India - Fifth Industrial Imports Project

RESTR I CTED FILE COPY Report No. P-662 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO INDIA FOR A FIFTH INDUSTRIAL IMPORTS PROJECT January 2, 1969  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECO:-MEiEDATION OF THE PRESIDEIT TO THE ELECUTIVE DIRECTORS ON A PROPOSED DE7ELOPMiIT CREDIT TO INDIA FOR A FIFTH INDUSTRIAL =PORTS PROJECT 1. On June 6, 1968, I submitted my Report and Recommendation on a proposed $125 million industrial imports credit to India (IDA/R68-24). The proposal was considered by the Executive Directors on June 18, and although no final decision was taken, it was agreed "that the project to be financed by the credit was in principle acceptable" and "that the credit, if approved, iwould provide for the reimbursement of payments made since January 1, 1968! (M68-7, IDA/M 68-23). Although the full second replenish- ment of IDA's resources has not yet been achieved, a number of Part I countries have given us assurances of advance contributions totalling $185 million. These funds, together with the 4130 million of available IDA resources listed in my memorandum to the Executive Directors dated September 3, 1968 (Sec M68-306), plus the $15 million supplementary contribution recently provided by Denmark, wil1 enable the Association to undertake tota-l commitments of at least $330 million in the fiscal year 1969. Under these circumstances I consider that we should now proceed promptly with this $125 million credit. 2. The credit would provide for reimbursement of approved expend- itures since January 1, 1968. I understand that the Indian Government had accumulated disbursement requests of about $100 million by December 31, 1968, and expects such requests to total 4P125 million by March 31, 1969. Taking into account the terms on which the advance contributions to the replenishment and the Baxics recent $75 million transfer have been made, it is clear that the Association will have available the cash resources to meet these requirements. PART I - HISTORICAL 3. The Association has made 21 credits to India, including 15 which are fully disbursed. The Bank has made 36 loans in India, including  - 2 - 30 which are fully disbursed. The status of Bank loans and IDA credits in India as of November 30, 1968, is summarized as follows: Active Amount (US $ Million) Loans/Credits (Less cancellations) Number Year Borrower Purpose Bank IDA Undisbursed 14 1961 India Salandi Irrigation 7.5 1.9 307 1961 IIS00 Coal Rining 19.5 6.9 19 1962 India Durgapur Power 18.5 2.7 24 1962 India Koyna Power II 17.5 4.6 27 1962 India Bombay Port 16.2 3.2 37 1963 India Kothagudem Povwer I 20.0 .9 414 1965 ICICI Industry VI 50.0 32.0 416 1965 India Power Transmission 58.0 35.6 417 1965 India Kothagudem Power II 14.0 3.0 89 1966 India Beas Equipment 23.0 13.6 456 1966 iis00 Balancing Scheme 30.0 29.1 515 1967 ICICI Industry VII 25.0 25.0 Loans/Credits fully disbursed 810.7 784.2 Total 1,007.2 886.9 of wqhich has been repaid to Bank and others 369.9 Total now outstanding 637.3 Amount sold 109.7 of wJhich has been repaid 103.8 5.9 Total now held by Bank and IDA 631.4 886.9 Total undisbursed 131.6 26.9 158.5 4. There have been delays in disbursement on several Bank and IDA financed projects in India. As proposed in my memorandum R68-137, disburse- ments are still being made in respect of the Power Transmission Project (Loan No.416-nf), pending consideration of the request of the Government of India to postpone the Closing Date from June 30, 1968 to December 31, 1970; I propose to make a recommendation on this matter in January 1969, based on the findings of a mission which returned recently from India. 'lie continue to give very close attention to the situation of the Indian Iron and Steel Company (Loans Nos. 307-IN and 456-IN), where various difficulties have considerably delayed both projects. In the case of the Bombay Port Project (Credit No. 27-mD), an end-use mission in July 1968 reported that work was now on schedule and, barring unforeseen difficulties, should be completed by the revised Closing Date of July 31, 1970. The industrial recession has resulted in a slower rate of disbursement by ICICI than expected (Loans Nos. 414-IN and 515-IN), although in recent months commitments have risen notice- ably.  - 3 - 5. As of December 31, 1968, there remained on deposit i,ith the Reserve Bank of India the equivalent of about ~622.6 million in interest- bearing demand deposit accounts. It is expected that the amount outstand- ing will be reduced further to about $15 million in the near future and that this balance wTill be -withdrawn by not later than March 31, 1971 (Sec lN 68-317). 