India - IFFCO Fertilizer Project

FILE COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1544-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED-LOAN TO THE INDIAN FARMERS FERTILISER COOPERATIVE LIMITED December 20, 1974 L This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization.-The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1.00 = Rs 7.5 Rs 1.00 = US$0.13 Rs 1 million = US$133,000 The Rupee is officially valued at a fixed Pound Sterling rate. As the Pound is now floating relative to the US Dollar, the US Dollar/Rupee exchange rate is subject to change. Conversions in the appraisal report and in this report have been made at US$1 = Rs 7.50 which was the rate prevailing at the time of appraisal. On December 18, 1974, the exchange rate was US$1 = Rs 8.13. FISCAL YEAR April 1 - March 31  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INDIAN FARMERS FERTILISER COOPERATIVE LIMITED 1. I submit the following report and recommendation on a proposed loan in an amount equivalent to US$109 million to the Indian Farmers Ferti- liser Cooperative Limited (IFFCO), with the guarantee of the Government of India, to help finance the construction of a fertilizer plant. Amortization would be over 16 years, including five years' grace, at an interest rate of 8% per annum. A guarantee fee of 2-1/4% per annum would be paid to the Government, in order to make the effective interest rate to IFFCO consistent with the Governmentes lending rate to industrial enterprises. PART I - THE ECONOMY 2. An economic report, "Economic Situation and Prospects of India" (402-IN, dated May 7, 1974) was distributed to the Executive Directors on May 20, 1974. A country data sheet is attached as Annex I. 3. India is exceptional among the Bank Group's member countries for its size, diversity, and the extreme difficulty of its economic conditions. India's economic policies and performance have their shortcomings, many of which are attributable to the open political system, where the reconciliation of conflicting political views tends to favor less than optimal economic solutions; others are due to the sheer magnitude of the task facing the Govern- ment. Governing a country divided into more than 20 states with a population of some 580 million and over 60 languages is an extraordinary responsibility. The country's poverty and poor natural resource endowment, supplemented by a net transfer of external resources averaging in recent years well below US$1 per head per annum, have imposed sharp limitations on the rate of growth. Any judgment of India's economic performance must take these underlying cir- cumstances into account. So, also, must account be taken of the uncertainties imposed by the uncertain availability of water. A bad monsoon, which is in- evitable from time to time, has a pervasive influence over the entire economy and wipes out the results of years of effort. 4. In the past 25 years, national income has grown at nearly 4% per annum, which compares very favorably with the average annual growth rate of less than 1% during the preceding 50 years. Population has also grown faster in the past two decades than previously, but per capita income has neverthe- less risen from a more or less stagnant level in the first half of this century to achieve an average growth of roughly 1% a year since independence. 5. Progress has been impressive on many fronts but disappointing on others and has all too often fallen short of India's massive needs. The growth of the socio-economic infrastructure (transport, education, health services, etc.) has been spectacular, but has often been achieved at high  - 2 - cost and has yielded results of variable quality. Many industrial, and agri- cultural investment schemes have been highly successful, but others have taken excessively long to be completed and have operated well below full capacity. In some regions of the country growth ancd structural change have been rapid and compare favorably witlh developments in many other parts of the world, but in other regions there has been stagnation an(d possibly even decline. Despite these improvements and although the distribution of income in India is relatively even by comparison with many other countries, there has b2en little impact upon the living standards of the vast masses of the urban and rural population. The Government has become increasingly concerned about the plight of the lower income strata which, conservatively measured, consist of some 200 million people with incomes of less than IJS$360 per head per year, and has initiated in recent years a varietv of programs specifically designed to alleviate poverty. 6. In broad terms, the structure of the economy has been slow to change. Agriculture remains the dominant sector, accounting for some 43% of national product in the early 1970s compared with around 49% twenty years previously. The share of output contributed by the industrial sector has increased only slowly and since the late 1960s has remained approximately constant at a level of 23%. There has, however, been a shift in the com- position of industrial production, with consumer, intermediate, and capital goods now contributing about one-third each compared with an overwhelming preponderance of consumer goods production 25 years ago. 7. The economic report contained a review of the immense difficulties confronting the Indian economy as the Fourth Plan period drew to a close. The final year of the Plan, 1973/74, witnessed a severe deterioration in India's terms of trade which was led by, but by no means restricted to, the dramatic increase in oil prices. The resulting balance of