India - Structural Adjustment Loan/Credit

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14582 PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) JUNE 7, 1995 Country Operations, Industry & Finance Division Country Department II South Asia Regional Office 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 EQUIVALENTS Currency Unit: Indian Rupees (Rs.) 1991 US$1.00 = Rs. 22.7 (Official Rate) 1992 US$1.00 = Rs. 26.0 (Official Rate) 1992 US$1.00 = Rs. 30.4 (Market Rate) ACRONYMS AND ABBREVIATIONS BWTR Board for Industrial and Financial Reconstruction EFF Extended Fund Facility ESAF Enhanced Structural Adjustment Facility GCA General Currency Area GDP Gross Domestic Product IDA International Development Association IMF International Monetary Fund LERM Liberalized exchange rate management system NRF National Renewal Fund NRIs Non-Resident Indians PCR Project Completion Report RBI Reserve Bank of India RPA Rupee Payment Area SAC Structural Adjustment Credit SAL Structural Adjustment Loan SICA Sick Industrial Companies Act FISCAL YEAR April 1 - March 31  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 7, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on India - Structural Adjustment Loan/Credit (Loan 3421-IN/Credits 2316-0-IN and 2316-1-IN) Attached is the Project Completion Report (PCR) for the India Structural Adjustment Project (Loan 3421-IN/Credits 2316-0-IN and 2316-1-IN) prepared by the South Asia Region. The Borrower did not prepare a Part II. This US$500 million project (of which US$250 million comprised an IBRD loan and US$250 an IDA credit) was approved in December 1991 and closed on schedule in December 1992. This project was the Bank Group's first policy-based loan/credit to India. It had the main objectives of (i) helping India to cope with a balance of payments crisis of unprecedented severity; and (ii) supporting a broad-based set of policy reforms aimed mainly at liberalizing the Indian economy and opening it up to more competition, both from within and abroad. Complementary stabilization policies were undertaken simultaneously under the aegis of an IMF program. Implementation was satisfactory in most respects. Indeed, in several key areas such as exchange rate policy, liberalization of the import regime and financial sector reform, the pace and scope of reforms exceeded the targets. Progress on these fronts has continued since the project closed. In other areas, however, progress was more gradual (exit policy for industrial firms, removal of restrictions on agricultural exports), and in the case of public enterprise reform, progress was considerably short of what was envisaged when the SAL was prepared. The SAL helped to catalyze substantial official inflows from other donors, enabling India to weather its balance of payments crisis. This support, in combination with the policy reforms-particularly in terms of reducing import barriers, reducing public expenditures and easing controls on private business activity-served to improve India's creditworthiness and stimulate large inflows of private foreign capital. India's economic growth slowed in 1991/92, due partly to the initial impact of the stabilization policies and partly to poor harvests, but has picked up since. The PCR provides a satisfactory description of the project's objectives and outcome; it does not, however, address important questions such as the operation's institutional development (ID) impact and its social costs. The outcome is rated as satisfactory and sustainability is rated as likely. The ID impact is inferred to have been substantial. A planned audit will give particular attention to the matters of sustainability and ID. A main lesson of the project is that India's initial success in reducing its fiscal deficit was instrumental in enabling it to undertake reforms in trade, finance and public enterprises, and also important in restoring the credibility and confidence needed to stimulate private investment. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.   FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) TABLE OF CONTENTS Page No. Preface . ....................................................... i Evaluation Summary. iii Part I: Project Review from the Bank's Perspective A. Project Identity. 1 B. Background and Developmental Perspective. 1 Continuing with Change. 1 Reforms in the 1980s. 2 C. The Adjustment Process. 2 A New Minority Government Coming into Power. 2 D. The SAL Program. 3 Loan Preparation. 3 Objectives and Scope of the SAL/SAC Program. 4 Implementation and Compliance. 7 Disbursement. 8 E. The Economy's Responses ................................... 8 Macroeconomic Performance .................................. 8 Improvements in the Balance of Payments ......... ............... 10 Turnaround in Macroeconomic Conditions ......... ............... 11 F. Conclusions .11 Part II: Project Review from the Borrower's Perspective (NOT SUBMITTED) .13 Part III: Statistical Information 1. Related Bank and IDA Loans .14 2. Project Timetable .14 3. Loan Disbursements .15 4. Project Costs and Financing .15 5. Use of Bank Resources .15 This document has a restricted distribution and may be used by recipients only in the performance of their official dutics. Its contents may not otherwise be disclosed without World Bank authorization.   i PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) PREFACE This is the Project Completion Report (PCR) for the Structural Adjustment Loan and Credits to India (Loan 3421-IN, Credits 2316-0-IN and 2316-1-IN) in an amount equivalent to US$500 million approved on December 5, 1991. The loan/credit has been fully disbursed. The PCR was prepared by the India Country Operations, Industry and Finance Division (SA2CI) in the South Asia Country Department II (Evaluation Summary, Parts I and III). Preparation of this PCR was started in February 1993 and is based, inter alia on the Report and Recommendations of the President, the Loan and Guarantee Agreements; mid-course review mission report, second tranche release document, internal Bank memoranda and Country Economic Memorandum (CEM) undertaken by SA2CI.   iii PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) EVALUATION SUMMARY 1. Objectives. As its central objective, the SAL/SAC program aimed to support the Government's efforts in liberalizing the Indian economy and opening it up to competition as a way of promoting long-term economic growth with sustainable balance of payments. These objectives translated at the time into the need for a broad based program covering the key interrelated areas of industry, trade, finance, and public sector. Being the first policy-based loan/credit to India, it was well recognized that the program had to be broadly based in order to secure the greatest gains possible from policy interlinkages involved. It also had to be decisive to signal a clear break from the piecemeal approach of the past, and had to be cognizant of the possible social costs. Such considerations implied a relatively large number of specific reform measures which could be included in the program, in part because such reform proposals had long been debated inside India and enjoyed a fair degree of consensus among key policymakers. In