India - Eleventh Industrial Imports Project

Document of F COPY The World Bank FOR OFFICIAL USE ONLY Report No.P-1754-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR THE ELEVENTH INDUSTRIAL IMPORTS PROGRAM February 2, 1976 This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as at December 8, 1975) Rs 1.00 = Paise 100 US$1.00 = Rs 8.91 Rs 1.00 = US$0.1123 Rs I million = US$112,250 (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 consisting of the U.S. Dollar, the Pound Sterling, the Deutschmark and the Japanese Yen. As all of these cur- rencies are now floating, the U.S. Dollar/Rupee exchange rate is subject to change. Conversions in the appraisal report were made, unless otherwise stated, at US$1 to Rs 8.75 which was the short-term average at the time of appraisal.) FISCAL YEAR April 1 - March 31  FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR THE ELEVENTH INDUSTRIAL ITtPORTS PROGRAM 1. I submit the following report and recommendation on a proposed credit to India in an amount equivalent to US$200 million on standard IDA terms for the Eleventh Industrial Imports Program. PART I - TIIE ECONOMY 2. An economic report entitled "Economic Situation and Prospects of India" (691a-IN dated May 1, 1975) was distributed to the Executive Direc- tors on May 20, 1975. A country data sheet is attached as Annex 1. Background 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 Government 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 inadequiate domestic savings, together with a net transfer of external resources averaging in recent years only about US$1 per head per annuim, 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 aervasive 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, 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 cost and has yielded results of variable quality. Many industrial and agricultural investment schemes have been highly successful, but others have taken excessively long to be completed and have operated well below fulL capa- city. 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 improvements and although the distribution of income in India is relatively even by comparison with most developing 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. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - 2 - 5. The structure of the economy has been slow to change. Agriculture remains the dominant sector, accounting for some 45% of natinnal product in the earl.y 1970s compared with around 49% twenty years previously. The share of output contributed by the industrial sector has increased onlv 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 preponderancce of consumer goods prodtuction 25 years ago. Development Potential 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 reas-onable chance of success in th-e longer run. In agriculture, as Ci.scussed in the economic report of MIay 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 extnt in Bihar and Wlest Bengal, but which has been losing momentum since about 1970. This is the result of deficiencies which can be corrected -- most importantly seed deterioration and lagging irrigation development. b. Better use of the vast potentials that have been created by surface irrigation through more expeditious project completion and complementary land and on-farm imiorovements to ensure better management and higher productivity of water. c. Acceleration of groundwater development, especially in the Eastern regi.ons, which are figuratively describhed as "floating on water," where the untapped potential. is large and where consequently there are large opportunit:ies for multiple cropping, bett-er water management and greater crop security. d. Promotion of increased production of monsoon rice, based on improved varieties which as yet have had onlv modest success but which are expected, on the basis of current research, to open the way to much greater product- ivity over India's vast rain-fed rice producing areas during the next few years. e. Pursuit of the promising, althouglh somewhat less definite, potential for greater productivity in dryland cultivation and for extensive introduction of higher-yielding varieties of coarse grai.ns. Because of the difficulties likely to be encountered in tihe effective devel- opment of these potentials, their realization is likely to follow unleven time  - 3 - patterns, probably coming in bursts of expanded production as in the case of the Green Revolution. And, along with administral:ive concentration and effectiveness, they will all require provision of the supplies and services, especially fertilizer and power for irrigation, whicth are essential comple- ments of the necessary technical and environmental changes. 7. Greater agricultural success would also make an important contri- bution 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 ex- ploitation of these various potentials unless administrative capabilities, which are overtaxed and diffused in an attempt to guide and control most economic activities, are focused on these areas. The requirement for indus- trial export stimulation would appear to be more generous and expeditious incentives, sufficiently attractive and reliable to induce domestic producers to venture into the competitive pressures of world markets. Finally, real- ization 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. Thus while there is potential for resuming the interrupted process of growth, there remains the formidable obstacle of the short-run difficulties facing India. Recent Trends 9. The past two to three years have been extraordinarily difficult for the Indian economy. Not only did agriculture suffer a severe setback in 1972 and 1974 on account of poor monsoons but India experienced a serious deter- ioration in her terms of trade as a result of the worldwide oil and commodity price rises. In this situation it was hardly surprising that adjustment to immediate difficulties was the prime economic preoccupation. Growth had necessarily to take a second place to short-run exigencies in the emphasis of economic policy at the start of the Fifth Five-Year Plan period. 10. In contending with these difficulties, the economy did succeed in posting some modest gains. National income rose by an average of just over 2% per annum during the two years 1973/74-1974/75. Hlowever, in the aftermath of the poor monsoons and inflation, industrial output was more severely affec- ted and, as a result, output actually declined in 1973/74 and achieved a growth of only 2.5% in 1974/75 (Annex VIII). The most significant achievement during  - 4 - this period was the outstanding success of the Government in curbing infla- tion which had been rising at a rate of 30% per annum in mid-1974 but which by mid-1975 was brought down to virtually zero. Tight credit restrictions played an important part in this achievement and monetary expansion, which had been running at a rate of 15% in 1973/74, was reduced to 6% in 1974/75. The 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. 