India - Cement Industry Restructuring Project

Document of The World Bank FOR OFFICIAL USE ONLY At 3,/c ,- /A/ Report No. 8422-IN STAFF APPRAISAL REPORT INDIA CEMENT INDUSTRY RESTRUCTURING PROJECT APRIL 10, 1990 Industry and Finance Division Asia IV Country Department This document has a restricted disttibution and may be used by ecipients only in the performance of their oflicial dudes. Its contents may not othenwise be disdosed without Wodd Bank auhOt  CURRENCY EQUIVALENTS Rs 1 - US$ 0.059 Rs 17 - US$ 1.00 FISCAL YEARS Government of India - April 1 - March 31 IDBI - April 1 - March 31 ICICI - April 1 - March 31 WEIGHTS ANID MEASURES Metric System ABBREVIATIONS AND ACRONYMS ACC - Associated Cement Companies, Ltd. AICD - Assam Industrial Development Corporation ATI - Advanced Training Institute BIFR - Board for Industrial and Financial Restructuring CCI - Cement Corporation of India CMA - Cement Manufacturers Association CTI - Century Textile and Industries, Ltd. DANIDA - Danish International Development Agency DCCI - Development Commissioner for Cement Industry DFI - Development Finance Institution EIA - Environmental Impact Assessment FOR - free on rail GOI - Government of India HED - Human Resource Development (Component) ICB - International Competitive Bidding ICICI - Industrial Credit and Investment Corporation of India IDBI - Industrial Development Bank of India IMR - Industry Modernization and Restructuring (Component) JIL - Jaiprakash Industries, Ltd. MRTP - Monopolies and Restrictive Trade Practices Act NDC - Northeast Development Council nm3 - Norm Cub'a Meters NVTS - National Vocational Training System OPC - Ordinary Portland Cement PBCT - Pilot Bulk Cement Transport (Component) PC - Program Coordinator PPC - Pozzolana Portland Cement PSC - Portland Slag Cement RBI - Reserve Bank of India RITES - Rail India Techno-Economic Service RTC - Regional Training Center SAIL - Steel Authority of India, Ltd. SC - Steering Committee SFC - State Financial Corporation SIDC - State Industrial Development Corporation SOE - Statement of Expenditure SPCB - State Pollution Control Board TA - Technical Assistance (Component) TISCO - Tata Iron and Steel Company tpd - ton per day tpy - ton per year  FOR OMCIL USE ONLY INDIA CEMENT INDUSTRY RESTRUCTURING PROJECT Lsoan and Prolect Summary Borrower: India, acting by its President BenefiLiaries: Industrial Development Bank of India (IDBI); the Industrial Credit and Invastment Corporation of India Limited (ICICI) and Office of Development Commissioner for Cement Industry (DCCI). Loan Amount: $300 million equivalent. Terms: The loan would be made at the Bank's standard variable interest rate and would be repaid over 20 years including 5 years of grace. Relending Terms: The Government of India (GOI) would utilize the proceeds of the loan as follows: Part A: GOI would relend $298 million equivalent of the Bank loan in rupees to IDBI and ICICI in equal proportions to finance part of the Industry Moderniza- tion and Restructuring component and the Pilot Bulk Cement Transport component. The relending rate from GOI to IDBI and ICICI would be 12 percent p.a. The on-lending rate to subborrowers from IDBI and ICICI would be development finance institutions' (DFI) term lending rate, currently 14 percent p.a. GOI would bear the foreign exchange and interest rate risks. ?axrt : 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. Zart C: GOI would provide $400,000 equivalent of the Bank loan as budgetary allocations to DCCI to finance part of the Technical Assistance component. Irotect Description: The proposed project is designed to support cement industry restructuring following the complete decon- trol of pricing and elimination of freight equaliza- tion for cement, implemented 1:, the Government in March 1989. The project has the following components- (a) the Industry Modernization and Restructuring component, which would finance capacity expansion in cement-deficit regions and modernization and restructuring of existing cement companies throughout India, and assist the industry in adjusting to a 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 - competitive environment; (b) the Pilot Bulk Cement Transort component, which would help establish and finance 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; (c) the Human Resource Development component, which would assist and finance a demand- driven, in-plant training system at selected regional training centers (RTC) to be established, at respect- ive lead plants, for groups of cement plants having geographic proximity; and (d) the Technical Assistance component, which would assist DCCI in studying policy options for the mini-cement sector, coal washery and use of lignite for the cement industry, environmental protection and pollution control measures for the industry, and future bulk cement transport and applications. Benefits and Risks: The project would improve the regional production structure by adding about 5 million tpy production capacity in the cement-deficit regions, bring slgnificant savings in cement transport and reduce the cost of this vital commodity in some of the poorest regions of the country. The project would support modernization and restructuring of existing cement companies, thereby reducing energy and other produc- tion costs and improving the economic efficiency of operations. The project would finance installation