India - Cement Industry Restructuring Project

Document of The World Bank FOR OFFaCIAL USE ONLY Rep)Ot No. P-5260-IN MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF TPE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA IN AN AMOUNT EQUIVALENT TO US$300 MILLION FOR A CEMENT INDUSTRY RESTRUCTURING PROJECT APRIL 18, 1990 This docuent has a resticted distribtion and may be used by recipint ondy tn the perfonace of thdir offkcl dutes. Its contents may not othrwis be disclosed without Word Bank authorization.  CURRENCY EQUIVALEN Currency unit - Indian rupee (Rs) Rs 1 - 0.059 Rs 17 - $ 1.00 FZff6 YZlAS Government of India - April I-March 31 IDBI - April 1-March 31 ICICI - April 1-March 31 WEIGHTS AND NEASURES Metric System ABBRVIAIONS ADAM=ACO DANIDA - Danish International Development Agency DCCI - Development Commission for Cement Industry DFI - Development finance institution EU * Environmental Impact Assessment COx - Government of India ICICI - Industrial Credit and Investment Corporation of India -DBI - Industrial Development Bank of India RTC - Regional trainlng center  FOR OFFICIAL USE ONLY INDA C%HENT INDUSTY RESTRUCTURING PROJECT Loan and Probest Summar Borrer: India, acting by its President Beneficiaries: Industrial Development Bank of India (IDBI); the Industrial Credit and Investment Corporation of India Limited (ICICI) and Office of Development Commissioner for Cement Industry (DCCI). Loan Amount: $300 million equivalent. Torms: Twenty years, including five years of grace, at the Bank's standard variable interest rate. RelendlMn Terms: Urt A: GOI would relend $298 million equivalent of the proceeds of the Bank loan to IDBI and ICICI in equal propor- tions in rupees at a rate of 12 percent p.a., repayable over 20 years including 5 years of grace, for on-lending to sub- borrowers at the development finance institutions' (DFI) term lending rate, currently 14 percent p.a. The Government will bear the foreign exchange and interest risks. Part-B: GOI would provide $1.6 million equivalent of the Bank loan as budgetary allocations through DCCI to finance part of the Human Resource Development component. Part C: GOI would provide $400,000 equivalent of the Bank loan as budgetary allocations to DCCI to finance part of the Technical Assistance component. Pinancing Plan: xLlliJn S 3ank 300.0 DANIDA 5.8 Industry 253.5 Other 176.9 Total 736.2 Economic Rate of Return: Minimum 12 percent for subprojects financed by the DPIs. Staff Appraisal Reort: Report No. 8422-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 disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR A CEMENT INDUSTRY RESTRUCTURING PROJECT 1. I submit the following memorandum and recommendation on a proposed loan to India for the equivalent of $300 million to help finance a cement industry restructuring project. The loan would be repaid over 20 years, including 5 years of grace, at the standard variable interest rate. Co-financing of $5.8 million equivalent is expected in the form of a grant from the Danish International Development Agency (DANIDA). 2. Backstround. The policy reform for the cement sector in the 1980s comprised phased decontrol of cement pricing and distribution and relaxation of industrial regulatory controls. This deregulation has led to impressive growth and substantial modernization of the cement industry. Production grew from 18 million tons in 1980 to about 43 million tons in 1988. Cement supply, which was in severe shortage only ten years ago, has now caught up with demand and created a competitive cement market. India now produces cement at a cost below the landed import price and has begun limited exports to neighboring countries. Per capita consumption of cement in India ia about 47 kg, very low in comparison with other developing countries of similar income. As the major cement-consuming sectors (irrigation, power and housing) continue to expand, there is an excellent opportunity to develop a modern and efficient cement industry in India. 3. In March 1989, the Government removed completely the price and distribution controls on cement, thereby eliminating all subsidies to the cement users in the public sector and all cross-subsidies relating to freight equalization and differences in levy quotas among cement manufacturers. The sust.inability of liberalization and further improvement of economic efficiency in this sector will depend on the industry's ability to adjust, through industrial restructuring, to the new and mo:e competitive environment. Restructuring during the coming years will focus on three key elements: (a) regional production canacity redistribution. Present cement production is concentrated in the southern and western regions of India. This concentration was caused by uneven distribution of limestone deposits and industrial infrastructure, but the imbalance has been exacerbated by the freight- equalization scheme, which fixed a common price for cement throughout India irrespective