India - External Sector and Investment Regime Liberalization Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14771 IMPLEMENTATION COMPLETION REPORT INDIA EXTERNAL SECTOR AND INVESTMENT REGIME LIBERALIZATION (LOAN 3627-IN) JUNE 30, 1995 Country Operations, Industry & Finance Division Country Department II South Asia This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY Rs/ US$ Currency Official Unified Market' Prior to June, 1966 4.76 June 6, 1966 to mid-December 1971 7.50 Mid-December 1971 to end-June 1972 7.28 1971-72 7.44 1972-73 7.71 1973-74 7.79 1974-75 7.98 1975-76 8.65 1976-77 8.94 1977-78 8.56 1978-79 8.21 1979-80 8.08 1980-81 7.89 1981-82 8.93 1982-83 9.63 1983-84 10.31 1984-85 11.89 1985-86 12.24 1986-87 12.79 1987-88 12.97 1988-89 14.48 1989-90 16.66 1990-91 17.95 1991-92 24.52 1992-93 26.41 30.65 1993-94 31.36 January 1995 31.37 February 1995 31.38 March 1995 31.65 Note: The Indian fiscal year runs from April 1 through March 31. Source: IMF, Inernational Finance Statistics (IFS), line "rf'; Reserve Bank of India. A dual exchange rate system was created in March 1992, with a free market for about 60 percent of foreign exchange transactions. The exchange rate was reunified at the beginning of March 1993 at the free market rate.  FOR OFFICIAL USE ONLY IMPLEMENTA'1'ION COMPLETION REPORT INDIA EXTERNAL SECTOR AND INVESTMENT REGIME LIBERALIZATION (LOAN 3627-IN) Table of Contents Page No. Preface ........ Evaluation Summary ...................................... iii PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE ... .... 1 1. Project Identity. 1 2. Background. 1 3. Project Objectives and Design ............................ 2 4. Achievement of Objectives. 4 5. Bank Performance. 6 6. Borrower Performance. 6 7. Project Sustainability. 6 8. Lessons Learned. 7 Tables 1. Summary of Assessment. 8 2. Related Bank Loans/Credits. 9 3. Project Timetalbe .10 4. Loan Disbursement: Cumulative Estimated and Actual .10 5. Status of Legal Covenants .11 6. Bank Resources: Staff Inputs .11 7. Bank Resources: Missions .............................. 11 Ths document has a restricted distribuiion 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.   i IMPLEMENTATION COMPLETION REPORT INDIA EXTERNAL SECTOR AND INVESTMENT REGIME LIBERALIZATION (LOAN 3627-IN) PREFACE 1. This is the Implementation Completion Report (ICR) for the External Sector and Investment Regime Liberalization project in India, for which loan 3627-IN in the amount of US$300 million equivalent was approved on June 24, 1993 and made effective on June 25, 1993. The loan was fully disbursed and closed by its original closing date in December 1993. 2. The ICR was prepared by Mr. Roberto Zagha, Country Operations, Industry and Finance Division, Country Department II, South Asia Region and reviewed by the Procurement Advisor and the Legal Department. Because of the one-tranche nature of the operation, the preparation of the ICR required no mission to India. The Borrower provided no comments on the ICR.  I'- HJ.  iii IMPLEMENTATION COMPLETION REPORT INDIA EXTERNAL SECTOR AND INVESTMENT REGIME LIBERALIZATION (IESIRL) [LOAN 3627-IN1 EVALUATION SUMMARY The operation reviewed in this report was approved by the Board in June 1993 and was the Bank's third adjustment operation in support of the economic program India started implementing in July 1991. The content of India's economic program and its achievements have been discussed in detail in the last Country Economic Memorandum (May 1995), and the last Country Assistance Strategy (May 1995). In a nutshell, the economic program aimed at reducing serious fiscal and external imbalances and ending four decades of centrally planned development. The latter was to be achieved through a comprehensive program of structural reforms focused on five priority areas: (i) the investment regime; (ii) the trade regime; (iii) the tax system; (iv) the financial sector; and (v) public enterprises. Over the last four years, significant progress has been achieved both on the stabilization and structural reform front. The June 1993 IESIRL loan came in the sequel of a US$500 million structural adjustment operation (half IBRD and half IDA) approved in December 1991, and a US$500 million IDA adjustment operation in support of India's Social Safety Net in December 1992. The IESIRL was part of a broad Bank program of support to India's economic program. As highlighted in the December 1992 first Country Assistance Strategy for India, of a combined IBRD-IDA lending plans of US$3 billion per year, 25- 30 percent were intended to be adjustment operations in support of reforms in the areas of investment and trade liberalization, financial sector, public enterprises, social policies, and sector-level policy and institutional frameworks. Because of the