of pollution control equipment, ensure better environ- mental assessments, and encourage productive use of slag, a waste product from steel plants which must be disposed of in an ecologically acceptable ma-ner. Financing the pilot bulk cement transport component would pave the way for significant efficiency improve- ment in the cement distribution system and produc- tivity increase in the construction industry. The project would also finance training programs for operating personnel and environmental professionals in much-needed skill categories for both new plants and existing plants under modernization. No unusual risks have been identified in subprojects in the proposed pipeline under the Modernization and Restructuring component. Introducing a bulk cement transport system requires the development of a new marketing and distribution systems and involves many players with substantial investment: it is therefore inherently risky. Measures designed to minimize risk are the provision of limited bagging facilities at the unloading terminal, phased implementation of the project, and the provision of further technical assistance for market development of bulk cement. Im- plementation of the Human Resource Development com- ponent is likely to be slow due to the innovative nature of the approach and the necessity of having  - iii - groups of cement plants joining in a common effort. Memoranda of Understanding signed between DCCI and each RTC's lead plant company would provide assuran- ces: (a) that the lead plants will commit financial and managerial resources for training and (b) that the RTCs would offer training services to other plants for appropriate fees. The Danish International Development Agency (DANIDA) has agreed to finance consultants to assist in project implementation for this component. Estimated Cost: J&cal Foreign Total -...---- (M'llion $)------- Modernization and Restructuring 585.0 90.0 675.0 Pilot Bulk Cement Transport 37.5 12.5 50.0 Human Resource Development 3.5 6.5 10.0 Technical Assistance 0.2 1.0 1.2 Total 626.2 110.0 736.2 Financing Plan: Bank 195.8 104.1 300.0 DANIDA 0.0 5.6 5.8 Industry 253.5 0.0 253.5 Other 176.9 0.0 176.9 Total 62672 110.0 736.2 Estimated Disbussement: IBRD FY 91 92 93 94 95 96 ----------- (Million $) ------------ Annual 25 105 90 40 30 10 cumulative 25 130 220 260 290 300 Economic Rate of Minimum 12 percent for subprojects financed by the Return: DFIs.  INDo CEMENT INDUSTRY RESTRUCTURING PROJECT STAFF APPRAISAL REPORT Table of Contents I. INTRODUCTION ................................................... 1 II. INpIAN CEMENT MANUFACTURING INDUSTRY ....... ...................... 2 A. Present Structure of the Industry ......... ............... 2 B. Past Policy Environment and Its Impact ...... ............. 4 C. Policy Reforms and Industry Responses ...... .............. 5 D. Economic Considerations .................................. 7 E. Demind and Supply Projections .......... .................. 9 1II. RESTRUCTURING OF THE CEMENT INDUSTRY AND ROLE OF THE BAK ........ 14 A. Cement Industry Restructuring Strategy ..... ............. 14 B. Bank Lending to Industry ................................ 19 IV. THE PROWECT AND THE PROPOSED LOAN .I.............................. 22 A. Project Objectives ...................................... 22 B. Project Description ..................................... 22 C. Environmental Aspects of the Project ..... ............... 27 D. Project Cost and Financing Plan ......................... 30 E. The Loan ............ .................................... 31 F. Procurement ........... .................................. 32 G. Disbursement .......... .................................. 34 H. Reporting and Audits .................................... 34 This report is based on the findings of a World Bank appraisal mission which visited India January 8-29, 1990. Mission members were Messrs. S. Wu (Financial Analyst), M. Fog (Senior Cement Industry Specialist), M. Pherwani (Senior Industrial Specialist), W. Futur (Senior Economist), J. Segerstrom (Technical Education Specialist), T. Loomis (Environmental Consultant), 0. P. Hansen (Senior Advisor, DANIDA), M. Bregnbak (Technical Adviser, DANIDA) and A. Austen (Consultant). Mr. G. Thomas (Consultant) also joined the mission as a resource person. The report was prepared by Messrs. S. Wu, M. Fog, M. Pherwani, W. Futur and J. Segerstrom.  V. IMPLEKEKTATION AR GME S. PARTICIPATING ORGANIZATIONS. AND PROJECT BENEFITS AND RISKS . .................................. 36 A. Development Commissioner for Cement Industry ..... ............. 36 B. Participating Financial Institutions .......................... 36 C. Organizational Arrangements for Human Resource Development Component ..................................................... 41 D. Project Benefits and Risks ......... ........................... 42 VI. AGREEMENTS. UNDERSTANDINGS AND RECOMMENAIO ..... ............... 44 A. Agreements and Understandings ................................. 44 B. Conditions of Effectiveness and Disbursement ...... ............. 45 C. Recommendation . ............................................... 45 ANNEXES Annex 1 Input Costs Increases ............. ............................ 46 Annex 2 Shadow Prices and Conversion Factors .......................... 47 Annex 3 Projection of Cement Production ............................... 