payments difficul- ties were compounded by the need for food imports following the drought of 1972/73, in order to sustain the public distribution system on which the poorest section of society is particularly dependent. Given India's perva- sively agricultural economy, the drought also had the effect of causing a general slow-down in economic activity which was further aggravated by infrastructure constraints, particularly widespread power shortages and labor problems of Indian Railways. Food shortages and other scarcities touched off an unprecedented inflationary spiral fueled by large budgetary deficits which were at least partly attributable to mounting expenditures for drought relief. The inflation in turn contributed to labor unrest while efforts to cope with it through budgetary cuts affected, among other things, the level of real expenditures for development programs. 8. Thus, at the commencement of the Fifth Plan period (1974/75-1978/79) the most urgent tasks facing policy makers were: to get agricultural pro- duction moving again; to bring inflation under control; to reduce India's dependence on oil imports by compressing energy consumption and by formulating and implementing programs to develop domestic energy sources; to boost export earnings and to tap additional sources of aid in order to sustain imports;  and, finally, to maintain a miriii'um investment program so as to avobi economic standstill in the longer run. Lven in the best of times, it would hiave been extremely difficult to pursue simultaneously suchl a variety of potentially inconsistent objectives. 9. Events since the preparation of the last economic report provide little encouragement. For the second time in the last three years, the weatlher has let down India's farmers with the result that the khariff (fall) crop recently harvested is believed to be considerably below last year's (about 60 million tons as compared with 67 million tons). The outlool for the next rabi (spring) crop is uncertain in view of continuing shortages of power for irrigation pumps and possible fertilizer shortages. The reduced avail- ability of foodgrains, the depletion of official food stocks, India's balance of payments difficulties, the inflationary setting and frequent changes in the Government's food procurement policy lhave led to hoarding for both speculative and insurance purposes. Procurement for public distribution has become extremely difficult. The public kitchens established in some of the worst-affected areas (Bihar, Bengal, Orissa) bear evidence of the serious- ness of the situation as well as of the Government's determination to prevent extreme hardship. 10. The spectre of massive food import requirements hangs over an already very difficult balance of payments situation in the current year. The need for six to seven million tons of foodgrains imports appears evident, and considerably more than half this amount either lhas been delivered already or has been purchased. There is little evidence of a major break in the prices of other commodities imported in substantial quantities by India (e.g. oil, fertilizers, steel, non-ferrous metals, rock phiosphate). 11. One of the few bright spots in the balance of payments picture has been the growth of export earnings. In 1973/74 export earnings recorded an unprecedented increase of about 30, and there are indications of a similar increase in the current year. While these increases - particularly that in 1973/74 - are primarily attributable to unit value increases caused by worldwide inflation, there is greater willingness to take advantage of export opportunities, as illustrated most dramatically by the recent diversion of sugar from domestic consumption to exports. 12. Nevertheless, despite the increase in export earnings, India is expected to run a massive trade deficit this year - probably of the order of US$1,600 million as compared with US$795 million in 1973/74 and a negli- gible one the previous year. ttoreover, despite the magnitude of the current deficit, it is unlikely that India's imports, excluding foodgrains, will be as large in volume as in 1972/73. In addition to financing a tracle deficit of this order, India will have to meet debt service payments of about USS730 million. These financing requirements will be partly offset through Consortium assistance and USSR aid, whichi are together expected to reach disbursement levels of about US$1,550 million in 1974/75 compared with about IS$J1,270 mil- lion in 1973/74. The deferred payment arrangements for part of her oil. require- ments that India is understood to have reached with Iran and Iraq will also  - 4 - provide welcome relief. Nevertheless, these various sources of financing hardly measure up to India's current requirements. India will have to draw on flct foreign exchange reserves, which, at about US$1,300 million, are c,i;:rently equivalent to less tnan tlhree months of imports. India has also drawn US$375 million on the 1SIF in the current year. The Government also intends to Inake use of the IN'F oil facility, and a drawing on this facility of aboult .TSS240 million hlas been recently approved for use in calendar year 1974. 