India - Electronics Industry Development Project

Documetit of The World Bank IFOR OFFICIAL USE ONLY /.A 3093 ,A AlJ 3 o /A/ Rtepot No. P-5044-IN MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO INDIA IN AN AMOUNT EQUIVALENT TO US$8 MILLION TO THE INDUSTRIAL DEVELOPMENT BANK OF INDIA IN AN AMOUNT EQUIVALENT TO US$101 MILLION AND TO THE INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LTD. IN AN AMOUNT EQUIVALENT TO US$101 MILLION FOR AN ELECTRONICS INDUSTRY DEVELOPMENT PROJECT MAY 24, 1989 Ilds docwent has a restrleted distribflion and may be used by recildent only in the performance of thelf offcial dutks Its contenls may oot otherwise be disclosed without World Bank aufthrizatioo.  CURNCY EOUIVALENTS Rs 1 - US$0.067 ks 15 - US$1.00 PIXSCAL YEARS Government of India - April 1 - March 31 IDBI - April 1 - March 31 ICICI - April 1 - March 31 ABBREUIATIONS AND ACRONYMS ASIC - Application Specific Integrated Circuits CAD/CAM - Computer Aided Design and Manufacturing CEDT - Center for Electronics Design and Technology DFI - Development Finance Institution EPABX - Electronics Private Auxiliary Branch Exchange ERAS - Exchange Risk Administration Scheme Eximbank -Export-Import Bank of India FERA - Foreign Exchange Regulation Act GOI - Government of India IC - Integrated Circuit ICICI - Industrial Credit and Investment Corporation of India IDBI - Industrial Development Bank of India IIT - Indian Institute of Technology JGF - Japan Grant Facility LSI - Large Scale Integration MES - Minimum Economic Scale ;ODVAT - Modified Value Added Tax MRTP - Monopolies and Restrictive Trade Practices Act OGL - Open General License PIU - Project Implementation Unit PMP - Phased Manufacturing Program PSE - Public Sector Enterprise RBI - Reserve Bank of India REP - Import Replenishment SCL - Semiconductor Complex Ltd. SDC - Swiss Development Cooperation SFC - State Financial Corporation SSI - Small Scale Industry VLSI - Very Large Scale Integrated Circuit  FOR OmCIAL USE ONLY INDIA ELECTRONICS INDUSTRY DEVELOPMENT PROJECT Loan And Project Summary Borrowers : (a) India, acting by its President. (b) Industrial Development Bank of India (IDBI); and (c) Industrial Credit and Investment Corporation of India (ICICI). Guarantor of the Loans to IDBI and ICICI : India, acting by its President Loan Amounts : US$210 million equivalent to be lent as follows: (a) US$8 million equivalent to India; (b) US$101 million equivalent to IDBI; and (c) US$101 million equivalent to ICICI. Terms : Twenty years, including 5 years of grace, at the Bank's standard variable interest rate. Relending terms : Development Financial InsiitutionM (DFI) Credit 2mponent. The loans to IDBI and to ICICI to be used for financing of fixed assets and permanent working capital would be relent to sub-borrowers in foreign exchange at the Bank's standard variable interest rate plus 2% to provide a spread for the financial institutions or in rupees at the prevailing Exchange Risk Administration Scheme (ERAS) rate (presently 15% with a cap rate of 18%). This rate would be adjusted according to ERAS terms to ensure that the exchange rate and interest rate risks are adequately covered. Financing Plan : Bank US$ 210.0 Government of India US$ 2.8 DFIs US$ 50.7 Sub-project sponsors & others USS 167.6 Swiss Development Cooperation US$ 16.2 Government of Japan USS 2.7 TOTAL US$ 450.0 Economic Rate of Return : Sub-projects financed by the DFIs would have a minimum economic rate of return of 12%. Staff Appraisal Report : Report No. 7704-IN. This document has a restricted distribution and may be used by recipients only in the performance of their offlcial duties. Its contents may not otherwise be discisd without Wodd Bank authorization.  MENORANDUM AND RECOMMENDATION.OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOAN3 TO INDIA TO THE INDUSTRIAL DEVELOPMENT BANK OF INDIA AND TO THE INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA I.IMITED FOR THE ELECTRONICS INXUSTRY DEVELOPMENT PROJECT 1. The following memorandum and recommendation on proposed Bank loans to India (US$8 million), Industrial Development Bank of India (US$101 million), and Industrial Credit and Investment Corporation of India Ltd. (US$101 million) is submitted for approval. The proposed loans would be for 20 years, including five years of grace, at the Bank's standard variable interest rate to help finance an electronics industry development project. Cofinancing of US$16.2 million equivalent from the Swiss Development Cooperation and US$2.7 million equivalent from the Japan Grant Facility are expected as grants. 