India - Madhya Pradesh Fertilizer Project

Document of The World Bank FOR OFFICIAL USE ONLY A F i Lel. <t6 _ 1 Report No. P-3776-IN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AN]D DEVELO. TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$203.6 MILLION TO INDIA FOR THE MADHYA PRADESH FERTILIZER PROJECT April 13, 1984 | 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 of April 11, 1984) US$1.00 = Rs 10.8044 Rs 1.00 = US$ 0.092554 Rs 1 million = US$92,554 The US Dollar/Rupee exchange rate is subject to change. Conversions in this report were, except as otherwise noted, made at the rate of US$1 to Rs1O.20. FISCAL YEAR April 1 - March 31 ABBREVIATIONS CIF - Cost, Insurance and Freight GDP - Gross Domestic Product GOI - Government of India MIP - Madhya Pradesh NFL - National Fertilizers Ltd. ONGC - Oil and Natural Gas Commission tpd - tons per day tpy - tons per year  FOR OFFICIAL USE ONLY INDIA NADHYA PRADESH FERTILIZER PROJECT LOAN AND PROJECT SUMMARY Borrower: India, acting by its President. Beneficiary: National Fertilizers Limited (NFL). Amount: uS$203.6 million, including a capitalized front-end fee. Terms: Repayment over 20 years, including five years of grace, at the standard variable interest rate. On-lending Terms: US$200 million from GOI to NFL for 15 years, including five years of grace, at an effective rate of not less than 12.75% per annum. The foreign exchange and interest risks would be borne by GOI. Proiect Descri2tion: The objective of the project is to expand domestic nitrogenous fertilizer capacity through the con- struction of a fertilizer plant at Vijaipur in the State of Madhya Pradesh using natural gas as feedstock. The plant would have a daily capacity of about 1,350 metric tons of ammonia and about 2,200 tons of urea. The project also includes the provision of infrastructure and auxiliary and offsite facilities required for the efficient operation of the plant. Possible risks facing the project include implementation delays and start-up and production stabilization difficulties. These risks are mitigated by the use of commercially proven technologies supplied by internationally recognized engineering firms who have experience in executing similar projects in India. The loan will also support a study to rehabilitate two coal-based fertilizer plants at Talcher and Ramagundam, owned by the Fertilizer Corporation of India (FCI). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -ii- Estimated Cast: (US$ millions) Item Local ForeiRn Total Equipment, Materials and Spares 51.8 173.7 225.5 Freight, Handling and Insurance 8.8 17.1 25.9 Duties and Taxes 82.9 - 82.9 Sub-total 143.5 190.8 334.3 License and Engineering Services 13.0 13.3 26.3 Project Management and Insurance 11.4 0.6 12.0 Land and Site Development 8.7 - 8.7 Civil Works and Buildings 33.0 2.0 35.0 Erection and Commissioning 38.4 11.4 49.8 Township 11.2 0.8 12.0 Infrastructure 3.3 0.3 3.6 Base Cost Estimate 262.5 219.2 481.7 Physical Contingency 13.1 11.0 24.1 Price Escalation 23.3 14.7 38.0 Total Installed Cost 298.9 244.9 543.8 Working Capital 30.6 1.0 31.6 Total Project Cost 329.5 245.9 575.4 Interest During Construction 14.0 45.6 59.6 Front-end Fee on Bank Loan - 0.6 0.6 Project Financing Required 343.5 292.1 635.6 FCI Rehabilitation Study 0.5 2.5 3.0 Overall Financing Required 344.0 294.6 638.6  -iii- (US$ millions) Local Foreign Total Equity GOI 207.4 207.4 NFL 100.5 - 100.5 307.9 307.9 Debt IBRD 200.0 200.0 Japan 63.0 63.0 Denmark 9.0 9.0 Italy 4.0 4.0 GOI 15.0 15.5 30.5 Total Long-Term Debt 15.0 291.5 306.5 Short-Term Debt 20.6 ___ 20.6 Total Financing Required by NFL 343.5 291.5 635.0 FCI Rehabilitation Study 0.5 2.5 3.0 Front-end Fee on Bank Loan - 0.6 _ Overall Financing Required 344.0 294.6 638.6 Estimated Disbursements: (US$ millions) FY85 FY86 FY87 FY88 FY89 Annual 21.1 68.4 62.5 39.7 11.9 Cumulative 21.1 1/ 89.5 152.0 191.7 203.6 Rate of Return: About 18%. Appraisal Report: No. 4657-IN, dated April 18, 1984. 1/ Including US$0.6 million as front-end fee.   INTERKATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR THE MADHYA PRADESH FERTILIZER PROJECT 1. I submit the following report and recommendation1 for a proposed loan to India in an amount equivalent to US$203.6 million, including US$0.6 million as capitalized front-end fee, to help finance construction of a fertilizer plant at Vijaipur in the State of Madhya Pradesh. The loan would also support a rehabilitation study of two coal-based fertilizer plants owned by the Fertilizer Corporation of India (FCI). Amortization would be over 20 years, including five years of grace at the standard variable interest rate. The Government of India (GOI) would onlend US$200 million of the proceeds of the proposed loan to National Fertilizers Limited (NFL) for 15 years, including five years of grace at an effective rate of not less than 12.75% per annum, and make US$3 million available to FCI. GOI would bear the foreign exchange and interest rate risks. PART I - THE ECONOMY 1/ 2. An economic report, "Economic Situation of India and Resource Mobilization Issues" (4395-IN, dated April 11, 1984), was distributed to the Executive Directors on April 19, 1983. Country data sheets are attached as Annex I. Background 3. India is a large and diverse country with a population of about 700 mil- lion (in mid-1982) and an annual per capita income of US$250. The economy is dominated by agriculture which employs more than two-thirds of the labor force. However, the land base is not sufficient to provide an adequate livelihood to everyone engaged in agricultural activities, especially those with little or no land. Growth of value-added in agriculture -- 2.2% since 1950/51 -- has been slower than growth of industrial value-added (5.0% per annum). As a result, there has been a gradual decline in the share of agriculture in GDP (at factor, cost) from 60% to just under 40%, while the share of industry rose from 15% to around 25%. But industrialization has not been rapid enough to absorb the growing labor force, or to bring about a rapid economic transformation, with significantly higher productivity and income levels. As a result economic growth has been slow over the past three decades, averaging about 3.6% per annum since 1950/51. 4. Nevertheless, there has been steady progress with per capita income rising by about 1.4% per year in the period 1950 to 1980. Despite the large 1/ Parts I and II of the report are substantially the same as Parts I and II of the President's Report for the Periyar Vaigai Irrigation II Project (No. P-3768-IN), dated April 10, 1984.  -2- population base and its relatively rapid growth, India has been able to eliminate persistent dependence on foodgrain imports through significant improvements in agricultural production. Savings and investment have increased markedly since 1950/51: gross national savings more than doubled from 10.8% of GDP (at factor cost) to 22.8% in 1982/83, while gross domestic investment rose from 12.5% of GDP to 24.9% in 1982/83. Foreign savings (balance of payments deficit on current account) have never financed a major portion of domestic investment: a peak of about 20% was reached during the early 1960s. Surpluses arose for a few years in the late 1970s, and at the present time, foreign savings are about 8% of investment. External assistance has been low both as a percentage of GDP and in per capita terms, never rising above 3% of GDP and averaging below 1% for the past five years. Net foreign savings have never risen above 3% of GDP, and presently stands at 2.1%. 5. Before the 1970s, India placed relatively less emphasis on export promotion and more on import substitution. The volume growth of exports between 1950/51 and 1969/70 averaged only 2.2% per annum, while the volume growth of imports over the same period was 4.3%. In the early to mid-1970s, however, India's terms of trade, which had remained roughly constant during the 1960s, deteriorated sharply. In response, the Government introduced various policy measures designed to stimulate exports. As a result, the volume of India's exports grew on average about 7.3% per annum for the 19708 as a whole, a performance which demonstrates that sustained rapid growth is possible. While expanding world markets, particularly in the nearby Middle East, con- tributed to this growth, liberalized access to imported inputs and more effec- tive export incentives played a major role. 6. Moving into the second half of the 1970s, the Indian economy was buoyed by higher levels of investment and an expanding level of foodgrain output. As a result, growth in real GDP and in agricultural and industrial value-added, substantially exceeded the historical 30-year trends (paragraph 3) averaging 4.9%, 3.9% and 5.6%, respectively. In 1979/80, however, this momentum was broken when the worst drought in recent years, combined with a doubling of international oil prices and domestic supply shortages, led to a sharp fall in foodgrain production, a decline in GDP, and the opening up of a large trade deficit. Severe inflationary pressures also emerged after several years of virtual price stability. These setbacks in 1979/80 coincided with the prepara- tion of the Sixth Five-Year Plan which laid down a program of adjustment that aimed at improving the trade deficit, removing infrastructural bottlenecks and ensuring price stability with an overall growth of the economy of 5.2%, 1.6 per- centage points above the trend growth of 3.6%. Recent Trends 7. In 1980/81 and 1981/82, the economy substantially recovered with real GDP growing by 7.9% and 5.2%, respectively. While industrial output expanded by 4% in 1980/81 and 8.6% in 1981/82, recovery was particularly robust in agriculture where normal weather helped output to rise by more than 15% and 5.5%, respectively. The availability of power, coal, and rail transport, already improved in 1980/81, was even better in 1981/82, recording growth rates of about 10%, 9.6% and 12.9%, respectively. The easing of constraints on the supply of infrastructure and basic commodities was a determining factor in the improved performance of the industrial sector. This overall improvement in the Indian economy, combined with a more restrictive monetary policy contributed to .a sharp decline in the rate of inflation. Wholesale prices rose by about 9% on  -3- an average annual basis in 1981/82 and by only 2.5% in 1982/83, reflecting a strong deceleration from a peak increase of 18% in 1980/81. 