of actual transport cost. Following the elimination of the freight-equalization system, sharp regional price differentials developed between the cement-deficit northeast regions and cement-surplus southwest regions. There is need for additional cement capacity in northern and eastern regions which include some of the poorest areas of the country; (b) moderni- zation and restructuring of existing cement companies. The need for modernization comes from strong competitive pressure and the Government's commitment to enforcing pollution-control standards. Major modernization schemes would also involve corporate restructuring programs, including rationalization and training of the work force and elimination of inefficient operations; and (c) introduction of bulk cement transRort systems and establishing manpower training systems that are responsive to the substantial modernization and expansion taking place in the industry. 4. Rationale for Bank Involvement. The Bank began to work in the Indian cement sector in 1980 with a subsector study, India--Cement Subsector Report,  - 2 - No. 3141-IN. This atudy contributed to the policy debate that led to the partial decontrol of the cement industry in February 1982. To support the phased implementation of the elimination of the cement pricing and distribution control, the Bank has provided loans for the Cement Industry Project (Lns. 2660/2661-IN) of $200 million, which became effective on November 10, 1986. The loans are 80% committed and are expected to be fully committed by the time the proposed project would become effective in September 1990. 5. Suosector restructuring strategy is at a formative stage, and the Bank is in a position to provide substantive assistance, based on experience in other countries, in the industrial restructuring of wet-process plants and the mini-cement sector, industrial training and bulk cement transport. In addition, support for the cement industry is consistent with the Bank's lending strategy for the industrial sector. This strategy focuses on policy reform and lowering costs of basic inputs in the economy. The success of cement industry restructuring would encourage reform in other industries. As discussed in detail in the Staff Appraisal Report, lessons from the first project have been incorporated into the design of the proposed project. Bank lending through subsector projects to the DFIs constitutes a small share of the total resources available to them, and the relending rate for the Bank funds is consistent with the overall DFI interest rates. The risk of causing an allocative distortion through subsector lending is small and is more than balanced by the catalytic role of the Bank in helping improve the efficiency of specific subsectors through restructuring projects and other measures contained in these subsector operations. 6. Project Ob1ectives. The proposed project would support the government's policy decision of complete elimination of cement price and distribution controls and would assist the industry in adjusting to an increasingly coia,)etitive environment. The proposed project is expected to enhance the industry's economic efficiency and pave the way for sustained growth to meet increasing demand in the 1990s. 7. Project Description. Part A of the proposed loan would help finance, through a line of credit to IDBI and ICICI, part of the following two components: (a) an Industry Modernization and Restructuring component which would finance (i) capacity expansion in the cement-deficit regions to reduce regional demand/supply imbalances and to reduce excessive transport of cement, and (ii) modernization and restructuring projects in existing cement companies throughout India to reduce energy consumption, enhance operational efficiency and improve environmental protection standards; (b) a Pilot Bulk Cement Trans- gort component which would help establish a pilot bulk cement transport system including loading facilities at participating cement plants, special bulk cement rail wagons, and unloading and distribution systems at Kalamboli Railway Terminal near Bombay. Part B of the loan would help finance part of a Human Resource Development component which would establish demand-driven, in- plant training systems at regional training centers (RTC), attached to respective lead plants, for groups of cement plants having geographic proximity. Part C of the loan would help finance part of a Technical Assistance component which includes the following studies and technical assistance programs: (i) a study of the general environmental status and pollution control measures for the cement industry; (ii) technical assistance  - 3 - for the Pilot Bulk Cement Transport component; (iil) a feasibility study for bulk cement transport by coastal shipping; (iv) a study for mini-cement development strategy; (v) a feasibility study for setting up coal washeries for the cement industry; and (vi) a feasibility study for use of lignite for the cement industry. 