6. Two new projects for Bank loans totalling about $30 million have been appraised and negotiations have been substantially completed. Both projects, which were originally considered for IDA financing, but are now being considered for Banikc loans because of the delay in the second IDA :7eplenishment, are in the agricultural sector, one for land drainage in the States of Punjab and Haryana and the other in Uttar Pradesh for the culti- vation, processing and distribution of high-yielding seeds; these projects are expected to be presented to the Executive Directors shortly. A third telecommunications project for up to $55 million (also initially considered for an IDA credit, but now proposed for a Bank loan) and a tenth railway project for an IDA credit of about $40 million (subject to further replenish- ment) are scheduled for appraisal in early 1969. Additional projects in transportation (ports and highways) and water supply are under preparation; a reconnaissance mission to identify financing opportunities in the field of agricultural credit has just returned from India, and a similar mission is planned for January to study irrigation projects. 7. IFC has made nine commitments in India totalling $17.6 million of which $12.5 million represent loans and $5.1 million equity, excluding two commitments for $2.3 million which were approved but subsequently terminated. As of November 30, 1968, $12.8 million had been disbursed. The largest investment amounting to $8.5 million (net of a cancellation in the amount of $3 million due to a reduction of the foreign exchange requirements) is in a fertilizer project of ICI at Kanpur. A number of other projects are currently under consideration, including two new fertilizer projects. PART II - DESCRIPTION OF THE PROPOSED CREDIT 8. BORROWMER: India, acting by its President. AIOUNT: Various currencies equivalent to 4125 million. PURPOSE: To enable selected priority industries in India to maintain and expand their production of capital goods and agricultural chemicals by financing part of their requirements of forgegn exchange for the import of raw materials, components, spare parts and miscellaneous items of manufacturing equipment. The foreign ex- change is sold by the Government of India to the ultimate beneficiaries.  AlHORTIZATION: In 50 years including a 10 year period of grace, through semi-annual installments of 1/2 of 1zO from September 15, 1979 through March 15, 1989 and l-l/2jo from September 15, 1989 through March 15, 2019. SERVICE CHIARGE: 3/4 of 1% per annum. 9. A report entitled "Appraisal of a Fifth Industrial Imports Project - India" (AS-140a), dated June 6, 1968, was distributed to the Executive Direc- tors together with my Report and Recommendation of June 6, 1968 (IDA/R68-24). The report described the general situation in major participating industries (e.g., commercial vehicles, machine tools, electrical equipment, fertilizers, pesticides and similar products) and their outlook for 1968/69. 1/ In general, the industrial situation remains much the same as described in the June reports, but the following recent developments should be noted. During the six months from April to September 1968, production in many priority industries iwas higher than during the corresponding period in 1967. Sub- stantial increases wrere attained by industries producing commercial vehicles, automotive components, agricultural tractors, fertilizers, and basic materials such as aluminum, zinc and synlthetic rubber. Production of machine tools, which had declined steadily for several quarters, showed a significant in- crease during the July-September 196$ period. Some other industries, however, showed little growth or even declined, for example heavy electrical equipment, cables and wiires. One of the most gratifying developments during the past few months has been a substantial increase in the export of engineering goods. PART III - ECONOMIC BACXGROUND AND JUSTIFICATION O'LF THE PROPOSED CREDIT 10. A note on the economic situation in India was distributed to the Executive Directors on May 2, 1968 (R68-61). Since then, there has been little change. Because of the shortages of food and of foreign exchange, the Government has followed a policy of fiscal restraint; in 1967/68 neither public nor private investment showed any significant increase over levels achieved in 1964/65 and 1965/66, and because of price increases investment may have declined somewhat in real terms. Despite sluggishness on the industrial side the record harvest of 1967/68, following the droughts of the previous two years, wias responsible for a nine percent growth in GIP. A smaller increase in agricultural production is expected this year, and G4lP is not likely to rise by more than four percent. Per capita income continues to be very low. II. The economic memorandum distributed to the Executive Directors and to the consortium last spring estimated that about $1,000 million of quick-disbursing aid (excluding PL-480 assistance) would be necessary this 1/ References are to the Indian fiscal year, April 1 - March 31.  - 5 - year. However, somewhat less than $500 million (including 4100 million in deb-t relief) has so far been authorized by consortium members. Because of the shortfall in resources the Govermnent has maintained a cautious policy toward new investment, and it now appears that India wjill be able to get by -Lith $600-700 million in new commitments of quick-disbursing aid (exclud- ing PL-480 assistance). 12c There has been some relaxation of pressure on the balance o0 pay- ments. One reason is an increase in export earnings, which this year, for the first time, should exceed the 1964/65 record of $1,715 million. Progress has been particularly noteworthy in promoting non-traditional exports. In 1968/69 exports of engineering goods are expected to be tirice as large as in the previous year; although still only six percent of total exports, this accounted for one-third of the overall increase. Another reason is the forced pace of import substitution, often wiith little regard to cost consider- ation, Nevertheless, the shortage of foreign exchange is such that India has been able to endure the current restricted level of imports only by accepting fiscal restraint, low1 investment levels, and modest overall growath. 13. These factors, together irith a gradual draudon in the aid pipe- line, have averted a foreign exchange crisis so far; they have also enabled the Government to continue wiith, but not expand, the limited program of import liberalization started in 1966. W1hen thefiscal year ends on March 31, 1969, and after meeting repurchase obligations to the DT , reserves are expected to be moderately higher than the year before. 14. The problem of how to break out of the vicious circle of low investment and lowJ grouth, at a time of aid stringency, is one of the principal issues to be resolved in the implementation of the Fourth Five- Year Plan (Aipril 1969 - IMarch 1974). The current aid stringency compounds a structural problem that would in any case have caused some slowdown. A decade of industrial investment created capacities i-ich in many branches of heavy industry wxould be well in excess of current demand even without a recession. The industrial structure was designed for a much higher rate of economic gro;,th than has been attained in fact. Now, any substantial increase in Government development expenditure in sectors which are not overcapitalized is precluded by the need both to keep food prices from rising again and to contain the demand for foreign exchange. The resource problem is aggravated by the low profitability of many public sector enter- prises, wJhich limits the funds available for expansion where it is needed; the recession has also cut into profits in the private sector. 15. Investment opportunities in India are substantially greater than the financing available from domestic savings and are constrained by the shortage of foreign exchange. There is a basic need to increase exports. IWith this in view., various export incentive schemes have been introduced; the gradual lifting of licensing restrictions and price controls is also contributing to raising industrial efficiency generally. In the meantime, any sizeable increase in the rate of economic development will depend on the availability of additional investment resources, including resources from abroad to supplement domestic savings. The Government of India can proceed wjith a reasonable development program only if it receives long-term external aid at a level of about three percent of G1NP.  - 6 - 16. It is against this background that I recoramend a credit, which is not for a specific project. The special circumstances that seem to me to Justify this recommendation are largely a reflection of the stracture of India's economny. Imports represent only about six percent of Giip in India, and less than one-fourth of total imports is accounted for by finished capital goods. iNot all of these capital goods are associated vith large investment projects, which in India typically require only 10-15 percent of their total cost in foreign exchange. Because of these factors the amount of external financing that can be transferred effectively to India in the form of financing for the foreign exchange component of specific projects is limited. At the same time, India spends substantial amounts of foreign exchange on rawi materials such as petroleum, nonferrous metals and rock phosphate. Furthermore, although industrialization has reached a stage where many types of machinery and equipment can be produced domestically, a large volume of imports of sophisticated components, spare parts, special steels and other production goods is required, for uhich indigenous capacity has not been established or is insufficient to meet demand. 