50 Annex 4 Technical Assistance Component ................................ 52 Annex 5 Guidelines fc. Preparing Environmental Impact Assessments for Major Cement Subprojects ........... ........................... 54 Annex 6 Disbursement Schedule and Projection .......................... 58  STAFF APPRAISAL REPORT IzD CEMENT INDUSTRY RESTRUCTURING PROJECT I. IN!RODUCTION 1.01 Policy reform in the cement sector in the 1980s comprised phased decontrol of cement pricing and distribution and relaxation in industrial re- gulatory controls. These reforms have resulted in impressive growth and substantial modernization of the industry. Cement production grew from 18 million tons in 1980 to about 43 million tons in 1988. Cement supply 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 to export a limited amount of cement to neighboring countries. The current per capita consumption of cement ir. India is about 47 kg, low in comparison with other developing countries of similar income. There is immense scope for cement consumption growth, as the cement- consuming sectors (irrigation, power and housing) continue to expand. The situation presents an excellent opportunity for the development of a modern and efficient cement industry in India. 1.02 In its 1989 budget, the Government of India (GOI) announced the com- plete removal of price and distribution controls for cement. This policy deci- sion has eliminated all subsidies to cement users in the public sector and all cross-subsidies relating to freight equalization and differences in levy quotas among cement manufacturers, and it has provided an environment that is conducive to rational investment and increased efficiency in cement production and distribution. The sustainability of liberalization and further improvement of economic efficiency in this sector will depend on the industry's ability to ad- just, through industrial restructuring, to the new and more competitive environment. To support the adjustment process in this recently liberalized subsector, GOI requested the Bank and the Danish International Development Agency (DANIDA) to prepare the Cement Industry Restructuring Project. 1.03 The proposed project would finance production capacity expansions in the cement-deficit regions and modernization and restructuring of the existing cement companies throughout India. The project would help to establish and finance demand-driven, in-plant training programs to support human resource development compatible with the substantial technological and structural transformation in the industry. The project would also help develop and finance a pilot scheme for transporting cement in bulk from a number of plants to Kalamboli Railway Terminal near Bombay. Successful implementation of this pilot scheme would introduce bulk movement of cement across the country, and potential productivity improvement for the construction industry. Finally, the project would assist DCCI in studying policy options for the mini-cement sector, coai washeries and use of lignite for the cement industry, environmental protection and pollution control measures for the industry, and future bulk cement transport and consumption. Overall, 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.  - 2 - II. ITDIAN CEMENT MANUFACTURING INDUSTRY A. Present Structure of the Industrv 2.01 Production Structure. The Indian cement industry has achieved considerable success in establishing adequate production capacity. As of March 1988, this industry consisted of 94 large and medium-size plants, 5 white cement plants and 135 mini-cement plants (i.e., clinker capacity less than 200 tpd). The large and medium-size plants produced 37 million tons of cement in 1987, 95 percent of the total cement production in the country. The mini-cement plants, although large in number, produced less than 2 million tons (less than 5 percent of total production) in the same year. About 25 million tons of energy-efficient, dry-process production capacity was added during the unprecedented growth which followed partial decontrol in 1982. As a result, the share of installed capacity based on the dry process increased from 53 percent in FY83 to 72 percent in FY88. With the expected further expansion in dry-process capacity and completion of a number of major wet-to-dry conversion projects in 1989 and 1990, about 80 percent of the country's cement production capacity will be based on the dry process. By 1988, around 26 percent of the installed production capacity was in plants of one million ton per year, a scale that is considered optimal based on today's technology. All new plants will be of this scale in the coming years. Conversion of the remaining wet-process plants to dry process, and expansion and modernization of old plants to reach optimal economies of scale and production technology will continue as the industry adjusts to the increasingly competitive market created by decontrol of cement pricing and distribution. 