment will be included in the adjustment lending program. Investment Lendina Obiectivye 15. In addition to policy-based lending in the above-mentioned areas, IBRD lending will support efficiency-improving investments in agriculture and infrastructure. IDA investment credits will support programs addressing basic human needs and core development priorities, emphasizing poverty alleviation (esperially through increased efficiency and production capacity in agriculture), human resource development and environmental protection. Sectoral issues and priorities are summarized below.  - 34 - 106. Agricultur-. Agriculture still accountq for about 30 percent of GDP, and continued agricultural growth at historical rates or better is essential to economic growth and reduction of poverty in India. The Bank's assistance strategy for poorer states and regions emphasizes agriculture. Workers employed in agriculture tend to be the poorest and most vulnerable, including women. The Bank's strategy for improving agricultural performance will focus on the following critical areas: (i) reform of policies and incentives which inhibit growth and have contributed substantially to the growing fiscal deficit, in par'icular subsidies, price supports and agricultural trade restrictions; (ii) high priority investments in growth-inducing infrastructure and technology with continuing emphasis on irrigation and better research and extension for rainfed farming; and (iii) resource management, including conservation of land and water resources, land reclamation, forestry development and river basin protection. Increased attention will be paid to efforts to draw women more effectively into the mainstream of agricultural development. 107. Infrastructure and energy. Improvements in these sectors are urgently needed to reduce the present risk that bottlenecks in transportation and energy undermine the supply response of the ongoing reforms. The emphasis in transport will be on better planning and project execution and improved efficiency of transport operations (railways, roads and ports), and efficient pricing policies and encouragement of private sector participation. In urban develooment, the Bank will seek through urban sector work and lending operations to improve the productivity of the urban economy and the quality of urban living by promoting more efficient provision and operation of urban infrastructure and services. Efforts will focus on institutional strengthening and improved incentives for efficient local government. 108. In Dower, primary emphasis will be placed on addressing the sector's critical institutional and financial problems. Key pre-requisites for maintaining Bank lending levels to the sector include increases in power tariffs in real terms (especially for agriculture and residential uses) improved bill collection and strengthened tanagement of the State Electricity Boards (SEBs). In the absence of such actions, power sector lending would be limited to: (i) viable private sector investments in generation and transmission; (ii) the few better managed SEBs that have maintained their financial strength or have taken specific steps to build it up; and (iii) innovative, small scale developments such as mini hydro and cogeneration schemes. In addition, the Bank will continue its dialogue with the National Thermal Power Corp ration and the Nat,onal Power Transmission Corporation and may finance the most critical components of these important central agencies' core investment programs. 109. Human resource develonment. The Dank will continue to expand support for efforts to improve access to, and the quality and efficiency of nutrition, health, family planning, and education investments that are orlented toward thte poorer sections of the population. Women will be a special focus of all these efforts. 