India - Second Tata Iron and Steel Project

R E S T R I C T E D Report No. P-147 FILE Cuff This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TATA IRON AND STEEL COMPANY, LIMITED November 12, 1957   REPORT AND RECOIg'iNEDATIQIIS F THE PRESIDENT TO TH-E EXECUTIVE DIRECTORS CONCERNING A PROPOSED SECOND LOAH TO TTHE TATA IRON AND ST'3EL COMPATITY, LrVIITED 1. I submit herewith the following report and recommendations on a proposed loan to the Tata Iron and Steel Company, Limited (TISCO), in an amount in various currencies equivalent to $p32.5 million. The proposed loan would provide additional financing required to complete the expansion and modernization of the Company's steel works, for which the Bank made a loan of $75 million in June 1956. PART I - HISTORICAL 2. At the time the first loan was made it was estimated that the Company would need an additional $55 million equivalent to carry out its program. The Company thought that there was a reasonable prospect of its beirng able to raise this sum in India, but undertook to consult the Bank pericdically concerning its financing plans. 3e In Febraariy 1957 the Company informed the P.ank that it had arranged with the State Bank of India to increase an existing line of credit to Rs. 100 million, thus making available the equivalent of about `20 rnillion, but that in view of the growing stringency of the Indian capital market there was little prospect of raising any more funds in India auring the con- struction period. The Company therefore requested the Bank to make a fur- ther loan of $35 million equivalent to meet the balance of its requirements. All of this sum would be needed in foreign exchange. 4. As I reported to the Board at its meeting on July 12, 1957, I told YMr. J.R.D. Tata, Chairman of the Company, that I should be prepared to recommend a second Bank loan of half this amount, that is $17.5 million equivalent, provided he could raise the other half elsewhere. Mr. Tata sub- sequently had discussions with a number of financial institutions in the U.S. and Canada, which agreed to lend the Company a total of $15 million. The State Bank has since agreed to extend its credit accommodation from Rs. 100 million to Rs. 150 million (4q31.5 million), part of which would be used as a loan to meet the remaining gap of 42.5 million required to match the Bank's loan of $17.5 million. The State Bank has given an undertaling not to call in this portion of its advances to the Company before the proposed loans from the U.S. and Canadian banks have been fully repaid, and the Government of India has assured the Company of its willingness to make appropriate amounts of foreign currencies available. I regard these arrangements as meeting the condition that half the additional finance needed to complete the Company's program should be met from sources other than the Bank. 5. The commercial banks and trust comoanies which have agreed to lend money to TISCO are The First National City Bank, The Chase-Manhattan Bank, The Bank of America, The Manufacturers' Trust Company, The Chemical Corn   - 2 - Exchange Bank, The Philadelphia National Bank, The Northern Investment Trust, The National Bank of Washington, D.C., and The Royal Bank of Canada and its subsidiary The Royal Trust Corporation. They agreed to do so on condition that their loans should have equal security to that of the prooosed Bank loan and should be guaranteed by India. in the light of this, and after discussions with the Company and the Bank, the banks and trust companies decided that the most convenient way of making their loans would be in the form of participations in the proposed Bank loan. The loan would therefore be for a total' of $32.5 million equivalent, of which the above-mentioned banks and trust companies would purchase ma-turities amounting to $i15 million at a rate of interest of 5-3/4% per annum,. 6. The 1957 Trust Deed securing the earlier loan would be modified so as to secure the proposed loan also. It would in addition orovide that $2.5 million equivalent of obligations could be issued by the Company, ranking pari passu with the a1bove, thus permitting the substitution of a further loan in foreign exchange for the State Bank loan referred to in paragraph 4. 7. If the proposed loan of 032.5 million equivalent were made it would increase the total amount of Bank loans to India to '356 million. At the end of October 1957, IBiiD loans to India aggregated the equivalent of $32l4 rillion, net of cancellations and refundings, and consisted of the following: Amount (net of cancellations) 1949 Railway Rehabilitation (Locomotives) $ 32,800,cco l1b49 Agricultural Mlachinery (Kans Grass) 7,203,813 1950 Electric Power Development (DVC) 16,720,500 1952 Iron and Steel Project (11SCO) 30,020,000 1953 Electric Power Development (DVC) 10,500,000 1954 Electric Power Development (Thombay) 16,200,000 1955 Industrial Credit and Investment (ICICT) 10,000,000 1956 Iron and Steel Project (TISCo) 75,000,000 1956 Iron and Steel Project (IISCO) 20,000,000 1957 Jet Aircraft (Air-India) 5,600,000 1957 Electric Power Development (Trombay) 9,&800,000 1957 Railway Imorovements 90,010,000 ,; 323,8541,33 As of October 31, 1957, $25 million l3ad been renaid and qvl8 million of effective loans remained undisbursed.21 The amount disbursed and out- standing was $311i million, of which $1 h million was due on maturities sold by the Bank. 1/ The 1957 Trombay Loan of .,9.8 million is not yet effective.   