India - Iisco-Scob Iron and Steel Project

fl~V~ tRESTRICTED P-43 T'his report is restricted to use within the Bank. 1 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS of the PRESIDENT to the EXECUTIVE DIRECTORS concerning a PROPOSED LOAN to the INDIAN IRON AND STEEL COMPANY, LTD. December 11, 1952 Department of Operations Asia and Middle East  INTERNATIONAL BA.NK FOR RECONSTRUCTION, AND DEVELOPIvENT REPORT AM RECOWiENATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS CONCERNING A PROPOSED LOAN TO THE INDIAN IRON AM STEEL COMPANY, LTD, 1. I sub=Lt herewth the f,llowirg report and recommendations with respect to the prppmed loan of $31,5 million, or the equivalent in other currencies, to the Indian Iron and St1 Company, Limited. PART I - HISTORIC&I 2. A Bank mission visited India in Nove ber and December of 151 to stuty various proects aunder the Five-Year Development Plan of the Governnrnt of India. Amwngst these projects were three for the expansion of iron and steel, productionp a program which has been given a high priority by the Government of India. The mission formed the opinion that the over-'81Q expansion of the iron and steel industry in India was highly desirable, and recommended that the Bank should help finance it. 3. When I visited India in February and March 1952, I held further dis- cussions with Government officials and leading members of the iron and steel industry. As a result I decided that the problems raised by the proposed ex- pansion in iron and steel production required a thorough investigation, not only from a technical angle but also from the viewpoint of production costs and methods of financing. I, thereforej wrote on April 23, 1952, to the Fin- ance Minister suggesting that the Bank should send a mission to India to con- duct such an investigation, and promised to indicate to him the form which Bank assistance might take, after the report of this mission had been studied. 4. A mission, headed by Mr. George VWoods, Chairman of the Board of the First Boston Corporation, visited India in June 1952. After an examination of all proposals put forward for expanding iron and steel production, this mission came to the conclusion that the program of expansion planned by the Indian Iron and Steel Company (IISCO) and the Steel Corporation of Bengal (SCOB) presented the most favorable possibilities for rapid and economic expansion of production. 5. These two private companies are in fact physically integrated, and the mission recommended that they should be formally amalgamated by transferring the undertaking of SCOB to IISCO. The Steel Corporation of Bengal was es- tablished in 1937 as a separate financial and legal entity on account of diffi- culties in raising capital to expand the existing IISCO plant. IISCO and SCOB are carrying out some extensiois of that plant with the help of a Rs. 50 minllion loan from the Government of India. The expansion, which it is now proposed the Bank should help finance, is a further and much larger program.  - 2 - 6. During the discussions held by the mission in India a suggestion was made to the Government that, in view of the difficulty of raising capital, consumer prices of steel should be increased to enable the Govern- ment to make advances from the Equalization `und to steel companies. The Equalization Fund is maintained by a system wphich allows the pro- ducer to retain only such part of the sale price of iron and steel as vill in the Governmentls view give him a fair overall return; the difference between the amount so retained and the sale price is put into this Fund, vrhich the Government intended to use to subsidize imports and re-rollers. The suggestion made by the mission was designed to obviate the need for further interest-bearing loans from the Government, which wvould have placed a heavy burden of debt on the Company. The Government agreed with the Company to make an advance on vwhich $nterest would not be charged before June 30, 1958, and then only if the retention price of steel is increased by the amount of a special element. This advance has no maturity date and can be repaid either by means of a special element or from the proceeds of a capital issue. The price of steel has been raised by Rs. 100 a ton. 7. In accordance with the recommendations of the mission, the Bank wrote to the Minister of Finance on August 11 that negotiations could com- mence as soon as the Bank had been informed: (a) that the IManagements of IISCO and SCOB had good reason to believe that the merger would be carried out; and that the Government is prepared to gu,arantee a loan to the reconstructed company; (b) that arrangements satisfactory to the Bank would be made (i) for the advance of the necessary funds (not less than Rs. 10 crores) by the Government from the Equalization Fund to IISCO-SCOB, and (ii) for the provision of adequate additional vorking capital to IISCO-SCOBI (c) that IISCO-SCOB could offer the Bank security for the loan at least as good as that enjoyed by any other creditor, 8. (a) The Government in a letter dated October 11 gave assurances on these points. (b) Faced with the prospeets of considerable delay over the merger of the companies, the Government of India, in consultation with the com- panies, passed an ordinance dated October 29, 1952 which provides for the merger as from January 1, 1953. This ordinance has the force of law for six wreeks from the date of its promulgation, and it is expected that the Indian Parliament will during the current session pass an act in terms similar to the ordinance. (c) After discussions wvith the Trustees for the holders of IISCO's First Mortgage (Sterling) Debentures, which are secured by a first fixed and floating charge upon IISCOIs assets, such holders agreed to vary their security so as to permit the Bankts security to rank pari passu therewith. This concession was given in consideration of an increase in the interest rate on the debentures from 4 to 4-3/4%, and an option to the debenture holders, to be exercised in September 1961, to have the debentures redeemed at par in that year instead of 1966.  - 3 - 9. Negotiations were started in lWashington with representatives of the Gov- ernment of India and of the Company on November 10. During these negotiations the Guarantee and Loan Agreements were discussed; and, in addition, the Bank has examined the terms of the agreement to be entered into between the Company and the Government of India, which assures necessary financial assistance to IISCO. The negotiations were completed on December 9. The Bank has been notified that the Indian Ambassador in Washington will be authorized to sign the Guarantee Agreement. The Loan Agreement will be signed by Sir Biren Mookerjee, an authorized attorney of IISCO. PART II - DESCRIPTION OF PROPOSED LOAN Borrower 10. The borrower would be the Indian Iron and Steel Company, Ltd. Amount 11. The loan would be in the amount of $31,500,000, or the equivalent in other currencies. The other currencies, which may be required, will not be known until contracts are awqarded. Purpose 12. The Proceeds of the loan would be used to acquire equipment from abroad to expand the designed production capacity of the Indian Iron and Steel Company, to modernize existing equipment and to increase prodvition of the Company's ore mines. The total cost of the Project for the five years ending 1958 is estimated to be the equivalent of -673.48 million, of which $31.5 million will be in foreign exchange. The Government of India has agreed to provide for the Project an ad- vance from the Equalization Fund equivalent to p21 million and a loan equivalent to 413.96 million, making a total equivalent to 434.96 iillion. The Project is designed to increase IISCOQs blast furnace capacity from 640o,0o tons of iron in 1952 to 1,400,000 tons in 1958, when 400,000 tons will be available for sale to foundries. In the same period, IISCOts steel capacity should increase from 350,000 tons to 700,000 tons. 1 13. The equipment to be financed with the Bank loan would consist of coke ovens, blast furnaces, mining and steel making equipment. Terms 14. The loan would bear interest at the rate of h-3/h% per annum, including the statutory commission of 1%, - 15. The commitment charge would be 3/4 of 1% per annum and would accrue from a date 90 days after the date of the Loan Agreement, or from the Effective Date of the loans whichever is the earlier. 16. On account of the tight cash position during the period of construction, the Company has asked thet interest and commitment charge due during this period should be included in the amount of the loan; and the Bank has agreed to this re- quest,. Tletails of the cash position are given :in the tecinical report (fppen- dix 4), SiSilar provisions tpply to the loan fromfthe Government of i ndia.  17. The loan would be amortized by semi-annual payments beginning April 15, 1959, which are calculated to retire the entire loan by maturity on October 15, 1967, as set out in Schedule 1 of the proposed Loan Agreement. 18. The loan would be secured by a first fixed and floating charge on the Company's assets ranking pari passu wvith the security for the First Mortgage (Sterling) Debentures, and ahead of the numerous other charges on the Company's assets which will be subordinated. 19. I consider the proposed Schedule for the repayment of principal and the rate of interest and other charges on the proposed loan to be reason- able and appropriate. Legal Instruments and Legal Authority 20. A draft Loan Agreement between the Indian Iron and Steel Company and the Bank is attached as Appendix 1. A draft Guarantee Agreement between the Republic of India and the Bank is attached as Appendix 2. 21. The Agreement between The President of India and the Company which regulates the relationships between the Company and the Government is in a form which represents many months of negotiation between the Company and the Government. At the suggestion of the Bank several chnnges were mide, most of w1 are designed to conform the Agreement to the results of the Comp;ny's negotiati with the Bank, One important provision in this Agreement that has been in- serted at the request of the Bank is that the Governmert of India agrees to advance to the Company, additionally to the loan and special advance, such sums as the Company might reasonably require to complete the expansion pro- gram or by wTay of working capital to maintain itself in a sound operating condition, if the Company should be unable to raise capital from private sources. 