110. Bank objectives in the edugation sector are twofold. The first is to support the development of basic education. The second is to support the development of industrial training for craftsmen, technicians and engineers to expand the supply of competent and productive labor. In population, health and nutrition, the Bank's primary objective is to promote improved health in the most vulnerable groups and to assist in reducing fertility. In addition, Dank  - 35 - economic and sector work will focus on the efficiency and effectiveness of health services and sanitation improvement needs to prevent waterborne diseases. 111. Environmental Protection. The effect of the severe environmental degradation taking place in much of India is particularly devastating on some of the poorest sections of the population. Bank assistance will support Indials efforts to preserve and enhance its resource base through projects related to rainfed agriculture, forestry, urban water supply and sanitation, and industrial pollution abatement. Increased attention is also being paid to environmental issues in energy and infrastructure projects and more generally through the application of the Environmental Assessment process to new and ongoing lending operations. Future assistance in these areas will be formulated withir the framework of an Environmental Action Plan (EAP) to be prepared by the Government using UNDP-financed technical assistance. 112. Resettlement and rehabilitation. Resettlement issues are a major concern in the implementation of both Bank-assisted and other Government investment projects. They are of special concern in irrigation and hydro power projects. Guidelines to improve the resolution of these problems are being developed by the Government. In addition, the Bank is studying underlying issues, including the legal framework, the availability of land and the functioning of the land market, and drawing on lessons from successful resettlement. Aid Coordination and Cofinancina 113. In the context of the comprehensive adjustment effort, the Bank as Chair of the India Aid Consortium will play a leadership role in mobilizing resources to meet India's financing needs over the next several years. The Bank, working closely with the IMF and IFC, will also seek to play a catalytic role in restoring India's access to private markets. Close cooperation with the IMF has been maintained during the preparation of the SAL/SAC and will be continued. We will also work closely with the ADB and other major donors in coordinating and strengthening the dialogue and lending strategy in key areas of sectoral pol'cy reform. Parallel cofinancings with ADB are under discussion. International Finance Corporation (IFCL 114. As of September 30, 1991, IFC had made investments in 58 Indian companies totalling US$1,010 million equivalent. India is IFC's third largest country commitment (after Mexico and Brazil) with US$547 million (9.6 percent) of IFC's total portfolio. About US$79 million of the commitments are in equity. The level of IFC's investments increased significantly over the past two years. In IFC's fiecal year 1990 approvals for India amounted to US$147 million in nine transactions. In fiscal year 1991, net investments totalled US$111 million in seven transactions with an additional amount of US$77.5 million in syndications approved and expected to be realized during fiscal year 1992. Disbursements for IJC's own account for fiscal year 1991 amounted to US$154 million. The past performance of LFC's Indian portfolio has been generally excellent, with prompt servicing of both loan and equity investments. 115. IFC's investment operations in the past three yearo have been characterized by considerable new investments in private sector power projects (all expansions of existing companies) and increasing investments in the capital  - 36 - markets area. Investments in general manufacturing, IFC's traditional investment area in India, have been more limited. As a result, the largest single sectoral concentration of IFC investments at present is in the power sector with 27% of held portfolio (US$147.5 million), with the balance of investments well diversified. 