PART II - DESCRIPTIOI- OF THE PROPOSED LOAN 8. The Borrower would be the Tata Iron and Steel Company, Limited. Guarantor 9. The Guarantor would be India, a member of the Bank. Amount 10. The proposed loan would be in various currencies in an amount equiv- alent to '32.5 million. Purpose 11. The proceeds of the proposed loan would be used to meet a part of the foreign exchan,e cost of goods and equipment (including spare parts), supplies and services needed for the Project, which consists of the ex- pansion and modernization of the Borrowser's works at Jamshedpur, desiined to increase their capacity to about 2,000,000 long tons of steel ingots and about 1,500,000 tons of semi-finished ana finished steel products. The development of the Borrower's coal and iron rm-ines, and other related and arcillary works, are also inclucded in the Project, w,hich is described in detail ir Schedule 2 of the draft loan agreement. 12. TISCO is the oldest and largest of the Indian producers of iron and steel products and it will remain the largest producer after the completicn. of three new government-onmejd plants now under construction. The Companyts program of modernization and expansion is sound, and arrangements for engineering and construction manaerenent are satisfactory. Pro-ress of construction is on schedule and cost estimates have remained virtually un- changed as compared with those on the basis of which the previous loan was negotiated. 13. The proceeds of the previous loan could be used to finance only that part of the so-called Two Million Ton ProLram (TNTP) being engineered and constructed under contract by Kaiser Engineers and its associated overseas corporation. Under the draft loan agreement the Company would be permitted to use the proceeds of the proposed loan, as well as the undisbursed portion of the previous loan ($27.5 million equivalent at October 31, 1957), to cover foreign exchange expenditures incurred in carrying out the Project as a whole. 14. Reimbursement, under both loans, of expenditures on parts of the Project not covered by the Kaiser contracts would be limited to expenditures incurred from March 1, 1957. Interest and other charges on both loans would be eligible for 'Withdrawal from either.   -4 - Amortization, Partici-ation and Withdrawal Arrangements 15r Tne proposed loan would be for 1341 years, amortized by semi-annual payments beginning October 1, 1960, calculated to retire the loan by April 1, 1971. The first repayment installment on theprevious loan will be due on December 1, 1959, and the last on June 1, 1971. 16. The first five maturities of the proposed loan would be sold to the commercial banks and trust comnanies wihich have agreed to participate. These five semi-annual maturities would be of equal amount, $3 million, so that the banks would be fully repaid by October 1962. Repayment of the Bank's portion would therefore begin with the next maturity due on April 1, 1963, and wiould continue in level installments of principal and interest until the retirement of the loan. 17. The security arrangements for the proposed loan would orobably take several months to comDlete, and it is not proposed to make their completion a conndition of effectiveness. However, withdrawals in the period before completion of these arrangements would be limited to i6 million, or about one-third of the Bank s contribution. A further limitation on withdrawals is required because the participating banks and trust companies have asked that their contributions should not bie called until July 1958; they would then make one-ninth of tlaeir contributions available for call by the Bank in that month and in each of thie eight succeeding months, provided that not more than one-third of the total Twrere actually called in any calendar quarter. It is proposed therefore, unless otherwise agreed, to limit with- drawals before Julyr 1, 1958 to the total of the Bank's contribution, i.e. $17.5 million, and to raise the limit on withdrawals thereafter as funds from the participating banks and trust companies becorme available, Interest and Other Charges 18. The loan would bear interest at the rate of 6% per annum, including the statutory comm,lission of 1%. The commitment charge would be 3/4 of 1% per annum and would accrue from a date 6o days after the date of the loan agreement. Legal Instruments and Authority 19. Attached is a draft of the loan agreement (No. 1) and the guarantee agreement (No. 2). Also attached is the Report of the Committee provided for in Article III, Section h(iii) of the Articles of Agreement of the Bank (No. 3). 