2.02 Regional Distribution of Capacity. India's installed cement production capacity is concentrated in the western and southern regions, where limestone deposits are abundant and adequate supporting infrastructure (such as rail and road network) is available. In 1988, about 85 percent of cement was produced in the states of Madhya Pradesh (26.0 percent), Andhra Pradesh (13.8 percent), Rajasthan (11.3 percent), Tamil Nadu (9.3 percent), Gujarat (8.7 percent), Karnataka (8.9 percent) and Maharashtra (7.2 percent). Between 1982 and 1988, the share of cement production in the western and southern regions increased from 68.8 percent to 74.8 percent. Conversely, not only did the production share of eastern states decrease from 13.6 percent to 6.9 percent, but also their production in absolute terms also decreased from 3.1 million tons per year to 2.8 million tons, due to suspension of production of two plants in Bihar. The regional cement production-consumption pattern for 1988 is presented in Table 2.1. The regi-nal imbalance of production capacity and demand contribute to high transpurt costs for the distribution of cement, which amount to an estimate of Rs. 8 billion per year. 2.03 Ownership Structure. The industry has been developed primarily by the private sector. Private firms accounted for 84 percent of installed capacity and 87 percent of total cement production at tL. end of FY88. The public sector's entry into the cement industry goes back several decades (the first such plant was built in 1938), but significant capacity was not added until the late 1960s and 1970s. At present, the public sector produces about 13 percent of  India's cement output (down from 14 percent in FY85), the Cement Corporation of India (CCI) accounts for 5.7 percent, and 7 state government-owned companies produce the remaining 7.3 percent. Moreover, GOI has moved away from its previous policy of supporting large capacity expansions in the public sector; i.e., the Government has abandoned its previous objective of reaching 25 percent public ownership of total installed capacity by the end of Seventh Plan. The distribution of capacity and production of cement by type of ownership during FY88 are summarized in Table 2.2. Table 2.1 9eaional Production and Conwumption, Jj8 Production Consumplo Surnlus/(Deficit) North 7.44 11.89 (4.45) East 2.81 7.10 (4.29) West 17.06 10.53 6.53 South 1341 10.86 2.55 Total 40.72 40.38 0.34 Source: Cement Manufacturers' Association (C_A) Cement Statistics 1988. Regions are de ined as: West GuJarat, Maharashtra, Madhya Pradesh and Goa; 'South: Andhr-. Pradesh, Karnataka, Tamil Nadu and Kerala; East: Bihar, Orissa, West Bengal and Northeastern states; North: Rajasthan, Uttar Pradesh and other northern states. Table 2.2 Distribution of Canacity and Production According to Ownership. 1987/88 (In million tons) Caoacitv gercent Production percent Public Sector CCI 3.75 6.8 2.23 5.7 State-owned 4.98 9_Q 2j.9 7.3 Total 8.73 15.8 5.12 13.0 Private Sector ACC 8.83 16.1 7.62 19.3 Others A/ 37.38 6..1 26L68 67.7 Total 46.21 84.2 34.30 87.0 TOTAL 54.94 100.0 39.42 100.0 a/ Including mini and white cement plant but excluding Rohtas, Sonevalley and Sewree which were closed down. Source: CMA, Performance of Cement Industry, 1987/88.  - 4 - B. Past Policy Environment and Its Impact 2.04 The industry grew ralatively slowly during most of the 1970s. Between FY70 and FY74 (the Fourth Plan), annual growth rates of capacity and production were 5.7 percent, and 3.7 percent, respectively. During the Fifth Plan, capacity growth fell to 2.6 percent p.a. As a result, between 1978 and 1983 the country experienced considerable shortage of cement (10-25 percent of annual consumption) and had to import 1-3 million tons of cement per year. The slow expansion of capacity and associated chronic shortages of cement experienced during the 1970s were caused by restrictive sectoral policies including controlled prices, rigid capacity licensing and freight equalization for distribution. 2.05 Price Control and Canacitv Licensing. For 40 years (1942-82), Indian cement prices had been were controlled by the Government, except for 1966 and 1967. The pricing policy over this period fixed the retention price (the ex-factory price of bulk cement) and the free on rail (FOR) destination price of bagged cement. Freight cost, packaging and incidental charges, and excise duties and sales taxes were then added to arrive at the retail price to the consumer. These pricing policies had a serious adverse impact on the profitabi- lity of investment in the cement industry. The decline in the expansion of cement production capacity during the Fourth and Fifth Plan periods was caused by the low return on investments because of controlled prices and to some extent the restrictive capacity licensing policies toward large industrial houses (MRTP companies). In the 1970s, particularly during 1970-77, retention prices failed to provide an adequate return on investment in the sector, which resulted in considerable slowing of expansion capacity during the Fifth Plan p.riod. The combined impact of all these, together with low capacity utilization attributed to power and coal shortages, resulted in chronic shortages of cement throughout the 1970s. 2.06 Freight Egualization and Remional Distribution of Capacities. The freight equalization scheme was introduced in 1956 to ensure uniform cement prices throughout the country. A pooled average freight charge was built into the free-on-rail (FOR) destination price of cement. Actual freight charges incurred were notional in that they only helped to define the average freight charge from all production locations. Under this system, cement transport from a given plant to the market was subsidized (or taxed) to the extent that actual freight charges exceeded (or fell short of) the notional