Bhutan - Calcium Carbide Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-4039-BHU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOXt OF BELTAZ FOR A w CALCIUM CARBIDE PROJECT April 25, 1985 This docment 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 Ngultrum (Nu) 1.0 = US$0.083 Nu 13 = US$1.0 Nu 1,000,000 = US$83,333 WEIGHTS AND MEASURES 1 Metric Ton (ton) = 1,000 Kilograms (kg) = 2,204.6 Pounds (lb) 1 Kilometer (km) = 0.62 Miles 1 Hectare (ha) = 2.47 Acres 1 Cubic Meter tm3) = 35.32 Cubic Feet (cf) PRINCIPAL ABBREVIATIONS AND ACRONYMS USED ADB - Asian Development Bank BCC - Bhutan Carbide and Chemicals Co. Ltd. DCM - Delhi Cloth Mills Kuwait Fund - Kuwait Fund for Economic Development KV - KiLovolt MECON - Metallurgical and Engincering Consultants, India MVA - Megavolt Amperes MW - Megawatt SPES - Shriram Projects and Engineering Services, India TCC - Tashi Commercial Corporation tph, tpd, tpy - Metric Ton Per Hour, Per Day, Per Year UNDP - United Nations Development Programme FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY BHUTAN CALCIUM CARBIDE PROJECT DEVELOPMENT CREDIT AND PROJ'RCT SUMMARY Borrower: The Kingdom of Bhutan Beneficiary: Bhutan Carbide and Chemicals Co. Ltd. (BCC) (a Joint Venture Enterprise) Amount: Special Drawing Rights (SDR) 9.4 million (US$9.0 million equivalent) Terms: Standard Relending Terms: The Government will relend the Credit to BCC for a term of fourteen years, including a grace period of four years and interest at 10.25X per annum. BCC will bear the foreign exchange risk. Project Objectives Bhutan is endowed with large-scale deposits of and Description: commercially exploitable limestone, dense and maturing forests that can provide wood for charcoal for use as a reductant, and substantial hydroelectric power potential which is beginning to be exploited. The project aims at utilizing these basic inputs for production of calcium carbide, mainly for export, to help Bhutan earn much-needed foreign exchange revenues for its economic development. The project would augment the country's limited industrial base, increase financial self-reliance and help train manpower in industrial production, mining and forestry. The project, with a capacity to produce 22,000 tons per year of calcium carbide, would be located at Pasakha in Southern Bhutan. The project would include: (i) a calcium carbid2 plant; (ii) limestone mining; (iii) forestry; and (iv) charcoal plants. In addition, the project provides for necessary infrastructure, technical assistance and training. Risks: The successful operation of many similar carbide plants in India indicates that there would be no inordinate technical risks. However, there could be potential risks due to the need for considerable coordination in project execution, Lack of trained manpower, delays in start-up and commissioning, difficulties in sustaining high capacity utilization, This document has a restricted distribution and may be used by recipienfs only in the performance of their omcial duties. Its contents may not otherwise be discuad without World Bank authorization.  -ii- and problems in marketing calcium carbide. To address these risks, the Government would establish an Inter-Ministerial Committee for overall project coordination and implementation of infrastructure and upstream facilities. Under the project, foreign consultants and technical advisory services (until two years after project completion) would be engaged. Suitable and experienced personnel would be recruited from neighboring countries and counterpart staff given training locally and abroad. Technical performance guarantees would be obtained from the contractors and implementation supervised by experienced consultants. Bhutan's long-term sales arrangements, already concluded with Indian companies, would reduce marketing risks. Estimated Project Cost: US$ Killion Equivalent Local Foreign Total Calcium Carbide Plant 1.47 10.56 12.03 Limestone Kining 0.01 0.62 0.63 Charcoal Plants 0.12 0.90 1.02 Forestry 0.31 1.43 1.74 Total 1.91 13.51 15.42 Contingencies: Physical 0.19 1.35 1.54 Price 0.28 2.70 2.98 Working Capital 0.54 1.60 2.14 Total Project Costs 2.92 19.16 22.08 Interest During Construction 1.41 0.45 1.86 Total Project Financing 4.33 19.61 23.94 . Financing Plan: US$ Killion Equivalent Local Foreign Total IDA - 9.0 9.0 Kuwait Fund - 6.6 6.6 Government of Norway - 3.9 3.9 Covernment of Bhutan 1.6 - 1.6 Tashi Commercial Corporation 1.4 - 1.4 Internal Generation 1.3 0.1 1.4 4.3 19.6 23.9  Estimated (USs Million Equivalent) Disbursements: IDA FY FY86 FY87 FY88 FY89 FY90 Annual 1.1 2.5 2.8 1.7 0.9 Cumulative 1.1 3.6 6.4 8.1 9.0 Economic Rate of Return: 20.7Z Staff Appraisal Report: Report No. 5430-BHU dated April 18, 1985 Map: IBRD 18520  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF BHUTAN FOR A CALCIUM CAiBIDE PROJECT 1. I submit the following report and recommendation on a proposed Credit to the Kingdom of Bhutan for Special Drawing Rights (SDR) 9.4 million (US$9.0 million equivalent) on standard IDA terms to help finance a Calcium Carbide Project. The proposed Credit will be onlent to BCC for a term of 14 years, including four years of grace and interest at 10.25% per annum. The sub- sidiary loan will be denominated in US dollars and BCC will bear the foreign exchange risk. The Kuwait Fund for Economic Development (Kuwait Fund) would lend Kuwait Dinars 2 million (US$6.6 million equivalent) to the Government of Bhutan which would onlend it to Bhutan Carbide and Chemicals Co. Ltd. (BCC) for a term of 14 years, including four years grace, and interest at 8% per annum. The Government of Norway would provide a grant of Kroner 35 million (US$3.9 million equivalent) which will be passed on to BCC as government equity. PART I - THE ECONOMY 2. The first economic report entitled, "Bhutan: Development in a Himalayan Kingdom" (Report No. 4307-BHU, dated April 7, 1983), was dis- tributed to the Executive Directors on April 21, 1983. Part I has been updated by the findings of a mission in November 1984. Country data are shown in Annex I. Country Background 3. Bhutan is a small and landlocked Buddhist kingdom in the eastern Himalayas. It has an area of about 46,500 square kilometers and is bordered by the Tibet region of China and the Indian states of Sikkim, West Bengal, Assam, and Arunachal Pradesh. The border with China follows for the most part the main ridge of the Himalayas. The border with India was negotiated in a series of treaties with the United Kingdom in the nineteenth century; it mostly follows the southern foothills of the Himalayas, which rise abruptly from the Brahmaputra plains. Bhutan's relatively remote location, rugged terrain, and formidable-natural borders, coupled with a strong sense of independence, allowed the country to remain in isolation until about 1960. 