2. Back&Lo- . India has the potential to develop a competitive electronics industry based on its large pool of engineering and scientific manpower and its potentially large domestic markets. Gross production of electronics products grew at an annual average of 22% from 1980-87 and reached Rs. 47.2 billion (US$3.7 billion) in 1987. The sector now accounts for more than 5 of manufacturing value added, which is shared about equally between the public sector, organized private sector and small scale industry. Though some firms produce cost competitive products, and exports (about 7% of production) are expanding, much of the industry is inefficient and its products are usually of high cost and relatively low quality. 3. The electronics industry's problems are rooted in past industrial policies which until recently had restrained domestic competition, discouraged technological updating, contributed to inappropriate scale and fragmentation of capacity, prevented import competition and discouraged exports. A priority industry, electronics has benefitted since 1981 from sector-specific policy measures and since 1985 from both sector-specific and general policy measures to improve its performance. They include deregulation of capacity licensing, easing of restrictions on dominant and foreign-owned firms, small-scale industry dereservations, elimination of the public sector enterprise monopoly of telecommunication equipment, reduction of quantitative restrictions and lowering of import tariff and excise tax levels and reduction in barriers to foreign technology. These measures have been complemented recently by liberalization in the financial sector, especially in capital markets. 4. These reforms have greatly increased domestic competition and facilitated access to foreign technology and as a result domestic prices of electronics projects have fallen sharply. This trend, together with improvements in export administration and reductions in the real effective exchange rate, have helped expand electronics exports. Investment, especially from the private and joint sectors, has increased dramatically. Import constraints are still significant, however, and industrial closure is difficult. Other industry constraints ir lude lack of communications infrastructure, undeveloped supporting servi_..es, inadequately trained skilled manpower, inflexibility of financing and lack of risk capital.  -2- 5. Rationale for fank Involvement. The Bank completed a sector strategy report (India* Develozment of the Electronies Industrv - A Sector =gg. No. 6781-IN) in mid-1987, which highlighted possible future directions for the industry and proposed a set of needed policy reforms. The proposed project would allow the Bank to continue to work with the Government on further reforms in electronics and more generally the industrial sector. In this project, the Bank would support tie 001's objective of developing an efficient electronics industry eventually capable of internationally competitive production by addressing the major constraints of the sector while laying the basis for additional policy reforms as part of the continuing dialogue begun during preparation of the sector report. 6. Proiect Objectives. The objective of the project is to assist the Government of India, IDBI and ICICI foster a competitive electronics study. It would (a) upgrade the capability of the financial institutions to identify, appraise and finance sound projects in this sector; (b) provide them with financial support to meet investment, working capital, and technology-purchase requirements of eligible electronics firms; (c) upgrade the capacity of technical education institutions to develop technical and professional skills required for the rapid and efficient growth of the industry; (d) help to shape the strategy, and identify specific projects for development in computer software; and (e) help to improve the informational and analytic basis for investment and policy decisions concerning the industry. 7. Prolect Descriotion. The project would include the following components: (a) private and joint sector investment (US$420.2 million) in fixed assets and permanent working capital with Bank financing through ICICI and IDBI (US$202 million) using a new "single window" mechanism to finance both fixed investment and permanent working capital requirements of sub-borrowers; (b) improvement of skilled man-power development and training capacity of selected education and training institutes (US$26.8 million) through grants from DOE (financed by US$8.0 million from the Bank, $16.2 million grant funds expected from the Swiss Development Cooperation and US$2.6 million from GOI) for equipment, training and other assistance; and (c) technical assistance (US$3.0 million) for: (i) development of the computer