average freight charges per ton of cement transported from all plants. Because of this policy, planning of cement production capacities gave little importance to location of markets. The cost of moving large volumes of cement to the eastern and northeastern states (cement-deficit regions) and coal in the opposite direction were not adequately taken into account when plant location decisions were made. This situation led to unwarranted concentration of production of capacities in the western and southern regions where limestone deposits are abundant and better basic infrastructure is more readily available (para. 2.02). The consequences of this regional production pattern are painfully evident today following the decontrol of cement prices and the elimination of the freight equalization scheme. As  would be expected, cement prices in the deficit regions have risen sharply. On the other hand, given the sizable excess capacity, cement prices in the surplus regions are very depressed. This situation constrains the financial performance of many cement producers in the surplus regions and cement users in the deficit regions. C. Policv Reforms a#d ndustry Res2onses 2.07 Recent Reforms. Efforts to reform restrictive cement sector policies commenced in 1976. Measures adopted in 1977 attempted to improve return on investment and stimulate creation of production capacities to meet growing demand. Towards this objective, a decision was made to change the basis for fixing cement prices from the 14 percent pre-tax return on total capital employed to a 12 percent post-tax return on net worth. The higher expected return on investments associated with this new pricing principle was sufficient to stimulate investments in the cement secror in the late 1970s. In the meantime, the Government imported cement to cover the shortage and to keep competition and price of cement in check. Subsequently, GOI took an important step to open the sector by allowing new entry and expansion of existing capacities by MRTP companies in the cement industry. As a result, by the end of 1981 about 12 million tons of capacity expansion was under implementation for commissioning during the early and mid-1980s. This major expansion, and the resulting easing of supply constraints, encouraged the Government to continue to liberalize its cement pricing and distribution policies leading to complete decontrol in March 1989. 2.08 The timing of these policy reforms for the cement sector coincided with, and formed an integral part of, the general industrial policy liberaliza- tion in the country. Of all the measures taken, the most important for the cement industry were relaxation of investment licensing, permission for entry of MRTP companies, the gradual reduction and elimination ef the requirements of levy cement, and elimination of the freight equalization scheme. These reforms allowed the industry to modernize and expand more easily in response to changing market conditions. Another important area of policy reform was the relaxation of foreign technology transfer and collaboration, which helped enhance the competitiveness of the domestic cement machinery manufacturing industry. 2.09 Industry Response. The cement industry responded well to these policy reforms (Table 2.3). Installed capacity and production of cement have expanded by about 11 percent p.a. since 1982; the share of the energy-efficient, dry-process units increased from 53 percent to 72 percent, due to both conversions from wet to dry process and installation of new capacities; a competitive cement market has emerged, as seen in Table 2.3: the free market (non-levy) cement price remained practically constant below Rs. 70 per bag during the last 6 years. The intensity of market competition was reflected in the declining market share of pozzolana portland cement (PPC) from 57 percent in FY83 to about 25 percent in FY88, as the consumers began to take advantage of the buyer's market situation to demand higher-quality ordinary portland cement (OPC) at a price very close to that of PPC.  Table 2,3 Industry's Response to Recent Policy Reform Policy Parameters Policy Parameters 82/83 83/84 8I485 85Z86 87/88 Levy Quota ( percent) pre-1982 plants 67 65 60 40 30 post-1982 plants 67 45 40 30 15 Levy Price (Rs./ton) (ex-factory) 335 375 375 400 435 Industry ResRonse Capacity (MT) 34.4 37.0 41.2 44.3 57.0 Production (MT) 23.3 27.0 30.1 33.1 39.4 Utilization (percent) 68 73 73 79 70 Nonlevy cement 68 64 70 67 70 price (Rs/bag) a/ Dry-Process Capaci. 53 56 60 65 72 as percent of total PPC as percent of total 57.1 58.5 55.1 45.1 25 cement output Operating Profit 15.8 13.5 11.1 9.3 8.0 Margin b/ a/ In 50 kg bag, including excise tax, sales tax, bagging costs, transport and dealers profit margin. hi Based on ICICI financed sample plants. Source: CMA, ICICI and staff estimates. 2.10 The industry fared less well in capacity utilization, partly because of power shortages caused by drought in 1985-87, initial technical difficulties with some of the new plants, and market constraints for plants in surplus regions. An analysis of ICICI-assisted cement companies shows that the combined impact of low capacity utilization, competitive pressure and the significant increases in the cost of inputs (Annex 1) have reduced the profitability of the cement industry. Many cement producers are experiencing serious financial distress, and there have been only a few capacity expansion projects since 1986. Unless investments are undertaken now for commissioning between 1992 and 1995, India may experience cement shortage as demand expands and exceeds supply capabilities (para. 2.21).  