22. The draft Loan Agreement differs in many respects from the Bank's normal form. Most of these' differences are a consequence of the loan being made to a Company wvhich already has a complicated series of charges, and which would grant security to the Bank. Attention is directed to the following points: a. The Agreement recites the circumstances under vhich the loan would be made. b. Provision is made in Section 5.04 for the security to be re- ceived by the Bank. c. The holders of the Company's existing First Mortgage Debentures agreed to vary their security so as to allow the Bank security to rank pari passu therewvith, upon the condition that each of such holders should receive an option to have his debentures repaid at par on December 31, 1961, The Company was enabled to grant this option by some adjustments in the years 1959, 1960 and 1961 to the Schedules of Amortization of the Bank and the Government loan. If any of the holders of the Debentures should  fail to .exrorcise their option on December 31, 1961, then these amortization schedules should be readjusted. Pro- vision is made for t us in Section 2.07 (a) (the adjust- ment of the amortizEtion of the Government loan is dealt with in the Governm-;nt Agreement). de Bonds would be recevable by the Bank against vwithdrawals from the loan account and such bonds would be in the form prescribed in the '.,ust Deed that will constitute the Bankts security. A first draft of this Trust Deed has been pre- pared but the docuaent cannot be completed until the other charges of *he Corpany have been anpropriately varied, Bonds under the L'an Agreement nmey only be issued to the Bank or to the Government of Inaia. e, The obligations cf the Company are to be binding upon its subsidiaries if cny. At present the Company has no subsidiaries. f. The Bank rould b) entitled to suspend vrithdrawals or pre- mature the loan if, in addition to the normal events of default, the sec-irity constituted by the Trust Deed were to become enforceable. g. Conditions of effectiveness are specified in Section 7.01 of the Loan Agreement. These include the completion of a fully effective Trust Deed in accordance with the Loan Agreement. h. The Bank's normal arbitration clause provides that the parties to the arbitration shall be the Bank on the one side and the Borrore r and Guarantor on the other, the third arbitrator being appointed by agreement of the parties or in default of agreement, by the President of the International Court of Justice or, failing him, by the Secretary General of the United Nations. In this case, the parties to any arbitration would be the Bank, the Borrower and the Guarantor and each must agree upon three arbitrators; if and to the extent to -which they should not agree, appointment vould be made by the outside parties mentioned above. 23. Since the borrower is a privately-owned Corporation, the guarantee of the Government under the Guarantee Agreement would extend only to the payment of principal, interest and other charges. 24, The Bank has osked for a stntement of representations regarding the soundness of the Comprny's financial condition. P similar statement as of current dato must be provided beforc the loan becores effective. 25. The report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank is attached as Appendix 3.  - 6 - PART III - APPRAISAL OF THE PROPOSED LOAN 26. A technical report describing and appraising the Project is attached as Appendix 4. 27. The economic background against -which the proposed loan should be considered is described in a report entitled "Recent Economic and Financial Developments in India." dated December 8, 1952, which is attached as Ap- pendix 5. The last economic report on India was submitted to the Board in February 1952.* 28. The financial and economic situation in the first half of 1952 can be characterized asa period of disinflation. As a result of the disin- flation and the world-wide slump in commodity markets, large scale dis- hoarding of goods took place in India, including stodks of grain hitherto hidden. The wholesale price index in India dropped from 433 in December 1951 to 365 at the end of May 1952. In November 1952, it was nearly 12% lover than in November 1951 and about 3% below the pre-Korean level. 29. The food position has shown substantial improvement since the begin- ning of 1952. Subsidies on imported grain have been abolished, except for milo, and control over distribution of grain has been relaxed in several States. The Government-held stocks of foodgrain have increased almost to the extent of total grain imports in 1952. Imports of foodgrains in 1953 are expected to be substantially lower than in 1951 and 1952. 30. The upward trend of industrial production has continued in 1952 despite declining prices. The index of industrial production vwas 129.2 in July 1952, compared:tp 11).4 in July 1951. 31. After a balance of payments surplus in 1950, India incurred sub- stantial balance of payments deficits in 1951 and the first half of 1952, caused mainly by large imports of grain and cotton and imports needed for development projects. The deficits were covered mainly by the $l90 million U.S. WTheat Loan and by a reduction in sterling balances. The trend seems to have been reversed recently, however, as indicated by the gradual rise in sterling balances since July 1952. 32. India financed substantial development expenditures in the past two years by non-inflationary means. The budgetary position in 1952-53 is ex- pected to be somewhat less favorable than in the past two years. It is likely, however, that the government cash balances will be reduced by less than the Rs. 756 million estimated in the budget. On November 1l, 1952, the government balances stood at Rs, 1,499 million, or only slightly below the opening balance on April 1, 1952. 