one-tranche nature of this operation, it achieved its objectives before it was presented to the Board, and was thus successful by definition. The operation also achieved a broader goal, however, which is support for India's investment and trade liberalization. As documented in the main text of this report, after this operation was completed, the authorities have continued to take significant measures to liberalize the trade and investment regimes with the result that India now has one of the more liberal investment regimes in Asia and the trade regime is significantly more open than it was in the past. Therefore, the operation supported a process at a moment when access to external finance was critical for maintaining the momentum of reform. Contrary to earlier expectations, however, there was no follow-up operation. As discussed in the main text of this report, this was because the improvement in India's balance of payments situation has exceeded the most optimistic forecasts and rendered unnecessary further adjustment operations.   PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE 1 Project Identity Name: External Sector and Investment Regime Liberalization Loan Number: 3627-IN RVP Unit: South Asia Country: India Sector: Trade and Industry 2 Background 2.1 The Government that came to power on June 21, 1991 inherited an economy in crisis. The central government fiscal deficit had reached 8.4 percent of GDP in 1990-91 and, if not corrected, would have reached 10 percent of GDP in 1991-92. At double digits since November 1990, India's historically low inflation rate continued to increase and reached 17 percent in August 1991. With reserves at about US$1 billion (two weeks of imports) and no external finance available from commercial sources, the country was on the verge of defaulting on its external debt. On the structural front, the various liberalization efforts in the 1980s had addressed India's most important structural problems only very partially, and had left basically intact the complex system of controls and interventions built over several decades of planned development. 2.2 In the last three years, the new Government has not only overcome the balance of payments crisis and reduced fiscal imbalances, but has also introduced comprehensive structural reforms aimed at ending four decades of a development strategy based on central planning and transforming India into an internationally competitive economy. The Government's structural reform program focuses on five priority areas: trade, investment licensing, the financial sector, taxation and public enterprises. 2.3 The government's adjustment efforts have been supported by substantial fast-disbursing assistance from official development agencies-notably, the IMF (US$4.9 billion), Japan (US$1.3 billion), the World Bank (US$1.3 billion), the ADB ((US$550 million) and Germany (US$500 million). This support has been critical to bolstering external confidence, and has allowed for stabilization of the economy without excessively contractionary financial policies. 2.4 The Bank extended three fast-disbursing loans in support of India's adjustment efforts. The first structural adjustment loan to India (US$500 million SAL/SAC in December 1991) supported the Government's efforts in liberalizing the industrial and trade regimes, reforming the financial sector, and restructuring public enterprises. The SAL objectives were generally fully met in all these four reform areas, and in fact the delicensing of imports of intermediates and capital goods and the introduction of a free foreign exchange market in March 1992, meant that the SAL  2 targets were significantly exceeded. In December 1992, the Bank extended a US$500 million IDA to support the government's safety-net program. In June 1993, the present one-tranche US$300 million loan was extended to India to support its continuing efforts to liberalize the trade and investment regimes. The loan was cofinanced by a US$250 million loan from the Export-Import Bank of Japan in September 1993. 3 Project Objectives and Design 3.1 The objective of the present loan was to support trade and liberalization measures taken prior to June 1993, including: (i) the amendment of the Foreign Exchange Regulations Act in January 1993; (ii) the reunification of the exchange rate in March 1993; (iii) the reduction in tariffs in March 1993; (iv) the limited measures taken to liberalize imports of consumer goods in October 1992-March 1993; and (v) the investment deregulation measures of March (mining) and April 1993 (automobiles, leather, and white goods). 