13. Onh the domestic front, the Government's present efforts are con- eentrated primarily on maximizing production in key sectors through a system of priorities in the allocation of scarce resources and through careful ;ioi.itoring of developments and nerformance. In agriculture this entails uovisi on of power on a priority basis for minor irrigntior and fertilizer rrfiduction and allocation. of adequate foreign exchange for as much fertilizer as can be iimportedl from the limited world supplies. Similarly, efforts are ;-,ade to identify production bottlenecks in such sectors as fertilizer pro- duction, coal mining and power generation; and special arrangements exist for -neating expedit:ousl1 the foreign e:chiange requirements of these sectors for such item:s as captive power units where appropriate, spares and replace- ment parts. The railways are also tied into this system and accordl priority to the movement of goods required by these sectors. In the fertilizer, coal and power sectors, senior officials are provided on a continuing basis with detailed production figures along with explanations for production shortfalls. Attempts are also being made to rationalize the administrative machinery of the Government in tihese sectors, as evidenced by the October 1974 decision to bring irrigation under the wing of the Food and Agriculture 'Ministry and to reg.roup power generation and coal mining under an Energy M4inistry. 14. In the short term, however, there are limits to the extent to which India's dependence on oil imports can be reduced and production of domestic sources of energy can be stepped up. Insofar as the compression of demand for oil products is concerned, these limits are determined, on the one hand, bv the relatively small proportion of oil products used for private con- sumption (possibly one-sixth) and, on the othier hand, by the limited avail- ability of donmestic substitutes (i.e. coal and power). The 13 million tons of crude oil plus 3 million tonls of product imports planned for the current year probably represent the lower lirmit beyond which these imports can be curbed without serious repercussions on domestic production. Had consumption been allowed to grow in line with recent trends, the present level of crude and product imports taken togetlher wqould probably be of the order of at least 18 million tons. 15. A major effort is being made to use existing capacity as fully as possible throughout the economy. To this end, despite the serious balance of payments problem described above, the Government is pursuing a relatively liberal policy toward imports of raw materials required by industry. Never- theless, it is hard to get away from the current infrastructure constraints and particularly the shortage and unreliability of power supplies which, though somewhat eased, continue to affect production. Fiscal and monietary  policies, including the cutback in budgetary expenditures and limitations on bank credit, are also restraining industrial output; and there is some evidence that, due to rapidly rising food prices and the consequent erosion of real purchasing power, the demand for some consumer items and industrial projects is being affected. Given the various constraints, there is likely to be little or no industrial growth in the current year which, in combination with the current agricultural situation, makes it unlikely that there will be any GNP growth either. In regard to inflation, the Government has made impressive efforts to curb budgetary expenditures and to tap additional sources of revenue. However, not surprisingly, in view of continuing food shortages and other scarcities, inflation has not abated. The wholesale price index, which in 1973/74 had recorded an increase of 29% over the pre- vious year, has risen by a further 14"% during the first five months of this fiscal year. 16. In present circumstances the Draft Fifth Plan, published in late 1973, has not been finalized. In real terms investment in the current Annual Plan is about 30% below the annual level implicit in the Draft Fifth Plan, and even this is unlikely to be reached. To adjust to reduced resource availability a number of investments are being postponed. Expenditures on some of the social sectors such as education and family planning are un- fortunately also affected. The focus once again is primarily on investments in key sectors such as fertilizer, coal, power, and steel, and quite rightly within these sectors the emphasis is on completing ongoing investments before committing resources to new schemes. 17. It is clear that to overcome her present difficulties and to resume the interrupted process of economic development, India will require substan- tially larger capital inflows than foreseen by the authors of the Draft Fifth Plan. It is equally clear that as large as possible a proportion of these requirements should be provided on concessional terms. However, even on very optimistic assumptions regarding India's success in narrowing her resource gap and the response of both Consortium and other donors, a gap will remain between external financing requirements and the availability of concessional aid. 18. India's external public debt outstanding on March 31, 1973, stood at US$9.9 billion. As a consequence of world-wide inflation and its effects on India's export earnings, service payments of about US$730 million due on this debt in 1974/75 are expected to be equivalent to about 17% of merchan- dise exports as compared with about 26% in 1972/73. However, substantial additional debt will have to be incurred as a result of increases in the prices of India's imports. In the future, therefore, the debt service ratio is likely to rise, given the magnitude of India's requirements and the un- avoidability of having to finance part of these on non-concessional terms.  - 6 - PART II - BANK GROUP OPERATIONS IN INDIA 19. Since 1949, the Bank Group has made 42 loans and 66 development credits to India totaling US$1,229 million and US$2,963 million (both net of cancellation), respectively. Of these amounts, US$655 million has been repaid and US$1,112 million was still undisbursed as of October 31, 1974. Annex II contains a summary statement of disbursements as of October 31, 1974, and notes on the execution of ongoing projects. 