India - Fertilizer Industry Project

C;R- -5q98-ISP CIRCULATING COPY TO BE RETURNED TO REPORTS DESK PILE coJP DOCEN 'TERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1723-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR A FERTILIZER INDUSTRY PROJECT December 2, 1975 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 It may not be published, quoted or cited without Bank Group authorization.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 (as at November 15, 1975) Rs 1.00 - Paise 100 US$1.00 Rs 8.89 Rs 1.00 US$0.1125 Rs 1 million - US$112,500 (Prior to September 24, 1975, the Rupee was officially valued at a fixed Pound Sterling rate. Since then, it has been fixed relative to a "basket" of currencies. As these currencies are now floating, the U.S. Dollar/Rupee exchange rate is subject to change. Conversions in the appraisal report were made at US$1 to Rs 7.8, which was the short-term average at the time of appraisal.) FISCAL YEAR April 1 - March 31  INTERINATIONAL DUVLLO.'ML::? A;.'CIAAiC, REPORT AND RECOf.rDN;DATION OF THE PESIi: s'; TO THE EXECUTIVE DIRECTORS Oii A PROPOS;ED CREDIT TO TIIE GOVEPN'MENT OF INDIA FOP A FERTILIZER INDUSTRY PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Government of India (GOI) in an amount equiva- lent to US$105 million on standard IDA terms to help finance increased fertilizer production from existing plants in India. PART I - THE ECONOMY 2. An economic report, "Economic Situation and1 Prospects of India' (691a-It' dated May 1, 1975), was distributed to the Lxecutive Directors on May 20, 1975. Country data sheets are attached as Annex I. 3. India is exceptional among the Bank Group's member countries for its size and diversity. While India's economic policies and performance have their shortcomings, the sheer magnitude of the task facing the Gov- ernment must be recognized; the country is divided into more than 20 states with a population of some 600 million and over 60 languages. The country's poverty and inadequate domestic savings, together with a net transfer of external resources averaging in recent years only about US$1 per head per annum, have imposed sharp limitations on the rate of growth. Account must be taken, also, of the uncertainties imposed by the erratic availability of water. A bad monsoon, which is inevitable from time to time, has a pervasive influence over the entire economy and wipes out the results of years of efforts. Thus, the annual growth of national income has averaged a modest 4% during the past 25 years, but only about 1% during the last four years (1971/72-1974/75), which have included two consecutive monsoon failures -- i.e., an actual decline in per capita terms. 4. Since independence, progress has been impressive on many fronts, bhut disappointing on others, and has all too often fallen short of Incia'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 cost and has yielded results of variable quality. Mtany inidustrial and agricultural 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 and structural change have been rapid and compare favorably with developments in many other parts of the world, but in 6ther regions there has been star.- nation and possibly even decline. Despite these improvements and although the distribution of income in India is relatively even by comparison with moost developing countries, there has been little impact upon the living  standards of the vast masses of the urban anid rura_ population. The Covern- ment has become increasin,lv concerned about the plight of the lower income strata, which - conservati vely measured - consist of some 200 million people with incomes of less than LIS$60 per head per year, and has initiated in recent years a variety of programs specifically designed to alleviate poverty. 5. The structure oa the econo;my has been slow to change. Agriculture remains the dominant sectcr, accounting 'or some 45% 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 composition 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. 6. Despite the slow pace of change and despite the undeniable magni- tude of the problems confronting her, India has the potential in a number of important fields to mount a development effort which has a reasonable chance of success in the longer run. In agriculture, as discussed in the economic report of May 1975, the particular opportunities of substantial promise for improving the food situation over the next decade are: a. Rejuvenation of the Green Revolution in wheat which has taken place in recent years in the Northwest and to a lesser extent in Bihar and West Bengal, but which has been losing momentum since about 1970. This is the result of deficiencies which can be corrected -- most importantly seed deteriora- tion and lagging irrigation development. b. Better use of the vast potentials that have been created by surface irrigation through more expedi- tious project completion and complementary land and on-farm improvements to ensure better manage- ment and higher productivity of water. c. Acceleration of groundwater development, especially in the Eastern regions, which are figuratively de- scribed as "floating on water,'" where the untapped potential is large and where consequently there are large opportunities for multiple cropping, better water management and greater crop security. d. Promotion of increased production of monsoon rice, based on improved varieties which as yet have had only modest success but which are expected, on  - 3 - the basis of current researchi, to open the way Lo mTch greater productivity over India's vast rain-fed rice producing areas during the next few years. e. Pursuit of the promising, although somewhat less definite, potential for greater productivity in drvland cultivation and for extensive introduction of higher-yielding varieties of coarse grains. Because of the difficulties likely to be encountered in the effective devel- opment of these potentials, their realization is likely to follow uneven time patterns, probably coming in bursts of expanded production as in the case of the Green Revolution. And, along with administrative concentration and effectiveness, they.will all require provision of the supplies and services, especially fertilizer and power for irrigation, which are essential comple- ments of the necessary technical and environmental changes. 