addition, Government's efforts to establish several high-level committees to formulate specific reform proposals, was very instrumental not only in bringing a blend of talent and expertise to policymaking circles, but also in ensuring a high degree of internal debate in the popular press and media, in the process thereby, widening public support for the reform effort. Implementation Experience 2. The overall progress in the implementation of structural and macroeconomic reform measures, supported under the SAL/SAC program was fully satisfactory. Indeed, in several key areas, such as exchange rate policy, liberalization of the import regime, and financial sector reform, the pace and scope of reforms exceeded the targets set out in the Government's Letter of Development Policy. With respect to exchange rate policy, a dual exchange rate regime was constituted on February 29, 1992 with a market-determined rate for most current and capital account transactions, and a managed official rate for a few key imports, principally, petroleum products and fertilizers. This exchange rate system provided an effective underpinning for the significant liberalization of quantitative restrictions on imports of capital and manufactured intermediate goods which was implemented under the support of the SAL/SAC program. Also, in the financial sector, the reform went beyond the agreed action under the SAL/SAC in the introduction of a more stringent accounting system; in strengthening of prudential regulation to conform with international norms and standards; in the deregulation of deposit rates (subject to the then ceiling of 13 percent); in the liberalization of bank branching policy; in the reform of taxation of capital income; and with respect to decontrol of corporate capital issues. 3. Of the twenty-five specific agreed actions contained in the SAL/SAC loan agreement, twenty-two had by the time of second tranche release (May 1992) been fully and three substantially  iv complied with. The latter related, specifically, to: (i) removal of administrative export controls on selected agricultural products; (ii) formulation of satisfactory policy for adjustment by industrial firms; and (iii) initiation of measures for restructuring/closure of patently unviable sick central public enterprises. With respect to the first item, a major reduction was undertaken, under the SAL/SAC support, in the March 1992 Export-Import Policy, when the number of items under export restrictions were reduced from 439, to 296. At the same time, the Government undertook a comprehensive review of export controls and indicated its intention of further reducing substantially items still subject to control, particularly those with significant export potential, such as silk, metals and minerals. These reductions in the number of items were introduced subsequently in the March 1993 Export-Import Policy when the number of items were reduced to 215. And, in the intertwined areas of general exit policy and restructuring/closure of patently unviable public enterprises, the Government was keenly concerned about the political implications of such measures on organized labor whose cooperation was deemed essential for the sustainability of the overall reform program. Hence, the thrust of reform in this area placed emphasis on the hardening of the budget constraint vis-a-vis the sick units, and on progress being made with regard to the discussions on IDA support for the National Renewal Fund in the context of the Social Safety Net Adjustment program. 4. Results. While their precise impact is difficult to gauge, it is clear that measures supported by the SAL program made a major contribution to the stabilization of the economy and the control of the balance of payments. On the macroeconomic front, the progress in stabilizing the economy has been considerable, with the management of the external sector and lowering of inflation taking initially overriding priority: reserves have been built up from less than US$1 billion in June 1991 to US$6.7 billion in March 1993, and inflation has been sharply reduced from a peak of 17 percent in August 1991 to about 6 percent in recent months. The initial slow down in economic activity and the industrial stagnation experienced in 1991/92 -- economic growth declined from 5.2 percent in 1990/91 to 1.2 percent in 1991/92 -- were caused by the poor performance of agriculture in that year, and the contractionary impacts of import compression, and fiscal retrenchment measures. Economic growth, however, recovered in 1992/93, and is forecast to have reached nearly 4 percent, and despite major import liberalization efforts introduced, deficit on the trade account of the balance of payments has been kept at manageable levels: from the very low level of US$1.6 billion in 1991/92 to US$3.9 billion in 1992/93. Such successes in macroeconomic stabilization have been central to the Government's sustained efforts to continue with its structural reforms. The greatest achievements on this front have included the freeing of industry from various bureaucratic licensing requirements, reunification of exchange rate; removal of quantitative restrictions on imports of capital and intermediate goods; reduction in custom tariff rates; and most recently, opening up of banking, mining and mutual funds industries to private sector investment. Lessons Learned and Sustainability 5. The key lesson derived from the experience of SAL/SAC program is that structural reforms can successfully be introduced in a democratic society such as India, provided that such reforms are cognizant of: (i) the need to undertake timely and decisive actions to restore macroeconomic stability, particularly to bring fiscal deficits under control; (ii) the importance of formulating and announcing such structural changes in a time-bound manner to signal Government's commitment and to provide an anchor for private sector expectations; (iii) the imperative of marshalling the political support and cooperation of various interest groups particularly, organized labor, through consultation, and actions to alleviate transitional social costs. The Government's  V success in reducing fiscal deficits, particularly the Central Government's deficit was instrumental in enabling it to launch important measures in the key areas of trade, finance and public enterprises. Without such success on the fiscal front, it would have been difficult, if not unfeasible, to lower custom tariff rates, to reduce reserve requirements on commercial banks, to deregulate interest rates, and to impose a hard budget constraint on public enterprises, which has indeed proven so far to be the most effective vehicle of reforming this sector in India. While the extent to which the fiscal adjustment program contributed to lowering of inflation remains debatable, its key role in enhancing the credibility of the overall reform program and in restoring external confidence cannot be doubted. Such confidence, in turn contributed to the rapid build-up in international reserves, and enabled the authorities to move faster and more boldly in liberalizing the import regime, particularly through introduction of a short negative list for imports of capital and intermediate goods. 