20. Since 1957, IFC has made 13 commitments in India totaling US$42.3 million, of which US$7.6 million has been repaid, US$7.6 million sold and US$6.3 million cancelled. Of the balance of US$20.8 million, US$13.7 million represents loans and US$7.1 million equity. A summary statement of IFC operations as of October 31, 1974 is also included in Annex II (page 2). 21. In recent years, the emphasis of Bank Group lending has been on agriculture. The Bank Group has been particularly active in supporting minor irrigation and other on-farm investments through agricultural credit operations. M4ajor irrigation, marketing, and seed development are other agricultural activities supported by the Bank Group. In recognition of the importance of adequate fertilizer supplies for agricultural output, the Bank Group has been active in financing the expansion of fertilizer production. Apart from investments in fertilizer plants, the Bank Group has lent support to the industrial sector through its sizeable assistance to development finance institutions, in a wide range of geographically scattered medium- and small-scale enterprises. IDA financing of industrial raw materials and components for selected priority sectors has been instrumental in facilitating better capacity utilization in these sectors. The Bank Group has also been active in supporting infrastructure development for power, telecommunications, and railways. Family planning, education, water supply development, and related urban investments have also received Bank Group support in recent years. 22. The direction of assistance under the Bank/IDA program has been consistent with India's needs and the Government's priorities. The emphasis of the program on agriculture, industry, power, and transport remains highly relevant. The priority of the agricultural sector has been further enhanced in the present world commodity situation. Thus, projects designed to foster agricultural production through the provision of essential inputs such as credit for on-farm investments, command area development of existing irrigation schemes, fertilizer and seeds form an important aspect of the Bank Group's program for the next few years. Special emphasis will be given to projects designed to increase the productivity of small farmers and landless laborers. Lending in support of infrastructure and industrial investments will focus on energy-related projects. Repeater credits for power and railways have high priority in this context, and discussions are under way with the Govern- ment in an effort to identify and prepare projects specifically designed to facilitate coal production and coal transport. Lending for fertilizer  - 7 - projects, which has been an important feature in recent years, is expected to continue to occupy a prominent place in the future program. 23. The need for a substantial net transfer of external resources in support of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. The need for readily usable foreign exchange assistance is especially pressing at a time when output and investment have to be adjusted to a radically different price situation. Consequently, Bank Group lending for critical industrial raw materials and components continues to be an essential element within the overall program of assistance. As in the past, Bank Group assistance for projects in India should include, as appropriate, the financing of local expenditures. India imports relatively few capital goods because of the capacity of the domestic capital goods industry. The import component of projects tends to be especially low in such high-priority areas as agricul- ture, education, and family planning. For the Bank Group to be able to make an appropriate contribution to the financing of projects in these sectors, it is important to cover a proportion of local expenditures. 24. As mentioned in the foregoing discussion of the Indian economy, as much as possible of India's external capital requirements snould be provided on concessionary terms. Accordingly, the bulk of the Bank Group's assistance to India has been, and should continue to be, provided from IDA. However, the amount of IDA funds that can reasonably be allocated to India remains small in relation to India's need for external assistance, and some Bank lending to India is appropriate. Since disbursements on existing Bank loans are projected to decline while repayments increase, a commitment level of about US$100 million a year would maintain the Bank's exposure in India roughly constant at US$500 - 550 million. 25. Of the external assistance received by India, the proportion con- tributed by the Bank Group has grown significantly. In 1969/70 the Bank Group accounted for 34% of total commiitinents, 13% of gross disbursements, and 12% of net disbursements, as compared with an estimated 35%, 27% and 37%, respectively, in 1973/74, and the contribution of the Bank Group is expected to continue growing. Whereas on March 31, 1973, the Bank Group share of lndia's outstanding external public debt was 21%, by 1979 it is projected to account for about 25%. Because Bank Group assistance to India is pre- dominantly in the form of IDA credits, debt service to the Bank Group will rise slowly. In 1973/74 about 12% of India's total debt service payments were to the Bank Group.  