8. After two years of fairly solid performance, the Indian economy faced a difficult year in 1982/83 due to the drought in mid-1982 which brought down the GDP growth rate to around 2% and put further strains on the already dif- ficult balance of payments and domestic resource situation. Besides a sig- nificant decline in the range of 4.5%-6.5% in agricultural production, GDP growth was also constrained by a slowdown in industrial growth from 8.6% in 1981/82 to about 4% in 1982/83. This resulted from a combination of several factors, notably the decline in agriculture income, persistent (though lessened) power shortages, a textile strike in Bombay, as well as depressed export markets and increased competition from imports. The Government was able, however, to protect the level of savings to a large extent and keep the momentum of the investment program through largely successful public sector resource mobilization efforts. Foreign savings played a crucial role in sup- port of this effort. Similarly, the timely implementation of various economic policies mitigated the otherwise very distressing effects of a poor monsoon. Continued improvements of the infrastructure sectors, although at a slower pace than in the previous two years, also reduced the negative effects of the drought. 9. Agricultural production in 1982/83 received a serious setback from the drought. Foodgrain production, which had reached a record 133 million tons in 1981/82, declined to 124-127 million tons. Production of most other major crops also declined in 1982/83. Corrected for weather variations, this still represents a creditable performance. In 1979/80, with a broadly comparable monsoon, foodgrain production reached only 109 million tons. The Government was able to mitigate the effects of the 1982 drought through efficient manage- ment of foodgrain procurement and distribution, careful timing of foodgrain imports, and appropriate allocation of power to irrigation pumps. These policies helped to avoid disruptions in basic food supplies and contributed to price stability during the year. While the management of the foodgrain economy after the drought was a significant achievement, the effect of the drought on production re-emphasized the continued importance of the monsoon in India's agriculture. The performance of the recent past and probable future trends suggest that on average foodgrain supplies will meet demand. The balance remains delicate, and the need for foodgrain imports to maintain con- sumer supplies or adequate buffer stocks could arise from time to time. Thus, programs to expand irrigation, strengthen extension and encourage the efficient use of other agricultural inputs continue to receive high priority. 10. Basic infrastructure services performed generally well in 1982/83, although growth of coal, power and rail transport failed to maintain the momen- tum of the marked recovery of 1981/82. Despite lower hydro generation due to the failure of the monsoon, overall power generation recorded an increase of about 7%. This was due largely to an increase in capacity utilization in thermal plants resulting from improved overall management, stabilization of most of the new large units and better availability of coal due to the combina- tion of increased coal production and improved railway performance. Nevertheless, power shortages remain the major bottleneck in the economy. Railway traffic grew by only 3.7% in 1982/83 reflecting a slowdown from 1981/82. The lower growth was due not to a decline in the operational efficiency of the railways but rather to slack demand from core sectors like steel, iron ore, coal washeries and fertilizers. Coal production growth (4% in 1982/83), after 10% growth in the two preceding years was creditable. There were no major shortages and there were improvements in the quality of coal.  -4- Recent easing of shortages and bottlenecks in infrastructure has come primarily from better utilization of existing capacity, but in the future most improve- ment must result from added capacity. It is therefore critically important that India maintain the pace of investment in these key sectors and mobilize sufficient resources to do so. 11e The Indian economy has reverted from a situation of resource surplus, which had been a temporary phenomenon of the late 1970s, to one of resource scarcity. Investment has again grown quicker than national savings, and the scope for further increases in the latter appears limited. India's gross national savings rate, which averaged 22.4% of GDP in the last three years, is high by any standard, particularly considering India's low income and the large proportion of its population living below the poverty line. Future increases in savings will depend heavily upon the enhanced profitability of public sector enterprises which would require better utilization of capacity, more efficient operations and adequate pricing policies. In 1981/82 there was a significant increase in public savings due to improved profitability of various public sector enterprises. This trend which was maintained in 1982/83 needs to be accelerated. The gap between gross investment and national savings which rose from 0.4% of GDP in 1979/80 to 1.8%, 2.3% and 2.1%, respectively in the first three years of the 1980s, has been financed by foreign savings. 12. India's ability to generate resources to meet its development objec- tives has become increasingly linked to the balance of payments. The current account balance which recorded surpluses between 1976/77 and 1978/79, sharply deteriorated to deficits of nearly US$2.9 billion in 1980/81 and US$3.8 billion in 1981/82 (1.8% and 2.3% of GDP, respectively). This was partly due to a sharp rise in the oil import bill as a result of both the disruption of oil production in northeast India in 1980 and significant oil price increases, and to a more liberal import policy aimed at providing producers with access to inputs for higher capacity utilization, greater efficiency, improved technology and capacity expansion. The current account deficit in 1982/83 declined to US$3.3 billion or 2.1% of GDP. The improvement would have been greater had not the drought resulted in the need to rebuild food stocks through imports and at the same time led to a lower level of GDP growth. This improvement in the balance of payments is to a significant degree the result of India's develop- ment and adjustment efforts over the past three years. It also reflects a reduction in the trade deficit as compared to the levels reached in 1980/81 and 1981/82. The trade deficit declined from US$7.6 billion in 1980/81 to US$6.0 billion in 1982/83 due to continued export volume growth (following the sub- sitantial resumption in 1981/82) despite poor world market conditions, coupled with the containment in import growth due to import substitution of petroleum products, metals and fertilizers while allowing substantial growth in "other" imports through more liberal import policies. Nevertheless, it is expected that the balance of payments will be under strain for the next several years, for India's adjustment program will continue to require high levels of imports. .13. The high investment rate, about 25% of GDP, envisaged in the Sixth Plan coupled with the limited possibilities of raising domestic savings beyond the present high levels, necessarily implies a need for external resources. Faced with a reduction in the availability of bilateral and multilateral concessional aissistance, India has begun to borrow significant amounts on commercial terms f-rom the Euro-dollar market in addition to much greater utilization of suppliers' and export credits. India's favorable debt service profile has enabled India to tap commercial capital markets at favorable spreads (over  -5- relatively high underlying rates). In the period 1980-82 India contracted commercial loans totalling over US$2,000 million and suppliers' credits of about US$520 million. The bulk of the loans are linked to specific development projects in the public sector while the credits are linked, by and large, to development projects in the private sector. India also reached an agreement with the International Monetary Fund for the use of the Extended Fund Facility for SDR 5 billion, of which SDR 2.5 billion have already been drawn. The transfer of funds under the EFF has stemmed the use of foreign exchange reser- ves which had fallen to less than four months of import coverage in 1981/82. In 1982/83, in addition to continued use of the EFF, financing requirements were met by increased non-concessional borrowing (about US$2,000 million in new commitments) and a 10% increase in net aid disbursement. DeveloPment Prospects 14. The experience of recent years illustrates that India has the capacity to grow and develop at a more rapid pace. Although the iLdustrial sector is small compared to the size of the economy, it nevertheless is large in absolute terms and has a highly diversified structure, capable of manufacturing a wide variety of consumer and capital goods. Basic infrastructure -- irrigation, railways, telecommunications, power, roads and ports -- is extensive compared to many countries, although there is considerable need for additional capacity as well as improvement in the utilization of existing capacity. India is also well-endowed with human resources and with institutional infrastructure for development. Finally, India has an extensive natural resource base in terms of land, water, and minerals (primarily coal and ferrous ores, but also gas and oil). With good economic policies and reasonable access to foreign savings, India has the capability for managing these considerable resources to accelerate its long-term growth. 15. The medium-term framework for advancing India's development objectives is the Sixth Five-Year Plan (1980/81-1984/85), which is now in its fourth year. The Plan assigns priority to agriculture, energy development, the growth of exports and domestic import substitutes where appropriate, and the removal of infrastructural bottlenecks. Overall performance has so far been encouraging, although bottlenecks in key sectors such as power and transport are likely to persist. Moreover, fulfillment of the Plan targets will require additional resource mobilization. The efforts of the Central Government to raise resour- ces have so far been impressive and are likely to be broadly sufficient to meet the financing requirements of the Central Government's share in plan investment, even if some increase in inflation is experienced above current low levels. However, a shortfall in public savings is likely to occur in some States unless further measures are introduced. There will be a need also for continuous efforts to maintain the current level of private savings. Recent increases in interest rates and tax concessions on time deposits and the con- tinued dampening of inflationary expectations should stimulate such savings. 