India - Eleventh Industrial Credit and Investment Corporation Project

FILE COPy DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1589-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE. INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LIMITED WITH THE GUARANTEE OF INDIA March 20, 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 It may not be published, quoted or cited without Bank Group authorization.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 of February 28, 1975) US$1.00 = Rs. 7.81 Rs. 1.00 US$0.128 Rs. 1 million = US$128,086 (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 were made at US$1 to Rs. 7.279, which is the central rate reported to the International Monetary Fund.) 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 INDUSTRIAL CREDIT AND INVEST- MENT CORPORATION OF INDIA LIMITED WITH THE GUARANTEE OF INDIA 1. I submit the following report and recommendation on a proposed loan to the Industrial Credit and Investment Corporation of India Limited (ICICI) with the guarantee of India for the equivalent of US$100 million to help finance ICICI's operations through June 1977. The terms of the loan would be an interest rate of 8-1/2% per annum and repayment according to the amortization schedule of sub-projects up to a maximum of 18 years, including 3 years of grace. PART I - TIIE 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 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 con- flicting political views tends to inhibit optimal economic solutions; others are due to the sheer magnitude of the task facing the Government. 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 under- lying circumstances into account. So, also, must account be taken 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 effort. 4. In the past 25 years, national income has grown at nearly 4 per- cent per annum, which compares very favorably with the average annual growth rate of less than 1 percent during the preceding 50 years. Population has also grown faster in the past two decades than previously, but per capita income has nevertheless risen from a more or less stagnant level in the first half of this century to achieve an average growth of roughly 1 percent 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  -2- services, etc.) has been spectacular, but has often been achieved at high 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 and structural change have been rapid and compare favorably with developments in many other parts of the world, but in other regions there has been stagnation and 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 been 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 US$60 per head per year, and has initiated in recent years a variety of programs specifically designed to alleviate poverty. 6. The structure of the economy has been slow to change. Agriculture remains the dominant sector, accounting for some 43 percent of national pro- duct in the early 1970s compared with around 49 percent twenty years pre- viously. The share of output contributed by the industrial sector has in- creased only slowly and since the late 1960s has remained approximately constant at a level of 23 percent. 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. ?. The economic report of May 1974 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 deterio- ration 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 difficulties 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 pervasively agricultural economy, the drought also had the effect of causing a general slow-down in economic activity which was further aggravated by in- frastructure 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;  - 3 - and, finally, to maintain a minimum investment program so as to avoid economic standstill in the longer run. Even in the best of times, it would have been extremely difficult to pursue simultaneously such 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 weather has let down India's farmers with the result that the kharif (fall) crop harvested towards the end of 1974 is believed to be considerably below the previous year's (about 60 million tons as compared with 67 million tons). The outlook for the present rabi (spring) crop is quite encouraging despite continuing shortages of power for irrigation pumps and fertilizer shortages. However, the reduced availability of foodgrains and the depletion of official food stocks during the course of 1974, the inflationary setting and frequent changes in the Government's food procurement policy have led to hoarding for both speculative and insurance purposes, thus making procurement for distrib- ution through Government shops extremely difficult. 10. The balance of payments situation is likely to remain difficult in the current year as there will be a continued need for foodgrain imports, hopefully at a somewhat lower level than the 6-7 million tons required last year, and because 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, rock phosphate). One of the few bright spots in the balance of payments picture has been the growth of export earnings. Export earnings recorded an unprecedented increase of 22% in 1973/74 and are expected to rise again by 29% in 1974/75. 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. 