20. The first loan and the bonds issuable thereunder are secured by a first specific mortgage and a first floating charge in respect of the Borrowerts properties and undertakings. This security was constituted by a Trust Deed dated May 9, 1957 in favor of Baring Brothers & Co., Limited, as trustees. This Trust Deed would be modified and extended so as to secure the proposed loan and the bonds, in addition to the first loan and the bonds issuable thereunder, all of -which would rank equally and rateably   - 5 - in respect of the security. As in the case of the first loan the State Bank of India w^ould consent to subordinate its security to the security con- stituted by the Trust Deed as so modified. The security arrangements are set out in Section 5e04 of the draft loan agreement. 21. In other respects the draft loan agreement conforms Eener2lly to the loan agreement entered into between the Bank and the Comiany at thie time of the first loan. The following are the major changes: (a) as described in paragraph 17 above, Section 2.02 provides for two limitations on the withdrawal of the loan; (b) in order to provide for the arrangements mentioned in paragraph 4 above, the limit put in Section 5.05 (i) on short-term borrowings which may be secured in priority to the floating charge has been increased, and the sub- paragraph has been extended to cover a limited amount of borrowings maturing more than a year after the date on which they were incurred. In Section 5.05 (ii-i) the amount of obligations, rapking pari passu with the first loan and the second loan in the security to be constituted by the Trust Deed, which the Borrower may issue without the consent of the Bank.has beon set at 42.5 mil'ion equivalent (see paragraph o above); (c) Article VII provides for the amendment of the loan agreement for the first loan. The major amendments are as follows: (i) amendment of Sections 3.01, 3.02 and Schedule 2 so that the loan may be used for the entire project described in Schedule 2; and (ii) amendment of sub-paragraphs (i) and (iii) of Section 5.05 and of Section 5.06(a) to make them identical to the corresponding provisions of the draft loan agreement. 22. The guarantee agreement is similar to previous guarantee agreements with India. Since the Borrower is a privately-ow,ned company, the guarantee would extend only to the payment of principal, interest and other charges. PART III - APPRAISAL OF THE PROPOSED LOAN 23. A report "Appraisal of the Tata Iron and Steel Company, Limited, Expansion and Modernization Project", No. T.O. 153a, dated October 21, 1957 is attached (No. 4). Justification of the Project 24. The importance attached by the Government of India to the expansion of the iron and steel industry has been demonstrated recently by its inclusion in the "core" of the Second Five-Ye.ar Plan. This is the part of the Plan,   - 6 - including also coal, transportation and related power, to which the highest priority is being given in the allocation of foreign exchange. India's demand for steel is growing rapidly, and any increase in domestic supplies will bring important savings in foreign exchange. In fact the Pian aims to make India self-sufficient in this respect by the early nineteen-sixties, and when the three new government plants come into operation there may even be for a time an exportable surplus in certain lines. India has abundant and conveniently located supplies of the raw materials needed for steel making, and costs of production are among the loiwvest in the world. Apart from saving much-needed foreign exchange, the expansion of the iron and steel industry vwill therefore be of considerable benefit to the economy as a wrhole. Economic and Financial Situation 25. The drain on India's external reserves continues. Between April 1, 1957, when the second year of the Second Five-Year Plan began, and October 25 the foreign excnange holdings of the Reserve Bank fell by Rs. 2 billion (4<82n million), and in addition India drew Rs. 0.34 billion (t,>71.5 million) from the rv7, so that the true loss of foreign exchange during the period mras Rs. 2.34 billion ($jL91.5 million). Of this Rs. 1.07 billion occurred in the April-June quarter, Rs. 1.01 billion in July-September and Rs. 0.25 billion in the four weeks ending October 25. At the latter date the Reserve Bank's foreign exchange holdings amounted to Rs. 3.27 billion (0687 millio0-?) and its gold holdings to Ps. 1.18 billion (*J248 million), making total reserves of Rs. 4.45 billion (p935 million). Against this India's liabilities to the DhF totalled Rs. 0.95 billion (tj.200 million). 