11. The shortage of food was especially acute over this period with the drought of 1972 being followed by similar conditions in 1974. A crisis was averted in 1974, however, by imports of more than 6 million tons of foodgrains during the year ending in March 1975 or almost twice as much as the. imports of 1973/74. With these imports and with relative emphasis on food distribution in the cities rather than the countryside, where supply conditions were presumed to be not quite so unmanageable, the threatening food situation was weathered, although not without hunger and privation for a great many of the 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%; fact- ories and power plants were converted from fuel oil to coal wherever possible and supplies of fuel oil were reduced by more than 15%; coal production, after years of stagnation, was increased by about 10%, 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 improvement in the operation of the deficient power system through special efforts to raise the low capacity utilization of thermal plants and by a more systematic allocation of available power, with special priority for requirements of agricultural irrigation and fertilizer production. Power shortages continued, however, to affect adversely many regions. 13. The balance of payments for 1974/75 turned out to be manageable in spite of a 47% jump in the import bill (Annex VII). ELconomies in import volume helped. More importantly, there was also an increase of 30% 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 Monetary Fund including the Fund's Oil Facility, larger aid from the India Consortium including the World Bank Group, oil purchaes 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$1,417 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. Situation in 1975/76 14. This year the economic situation, though still very difficult, is more encouraging than last year. With a favorable summer monsoon and good prospects for the forthcoming spring (rabi) crop foodgrain production is  -5- confidently predicted to achieve a record of over 110 million tons. Infla- tion continues to be tightly curbed, and the wholesale price index for July 1975 was actually 2.1% lower than a year earlier, unacljusted data indicated that the index will show a further decline by the end of 1975. With good rains and greatly increased coal production, the power situation has improved, and the Government's expectation is of 20% growth in power generation over the year. At the same time there has been a substantial improvement in the availability of domestic raw materials, most notably steel. However, although the performance of several public industries has improved considerably, de- mand, particularly for consumer goods, continues to stagnate, and the Gov- ernment's expectation of 5-7% growth is unlikely to be achieved. Industrial growth of 4-5% now appears much more likely. 15. Exports during the first six months of 1975/76 showed some volume increases although in dollar terms, earnings showed only a marginal rise on account of exchange depreciation. The trade deficit is likely to be almost US$1.5 or somewhat lower than the US$1.7 billion deficit of last year. How- ever, this should be compared with 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 exsternal 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 (Annex IV). 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 !3ank Group sources. Eastern Europe is expected to provide perhaps US$100 million, 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$500 million from disbursements out of Consortium pledges made in June. This leaves IJS$600 million to be financed from other sources, including a possible dlrawdown of foreign exchange reserves, which stood at about US$1,480 million at January 9, 1976, or the equivalent of just under 3 months of payments for imports and debt service. 17. To highlight the crucial variables in India's longer-term payments outlook, the May 1975 economic report contains some projections, for the 10 years following 1975/76, illustrating India's debt management problem. Broadly speaking, the conclusion which emerges is that a modest increase in India's import capability - an average of 5.2% per annum after allowing for inflation - could be achieved, provided: (a) new aid commitments 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 outstanding and disbursed on March 31, 1974, stood at US$10.2 billion. 18. Clearly, further improvements in export performance will be crucial to a successful development effort and for this reason India's export performance and prospects are given special atten tion in Part II below. PART II - EXPORT PERFORMANCE AND PROSPECTS Past Developments and Problems 19. Long Run Trends: Although the rate of growth of exports in real terms has been rising over time, export performance since India's Independence has been poor. As a result of this and rising import costs, India has experienced a succession of severe balance of payments crises and a chronic foreign exchange shortage. Moreover, the slow rate of growth of industrial exports has limited the overall growth of the sector, given the diminishing potential of import substitution as an engine of growth. Over the period 1960/61 to 1974/75, growth of exports in real terms averaged only about 3.5% p.a. although over the past three years (1972/73 to 1974/75) the growth rate was higher at an average of 5% p.a. (Annex V). 20. Part of the explanation for India's generally poor export per- formance has been the initial dominance of stagnant items like jute, cotton textiles, and tea which in 1950/51 accounted for 52% of India's exports. Given their low rate of growth and steady decline in importance to a level of about 23% of India's export in 1973/74, the overall rate of growth should have risen as other, and particularly more dynamic, items gained greater weight. However, although there have been many items that have grown significantly over the past 25 years, characteristically the growth of individual items has been spasmodic rather than sustained. A result of India's failure to find items with sustained rapid growth has been her declining share of overall world trade and of world trade in all major categories. For instance, whereas India secured about 2% of world trade in 1950/51, this percentage had declined to just over 0.5% in 1973/74. 21. A significant feature of India's exports has been the growthl in earnings from barter trade with Eastern European countries. From 1955/56 to 1967/68, of a total increase in export earnings of US$346 million, US$290 million (84%) was accounted for by growth in this trade, which does, of course, severely limit India's flexibility in balance of payments manage- ment. However since 1967/68, the almost total stagnation in India's earnings of convertible currency appears to have ended. Thus, while the average growth rate in earnings from barter trade continued at around 16% per annum between 1960/61 and 1974/75, that of convertible currency earnings jumped from only 0.2% between 1960/61 and 1967/68 to 14% from 1967/68 to 1974/75 (Annex VI). 