11. Nevertheless, despite the increase in export earnings, India is expected to run a massive trade deficit in 1974/75 - probably of the order of US$1,800 million as compared with US$560 million in 1973/74 and a negli- gible one the previous year. Moreover, 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 trade deficit of this order, India will have to meet debt service payments of about US$730 million. These financing requirements will be partly offset through Con- sortium assistance and Non-Consortium aid (including assistance from oil producing countries), which are together expected to reach disbursement levels of about US$1,750 million in 1974/75 compared with about US$1,175 million in 1973/74. Nevertheless, these various sources of financing fall short of India's current requirements. India will have to draw on her foreign exchange reserves, which, at about US$1,400 million, are currently equivalent to less than three months of imports. During Fiscal Year 1974/75, India has drawn down her First Credit Tranche in the IMF for $282 million, as well as her Gold Tranche for $91 million. The Government has also taken advantage of the Oil Facility, from which $240 million was drawn in October.  - 4 - 12. On the domestic front, the Government's present efforts are con- centrated primarily on maximizing production in key sectors through a system of priorities in the allocation of scarce resources and through careful monitoring of developments and performance. In agriculture this entails provision of power on a priority basis for minor irrigation and fertilizer production and allocation of adequate foreign exchange for as much fertilizer as can be imported from the limited world supplies. Similarly, efforts are being made to identify production bottlenecks in such sectors as fertilizer production, coal mining and power generation; and special arrangements exist for meeting expeditiously the foreign exchange requirements of these sectors for such items as captive power units where appropriate, spares and replace- ment parts. The railways are also tied into this system and accord 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 these sectors, as evidenced by the October 1974 decision to bring irrigation under the wing of the Food and Agriculture Ministry and to regroup power generation and coal mining under an Energy Ministry. 13. The recent discovery of new oil reserves offshore in the Bombay High structure has considerably improved prospects for domestic oil production, which presently accounts for about 7 to 8 million tons or one third of India's consumption. It is still too early to give a firm estimate of the overall level of extractable reserves concentrated there, but it is possible that in the early 1980s output from this field could double the present domestic production. So, even after allowing for some increase in demand, it is pos- sible that Bombay High production could reduce India's future oil import needs considerably. However, the feasibility of the program to extract Bombay High oil will depend upon the availability of expertise, finance and equipment, and while the Government of India may be able to overcome the first two constraints, the international scarcity of offshore oil extraction equipment may delay exploitation. 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, by the relatively small proportion of oil products used for private con- sumption (possibly one-sixth) and, on the other hand, by the limited avail- ability of domestic substitutes (i.e. coal and power). The 13 million tons of crude oil plus 3 million tons of product imports planned for 1974/75 probably represent the lower limit beyond which these imports cannot 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 together would probably be of the order of at least 18 million tons.  - 5 - 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 monetary 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 products is being affected. Given the various constraints, there was little industrial growth during 1974 which, in combination with the current agri- cultural situation, makes it unlikely that there will have been 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. In spite of continuing food shortages and other scarcities, these actions appear now to have achieved some results as the rate of inflation had declined from an annual rate of 30%, which was being experienced in mid 1974, to 23% by the end of November 1974. 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. In the long run, given her groundwater, coal, hydroelectric, iron ore, non-ferrous metals and human resources, India undoubtedly has the capability to overcome her present difficulties. It is, however, clear that to overcome them and to resume the interrupted process of economic develop- ment, India will require substantially 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 con- cessional 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  - 6 - 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. PART II - BANK GROUP OPERATIONS IN INDIA 19. Since 1949, the Bank Group has made 43 loans and 67 development credits to India totalling US$1,338 million and US$3,050 million (both net of cancellation), respectively. Of these amounts, US$674 million has been repaid, and US$1,273 million was still undisbursed as of January 31. 1975. Annex II contains a summary statement of disbursements as of January 31, 1975, and notes on the execution of ongoing projects. 