3.2 Amendments of the FERA in January 1993 removed all restrictions which previously prevented companies with more than 40 percent foreign equity (called FERA companies) from borrowing funds or raising deposits in India, from taking over any business interest from an Indian resident, from acquiring or disposing assets (including land), from appointing technicians or managers without clearance from the Reserve Bank of India (RBI), and from using their trade marks without RBI clearance. Except for restrictions on acquisition by FERA companies of enterprises in the agriculture and plantation sectors, FERA companies (regardless of proportion of foreign equity participation) are now treated at par with domestic investors and are permitted to remit dividends abroad without limitations or restrictions. 3.3 Reunification of the exchange rate in March 1993 moved India to a floating exchange rate regime with all permitted current and capital foreign exchange transactions taking place at a rate determined in the interbank market. Foreign exchange dealers can now maintain balances in convertible currencies domestically and abroad, and deal spot and forward in all major currencies. Except for some services such as purchase of insurance abroad and some imports still subject to licensing restrictions (see para. 3.5), all current account transactions are now permitted and do not require government approval. 3.4 The March 1993 reduction in tariffs continued India's tariff reforms and further reduced the maximum tariff to 85 percent (from a maximum of 350 percent before the July 1991 reforms). Together with steeper tariff cuts on selected capital goods, the import-weighed tariff was reduced from 77 percent prior to the reforms to 41 percent. 3.5 A limited liberalization of consumer goods imports was initiated in October 1992 with the introduction of the Special Import License (SIL) scheme. The SILs, granted to exporters as shares of their gross export earnings (ranging from 2 to 4  3 percent), are tradable and can be used to import a specified list of consumer goods. In addition, in February 1993, the government reduced from 255 percent to 150 percent tariffs on consumer goods imported as baggage and abolished restrictions on the resale of these imports. 3.6 The new National Mining Policy introduced in March 1993 aimed at removing all mining products (except hydrocarbon, uranium and coal) from the reserve of the public sector. This opened for the first time in decades mining (except hydrocarbon, uranium and coal) to the private sector. Foreign equity participation of up to 50 percent was also permitted. Aside from those mining sectors, only railway transport, uranium production and processing, coal extraction, and defence industries continue to be under public sector reservation. In April 1993, investment licensing restrictions were removed for three important sectors: leather, automobiles and household appliances. Together with the earlier delicensing measures taken in July 1991, only less than 15 percent of value-added in manufacturing (mostly agro-industries) still remains subject to licensing requirements. 3.7 The aforementioned measures supported by the loan form part of the Government's medium-term trade and investment reform program which aims to remove all import licensing restrictions (except for those related to environment and safety), reduce tariffs to an average of 25 percent, and eliminate licensing for all industries except defense, explosives and hazardous chemicals by the end of its Eighth Plan (1996- 97). In support of these medium-term objectives of the Government, the President's Report of the loan also underlined the importance for India to make further progress over the next few years to liberalize imports of consumer goods, reduce tariffs, and eliminate remaining export controls and investment licensing requirements to lay the basis for increasing the export orientation of India's industrial sector and integrating India into the world economy. 3.8 The loan was conceived as a one-tranche operation because, given India's parliamentary system, the Government found it difficult to make commitments--with the degree of explicitly required in a Bank loan--on national policy issues which typically require prior parliamentary discussion and approval. Because the government had well- articulated medium-term objectives, and its track record demonstrated commitment and full ownership, the one-tranche operation was appropriated to the circumstances. 3.9 The Bank stands ready to continue supporting India's ongoing efforts in reforming its trade and investment regimes. However, in view of India's much strengthened balance of payments position which has resulted in part from these reform measures (paras. 4.7-4. 10), this support will not take the form of adjustment lending, at least for the foreseeable future. It will consist of economic and sector work, and other forms of assistance, such as a recently approved Institutional Development Fund to help the codification and consolidation of all the laws and regulations governing India's investment regime.  