22. Another significant aspect of India's efforts to adjust the direction of its exports, and take advantage of new opportunities, has  - 7- been its exports to Middle Eastern OPEC countries. Exports to these countries rose from US$108 million in 1972/73 to US$560 million in 1974/75. Engineering exports, for which there is a particularly good potential, rose from US$38 million in 1972/73, to US$62 million in 1973/74 and US$132 million in 1974/75. Thus, these countries' share of India's total engine- ~ring exports, rose from 19% in 1972/73, to 28% in 1974/75. Apart from ngineering goods, India has had success in exporting increased amounts )f cement, sugar, jute bags, basmati rice, and livestock. This is a rela- lively successful area of recent performance. 73. The factors that have caused the generally poor performance are nany and varied, since the composition of India's exports is extremely ieterogeneous. In particular, distinctions must be rmade between problems 3f agricultural and manufactured commodities, and between thie situation Df those homogenous commodities in the public sector and other items which are produced by a wide range of profit-oriented private farmers and Dusinessmen. As far as homogenous commodities like :iron ore, steel and coal are concerned, the basic problem has been one of production and, in the case )f iron ore, of transportation facilities. For agricultural commodities, productivity and profitability for the farmer have been key issues. In addition, overseas market conditions, the exchangc rate, and export taxes aave all affected the various items in differing degrees. For the wide range of commodities produced or processed by the private sector, the most fundamen- tal problems have, undoubtedly, been those of the effective exchange rate and Df the control system. The dominant orientation of Indian industrial develop- nent has been towards total import substitution. Detailed studies have indicated both that effective rates of protection and domestic resource cost ratios have been variable, and that the effective exchange rate for export activity, even allowing for the various export incentives, is far lower than for activities oriented towards the domestic market. Correspondingly, profit- ability has also generally been lower in exports. The control system, which has been the main instrument of industrial policy and of foreign exchange rationing, has had many significant effects on exports from the private sector. In particular, firms have found the procedures for obtaining per- mission to expand difficult and often restrictive. As a result many of the firms that could have been the backbone of the export drive were discouraged. Foreign exchange controls have restricted the access of exporters to appro- priately priced inputs, and, in particular, have imposed numerous delays, making it difficult to meet export deadlines. Other serious problems facing private firms are those of (i) slow and unreliable and expensive freight the last mentioned influenced to a considerable extent by control through conference lines, and pervasive port congestion, (ii) regulations affecting the use of labor, especially female labor, in industries like garments, and electronics; and (iii) frequently changing rules and regulations restricting the firms' speed of response and ability to plan, which are both most import- ant for any export activity. 24. The Government devalued by 57.5% in June 1966, partly in order to tackle the problem of inadequate profitability in exports. However, at the same time it reduced many export subsidies and imposed export duties on many "traditional items" over which it thought India had monopoly power. The resulting net devaluation on trade account was 21.6% for exports and 42.3% for imports. Thus, in a somewhat perverse development, although  - 8 - the devaluation increased the profitability of tradeables vis-a-vis non- tradeables, it also increased the incentive to produce import substitutes by more than that to produce exports. Subsequently, the inadequacy of the devaluation as executed was revealed, as were many of the problems con- sidered above; in response, the Government introduced several further measures which were defective in many respects. These are described below as background to the policy changes introduced in 1975 which are described in the following section. 25. Cash assistance was introduced to offset domestic taxes and levies which were incurred at various stages in the manufacturing process and which were not covered by duty drawback arrangements. The computation of this as- sistance was based primarily upon the differences between domestic short-run marginal costs of production and f.o.b. realizations. As a compensatory arrangement, however, there was no relationship with the extent of domestic value added. Most of the assistance went to the engineering goods industry, which still accounts for only about 10% of total exports. Other industries, many of which have been the basis of other LDC exports performance and have great promise for India, such as leather goods, jute, and textiles, have received less assistance. An additional problem was the practice of announc- ing cash assistance on an annual basis, which discouraged firms from planning export-oriented investments. Further, since cash assistance was not designed to cover long-run cost effects, it provided no incentive for such investment. 26. Another incentive was the import replenishment license (REP) which is a supplement to the normal import license. A manufacturer received an import license on the basis of his production needs and in accordance with the priority of his industry. If a manufacturer exported some of his output he would receive an REP equivalent to the estimated import content of his exports. REPs were transferable within certain limits laid down by GOI and could command a premium on the domestic market. The market for REPs has been small as manufacturers preferred to retain their import entitlements. However, to the extent REPs were traded, their value was affected by availability of domestic raw materials and was influenced by the business cycle, all of which led to unpredictable prices for REPs. This price volatility ran counter to the objective of trying to establish a more secure environment for sustained export growth. But, of much more importance was the application of "indigenous angle" clearance, and restrictions on the proportions of the license alloted for specific items, which severely reduced both the value of the license and the flexibility it provided to exporters. 27. The third important incentive, the duty drawback, was designed to repay to the exporter all excise and import duties, which can be very high. Difficulties were created by the complex procedures for agreeing on the initial rate of drawback and on securing payment. The former was especially discouraging for those firms which have a constantly changing input-mix, while the latter was an unnecessary disincentive. 