PART III - THE FERTILIZER SECTOR 26. Increased fertilizer production is an essential elemlent in India's program to increase agricultural production. Approximately 24, of total development expenditure by the public sector has been devoteci to agriculture in recent years, with priority being given to accelerating the spread of modern technology through increasing the availability of inpuits such as improved seeds, irrigation, credit and fertilizers. The output of foodgrains, particularly the higph-yieldin g varieties of wheat and rice, is largely a function of the fertilizer application rate. It is estimated that, under present average conditions in India. the application of one ntutrient ton of fertilizer yields an incremental production of five to seven tons of grain. T17hus, shortfalls in the supply of fertilizer, whether imported or produced domestically, have consequences of the utmost gravity for essential food supplies. 27. Consumption of fertilizers in India has been increasing at an average annual rate of about 17% since 1953/54, when it was at a level of 113,000 nutrient tons, but it still remains very low relative to usage in other countries. In 1973/74 it reached a level of 2.8 million tons, of which 66% was nitrogen, 22% phosphate, and 12, potash. IMore than 40% of this total was imported. The level of imports, and therefore the increase in consumption, would have been higher were it not for the scarcity of fertilizer on the world market and the extremely high prices prevailing. 28. Currently, India has an installed capacity of about 2.5 million nutrient tons of nitrogenous and phosphiatic fertilizers, which is inadequate to meet even the depressed level of consumption. The gap between domestic production and consumption is about one million tons wider because of limited utilization of capacity in the fertilizer industry. Domestic production of fertilizer has grown at an average annual rate of 16% over the past two decades, reaching 1.45 million tons in 1973/74, or slightly more than half of consump- tion. Projections through the end of the decade show a continuing deficit, even assuming optimistic start-up schedules for new projects and relatively high capacity utilization for all plants. 29. Only about 67% of India's installed nitrogenous fertilizer capacity was used in 1973/74, largely for reasons outside the control of the industry itself. The largest single cause of low capacity utilization was power shortages and fluctuations. It is estimated that power problems and shortage of raw materials resulted in the loss of about 112,000 tons of nitrogen production in 1973/74. This is about 8% of installed capacity and is worth about US$60 million at present import prices. In addition, design deficiencies and aging equipment result in the fact that the effective capacity in several plants is less than the rated capacity. Projects under construction suffer from delays in commissioning, particularly because of procurement and start- up dlifficulties, shortages of cement and steel, and delays in the supply of equipment. The Government has undertaken a concerted effort to overcome these problems and bottlenecks. US$17 million was allocated for a Plant Operations  Improvement Program in Credit 481-IN of June 19, 1974; these funds are being used to meet the foreign exchange costs of equipment, materials, and consulting services for individual plant optimization programs. 30Q The present intention is to create an installed capacity of about 4.9 million tons of nitrogen and 1.2 million tons of phosphate by 1978/79. These targets are reasonable, although they are probably the maximum which can be accomplished, given the constraints imposed by financial resources and implementation capability. There are 28 projects under construction or at an advanced stage of planning with a total capacity of 3.6 million tons. When these are completed, about 60% of installed capacity will be in the public sector and the balance in the private and cooperative sectors. 31. With the exception of three new projects which are coal-based, all of India's existing and planned fertilizer plants are based on petroleum products, including naphtha and fuel oil, or domestic natural gas. In the long rua, coal may well become the preferred feedstock for production of nitrogenous fertilizers in India, given her sizeable coal deposits and the impact that recent increases in petroleum prices has had on the economics of fertilizer production. Expansion of fertilizer capacity in the near future, however, is expected to be based on heavy fuel oil, because of const- straints on coal production, more immediate economic utilization of additional coal output as a substitute for petroleum products in power generation and other industrial uses, and the desirability of taking advantage of anticipated progress in the technology of coal-based ammonia synthesis. At current prices, about US$30-35 is needed to pay for the fuel oil for each ton of urea, which currently costs about US$250-350 to import and is expected to cost about US$175 in 1978. Thus, for the next two or three years India should pursue the rapid implementation of projects based on petroleum feedstocks which are already at an advanced stage of preparation. 