4. Bhutan' s terrain is among the most rugged in the world. Within fewer than 100 km, land rises from an altitude of less than 160 m above sea level  -2- in the south to more than 7,000 m above sea level to the north, and is characterized in between by steadily rising hills cut by deep river valleys. The climate is correspondingly extreme, ranging from sub-tropical conditions in the southern foothills to the perpetual ice and snow of the high Himalayas. Most of the population lives between altitudes of about 1,000 to 3,000 m, in the hills of the so-called "inner Himalayas," with its generally temperate climate and number of relatively broad river valleys. These valleys, along with some sections of flatland below the southern foothills, account for most of the readily cultivable land in Bhutan. Only about 5Z of the land is cultivated or inhabited, while about half of Bhutan remains under natural forest cover. Most of the remaining land is seasonal grazing land or under perpetual snow. 5. Prior to 1907, Bhutan was a theocracy with full power, in principle, vested in the Shabdung, the head lama. Over time, the power of the Shabdung and monastic establishment over secular matters declined, and there was constant turmoil as governors of various regions competed for power. In 1907, a governor of sufficient strength emerged to unify the country under a hereditary monarchy. The present king, His Majesty Jigme Singye Wangchuck, is the fourth monarch. 6. The first two monarchs concentrated on centralizing authority around the monarchy, but the third monarch favored Bhutan's evoLution into a con- stitutional monarchy. In 1953, the National Assembly was formed. It has a Speaker, 100 representatives of the people, 10 representatives of the monastic establishment, and some 40 government officials appointed by the King. A Cabinet and the first government ministries were established in 1968. Today, the government has six Ministries -- finance; home; foreign; trade, industry, and forests; communications and tourism; and development. For internal administration, Bhutan is divided into 18 districts, with gover- nors of each district being appointed by the King and reporting to the Ministry of Home Affairs. Although its power has declined, the monastic establishment continues to play an important role, and religion continues to be one of the strongest forces of national unity. 7. In 1949, following the departure of the United Kingdom from the sub-continent, Bhutan signed a treaty with India confirming non-interference in Bhutan's internal affairs, and Bhutan's agreement to be guided by India's advice in the conduct of external affairs. Until the late 1950s, Bhutan's principal ries had been with Tibet, because of a common religious heritage and trade links -- foodgrains from Bhutan being exchanged for wool and salt from Tibet. In 1959, Bhutan began accepting Indian offers of economic assis- tance and started building its first road link from the Indian border to Paro and Thimphu. Since then, Bhutan's relations with India have been close, and almost all the developmental effort to date has been financed with Indian grant aid. Bhutan has been gradually expanding its international ties -- between 1962 and 1971, it joined the Colombo Plan, the Universal Postal Union, and the United Nations. During 1981-82, Bhutan joined the International Monetary Fund, the World Bank and the Asian Development Bank (ADB). Bhutan also has full diplomatic relations with Bangladesh. 8. 3hutan is well-endowed with natural resources. namely dense forests, hydro-power and minerals deposits for which there are ready markecs in neigh- boring countries. Limestone and dolomite constitute the largest known  -3- mineral deposits, and reserves of various grades are estimated at 28 billion tons. Hydro-power potential is estimated at up to 20,000 MW. Present hydro- power capacity of only 3 MW is expected to increase sharply when the 336 MW hydro-power project at Chukha in western Bhutan is completed during 1985-86. In forestry, current extraction is only a small fraction of the annual forest increment, wnile some of the forest is beginning to decay because of overage. * There is, thus, great potential for forest-based exports from Bhutan. Major constraints to the exploitation of Bhutan's natural resources are limited revenues and the serious lack of infrastructure and trained manpower. Economic Background 9. Given Bhutan's long isolation, it is not surprising that the economy is at a very early stage of development, and that much basic economic and demographic information is still unavailable. The government is aware of these gaps and has recently undertaken several major statistical efforts, including two agricultural surveys, nutrition surveys, and a livestock census. The Planning Commission has recently prepared a set of national accounts estimates (1980/81). A population census is also underway. At present, the popuLation is officially estimated at 1.2 million and the population growth rate at 2% per annum. 10. Bhutan's economy is still highly subsistence-oriented and centered around agriculture. It is also overwhelmingly rural, with the two largest towns -- Thimphu, the capital, and Phuntsholing, the main gateway town, each having a population of less than 20,000. Based on the national accounts estimates and official population estimates, the per capita GDP of Bhutan is about US$120, one of the lowest in the world. It would appear, however, that Bhutan's overall standard of living is higher than indicated by this figure. The overall population-land ratio is lower than in neighboring countries and nutrition surveys have indicated an average calorie intake per capita of about 2,500 per day, some 25% higher than for South Asia as a whole. Literacy is estimated at only 10%, infant mortality is high, and as a result, life expectancy is low (43 years compared to about 52 years for South Asia as a whole). 