6. Since the launching of the adjustment process in July 1991, questions have been raised as to whether the Government would be able to build the requisite consensus within the ruling Congress (I) Party and muster the broader political support necessary to maintain the momentum of the reform process. As evident by the initiatives taken over the last few months and in the midst of the disturbances of December 1992-February 1993, the Government has demonstrated its resolve and commitment to continue with its structural reform process. In continuing such reforms, the very important measures introduced under the Bank's support in the context of the Social Safety Net Adjustment Program (approved in December 1992); and the Liberalization of the External Sector and Investment Regime (approved on June 24, 1993), are clear confirmation of Government's skillful management of the politics of reform as well as its recognition of the necessity of such reforms for the long-term economic growth of Indian economy and efforts to alleviate poverty. The improvements in the economic situation over the last year and the smooth passage of the 1993-94 Budget by Parliament in May 1993 suggest that the Government's adjustment program is proving successful.   PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE A. Project Identity Name : Structural Adjustment Loan/Credit Loan/Credit Nos. : Loan No. 3421-IN, Credit Nos. 2316-0-IN and 2316-1-IN RVP : South Asia Region Country : India Sector : SAL/SAC B. Background and Developmental Perspective Continuing with Change 1. Since Independence in 1947 India has pursued a strategy of mixed economic development, relying on state control of many key sectors of the economy on the one hand, and accommodating a vigorous and expanding private sector on the other. The boundaries between public and private sector interaction however, have not been ruled by rigid ideology, but by pragmatism and above all the imperatives of social and economic development. In a country with a large poor populous, divided along ethnic, linguistic and religious lines, national economic policy has required, both at its formulation and implementation stages, building consensus across a multitude of political and regional spectrums. 2. National economic policy in India in the Post-War era, assigned a dominant role to the state which served to foster economic growth and act as custodian of a large section of society whose dismal economic fortunes have needed state intervention in economy in order to integrate them in the economic mainstream. Such interventions in India went beyond the usual dirigiste strategy pursued by most developing countries in the second post-World War era. Driven by the goal of achieving national self-reliance, industry was tightly regulated, including firms' entry, expansion, diversification, and modernization, as well as labor deployment, asset restructuring or liquidation, on a case-by-case basis. As an integral part of this policy, a highly protective trade regime was built up with numerous quantitative restrictions, high tariffs, and a multiplicity of discretionary import licenses. A large number of public enterprises were established by both Central and State Governments. These ware often granted monopolistic positions in key sectors of infrastructure, manufacturing, services, and were nourished by Government preferences, including easy access to budgetary  2 resources, guaranteed and subsidized credit, and protection from import competition. In the financial sector, the Government maintained a dominant ownership position in the banking, mutual funds, and insurance industries following nationalizations in 1969 and 1980. Reforms in the 1980s 3. In early 1980s, a consensus emerged that India needed to liberalize its economy and enhance its efficiency so as to meet the objectives of providing gainful employment for a rapidly growing labor force, while also generating sufficient resources for social programs and modernization of industry and infrastructure. Thus, throughout the 1980s, important policy changes were introduced geared to liberalize trade, industrial and financial policies. Although these measures helped GDP growth to accelerate to over 5 percent per year during the 1980s, and reduced poverty more rapidly, India's most fundamental structural problems were addressed only very partially. Tariffs continued to be very high and quantitative restrictions remained pervasive. While controls on capacity utilization and borrowing were lifted, the investment licensing regime continued to make firms' investment decisions conditional on cumbersome Government approvals and resulted in foreign investment levels well below those achieved in other large developing economies. State-owned banks continued to dominate the banking system and to serve as an important instrument of fiscal apparatus, and of channelling resources to priority sectors. With few exceptions, the inefficiency of public enterprises (which generate 17 percent of GDP) continued to be a serious issue. 4. These problems were compounded in the late 1980s, by political uncertainty (there were two general elections and four changes of Government between end 1989 and July 1991) which slowed the pace of reform and prevented the Government from addressing serious macroeconomic imbalances, which soon grew to a crisis proportion. The Central Government fiscal deficit reached 9 percent of GDP in 1990/91 and from single digits throughout the 1980s, inflation rose to 10.2 percent on a point to point basis in November 1990, and 17 percent in August 1991. On the extemal front, the current account deficit of the balance of payments rose to 3 percent of GDP, the country's external debt grew to US$70 billion, and the debt service ratio increased to 29 percent. External commercial borrowing relied heavily on volatile funding from the Indian community living abroad. At US$13 billion, deposits from Non-Resident Indians (NRIs) accounted for almost one-fifth of India's total external debt. Combined with political uncertainty and the consequent lack of an effective adjustment strategy, the August 1990 developments in the Gulf put additional pressure on the balance of payments, eroded the confidence of foreign lenders, triggering accelerated capital outflows from NRI deposits and leading commercial banks to reduce their exposure in India. The Indian Government responded by compressing imports drastically, and mobilizing part of India's gold stock. Multilaterals and bilaterals, particularly Japan, provided significant assistance in the first half of 1991. These efforts notwithstanding, foreign exchange reserves declined to about US$1 billion (about two weeks of imports) in June 1991. C. The Adjustment Process A New Minority Government Coming into Power 5. Against this backdrop the Narasimha Rao Government came into power in June 1991, with the ruling Congress (I) party commanding 231 Members of Parliament out of a total of 521 Lok  3 Sabha (the lower house) members, thirty short of a majority. Even with the addition of eighteen allies from diverse regional parties, the party was still left short of the majority by twelve members. The government found a rallying point in the form of the imperative for economic reform, which was used skillfully to muster political support for its major economic liberalization initiatives. With a candid recognition from the outset', that the longer-term causes of the balance of payments crisis lay closer home--in the poor performance of the public sector and the over-regulation and protection of the domestic industry which resulted in an pronounced export bias--the Government moved swiftly to introduce an impressive set of measures aimed at dealing with the immediate external liquidity crisis, redressing accumulated fiscal imbalances, and equally important, a fundamental restructuring of the economy. 