4 4 Achievement of Objectives 4.1 Since the loan is one-tranche, the loan objectives had already been fully met at the time of Board presentation in June 1993. In a broader sense, the loan has also achieved the broader objective of supporting the momentum of reform as the Government has continued to take measures to liberalize India's trade and investment regimes after June 1993, in the following areas. 4.2 First, the Government has taken further measures to liberalize the external payments regime such that by August 1994 India has achieved current account convertibility according to Article VIII of the Articles of Agreement with the IMF. There are now no limits (except indicative ones) on foreign exchange allowances for all permitted current international transactions including travel, education and medical treatment; the multiple currency practice sustained through exchange rate guarantees on Non-Resident Indian deposits has been eliminated; and the rules on repatriation of dividends and interest have been liberalized. 4.3 Second, the Government has further liberalized consumer goods imports with the expansion in March and July 1994 of the list of items that can be imported using Special Import Licenses (SILs), and with the higher value of licenses now granted to exporters ranging from 3 to 10 percent (compared to the previous 2 to 4 percent). As a result, the share of consumer goods items in the harmonized classification importable using SILs has increased from 4 percent to 20 percent. 4.4 Third, the Union Budget for 1994-95 has continued the process of reduction and rationalization of custom duties. The budget has further reduced the peak rate of custom duty from 85 percent to 65 percent. Together with steeper cuts on tariffs of some capital and intermediate goods, the import-weighted tariff has been reduced from 41 percent to 32 percent. 4.5 Fourth, the Government has further liberalized the investment regime. In January 1994, the Mines and Minerals (Regulation and Development) Act, 1957 was amended in line with the new National Mineral Policy of March 1993, opening mining (except for hydrocarbon, uranium and coal) to the private sector for the first time in decades. In February 1994, the Air Corporation Act of 1953 was repealed allowing private airlines to compete on an equal basis with public airlines. And in May 1994, in a landmark decision, the Government opened telecommunications to private investment. Even in sectors still reserved for the public sector (including hydrocarbons, coal, and postal services), the government has taken a more liberal stance towards private investment. In February 1994, private investment in "captive" coal mines was allowed. In March 1994, the Coal Ministry offered 13 proven coal mines to private power, iron and steel companies and power companies including foreign companies. Private courier services have been allowed to compete with the government postal service; railways container depots and container stations have been opened to the private sector; and the inland waterway was opened to private vessels in December 1993.  5 4.7 Impact on the economy. While the process of stabilization and reform (of which the measures supported by the present operation are an integral part) has yet to be completed, and the full benefits of the reform measures already taken will not be realized for some time, some positive results can already be discerned. These include the recovery of export and industrial growth, and the substantial increase in foreign capital inflows. 4.8 The recovery in export growth has been remarkable, reaching 20 percent in dollar terms in 1993-94 after the -2 percent performance in 1991-92 and the modest recovery of 2 percent in 1992-93. This strong recovery in exports can be attributed in part to the improvement in export incentives arising from the reforms, in particular the substantial real depreciation of the exchange rate and improvement in export promotion schemes. Improvement in export promotion schemes (supported by the SAL and still ongoing) have also increased diversification of India's export products. This should boost the resilience of India's exports against external market shocks which had been partially responsible for the collapse of these exports in 1991-92, as well as help sustain the high export growth necessary for the continuation of the reform process. This remarkable export recovery has contributed to the major reduction in the deficit of the current account from US$10 billion (3.5 percent of GDP) in 1990-91 at the beginning of the crisis to US$0.8 billion (0.3 percent of GDP) in 1993-94. 