D. Economic Considerations 2.11 Although cement manufacturing is both capital- and energy-intensive and India is a net importer of both, it is economic and efficient by interna- tional standardF India's comparative advantage is attributable to its relatively abundant limestone and coal resources, established labor force with technical and managerial experience, and a well-established and competent cement machinery manufacturing industry with long-standing foreign technology collaboration. 2.12 Production Cost. A sample financial and economic production cost structure of both wet-process and dry-process plants is shown in Table 2.4. The financial costs are estimated on the basis of the average of the FY88 production costs of six cement plants (three dry and three wet plants). The economic cost is derived from financial cost data using conversion factors estimated by the appraisal staff (Annex 2). In economic terms, the average production cost of the wet-process plants (excluding capital charges) is Rs. 567 per ton of cement compared to Rs. 427 per ton for new, dry-process units. The full production cost of new dry-process plants (including provisions for capital charges) is about Rs. 580 per ton. These cost parameters are below the CIF value of imported cement estimated to be about Rs. 730 per ton ($50 at exchange rate of in FY88). This is a broad indication that domestic production of cement is economically efficient for meeting domestic demand. Table 2.4: Financial & Economic Cost of Production (.Rs. per ton cement) get Process Drv Process Financial Economic Financial Economic Raw Material 91.4 64.0 93.0 65.1 Packing Materials 102.2 71.5 100.0 70.0 Coal 189.6 166.8 110.5 97.2 Power 107.2 128.7 98.5 118.2 Store & Spares 38.1 28.9 34.5 26.2 Labor 90.8 72.7 39.0 31.2 Factory Overhead 43.4 339 23.5 18.8 Operating Cost 661.7 566.5 499.0 426.8 Capital Cost 64.4 A/ 134.5 A/ 152.8 / Total Cost 726.1 633.5 579.5 a/ Book value of depreciation and financial charges. k/ Replacement cost based on shadow price, Annex 2.  - 8 - 2.13 Imoorted Cement. Cement is imported only by government agencies (canalized). During the years of 1978-1984, when the cement shortage was most acute, 001 allowed Imported cement at a low (15 percent) tariff rate to cover 'he expected shortage and stabilize cement prices. Since 1985, the Government nas not imported cement (except special oil-well cement). Domestic production is meeting demand, and domestic competition has kept the domestic price below the landed cost of imports, even in coastal cities like Bombay and Calcutta. The recent manufacturer's realizations (ex-factory price plus transport excluding excise tax, sales tax and dealers margin) at Bombay and Calcutta were Rs. 750 and Rs. 900 per ton, respectively. These prices ar. competitive with the probable price of imported cement at port of Rs. 900/ton at today's exchange rate ($50 CIF plus at least Rs. 50/ton port handling and distribution). Moreover, the Indian ports now are congested and lack bulk handling facilities. Therefore, expansion of domestic cement production capacity is the lowest-cost option for meeting domestic demand. 2.14 Capital Cost. Production of cement is an energy- and capital- intensive proce3s. As shown in Table 2.4, capital charges are the second largest cost item in the production cost of cement. India has acquired a comparative advantage in the manufacture of modern cement machinery and therefore has an advantage in the construction of cement plants at international standards. The average investment cost per annual ton of cement capacity installed in India is estimated to be within the range of $100-130, compared to $150-200 in developed countries. This cost advantage is attributed to the existence of an internationally competitive cement machinery manufacturing industry with reputed foreign technology collaborators. Competition among these manufacturers is so strong that their foreign collaborators continue to transfer their latest technology to maintain and improve the market position of their local partners. Due to the combined effects of domestic competition and strong support from foreign technology collaborators, the Indian cement machinery industry has ample capability to supply turnkey cement plants with critical equipment imported from their collaborators. 2.15 Raw Material. Limestone is the principal raw material in the manufacture of cement. The relative abundance of cement-grade limestone deposits in different parts of the country permitted development and rapid expansion of the Indian cement industry. At present, India's limestone reserves are estimated at about 60 billion tons, of which 13 billion are proven, 4 billion are indicated ana 43.2 billion are inferred. India's limestone deposits are, however, highly concentrated within the states of Andhra Pradesh, Karnataka, Gujarat and Madhya Pradesh, which together account for over 80 percent of known reserves. This concentration of deposits was originally responsible for the concentration of cement production capacities in the western and southern regions of the country. But the freight equalization system intensified the regional supply-demand imbalance to an unwarranted degree (paras. 