28. The Government also introduced export obligations in the hope that those firms which were restricted from expanding would be encouraged to accept an obligation in order to obtain increased access to the domestic market. In general, the export obligation was set at around 60%, although specific levels were developed for certain industry groups and categories of  - 9 - ownership. However, faced with inadequate profitability from exports, many industrialists appeared unwilling to invest in expansion even with the pros- pect of increased access to the domestic market. Further, in the case of engineering goods, it is unlikely that such extreme export orientation is sustainable and where obligations have been accepted, there have been ins- tances where these have been fulfilled through the export of poor quality goods which have damaged India's reputation. 29. To summarize, in looking at India's past performance as a whole, there are some commodities whose export expansion has been constrained by market factors outside India's control. But for a large proportion of India's exports, and certainly for that portion which has potential for dynamic growth, the points mentioned above are indicators of the more deep-seated problem of how to overcome the effect of years of domestic protection in the interest of import substitution. Central to this problem are the two over- riding obstacles to better performance, namely profitability and competitive- ness in terms of price as well as quality. Related to these obstacles are the key issues of (1) granting greater freedom to efficient firms to expand since they will be the basis of any export drive; (2) developing a more secure industrial policy environment; (3) improving profitability especially in respect of exports; (4) giving exporters access to essential inputs at reasonable prices through freedom to import when needed. Policy Changes in 1975 30. A growing recognition over the past three years of the obstacles just mentioned led to some improvements, largely procedural, being introduced. But it was only during 1975 that the Government recognized fully the need to set export goals and to introduce more substantive changes. This recognition was heralded by the Prime Minister who in a recent Speech stated: "We must prepare ourselves to achieve an annual growth in exports of at least 8%-10% in volume." She also said: "Perhaps we have lived too long in the rather cosy atmosphere of a high cost sheltered domestic market.. Now we must venture out into the world with a new spirit of dynamism and eff-iciency." Further, on the importance of export profitability, Mrs. Gandhi stated" "It is obvious that exports cannot be increased by mere exhortation. We are alive to the need to make it worthwhile for exporters to sell in the more exacting markets abroad." While Indian policy is still directed towards import substitution, which leads to the banning of competitive imports and the use of controls, shifts in emphasis and in the operation of policy have been made which are likely to lead to better utilization of current export potential, and which indicate a new willingness to make policy adjustments, when necessary, to expand exports. The changes made so far cover four important areas, namely, industrial licensing, import licensing, bureaucratic procedures, and the level and extent of cash incentives. 31. The most significant changes in industrial licensing policy, at least for exporters of engineering goods, have resulted from the recommendations of the Sondhi Committee (a Government Committee chaired by Mr. M. Sondhi, Secretary of the Department of Heavy Industry which reported in May 1975). Of  - 10- particular interest is the automatic approval for production beyond authorized capacity, when earmarked for exports, and improved arangements for the supply of inputs for export production; a second major policy change is the permission granted to all firms for automatic expansion of 25% in capacity over a five- year period for a broadly defined group of "select" industries. Other import- ant recommendations of this committe, not strictly limited to industrial licensing, were (i) lengthening the period for which cash assistance is guaranteed; (ii) exempting import duty on raw materials imported under advance REP licenses; (iii) focusing the right to impose export obligations in the Licensing Committe; and (iv) various changes in export credit. All these recommendations have been accepted except the future basis for the computation of cash assistance which is still under discussion within the Government. 32. The second major area in which changes have occurred is that of import licensing where significant improvements in liberalization have been introduced. Under the new import policy any actual user amongst the "select" (i.e. priority) industries is guaranteed an automatic license for imports of raw materials to meet the user's production target for the year. Users in other than "select" industries who exported more than 20% of their production are also receiving automatic licenses on this basis. At the same time replenishment licenses have been increased by 10% for all exporters, and by an additional 10% for those whose domestic value added is more than 50%. Finally, both the transferability of replenishment licenses, and the flexi- bility with which they can be used, have been significantly increased, partly through some pragmatic relaxation of "indigenous angle" clearance. Thus, problems with the availability of raw material imports are significantly reduced. Furthermore, since exporters can get all of last year's imports through actual user licenses, the replenishment license is now clearly an incentive. 33. In the case of cash assistance, GOI announced in October 1975 an increase in cash assistance for a range of eligible industries, primarily in the engineering goods sector, and the extension of cash assistance to industries such as marine products, chemicals, and jute carpet backing which had not been receiving this assistance before. Indeed, in the case of jute backing, the Government imposed an export tax until quite recently. This change is a positive indicator of GOI's willingness to extend assistance for the expansion of exports. A change in the basis of computing cash assist- ance, which would have the effect of a yet further increase of their value, is still under discussion as mentioned above in paragraph 31. 34. The final area of improvement has been procedural. The details are complex, but it is clear that over the past two years there has been a continuing acceleration in the speed with which the various industrial and import license applications and incentive payment are being processed. This is expected to go further with the present proposal to introduce automatic payment of duty drawbacks and cash assistance, on receipt of claims, through the commercial banks.  - 11 - 35. Policy on the Exchange Rate: Policy towards the exchange rate is clearly important. During the period of exchange instability which began in August, 1971, the Rupee was tied to the pound sterling. This has meant a fairly steady devaluation against most currencies and has therefore partially offset the decline in India's competitiveness that inflation was bringing about. More recently, price stabilization in India has worked in favor of the price competitiveness of India's exports. Since September 1975, the rupee has been linked to a basket of currencies representing India's major trading partners, which is expected to introduce stability into the Rupee exchange rate. 36. Monitoring Export Progress: A Cabinet Committee consisting of the Ministers of Finance, Commerce, and Industry has been established. It possesses the delegated power of the Cabinet. Its establishment has clearly speeded up decision-making, cut through inter-ministerial conflicts, and focussed attention on the importance of exports. Several examples can be cited of its effectiveness: the speed with which the recommendations of the Sondhi Committee on engineering exports were accepted (paragraph 31); the ease with which significant increases in the automaticity and flexibility of import licensing were introduced; the speed with which the October decision to expand the scope of cash assistance was taken; and the willingness to push through and organize the politically and administrative- ly complex task of exporting a quarter of the available sugar. The Cabinet Committee is serviced largely by the Ministry of Commerce and is receiving regular information on short-term progress from these sources. Information on specific industries comes largely from the export promotion councils which meet regularly with their sponsoring ministries. Perhaps the most important such meeting is a monthly one between the Engineering Export Promotion Council and the Secretary of the Department of Heavy Industry. Although statistics on exports are usually about four months out of date, the Trade Development Authority prepares quarterly forecasts, which are of high quality. Thus, the primary inflow of information into the Government is quite good. 37. Export Outlook for 1975/76. GOI originally projected 1975/76 exports at Rs 38 billion, which implied volume growth of more than 12% over 1974/75 compared to the average rate of growth of 5% in volume since 1969/70. Since 1975/76 is proving a decidedly adverse year for world trade, this estimate has now been revised to Rs 35-36.5 billion based upon a 6% volume growth. The lower and upper limits of volume growth are estimated at 4% and 8% growth, respectively. GOI's original target depended upon achieving extremely high increases for sugar (which accounts for 45% of the targeted volume increase), iron and steel (which account for 23%), cotton textiles (which account for 10%) and leather and leather manufactures (which account for 9%), and upon avoiding sharp falls in vulnerable items like jute manufac- tures, tea, iron ore, and cashews. 38. The very large increase in sugar exports is, on the basis of contracts already entered into, feasible. Much of the target for iron and steel should also be achieved, since there is now a very substantial  - 12 - exportable surplus. But, at present, the world market for steel is soft so contract breaking as well as renegotiation' of prices is very probable and a shortfall from the target may occur. Of the items expected to grow over. 1974/75, cotton textiles are the most dubious, especially millmade piecegoods, and a shortfall of more than 10% from GOI's 1975/76 target is likely. For leather the target is likely to be achieved. Chrome tanned and,, particu- larly, finished leather are going very well and the latter is likely to double in volume over 1974/75. This is very encouraging for GOI's overall program of conversion from semi-finished to finished leather. It appears, therefore, that three of the four categories expected by GOI to generate much of the growth should do well. However, other items are likely to fall short of expectations, for a variety of reasons, but largely because of poor world demand. These include gems, iron ore, chemicals, and tea. 39. On balance, it is the expected shortfalls in the various vulner- able items that lead to the view that a 6% volume growth rate is the most probable outcome. However, a small decrease in dollar value over last year's level of about US$4,130 million may occur because of an expected decline in the dollar prices of India's exports by about 5.5% since 1974/75. Export Program 40. Somewhat over a half of India's export earnings come from manufac- tured items. The balance comprises various commodities for which individual export programs need to be , and are being, developed by the Government. For the purposes of this credit, the Association has concentrated upon the export development of manufactured items. Clearly,, the emphasis on import substitu- tion, the persistent shortage of foreign exchange and concern over concentra- tion of economic power have all deeply influenced the structure and management of industry over the past two decades and the resulting industrial policy administration has led to the obstacles to better export performance. In these circumstances, the task of reorientating the focus of industrial activity will take time and thus an export program will have to be concerned with the short- and long-run aspects. 41. For the short term, the essential feature of policy must be more use of existing capacity for export. The measures described in paragraphs 30-34 will undoubtedly assist in this direction. The Government has indicated that a minimum real growth rate in exports of around 8% per annum should be the objective, and this will be no easy task to accomplish especially over the next year or so on account of worldwide trends. The Government intends to monitor progress closely in order to make further adjustments as when and necessary. The Government.will send (in. acccordance with Section 3.04(c) of the Development Credit Agreement) to the Association a quarterly report on its monitoring activity which will include an aqalysis of trends and proposals for remedial measures. 42. For the longer term, GOI has recognized the need for some fundament- al structural changes. Most especially this recognition is to be found in respect of engineering goods in the Sondhi Committee report (see also paragmph 31), but a program which will provide conditions and incentives for promoting new investment for export and more vigorous exploitation of India's export  - 13 - potential has yet to be formulated. This will be a particularly difficult and complex task and the Association will be maintaining a close dialogue with the Government on this aspect. GOI representatives at the negotiations of this credit explained that the Government had initiated the formulation of develop- ment programs for modernization and expansion for four key exporting industries, sugar, cotton textiles, cement and engineering industries which in 1974/75 ac- counted for 30% of India's total exports and have considerable potential in the future. The Government will send the Association by August 1976 informa- tion on the progress in preparing these programs and will also examine the pos- sibility of identifying projects or programs which the Bank Group could assist. The Government will also send a response to the various policy proposals set out in the Textile Machinery report which was prepared by the Association as part of the appraisal of this credit and which is available to Executive Directors on request (Report 976-IN of January 27, 1976). The summary and con- clusions of this report are attached as Annex XI which, in turn, is summarized in paragraphs 75-80. ICICI is carrying out under Loan 1097-IN a study of export performance, problems and prospects of its clients. The results should be directly relevant to the export policy considerations of the Government. PART III - BANK GROUP OPERATIONS IN INDIA 43. Since 1949, the Bank Group has made 44 loans and 75 development credits to India totalling US$1,436 million and US$3,635 million (both net of cancellation), respectively. Of these amounts, US$721 million has been repaid, and US$1,519 million was still undisbursed as of November 30, 1975. Annex II contains a summary statement of disbursements as of November 30, 1975, and notes on the execution of ongoing projects. 