16. The higher capital formation rates of the past few years augur well for future income growth. However, returns to investment have so far been relatively low. Much of this phenomenon relates to India's stage of development, in which a large and growing proportion of investment has been needed to build up basic infrastructure. These services, such as power, tran- sport and irrigation, have inherently high capital-output ratios. However, there is scope to improve the sectoral capital-output ratios through greater efficiency and better management. Bottlenecks in basic infrastructural sectors  -6- clearly can prejudice growth in other sectors where large investments have been made. As demonstrated in the last three years, performance in the basic serv- ice sectors can be improved through better planning and management, thus lead- ing to higher productivity and capacity utilization throughout the economy. At the same time, programs to expand domestic capacity are vital. In the case of tradeable commodities like coal, steel and cement, this is justified on the grounds of comparative advantage. For sectors such as irrigation, power and transportation, expansion of planned capacity in accordance with the require- ments of the rest of the economy will be vital to overall medium- and long-term development prospects. In the short term, however, achieving an adequate balance between supply and demand in these sectors will remain a difficult objective. 17. Under the Sixth Plan, India has an ambitious oil production program backed by substantial financial commitment. While the gap between domestic consumption of petroleum and production remains large, the prospects for progressive substitution of domestic petroleum for imports are quite bright. In 1981, and again in early 1983, resources for exploration and development were raised by successive price increases for domestic crude and products. India's dependence on oil imports dropped from 63% in 1979/80 to about 45% now and a scheduled expansion in production is expected to decrease oil imports (in crude equivalent terms) to about 33% of consumption by 1984/85. The rapidly expanding level of exploration activity, combined with the possibilities for accelerated offtake from known fields, offers much encouragement for India's longer-term energy prospects. 18. Despite an expected continued decline in its current account deficits from the current 2.1% to about 1.7% of GDP by the late 1980s, India will require growing access to world financial markets to complement concessional assistance. These commercial sources of funds will be important in the future since India's current account deficits, though not large relative to the size of the economy, will nevertheless be large in absolute terms and will neces- sitate external borrowing beyond levels expected to be available from normal concessional sources. Given the favorable structure of India's external debt, which reflects the past reliance on concessional sources, India should remain creditworthy for a substantial growth in external borrowing. 19. India's development prospects over the next few years will hinge on the extent to which the economy can be brought into both internal and external balance, while at the same time achieving more rapid growth than in the past. In the longer term, income growth represents the best strategy for achieving these needed adjustments, both by generating higher savings for further investment, and by fostering the development of export and import-substituting industry to improve the balance of payments. In the short term, a relatively large external borrowing, including an increased emphasis on commercial borrowing, will be necessary to cope with the balance of payments consequences of such a growth strategy. However, an important element in providing India with the capacity to adjust flexibly will be adequate flows of concessional assistance. Although India is currently in a position to increase borrowing on commercial terms from the very low levels of the past, there are, of course, limits beyond which India will choose to sacrifice growth objectives rather than accept debt on unfavorable or unmanageable terms. The Government's effort to maintain an adequate rate of growth while adjusting the structure of the Indian economy to a more open and efficient environment requires foreign resources in addition to the level of commercial borrowing available to India.  -7- India is still a very poor country with a large rural sector and enormous investment requirements for human development and basic infrastructure. The fact that India has been able over the past seven years to maintain a rate of growth above the long term trend, despite the poor monsoons of 1979/80 and 1982/83, lends substance to the hope that a more open trade policy and con- certed efforts to remove constraints on the growth of productive capacity, supported by adequate mobilization of savings both foreign and domestic, can sustain a rate of growth closer to 5.0% per annum than the long-run trend of 3.6% per annum. Combined with a reduction in the rate of population increase to below 2.0% per annum, a 5.0% growth rate would mean a doubling of the trend rate of growth of per capita income of less than 1.4% per annum. Success in these efforts would make a significant difference to the prospects of easing poverty in India. 20. A large and growing population and severe poverty underline the need to accelerate India's development efforts. The 1981 Census placed India's popula- tion at 683.8 million, or about 12 million higher than official projections. The fact that there was no decline in inter-census rates of population growth, equivalent to about 2.2% per annum, is a cause for concern. While further analysis of the Census may suggest this rate of growth to be slightly overestimated, the expectation of a measurable decline in the population growth rate has not materialized. Until the results of the Census are fully analyzed, firm judgements about the reasons for this outcome are not possible. However, the results re-emphasize the need for continuing efforts to strengthen the health and family planning program in a broad range of activities and services. These efforts are given high priority in the Sixth Plan, which aims at a rise in the proportion of protected couples in the reproductive age group from its estimated 1979/80 level of about 23% to over 35% by 1984/85. 21. Reduction of poverty remains the central goal of Indian economic growth. More than one-third of the world's poor live in India, and more than 80% of the Indian poor belong to the rural households of landless laborers and small farmers. About 51% of the rural population and 40% of the urban popula- tion subsist below the poverty line. Improvements in the living standards of the poor will depend to a large extent on the overall growth of the economy, particularly on increases in agricultural production and employment, and in non-farm rural employment. These developments will have to stem in large part from market forces which can be encouraged and reinforced by appropriate Government policies and the strengthening of basic services and infrastructure. The declining trend in real foodgrain prices between 1970 and 1981, resulting from India's sustained effort to raise agricultural production, reflects such developments. There is also a role for direct Government action in faster implementation of land reform (though the scope for significant reduction in poverty through land redistribution is quite limited in India), in increasing the supply of credit available to small farmers and rural artisans, and finally in broadening the provision of those services which enhance the human capital of the poor and improve living standards. Many of the latter are elements of the Minimum Needs Program, which has been an integral part of Indian planning for the past decade. Progress has been slow but steady in the expansion of primary education, the extension of rural health facilities and the provision of secure village water supplies. Operations such as the community health volunteer program and the national adult literacy campaign provide encouraging evidence that well-targetted, relatively low-cost programs can lead to enhanced prospects for India's poor.  -8-- PART II - BANK GROUP OPERATIONS IN INDIA 22. Since 1949, the Bank Group bas made 71 loans and 156 development credits to India totalling US$4,683 million and US$11,447 million (both net of cancellation), respectively. Of these amounts, US$1,332 million has been repaid, and US$5,907 million was still undisbursed as of March 31, 1983. Bank Group disbursements to India in the current fiscal year through March 31, 1983 totalled US$1,008 million, representing an increase of about 17 percent over the same period last year. Annex II contains a summary statement of disburse- ments as of March 31, 1983, and notes on the execution of ongoing projects. 23. Since 1959, IFC has made 28 commitments in India totalling US$220.4 million, of which US$28.3 million has been repaid, US$56.2 million sold and US$17.3 million cancelled. Of the balance of US$118.6 million, US$111.1 mil- lion represents loans and US$7.5 million equity. A summary statement of IFC operations as of March 31, 1983, is also included in Annex II (page 5). 24. The thrust of Bank Group assistance to India has been consistent with the country's development objectives in its support of agriculture, energy and infrastructure. Of particular importance have been investments in irrigation, extension and on-farm development designed to increase agricultural productivity, and efforts to improve the availability of basic agricultural inputs to farmers through credit, fertilizer, marketing, storage, and seed projects. Major elements of the lending program have also been directed at helping to meet the energy needs of the economy while curbing the growth of oil imports, and to ease the infrastructure bottlenecks which have hampered economic growth in India, particularly through power generation and distribution, and railways and telecommunications projects. The Bank Group has also provided financing for a broad range of medium- and small-scale industrial enterprises, primarily in the private sector, through its support of develop- ment finance institutions. Recognizing the importance of improving the ability to satisfy the essential needs of urban and rural populations, the Bank Group has supported nutrition and family planning programs, a rural roads project, as well as water supply and sewerage and other urban infrastructure projects. 