32. The Bank Group has been actively supporting the fertilizer industry in India for some time. IDA has made five credits, for the Fertiliser and Chemicals, Travancore Ltd. (FACT) plant in Cochin and for the Gorakhpur, Nangal, Trombay and Sindri Units of the Fertilizer Corporation of India (FCI). These projects have all aimed at a balanced expansion of capacity while at the same time removing bottlenecks to the efficient utilization of existing capacity. Work on the FCI plants is proceeding satisfactorily. The Cochin II project, which was approved in July 1971, was envisaged as a follow-up to Cochin I, a major ammonia/urea complex financed by a bilateral credit, which was expected to commence operations in mid-1971. However, labor and procure- ment difficulties and problems in the implementation of Cochin I have led to delays in Cochin II, which is now almost two years behind schedule. Procurement for Cochin II has, however, now been virtually completed and substantial disbursements made. IFC has participated in two private sector fertilizer projects: Indian Explosives Ltd. and Zuari Agro-Chemicals Ltd., both of which are now in operation.  - 10 - PART IV - THE PROJECT 33. Tne proposed project was appraised in March/April 1974. The appraisal report (No. 591-Ia dated December 9, 1974) is being distributed separately to the Executive Directors. Negotiations were held in Washington in October 1974. The Government of India was represented by Messrs. K. balachandran and S. Venkataraman of the Ministry of Petroleum and Chemicals, K. S. Bawa of the Department of Cooperatives, and V. N. Raiagopalan of the Mdnistry of Finance; IFFCO was represented by J. Mehta (Chairman), Paul Pothen (Managing Director), and B. B. Singh (Finance Director). Attached as Annex rIL is a loan and project summary. 34, The proposed loan would help finance the construction of a plant in Phulpur, Uttar Pradesh, to produce 900 metric tons per day (TPD) of ammonia aItu 11950n TPD of urea. The project, which is expected to start commercial proc uctiol in September 1978, would add about 230,000 tons per year (TPY) of n.:Ltrogen to India's fertilizer capacity. It would include all necessary off-sites such as railroad sidings, oil and coal storage and handling, ash disposal, water ard effluent treatment, product storage and shipping, mainte- nance shops, offices and personnel facilities. About 170 of the 200 hectares of land needed for the project is being provided by the Uttar Pradesh Govern- ment, and 40 hectares of contiguous land is being provided by a public trust. Final action necessary for the purchase of the land is expected to be com- pleted shortly. Possession by IFFCO of the necessary land is a condition of effectiveness. 35. The Phulpur project would be implemented by IFFCO, a cooperative society established in 1967 and jointly owned by the Government of India and some 24,000 cooperative institutions representing about 20 million farmers. Its authorized capital is Rs 1,000 million and its paid-up capital 285 million. Although about two-thirds of the shares are held by the Government, IFFCO's by-laws provide for the eventual transfer of the Government shares to the cooperatives. Shareholders who contribute Rs 100,000 or more have the right to a seat on IFFCO's Representative General Body, the general shareholder's group, and every 200 societies with smaller shareholdings can jointly elect one representative. During the first ten years of IFFCO's existence, the Government appoints the Board of Directors and the principal officers; thereafter, the principal officers and five members of the Board will be selected by the Representative General Body, and the rest by various coop- erative and financing institutions. An Executive Committee has been esta- blished with adequate authority to decide matters affecting the day-to-day operations of the society. 36. The idea of the Indian cooperative movement engaging in the large- scale manufacture of fertilizers was suggested in 1964 by the Cooperative League of the USA. IFFCO is about to complete the construction of its first two plants - one at Kalol, in Gujarat, with a final product capacity of 392,000 TPY of urea and the other at Kandla, also in Gujarat, with a capacity of 376,000 TPY of complex fertilizers. Foreign exchange financing was  - 11 - provided by the US, the UK, and the Netherlands. The successful implementa- tion of these two projects indicates that IFFCO's management and technical expertise are satisfactory. Ammonia production at Kalol began in November 1974 and the urea plant is expected to go on stream by the end of December, but Kandla's start-up has been delayed by a shortage of imported phosphoric acid. 37. In view of the difficulty in mobilizing capital from a large number of cooperative institutions, financing of the two projects was highly leveraged and IFFCO's debt/equity ratio will be about 70/30 at the end of 1974. In order to improve the financial structure of the society, the Government has agreed to subordinate IFFCO's present debt and to provide about 27% of the project financing as equity or subordinated debt (Section 2.02 of Guarantee Agreement). This would bring the effective debt/equity ratio for IFFCO and its Phulpur Unit to the more satisfactory level of 60/40. The Government has also agreed that principal and interest payments on the subordinated debt will be permitted only if IFFCO's current ratio remains at least 1.5:1; furthermore, IFFCO has agreed to maintain a current ratio for itself after December 31, 1976, and for the Phulpur Unit after completion of the project of at least 1.5:1, to maintain a debt service coverage of at least 1.4 and not to undertake additional investments in fixed assets in excess of US$3 million a year without prior Bank approval (Section 3.05 of Guarantee Agreement and Section 5.05 of Loan Agreement). 