44. Since 1957, IFC has made 14 commitments in India totaling US$51.8 million, of which US$9.6 million has been repaid, US$7.6 million sold and US$6.9 milion cancelled. Of the balance of US$27.7 million, US$21.2 mil- lion represents loans and US$6.5 milloin equity. A summary statement of IFC operations as of November 30, 1975, is also included in Annex II (page 2). 45. In recent years, the emphasis of Bank Group lending has been on agrictulture. The Bank Group has been particularly active in supporting minor irrigation and other on-farm investments through agricultural credit operations. Major irrigation, marketing, seed development, and dairying are other agricultural activities supported by the Bank Group. Also, the Bank Group has been active in financing the expansion of output in the fertilizer sector and through its sizeabre assistance to development fi- nance institutions, in a wide range of geographically scattered medium- and small-scale industrial enterprises. IDA financing of industrial raw materials and components for selected priority sectors under previous industrial imports program credits has been instrumental in facilitating better capacity utilization in industry. The Bank Group has also been  - 14 - act-ve in supporting irnfrastructure development for power, tel.ecommuni- cati-ons. and railways. F'amily planning, education, water supply develop- mnerit. andc urban investments have also received Bank Group support in recent years . 46. The direction of assistance uLnder the Bank/IDA program has been consistent with India's needs and the Government priorities. The empha- sis of the program or agriculture, industry, power, and transport remains highly relevant. 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, and seed produc- tion form, an important aspect of the Bank Gro(up's program for the next years. Special emphasi-s will be given to projects benefitting smal'L farmers. Lending in support of infrastructure and industrial investments will focus on energy- related projects. Repeater credits for power anod railways 1-have priority in this context, and discussions are under way withi the Government in an effort to identify and prepare projects specifically designed to facilitate coal transport. Lending for fertilizer projects, which has been an important feature in recent years, is expected tc, continue to occupy a prominent place in the future program. 47. The need for a substantial net transfer of ext:ernal resources min support of India's economy has been a recurrent theme of Bank economic reports and of the discussions withlin the lndia Consortium. The need for readily usable foreign exch-iange assistance is especially pressing at a tPime when output and investmrent have to be adjusted to a radically different price situation. Consequenitly, 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 appropri.ate, 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 p],anning. For the Bank C-roup to he able to make an appropriate contribution to the financing of projects in these sectors, it is importanit to cover a proporti,on of local expenditures. 48. Of the external assistance received by Tndia, the proportion cooi- tributed by the Bank Group has grown significantly. In 1969/70, the Bank Grotup accounted for 34% of total comnitments, 13% of gross disbursements, and 12% of net disbursements as compared with an estimated 35%, 28% and 42A, respectively, in 1973/74, and the contributiort of the Bank Group is expected to continue growing. Vhereas on March 31, 1974, the Bank Group's share of India's outstanding external ptublic debt was 23%, by 1979, it is likel]y to account for about 25%. Because Banlk GrCLup assistance to India is predominantly in the form of IDA creclits, debt service to the Bank Group will rise slowly. In 1974/75, about 14% of rndia's total debt service payments were to the Bank Group.  - 15 - PART IV - THE PROPOSED PROGRAM CREDIT THE CASE FOR PROGRAM ASSISTANCE 49. The case for program assistance is based on our assessment of two general factors, India's needs and the Government's own effort to promote development especially in the areas of agriculture, energy and exports. India's need for assistance requires little amplification. India has one of the lowest per capita incomes; she ranks among the countries most affected by the oil crisis and commodity inflation; and she has to endure the vagaries of the monsoon the failure of which can have such devastating effect. In the past, the Association has emphasized the difficulty of India's domestic resource situation, the inadequate foreign exchange available to supplement these domestic resources, and thus India's need for aid. The last Industrial Imports Credit (Cr. 528-IN) for US$100 million was signed on February 14, 1975. The amount of the credit was subsequently raised to US$200 million and an amendment to the Development Credit Agreement to this effect was signed on March 7, 1975. The Closing Date of the Credit is June 30, 1976. However, the credit had been fully disbursed by the end of January 1976. Approval of a further credit at this time will assist the Government to ensure an uninter- rupted flow of maintenance imports for the industrial sector. Domestic Resource Position 50. By a combination of fiscal and monetary measures, the increase in wholesale prices in the year ending March 1975 was only 7.7% as compared to about 30% in the corresponding period of the previous year. Since March 1975 wholesale prices have been declining and unadjusted data for the latter part of 1975 show that by the end of this year, the index will be below the level of 12 months previously. Efforts to enforce greater discipline in non develop- ment expenditure were further reinforced by measures to mop up additional pur- chasing power by impounding one-half of the increase in wages, and by imposing a ceiling on distributable profits. The Bank rate was raised from 7% to 9% in July 1974, and the overall credit policy has been one of restraint. Mobiliza- tion of resources by the Central and State Governments reached a record level of Rs 1,048 crores, but on