2.02 and 2.06). 2.16 EnergI Inputs. Energy is the most important input in the manufacture of cement in India. Although India is a net energy-importing country, it has ample coal reserves to meet the requirements of the cement industry for the foreseeable future. Indian coal is, however, low quality and must be transported long distances to cement plants in the western and southern states. The ash content of Indian coal is high and is expected to increase in view of the declining quality of known coal deposits and production methods being used.  - 9 - Even though the cost of domestic coal per unit of energy contained is close to that of imported coal, it has a negative impact on the quality of cement produced and the productivity of the cement industry. To overcome this problem, the industry and GOI are exploring options to reduce the ash content of coal for the cement industry (para. 3.15). Power has been a major constraint on the cement industry for years. However, the magnitude of the problem has been gradually reduced over the last few years by the installation of captive power plants which now supply about 15 percent of the industry's total power requirement. While supply of power still remains a binding constraint for sustained capacity utilization of many cement plants, it is not expected to be as critical as in the past. 2.17 Transport Cost. Given the imbalance in the location of limestone reserves, coal mines and major cement markets and past sectoral policies, development of the cement industry has been plagued by high transport cost (paras. 2.02, 2.06 and 2.15). Cement produced in India has to travel an average of 650 km to the final user, at an average freight cost of more than Rs. 250/ton. For the northeastern states, cement has to be transported around 1,000 km from Madhya Pradesh at an estimated cost of Rs. 400/ton. Transport cost adds significantly to the total delivered cost of cement. In fact, freight cost, and excise and sales taxes make the delivered cost of cement twice the ex-factory price. Transport cost is largely responsible for the price differentials observed in different parts of the country. In the present free-market environrment, individual plant viability will largely depend on the distance between the plant's location and the market it serves. E. Demand and SUDD1 Proiections 2.18 'Consumtion. Apparent annual cement consumption in India increased from 14.5 million tons in FY75 to about 42 million tons in FY89, corresponding to a compound annual growth rate of 7.3 percent. The current 47 kg per capita annual consumption of cement in India is still low compared to other countries, as shown in Table 2.5. The long-standing price and distribution controls, the lack of incentive to market cement in rural areas, the failure to promote potential markets in areas such as concrete roads, and the lack of financing for housing development have all contributed to India's low per capita consumption of cement. As these constraints ease and the GNP grows, there is immense scope for cement consumption growth.  - 10 - hible 2.5: Cement Per Caoita Consumption. 1987 GNP per Capita Industrial VA Per capita cement (8 eauivalent) A/ as percent of GDP h/ consumption (kg) Q/ Turkey 1200 36 454 Egypt 670 25 335 Mexico 1820 34 230 Brazil 2020 38 182 China 290 49 167 Zimbabwe 590 43 81 Pakistan 350 28 66 India 300 30 47 Kenya 330 19 39 Source: a/ World Table 1988-89 k/ World Development Report, 1989 Al World Statistical Review, CemBureau, 1989 2.19 Demand Projectioa. Four major studies on cement demand projection, by Mangesh International Service, by Tata Economic Consultancy, by ICICI and by IDBI were made available to the Bank. Their projections up to FY95 are presented, along with the appraisal staff's estimate, in Table 2.6: Table 2.6: Cement Demand Prolection (million tons) Mangesh Studs Tata Study 4.1% GNP 5.1% GNP Econo- End-User ICICI IDBI Staff Estimate Growth matric Nethod Study Sig&y Case I Case II 1989-90 44.5 45.5 43.1 46.0 45.9 45.6 46.6 45.8 1990-91 47.3 49.1 47.4 50.0 49.8 49.7 50.2 48.8 1991-92 50.3 53.1 52.3 54.4 54.0 53.9 54.3 51.9 1992-93 53.6 57.4 58.0 60.4 58.6 58.7 58.7 55.9 1993-94 57.1 62.0 64.4 64.3 63.6 63.9 63.5 58.9 1994-95 58.6 67.1 72.5 69.9 69.0 69.5 68.6 62.7 Source: Mangesh International Services, March 1987 Tata Economic Consultancy Services, February, 1989 ICICI, December 1989; IDBI, September, 1989. 2.20 To relate historical cement consumption with general economic variables, the Mangesh study chose GNP and the effect of the Green Revolution (between FY76 to FY86) and the price index, which might have had an impact on private consumption of cement. The Tata study chose gross domestic fixed capital formation, which correlated most closely with the cement consumption. The Tata study also tried to project the cement demand in major end-user sectors. In both  - 11 - analyses, the historical elasticity of cement consumption to GNP was estimated at about 1.5. The difference in the projected demand scenarios is primarily due to assumptions about the future GNP growth rate. As indicated by the Tata Study, the major end-users of cement in India are private housing (45 percent), irrigation and power (19 percent), public works including roads (6 percent) and public housing (5 percent). These sectors are expected to grow rapidly. The