116. In the expectation that the favorable reform momentum achieved so far will be sustained, IFC expects to expand and broaden its operations in India, with conginued strong emphasis on efficient investments that can yield significant financial and economic benefits. Economic efficiency of industrial projects is particularly important during a psriod of continuing llberalization, when levels of effective protection can be expected to be reduced, and when the short-term effects of the adjustment program could lead to some reduction in demand. At the same time IFC's catalytic role could be helpful in permitting some high priority projects to proceed and in mobilizing other sources of finance as these become available. 117. Thus, IFC is at present giving priority to sound industrial expansion prospects which have a large foreign exchange content. Typically, such prospects can benefit from IFC's review of project and contractual arrangements and IFC can complement the role of other financing including that from the local financial institutions. The Corporation is currently considering a variety of investment proposals, including projects in general manufacturing, steel, power, textiles and the finan:lal sector which could lead to a substantial increase in annual investment levels. These increased investment levels are expected to include an increased focus on equity investments, both in new start-up prospects and in expansions. 118. IFC also envisages playing a significant catalytic role by enhancing the international flows of foreign private funds in the form of both equity and debt. On the equity side, IPC can provide equity investment and comfort in the promotion of joint ventures where foreign companies invest directly in Indian companies. With its large domestic market, its educated, skilled, and competitively priced labor force, an improved exchange rate policy, and further deepening of reforms, India could become an attractive base for foreign private investment. In a reformed industrial and financial framework, IFC's experience in promoting joint ventures that bring together a combination of foreign direct investment, management, technology and markets on an ongoing basis (whether in industrial, services or capital markets projects) could prove extremely relevant to India's needs. 119. On a potentially larger scale, IFC can assist Indian companies in making international issues of equity or convertible securities. Dlscussions are underway with the Government and several companies. While a number of policy measures would need to be taken to parmit such issues it is generally recognized that this could become an important supplemental source of foreign finance for the private sector. On the debt side of international capital flows, IFC can help in mobilizing commercial bank interest on favorable terms through participation in IFC loans. IFC already has a number of good prospects that will be syndicated as soon as suitable market openings develop. 120. In the financial sector the Corporation intends to assist in the development of the domestic capital market both through direct support for private sector financial services companies and venture capital and mutual funds  - 37 - and also through provision of technical assistance. Progress in this area would be influenced by the pace of liberalization of the financial sector. In addition, wholesaling arrangements with financial institutions, such as agency credit lines to reach small-and medium- scale enterprises in a cost effective manner, will be considered where appropriate. 