8. The total cost of the project is estimated to be $736 million, with a foreign exchange component of $110 million. A breakdown of project costs and the financing plan are shown in Schedule A. Amounts and methods of procurement, disbursements, and the disbursements schedule are presented in Schedule B. A timetable of key prcject processing events and the status of Bank Group operations in India are given in Schedules C and D, respectively. The Staff Appraisal Report, No. 8422-IN, dated April 10, 1990, is being distributed separately. 9. Agreed Actions. For Part of the Loan, GOI has agreed to relend $298 million of the proceeds of the Bank loan to IDBI and ICICI, in equal proportions, in rupees at a rate of 12 percent p.a., repayable over 20 years including 5 years of grace, for on-lending to subproject borrowers at the DFIs' term lending rate, currently 14 percent p.a. An understanding was also reached that GOI would review the DFIs' term lending rate from time to time in relation to inflation and other domestic and international market conditions and adjust this rate as necessary to ensure that the on-lending rate on new subloans will remain positive in real terms, reflect market conditions and provide a reasonable spread to the DFIs. For Part B of the loan, GO has agreed: (i) to pass on $1.6 million of the proceeds of the Bank loan as budgetary allocations through DCCI to finance part of the Human Resource Development component; (ii) through DCCI, to enter into Memoranda of Under- standing (NOU) acceptable to the Bank with selected cement companies for the establisbment of RTCs and to ensure that the RTCs operate effectively and efficiently in accordance with agreed operating guidelines; (iii) to establish a Steering Committee chaired by DCCI; and (iv) to position a Program Coordinator by December 31, 1990 to assist implementation of the Human Resource Development component. For Part C of the loan, GOI has agreed: (i) to pass on $400,000 of the loan as budgetary allocations to DCCI to finance part of the Technical Assistance component in accordance with the terms of references acceptable to the Bank, and (ii) to discuss the results and follow-up actions of the assisted studies with the Bank during project implementation. 10. IDBI and ICICI have agreed to (a) maintain internal debt:equity and debt-service coverage ratios acceptable to the Bank; (b) adopt subproject and participating company criteria including that for adequate economic and financial rates of return; and (c) adopt adequate environmental assessment requirements and review procedures, and employ environmental consultants whenever in-house expertise at IDBI and ICICI is not adequate for subproject appraisal. For subprojects costing over $20 million, the Bank's approval of the IDBI or ICICI appraisal report and the Environmental Impact Assessment (EIA) would be required before a subloan commitment is made. IDBI and ICICI would seek assurance from subproject borrowers that all subprojects comply with necessary requirements to protect the environment. 11. The Government's entering into Subsidiary Loan Agreements with IDBI and ICICI would be a condition of effectiveness of the Bank loan. The effect-  - 4 - iveness of the Financing Agreement between the Government and DANIDA, and the establishment of the Steering Committee would be conditions of disbursement of the Human Resource Development component. 12. Bjngsft. The proposed project would add about 5 million tpy production capacity in cement-deficit regions, bring significant savings in cement transport costs and reduce the cost of cement in some of the poorest regions of the country. The project would support modernization and restructuring of existing cement companies, reduction in energy and other productLon costs, and improvement in the economic efficiency of operations. The project would also support installation of pollution control equipment, ensure adequate environmental assessment of subprojects, finance a study for subsectoral environmental protection and pollution controls, and support productive use of slag, a waste product of steel plants, which must be disposed of in an ecologically acceptable manner. Financing the pilot bulk cement transport project would pave the way for significant long-term efficiency improvement in the cement distribution system and promote productivity increases in the construction industry. The project would also finance training programs for operating personnel and environmental professionals in much-needed skill categories. 13. Rlsks. No unusual technical risks would in-Ive in construction and modernization of cement plants under the Industry odervization and Restruc- turing component. Introducing a bulk cemont transport system requires the development of a new marketing and distribution approach and involves many players with substantial investments: it is therefore inherently riskf. Measures that have been designed to miniw