4.9 The success of the government's stabilization program and the credibility of its reform agenda have also led to a major surge in foreign capital inflows. Foreign investment reached an unprecedented high of US$4.7 billion in 1993-94, of which US$4.1 billion was portfolio investment. These remarkable improvements in the current and capital accounts have led to an accumulation of foreign exchange reserves to reach nearly US$17 billion in August 1994. 4.10 These developments in India's external payments situation have drastically reduced its needs for exceptional balance of payments financing. The previously projected exceptional financing need of US$1.8 billion for 1993-94 (of which US$300 million were scheduled to be met by the current operation) had declined to US$900 million. Projections of exceptional financing needs for 1994-95 and beyond have also been revised downwards from US$2.3 to US$2.5 billion to US$500 million in 1994-95 and zero thereafter. 4.11 The recovery in external investors' confidence has been followed by similar recovery on the domestic side. After declining to 1 percent in 1991-92 and the modest recovery of 2 percent in 1992-93, industrial growth has recovered to reach 5 percent in the last four months of 1993-94 and higher rates in the first half of 1994-95. 4.12 Impact on the poor. Although not conceived as an operation directly focused on the poor, the poor can be expected to benefit from the higher growth path resulting from the overall program of stabilization and reform.  6 5 Bank Performance 5.1 The Bank's performance has been highly satisfactory in the identification, preparation and appraisal of the project. Discussions with the authorities on a policy- based loan in support of the liberalization of India's trade and investment regimes had begun in June 1992, shortly after the second tranche review of the SAL. These discussions have been underpinned by analysis of India's trade and investment regimes based on the earlier comprehensive reviews of these two sectors in the India: Strategy for Trade Reform report (November, 1990) and the India: Industrial Regulatorv Reform report (May 1991) and updated during the preparation of the SAL. 5.2 Subsequent to the present operation, the Bank has undertaken a comprehensive review of the progress in trade liberalization in India in the India: Issues in Trade Reform report (August 1994). In addition to recommendations for future policy reforms, the report also provides a detailed treatment of export administration issues in recognition of the importance of high export growth in sustaining the reform process. The recommendations of the report would provide the basis for future adjustment operations in this area should the need for balance of payments support arise in India, and also the basis for a potential investment operation which could include technical assistance to GOI for the strengthening of its export promotion institutions. 6 Borrower Performance 6.1 The commitment of the government to its program of trade and investment liberalization has been amply demonstrated by the reform measures it has continued to pursue after the present operation in the areas of external payments, liberalization of consumer goods imports, tariff reduction and investment delicensing (paras. 4.2-4.5). 6.2 There were no disbursement issues associated to the loan. Of the US$300 million total loan amount, US$58.6 million was disbursed on June 30, 1993, shortly after loan effectiveness, and the balance was completely disbursed by January 14, 1994. 7 Project Sustainability 7.1 The trade and investment liberalization measures supported by the loan are part of the government's carefully prepared program of reforms which also cover the areas of finance, public enterprises and taxation. The government had appointed expert committees to formulate proposals for reforms in all these areas. These reform proposals have been made public and amply discussed with academics, industrialists and unionists. By adopting this approach to reform, the government has built consensus around the economic program, anticipated public reactions to reform measures and avoided the reversals that have sometimes derailed adjustment programs elsewhere in the world. The commitment of the government to the completion of its reform program, as underlined  7 by the continuation of reform measures in trade and investment after the adjustment operation, further reinforces the sense that the government fully owns the program of reform. 7.2 Sustainability of trade liberalization will also be contingent on success in tax reforms and public expenditure restraint, promotion of high export growth, continued recovery in investment and industry, and enhanced effectiveness in poverty alleviation programs. 