121. In order to help meet the growing needs of clients in India and the Region, IFC is in the process of significantly strengthening its Regional Mission in New Delhi. 122. IFC and the Bank have made special efforts to coordinate their respective operations and have worked closely in developing the Bank's policy dialogue in industry, finance and the private sector. Even closer cooperation is envisaged for the future. Portfolio Management 12 The Bank's experience, shared with several of India's other don.rs, is of continuing weak project implementation capacity in most sectors in India, leading to slow and incomplete utilization of aid commitments. The Bank has made considerable efforts over the last few years to address some of the major problems which have led to slow disbursements. In addition, a full-fledged review of the portfolio, carried out jointly with the Government, has just been completed, leading tc. the identification of substantial portions of the undisbursed IBRD loans and IDA credits which can be canceled without interfering with the achievement of project objectives. A proposal is currently before the Board4 to re-commit the IDA cancellations to India as fast-disbursing credits in support of its adjustment program. Our assistance strategy will continue to give priority to intensive portfolio management to improve the effectiveness of IBRD/IDA resource transfers and the sustainability of the development benefits. B. The Rank's Lendina Proara 124. Until now, Bank lending to India has been almost exclusively in the form of investment lending. Over the past five years about 54 percent of Bank lending has gone into development of infrastructure, with power accounting for about 27 percent of total lending (see Table 2). Agriculture has accounted for 16 percent of the program with about one third of that in irrigation. Industry and finance absorbed 16 percent of the Bank program and population and human resources 10 percent. 4 Ref. R91-241 [IDA/R91-1491, dated November 12, 1991.  - 38 - Table 2 Bank Lendina. Fiscal Year 1987/91 (billions of US dollars) Number of Sector Amount Percentage projects Agriculture 2.1 16 13 Industry and finance 2.1 16 6 Power 3.5 27 10 oil, gas and coal 1.5 13 5 Transport 0.8 6 5 Urban and water 1.1 9 7 Education 0.8 7 3 Population, health and nutrition 0.5 4 5 Other 0.4 3 1 Total 12.8 100 55 125. Over the next four-year period FY92-95, the level and composition of the lending program will be closely linked to progress in India's stabilization and reform program. It is envisaged that this lending program would draw on the following resources: - IBRD lending of up to $2.0 billion per annum; - IDA resources of approximately $0.9 billion per annum; and - IDA resources of $0.65 billion from the redeployment of funds cancelled from the current IDA portfolio as proposed in the Board Paper (ref. paragraph 123). Reflecting the projected pace of implementation of the Government's stabilization and reform program and its financing requirements, about one-third of the Bank's lending could take the form of policy-based loans and credits. PART V. RELATIONS WITH THE IN? 126. As at the end of October 1991, India's outstanding obligations to the IMF totalled SDR 2379 million. Much of this reflects recent transactions with the IMF. Since January 1991, India has made drawings totalling SDR 1904 million from the Fund under a first tranche stand-by arrangement and the compensatory and contingency financing facility. On October 31, the IMF Board approved an additional stand-by credit to India in the amount of SDR 1656 million, to be drawn over the next twenty months. 