26. At the end of October the Government issued an Ordinance amending the currency backing provisions of the Reserve Bank of India Act of 1934. Hitherto, under an amendment to the Act introduced last year, the Issue Department of the Reserve Bank h1as been required to hold as currency cover a minimum of Rs. 1.15 billion (4$24L15 million) of gold plus Rs. h billion (`,8Lo million) of foreign securities - subject to the proviso that the Government could authorize the Rs. L billion to be reduced to Es. 3 billion for periods not exceeding six months in the first instance (vehich periods might be extended with similar sanction for further periods not exceeding three months at a time). The effect of the new Ordinance, which must be submitted to Parliament for approval within six weeks, is to reduce the required foreign security cover from Rs. 4 billion to Rs. 0.85 billion ($;l78.5 million), with the proviso that the Government may sanction this cover to be dispensed with altogether for a period of six months (with 3-monthly extensions as before). The minimum gold cover is to remain un- changed at Rs. 1.15 billion. 27. wlhile detailed balance of payments statistics only go up to the end of March, it is clear that the continuance of the foreign exchange deficit in recent months is primarily attributable to heavy payments for imports of capital goods, industrial materials and components. Export earnings have probably been running- at about the same level as last year. A special factor contributing to the heavy drain on reserves during the summer was the   - 7 - drawing by Burma of half the Rs. 200 million (N$42 nillion) loan made by India last year. The expectations of exchange rate adjustments among the major world currencies, which w,ere vridely prevalent in August and September, no doubt also played their part in increasing the pressure on India's balance of payments in various wrays. In addition the decline in the market value of British GoverrEnent securities held by the Reserve Bank has been reflected in India's reserve figures, since long-term sterling securities are valued at current prices; in the w,eek in vwhich Bank Rate in London was raised to 7T' this factor wvas held responsible for a loss of reserves amounting to about Rs. 90 million. 28. The summer months are the "slack season" in India, and money supply has declined significantly since the end of bMay, with some reduction in the rate of deficit financing by the Government and a seasonal contraction of bank credit to `the private sector. Government transactions have continued to exert an uwar d pressure on money supply, but this has been more than offset by the effects of the balance of payments deficit. WNith the help of record agricultural production last year and a steady flow of grain shipments fram the U.S.A. under the PL 480 agreement considerable pro-ress has been made towards the restoration of internal price stability. The index of wholesale prices rose by 2% in April and 3% in May, remained steady in June and rose by 1-1/2a in July; it then fell by 1% in August and by another 2% in September. At the end of Septernber it was 20 higher than in September 1956. The changes in recent months have been mostly attributable to food; wholesale prices of manufactures have changed little, textile pDrices actuallyi showing a s'light downaward tendency. 29. The local food shortages which occurred during the summer now appear to have been relieved. Preliminary indications vwere that the monsoon had again been favourable this year, but the failure of the late rains is reported to have resulted in drought conditions in certain areas - a situation which could lead to renewed pressure on prices. Industrial production continues to expand at the rate of 8% or 9% a year. In the first half of 1957 mill production of cotton textiles was 5%, higher than in the sarme period of 1956, and armongst other established inclustries output of sugar was up by 5%, of paper by 7%, of steel by 5%, of cement by 9% and of coal by 1C%. The only major industry to show a significant fall in output wras jute manufacturing. It was, however, among the ne-wer industries that the most striking advances occurred. Output of automobiles rose by 12%, of electric lamps by 17%, of tires and tubes by over 20%,, of bicycles and radio receivers by about 30%, of electric fans by 50% and of razor blades by over 100%. With the rise in domestic production and imports the internal transport system has been under heavy pressure, and port congestion in particular has been a cause of serious concern. A Bank Mission has been in India during October and November study- ing the development schemes of the major ports. 