7.3 Success in tax reforms is essential as further tariff cuts to achieve the government's medium-term target of a 25 percent average tariff will reduce fiscal revenues. This reduction in fiscal revenues would need to be offset by alternative revenue sources, particularly in light of the need for further fiscal consolidation. This fiscal pressure could be mitigated to the extent that the government makes significant progress in restraining public expenditures. 7.4 High export growth would allow for continued import liberalization without risking a major exchange rate devaluation which would jeopardize the fiscal stabilization program. To this end, it is important that the government strengthens the existing export incentive schemes, particularly those which guarantee free-trade access to exporters, provide easy access to trade finance, facilitate foreign-domestic collaboration for export market access and product development, and provide access to overseas market networks (discussed in the Bank's India: Issues in Trade Reform economic report, August 1994, see para.5.2). 8 Lessons Learned 8.1 The key lesson derived from the External Sector and Investment Regime Liberalization operation is the central importance of government ownership of and commitment to the adjustment program for its success. The reforms of the trade and investment regimes, while not yet fully completed, have already generated positive results (major improvement in the balance of payments and recovery in growth) without adverse social consequence largely due to: (i) the wide-ranging consensus built by the government over its reform program (see para.7. 1); and (ii) the government's adherence to a schedule of reforms, the ultimate objectives of which have been pre-announced. The other important lesson derived from this operation is that in the presence of a government committed to reform, with clearly articulated medium-term objectives, and an established track record, a one-tranche operation is an appropriate form of support to an adjustment process which avoids the political complexities inherent in a situation where a sovereign government needs to make commitments on national policies with a foreign lender.  8 Table 1 Summary of Assessment A. Achievement of Substantial Partial Negligible Not applicable Obiectives (/) (v') (/) Macroeconomic policies V Sector policies V Financial objectives / Institutional development V Physical objectives Poverty reduction Gender concerns V Other social objectives V Environmental objectives Public sector management V Private sector development V Other (specifv) ' B. Proiect sustainabilitv Likely Unlikelv Uncertain (v' (V) (O) Hi2hl C. Bank performnance satisfactorv Satisfactory Deficient (1) (V) (1) Identification V Preparation assistance V Appraisal v Supervision NA D. Borrower performance Preparation / Implementation / Covenant compliance V Operation (if applicable) E. Assessment of outcome /  9 Table 2. Related Bank Loans/Credits Loan/Credit Title Purpose Year of Approval Status Preceding operations 1. Structural Adjustment Support December 1991 Fully Loan/Credit stabilization and disbursed structural reform 2. Social Safety Net Strengthen December 1992 Fully Credit India's social disbursed safety net programs  10 Table 3. Project Timetable Step in project cvcle Date rlitiating Memorandum March 8. 1993 Appraisal March 29. April 9. 1993 Negotiations May 24-28, 1993 Letter of development policv April 30, 1993 Board presentation June 1, 1993 Signing June 24, 1993 Effectiveness June 25, 1993 Loan closing December 31, 1994 Table 4: Loan Disbursements: Cumulative Estimated and Actual FY93 FY94 Appraisal estimate NA 300,000 Actual 58,600 300,000 Actual as % of esumatc NA 100 Date of final disbursement 1/14/94  11 Table 5: Status of Legal Covenants Ornginal Revised Descnption Covenant Present fulfillment fulfillment of Aereement Section . typ stalls date dale covenant Conunents 3.02 Procurement fulfilled 3.03 (a) Record-keepimg 3.03 (b) Auditing 3.03 (c) Record-keeping Table6: Bank Resources. StaffInputs Stage of Planned Revised Actual project cvcle Weeks USS Weeks USS Weeks US$ Through appraisal 109.3 303,248 110.7 307,207 126.6 352.172 Appraisal-Board 30.0 84,840 30.0 84,840 51.3 145,076 Board-effectiveness 0.0 0 0.0 0 0.6 1,697 Supervision 7.0 20,391 7.0 20,391 4.3 12,509 Completion 3.0 8,739 3.0 8,739 1.0 2,957 TOTAL 149.3 417.218 150.7 421,177 183.8 514,411 Table 7: Bank Resources: Missions --_ _ - - ~-- -Performance ratin _ Stage of Number Days Specialized Implemen- Develop- project Month/ of in staff skills Lation ment Types of cvcle year persons field represented status impact problems Through 12/92 2 10 Trade appraisal 1/93 2 10 macro Appraisal 4/93 9 15 Legal through Board approval Board- approval through effectiveness Super-vision HS HS Comple- tion __.      IMAGING Report No: 14771 Type: ICR