127. Close cooperation with the IMF will be eesential since both the Bank and the Fund are assisting India in the preparation of its stabilization and  - 39 - adjustment program, expect to provide a major share of the funding, and are seeking to mobilize other official financing. The framework for this cooperation is in place. The Bank closely coordinates its economic and sector work and policy dialogue with Fund staff, and regularly reviews draft Fund staff briefing papers and reports. Loss formally, Bank and Fund staff frequently exchange views on recent developments and policy options. Consultations between the two institutions are particularly close during the current difficult times facing India, and staff members participate in missions fielded by the other institution. PART VI. RECOMUENDATION 128. I am satisfied that the proposed loan and credit would comply with the Articles of Agreement of the Bank and Association, respectively, and recommend that the Executive Directors approve the proposed loan and credit. Lewis T. Preston President Attachments Washington, D.C. November 12, 1991  KEY MACROECONOMIC INDICATORS a/ Actual Prelim. Projections 1987 1988 1989 1990 1991 1992 1993 1994 1996 1097 19 (MP Grotth Rate 4.5% 10.4% S.2% 6.0% 2.1X 3.0% 3.6% 4.0% 5.3% 6.8% 6.1% ODY Growth Rate 4.56 9.8% 4.8% 4.8% 3.8% 2.2% 3.8% 4.4% 4.8! 6.7% 6.2% CDY/Capita Growth Rat 2.1% 7.3% 2.4X 1.9% 1.9% O.8% 1.8X 2.65 2.9% 4.0% 4.4X Consumption/Capita arowth Rate 2.2% 6.8% 2.38 2.5% 2.?% -0.4X 1.1X 1.3X 1.6% 3.2% 3.7% Debt Service (Use i.) 5702 6807 8442 7143 6953 7496 8268 O980 11560 10681 12408 Debt Service/xp. G.A Serv. 29.4% 8o.8% 27.4% 28.8% 27.7% 28.8% 2S.7% 2B.8% 27.6% 19.6% 18.0% Debt Service/GODP 2.2% 2.8% 2.4% 2.6X 2.9% 8.2x 8.3% 8.7% 4.1% 3.2X 3.2% Gross Investment/GDP 22.7% 23.9% 23.8X 23.2% 21.7% 22.1% 22.6% 23.4% 24.1% 25.4% 26.8% DoesWtic Savings/GOP 20.1% 20.8% 21.0% 20.4X 19.8% 20.e% 21.3X 22.5% 23.5X 2S.OX 26.SX National Savings/GP 20.2X 20.7% 20.8% 19.7% 19.1X 19.7% 20.4X 21.8% 22.7% 24.3% 26.6% Marginal National Savings Rate 18.8% 24.0% 20.3% 14.2X 15.1% 27.7X 27.6% 33.2% 32.7% 31.5% 31.2% Pubi IC nveetment/Gop 10.4% 9.8X 10.8% 10.8% 9.9% 9.1% 8.7X 9.2X 9.2% 9.8% 9.9% Public Savings/QDP 1.5% 1.2X 0.5% O.1% 1.9X 2.8% 3.2% 4.2% 4.2X 4.8% 4.9% Private Investment/GOP 12.2% 14.1% 13.0% 12.8% 11.8% 18.0% 18.8X 14.2% 14.9X 16.8% 16.6% Private Savings/0GOP 18.7% 19.SX 20.1X 19.8% 17.1X 17.1% 17.2X 17.4X 18.8% 19.7% 20.7% Ratio of Public/Private Invest.. 88.9X 88.7X 79.5% 84.0X 84.5% 89.8% 83.2x 84.8% 81.8% 80.7% 69.7X Government Renenuee/GP b/ 25.7% 26.6% 26.1% 26.9X 26.7% 26.7% 26.SX 26.8% 26.2% 25.1X 26.1% Government Expenditures/GOW b/ 24.2% 24.3% 25.SX 26.8%1 24.8% 23.11% 22.3% 21.04 21.0X 20.SX 20.2X Deficit/GDP c/ 8.9x S."% 10.1% 10.6% 8.ox 8.65 5.53 5.0% 6.0% 5.0% 5.0X Export Growth Rate 8.1% 11.0% 12.1% 3.sx 1.OX 9.2% 9.9x 10.0% 9.8x 8.7x 8.1X Exports/GDP 8.3X 8.7% 7.9X 8.0% 9.ex 10.9% 11.9% 12.9% 13.9% 15.8% 17.0% Import Growth Rate -1.8% 18.0% -1.2% 1.1X -2.0% 4.1% 5.0% 4.6X 5.7X 7.73 6.0% Importe/GOP 8.9% 9.7% 10.4X 10.8% 11.8% 12.43 13.2% 13.7? 14.65 16.9% 17.2X Current Account (USS m.) -6397 -8877 -7888 -9829 -8803 -6598 -6300 -4684 -4164 -3495 -3612 Current Account/GOP -2.5% -3.2% -3.0% -3.6% -2.8X -2.4% -2.1% -1.7% -1.5% -1.13 -0.9% a/ Datot refer to Indian fiscal years. Thus, 1990 refers to the fiscal year 1990/91, running from April 1990 through March 1991. b/ Refers to Total Public Sector, which Includes the Central Government, the State Governments and > Non-Financiel Public Enterprises. c/ Refers to the Savings-Investment Balance of the Total Public Sector (National Accounts classification). F > o H  8ALANCE OF PAYMENTS a/ (US6 s1ll1ons of Current Prices) Actual Prelim. Projected 1985 1986 1987 1998 1999 1990 1991 1992 1993 1994 1996 1997 1999 __ ~~~~~~~~- -- - -- - -__- - - -- - - - - -- -- -- _- - -- -- -- -_- -- -- -- -- -- -- -- -- -- -- - -- -- - -- - - - - - - - - -__- - - - - - A. Exports of Goods NFS 1277 18677 18216 18218 209s1 22685 22900 25847 29684 84264 3so8 1171 65819 1. Merandise (FOS) 9401 10460 12644 14282 18680 18485 1989 s 21320 24698 28747 83275 487s3 sa6es 2. Non-factor Service. 