6. In formulating such policy responses the Government placed priority on avoiding defaulting on India's external debt.2 With such a commitment, domestic macrostabilization measures were combined with assistance from international financial community to operate on both the current and capital accounts of the balance of payments. Thus, On July 1 and 3, the Reserve Bank depreciated the rupee by 23 percent. An austerity budget was presented to Parliament on July 24 setting ambitious targets for 1991/92: to reduce the Central Government's fiscal deficit from 9 percent of GDP in 1990/91 to 6.5 percent of GDP in 1991/92, restrict broad money growth to 13 percent (down from 15 percent in 1990/91) and reduce inflation from 12 in 1990/91 to 9 percent in 1991/92. As these measures were deemed insufficient to contain excess demand for imports, the new Government maintained the emergency import restrictions that the Reserve Bank of India (RBI) had put into place after the Gulf crisis. It was made clear that they would be eliminated as soon as the foreign exchange position improved. And, to address the longer-term, supply-side causes of India's problems, the Government announced its intention to reform policies governing i) international trade; ii) private investment in the industrial sector, as well as labor and capital mobility; iii) the financial sector; iv) taxation; and v) public enterprises. These initial measures constituted the basis for a SAL from the World Bank and a Stand-By facility from the IMF. D. The SAL Program Loan Preparation 7. Discussions with GOI on policy-based lending in support of stabilization and structural reforms were initiated in January 1991. At that time, the Bank indicated that the reform measures I This recognition was clearly articulated by the Minister of Finance in the Budget speech of July 24, 1991, when he stated that "the origins of the probLem are directly traceable to Large and persistent macroeconomic imbalances and the Low productivity of investment, in particular the poor rates of return on past investments." Such a recognition was also echoed in the academic and intelLectuaL community. In a joint statement, "Agenda for Economic Reform" (issued in New Delhi, on July 1, 1991), three prominent Indian economists described the symptoms of the crisis and offered their diagnosis as, "... this situation has come about because, as a nation, we have got [sic] used to living beyond our means. Our persistently high fiscaL deficits and current account deficits are testimony to the firmly-grounded belief that social and economic irresponsibility carries no penaLty. But history has no special favorites. We cannot afford the Luxury of apportioning the blame." 2 Such a policy stance adopted by Indian poLicymakers is noteworthy, reflecting the motto of "self reliance" so deeply rooted in the country's sociopoLiticaL culture, and cherished by its political leaders and economic planners. The option of defaulting and/or restructuring of debt obligations, were never considered by Indian policymakers.  4 that would be contained in the 1991/92 budget and in the related policy statements could provide an important basis for fast-disbursing assistance. In the context of these initial discussions, the Bank organized an informal donors meeting in April 1991 that was important in mobilizing support for India's emerging program. However, the interim nature of the Government, and the postponement of the elections caused by the assassination of Mr. Gandhi, created delays in program formulation and presentation of the budget. The discussions, however, accelerated after the new Government assumed office, and requested the World Bank's and IMF's assistance in support of its stabilization and adjustment program. 8. The Bank supported the new Government's reform efforts through the initiation of adjustment lending. The SAL/SAC was promptly prepared and processed 3 -- a preparation mission took place in August 1991, the loan was appraised in September and became effective in December 1991, which laid the foundation for the subsequent adjustment lending operations: i.e. the Social Safety Net Adjustment program (US$500 million) approved in December 1992, and the Liberalization of India's External Sector and Investment Regime (US$300 million) which was approved on June 24, 1993. Such Bank supports contributed significantly in meeting part of India's exceptional financing requirements of US$2.5 billion a year in 1991-92 and 1992-93; they also acted to consolidate the Bank's catalyzing role in securing broader multilateral and bilateral assistance. 9. In the last two years, the IMF has approved SDR 3.6 billion of loans to India, including an SDR 1.7 billion under the twenty-month Stand-By approved in October 1991 and ending in June 1993. The Stand-By has succeeded in achieving macro-economic stabilization and most of its structural benchmarks have been met or exceeded. Discussions between the Government and the Fund on an Extended Fund Facility (EFF), complemented by resources from the Enhanced Structural Adjustment Facility (ESAF), are expected to begin July 1993. Objectives and Scope of the SAL/SAC Program 10. As its central objective, the SAL/SAC program aimed to support the Government's efforts in liberalizing the Indian economy and opening it up to competition as a way of promoting long-term economic growth with sustainable balance of payments. These objectives translated at the time into the need for a broad based program covering the key interrelated areas of industry, trade, finance, and public sector. Being the first policy-based loan/credit to India, it was well recognized that the program had to be broadly based in order to secure the greatest gains possible from policy interlinkages involved. It also had to be decisive to signal a clear break from the piecemeal approach of the past, and had to be cognizant of the possible social costs. Such considerations implied a relatively large number of specific reform measures could be included in the program, in part because such reform proposals had long been debated inside India and enjoyed a fair degree of consensus among key policymakers. In addition, Government's efforts to establish several high-level committees to formulate specific reform proposals, was very instrumental not only in bringing a blend of talent and expertise to policymaking circles, but also ensuring a high degree of internal debate in the popular press and media, in the process widening public support for the reform effort. 