7. Greater agricultural success would also make an important contribu- tion to India's perenially difficult balance of payments situation, which is frequently aggravated by the need for large food imports. From the balance of payments viewpoint, another essential ingredient for a resumption of modest growth is sustained export volume growth at considerably higher rates than have been achieved historically. In view of the composition of Indian exports, the momentum for such growth would have to be provided primarily by the rapid expansion of industrial exports which, in addition to easing the foreign exchange constraint, would act as an important stimulant to industrial growth -- notably absent since the mid-sixties. In the field of energy, too, there is considerable potential in the development of recently discovered oil resources and in the continued expansion of coal production. 8. It is hard, however, to conceive of the timely and effective exploitation of these various potentials unless administrative capabili- ties, which are overtaxed and diffused in an attempt to guide and control most economic activities, are focused on these areas. The requirement for industrial export stimulation would appear to be more generous and expedi- tious incentives, sufficiently attractive and reliable to induce domestic producers to venture into the competitive pressures of world markets. Finally, realization of India's potential will undoubtedly also require a considerable infusion of external assistance, both to ease the payments constraints and to supplement the limited domestic resources available for development. 9. While there is thus potentiai for resuming the ilnterrupted process of growth, there remains the formidable obstacle of the short-run difficulties facing India. Last year began with deficient winter rains and a poor spring harvest, with one of the worst Governmient wheat procurement experiences on record, with a prospective balance of payments deficit of US$2.5 billion or twice as much as in the preceding year, with inflation running at an annual  rate of 30% and a fiscal situ aci,Ln s eirig ly out of harnd. a .d wiLh :e, energy and material shortages and litclu prosTact. for al eviatirn i i I Jn ;,u r imports within the severe constra:ints of th.e balance o( payments. E :as hardly surprising in this situaton that adiustrtent to irr-redlate siificult,-cs was the prime economic preoccupaLion. Growuth hz.d necessarily to ta"'c a secolid place to short-run exigencies in the emphasis or economic policy in this first year of the Fifth Five--Year Plan period. 10. Monetary expansion, which bad been ranning at a rate of 15, in 1973/74, was reduced through tight credit restrictions. Tne burden of these restrictions was borne largely by private and Government commercial activities, without a significant reduction in the rate of increase in net bank financing of the Government Budget. To this curtailment of credit to the commercial sector, there was added thie deflationary influence arising from a massive trade deficit; as a result, the rate of monetary expansion in 1974/75 was reduced to about 6%, or less than half that of the previous year. This, in combination with some improvements in physical supply, relieved the upward pressure on prices, and there was even a small price reduction in the second half of the fiscal year. With continuing tight monetary policies, prospects are for price stability this year. 11. The food problem was probably the single most threatening element on the economic scene last year. A poor harvest and low procurement in the spring was only the start of agricultural adversities. Next was failure of the mid-year monsoon in many key agricultural areas and a monsoon (kharif) crop which fell below that of 1973 by about 5 million tons. The result was a severe shortage of domestic foodgrains for the public distribution system, with availabilities only about half of an austere level of requirements. A real food crisis was averted, however, by imports of more than 6 million tons of foodgrains during the year ending in March 1975; this was almost twice as much as the imports of 1973/74. With these imporrs and with relative en.pha- sis on food distribution in the cities rather than the countryside, where supply conditions were presumed to be not quite so unmanageable, the threat- ening food situation was weathered, although not without hunger and priva- tion for a great many of the rural poor who were unable to afford much of what food was available. 12. The oil situation was managed, although at double the cost for a marginally lower import level, by curbs on consumption and by substitution. Motor spirits were heavily taxed to reduce consumption by about 20%; factories and power plants were converted from fuel oil to coal w1herever possible and supplies of fuel oil were reduced by more than 15%; coal production, after years of stagnation, was increased by about 13%, and, after a poor start, transport managed to keep up with the additional coal in spite of serious labor troubles on the railways. There was also some improvemenL ill the operation of the deficient power system tihrough special efforts to raise the low capacity utilization of thermal plarts and by a more systematic allo- cation of available power, with special priority for requiresients of a,ri- cultural irrigation and fertilizer production. Power shortage has remiainod, nevertheless, a severe constraint on the economies of many regions. Among  other critical shortages, the supply situation eased in the course of Ehe year, especially for fertilizer, steel and non-ferrous metals. The fer- tilizer situation was brought into better balance by a combination of substantial imports and some lag in demand attributable largely to poor weather and sharply increased prices. Steel and other metal supplies also improved during the year, with some increase in domestic production in the case of steel and also because of price resistance and uncertainty in a sluggish industrial situation. 