3310 3217 8671 s86s 4068 4200 4208 4527 4987 5517 60s5 7418 6950 8. lporte of God& aFWS 19419 19950 22839 26564 27752 0591 27650 29424 8288 a8472 41078 52371 66165 1. Morebandise (FOB) 17296 17728 19812 23389 24414 27214 24281 26879 28909 82150 88263 468I 58771 2. Non-factor Service 2124 2222 82 8225 8888 8877 8819 8545 3921 4822 4820 5990 7896 C. Resource Bslance -6648 a278 -6624 -8346 -6889 -7906 -4860 -8577 -8146 -2208 -1718 -1200 -847 0. Net Factor Incom -1512 -2045 -2471 -298S -38 -3928 -397S -4154 -4891 -4016 -4682 .4588 -4911 1. Factor Roceipt 547 501 448 a97 896 199 161 222 30 449 460 789 1279 2. Factor Paym ent. 2099 2548 2917 3882 8700 4121 4186 4875 4752 50s6 5142 5827 8190 E. Not Current Transfer 2207 2827 2898 2654 2256 2000 2828 2188 22U8 22a9 2241 2244 2247 F.. 1. Current Recipt. 2219 2389 2724 2670 2271 2018 2100 2160 2255 2267 2280 2264 2269 aD. Workers Reamittanc 2219 2899 2724 2226 2186 1947 2016 2008 2141 2148 2145 2160 2154 b Other Current Transfors 0 0 0 445 85 69 84 U4 114 114 114 114 116 2. Currnt Payments 12 12 26 16 15 16 16 17 17 18 19 20 22 F. Current Account Balamne -5998 -5991 -6897 -8677 -7888 -9829 -8303 -55s8 -5800 -4654 -4154 -3495 -3812 0. Net Log-Term Capital Inflow 4641 5389 680 7706 7427 5017 4938 5691 6058 6264 6264 724 7820 1. Foreign Direct Investment 16O 208 181 287 360 263 200 860 620 600 1000 1500 1500 2. OfficIal Capital Grants as3 403 410 406 S60 524 549 576 603 682 662 712 76 8. Not LT LOaD. 4122 4728 7689 7018 677 4240 4180 4765 4934 4952 4601 4991 5065 a. Disbursment. 56481 7017 7861 8962 8506 6720 6746 7773 8549 9188 9498 10428 11598 b. Repaym 1809 2289 1892 1949 1929 2480 2657 8oo00 861 4181 4892 5482 1644 H. Total Otber Item (not) n2s 1872 760 749 618 2014 200 -157 -100 -50 20 28 27 1. Not Short-Tere Capital 278 168 222 265 917 219 0 -157 -100 -50 20 26 27 2. Capitol Fle NEI 1416 1306 1289 855 -465 1796 0 0 0 0 0 0 0 S. Error& Aomissione 474 -102 -781 141 1e7 0 200 0 0 0 0 0 0 I. Chang in Not Reer,ee -812 -720 -748 m -157 2798 1l65 84 -658 -180 -2180 -n873 -3836 1. Not III Cedilt -284 -646 -1082 -1210 -1008 1028 1877 680 571 -415 -1770 -200 -430 2. Otber Reervo Cha_ng (excl. Gold) -548 -72 38a 1482 851 1770 -212 -1e6 -1229 -1216 -80 -8635 -840 (- Indicates tencrase) a/ Date ref r to Indian fiscal yvers. Thus, 10 refere to the fiscal yer 1990/91, runnings frm April 1990 through March 1991. Idl  8ALANCE OF PAYMENTS a/ (USS millions of Current Prices) Actual Prelim. Projectod 198S 1998 1987 1988 1989 1990 1991 1992 1998 1994 1996 1997 1999 Shares of COP (current US8) 1. Reeoure salanco -8.11 -2.7X -2.61 -3.1X -2.6% -2.8X -2.0% -1.5S -1.33 -0.8X -0.6X -0.41 -0.2X 2. Total Interest Payments 0.90 1.0 1.13 1.2% 1.3X 1.4% 1.7% 1.61 1.9% 1.61 1.7% 1.53 1.4U 8. Current Account Balance -2.8X -2.83 -2.61 -3.21 -8.0X -3.SX -2.6% -2.43 -2.1% -1.7X -1.6% -1.13 -0.91 4. Net LT Capital Inflow 2.2X 2.31 2.51 2.8% 2.8% 1.8% 2.1X 2.43 2.4% 2.4X 2.23 2.2X 1.91 S. Net Croedt fre the IMF -0.13 -0.83 -0.43 -0.4% -0.43 0.41 0.61 0. 3X 0.2X -0.23 -0.61 -0.1% -0.1 Memorandum Ite.. GOP (mll I. US$) 214032 228348 256480 272848 286720 284298 238878 286408 249658 285619 283449 328978 384202 Foreign Exchang Reserves: End-Year Res"rves (a. S) 6857 8730 8391 4959 4108 2338 2C50 8186 4395 6610 6970 11110 18010 Reserves In Months of Imports 4.8 4.6 3.9 2.5 2.0 1.0 1.8 1.5 1.8 2.1 2.0 2.9 3.7 Exchange Rates (Ra/US$): b/ Nominal Official Exchange Rate 12.24 12.79 12.97 14.48 16.86 17.95 24.50 27.00 28.21 29.43 30.62 32.82 36.29 Real Exchange Rat Irdex (1980/81=100) 94 110 116 128 183 140 175 186 190 194 198 206 214 a/ Dates roefr to Indian fiscal yea.. Thus, 1990 refers to the flscal year 1990/91, running from April 1990 through March 1991. bJ Refrs to period averae. 10 lbH 4,.  DEBT SERVICE ASSUMPTIONS a/ Aetzial Prel im. Projected 1990 1984 1968 1989 1990 1991 1692 1993 1994 1996 1997 1999 Principal Repaymnts Multilaeral 88 132 397 482 609 692