3 The rapid processing of the program was faciLitated by the Bank's inventory of economic and sector studies on the most pressing areas of reform.  5 11. Industrial Policy. Following the major reforms announced in the Industrial Policy Statement of July 1991, the Government introduced several additional concrete measures geared to deregulation of entry and removal of industrial licensing, [exceptions in cases required on environmental, safety, land use, congestion, urban planning, and related concerns]. Complementary to the deregulation of entry, the Government also took actions intended to facilitate adjustment by industrial firms (including rehabilitation, restructuring and winding up where necessary). To that end, agreed actions under the SAL/SAC related specifically to: i) placement of amendments to the Sick Industrial Companies Act of 1985 (SICA) before the parliament to institute more appropriate criteria for sickness, strengthen the Board for Industrial and Financial Reconstruction (BIFR), improve its functioning, and streamline its procedures; ii) establishment of a National Renewal Fund (NRF) to provide workers with a safety net; iii) adoption of measures necessary to refer public enterprises that are sick according to the criteria specified in the SICA to the BIFR for assessment of their prospects and subsequent winding up or rehabilitation; iv) formulation of a satisfactory policy, based on the review and recommendation of the interministerial working group to facilitate adjustment by industrial firms taking into account the need for adequate safeguards for workers; and v) formation of an action program to initiate restructuring and closure procedures for central public enterprise units that are patently unviable. Also, controls on steel were removed on January 26, 1992, complementing the deregulation of entry in that industry and liberalization of the trade regime for steel items. 12. Trade Policy. Starting in July 1991, and in several phases since then, the Government has announced a series of major measures to reform the trading and payment system. In some instances, such as (partial) rupee convertibility, the reform measures went beyond the agreed area of actions envisaged in the trade policy component of the SAL/SAC. Beginning with the removal of all the emergency measures that had been introduced by RBI in the midst of the balance of payments crisis of 1990-1991, the Government moved further and faster than envisaged under the SAL/SAC program by allowing all manufactured intermediate and new and some second-hand capital goods to be freely imported unless they were listed in a newly created negative list of imports. Only thirty-eight intermediate items and eight capital goods items were included in this negative list. The resultant reduction in quantitative restrictions on imports was considerable and exceeded agreed targets under the SAL/SAC program.4 Also, based on the recommendations of the Chelliah Committee, the Government implemented a substantial reduction in import tariffs. This measure was incorporated in the 1992/93 budget, and reduced the maximum tariff from 150 percent to 110 percent. Furthermore, the Government indicated its intention of further reducing tariffs to an average level of about 25 percent over the following few years. Two broad sets of actions were taken to enhance export incentives: i) the (partial) rupee convertibility enhanced profitability for a broad range of commodities; and ii) administrative controls were removed for a large number of products, and the control status of others was relaxed (e.g., by allowing the issue of export licenses for previously prohibited products). As a first step in the process to reduce export controls, most manufactured commodities were decontrolled. This left agricultural, mineral, and processed agricultural and mineral products still subject to export licensing, canalization, or minimum export price restrictions. 13. Financial Markets and Institutions. In supporting the Government's efforts to reform India's well-diversified financial system, the SAL/SAC program placed considerable priority on: i) 4As measured by value added, it is estimated that about 96 percent of domestic machinery and equipment production and 81 percent of the domestic production of manufacture intermediate goods is now freely importabLe at the market exchange rate. For manufacturing as a whole, the share of value added protected by quantitative restrictions on imports has been reduced from about 90 percent in 1990 to about 46 percent at present.  6 limiting the scope of Government direct intervention in the banking sector; ii) improving investor protection in the capital markets; and iii) opening up the mutual funds industry to private sector participation. Thus, the SLR was reduced (as of April 3, 1992) from 38.5 percent to 30 percent of incremental domestic bank deposits. The Government took a number of actions to complement this measure, including raising coupon rates on its long-term bond, and introducing a tradable 364-day treasury bill instrument to promote the development of a broad based Government securities market. In line with the liberalization of lending rates, interest rate subsidies on priority sectors were reduced. Thus, interest rates on term loans to agriculture, small scale industry, and transport operators with two wheelers, were increased on average from 12.4 percent to 13.7 percent effective April 22, 1992. With the exception of loans less than seven and half thousand rupees (US$250), all other lending rates were raised above the prevailing rate of inflation and exceed banks' cost of funds. As an important step to improve investor protection and to regulate and promote the development of capital markets in an orderly fashion, the SEBI Act, 1992, was enacted by Parliament, establishing SEBI as an independent regulatory power to regulate the functioning of securities markets, securities industry intermediaries such as mutual funds, equipped/vested with the authority to prevent fraudulent and unfair trading practices relating to the securities business, in particular, insider trading, and to regulate corporate acquisitions and takeovers. The passage of legislation empowering SEBI represents an important threshold in the evolution of India's regulatory framework. As an integral part of this process, the Capital Issues Control Act of 1947 was abolished through the promulgation of a presidential ordinance (May 29,1992). Accordingly, the Government's control over corporations' issuance and pricing of capital via the Controller of Capital Issues has been removed. Further complementing these actions was the reform of the trading mechanism of stock exchanges, including setting up a system of national clearance and settlement and a central depository trust, which the Government initiated under the SAL/SAC program. Also, as under the SAL/SAC program, the Government opened up the mutual funds industry to private and joint sector participation. Guidelines for the constitution and functioning of private sector mutual funds were issued (February 14, 1992), and the responsibility for regulating the industry was assigned to SEBI and RBI. 14. Public Enterprise Reform. Under the SAL/SAC program, the Government purposefully adopted two distinct reform measures: reduction of budgetary support and disinvestment of Government ownership in public enterprises. In recognition of the salutary impact of hard budget constraints on improving managerial efficiency and in facilitating company restructuring, the following actions were implemented in the allocation of budgetary support to public enterprises: i) reduction by 10 percent of the plan investment for public sector enterprises; ii) announcement of progressive reductions in such investments and ultimately elimination by end 1994/95; iii) significant reduction in the volume of nonplan loans to sick public sector enterprises from Rs. 55.41 billion in 1991/92 to Rs. 36.56 billion in 1992/93; and iv) adoption of a policy limiting Government guarantees of central public sector enterprises' borrowing to essential infrastructural public sector units. 