20. Since 1957, IFC has made 14 commitments in India totalling US$51.8 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$30.3 million, US$23.3 mil- lion represents loans and US$7.1 million equity. A summary statement of IFC operations as of January 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 in supporting minor irrigation and other on farm investments through agricultural credit operations. Major irrigation, marketing, and seed development are other agricultural aptivities 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 in- dustrial sector through its sizeable assistance to development finance institutions, in particular ICICI. IDA financing of industrial raw materials and components for selected priority sectors has been instrumental in facl- itating better capacity utilization in these sectors. The Bank Group has also been active in supporting infrastructure development for power, tele- communications 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 inputq such as credit for on-farm investments, command area development of existing irriga- tion schemes, fertilizer and seeds form an important aspect of the Bank Group's program for the next 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 rail- ways have high priority in this context, and discussions are under way with the Government in an effort to identify and prepare projects specifically designed to facilitate coal production and coal transport. Lending for fertilizer 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 should 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. In recent years the Bank has been lending to India at the rate of some $50 million a year with the result that the amount of outstanding and disbursed loans to India has been stabilized at something less than $600 million ($565 million as of January 31, 1975, as comfpared to the peak figure of $613 million reached in 1970). As mentioned in paragraph 18 above, India's debt service ratio has recently dropped con- siderably, as a consequence of inflation, from about 26 percent in 1972/73 to 17 percent in 1974/75; on the other hand, this ratio is expected to rise in the future as India begins to service the increased level of debt which it has recently been undertaking. In these circumstances, and in view of the special requirements of India as one of the countries most seriously affected by recent commodity developments, I believe it is appropriate, and within a reasonable judgment of India's creditworthiness, to increase the rate of Bank lending to India this year, although I think our longer-term policy toward lending to India should be held in abeyance pending further appraisal of India's rapidly evolving situation. The present loan, together with the $109 million loan to IFFCO approved on January 7, 1975, would raise total lending to India in the present fiscal year to $209 million. Assuming no Bank lending to India in future years in excess of the $50 million level, this would raise India's outstanding and disbursed debt to the Bank to a peak of between $600 and $650 million in 1981.  - 8 - 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 percent of total commitments, 13 percent of gross disburse- ments, and 12 percent of net disbursements as compared with an estimated 35 percent, 27 percent and 37 percent, 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 India's outstanding external public debt was 21 percent, by 1979 it is projected to account for about 25 percent. Because Bank Group assistance to India is predominantly in the form of IDA credits, debt service to the Bank Group will rise slowly. In 1973/74 about 12 percent of India's total debt service payments were to the Bank Group. PART III - INDUSTRY 26. Over the past two decades the Government of India (GOI) followed a policy of vigorous import substitution which gave rise to quite a rapid growth of industrial output of about 9% per annum during the late 1950's and the first half of the 1960's. As a consequence by the middle 1960's India had developed an industrial structure capable of producing a wide diversity of goods, including highly sophisticated items. However, since 1966 the record of industrial growth has been disappointing, having aver- aged less than 4% in the seven years through.1972. More recently, the record has been even more disappointing with a growth in output of less than 1% in 1973 and the expectation that there was little, if any, more in 1974. 27. The reason for the poor record of recent years is complex, but undoubtedly important factors have been the overall stagnation of the eco- nomy, the inadequacy of vital inputs, and the economic and social environ- ment. The drought induced periods of stagnation over 1965-67 and over the past three years have had such a severe impact on the economy that the average rate of growth for the economy from 1965/66 to 1972/73 has been just under 2.5%. This stagnation set in just after the potential for import substitution had been largely exploited, thus there was no other internal stimulus to industrial activity. Exports could, of course, have provided some stimulus but until very recently export development has been given inadequate attention. 28. The inadequacy of vital inputs arises from the acute shortage of foreign exchange for imported raw materials and the variability in the out- put of domestic agricultural raw materials upon which about 40% of industrial activity is dependent. In addition, over the past two years industry has been plagued by chronic shortages of power and has had to contend with often inadequate rail and road facilities. Finally, the many social and political objectives which in addition to the prevailing shortages have led the Govern- ment to rely on a system of controls for the industrial sector that easily comes into conflict with the need to exploit more fully India's growth poten- tial and comparative advantage.  - 9 - 29. There are three main elements of industrial policy administration, industrial licensing, price controls, and import licensing. In February 1973, the Government made an announcement which re-confirmed the areas for private and public sector activity and clarified the criteria for expansion by large industrial houses and investment by foreign corporations. The Government also said that a single secretariat would be set up to stream- line administrative procedures for the granting of industrial licenses. This announcement was well received by the private sector at the time, and since then there is a clear consensus that administrative arrangements have improved under the new Secretariat for Industrial Approvals. Steps have also been taken to remove price controls which had had a deleterious effect upon a number of industries. By the end of 1974, the prices of a wide range of industrial raw materials and manufactured goods had been decontrolled. Measures have also been taken to simplify import licensing and to improve the administration of the export incentive schemes. 30. The changes in the administration of industrial policy have induced a much more favorable climate for investment. Indeed, despite the depressed state of the economy, there are indications that industrial investment in 1974 and intentions for 1975 will at least maintain the 1973 level of activity. However, the distribution of this investment is likely to show a shift towards the high priority sectors of electrical equipment, agricultural machinery, fertilizer, transportation and machine tools. Fur- ther, evidence of sustained investment interest is the rising demand for assistance from the principal financial institutions, including ICICI. 31. Underutilization of capacity is prevalent in the industrial sector and the reasons are complex and vary from industry to industry and, indeed, from firm to firm. In general, the domestic supply and demand situation as well as the shortage of imported raw materials have been important factors. The improvement of utilization has been given priority by the Government and aid donors are also helping by providing foreign exchange in non-project form. Notwithstanding the need to increase output from existing plants, there is also a need to promote the restructuring of industry to make it competitive and responsive to the high priority requirements of the economy. For this purpose new investment is required to modernize and balance existing plants, to expand capacity where there are constraints, and to develop export-oriented industries. Industrial Financing 32. The industrial sector is served by a number of financial institu- tions. The Industrial Development Bank of India (IDBI), the Industrial Finance Corporation of India (IFCI), and ICICI, the beneficiary of the proposed loan, operate on a large scale throughout India. At state level, there are State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). The national institutions are primarily engaged in term lending. Their assistance has been directed mainly to medium and large scale enter- prises, primarily in the private and joint sectors.  - 10 - 33. IDBI is the most important source of institutional industrial finance. It provides funds both directly to industrial enterprises and in- directly through refinancing SFCs and commercLal banks. Its activities include granting loans, rediscounting commercial bills, providing export financing and underwriting and guarantee operations. In January 1973, IDA extended a credit of US$25 million to IDBI in order to meet the foreign ex- change cost of SFC-financed projects and thereby to assist the small scale sector. Utilization of this credit had a slow start, but commitments for sub-projects are now gaining momentum (US$4.7 million as of February 28, 1975) and disbursements have begun. 34. IFCI, which is owned by IDBI and other financial institutions, also provides Rupee and, to some extent, foreign currency loans. Its emphasis lies on financing cooperatives, particularly in the traditional sub-sectors such as sugar and cotton. Commercial banks, the Life Insurance Corporation of India (LIC), and the Unit Trust of India (UTI) also provide long-term industrial finance. The latter two primarily underwrite new issues and invest in industrial shares and debentures. The Industrial Reconstruction Corporation of India (IRCI), originally established for the State of West Bengal, is expanding beyond the State borders and pro- vides both, managerial and financial assistance to "sick" enterprises. The National Small Industries Corporation (NSIC) has specialized on hire- purchase financing for small scale industries. 35. For industrial financing at the State level, the SFCs' role has considerably increased over the last years. Total loans sanctioned by the SFCs have increased sharply, reaching Rs 1,057 million in 1973/74 (38% in- crease over 1972/73). The bulk of SFC assistance has been to the small- scale sector. For the medium and large scale industries, the SIDCs are more important and generally account for nearly 10% of all institutional industrial financing. The SIDCs also engage in promotional activites. PART IV - THE PROJECT 36. The Bank has been closely associated with ICICI since its founda- tion in 1955. The proposed loan would be the Bank's eleventh to ICICI and would bring the total amount of lending by the Bank to ICICI to US$426 mil- lion (net of cancellations). It would help finance ICICI's projected for- eign exchange requirements through June 1977. 