11. The nationaL accounts estimates indicate that agriculture and animal husbandry account for almost 50% of GDP, and together provide livelihood for about 95Z of the population. Landlessness is not a major problem, and farm- land appears to be reasonably equitably distributed. According to the recent agricultural survey, net foodgrain production amounted to 125,000 metric tons (tons) in 1981/82, and Bhutan required imports of about 25,000 tons of rice from India to meet its needs. Historically, Bhutan had been seLf-sufficient and even exported foodgrains. Therefore, it should be a high government priority to achieve once again self-sufficiency in foodgrains. Maize is the predominant foodgrain, accounting for almost 50% of total production, and is grown mainly in eastern Bhutan under rainfed conditions. Paddy, accounting for about 35% of production, is the main crop in western Bhutan, and is grown at altitudes as high as 2,500 m above sea level. Wheat and other foodgrains are grown at even higher altitudes. Other important crops include ginger, chillies, pulses, and mustard seeds at Lower altitudes, and potatoes at higher elevations. In recent years, cash crops such as apples, oranges, and cardamom have emerged, especially in southern and western Bhutan where marketing is easier. Although the forestry sector accounted for 15% of GDP  -4- in 1980/81, this level was probably low by historical standards. In 1979, the Government, recognizing the importance of properly managing its valuable forest resources, gave the Department of Forests the sole right to extract logs for commercial purposes and placed restrictions on the export of low- value wood products. A plant for veneer and sawnwood has been constructed at Gedu with UNDP and Kuwait Fund assistance. Industry accounts for only about 5% of GDP, due to the small domestic market and the shortage of domestic entrepreneurial capacity. Three relatively large industries -- a 100,000-ton capacity cement factory, a distillery complex, and a fruit processing plant -- account for the bulk of the value added. Other smaller industries include sawmills and furniture, matches, candles, soap, and handicrafts. Services account for the remaining 30% of GDP, with more than half of services originating in the public sector. 12. Indian financial and technical assistance is helping Bhutan implement most of its development activities, while almost all of Bhutan's trade is conducted with India. A state of free trade exists between the two countries. Imports from India consist mainly of petroleum products, rice, metal products, machinery, and truck chassis. Many of these are controlled items in India, and exports to Bhutan are supplied under mutually agreed quotas. Bhutan's exports to India consist primarily of agricultural products, timber, and cement. Its main export to third countries is cardamom, and the main imports from them are automobiles and spare parts. The Indian rupee circulates freely alongside the ngultrum in Bhutan and accounts for most of the currency in circulation. Over time, Government policy is to convert entirely to the ngultrum. Apart from the recently established Royal Monetary Authority, which is gradually assuming central banking functions, the banking system consists of one commercial bank, the Bank of Bhutan, which is owned jointly by the State Bank of India and the Covernment of Bhutan. Other financial institutions are the Royal Insurance Corporation and the Unit Trust; both have been actively involved in making commercial loans. Given the good relations between Bhutan and India, trade and transit matters have not been a significant constraint to Bhutan's development. In 1984, a new trade and commerce treaty was signed with India, which gives Bhutan full control over its overseas trade. Planning and Economic Development 13. Development activities in Bhutan began in 1959 when, with the assis- tance of India, the Government began preparing its first five-year develop- ment plan. Since then, Bhutan has completed four five-year plans (1961/62-1980/81). The plans showed a steady growth in sophistication of the planning mechanism and in development priorities. The First Plan devoted almost two-thirds of ou-tlays to roads development in order to end external isolation and to begin linking the regions of the country. By the Third Plan, investment priorities reflected more directly productive activities such as agriculture and industry, and the need to increase social services. The first three plans were almost entirely financed by India, although by the end of the Fourth Plan, United Nations Agencies had become significant con- tributors accounting for about 18Z of total financing. 14. The Fifth Plan (1981182-1986/87) represents an unprecedented develop- mental push. The underlying objective of the Plan is to increase Bhutan's ieconomic self-reliance", i.e., its ability to manage and finance economic  -5- activities from within. The principal vehicles for achieving this goal are resource-based industrial projects designed to exploit markets in neighboring countries, particularly India. Including expenditures on a number of large resource-based industrial projects, which may or may not be undertaken during the plan period, development expenditures are to more than trinte. Under the Fifth Plan, some 50Z of activities, based on development plans drawn up by individual districts, are being implemented by district administrations. Such decentralized execution is intended to be more responsive to and consis- tent with locally perceived needs. A condition for including such projects in the Fifth Plan was that districts provide, on a voluntary basis, the labor required in implementation, thereby greatly reducing costs and achieving greater overall development effort. To help implement district plans, numerous line ministerial staff were transferred from the central to district administrations. 15. A 1984 mid-plan review indicated that overall performance has been good so far, considering the major institutional changes introduced. Overall Fifth Plan expenditures are expected to be significantly higher (22%) than originally projected, largely due to higher inflows of international assis- tance that permit some additional projects, and to underestimation of costs of some industrial projects. The districts are also likely to achieve their investment targets, although due to shortages of technical staff, the quality of project design and construction has, in some cases, been sub-standard. In response, the Government is beginning to place less emphasis on the achieve- ment of targets in the narrow sense and more on ensuring better design and construction of projects and their proper utilization. Recent Economic Performance 16. Due to the paucity of economic data, it is not possible to review Bhutan's overall economic growth trends. However, a follow-up to the 1980/81 agricultural survey suggests that production in agriculture, the most impor- tant sector, has been growing at about 6% per annum. At the same time, there have been major improvements in economic management. Covering recurrent government expenditures from domestic revenues has been an important