25. This pattern of assistance remains highly relevant, and consonant with Government priorities, as reflected in the Sixth Plan. The continued active involvement of the Bank Group in agriculture, energy and infrastructure development will appropriately contribute to India's adjustment and growth prospects. Irrigation will need continuing support, with emphasis on improved efficiency in water conveyance systems to ensure reliable delivery to farmers' fields. In addition, major investments to develop the large Narmada River basin will be vital to India's efforts to increase agricultural production. Important complements to these efforts, such as fertilizer production and distribution, agricultural credit and extension, will continue to receive support. A continued program of investments aimed at rapidly increasing the domestic supply of energy will clearly be necessary if India is to curb the cost of oil imports and alleviate the critical power shortages which constrain output in both the agricultural and industrial sectors. Exploitation of oil and gas resources is a central element of this program, which should be supple- mented by investments in hydro and thermal power generation, and in the expan- sion of the transmission and distribution networks. Industrial projects to increase the domestic production of basic commodities, which have been in short supply and which India has a comparative advantage in producing, should also receive high priority. Finally, raising the efficiency and levels of transpor-  -9- tation infrastructure would mitigate a key constraint to achieving higher levels of economic growth so that further support of the railways and for ports development will be particularly appropriate. 26. The need for a substantial net transfer of external resources in support of the development of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. Thanks in part to the response of the aid community, India successfully adjusted to the changed world price situation of the mid-1970s. However, there is now a need for increased foreign assistance to India, not only to help the economy adjust to the more recent oil price increases and the overall deterioration in the world trade environment but also to maintain the rela- tively higher growth rates achieved during the first two years of the Sixth Plan. As in the past, Bank Group assistance for projects in India should aim to include the financing of local expenditures. India imports relatively few capital goods because of the capacity and competitiveness of the domestic capital goods industry. Consequently, the foreign exchange component tends to be small in most projects. This is particularly the case in such high-priority sectors as agriculture, irrigation, and water supply. 27. India's poverty and needs are such that whenever possible, external capital requirements should be provided on concessionary terms. Accordingly, the bulk of the Bank Group 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 needs for external support. This requirement for additional assistance can be met, in part, through Bank lending. Given its development prospects and policies, India is judged credit-worthy for Bank lending to supplement IDA assistance. A con- tinuation of efforts already underway to achieve growth in productive capacity, trade expansion, higher levels of savings, foodgrains self-sufficiency and a reduction in the rate of population growth should result in continued economic growth and improvement in the balance of payments. Despite recent setbacks, India's external payments position is still manageable. The ratio of India's debt service to the level of exports was about 11% in 1982/83 and is projected to remain below 20% through 1995/96. As of March 31, 1983, outstanding loans to India held by the Bank totalled US$3,471 million, of which US$1,854 million remain to be disbursed, leaving a net amount outstanding of US$1,617 million. 28. Of the external assistance received by India, the proportion con- tributed by the Bank Group has grown significantly. In 1969/70, the Bank Group accounted for 34% of total commitments, 13% of gross disbursements, and 12% of net disbursements as compared with 50%, 43% and 53%, respectively, in 1981/82. On March 31, 1982, India's outstanding and disbursed external public debt was about US$17.9 billion, of which the Bank Group's share was US$7.1 billion or 38% (IDA's US$5.9 billion and IBRD's US$1.2 billion). In 1981/82, about 16.0% of India's total debt service payments were to the Bank Group.  -10- PART III - THE FERTILIZER SECTOR 29. Increased fertilizer use is central to India's efforts to increase agricultural output. Consumption of fertilizers in India increased at an annual average rate of about 15% between the early 1960s and mid-1970s but the rate of increase declined somewhat from 1977/78 to about 8.6% per year. Consumption is currently estimated to be 7.3 million tons per year (tpy) of nutrient, of which 67% is nitrogen, 22% is phos- phates and 11% is potash. Although fertilizer consumption has been grow- ing rapidly, application rates in India (36.6 kg of nutrient per hectare (ha) in 1982/83) are still low when compared to many other developing countries. There are also widespread disparities in fertilizer use among states, so that considerable scope exists for further expansion of fer- tilizer use. Despite this scope for expanded use, however, projections of nitrogen demand are based on slower rates of annual demand growth of 6% by 1989/90 and 5% through the 1990s. 30. India's production capacity for both nitrogen and phosphatic fertilizers has grown from 148,000 tpy (of nutrient) in 1952 to its cur- rent level of 5 million tpy. Production technologies and plant capacities have changed considerably over this period and have been broadly in line with international trends. Locational decisions have been made in the light of regional demand/supply, raw material sources and infrastructure considerations. Feedstock choice initially emphasized naphtha and later fuel oil which were available from existing domestic refineries and, subsequently, coal so as to decrease dependence on imported hydrocarbons. After the discovery of large quantities of natural gas in the Bombay High and Bassein fields, all new plants have been based on this feedstock. India is currently the fourth largest fertilizer producer in the world. Production capacity (including the Madhya Pradesh project) is expected to reach 7.4 million tpy by 1988/89. 31. Despite an impressive build-up in production capacity, India still needs to import about one-third of its fertilizer requirements. In 1981/82 imports were 2 million tpy, valued at about US$750 million, repre- senting some 9% of merchandise export earnings. Imports decreased to 1.1 million tpy in 1982/83 due to increased domestic production and a drawdown in stocks. To increase domestic production of fertilizers so as to substitute for imports, the Government attaches high priority to the installation of new production capacity, with emphasis on large, gas-based plants. Under current demand/supply projections, imports would remain about in line with 1982/83 levels through most of the 1980s, but would rise once more to about 1.4 million tpy by 1989/90 and reach about 3.1 mil- lion tpy by 1994/95. 32. In addition to establishing new facilities, the Government is keenly aware that in order to mitigate the cost of imports, the utiliza- tion of existing capacity will need to receive attention. Capacity utilization has varied widely over time and between different plants and companies. From an average of 58% in 1974, capacity utilization improved to 72% in 1978/79. However, production in several cooperative and public sector plants suffered in late 1979 and throughout 1980 on account of the non-availability of inputs such as naphtha, fuel oil and coal, and because  -11- of power cuts, sharply reducing the country's overall capacity utilization in 1979/80 to 66%. Partly as a result of improved input supply, the current all-India average capacity utilization has risen slightly to about 68%. The cooperative sector (i.e. IFFCO) has shown on average the highest level of capacity utilization, followed by the private and joint sectors. The overall performance of the public sector has been somewhat lower. These differences in capacity utilization, however, cannot be entirely explained by management and ownership factors alone. The private sector plants are generally of smaller capacity based on proven design. As a group they have been in operation longer and have already solved initial problems. The public sector plants, on the other hand, being generally of more recent origin, are larger, use a more varied range of feedstocks and have been built with much greater content of local equipment and engineering. Two large coal-based plants at Talcher and Ramagundam have suffered technical problems associated with the use of a new and difficult coal gasification technology for ammonia production. Among other major factors leading to low overall capacity utilization have been problems of commissioning new plants, equipment failures, raw material supply problems, continuing operating problems due to design defects in several older public sector plants, power supply and coal transportation problems. Additionally, foreign exchange shortages have placed substantial reliance and strains on indigenous engineering and equipment suppliers. 33. It is difficult to generalize about the causes and measures needed to correct the physical deficiencies of many existing Indian fer- tilizer plants. It is recognized by GOI that a comprehensive approach needs to be taken, based on systematic review and analysis, leading to investments to debottleneck certain plants, Regarding new undertakings such as the MP project, GOI is already taking measures to avoid past mistakes; projects are now more closely scrutinized by technical commit- tees which include representatives from the operating firms, the Government and engineering firms; more attention is now given to the use of proven technology and proven equipment, with foreign firms participating. Also, new plants are normally approved with sufficient captive power generation capacity to enable them to operate without reliance on an unstable grid supply. Moreover, the use of natural gas as feedstock minimizes the plants' dependence on the transport system for supplying feedstock. Also, greater importance is given to ensuring the availability of adequate transport and infrastructure facilities. 