38. The principal inputs to be used in the Phulpur Unit would be heavy fuel-oil for feedstock (up to 250,000 TPY), coal for steam and power genera- tion (about 400,000 TPY), and power (about 15 MVA, of which about 80% will be provided from the Unit's own generating plant). In view of the increasingly tight supply conditions for these raw materials and utilities, IFFCO has agreed to conclude long-term agreements for their supply prior to December 31, 1975 (Section 3.07 of Loan Agreement). Water is available from the area's ample groundwater resources. The Government has also provided assurances that sufficient railway tank cars (about 40 per day) and wagons (about 100 per day) will be available for transporting fuel oil, coal, and fertilizer (Section 3.06 (b) of Guarantee Agreement). 39. The project would be implemented with the assistance of several engineering firms -- two foreign firms having the necessary experience in ammonia and urea manufacture based on fuel-oil feedstock and one or more Indian firms for design and engineering of offsites. The project would be coordinated and managed by a Project Implementation Unit, according to an implementation plan and schedule which have been found satisfactory. The anticipated starting date for project construction is February 1, 1975, when all necessary engineering contracts and financial arrangements are expected to have been completed. All technology and equipment for the project will be of proven design and construction -- including a fuel-oil based ammonia unit closely resembling that of the IDA-financed Nangal project and the proposed Sindri project -- which should help to ensure efficient plant operation. 40. The project provides for adequate equipment to control its potentially harmful emissions. IFFCO has agreed to comply with environmental quality standards satisfactory to the Bank (Section 3.08 of Loan Agreement). Sulphur  - 12 - from the heavy oil feedstock will be recovered as elemental sulphur and sold, and carbon from the partial oxidation process will be continuously collected and used to produce steam. Water contaminated with methanol and other compounds will be sent to an effluent treatment unit prior to disposal. 41. The project is estimated to cost US$220.5 million (including US$26.3 million in interest during construction and US$42.1 million in physi- cal and price contingencies), of which US$107.3 million is foreign exchange. A breakdown of the estimated capital cost is included in Annex III. In addi- tion to the proposed Bank loan, which would cover 49% of the cost, financing would be provided by equity contributions from cooperative institutions and State Governments (US$29.2 million) and from the Government (US$59.0 million, including US$11.0 million in "quasi-equity" in the form of subordinated debt) and a long-term loan from the Industrial Development Bank of India and other financial institutions (US$23.3 million). The capital cost estimate is based on projected December 1974 prices. Physical contingencies have been estimated at 10%; price escalation rates have been taken at 11% during 1975 and 7.5% annually thereafter for all equipment and foreign exchange costs and 10% and 8%, respectively, for civil works and other local currency costs. 42. The proposed loan would be disbursed against the cost, including price escalation, of imported equipment, materials and spare parts (US$50.4 million), the ex-factory cost of equipment and spares expected to be won by Indian suppliers through international competitive bidding (US$16.9 million), and the foreign exchange costs of license fees and design engineering (US$11.4 million), project management, erection and supervision (US$5.2 million), and interest during construction (US$16.6 million). US$8.5 million would be unallocated to meet physical contingencies on the above items. Indian suppliers competing under international competitive bidding would be granted a 15% preference or the current rate of import duty, whichever is less. It is estimated about 15% of equipment contracts are likely to be won by Indian bidders; in that case, the loan would involve local currency financing of about US$11 million. 43. All goods and services financed by the loan would be procured according to Bank guidelines. Equipment and materials would be procured by international competitive bidding except that, subject to prior approval of the Bank, proprietary equipment essential to the process and items in limited supply which are critical for the timely completion of the project (estimated to have a total value of about US$8 million) may be procured by bidding from short lists of qualified suppliers, and small items costing US$50,000 or less (estimated to have a total value of about US$2 million) may be purchased from manufacturers and local representatives of foreign suppliers, on the basis of suitability, availability and price considerations following approval by the Bank of the list of items involved. Neither the local costs nor the foreign exchange component of about US$38 million worth of equipment and civil works to be procured without international competitive bidding would be financed under the proposed loan.  - 13 - 44. IFFOO's properties at Kalol and Kandla have been mortgaged to five lenders in India. Under arrangements agreed with the Government and IFFCO, all these liens will be vacated by June 30, 1975 (Section 3.07 of Guarantee Agreement). The Bank has agreed that IFFCO may replace the mortgages so vacated by a lien in favor of the Government. The other lenders, who will vacate the existing mortgages, will be given Government guarantees for their loans to IFFCO. IFFCO may also create certain liens in favor of the Govern- ment on the properties related to the Phulpur Unit. Arrangements will be made to ensure that the Bank will receive a proportional share of any amounts recoverable under these liens until its loan is fully repaid. No other liens can be created except with the approval of the Bank (Section 5.04 of Loan Agreement). 