account of the increase in dearness allowances, food subsidies, larger purchases of fertilizers and additional outlays in capital formation, the aggregate deficit in 1974/75 was Rs 727 crores or Rs 234 crores higher than in the previous year. 51. The Annual Plan for 1975/76 envisages an increase in development outlays of about 23% over 1974/75. Domestic budgetary resources are expected to finance 82% of the plan outlay as against 79% in the previous year. External assistance including oil credits is expected. to provide about 14% while the remaining 4% would be met through deficit financing. The Government has introduced measures to improve tax collection and. has also made clear its determination to control wage increases. An underlying trend which has adversely affected the domestic resource position for some years now has been the low level and stagnation in savings. In the early sixties, the total savings ratio averaged 13%. By 1973/74, this ratio had fallen to 12%. This has  - 16 - compounded India's difficulty in trying to achieve economic growth and there would seem to be no easy remedy as the only sustainable solution lies in the long and arduous task of making more effective use of the country's existing capabilities for domestic as well as export production. GOI has indicated that for the next fiscal year (1976/77) development expenditures are likely to increase by a further 20% which, in view of the price stability now achieved, should stimulate a substantial and real increase in investment activity. Priority will again be given to completing on-going irrigation and power projects with continued emphasis on industrial investment especially for fertilizer. Ralance of Payments 52. Between 1972/73 and 1974/75, India's terms of trade declined quite sharply by as much as 30%. Although this deterioration may be coming to an end, India is still faced with an enormous trade deficit and dif- ficult trading conditions in which to expand real export earnings. Improve- ments in foodgrain production together with the rise in output of domestic caily produced fertilizer and steel could significantly reduce foreign ex- change outlays for the import of these items in future years, and thereby give India some flexibility in financing essential raw materials for in- dustry which has had to make do with imports in real terms at about the same level for the past four years. However, this flexibility will not be appre- ciable in the short term, so that India's need for aid in non-project form will continue. 53. In more specific terms, imports in 1975/76 are expected to be at about the same level as or slightly lower than 1974/75. The composition will also be much the same with about 60% of imports being accounted for by oil (25%), foodgrains (20%) and fertilizer (15%). Export earnings, too, will remain about the same level in dollar terms although a 6% increase in volume terms is expected (paragraph 39). The trade deficit is expected to be about US$1.5 or somewhat lower than the level of the previous year (US$1.7 billion). For 1976/77, the most recent forecast indicates that the growth in real terms of exports is again likely to be 6% and as prices overall are expected to show little change, the increase in export earnings will he of the order of 6% as well. India's requirements for foodgrains and fertilizer in quant-ity terms is likely to remain much the same, the former to permit the re-building of India's essential stocks. In the case of the latter, the substantial decline in international prices will enable India to reallocate more resources for other imports including primarily industrial raw materials. At this stage, GOI's initial forecast indicates that the trade deficit may be at about the same level as, or perhaps lower than) projected for this year (i.e. US$1.5 billion). However, in view of the expected revival of domestic demand following the good harvests of 1975/76, an increase in import capabi- lity will be essential to respond to the favorable demand factors especially for manufactured goods. The requirements for rebuilding inventories, which were drawn down heavily in 1975, and the desire on the part of GOI to make import licensing more liberal will be amongst these demand factors. Conse- quently, India will need increased import capability, over and above the present projection, if the economy is to recover from the unacceptably low levels of economic activity over the past two years.  - 17 - The Government's Development Efforts 54. Over the past three years, the Government's efforts have been directed towards making adjustments in the face of the oil and commodity price situation and rampant domestic inflation. The Government has been remarkably successful in both these areas and during this period of re- adjustment, GOI has been reconsidering the priorities and requirements for longer term economic development. Much of the Government's present proposals in this respect have been mentioned in Part I of this report. There are, however, three areas of special interest to the Bank Group at this time namely agriculture, energy and exports, the first two of which have been receiving substantial project assistance from IDA. The Government:'s development efforts are summarized below. 55. In the case of agriculture, a pragmatic assessment of potentials and constraints is being made and priority will now be given to rejuvenating wheat production, to better use of surface irrigation water from existing projects, to development of improved rice varieties and thereby of rice production, and to more exploitation of groundwater. The Association has established a satisfactory dialogue with GOI and a number of new projects are being prepared for IDA assistance in the critical areas of seed production, irrigation and command area development and extension. A noticeably weak area, both at the Center and in the States, is planning capacity to prepare food production programs and this is now being given special attention by GOI together with the Association. 56. In the case of energy, the Government has made: substantial changes in the allocations so that this sector now receives 50% more in development funds than before 1972. The emphasis has been placed on. improving coal pro- duction, stepping up oil exploration and installing more generating capacity. In each of these areas significant progress has already been made or is in the offing. Coal production increased by 10% in 1974/75 with a further increase of 15% in 1975/76 now expected. Arrangements to intensify oil exploration through contracts with foreign companies are being made. In the case of Bombay High Offshore production is expected to begin and to reach 0.5 million in 1976. Thereafter production is expected to rise until full development of an estimated 7-8 million tons p.a. (just over 30% of present consumption) in the early 1980s. Finally, there has been marked improvement in the commis- sioning of power generating capacity. 1,700 MW came into operation in 1974/75 and further 2,000 MW is expected in 1975/76 representing in total for the two years an addition to existing capacity of about 14%. 