34. With respect to existing plants, the Government, in consultation with the Bank, initiated in 1983 comprehensive plant-by-plant studies to identify technical rehabilitation measures which would permit higher capacity utilization and energy conservation investments to reduce operat- ing costs. The program began with the three NFL plants at Nangal, Bhatinda and Panipat whose evaluations are under review by the NFL Board. By December 1, 1984, the approach will be extended to plants of three other public sector companies, and thereafter to all public sector plants. Based on systematic reviews and analysis, with which the Bank will be associated, investments will be formulated to debottleneck certain plants or to gradually phase out those plants which cannot be economically con- verted into efficient production facilities. A special area of focus will be the coal-based plants at Talcher and Ramagundam whose capacity utiliza-  -12- tion reached only 19% and 33%, respectively, in 1983/84. Consultants, to be financed under the proposed loan, will conduct comprehensive studies to prepare rehabilitation plans for these two plants. The studies are expected to be completed by the end of 1984. 35. Apart from the technical problems outlined above, there have also been problems with the management of public sector companies insofar as too little incentive was provided to improve capacity utilization and reduce production costs. Recognizing these constraints, the Government has devised an improved incentive system for managers whereby they are given bonuses for achieving predetermined production and input consumption levels. This scheme is currently being used on an experimental basis experimentation in three plants and, if successful, would be extended to all public sector plants. A bonus system for all staff engaged in project implementation is also being tested in the public sector in the Thal Project, and will be used in the Madhya Pradesh Project. Fertilizer Prices 36. The retail and ex-factory prices of fertilizers in India are administered by the Government. Prices at which fertilizers are sold to farmers are uniform throughout the country and are set at levels to ensure that farmers have sufficient incentives to increase fertilizer use. Ex-factory or retention prices are set on a plant-by-plant basis at levels which will allow each producing unit, when operating efficiently to earn post-tax returns of 12% at 80% capacity utilization. This price-setting formula (i) permits new plants to be financially viable; (ii) gives incentives to raise levels of capacity utilization; and (iii) gives producers sufficient incentives to invest in new capacity. Since this pricing system was introduced in 1978, domestic retail prices have been increased steadily so as to keep them in harmony with international prices (except briefly in 1974/75 and 1979-81 when international prices rose exceptionally rapidly), as indicated below:  -13- India: Comparison of Past Domestic Retail Prices and Import Costs of Urea (current Rupees per ton) Delivered Cost Retail of Fertilizer Price a/ Import b/ March 1972 959 660 October 1973 1,050 1,164 June 1974 2,000 2,820 July 1975 1,850 2,620 March 1976 1,750 1,215 February 1977 1,650 1,295 October 1977 1,550 1,455 March 1979 1,450 1,530 November 1979 1,450 2,310 June 1980 2,000 2,640 July 1981 2,350 3,000 March 1983 2,350 2,370 July 1983 2,150 2,000 March 1984 2,150 2,170 a/ Excludes pool equalization surcharge and local taxes. b/ CIF Bombay (converted at exchange rates prevailing at the time), plus allowances for port handling and related charge. The present retail price of Rs 2,150 (US$211) per ton of urea is close to the imported cost of urea of Rs 2,170 per ton. It is substantially above prices paid by farmers in neighboring countries. Moreover, the real price of nitrogen in terms of the number of kilograms of paddy or wheat required to purchase a kilogram of nitrogen is higher in India than in neighboring countries. Adjustments in fertilizer prices can, therefore, only be implemented gradually and in parallel with changes in crop prices if adequate profitability for fertilizer use by farmers is to be maintained. The weighted average ex-factory retention price allowed to Indian fer- tilizer producers is currently Rs 2,800 (US$287) per ton, which is below the world equilibrium CIF price of US$325 per ton projected for the end of the 1980s. Since current average retention prices are above retail prices, a Government subsidy is required to sustain the producer incen- tives r.ferred to above. The overall costs of that subsidy rose rapidly in the early 1980s due principally to the sharp rise in energy prices in  -14- India which constitute a significant element of production costs, L/ as well as the costs of other by inputs. The subsidies paid by GOI for fertilizers are as follows: Impact of Fertilizer Price Support on Public Finances US$ million (in constant 1981/82 prices) 1981/82 1982/83 1983/84 1984/85 (estimates) Government 435 690 1,085 1,007 Outlays Consumption 6,067 6,418 7,331 7,800 Nutrients Tons (thousands) Government Support 72 108 148 129 (US$) Per Nutrient Ton Not all of these subsidies represent a net outflow of funds from the Government's budget, since payments under the retention price for high energy costs and for high duties and taxes on capital equipment will accrue as revenues to other public sector undertakings and Government departments. Nevertheless, the Government recognizes the need to contain the increase in subsidies for the fertilizer sector, and has initiated a number of actions, in addition to those described above in paras 33 through 35, designed to reduce production costs and improve the efficiency of the fertilizer sector. First, a high level inter-agency committee of the Government has been formed to review the fertilizer pricing system. Specifically, it would address issues such as the appropriate level of input prices, plant feedstock and utility consumption efficiencies, capacity utilization norms and other key aspects of the system of comput- ing retention prices. Recommendations of the Committee are scheduled for early 1985. Second, to reduce Government expenditure on the distribution of fertilizers, imports are being timed so as to reduce inventories. Average levels of stocks have been reduced considerably in the past two years. Movements of fertilizer from ports and plants to consuming areas are being rationalized, with average haulage distances having been reduced by about 20% over the past three years. These measures have begun to take effect, and both the aggregate and per ton amount of subsidy are expected 1/ Between 1979 and 1983 natural gas prices were increased by 1,290%, naphtha, by 155%, power by 75%. For the MP Project, energy costs account for over 50% of total production costs per ton of urea or about US$126 compared to energy costs for similar plants in the US and Eastern Europe of about US$74 and US$27, respectively.  -15- to decline in the future (see Table above). It is difficult to quantify with any precision the overall savings to the Government which might result from all these measures. On average, however, energy consumption can be reduced by 15%, and as a result production costs could decrease by about 10%. A concerted program of energy conservation, combined with other measures being considered by GOI (such as duty reductions on imported equipment to lower project capital costs, and changes in the capitalization ratio of public sector fertilizer companies), would con- siderably reduce Government payments under the retention price formula and could reduce subsidy payments per ton of urea by as much as 30%. Appropriate follow-up measures will be evaluated by the Bank after comple- tion of the technical and energy audits and the Government study on prices. Overall, GOI's fertilizer pricing policy effectively meets its twin objectives of promoting agricultural production by ensuring appropriate incentives to farmers to use fertilizer while at the same time attracting private investment in fertilizer production and ensuring suffi- cient financial returns to investors. Under the project, the Government would not take, or cause to be taken, any action which would prevent fertilizer manufacturers from meeting their expenses, servicing their debt and earning a reasonable return on invested capital (Section 4.04, Loan Agreement). Fertilizer Investment Strategy 37. Given the large quantities of natural gas available from West Coast and offshore sources and the advantages of using natural gas as feedstock, the principal thrust of India's investment program in fer- tilizers will be to expand nitrogen production through the construction of large ammonia/urea plants. In addition to the project, five additional plants are scheduled for construction over the next few years. Recognizing, however, the substantial alternative claims on public funds, and limitations in the managerial capabilities of the public sector, the five additional plants are planned to be implemented in the private and cooperative sectors. Previous Bank Group Operations 38. The Bank Group has supported the fertilizer industry in India through 11 projects with a total financial contribution of nearly US$900 million. The financing has been through IDA for seven public sector projects, IFC for three private sector projects, and IBRD for a coopera- tive sector project. Five of the IDA projects, which aimed at balanced expansions of capacity in the public sector while at the same time remov- ing bottlenecks to the efficient utilization of existing capacity, have been completed. According to their project completion reports, the first three of these, at Cochin (Credit 624-IN of July 1, 1971), Gorakhpur (Credit 279-IN of December 21, 1971) and Nangal (Credit 357-IN of January 30, 1973), experienced completion delays following delays in finalizing the engineering arrangements (Gorakhpur), poor project manage- ment (Cochin) and late delivery of equipment (Nangal), as well as cost overruns of 35% to 45% following the 1973 oil crisis. The completion report for the Sindri Project (Credit 520-IN of November 26, 1974) indi- cates that inadequate equipment fabrication capacity of local suppliers  -16- and consequent delays in equipment deliveries accounted for a six-month delay in project completion. Performance has improved substantially under the more recently financed projects. The Trombay Project (Credit 481-IN of June 1, 1974) was physically completed with only three months' delay, and at or close to appraisal cost estimates. The IDA-financed Fertilizer Industry Credit (Credit 598-IN of November 16, 1975) included a variety of sub-projects designed to increase capacity utilization at several existing plants; after initial delays which resulted in the replacement of some sub-projects not being implemented, this project has proceeded satisfac- torily and is near completion. Two of the three private sector projects in which IFC has invested (Indian Explosives Limited and Zuari Agro-Chemicals Limited) are now in satisfactory operation, while the third (Deepak Fertilizers and Petrochemicals Corporation Limited), approved by the Board on November 13, 1979, is presently under implementation. A Bank loan of US$109 million for the Phulpur Project was made in 1975. The project was completed in March 1980, nineteen months behind the original completion date because of the decision to change feedstock and has started commercial production. Despite the delay, project capital costs were only about 6% above original estimates, and the investment is economically justified. A Project Completion Report (SecM83-639, dated June 22, 1983) has been distributed to the Board by the OED. Lessons learned from the Bank-financed projects relate to improved implementation, monitoring and management systems, prompt Government decisions, and greater selectivity in the use of engineering and equipment. Furthermore, greater reliability in feedstock and power supply is required. These lessons have been reflected in the design and scope of the more recent projects supported by the Bank. The proposed NP Fertilizer Project includes not only captive power and steam generation plants but is based on a natural gas feedstock and fuel to be supplied by a pipeline that will be less prone to supply interruptions. Furthermore, gas-based ammonia/urea complexes are easier to maintain and operate than plants based on other feedstocks. 