15. The Government's motivation for disinvesting the equity of PSE's arose from the need to contain the budgetary deficit and mobilize resources for the National Renewal Fund. The disinvestment process posed the Government with three areas of concern: the choice of the enterprises; the pricing of the equity and the actual mechanism of disinvestment. These concerns were resolved by adopting a detailed selection criteria, developing an appropriate pricing formula and employing an auction process in which shares were offered in a "portfolio context". 16. These measures were successful in the 1991-92 period. In a two-phase competitive bidding operation, 870 million shares were off-loaded, raising over Rs.30 billion. As much as 20  7 percent of the shares of fourteen companies were sold, with the shares of others sold ranging from 0.27 percent to 16.69 percent. The program of disinvestment continued in 1992/93, with total proceeds targeted of Rs.35 billion. Private sector parties participated for the first time in these auctions, although the stagnation in the stock market undermined the enthusiasm of the private sector, resulting in only half of the annual target to be realized. Implementation and Compliance 17. Implementation of the program supported by the SAL/SAC was monitored by the Country Operations, Industry and Finance Division of the India Department of the South Asia Region (SA2CI). A mid-term review mission was in the field in early February 1992, when after taking stock of progress achieved at the time, the mission highlighted those aspects of the program which required close attention of the authorities.5 Following that, an intensive review of second tranche release took place, as scheduled, in May 1992, when the overall progress in the implementation of structure reform measures, supported under the SAUSAC program, was declared fully satisfactory. 18. Indeed, in several key areas, such as exchange rate policy, liberalization of the import regime, and financial sector reform, the pace and scope of reforms were recognized to have exceeded the targets set out in the Government's Letter of Development Policy. With respect to exchange rate policy, a dual exchange rate regime was constituted in February 29, 1992 with a market-determined rate for most current and capital account transactions, and a managed official rate for a few key imports, principally, petroleum products and fertilizers. This exchange rate system represented a major step forward in equilibrating the current account and provides an effective under pinning for the significant liberalization of quantitative restrictions on imports of capital and manufactured intermediate goods which had already taken place. Also, in the financial sector, the reform went beyond the agreed action under the SAL/SAC in the introduction of a more stringent accounting system; in strengthening of prudential regulation to conform with international norms and standards; in the deregulation of deposit rates (subject to then ceiling of 13 percent); in the liberalization of bank branching policy; with reform of taxation of capital income; with respect to decontrol of corporate capital issues. These measures laid a firm foundation for further deepening of reforms in the key areas of trade and finance. On macroeconomic fronts, an IMF mission determined in April 1992 that the Stand-By program was broadly on track, and the IMF Board considered the staff report for the First Review on June 29, 1992, and the third purchase in the amount of SDR 61 million was made available. 19. Of the twenty-five specific agreed actions contained in the SAL/SAC loan agreement, twenty-two had by the time of second tranche release (May 1992) been fully and three substantially complied with. The latter related, specifically, to: i) removal of administrative export controls on selected agricultural products; ii) formulation of satisfactory policy for adjustment by industrial firms; and iii) initiation of measures for restructuring/closure of patently unviable sick central public 6 Contributing considerably to the monitoring of the SAL/SAC program and the fulfillment of its supported agreed action, was the cooperation of the Indian authorities. To facilitate coordination among the various line ministries to which the SAL/SAC related, the Government set up two committees: i) a Monitoring Committee, headed by the Secretary of Economic Affairs, DEA, which met fortnightly; and ii) an Operational committee, which met every week and reported to the Monitoring Committee. This procedure helped to update progress in reform impLementation on a regular basis, and focused the attention of key policymakers on areas where progress was Lagging.  8 enterprises. With respect to the first item, a major reduction was undertaken, under the SALfSAC support, in the March 1992 Export-Import Policy, when the number of items under export restrictions was reduced from 439, to 296. At the same time, the Government undertook a comprehensive review of export controls and indicated its intention of further reducing substantially items still subject to control, particularly those with significant export potential, such as silk, metals and minerals. Such reductions in the number of items were introduced subsequently in the March 1993 Export-Import Policy when the number of items was reduced to 215. 20. In the intertwined areas of general exit policy and restructuring/closure of patently unviable public enterprises, the Bank was conscious of the difficulty facing the Government in dealing more boldly with these politically sensitive issues. While remaining concerned about the pace of progress in these difficult areas, the measures taken at the time, including the hardening of the budget constraint vis-a-vis the sick units, and the progress being made at the time with regard to the discussions on IDA support for the National Renewal Fund in the context of the Social Safety Net Adjustment program, were recognized to have fulfilled substantially the agreed actions under the SALJSAC program. Disbursement 21. Disbursement of the Loan and the Credit was completed well before the Closing Date of December 31, 1992. However, in disbursing the funds, a number of difficulties were experienced. A large number of withdrawal applications were delivered to the Bank late in FY92, and therefore, most of the disbursement took place in late 1992 and in FY93. Due to the need to handle the large volume of applications delivered at the same time, delays were experienced in disbursing the funds. Furthermore, the poor quality of some applications (e.g., inclusion of ineligible items, inclusion of payments on prior review contracts in SOE applications, lack of required information such as contract amounts, and source of supply, and general illegibility of documentation submitted) also contributed to such delays. E. The Economy's Responses Macroeconomic Performance 22. While their precise impact is difficult to gauge, it is clear that measures supported by the SAL program made a major contribution to the stabilization of the economy and the control of the balance of payments. Key macroeconomic indicators are reported in Table 1, and are elaborated below. 