37. The project was appraised in July/August 1974. A loan and proj- ect summary is given in Annex III. A report entitled "India - Appraisal of the Industrial Credit and Investment Corporation of India Limited", dated March 14, 1975, Report - No. 637a-IN, is being circulated separately to the Executive Directors. Negotiations were held in Washington from February 20 to 26, 1975. The Borrower was represented by Mr. S.S. Mehta, Managing Director, and Mr. S. Kumarasundaram, General Manager. The GOI as guarantor has reviewed and approved the proposed legal documents.  Role, Ownership and Resources 38. ICICI's role is to promote large and medium scale enterprises in India, primarily in the non-traditional sectors of industry. It is the principal source of foreign exchange for industrial projects in the private sector. Ownership of ICICI is dominated by public sector corporations in- cluding the Life Insurance Corporation of India, the Unit Trust of India, and a number of commercial banks, which were nationalized in 1969. Of ICICI's paid in share capital, which stood at Rs 150 million as of January 31, 1975, public institutions hold 71% of ICICI's capital. Foreign share- holders, mainly banks, hold 18%. The balance of 11% is held by private Indian investors. 39. The Bank has been ICICI's most important source of funds. Up to the end of December 1974, the Bank had provided 46% of ICICI's total outstanding resources and 83% of its foreign currency resources. Other sources of foreign funds have been USAID, Kreditanstalt fur Wiederaufbau (KfW), the Overseas Development Administration (ODA) of the United Kingdom and, in 1973, a Bond issue in Switzerland. ICICI has raised its rupee funds through Government and IDBI borrowings, through share issues, internal cash generation and more recently through a successful series of debentures. In the future, ICICI plans to supplement the traditional local currency sources by larger and more frequent debenture issues. In 1976 ICICI plans to increase its share capital by an additional Rs 50 million. For foreign currency, ICICI is keen to diversify its sources, a policy that the Bank bas encouraged and entirely supports. Starting in 1975, ICICI expects to be able to raise new foreign exchange resources in the Middle East in the order of US$15-25 million at a reasonable cost. It is also exploring the possibility of raising funds from the US Exim Bank. Management and Board 40. ICICI is well-managed and operates effectively. Mr. H. T. Parekh and Mr. S. S. Mehta continue to be Chairman and Managing Director respec- tively. In April 1974, Dr. Medhora was appointed Joint Managing Director and became a member of ICICI's Board of Directors. The Board now consists of 16 directors, of whom five are private industrialists, three are from public financial institutions, three represent foreign shareholders, two represent the Government of India, and the remaining three are officers of ICICI (Chairman, Managing Director, Joint Managing Director). Though ICICI maintains close contact with GOI on industrial policy matters, it nonethe- less retains its operational autonomy. Operating Policies and Procedures 41. ICICI's policy is to promote primarily large and medium scale enterprises within the framework of the industrial policy set by the Govern- ment. A major objective is to assist enterprises using newer technologies, and in this ICICI has been successful. In addition, ICICI underwrites share issues, particularly for new industrial enterprises, which would not otherwise have been able to approach the capital market.  - 12 - 42. At the Bank's suggestion, ICICI has prepared a statement outlining its development strategies and financing priorities over the next few years (see Annex 32 of the Appraisal Report). In line with GOI policies, emphasis is being put on the development of high priority industries such as: coal, power and transport; agricultural inputs and food processing; capital goods industries for industrial expansion; mass consumption goods, which need to be available in adequate quantity; and balancing and modernization programs. The statement highlights in particular the priority of export-oriented in- dustries and supporting activities and points out that ICICI-assisted projects undergo systematic examination of their international competitiveness. In order to obtain a deeper understanding of the basic problems facing exporters and, at the same time, to indicate the contribution of ICICI clients to India's exports and to analyze what ICICI itself has done and can do to promote export activities, ICICI has undertaken to prepare a detailed study of the problems and prospects for manufactured exports on the basis of a sample survey of its clients. The results of this study would also be of interest to the Bank, as they could form an appropriate platform to comment sensibly on Indiats programs and progress in this vital area. 43. ICICI's investigations into projects continue to be thorough and sound. Technical, financial, management and market aspects are well covered. Evaluation of the projects' economic contribution is adequate. ICICI was among the first development finance companies associated with the Bank Group to include an assessment of the economic rate of return in its appraisals. Follow-up procedures and project supervision are satisfactory. 