goal under the Fifth Plan. Revenues in 1980/81 amounted to around 10Z of GDP (a reasonably good level considering Bhutan's stage of development), but recur- rent expenditures amounted to 17Z of CDP. The Government covered the dif- ference out of development assistance. Nevertheless, further measures were necessary because recurrent expenditures associated with development efforts were rising rapidly and the revenue-expenditure gap continued to widen. The Government's strategy to improve public savings performance concentrated on both reducing recurrent expenditures and increasing revenues. In 1981/82, it effectively reduced the size of the civil service by about 8% and since then has, with considerable success, controlled growth in public sector hiring. This move was supported by three major fiscal reforms designed to improve budgetary efficiency: (a) the existing dual budget system was replaced by a consolidated budget under the Ministry of Finance; (b) government finances were reorganized to flow through two main accounts -- one for the release of expenditures and one for deposit of revenues; and (c) many service functions that had operated as government departments were, as of 1982/83, instructed to function on commercial lines. Concurrently, a 30% profits tax was intro- duced on these services and larger commerciaL and industrial units. Finally,  -6- to increase the revenue base over the longer run, the Government started investing in natural resource-based, export-oriented projects. 17. The impact of these measures has been profound. Between 1980/81 and 1983/84, growth in recurrent expenditures was Limited to 8% per annum, while revenues grew by 23% per annum. As a result, revenues in 1983/84 covered 882 of recurrent expenditures, compared to 60X in 1980/81. While most of these revenues were from taxation of major entities, such as financial institutions and industries, further reforms were initiated in the 1984/85 budget to broaden the general tax base by revising the sales and income taxes. With these measures, as well as the anticipated receipt of revenues on hydropower sales to India from the Chukha project, Bhutan stands an excellent chance of meeting its goal of covering recurrent costs from current revenues by the end of the Fifth Plan period. 18. Complete balance of payments data for Bhutan are not prepared on a regular basis, but based on analysis of changes in reserve levels, Bhutan has continually had an overall surplus in its balance of payments, with both India and other countries. Bhutan consistently runs trade deficits, but external assistance and tourism receipts more than cover these deficits. As of end-1983/84, Bhutan's foreign exchange reserves stood at a healthy US$35 million equivalent, including US$10 million in overseas currencies. Indian rupee reserves were sufficient to cover about 10 months of imports from India, and overseas currency reserves almost 20 months of overseas imports. Bhutan has no external debt problem. The only major loans the Government has incurred are an Indian rupee loan for the Chukha project, that will effec- tively be repaid in electricity sales to India, and several concessional loans from IDA (paragraph 20), ADB, IFAD and the Kuwait Fund. All other aid to Bhutan has been on grant terms, and given that aid inflows are likely to continue meeting more than the country's import needs, debt service is unlikely to pose a significant burden for the foreseeable future. In this context, the primary role of external assistance in Bhutan is to enable an increase in the overall level of investment by supplementing the Government's domestic savings efforts and to provide technical assistance in developing efficient administrative and technical practices. PART II - BANK GROUP OPERATIONS IN BHUTAN 19. Bhutan became a member of the Bank Group in September 1981. A program mission visited Bhutan in June 1982 to obtain general overview of the country's needs and an economic mission followed in October 1982. Thereafter, missions visited Bhutan to identify possible areas of assistance in forestry, education, rural and urban water supply, communications, mineral development and small resource-based industries. Consultancy services were also arranged to review prospects of setting up an industrial development and finance organization to assist medium- and-small scale enterprises. 20. IDA operations in Bhutan began in FY84 with IDA credits of US$3.0 million equivalent for a Technical Assistance Project (Credit 1416-BHU) followed by US$5.5 million equivalent for a Forestry Development Project (Credit 1460-BHU). The proposed Credit in FY85 would bring the total amount  -7- of IDA assistance to Bhutan to US$17.5 million equivalent. Annex II contains a Summary Statement of Bank Group operations as of March 31, 1985. 21. IDA's current strategy is to help Bhutan achieve its two principal objectives. First, to achieve economic self-reliance through greater produc- tivity and exports and increased revenues, and second, to develop human resources to accelerate development while reducing dependence on expatriates. IDA's involvement is, therefore, geared to help Bhutan nurture and harness its natural resources principally in forests, minerals and hytrropower, aug- ment the industrial base to increase exports, and improve educational stand- ards and institutions to enlarge its trained manpower pool. The Bank Group is careful to channel its lending to subsectors not generally supported by other donors and in amounts commensurate with the country's technical and administrative absorptive capacity. 22. Under the ongoing Technical Assistance Project, disbursements have been slow, as anticipated, but the Bank's technical assistance has helped Bhutan prepare several projects for financing by other donors, principally ADB and the UN agencies. The Forestry Development Project, which started very well, would promote long-term reforestation and use of mature forests for wood industries and other industrial uses, while increasing log exports and fuelwood supply for local use. IDA's proposed lending program in the near term includes a second forestry project which together with the first project would, in late 1980s, enable Bhutan to reforest at least 2,500 ha annually. In education, projects planned would assist in the rehabilitation of existing primary and secondary schools and construction of new schools, technical and vocational training, the design of curriculum and provision of training aids, training of teachers, and planning and administration. In industry, the proposed Calcium Carbide Project would utilize vast high-grade limestone