33. Public expenditure-on development in 1952-53 is estimated at Rs. 4,100 million. It can be assumed that funds vwill be available to meet these expendi- tures, but external assistance will be needed for the remaining three years of the Five Yepr Plan in addition to thc i 35 million annually to be releasod from the sterling balances. The main problexa confronting the Government of India at the present time is how the Dcvclopment Plan can be prried on in the remaining three years at the present accelerated rate without creating major inflationary pressures. * The Five Year Plan of India and India's Creditworthiness - E-207a, Feb.ll, 195:  - 7 - 34. In the report on "The Five Year Plan of India and Indiats Credit- worthiness" in February 1952, it was considered appropriate for the Bank to be prepared to participate in the financing of India's Five Year Plan in the current year to the extent of loans in the aggregate amount of $60-70 million. Despite imnportant changes wlich have taken place in re- cent months, the assessment of India's creditworthiness does not,have to be altered. The service of this additional amount is within Indiats capa- city, even if the total amount imposed a liability for repayment in dollars. Justification of the Project 35. The expansion of iron and steel production is fundamental to the eco- nomic development of India. The Five Year Plan has given the very highest priority to plans for increasing agricultural production, but it would be impossible to implement these without iron for foundries which Droduce agri- cultural implements and without steel for large irrigation and flood control works. Hydro_electric rork<s, which will provide the rower, without which much of the industrialization planned for the future would be difficult to achieve, are in many cases linked in multi-purpose projects with irrigation works. In addition, much needed extension of railroads, roads, and housing programs will be impossible without increased supplies of steel. 36. India is rich in the rawv materials needed for steel making. Labor is plentiful and comparatively cheap. In relation to sources of supply, the plants of IISCO and SCOB are well situated. They are in the center of large metallurgical coal fields, at no great distance from supplies of iron ore and limestone, and close to supplies of water from the Damodar River. The Project includes plans for increasing production of ore at the Companyts- own mines to meet the whole of its estimated future requirements; for obtain- ing an adequate reserve of electric powver from the Damodar Valley Corporation; and for increasing open hearth capacity to make possible the use of mill scrap, 37. The current demand in India for both iron and steel is in excess of current domestic supplies. India's total production of steel in 1952 is ex- pected to be about 1 million tons. In addition, it is expected that 300,000 tons of finished steel will be imported. Demand has been estimated by the Government at about 2 million tons in 1952. The plans for expansion, which include the IISCO Project, would raise total production of finished steel in India to about 1.7 million tons by 1958. 38. Part of India's requirements of steel has been met by irmports. Indials Imports of Steel 19h9 1950 1951 Quantity (Tons) 140,000 220,000 177,000 Cost (U.S. $ Equivalent in Millions) 18.4 23.3. 33.2  - 8 - The need to conserve foreign exchange, and the world shortage of supplies has probably kept down the level of imports during these years but, even if world supplies become more plentiful, Indials potentialities as a low cost producer provide adequate economic justification for increasing domestic capacity. The present landed cost of imported steel is substantially above the price of domestic steel retained by the producer. During a period of heavy capital investment both by private industry and by the Government, the importance of increasing low cost capacity is clearly great. Thus, a- part from other advantages the savings in foreign exchange are likely to be considerable. The report attached as Appendix 4 shows in detail the expected effect of the increase in IISCO's output on its earnings. 39. I am satisfied that the Project A,a -whdle is well conceived, and is of high priority in the development of India's economy. Prospects of Fulfillment of Obligations 40. The expected earnings of the Company should make it possible to retire the loan by 1967 and leave the Company in a greatly strengthened financial condition. The present economic and financial position of India and the sound fiscal policies of the Government indicate that foreign ex- change will be available as required for servicing the Bank loan. PART IV - COMPIIANCE WITH ARTICLES OF AGREMENT 41. I am satisfied that the proposed loan complies with the requirements of the Articles of Agreement of the Bank. PART V - RECOMMENDATIONS 42. I recommend that the Bank grant to the Indian Iron and Steel Company, Ltd., a loan of $31,5OO,OOO, or the equivalent in other currencies, for a term of 15 years, guaranteed by India, at such rates of interest and on such other terms as are specified in the draft Loan Agreement attached. Eugene R. Black President Washington,-D. C. December ,1952