39. The Bank Group's principal objective in all the above projects has been to support India's strategy for increasing domestic production of basic commodities such as fertilizer in which India has a comparative production advantage. It has played a central role in helping to build up India's fertilizer production capacity. Its association with the industry has been beneficial in helping particular plants to optimize their design, scope and technology choice and hence to avoid delays in implementation and protracted commissioning, which have hampered earlier plants financed without external assistance. Financing these projects has provided India with access to the latest fertilizer technology and also avoided an over- reliance on domestic engineering and equipment which has also plagued many projects elsewhere in the sector. Through assistance from foreign licen- sors and equipment suppliers, domestic engineering and contracting firms have been able to build their capabilities to a point where domestic replication of new generation fertilizer plants is feasible. Continued Bank Group assistance is necessary and justified considering that during the next ten or so years, India plans to invest some US$4 to US$5 billion in new fertilizer production and related gas supply facilities, and that the new generation of plants involves the development of new entities and larger and more complex organizations than in the past. The Bank should  -17- continue the process of assisting ensuring the transfer of the latest proven technology to India. It is in this context that the Bank can demonstrate the experience it has gained in many countries over the past decade to the advantage of the Indian fertilizer industry. Participation in this project will permit the Bank to continue its close involvement with the initiatives already taken concerning, principally, pricing, production efficiency, project execution capability and public sector management in the industry. The Bank's involvement in the preparation of measures to rehabilitate the two coal-based plants will help to identify a comprehensive rehabilitation program and measures to ensure their effec- tive execution. PART IV - THE PROJECT 40. The project was originally appraised by missions which visited India in March and August 1983. Following a Government decision to change the process technology for the ammonia unit, the project was reappraised in February 1984. The Staff Appraisal Report (No. 4657-IN, dated April 18, 1983) is being distributed separately to the Executive Directors. Negotiations were held in Washington, D.C. in March, 1984, with the Borrower represented by Mr. N. Misra of the Department of Economic Affairs, Ministry of Finance, as coordinator of the Indian delegation. A supplementary Project Data Sheet is attached as Annex III. Project Description 41. The proposed loan would help finance construction of a fer- tilizer plant at Vijaipur in the State of Madhya Pradesh with a capacity of 1,350 metric tons per day (tpd) of ammonia and 2,200 metric tpd day of urea. It would consist of a single train gas-based ammonia unit, two urea units, integrated power and steam generation units and would include all the necessary auxiliary and offsite facilities. The project also includes a township, road and rail links and a power link from the State grid to the project site, The project excludes the cost of development and trans- mission of natural gas which will be undertaken by the Oil and Natural Gas Commission (ONGC). Capital and operating costs related to the provision of gas will be reflected in the price of gas to be paid by the Project. 42. The proposed project is an integral part of the Government s plans to utilize associated and non-associated gas from the Bombay High and South Bassein offshore oil and gas fields, production from which is being assisted with three Bank loans (Loan 1473-IN, Loan 1925-IN and Loan 2241-IN). The supply of gas is sufficient for industrial and commercial purposes in the Bombay area and for use as feedstock for petrochemical and fertilizer plants in Maharashtra, Gujarat and hinterland states of Madhya Pradesh, Rajasthan and Uttar Pradesh. In addition to the MP Fertilizer Project, the Government's plans call for the construction of five addi- tional fertilizer plants based on West Coast gas reserves. GOI would ensure adequate and timely supplies of gas to the project by October 1, 1986, through the completion of a gas pipeline project in accordance with a schedule agreed with the Bank (Section 4.03, Loan Agreement).  -18- Project Implementation 43. The project would be constructed and the plant owned and operated by National Fertilizers Limited (NFL), a wholly-owned Government fertilizer company. NFL was incorporated as a limited liability company in August 1974 with the specific responsibility for implementing two large fertilizer complexes at Bhatinda and Panipat, each consisting of a 900 tpd ammonia plant based on fuel oil and a 1,550 tpd urea plant. Both com- plexes were completed and successfully commissioned in 1979. Following the geographically-oriented reorganization of the erstwhile Fertilizer Corporation of India into separate companies which came into effect in April 1978, NFL took over ownership of the old Nangal plant, as well as the new, Bank-financed, large scale ammonia/urea complex at the same location which started operations in 1978. As of March 31, 1983, NFL's paid-in share capital amounted to Rs 2,743 million (US$269 million), fully subscribed by the Government. The Board of Directors of NFL consists of eight members, comprising two members from the Government, four members from outside companies and the Managing and Finance Directors of NFL. The General Managers heading the above-mentioned fertilizer complexes are responsible for day-to-day operations and most administrative functions. They report directly to the Managing Director of NFL. The head office plays a coordinating role, assisting the plant units with specialized expertise and long-term planning or taking decisions which are relevant to more than one plant. Each operating unit has its own independent accounts, functioning as a separate profit center. 44. Although NFL is a relatively young company, it has experienced rapid growth and obtained considerable expertise in both project execution and operations, on account of the successful implementation and operation of India's first three fuel oil-based ammonia/urea complexes. While the three plants have proved capable of operating at rated levels of capacity, their average annual performance has suffered from extended supply inter- ruptions of coal and power. In 1982/83 their average capacity utilization was 71%. Capacity utilization is expected to be about 73% in 1983/84, with further improvements expected after the planned installation of captive power plants at Panipat and Bhatinda scheduled for completion in 1987/88. 45. In all the three fertilizer complexes, NFL has introduced incen- tive schemes to motivate operators, technicians and supervisory personnel and to achieve better overall performance. In concept, the schemes are the same in all NFL plants, differing only in details to meet demands from the individual plant unions. It has two components: one for capacity utilization, and another for raw materials and utility consumption. Capacity utilization beyond 70% on a daily or monthly basis triggers off incentive payments rising gradually in direct relation to the actual achievement. Similarly for each input, certain consumption norms are established. If consumption falls below the defined benchmarks, bonuses are paid in proportion to the realized savings. Each of the two incentive components can lead to a performance reward of up to 15% of the base salary. The Government is currently sponsoring a study which will review the effectiveness of operating and management incentive systems on an industry-wide basis and make recommendations for further improvements.  -19- 46. The existing NFL organization has over 500 qualified profession- als with a wide range of experience relating to ammonia/urea production, technical services, maintenance and project execution. From these, NFL will form a Project Management Team (PMT), structured as a task force and independent of normal line management functions. It will assume exclusive responsibility for the control of project implementation, within the stipulated time and cost, by coordinating the activities of the foreign and local design and engineering consultants and other contractors. Many team members will have had project management experience on NFL's Nangal II, Bhatinda and Panipat projects, which now form the major part of the Company's operations. The General Manager, as head of the Project Management Team, will be assisted by four senior managers responsible for the functional activities under the project. The senior managers respon- sible for engineering, pre-construction site work, construction, and finance and administration have been appointed. They are considered well qualified for these key positions. Within the PMT, the main respon- sibilities of the Coordination and Monitoring Department will be dis- charged by: (a) project groups for coordination with the consultants during design, engineering and procurement and for cost, schedule and quality supervision; (b) a planning and monitoring section for management information systems (including a computerized system to cover materials status, cost and schedule control), manpower scheduling and incentive schemes; and (c) process groups for design reviews and work preparatory to commissioning and operations, including training. These groups will also liaise with the work of the Construction Department, which will consist of sections responsible for each major construction area and for inspection, utilities' supply and advance planning for spares, maintenance, tools and materials. The Administration Department will handle equipment and materials transportation, receipt and storage management, as well as the normal administrative procedures regarding industrial relations, recruit- ment and outside contacts. Budgeting, control of expenditures and overall financial discipline in handling funds will be exercised under the Finance Manager. NFL has developed a detailed Project Implementation Manual, which is satisfactory. It has also prepared and furnished to the Bank a satisfactory training and recruitment plan for the operational staff. 47. The engineering arrangements for the project have been concluded. They are substantially the same as those being successfully employed in the Thal Project. The process design for the ammonia unit, will be based on technology offered by Haldor Topsoe A/S (Denmark) and, for the urea unit by Snampogetti of Italy. The processes have been employed successfully for plants of such capacities elsewhere in the world. Topsoe will engage the local engineering firm Planning and Development India Limited (PDIL), as sub-contractor for engineering and procurement of non-critical equipment. Topsoe will also be responsible for carrying out basic design and engineering, procurement services for critical equipment, construction supervision and technical supervision of the commissioning of the ammonia unit. Snampogetti will also associate with PDIL for execution of the basic and detailed engineering, procurement and construction supervision of the urea plant. Repetition of engineering arrangements which are being successfully employed at Thal will facilitate the transfer of technology so that, subject to confidentiality, Indian  -20- firms will be able to design, execute and commission such plants in future with the minimum of assistance from the foreign licensors. The overall project schedule calls for mechanical completion of the process plants and associated offsites within 45 months of commencement of the project, with commissioning three months thereafter, i.e. by March 31, 1988. Infrastructure 48. The project's infrastructure requirements will be built as follows: (a) township by NFL; (b) road strengthening, water supply and power line by State Government agencies; and (c) gas supply and rail siding by Central Government agencies. GOI will ensure that rail facilities critical to the movement of raw materials required for the project and for the finished products to be manufactured under the project are provided in timely fashion. Site acquisition and detailed soil inves- tigations have been completed. The infrastructure and utilities required for the project are substantial and their timely availability is critical to the timely implementation of the project. GOI has, therefore, set up a high level committee, headed by the Secretary, Ministry of Chemicals and Fertilizers, and made up of concerned Central and State Government agen- cies to review the progress of construction of these facilities and to provide the needed inputs and resources for their timely completion. NFL would also make satisfactory arrangements with appropriate agencies and authorities for the provision of adequate and timely supplies of natural gas, power and water for the project (Section 3.04, Project Agreement). Environment 49. The project is located at Vijaipur, a generally barren and sparsely populated area and, therefore, will not cause any significant detraction from the local environment. Adequate pollution control measures will be adopted by constructing effluent treatment and discharge facilities to handle potential pollutants produced by the project. In addition, NFL proposes to establish within its Technical Services Department at the complex a separate group of specialized staff, equipped with the appropriate laboratory facilities, to monitor pollution abatement in conjuction with operational staff responsible for effluent treatment. The project will be designed and operated to meet rigorous liquid effluent tolerances and limits for gaseous emissions according to Indian standards, which are comparable to standards applied for such facilities in industrialized countries. NFL would build and operate the project in accordance with environmental standards satisfactory to the Bank (Section 2.08, Project Agreement). Proiect Cost and Financing 50. The financing required for the project and for the rehabilita- tion study for the two coal-based plants, including contingencies, inter- est during construction and working capital and the front-end fee is US$638.6 million of which about US$295 million is in foreign exchange. Taxes and duties amount to US$83 million. Physical contingencies have been calculated at 5% of base cost. This is considered adequate, given the degree of definition of equipment and material needs based on the Thal  -21- and Hazira Projects. Price contingencies have been calculated at 3.3% in 1984, 8% in 1985 and 6% thereafter for foreign currency expenditures. Price escalation on local items is 7% through 1986 and 6% thereafter. 51. The proposed Bank loan of US$203.6 million would finance about 36% of the costs of the NFL project, net of taxes and duties, and the front-end fee, as well as the costs of carrying out the rehabilitation study for the two coal-based plants and Talcher and Ramagundam. The proposed loan would be made to the Government of India for 20 years, including five years of grace at the standard variable interest rate. The proceeds of the proposed loan required to execute the NFL project would be on-lent by GOI to NFL for a period of 15 years, including five years of grace at an effective interest rate of not less than 12.75% per annum. This interest rate should remain positive in relation to domestic rates of inflation, which are not expected to exceed 8% per annum in the near future. The execution of a Subsidiary Loan Agreement satisfactory to the Bank is a condition of effectiveness of the proposed Bank Loan (Section 6.01, Loan Agreement). Additional debt financing of US$106 million would be provided by Government loans. It is expected that the Overseas Economic Cooperation Fund of Japan (OECF) will finance certain equipment items worth approximately US$63 million. The Government is also expected to seek US$9 million equivalent from Denmark for the financing of the ammonia engineering contract and US$4 million equivalent from Italy to finance the urea engineering contract. About US$20 million will be sought by NFL as short term financing from local commercial banking sources to cover part of the working capital requirements. Of the required equity of US$308 million, the Government would provide about two-thirds in the form of a share capital increase. NFL will contribute about US$100 million to the project through internal cash generation. GOI would promptly provide NFL with any additional funds and facilities required to complete the project and cover any possible cost overrun (Section 3.02, Loan Agreement). Procurement and Disbursement 52. Equipment financed by the Bank loan will be procured through international competitive bidding (ICB) using procedures consistent with Bank guideliness. Exceptions to ICB will be made for equipment proprietary to the process design, items whose supply is critical for efficient project execution and small items, each with estimated value of less than US$200,000, which may be procured through limited international tendering from qualified suppliers from at least three Bank member countries. The aggregate of contracts under the Bank loan to be procured under procedures other than ICB will not exceed US$27 million equivalent. The procurement methods and financing sources are as follows;  -22- US$ Million Equivalent Bank Funding a! Other Sources ICB LIB OECF Denmark Italy LCB N.A. Equipment & Materials 176 6 63 - - 28 - License & Engg. Services - 5 - 6 3 14 - Project Management & Insurance - - - - - 14 - Ere!ction & Supervision 7 5 - 2 1 29 - Conimissioning Expenses - 1 - 1 - 13 - Land & Development, Civil Works - - - - - 50 - Township & Infrastructure - - - - - 17 - Local Handling - - - - - 10 - Duties and Taxes - - - - - - 93 IDC & Working Capital - - - - - 91 Total 183 17 63 9 4 175 184 a/ Excluding front-end fee. For purposes of bid evaluation under ICB, qualified local suppliers will receive a margin of preference of 15% or the applicable duty, whichever is lower. Indian manufacturers are expected to supply one-third of equipment procured under ICB. The Bank loan will also be used to finance costs of the foreign consultants who will carry out the rehabilitation study of the two coal-based plants. About 200 man-months of expatriate technical assistance is envisaged at about US$12,000 per man-month. 53. The proposed loan would be disbursed against 100% of the CIF or ex-factory cost of equipment, materials and spares procured under ICB, 100% for engineering, construction and commissioning services, 100% of the costs of the rehabilitation study, and the capitalized front-end fee. It is recommended that the Bank finance retroactively up to US$5 million of eligible expenditures on engineering services and advance payments for procurement of long delivery items incurred after January 1, 1984. Such expenditures were required to ensure timely project execution (paragraph 4 of Schedule 1, Loan Agreement). Marketing Arrangements 54. Fertilizers are marketed to Indian farmers mainly through cooperatives and other agencies and manufacturers dealers. In India, the cooperative system is the most important fertilizer channel, distributing about 60% of all fertilizers through some 43,000 cooperative selling points. In almost all States, there is an Apex Cooperative Marketing Federation which coordinates the marketing of fertilizers and other agricultural inputs in the State. The private trade comprises wholesale  -23- agencies, including three major companies operating country-wide, and retailers which are appointed by manufacturers or the wholesale agencies. Private retailers sell their materials partly to sub-dealers and the rest directly to farmers. 