deposits, maturing forests and cheap hydropower to generate foreign exchange revenues of about US$10 million equivalent per year from the export of products. The project includes technical assistance for planning, coor- dination and execution, and training of national staff. In a proposed mineral project, Bhutan's extensive mineral deposits of Limestone, dolomite, marble, slate, graphite, gypsum (already being exported in small quantities), * coal, copper, etc. will be surveyed, and mining facilities and infrastructure provided for production and export. Under all these projects, the Bank would endeavor to help Bhutan train counterpart staff and develop a cadre of experienced engineers, technicians, and skilled manpower. These projects would help augment the country's revenues and improve administrative, planning, implementing and marketing capacity. PART III - THE INDUSTRY SECTOR Industry Sector Overview 23. Bhutan has a low industrial base, with industry accounting for only 5% of GDP. The manufacturing and processing industry, about one-fourth of which is cottage industry, accounts for 3.3% of GDP, compared to an average of 13Z for low-income developing countries. Food processing, distillery operations, and cement account for 67X of total industrial production, mainly reflecting the production of three large entities: the Bhutan Fruit Products  -8- Company; the Government Welfare Project, which runs distillery operations; and the Penden Cement Authority. They also account for two-thirds of Bhutan's industrial employment. There are about 60 other small industrial units, each with an output of less than Nu 0.5 million (about US$40,000) and employing fewer than 20 persons. These small units manufacture basic con- sumer goods such as soap, candles, matches, furniture, and simple processed foodstuffs. A plT,ood plant at Gedu and particle board project near Phuntsholing are under construction. Almost all manufacturing industries are located in southern Bhutan where infrastructural fa;.ilities and the availability of raw materials and labor are better. Sector Organization and Policy 24. In 1979, a National Commission for Development of Trade and Industries was established under the chairmanship of the King. Members include the Minister of the recently reorganized Ministry of Trade, Industry and Mines, and the Deputy Ministers of Planning and Finance. The Commission reviews all major industrial projects to ensure that they are economically viable and in compliance wit;: Government policy. Daily operation of the Commission is handled by a working committee chaired by a Joint Secretary. Covernment policy is to stimulate industrial growth, as far as possible, through private and joint ventures. While private participation in medium- and-large scale plants is encouraged, individual private firms are not allowed to own more than 20% of the equity. Once a plant is established and operating well, the Government intends to allow the sale of its shares to the public, with the aim of ultimately reducing its participation to about 20Z in such joint ventures. Foreign investments are not currently permitted in Bhutan. Cotistraints to Industrial Development 25. The major constraints to industrial development have been inadequate power, communications, trained manpower and a limited domestic market. The power shortage would be overcome with the commissioning of the 336 MW Chukha Hydro project. Communication facilities in selected locations would improve with the completion of the Indo-Bhutan microwave system in 1986. To overcome the constraint of a limited local market and also to help earn much-needed foreign exchange, the Government is encouraging export-oriented industries. The shortage of trained manpower is being met by hiring competent expatriates, mostly from neighboring countries (e.g., India, Nepal, and Bangladesh), and ensuring participation and training of counterpart staff. At the same time, the Government is making concerted efforts to develop educational institutions in the country and to train abroad an increasing number of Bhutanese nationals. As local resources are developed and local personnel are trained, Bhutan could expect a significant growth in industrial development. The abuidance of natural resources, low-cost electric power from Chukha and other proposed hydro-power projects, and a huge neighboring market would encourage development of resource-based and power-intensive projects, such as the proposed calcium carbide project. Calcium Carbide 26. Calcium carbide is a basic inorganic chemical with veried uses, the most significant being for the production of acetylene used for metal cutting  -9- and welding in the engineering industries. Other industrial uses include manufacture of acetylene black used in dry-cell batteries, desulfurization compound for the manufacture of low-carbon steel, and chloro-solvent and other chemicals including polyvinyl chloride (PVC). Carbide is also used for producing low-pressure acetylene gas for illumination in rural nreas, and carbide fines help early ripening of fruits. World Outlook 27. The total world production of carbide in 1981 was estimated at about 8.5 million tons. China was the leading producer, followed by the Democratic Republic of Germany, USSR, Japan, the Federal Republic of Germany, Poland, and the United States. The world carbide industry is expected to contract, especially in the developed countries, because of high costs of energy, lack of good quaUlcy limestone and carbonaceous materials (coke, charcoal, etc.) and the high cost of transporting carbide over long distances. At the same time, use of carbide (mainly acetylene for welding and metal cutting) is incseasing in developing countries where repair and rehabilitation of exist- ing machinery, equipment and vehicles is necessary. In this respect, Bhutan is competitively placed, compared to other potential producers, and also has the additional advantage of being close to India, a major consumer, as well as to markets in Bangladesh, Pakistan, and Sri Lanka. 