45. The Indian cooperative movement participates actively in the distribution of fertilizer and other inputs. IFFCO has pioneered in the promotion of balanced fertilizer application and proper farming practices. Since the two States which have the largest proportion in IFFCO's cooperative shareholdings, the Punjab and Uttar Pradesh, are also the largest potential consumers of fertilizers, IFFCO's marketing strategy will be largely directed toward these two States. Supply and demand projections for nitrogenous fer- tilizers in IFFCO's marketing area show a continuing deficit through 1983/84. Thus, IFFCO should have no difficulty in marketing its output. 46. Urea and other nitrogenous fertilizer prices are statutorily con- trolled by the Government. The retail price of urea, which had been kept within rather narrow bounds since the mid-1960s, has almost doubled within the past twelve months. Although an important part of this increase is used to reduce the Government's losses in subsidizing fertilizer imports, the average ex-factory price has also increased by about 46%. This has served to offset the increased cost of urea production resulting from the rise in prices of petroleum feedstock and equipment. 47. It is assumed that in the future input costs and ex-factory urea prices will continue to increase at the same rate as each other. The O'A'- factory price of urea at the Phulpur Unit has been projected to increase from its present level of Rs 1,100 to Rs 1,450 per ton by 1978, and would then be approximately in line with anticipated long-range international prices for urea. The retail price to farmers, which consists of both the ex-factory price and an element of price equalization between domestic production and subsidized imports, is not expected to rise above its present level. Assuming an ex-factory urea price of Rs 1,450 per ton and a fuel oil price of US$75 per ton delivered at factory, the financial rate of return is estimated at 13.9% before taxes and 10.3% after taxes. This relatively low return is attributable to the relatively high capital costs and long construction time -- due in turn to tight equipment supplies and high prices and to the need for infrastructure at the project site -- and to the high income tax rate (55%). The financial return remains adequate  - 14 - even under moderately adverse circumstances, including a one-year delay in cor.struction, a 10% increase in operating costs or a 10% cost overrun. The Govern-ien.t has provided assurances that its pricing policies will continue to vcrmit a reascnable return on invested capital (Section 3.04 of Guarantee Atgreement). 48. The project's economic rate of return is 16%, based on the pro- jected 1978 world price of urea. With a one-year delay in construction and a 10% cost overrun, sensitivity analysis shows the return would drop to 1.3%. still a satisfactory level. The gross direct annual foreign exchange savilng would be about US$59 million, or about 55% of the foreign exchange capital cost of the project. The project's output would help increase India's foodgrain production by over one million tons annually, and the Phulpur Unit %%ould provide direct employment to about 600 people (2,000 during the con- tr!ction pnase) . As a cooperative organization, IFFCO is very conscious ox 'L:. social, role and will assist the local community and cooperatives in Mirany ways, maInly through training in industrial skills, marketing and ad farming methods. PARE V - INSTRUMENTS AND AUTHORITY 49. The draft Loan Agreement between the Bank and IFFCO, the draft Guarantee Agreement between India and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of the Resolution approving the proposed loan are being dis- tributed to tihe Executive Directors separately. 50. Features of the Loan Agreement and the Guarantee Agreement of special interest are referred to in paragraphs 37, 38, 44 and 47 of this Report. In addition to these special features: (a) dissolution or disesta- blishment of the Phulpur Unit have been added as events of suspension and default (Sections 6.01 and 6.02 of the Loan Agreement); and (b) possession by IFFCO of approximately 200 hectares of land suitable for construction and operation of the project is an additional condition of effectiveness of the Loan (Section 7.01 of Loan Agreement). 51. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 52. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments December 20, 1974  ANNEX I DATA - NA Page 1 3.,I5783 ka M7 TMII. (mid-1973) DENSITy Prho rbeln 350 P.k.f ..IW SOCIAL DIDCAI0RS India -7.IciPhrIjj 8esl -to Ktoic;t uW MR CAPITA US$ (ATLAS BSInS) .- 110 /a 90 Ia 220AI 2,60D A Crue brth rate (per thousand1 36; /b 30/c 34 /6 Itd 16.2 Crude death rate (per thousand) li 7; i6 ft 9Ljd,4 12 le 11.a Infant mortality rate (par thoueand live births) 139 7-e 12-110807 .17:.5a Life expectancy at birth (peers) 41 71 5o 4 8 5Si 72 Oroon reproduction rateL2 . 2.9 3.? 3.3 1.3 population growth rate tj2.3 2.3A. 2.0A/ 3.0/6h 0.5 /th Population growth rate - urban 3 /gA.i 4 Zr 5 7- 4 7; 0.5 Age structure (per cent) 15-61 41 42 45: h3 23.6 65 and over 3 3 2I 4 13.4) Denendancy retic Ak 1.0 1.2 /tdl 1. I 1.3 In 0.9/. Urbanyopulation snperentof total l8A/ 20/A 17 /4 32 / 78 atauty planning, tH. of mecuptoro cuulamtive (thous.) 1 0o0, 7; .- 175 409 mu. of users (% of earnied winen) '. .. IMu Tahor force (thonemand) 1i9,Xii. A. 221,000 LS, 6. 0,100 Ic 13,200 /4 25,600 percentage employed In agriculture 73 71 63 - S3i/t 3 Percentage uneuployed ...2 7 ~ 36 Wi~~atT5U~~aaInomoece