23. Improved Fiscal Management. At the heart of the Government stabilization effort was a process of fiscal adjustment focussing on the Central Government finances. In India's federal framework of Government, the primary targets of fiscal adjustment had to be the Central  9 Government. Yet, both the public enterprises, as well as the state Governments6 have also been affected by the broader thrust of the reforms, in particular, by those in the realm of the financial sector. 24. Within this broader perspective, the consolidated fiscal deficit, including the state Governments and public enterprises declined from 11.51 percent of GDP in 1990/91 to 8.84 percent in 1991/92 and is estimated to have declined further to 7.5 percent of GDP in 1992/93. At a more disaggregated level, the Central Government succeeded in reducing the gross fiscal deficit from 8.41 percent of GDP in 1990/91 to 5.7 percent of GDP in 1991/92 and 5.4 percent of GDP in 1992/93. This resulted in the primary (non interest) deficit falling sharply from 4.4 percent of GDP in 1990/91 to 1.3 percent in 1991/92. The deficit figure for 1992/93 exceeded the GOI's target by 0.4 percent of GDP. While tax revenues exceeded the Budget Estimate because of increased buoyancy of direct taxes arising from steps taken in April 1992 to broaden the base and improve tax administration, there was a shortfall in expected revenue from asset sales (see para. 16 above). On the expenditure side, defense and capital spending fell as budgeted, but the targets for subsidies and transfers to state Governments were exceeded. The Union budget for 1993/94 projects a total expenditure decline of 1.3 percent, with almost half of the reduction in non-interest expenditure coming from subsidy cuts (mainly the fertilizer subsidy). Table 1. Macroeconomic Indicators, 1980-81 and 1985-93 Indicator 1980/81 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 Fiscal deficit Central deficit/GDP(X) 6.42 8.34 8.99 8.12 7.80 8.35 8.41 5.7 5.40 Consolidated public sector deficit/GDP(%) 8.05 9.40 11.90 10.08 9.99 11.06 11.51 8.84 7.50 Percentage Growth in broad money supoLy 18.28 16.64 18.63 15.98 21.89 15.34 15.10 18.53 14.51 Nominal exchange rate (Rs/$) 7.89 12.24 12.79 12.97 14.48 16.66 17.95 24.52 26.4 Real GDPfc growth rate Total 7.2 4.1 4.3 4.3 10.9 5.6 5.2 1.2 4.0 Industrial sector 3.5 4.6 7.3 6.4 10.1 7.2 6.9 -0.1 3.8 Rate of inflation a/ 18.2 4.4 5.8 8.2 7.5 7.4 10.3 13.7 10.0 Current account deficit Billions of dollars 2.9 5.99 6.04 6.4 8.96 7.8 7.7 2.02 5.22 Percentage of GDP 1.7 2.8 2.6 2.5 3.3 2.9 2.6 0.8 2.1 Merchandise Exports b/ 18.32 9.46 10.42 12.65 14.26 16.96 18.49 18.14 21.3 Merchandise Imports b/ 15.86 17.3 17.74 19.82 23.62 24.41 25.24 19.73 24.7 a/ Percent change in UPI. b/ Billions of dollars. 6 The importance of the states finances in the fiscal adjustment process needs to be emphasized, with the net fiscal transfers from the central government to the states amounting to as much as 5.8 percent of gross domestic product in 1992/93 and budgeted to be 5.2 percent in 1993/94 and with seven out of the twenty-five states in India having populations in excess of 50 million.  10 25. In India, traditionally, a major part of the deficit of the Central Government has been financed through mandatory reserve requirements imposed on financial institutions. As Table 2 shows, the share of commercial banks in the financing of the Central Government's deficit has been steadily rising reaching nearly Rs. 100 billion in 1991/92 or 27.0 percent of the deficit. An additional Rs.40 billion of commercial bank resources went to finance the deficits of the states and non-financial public enterprises. Thus, the prevailing pattern of financing of fiscal deficits underscores the importance of the ongoing reforms in the financial sector with in particular, the efforts to develop a broad based market for Government securities expected to have an enduring impact on fiscal adjustment. The move to a market based system of funding Government borrowing would provide the necessary credibility to the fiscal adjustment process. In the short run the Governments interest payments may well rise from their present ratio of 3.7 percent of GDP, but the progress in reducing inflation, coupled with continuing liberalization of the financial system, would together imply lower interest payments in the long-run. Improvements In the Balance of Payments 26. The progress on the fiscal front has been matched by achievements on the external side. India's foreign exchange reserves recovered from a low of US$1.1 billion in September 1991 to about US$5.5 billion by end March 1992. This build up in foreign exchange reserves resulted from improvements in both the trade and capital accounts. The capital account benefitted from support from multilaterals and the sale of US$1.6 billion of India Development Bonds to Non Resident Indians (NRIs) during the period August 1991 to January 1992. The trade account deficit declined from 2.3 percent of GDP in 1990/91 to an estimated 0.7 percent of GDP in 1991/92 as a result of a severe compression of imports, with non-fuel merchandise imports declining from US$19.21 billion in 1990/91 to an estimated US$14.36 billion in 1991/92. At the same time exports suffered from both the economic decline of the erstwhile USSR and Eastern Europe and the economic slowdown in major industrialized countries. The strengthened foreign exchange reserve position afforded the Government the necessary cushion to move toward partial rupee convertibility on the current account. The rupee was made partially convertible in March 1992 under a new liberalized exchange rate management (LERM) system. Table 2. Financing of the Central Government Deficit (in Rs. billions) 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 B.E. Gross fiscal deficit 270.45 309.22 379.30 446.5 363.25 348.08 Financed by RBI 65.59 65.03 138.13 147.45 55.08 - Commercial banks 39.36 46.20 46.79 54.28 100.14 - Private sector 125.95 151.35 168.85 212.50 154.88 - External 29.24 25.23 27.71 33.40 54.00 - Source: India, Country Economic Memorandum, 1993.  