28. Production and Consumption in India. In India, there are seven carbide plants; two exclusively for captive PVC production and the other five for manufacturing carbide for the market. Three new plants are currently under implementation. If the present power situation and capacity utiliza- tion improve, carbide production in India is likely to reach between 115,000 and 123,000 tons by 1989/90. On the other hand, consumption of carbide has increased at an average annual rate of around 9.5% during the last decade, reaching about 96,000 tons in 1984/85. Because of recovery in and expansion of the engineering and steel industries, demand is projected to rise to about 142,000 tons by 1989/90. Based on these supply and demand pro_ections, India's cariide deficit is expected to range between 19,000 tons and 27,000 tons by 1989/90. The proposed carbide project would be able to market 17,000 tons of carbide in India. In addition, it is expected that some 3,000 tons could be exported to Bangladesh based on its current import level. Bhutan's domestic consumption is not expected to exceed 50 tons. 29. Advantage of Project Location. The proposed project would be located in Pasakha, near Phuntsholing the prime marketing zone in eastern India (West Bengal, Assam, Bihar, Madhya Pradesh and Orissa) where much of India's steel is produced. Total carbide demand of this region's steel plants and other industries is projected at more than 36,000 tons by 1989/90, whereas there is only one carbide plant in eastern India, with an installed capacity of 15,500 tons per year (tpy). A new plant may come on stream with a capacity of 10,000 tpy in 1987/88. Even if these plants operate at an average capacity of 90X by 1989/90, there would be a carbide shortfall of about 13,500 tpy. If the new plant is delayed, the shortfall in eastern India would be higher (22,500 tons). Whether this plant is completed or not, carbide production under the project would find a ready market in India. Nevertheless, to minimize its market risk, BCC has signed Letters of intent with Indian com- panies for the sale of all of its carbide production. Further, it has signed a long-term contract with Shriram Fertilizers and Chemicals Ltd., India, for  -10- the sale of 6,000 tpy. BCC would prepare and furnish to IDA by April 1, 1987, a detailed stratpgy for marketing calcium carbide (para 6, Schedule 2 of the draft Project Agreement (PA)). PART IV - THE PROJECT 30. The proposed project was identified in August 1983 and appraised in June 1984. A Staff Appraisal Report entitled "Bhutan-Calcium Carbide E Project" (Report No. 5430-BHU, dated April 18, 1985) is being distributed separately. Technical discussions followed by negotiations were held in Washington, D.C. from March 11 to March 18, 1985. The Bhutan delegation was lead by Dasho C. Dorji, Secretary, Ministry of Trade, Industry and Mines. A timetable of key events relating to the project and special conditions of the proposed Credit are given in Annex III. Project Objectives and Description 31. The Government of Bhutan gives high priority to developing the country's natural resources and achieving increasing financial self-reliance through exports to neighboring countries, especially India. After careful review, the proposed Calcium Carbide Project was selected as one of the most promising export-oriented ventures for Bhutan. The basic inputs required for production of calcium carbide are limestone, electric power, and a good grade carbonaceous reductant (e.g., charcoal). Bhutan is endowed with large deposits of commercially exploitable limestone, dense forests which can provide charcoal for use as a reductant, and large-scale hydroelectric power potential which is beginning to be exploited under the Chukha project. 32. The proposed project with a capacity to produce 22,000 tons per year of merchant calcium carbide would be located in an isolated site, about 15 km from the industrial town of Phuntsholing on the Bhutan-India border. The Project would include: (i) a calcium carbide plant and ancillary equipment and facilities; (ii) limestone mining; (iii) forestry; and (iv) charcoal production. The project would also provide for necessary infrastructure and technical assistance and training. 33. Calcium Carbide Plant, which is the main component of the project, includes: (i) a 12 KVA open-rotating type, submerged arc furnace, raw material proportioning and charging system, product tapping equipment, and handling and packing facilities; (ii) a 100-ton per day (tpd) Lime kiln; (iii) raw material storage and handling systems; (iv) a producer gas plant to allow flexibility in using producer gas from coal instead of fuel oil in the lime kiln; (v) water treatment and supply facilities; (vi) workshop and drum manufacturing unit; (vii) service facilities for laboratory testing, fire fighting, etc.; (viii) office and plant buildings; and (ix) infrastructure, including housing, power transmission lines, and roads. 34. Limestone Mining. Availability of chemical grade limestone (92-98X carbonate content) is crucial for the success of the project. At full capacity, the carbide pLant would require about 50,000 tpy of limestone. There are four limestone deposits within a radius of 10-30 km from the project site, at Hauri Khola, Purbia Khola, Kaleshwar and Mirchang. Proven  -11- reserves are about 600,000 tons. Probable and possible reserves are estimated at 460,000 tons and 1.9 million tons respectively. The largest chemical grade limestone reserves are at Hauri Khola. The secondary sources would be Purbia Khola, Kaleshwar and Mirchang. Detailed sampling and drill- ing work has been done at Purbia Khola and Mirchang. In Kaleshwar, this work started in early December, 1984 and in Hauri Khola in January, 1985. Results of such work show that proven reserves would be adequate to meet project needs for about 12 years. Assuming that at least half of probable and 25% of possible reserves are proven, the available chemical-grade limestone would be adequate to support the project for about 28 years. In any event, proven chemical grade limestone is also available, in adequate quantities, at Paro and Nanglam. To accelerate drilling, sample investigation of phosphorus and sulphur content and calcination tests, IDA has agreed to the use of US$300,000 from the Technical Assistance Credit (Credit 1416-BHU). The Government would provide the remaining financing and ensure that drilling and sampling work, to establish proven reserves of 1 million tons (project requirement of 20 years), at Hauri Khola and Kaleshwar is completed by March 31, 1986 (Section 4.01 of the draft Development Credit Agreement (DCA)). Open-pit mining and laboratory testing of limestone from deposits at Hauri Khola, Purbia Khola, Kaleshwar and Mirchang would be carried out by BCC to ensure quality control and long-term supply. The Government has granted BCC the exclusive mining rights at these sites to enable BCC, with assistance from consultants, to carry out limestone mining activities in a timely manner (para 7, Schedule 2 of the draft PA). 