57. In the case of exports, the Government's efforts to date have been discussed in Part II and as already explained there, the Association will be closely involved in a continuing dialogue with Government on this subject (paragraphs 41 and 42). 58. To summarize, India's need for aid, particularly in program form, has been mentioned above in paragraph 46 and the case for this type of assistance is further reinforced by the fact that the structure of the economy, and especially the large capital goods industry, places a limit on  - 18 - t'he e:-tent to which aid can be in project form financing capital equipment. Indeed. 807% of India's import requi.rements are for industrial raw materi.als and food., The other part of the case is the Government's own efforts toward development. HiUstorically, thes2 have been considerable although the achieve- Meat of significant progress has been frustrated ly natutral disasters, the recent oil and commodity price situation, and the effort to find a balance between social and economic goals. Nonetheless, Government has persisted and therc is evidence that a growing pragmatism and desire to improve economic perrormance are determining new policy considerations. Thus while new stra- tegies are being evolved in many areas, and in particular for exports and industry, continued program assistance can provide flexibility to the Govern- ment in the management of India's balance of payments to support these ef- forts. 59. The Bank Group has approached India's need in a flexible manner by financing under project assistance 'o'-l curren1cy expenditu-res. How,aver, the level of such disbursements is dependent upon the project mix of the Bank Group's commitments as well as the rate of implementation of pro- jects. Through program lending the AssocLation can assure a more predictable flow of resources, thereby complementing the efforts of Consortium members to meet the urgent needs of the country in the most effective manner. THF PROPOSED CREDIT 60. This credit was appraised by a mission which visited India du-ing October 1975. Negotiations were held in IJashington from January 20 to 22, 1976. The (;overnment of India was represented by J.S. Saijal, Joint Secretary, Department of Eronomic Affairs, Ministry of Finance, and Dr. B.N. Jalan, Economic Advriser, Ministry of Industries and Civil Supplies. A credit and program s-mmarv is attached as Annex III. 61. T.he elements of the case for program assistance have, of course, in.fluenced the design of the previous industrial -imiports credits (ten credits wiere approved between 1964 and 1975 for a total. of US$1,130 million). Tihe pri.mary objective has been to ensure a rapil transfer of resources and thereby to support the Government's overall development effort. A further objective, ^-ihich has been increasing in importance, has been to provide directly to certana priority industries an improved flow of imports so that efficiency and comnp?titiveness can be improved. And related tG this objective has been the es:-ahlishment of a dialogue with GOT on industrial policy in general and on tae develnoment of certain industries in particular. Hitherto, the selection of industries has been in terms of priority for the domestic economy and there have been only rather marginal clhanges in the selection of industries. Over "le past three years, the Associatian has carried out a seri.es of special studies on the manufacture of commercial vchic..Ies, tractors, forgings and foundries and textile machinery. These stuc'ies have drawn attention to the export potential of these industries as well as the measures required to enable them to manufacture competitivel-y. Againzt this background and the Association's overall concern that India's export performance should improve, some changes in the design of the proposed credit compared with previous credits have been made as explained in paragraph 63 below.  - 19 - 62. The industrial situation against which the proposed credit has to be considered is set out in Annex X. Very briefly, the present situa- tion is that industrial production in 1975/76 is now expected to increase by between 4% and 5%. This compares with previous growth rates of 2.5% during 1974/75 and a decline in output of 0.4% in 1973/74. The poor per- formance during 1973/74 was the direct consequence of the drought in genera- tion, all of which have been referred to in Part I of this report. It has proved a slow process to overcome these early setbacks and during 1975/76 demand for industrial products has remained constrained by low overall eco- nomic growth. The industrial prospects for 1976/77 look encouraging with considerably improved availability of raw materials and power and the expec- tation that the much improved agricultural performance should stimulate a revival of overall demand. 63. The design of the proposed credit to respond to the present situa- tion has been arranged so that allocations fall into three main categories. The first category is to support export development through assisting in the cost of financing import replenishment licenses for exporters; this is the first time that this type of assistance has been proposed under these industrial imports credits. The second category is to support industries which are vital to the economy while also having export potential. Finally, the third category includes support for those industries which are vital to the priority sectors of agriculture and power. The combined list of eligible industries emerging from the last two categories does not differ very markedly from the lists under previous credits, although there has been some modifi- cation of industry groups and aluminum smelting and manufacture of heavy construction equipment have been dropped; the former because the special need for funds no longer exists and the latter because of the downturn in demand. Textile machinery has been included for the first time following on the Special Study which formed part of the appraisal of this credit (see also paragraph 75). The lack of change is because these industries continue to be crucial for the supply to the economy of essential capital goods and inputs as well as being an important source of export: potential. The: purpose of the reclassification of the list into the two categories proposed here is to focus attention on the'export potential of certain industries and in this context to provide through the Technical Development Fund, to be financed under the credit, a means for providing capital equipment and know how for modernization. The allocations are set out below andl details on the cate- gories and the Technical Development Fund are described in the succeeding paragraphs. The performance and prospects of the selected industries are described in Annex IX. Table 5 of Annex IX shows theb disbursement of previous credits amongst the IDA-assisted industries.  - 2 0 - Proposed Allocation of the Credit Estimated Foreign Amount Allocated Exchange Require- Amount as Percentage of ment in 1976/77 Allocated Requirement To Support Export Development ------------US$M