17. In such circumstances external fillancing tied to the direct foreign exchange content of projects would be inadequate to support a significant development program and must be supplemented by other types of lend'ing, such as the proposed industrial imports credit. A similar economic effect could be obtained by foreign exchange financing for a substantial part of the local currency expenditure on investment projects. In future it is my intention to provide as mu_h as possible of our assist- ance to India by means of loans and credits for specific projects; but for the next few years I believe that industrial imports financing is likely to continue to be a necessary, though diminishing, proportion of the Assoc- iation's activities in India. 18. As in previous industrial imports credits, foreign exchange is sold to importing industrialists and the rupee proceeds -i-o-uld accrue to the Government, thereby enabling public investment to be significantly higher than otherwise. The proposed credit wfould also assist the Govermmeent in continuing the liberalized import policy whl-ich came into effect in 1966. Under this policy licenses for certain production goods are issued to firms in priority industries as and when required by individual manufacturers. This has helped key industries to expand or at least to maintain production, The import liberalization and other measures of industrial decontrol have also allowed - and even forced - firms to compete with each other, often for the first time. A process of rationalization is emerging, inventory levels are slowly being brought down, and more and more manufacturers are becoming aware of the importance of cost reduction and of improving the quality and design of their products. The liberalization policy is sound and should, if possible, be expanded. When the Government adopted this and other promising new policies in 1965 and 1966, the Baik Group and its consortium colleagues recognized that the full benefit of these policies would be achlieved only after some years and that India would need a high level of aid for at least another decade. The proposed credit would play a small but essential part in sustaining these policies.  - 7 - 19. Taking all these special circumstances into account, I believe that the proposed industrial imports credit would be an appropriate response to the situation which w e confront in India at this time. PA1T IV - LEGAL IMSTRUIHENTS AND AUTHORITY 20. The draft Development Credit Agreement between India and the Association and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement were distributed to the Executive Directors with IDA/R68-24-L, dated June 12, 1968. The terms and conditions of the credit as presently proposed require the following revisions to the draft Development Credit Agreement: (i) In viewi of the present availability of IDA funds, the proviso at the end of Section 2.02 relating to the rate of uithdrawals from the Credit Account is deleted; and, (ii) The dates specified in Section 2.06 are changed to "September 15, 1979", "Hiarch 15, 2019" and "liarch 15, 1989", respectively. The provisions of the draft Development Credit Agreement followi substan- tially the pattern of the agreements for Credits !Dos. 92-k\! and 97-I1J. PA1LT V - COiPLIiTC-E llIT-I ARTICLES OF AGREEIE-IT 21. I an satisfied that the proposed credit wzould comply iwith the Articles of Agreement of the Association. PAIRT TI -REC0i111IDDATIO] 22. I recomnend that the IExecutive Directors adopt the folloiwing resolution: RESOLUTION NO. Approval of a Development Credit to India in an amount equivalent to U. S. $125,000,000 RES0LVED-: THIAT the Association shall grant a development credit to India in an amount in various currencies equivalent to one hundred and twenty-five million United States dollars (U. S. $1l25,000,000), to mature on and p:ior to ilarch 15, 2019, to bear a service charge  - 8 - at the rate of three-fourths of one percent (3/lh of 1iJ) per annum, and to be upon such other' terms and conditions as shall be substantially in accordai-ce lTith the terns and conditions set forth in the form of the Development Credit Agreement (Fifth Industrial Imports Project) between India and the Association, iwhich has been presented to this meeting. Robert S. MIcNamara President Janualy 2, 1969