software industry (studies, seminars, and project identification); (ii) support of electronics investment and policy development (seminars and studies); and (iii) upgrading the capability of financial institutions to screen and appraise electronics projects (financing of US$2.7 million expected from the Japan Grant Facility, $0.2 million from GOI, and US$0.1 million from the DFIs). The total cost of the project would be US$450.0 million, of which US$211.9 million would be in foreign exchange. A breakdown of costs and financing plan are shown in Schedule A. Amounts and methods of procurement are shown in Schedule B. A timetable of the project's key processing events and the status of Bank Group operations in India are given in Schedules C and D, respectively. The Staff Appraisal Report, No. 7704-IN, dated Nay 23, 1989, is being distributed separately. 8. Agreed Actions. The Government and the DPIs have established an Exchange Risk Administration Scheme (ERAS) for relending to large scale borrowers which was reviewed in the context of the Export Development Project approved on May 12, 1989. Under the ERAS scheme, DFIs will pool  -3- their foreign currency borrowings and relend in local currency at adjustable rates, which will be adequate to provide a 2% spread for DFIs and cover the foreign exchange and interest risks. Each subloan will initially bt set at the prevailing ERAS rate with a maximum cap rate (presently 15% and 18%, respectively). The Government would: (a) adjust the ERAS rate as necessary to cover the interest rate and foreign exchange risks; and (b) would make ar. advance to the ERAS fund if tne fund runs into a deficit in the short-run due to unexpected exchange rate movements, but would be repaid when the Fund is in surplus. 9. With respect to the Manpower Development and Technical Assistance components, (i) the Government has agreed to establish a Project Implementation Unit (PIU) and Steering Committee in accordance with a timetable and staffing acceptable to the Bank; (ii) to select and support under the project resource centers, engineering colleges, polytect.1c institutions, and centers for electronics design and technology satisfactory to the Bank; and (iii) enter into an agreement with the Government of Switzerland for cofinancing which will become effective no later than December 31, 1989, and (iv) to conduct the programs on software industry development and support of electronics investment and policy development in accordance with a schedule, organizational arrangements and procedures to be agreed with the Bank. 10. The financial institutions have agreed to: (a) follow procedures for administering the term lending component, acceptable to the Bank, including repayment terms of no more than fifteen years (five year maximum for permanent working capital loans) including up to three years of grace, a free limit of US$8 million for a single sub-project, minimum financial and economic rates of return of 15% and 12% on sub-projects, respectively, working capital to be financed only as part of investment project financing; and (b) provide the Bank with a satisfactory work program for the implementation of the DPI technical assistance component by September 30, 1989. 11. f The project would support the Government's long-term goal of making the electronics industry internationally competitive and of disseminating the benefits of information and telecommunications technology more widely in India. It would strengthen the ability of two major DFIs to identify and finance viable new projects in this sector, as well as upgrade the technical capability of existing firms. All investments financed would have satisfactory financial and economic rates of return. The credit component would finance about 30 sub-projects, resulting in investments of about US$420 Pillion and employment of about 12,000 people. The project also would provide improved training for this industry's principal resource, skilled manpower, which in turn would raise productivity and facilitate transfer of technology that is critical for electronics development. This component would result in an upgraded capability to produce 4,000 middle and higher level technical and professional staff annually in the fields of electronics and computer software. The project would develop programs and identify projects to help relieve other constraints in the highly promising computer software industry. Finally, it would foster a more informed dialogue within India about the future of this industry, and how it can become a viable part of the electronics industry worldwide.  .4- 12. Rlska. First, the Government will be slow in implementing further needed reforms, espe