ICICI and IDBI studies have analyzed cement demand by regions and projected that cement growth would be faster in the northern and eastern regions. These studies also analyzed interregional movement of cement and identified the regional demand/supply pattern. Both ICICI and IDBI studies have indicated that the growth of cement in the next five years is likely to remain high, as in the past six years after partial decontrol, for a number of reasons: (a) with the setting up of the National Housing Bank and the emphasis on housing by GOI, the housing sector is expected to grow at a higher rate. The entry of some commercial banks into housing finance is also expected to give an additional resource for housing sector growth; (b) concrete roads are now being built for the first time in India. Such new applications of cement, even on a small scale, would have a significant impact on growth in cement demand; and (c) the anticipated devolution of financial power to local governments would spur development activities in the rural areas. This would likely increase conatruction and cause an increase in cement demand in rural areas. To indicate a likely range of future demand, the appraisal staff made its estimates in Table 2.6 based on the following assumptions: (a) GNP growth rate of 5.4 percent for the next 5 years. This growth rate is below the official GOI projection six percent and reflects the Bank assessment in the most recent Country Economic Memorandum; and (b) elasticity of cement consumption vs GNP: Case I: 1.5 representing historical statistics in India; Case I1: 1.2 representing an average of countries at similar development stage. 2.21 Projected and Demand/Supply Balance. First, cement production from existing capacity and capacity expansions already under implementation is projected as a baseline case and compared with estimated demand (Table 2.7). The domestic cement market is likely to be in modest surplus in the next two or three years because of the enormous capacity commissioned during the last three years. Investors anticipated this surplus, and investment in this sector has decreased significantly since 1986, resulting in a small number of expansion projects which would add less than seven million tons of capacity up to 1992. Production from existing capacity and capacity presently under construction will be limited to about 56 million tons, even as the average capacity utilization rate approaches a somewhat optimistic 84 percent (Annex 3) by 1992/93. Since construction of a cement plant takes about three years from the time its financing plan is finalized, and it is also common to take an additional two years to achieve an acceptable utilization rate, a potential cement deficit of 6.9 - 12.8 million tons is likely by 1994/95. The detailed assumptions for  - 12 - projecting cement production are presented in Annex 3. It is also important to note that the production projection used has not taken into account any possible closures. In fact, the competitive market in surplus regions may force a significant amount of inefficient capacity to suspend production or close. Implementation of the modernization and expansion projects currently being prepared is needed to meet the growing demand in the 1990s. Table 2.7: DemandZSupplX Balance Based Existing Capacity (million tons) Projected Capacity Demand/Supply Demand/Supply and Production A/ (Case I) L k/ (Case II) C/ Surplus Surplus Capacity Production Demand (Deficit) Demand (Deficit) 1988-89 59.0 44.0 43.0 1.0 43.0 1.0 1989-90 61.4 47.8 46.5 1.3 45.8 2.0 1990-91 64.7 51.7 50.2 1.5 48.8 2.9 1991-92 66.7 54.9 54.3 0.6 51.9 3.0 1992-93 66.7 55.8 58.7 (2.9) 55.3 0.5 1993-94 66.7 55.8 63.5 (7.7) 58.9 (3.1) 1994-95 66.7 55.8 68.6 (12.8) 62.7 (6.9) a/ Based on existing installed capacity and capacity expansion currently under implementation (Annex 3). Demand projection is based on Case I in Table 2.6 e/ Demand projection is based on Case II in Table 2.6. 2.22 The investors have anticipated the projected shortage of cement, and the financial institutions have received project proposals and loan applications for modernization, expansion and greenfield cement projects. The list of proposed projects and assumptions for projecting production from them are also presented in Annex 3. These proposed projects, if materialized, would add approximately 10 million tpy production capacity by FY95. This capacity installation, plus the 7 million tpy already under implementation, could increase total production capacity to about 74 million tpy by FY95, producing about 62 million tons of cement at an estimated average utilization rate of 83 percent. Total production including new projects is projected and compared with estimated demand in Table 2.8. 2.23 Most of the proposed capacity expansion would be in or close to cement-deficit regions, in response to the price differentials already developed after elimination of freight equalization. If all investments materialize, the regional demand/supply situation would improve as estimated by the appraisal  - 13 - staff in Table 2.9. A large portion of the surplus shown in the western region is produced in northern Madhya Pradesh, supplying cement to the close-by Uttar Pradesh market. Table 2.8: Demand/Supply Balance Based Existing and Prolosed New Cavacitv (million tons) Projected Capacity Demand/Supply Demand/Supply and Production (Ca / , (Case II)