35. Firewood. About 68,000 cubic meters (m3) of firewood per year would be needed to meet the charcoal requirements of the project and would come largely from three sources: (i) logging centers; (ii) salvage logging in the course of developing new forest plantations; and (iii) thinning and clear- felling short and medium rotation wood species, included in the IDA-financed Forestry Project (Cr. 1460-BHU). To ensure against temporary shortages of wood, BCC with assistance from TCC, would carry out forestry development components in a timely manner, including establishing a 1,000 ha captive plantation at Pachu, near the project site. The Government would permit BCC to use the nurseries established at Phuntsholing for this purpose (Section 4.03(b) of the draft DCA and para 7, Schedule 2 of the draft PA). To ensure against any denudation of forests, the Government would prepare and furnish to IDA, a reforestation program by December 31, 1985 (Section 4.03(a) of the draft DCA). 36. Charcoal. The project's requirement of about 15,850 tpy of charcoal would be met by 16 charcoal plants, each with a capacity of about 1,000 tpy. In order not to be completely dependent on outside suppliers, BCC would establish seven plants, each with a capacity of 1,000 tpy under the project. Tashi Commercial Corporation (TCC) has established a charcoal plant for the purpose, and private companies have sought licenses to establish 8 other plants. Further, in case local production falls short, BCC has signed a Letter of intent with the Bihar State Government, India, for the purchase of 5,000 tpy of charcoal By October 31, 1985, BCC would prepare a detailed plan for the production and supply of charcoal required for the project (para 9, Schedule 2 of the draft PA). The Government would take necessary steps to ensure that the charcoal component of the project, particularly the charcoal plants operated by private interests, does not have any adverse impact on forests and ecology (Section 4.02(b) of DCA). To ensure ease of operation  -12- and to stabilize production at high levels as soon as possible, the carbide plant would be designed to have the flexibility to use up to 30% petroleum coke, along with charcoal, am a reductant. Once production is stabilized at high levels, the project will use charcoal and petroleum coke on a 90/10 ratio to reduce operating costs. Petroleum coke is easily available from the oil refineries in eastern India, near the proposed carbide plant. Infrastructure .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 37. At present, there is no access road to the project site. To make the project site accessible, BCC has completed the 2 km road from Barsa to the project site. BCC has completed levelling of the existing pathway through the beds of the two streams up to Barsa, and would construct a steel bridge (about 7 meters long) across the Barsa Stream (para 3, Schedule 2 of draft PA). In addition, a permanent road from Kharbandi, about 6 km from Phuntsholing, to Barsa would be completed by the Public Works Department by June 30, 1986 (Section 4.05 of the draft DCA). The power requirements of the project (15 MW) would be met from the Chukha project. One of Chukha's four 84 MW units is scheduled to be commissioned in 1985, and the remaining three during 1986. A substation, built adjacent to the project site, has been connected to Phuntsholing via a 66 KV line and it would be connected to Chukha as soon as a 220 KV line is completed by end 1986 (Section 4.02(a) of the draft DCA). Organization and Management 38. The Project would be implemented and operated by BCC, which was incorporated as a limited liability company in October 1984. The Government owns 80% of the company's shares and TCC, the remaining 20%. BCC has a five-member Board of Directors, of whom four are nominated by the Government, and one by TCC. The Deputy Minister, Planning Commission, is the Chairman and TCC's nominee is the Managing Director of BCC. To assist the Managing Director in day-to-day matters, BCC would appoint, by December 31, 1986, a a General Manager with extensive experience in operating carbide plants (Section 3.04(a) of the draft PA). BCC has already appointed a capable and experienced Project Manager, who is responsible for project implementation. By March 31, 1986, BCC would prepare and review with IDA an organizational and staffing plan and subsequently implement this plan in time for project commissioning and operation (Section 3.04(b) of the draft PA). BCC, with assistance from TCC, would recruit and maintain key management personnel (para 2, Schedule 2 of the draft PA). In order to ensure proper linkages between various Government and private entities involved, an Inter- Ministerial Committee would be established, by August 1, 1985, for overall project coordination including infrastructure and upstream facilities (Sec- tion 4.04 of the draft DCA). 39. Technical Assistance. BCC has retained Shriram Projects and Engineering Services (SPES), of DCM Group, India, to provide technical advisory services (para 1, Schedule 2 of the draft PA). SPES has extensive experience in implementing and operating carbide projects and is familiar with local conditions in Bhutan. SPES would assist BCC management in: (i) project implementation including initial operation of the plant for about two years after commissioning; (ii) preparation of legal contracts with suppliers of equipment and services; (iii) development of organizational and management  -13- structure; (iv) development of a staffing and organizational plan; (v) recruitment of personnel; (vi) development and implementation of a training program, including preparation of operating and maintenance manuals; (vii) project reporting to financing institutions; and (viii) installation of a modern financial and accounting system. SPES has agreed to pr^vide 300 man-months of services, over a period of five years including two years after commissioning, at a cost of about US$462,000 equivalent. SPES, as well as the personnel assigned to the project, are fully acceptable and the cost of the services is reasonable. Considering that technical advisory services are critical for the success of the project, IDA has agreed to finance the con- tract for these services. BCC would also employ furnace and engineering contractors and consultants to advise on planning and implementation of the limestone mining, forestry and charcoal components (para 41). 