55. The output of the Madhya Pradesh Project will be marketed by NFL. Since production commenced in 1978/79 at the company's three large plants located in Punjab and Haryana, NFL's marketing group has estab- lished itself as the principal fertilizer sales and distribution organiza- tion in the Northern states of India. Apart from establishing distribu- tion channels via the cooperatives, NFL has developed in its traditional markets a network of private dealers through which 50% of its production is distributed, applying intensive and imaginative market development and promotion efforts, including farmer assistance programs, farmer meetings, and education programs which provide an important catalytic effect to increase consumption. 56. Following its commissioning in late 1987 or early 1988, there will be a rapid build-up in output to be marketed by NFL. It is, therefore, essential for NFL to develop higher fertilizer demand in the new marketing areas before the plant comes on stream. To prepare the market's receptivity to the project's output, the company has developed a fertilizer seeding program during which fertilizer sales will begin in 1983/84 and be gradually increased thereafter. With respect to new areas to be covered by the seeding program, the expanded marketing organization will undertake rigorous sales promotion, publicity and service programs, using NFL's expertise developed in Punjab and Haryana. The seeding program has the Central and State Governments' support. GOI would provide NFL with adequate quantities of urea for the program, beyond those avail- able from NFL's own production, from its imported fertilizer pool until the project starts commercial production. Given the overall shortfall in nitrogenous fertilizer supply expected to prevail in India for some time to come, together with the considerable scope that exists for increasing the intensity of fertilizer use, there should be little difficulty in marketing the urea output of the project. 57. The railways carry about 60% of all fertilizers distributed in India. Though this represents only some 4% of total rail movement, tran- sportation and distribution of fertilizers face difficulties because of railway capacity and operational constraints. Some important corridors are unable to cope with traffic due to capacity constraints. This problem is generally recognized by GOI and is being tackled through an active program of railway modernization. No constraints in track capacity are, however, expected in the project's marketing area. NFL has received adequate assurances concerning product movement from the Indian Railways. 58. To ensure efficient transportation of the MP Project output, rail movements will be carried in unit trains consisting of some 60 wagons each, carrying a total of 1,500-2,000 tons. Under this scheme, urea is moved to a limited but sufficient number of nodal points in different states which have been identified on the basis of proximity to centers of demand. To effect product distribution system will need additional storage capacity throughout the country, together with necessary off-  -24- loading facilities to handle frequent rakehauls, railway sidings with platforms of the requisite length, and covered platform storage. Facilities proposed for distribution of the project output within the project market area are satisfactory. However, studies are underway within the Government of means to expand the nodal points scheme and upgrade facilities at the nodal points elsewhere in India. Financial Evaluation 59. Principally as a result improvements in its operation and hence sales, NFL's financial condition is sound. It earned sizeable profits in the last two years, and all its financial ratios are better than the standard benchmarks considered prudent for the industry. The project will have a further positive effect on NFL's financial performance. During the first three years when production build-up takes place, project-generated sales revenues will increase rapidly. Profits are projected from the Project first year of operation and profits before taxes are expected to rise to a level ranging between Rs 1.2 billion and Rs 1.3 billion per annum from the third operating year onward when capacity utilization is expected to reach 95%. Debt/equity, debt service coverage and current ratios are at satisfactory levels. 60. After start-up of the MP Project in FY1987/88, NFL's net profit after taxes will continue to rise in current terms. NFL's capacity for internal cash generation is good and provides it with the option to finance substantial portions of its future investment program internally or alternatively accelerating its debt repayment schedule. In order to ensure NFL's continued financial soundness, NFL would maintain (i) its long-term debt/equity ratio at 60:40 or better; (ii) a current ratio of at least 1.2; and (iii) a debt service ratio of at least 1.3. Moreover, NFL would not declare any dividends or prepay any debt if, as a result, its current ratio would fall below 1.4 (Section 4.03, Project Agreement). In addition, NFL would submit to the Bank (a) audited annual financial reports within nine months of the close of its financial year, and (b) such progress reports and periodic financial statements as the Bank may reasonably request (Section 4.02, Project Agreement). Benefits and Risks 61. The net foreign exchange savings over the Project's conserva- tively assumed 12-year life due to reduced fertilizer imports are estimated at over US$2.6 billion in 1984 dollars after providing for principal and interest payments on the foreign loans. The project will create about 1,000 permanent jobs and, in addition, more than 3,000 people during peak construction. Local engineering firms involved in the project will gain valuable experience and know-how. The project will have sig- nificant backward linkages into the industrial sector, creating additional jobs and investments. 62. The project's economic rate of return is about 18% based on projected international fertilizer prices. The rate is sensitive to changes in product prices, and to a lesser extent, to operating costs. A 10% drop in fertilizer prices would reduce the return to about 14%, while  -25- a 10% increase would raise it to over 22%. Even under an unlikely com- bination of adverse circumstances, the project would yield an acceptable rate of return. 63. The project faces possible risks in the form of (a) delays in its implementation and in the availability of necessary infrastructure; (b) delays in start-up; and (c) possible difficulties in stabilizing production. The risk of serious delays in implementation, as well as delays in commissioning are minimized by the use of commercially proven technologies supplied by suitably qualified and internationally recognized engineering firms. Furthermore, NFL has a pool of sufficiently experienced managers who are being assigned to the project management team. Since the plant is substantially the same as the Thal Project, experience from that plant will be available to NFL's management. Potential risks associated with availability of the necessary infrastruc- tural facilities will be reduced by the arrangements referred to in para 48 above. In particular, the Government has agreed to implement the pipeline project to transport the gas to the project site on an acceptable timetable. PART V - LEGAL INSTRUMENTS AND AUTHORITY 64. The draft Loan Agreement between India and the Bank, the draft Project Agreement between the Bank and NFL and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 65. Special conditions of the project are listed in Section III of Annex III. The execution of a Subsidiary Loan Agreement between GOI and NFL is an additional condition of effectiveness of the loan (Section 6.01 of the Loan Agreement). 66. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART V - RECOMMENDATION 67. I recommend that the Executive Directors approve the proposed loan. A.W. Clausen President April 13, 1984  I I I  ANNEX I Page 1 of 5 INDIA - SOCIAL INDICATORS DATA SHEET INDIA REFERENCE GROUPS (WEIGHTED AVERAGES) /a MOST (MOST RECENT ESTIMATE) /b lb b RECENT LOW INCOME MIDDLE INCOME 1960- 1970- ESTIMATE- ASIA & PACIFIC ASIA & PACIFIC AREA (THOUSAND SQ. KM) TOTAL 3287.6 3287.6 3287.6 ACRICULTURAL 1760.7 1780.5 1811.3 GNP PER CAPITA (US$) 70.0 100.0 260.n 276.7 1028.6 ENERGY CONSUltT ION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) 114.0 165.0 210.0 398.4 792.8 POPULATION AND VITAL STATISTICS POPULATION,MID-YEAR (THOUSANDS) 434850.0 547569.0 690183.0 URBAN POPULATION (T OF TOTAL) 18.0 19.9 23.7 21.5 32.9 POPULATION PROJECTIONS POPULATION IN YEAR 2000 (MILL.) 1001.3 STATIONARY POPULATION (MULL) 1838.3 YEAR STATIONARY POP. REACHED 2140 POPULATION DENSITY PER SQ. EM. 132.3 166.6 205.3 161.7 260.7 PER SQ. KM. AGRI. LAND 247.0 307.5 372.7 363.1 1696.5 POPULATION AGE STRUCTURE (1) 0-14 YRS 40.9 42.7 39.7 36.6 39.4 15-64 YRS 54.5 54.2 57.2 59.2 57.2 65 AND ABOVE 4.6 3.1 3.0 4.2 3.3 POPULATION GROWTH RATE (%) TOTAL 1.8 2.3 2.1 1.9 2.3 URBAN 2.5 3.3 3.7 4.0 3.9 CRUDE BIRTH RATE (PER THOUS) 43.7 40.0 35.4 29.3 31.3 CRUDE DEATH RATE (PER THOUS) 21.8 16.7 13.3 10.9 9.6 GROSS REPRODUCTION RATE 2.9 2. 7 2.4 2.0 2.0 FAMILY PLANNING ACCEPTORS, ANNUAL (THOUS) 64.0 3 782.0 682 6.0 USERS (% OF MARRIED WOMEN) .2. 2.0 23.0 48.1 46.6 FOOD AND NUTRITION INDEX OF FOOD PROD. PER CAPITA (1969-71=100) 98.0 102.0 107.0 111.4 125.2 PER CAPITA SUPPLY OF CALORIES (% OF REQUIREMENTS) 96.0 90.0 87.0 98.1 114.2 PROTEINS (GRAMS PER DAY) 54.0 50.0 47.0 56.7 57.9 OF WHICH ANIMAL AND PULSE 17.0 15.0 13.0/ 13.9 14.1 CHELD (AGES 1-4) DEATH RATE 26.2 20.7 17.0 12.2 7.6 HEALTH LIFE EXPECT. AT BIRTH (YEARS) 43.2 48.1 52.2 59.6 60.2 INFANT MORT. RATE (PER THOUS) 165.0 139.0 121.2 96.6 68.1 ACCESS TO SAFE WATER (%POP) TOTAL .. 17.0 33.0/d 32.9 37.1 URBAN ,, 60.0 83.07W 70.8 54.8 RURAL .. 6.0 20.07o 22.2 26.4 ACCESS TO EXCRETA DISPOSAL (Z OF POPULATION) TOTAL , 18.0 20.0/e 18.1 41.4 URBAN ,, 85.0 87.0/e 72.7 47.5 RURAL .. 1.0 2.07. 4.7 33.4 POPULATION PER PHYSICIAN 4850.0 4890.0 3640.0/f 3506.0 7771.9 POP. PER NURSING PERSON 10980.0/g 8300.0 5380.0/f 4797.9 2462.6 POP. PER HOSPITAL BED TOTAL 2180.0 1650.0 1310.0/d 1100.6 1047.2 URBAN .. .. 370.07W 298.4 651.1 RURAL .. .. 10410.07o 5941.6 2591.9 ADMISSIONS PER HOSPITAL BED .. .. .. .. 27.0 HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL 5.2 5.6 5.2/e URBAN 5.2 5.6 4.87.. RURAL 5.2 5.6 5.37.. AVERAGE NO. OF PERSONS/ROOM TOTAL 2.6 2.8 .. URBAN 2.6 2.8 RURAL 2.6 2.8 ACCESS TO ELECT. (% OF DWELLINGS) TOTAL .. URBAN .. RURAL ..