44. ICICI's lending rates were increased in August 1974, against the background of rising interest rates in India. The rate for Rupee Loans is now 10-1/4% per annum, in line with IDBI's rate increase. Foreign cur- rency rates rose to 10-1/2% per annum for ordinary loans and to 9-1/2% per annum for concessionary loans to industries in backward areas. A commit- ment fee of 1% per annum is levied on undisbursed loan amounts. The for- eign exchange risk is passed on to the sub-borrowers, as previously. ICICI's lending rates are in accord with the general interest rate structure in India. In view of the Bank's recently increased lending rate, ICICI will review its own lending rate for foreign currency loans by September 30, 1975. 45. ICICI generally requires that its clients procure equipment on the best terms. It insists on competitive quotations from three or more manufacturers or suppliers of international standing. Bids are carefully evaluated. Disbursement procedures are satisfactory. ICICI intends to open its own letters of credit in order to provide faster service to its clients. Past Operations 46. The sectoral distribution of operations continues to be wide. Modern non-traditional industries remain prominent, such as chemicals and petro-chemicals, followed by metals and metal products as well as machine manufacture. ICICI-assisted projects account for substantial portions of  - 13 - country's manufacturing capacity in some leading industries like syn- thetic rubber and electrical machinery. They have contributed significantly to employment creation and have generated satisfactory net benefits to the economy. 47. Operations tend to be geographically concentrated in the estab- lished industrial centers of the Western States. In line with GOI objec- tives, ICICI has continued to put increasing emphasis on lending to backward areas. Loan and investment approvals for backward areas accounted for 45% of total approvals in the first half of 1974, compared to 17% since ICICI's inception. This impressive result has been aided by ICICI's recent emphasis on project promotion, particularly in backward areas. In addition, ICICI established a new department in 1973 to develop and promote new project ideas. It also plans to expand the role of its Regional Offices. 48. Over the past years, ICICI's operations have continued to expand. Total approvals, however, increased in 1974 by only 6% (representing a decline in real terms) to Rs 627.2 million, compared with Rs 592.7 million in 1973 and Rs 523.5 million in 1972. Commitments, which had sharply in- creased in 1973 to Rs. 629 million from Rs. 362 million in the previous year because of a large backlog of foreign currency loans approved, declined to Rs. 505 million in 1974, mainly because of foreign resource constraints, which forced ICICI to slow down foreign currency commitments. Disbursements went up by 16% in 1974 to Rs. 484 million, compared with Rs. 416 million in 1973 and Rs. 375 million in 1972. Portfolio and Financial Results 49. The repayment performance of ICICI's borrowers has remained good. On June 30, 1974, the total principal outstanding from loans affected by arrears was Rs. 109.7 million or 6.8% of the total loan portfolio. Prin- cipal in arrears was only 1.7% of the outstanding loan portfolio. The in- vestment portfolio has also shown satisfactory results. 50. During 1974, ICICI's net income rose by 7% to Rs 26.6 million, though the return on equity investments declined slightly from 10.7% to 10.1% on account of a reduction in income from equity investments. The 1974 increase in lending rates, scheduled for review again by September- 1975, will permit ICICI to retain its earnings record at an adequate level. ICICI's liquidity position is somewhat tight but remains adequate and is expected to improve again in 1976. Its debt service coverage ratio, at 1.2 times during 1974, has been satisfactory. Total reserves and provisions stood at.Rs 146.4 million on Demceber 31, 1974 or 7% of the loan and invest- ment portfolio, which is adequate. 51. In recent years, fluctuations in foreign exchange rates have been affecting ICICI's ability to plan its future operations within the debt/ equity ratio of 9:1 set out under the three previous loan agreements. ICICI fully understands the need&to raise additional equity and intends to do so in regular intervals as its business expands. However, the Indian stock  - 14 - market has been severely depressed by the Government's ceiling on dividend payments introduced in July 1974 as part of GOI's policy to curb inflation. ICICI's shares have been adversely affected along with the rest of the marker, thus making it uncertain at this point in time that ICICI could go to the market on reasonable terms in early 1976, when ICICI had originally planned to raise additional equity. In the course of reviewing ICIC's debt/equity ratio, it was concluded that it would be reasonable for ICICI to treat as short-term debt all portions of long-term debt maturing within twelve months, so that current portions of long-term debt would be excluded from the calculation of the debt/equity ratio. The effect of applying this redefini- tion is that ICICI's debt/equity ratio as at December 31, 1974 would be 8:1. Projected Operations and Resources 52. Despite the poor overall performance of the industrial sector in 1973, the prospects for certain segments of the sector have shown promise, particularly over the long-term. Specifically the capital goods indus- tries, in which ICICI is particularly active, recorded a growth of 13.7% in the first nine months of 1973 and, for the most part, enjoyed satis- factory levels of capacity utilization. Moreover, GOI has shown a keen interest in improving the situation through recent actions (as stated in paras 30-33 above) and investor interest has continued to grow, as meas- ured by the issuance of letters of intent and industrial and import li- censes, particularly in those industries where ICICI is active. Thus, ICICI can expect a continued growth in loan applications. 