30. In a recent statement on the rephasing of the Second Five-Year Plan the Government made it clear to the public that the full expenditures originally proposed could not be carried out wvithin the five years. The total cost of the Plan is now, put at Rs. 54-Rs. 55 billion; against this it has been officially stated that expenditure during the five yearscannot   - 8 - exceed Es. 48 billion, which wvas the original figure for the Plan. In preparing their programs for 1958/59 the Central Ministries and State Governments have been asked not to include any scheme involving foreign exchange on which a substantial start has not already been made, and even where schemes have been started foreign exchange requirements are to be revie-ed so as to reduce com;nitments to the minimum. Development outlays of the State Governments next year are not to exceed this year's level. 31. The Budget was approved by Parliament at the end of August in sub- stantially the same form as originally proposed. However, the expenditure tax has not yet been passed into law. Provision is made for tax increases amounting in all to around Es. 1 billion (;.,210 million) in a full year. Early in August the Central Government successfully floated two loans totalling over Rs. 1 billion, of irhich about two-fifths consisted of con- versions. The first loan, -hich wiias issued at a discount of 1/2%, is for ten years and carries interest at 3-3/4%; the second was issued at par and matures in 1972, with interest at Lii. More recently tWo States, Bornbay and Milysore, have issued loans tota&ling Es. 90 million, and these have been over-subscribed. In support of fiscal and monetary policies designed to restrain internal demand the Governor of the Reserve Bank has called upon the com,ercial banks to 1eep a tight control over their advances and lhas particularly stressed the need to restrict advances against foodgrains and other agricultural cormmodities so as to discourage speculative hoardiLng. Further drastic cuts in imports of consumer goods were announced in September. Prospects of FulfiJinent of Obligations 32. The proposed loan, together with the increased accommodation extended by the State Bank of India, will cover the gap in the Company's investment needs and provide an ample margin of working capital. The Com-pany should have no difficulty in selling its output, both in the inmediate future and after the completion of the expansion program. INet profits after taxes betiwreen novw and 1960, when repayment of the Banlc loan wiould be due to begin, should be sufficient to enable the Company to reduce its overdraft writh the State Bank by more than half. Thereafter net profits are likely to Jall somewThat - partly owing to the highaer taxes v,hich Vill be due -when the special concessions allolwed in India on new fixed assets have lapsed - rising again from 1963 onwvards. But it is estimated that, even during this lowlr period, earnings (before depreciation and interest but after taxes) would cover service on the twro Bank loans and the interest on the State Bank credit at least twice. 33. At the peak of indebtedness in 1960 the ratio of debt to equity wvould be within the limit (50:50) fixed by both the previous and the proposed loan agreements. The Company's liquid position would be satisfactory throughout the construction period and the early years of operations. 3h. India's external public debt now amounts to the equivalent of ;'716 million, excluding U.S. Government loans repayable in rupees. Service payments on this debt may average :L68 million a year from 1960 to 1964, Z60 million a year from 1965 to 1969, and ,p23 million a year from 1970 to 1971.   -9- Average annual service payments during the first of these periods represent about 3.5% of India's external receipts on current account during the year ended last March. The service of the proposed loan vwould require an average of about $7.5 million a year from the middle of 1960 to the end of 1962, the period in which the participating banks would be repaid, and about ,2.5 million a year thereafter until the retirement of the loan in 1971. This should be writhin India's capacity to pay. Method of Procurement 35. Virtually all procurement has been and will be based on international competition. PART IV - CGVPLIA1CE 7jITH ARTICLES CF AGREEI1'ETTi 36. I am satisfied that the proposed loan complies with the requirements of the Articles of Agreement of the Bank. PART V - RECO,-0,IZI,'.DATIO0iS 37. I recomnend that the Bank grant a loan to TISCO in various currencies equivalent to i;32.5 million for a term of 13-1/2 years at an interest rate of 6% with the guarantee of India, and on such other terms and conditions as are specified in the draft loan and guarantee agreements attached, and that the Executive Directors adopt a Resolution to that effect in the form attached (No. 5). Eugene R. Black Attachments ti'ashington, D.C. November 12, 1957