13. Last year's balance of payments turned out to be manageable in spite of a 47% jump in the import bill. Economies in import volume helped. More importantly, there was also an increase of 28% in the value of exports. The main payments support, however, was an increase of about US$1 billion in external financing, made up of large drawings on the International Mone- tary Fund including the Fund's Oil Facility, larger aid from the India Consortium including the World Bank Group, oil purchases on credit, a million tons of wheat on loan from the USSR, and additional food aid from several other countries. With all this, in 1974/75 India had to draw on its gross reserves (US$1,416 million as of March 31, 1974) by only about US$50 million, but external debt service requirements in the medium term were increased, as were obligations to the IMF. 14. This year (1975/76) the economic situation, though still very difficult, has started much more favorably than last year. With an excellent spring (rabi) crop, and a favorable summer monsoon, foodgrain production is confidently predicted to achieve a record of over 110 million tons. Inflation continues to be tightly curbed, and the wholesale price index for July 1975 was actually 2.1% lower than a year earlier. With good rains and greatly increased coal production, the power situation has improved, and the Govern- ment's expectation is of 20% growth in power generation over the year. However, although the performance of several public industries has improved consider- ably, demand, particularly for consumer goods, continues to stagnate, and the Government's target of 5-6% growth is unlikely to be achieved. Industrial growth of 3-4% now appears much more likely. 15. Exports in terms of rupees rose by 15% in the first six months of 1975/76 over the corresponding period of 1974/75. This rise reflects both the effects of exchange depreciation and significant volume increases. Despite a continued good export performance, the trade deficit is likely to be as much as US$1.8 billion, compared with about US$1.7 billion last year, and hardly any trade deficit at all in 1972/73, which was before India's terms of trade worsened. Adding to the 1975/76 trade deficit another US$800 million of payments on external obligations, and taking account also of probable net invisible receipts, this year's overall balance of payments deficit seems likely to come to about US$2.4 billion, or about the same level as last year. These enormous deficits persist in any reasonable calculation of minimum import requirements of fuel, food, fertilizer and other essentials, for which further compression seems hardly feasible, especially with the expected pick-up of the economy.  16. Fortunately, nearly half of this year's prospective deficit (about US$1,155 million) can be covered from gross disbursements of previously committed foreign aid, including just over a billion dollars of Consortium aid about evenly divided between bilateral and World Bank Group sources. Eastern Europe is expected to provide perhaps US$100 mil- lion, which is down considerably from last year in the absence of further food assistance from the USSR. India has already drawn US$240 million from this year's Oil Facility, and can reasonably expect about US$570 mil- lion from disbursements out of Consortium pledges made in June. This leaves US$600 million to be financed from other sources, including an inevitable drawdown of foreign exchange reserves, which stood at US$1,392 million at August 31, 1975. 17. To highlight the crucial variables in India's longer-term pay- ments outlook, the May 1975 economic report contains some projections, for the 10 years following 1975/76, illustrating India's debt management prob- lem. Broadly speaking, the conclusion which emerges is that a modest in- crease in India's import capability - an average of 5.2% per annum after allowing for inflation - could he achieved, provided: (a) new aid commit- ments in real terms (including IMF facilities and the aid provided by oil producers) remain approximately at 1974/75 levels, (b) India's exports attain an average volume growth of about 8% between 1976/77 and 1985/86, and (c) the bulk of new aid continues to be provided on concessional terms. Given the above assumptions, the debt service ratio (expressed as a percentage of export earnings) would rise from about 19% in 1974/75 to 23% in 1979/80 and then decline slowly. India's external public debt out- standing and disbursed on tarch 31, 1974, stood at US$10.2 billion. 18. A considerably improved export performance, which will require policy measures to improve incentives, is crucial to a successful develop- ment effort. To the degree that exports fall short of the 8% growth target, India would not be able to increase her borrowing to meet a larger balance of payments deficit; the result would be slower growth throughout the eco- nomy. Against this background, it is encouraging that the Government is showing an increased determination to exploit India's export potential. Many measures have been announced that will make exports both more profit- able and easier to produce. For example, priority is being given to ex- porters' need for scarce raw materials; exporters will be protected against rises in the price of steel that occur after the signing of contracts; pro- duction for export beyond authorized capacity will be permitted automati- cally; cash assistance rates will be increased to take fixed costs into account; and import replenishment licenses will be liberalized. PART II - BANK GROVP OPERATIONS IN INDIA 19. Since 1949, the Bank Group has made 44 loans and 75 development credits to India totaling US$1,436 million and US$3,635 million (both net of cancellation), respectively. Of these amounts, US$715 million has been  repaid, and US$1,559 million was still und-sbursed as of October 3i, 29;. Annex II contains a summary statement of d.sbursements as of October 3, 1975, and notes on the execution of ongoing projects. 20. Since 1957, IFC has made 14 commitments in India totaling US$,'.; million, of which US$9.6 million has been repaid, US$7.6 million sold a2',1 US$6.9 million cancelled. Of the balance of US$27.7 million, US$21.2 mil- lion represents loans and US$6.5 million equity. A summary statement of 1FC operations as of October 31, 1975, 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