53. ICICI's uncommitted foreign currency resources at December 31, 1974 were US$15 million. Of the previous Bank loans to ICICI not fully disbursed, the Ninth Loan (Ln. 789 of October 1971) is fully, and the Tenth Loan (Ln. 902 of June 1973) is more than three quarters committed, both ahead of schedule. ICICI expects to exhaust its foreign exchange resources by July 1975, when the proposed loan would become effective. For the two year period starting July 1, 1975, ICICI expects to commit total foreign currency loans of US$143 million, of which about US$40 million would be financed from expected KfW and UK lines of credit and Middle East borrow- ings. Thus, ICICI's foreign resource gap for the two years from approxi- mately the time the proposed loan would become effective is about $100 million. A Bank loan for this amount would meet about 70% of ICICI's requirement over this period. ICICI's Developmental Impact 54. A Special Study was undertaken in 1973 jointly by the Bank and ICICI to measure ICICI's developmental impact. ICICI itself prepared economic rate of return analyses on an ex post basis for 42 of its projects. These formed the core of the Study. The results showed that as many as 32 of these projects had economic returns exceeding 12% and 20 projects had economic returns of more than 20%. Only 10 projects had low or marginal economic returns (12% or less). Since then, ICICI has continued to calcu- late such returns for proposed projects where ICICI assistance is greater  - 15 - than Rs 5 million, or where total project cost is greater than Rs 25 mil- lion. The results of these calculations have generally been similar to those of the Special Study. On the basis of an analysis of 39 projects (ex ante), none of the projects had economic returns of less than 8%, while 18 had economic returns in excess of 20%. 55. Thus, the results reinforced ICICI's long-standing reputation of high quality project assistance. Further, they have shown the inter- national competitiveness of ICICI-financed projects and their potential for export. In a selected group of industries, in which ICICI is active, its clients accounted for almost 18% of India's total exports. ICICI's other contributions have included the training of many development banking staff from both India and abroad, client assistance in the formulation of foreign technical and financial collaboration agreements, advice on appro- priate product mixes, as well as general financial counselling and under- writing assistance, which has been enhanced through its recently established merchant banking unit. The Proposed Loan 56. ICICI remains a creditworthy borrower. It is a financial inter- mediary, through which the Bank can continue to play an important role in providing assistance to the Indian industry. The amount of the loan has been proposed on the basis of ICICI's financing requirements. The use of the proposed loan would be limited to foreign expenditures. The terms would follow those of recent Bank loans to development finance companies, including the standard commitment charge. As in the last three Bank loans to ICICI, only projects that need more than US$4 million of ICICI's re- sources, including Bank funds, will require prior approval by the Bank (see Sec. 2.02 of the draft Loan Agreement). It is expected that the proceeds of the loan will be used for both modernization and balancing, which would increase the level of capacity utilization, as well as for new and expansion projects, where appropriate, on a case by case basis. PART V - LEGAL INSTRUMENTS AND AUTHORITY 57. The draft Loan Agreement between the Bank and the Industrial Credit and Investment Corporation of India Limited, 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 a draft resolution approving the proposed loan are being distri- buted to the Executive Directors separately.  - 16 - 58. A feature of the Loan Agreement is referred to in paragraph 56. The draft legal documents conform to the normal pattern for loans to devel- opment finance companies. 59. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 60. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments March 20, 1975  ANNE I Page 1 00W1N7R DATA - INDIA ARELA POPULATIONI rESITT 3,780,0,3 510s"e(idiI)350 v., helof .ro.. LandI 8001AL DflDICAIVR GO? PER CAPITA USA (AroiA Bn31S)4 .. 110 j, 0 4 ~ 220 44 2,600A4 DEMO7RAHIUC 3h 1 rdeO rthrta (per tho-and) 3I5. 3 /o. 5 552 13. 45 Oru deethrs.t (P.,rthsisand) '4 61 e 1 L5OOt Infant mortality rate (per th-asnd lime births) 139 120-150 o . 0 17.5 ~C_ Life expsotanoy at birth (years) 51 h 80 5 58 72 Gross reproduCtion rata412 2.7 /,h.1 2.9 3.2 3.3 1.3 Peptiation growth rothg 2.3 2.3 2.0t 3.0 0.55 opejelotion growth rota - orbao 344hk