40. Employment and Training. There is an acute shortage of trained manpower and construction labor in Bhutan. However, because of comparatively higher tax-exempt wage and salary scales in Bhutan, suitable manpower would be available from neighboring countries. At the construction stage, about 500 laborers would be required, of which about 20% would be Bhutanese nationals. After the project is completed, BCC would have about 500 employees including 14 key management personnel, 15 trained engineers, and 100 technicians. Of these, about 25 Bhutanese nationals graduating from engineering colleges in India and local polytechnics would be recruited and trained. Selected personnel would be trained abroad. Semi-skilled local personnel would be trained in operations and maintenance. Recruiting and training of local personnel, whenever possible, are an important part of the functions of the technical advisory services. BCC would develop a training program, as part of a detailed organizational and staffing plan, by March 31, 1986 for implementation in time for project commissioning and operation (Section 3.04(b) of the draft PA). Project Execution 41. The project would be executed under two main contracts: the Engineering contract and the Furnace contract. The Engineering Contractor would be responsible for detailed engineering, procurement, and commissioning for all units, except the furnace; for civil and erection work for the entire project, and for appointing the respective sub-contractors after competitive bidding among Bhutanese and Indian firms. The Engineering Contractor would furnish necessary performance guarantees. IDA has confirmed BCC's selection of ICB Private Ltd. (India) to undertake the engineering contract which would be financed by the Kuwait Fund. The Furnace Contractor would be responsible for the supply of calcium carbide furnace equipment, and the bag filter for pollution control; scope drawings for civil works; load data for the furnace foundation; and supervision of furnace erection and commissioning. BCC has negotiated the furnace contract with Elkem (Norway), one of the leading carbide furnace suppliers in the world. For the limestone mining, forestry, and charcoal components of the project, BCC would employ consultants, by September 30, 1985, on a retainer basis, to be caLled upon to review and advise at critical phases of planning and implementation of these components (para 5, Schedule 2 of the draft PA). The carbide plant component of the project is expected to be commissioned in April 1988 (36 months after the effectiveness of the contract with the Engineering Contractor), the mining component i.a November 1987, and the charcoal component in July 1987. The  -14- implementation of the forestry component would start in April 1985 and would continue until 1991. Cost and Financing 42. The total cost of the project is estimated at about US$24 million equivalent (Nu 311 million), of which about US$19.6 million would be foreign exchange. The estimate includes provision for physical and price contingencies, working capital, and interest during construction. Cost estimates are based on the feasibility report prepared by ICB Private Ltd., after taking into account changes in the project scope and price offers received from two leading furnace manufacturers, Demag (the Federal Republic of Germany) and Elkem (Norway). Physical contingency has been estimated at 10% of base cost estimate. Price contingency, computed using Bank projec- tions for local and international inflation rates, is estimated to be 17.6% of base cost plus physical contingency. Cofindncing arrangements include US$6.6 million equivalent from the Kuwait Fund and US$3.9 million equivalent from the Government of Norway. The proposed IDA Credit would be onlent to BCC under a Subsidiary Loan Agreement between the Government and BCC. Signing of this Agreement, with terms and conditions satisfactory to IDA, will be a condition of effectiveness (Section 6.01(a) of the draft DCA). Local financing (US$4.3 million equivalent), as well as cost overruns and cash shortfalls would be covered by internal cash generation and by the Government and TCC. As a condition of effectiveness, the Government and TCC would execute a Shareholders' Agreement satisfactory to IDA (Section 6.01(b) of the draft DCA). Procurement and Disbursement 43. Equipment financed by the IDA Credit would mostly be procured through international competitive bidding (ICB) and partly through other procedures such as limited international bidding (LIB) and limited competitive bidding (LCB)} consistent with Bank Group guidelines. Small items and items that are critical for efficient project execution and operation, costing less than US$200,000, may be procured through LIB after inviting bids from qualified suppliers from at least three eligible countries. The total contract value of such items would not exceed US$2.0 million equivalent, approximately 22Z of the IDA credit. LCB is not expected to be in excess of US$0.5 milLion. To expedite project execution, IDA Credit would finance retroactively up to US$0.5 million of eligible expenditures for technical advisory services and down-payments for procurement of long-delivery items incurred after September 1, 1984. 44. Special Account. Further, to help expedite procurement, a Special Account of US$500,000 would be established to assist in the procurement of IDA financed items (Section 2.02(b) of the draft DCA). Deposits into and payments out of the Special Account may be made for IDA funds only. The initial deposit in the Special Account is an advance disbursement tc the Borrower to prefinance items eligible for reimbursemenc by IDA. No documen- tation is required in respect of the initial deposit, except verification that the Special Account has been _stablished in accordance with IDA requirements. Replenishments to the Special Account would be made against reimbursement applications, submitted on a monchly basis, supported by stand- ard documentation (contract documents, bilLs, invoices. receipts, shipping  -15- documpnts and statements of expenditures as provided under the project), and a copy of the handling bank's statement of account for the reporting period (normally the previous month), showing each transaction under the Special Account. The statement of account would show date of payment, currency and amount paid, rate of exchange, opening balance, any deposit by IDA during the reporting period and the closing balance. Recovery of the initial advance into the Special account would be made by accepting documented withdrawal appLications, but reimbursing only 50X of such reimbursement requests. This process would commence when the undisbursed amount in the Credit account, less any amount committed by IDA under its Agreements to Reimburse, is equal to twice the amount of the initial deposit, or as otherwise specified by IDA (para 5, Schedule 3 of the draft DCA). Procurement Arrangements /a 45. Project Elements Not ICB LCB Others Applicable Total