11 27. Success in overcoming the external payments crisis came initially at a cost to growth however. Real GDP recorded a poor growth rate of 1.2 percent in 1991/92, largely because of a weak performance by manufacturing and agricultural sectors. Driven by the large exchange rate adjustment, increases in prices of agricultural commodities, as well as increases of administered product prices such as fertilizer and railway tariffs, inflation in 1991/92, at a level of 13.7 percent, remained a source of concern, and overshot the Government target of 9 percent. Turnaround in Macroeconomic Conditions 28. The turnaround in macroeconomic conditions came in 1992/93, when inflation was reduced and signs of economic recovery appeared. Inflation has remained at around 7 percent (as measured by the wholesale price index) since January 1993. This decline has occurred despite large increases in the administered prices of fertilizer, by 44 percent and petroleum product prices, by an average of 18 percent. Also during 1992/93, merchandise exports displayed a growth rate of 2 percent in dollar terms. This is in comparison to a decline of 2 percent during the corresponding period in 1991/92. This transformation occurred primarily because of a recovery in competitiveness, improvements in export incentives and a successful transition from exports to the Rupee Payment Area (RPA) which declined by a further 64 percent, to the General Currency Area (GCA), which increased by about 10.5 percent. The exports to the RPA are no longer a source of vulnerability for Indian exports with their share down to 3 percent of total exports from the 20 percent level that existed as recently as 1989/90. Significant gains were seen in the export of engineering goods (23 percent) and textiles and garments (22 percent). Large reductions in quantitative restrictions on intermediate and capital goods imports led to merchandise imports rising sharply by over 25 percent in 1992/93 compared to the 22 percent contraction witnessed in 1991/92. Decreased production and increased demand combined to make oil and petroleum imports rise during this period, with the bill for these imports going up to US$6.1 billion compared to the US$5.5 billion projected at the beginning of the year. However, machinery and project imports rose by only 8 percent during 1992/93, confirming the view that the overall increase in imports during the year was more for re-stocking than restructuring purposes. The invisible balance also worsened partly due to the decline in tourism receipts because of the Ayodhya incident and the domestic airlines strike. Overall, the trade deficit, deteriorated substantially in 1992/93 to US$3.9 billion from US$1.6 billion the previous year, with the external current account deficit going up from US$2.0 billion (0.8 percent of GDP), to about US$5.1 billion (2.0 percent of GDP). F. Conclusions 29. The SAL/SAC operation was prepared and negotiated at a time when India faced a balance of payments crisis of unprecedented severity. As described by the Finance Minister in his budget speech of July 24, 1991: "The crisis in the economy is both acute and deep. We have not experienced anything similar in the history of independent India." Unsustainable fiscal and balance of payments deficits combined with the impact of the 1990 Middle East crisis and domestic political instability, had the country on the verge of default. In the span of two years the new Government that came into power in June 21, 1991, has managed not only to turn around macroeconomic conditions, but has also begun a major transformation of India's development strategy. On macroeconomic fronts, as highlighted above, the progress in stabilizing the economy has been considerable, with the management of the external sector and lowering of inflation taking initially  12 overriding priority: reserves have been built up from less than US$1 billion in June 1991 to US$6.7 billion in March 1993, and inflation has been sharply reduced from a peak of 17 percent in August 1991 to about 6 percent in recent months. The initial slow down in economic activity and the industrial stagnation experienced in 1991/92 -- economic growth declined from 5.2 percent in 1990-91 to 1.2 percent in 1991/92 -- were caused by the poor performance of agriculture in that year, and the contractionary impacts of import compression measures and fiscal retrenchment which depressed public and private investment. Economic growth, however, recovered in 1992-93, and is forecast to have reached nearly 4 percent, and despite major import liberalization efforts introduced, deficit on the trade account of the balance of payments has increased from the very low level of US$1.6 billion in 1991/92 to US$3.9 billion in 1992/93. 30. The success in macroeconomic stabilization has enabled the Government to continue with its structural reform agenda. The greatest achievements on this front have been the freeing of industry from various bureaucratic licensing requirements, reunification of exchange rate, removal of quantitative restrictions on imports of capital and intermediate goods, reduction in custom tariff rates, and most recently, opening up of banking, mining and mutual funds industries to private sector investment. Furthermore, the very important reform measures taken under the Liberalization of External Sector and Investment Regime Project approved by the Bank's Board of Executive Directors on June 24, 1993, demonstrate the Government's commitment and resolve to continue with its process of opening up the economy and enhancing efficiency through domestic and external competition. Also, in the key area of the financial sector, where reforms have had to be paced more closely with progress in fiscal adjustment, the Government has continued with a major strengthening of the regulatory framework, and with the formulation of an action plan that is designed to restore financial health to the banking institutions. The latter reforms are expecte.d to accelerate in the coming months.  13 PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) PART II. PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE The Borrower did not submit Part II of the PCR.  14 PROJECT COMPLETION REPORT INDIA STRUCTURAL ADJUSTMENT LOAN/CREDIT (LOAN 3421-IN; CREDITS 2316-0-IN AND 2316-1-IN) PART III. STATISTICAL INFORMATION 1. Related Bank and IDA Loans Year of Loan Approval Ln/Cr No, Loan Title Amount Status (US$ million) 1991 Ln. 3421-IN Structural Adjustment Loan 250.0 Closed Cr. 2316-IN Structural Adjustment Credit 250.0 Closed 1992 Cr. 2448-IN Social Safety Net Sector Adjustment Program 500.0 Closed 1993 Ln. 3627-IN Liberalization of External Sector and Investment 300.0 Closed Regime 2. Project Timetable Item Date Planned Date Revised Date Actual Appraisal Mission 09/30/91 09/27/91 09/27/91 Loan/Credit Negotiations 10/30/91 10/28/91 10/28/91 Report & Recommendations of the President - 11/12/91 11/12/91 Letter of Development Policy - 11/11/91 11/11/91 Board Approval 12/05/91 12/05/91 12/05/91 Loan/Credit Signature 12/05/91 12/05/91 12/05/91 Loan/Credit Effectiveness 12/30/91 03/04/91 12/11/91 Loan/Credit Closing 12/31/92 12/31/92 12/31/92 Loan/Credit Completion 06/30/93 06/30/93 06/30/93  15 3. Loan Disbursements Cumulative Estimated and Actual Disbursements (US$ million) 1991 1992 Appraisal Estimate 300 500 Actual 300 500 Actual as % of Estimate 100 100 Date of Final Disbursement: June 18, 1992 4. Project Costs and Financing Project Financing Planned Loan/Credit Source Agreement Final (US$ million) (US$ million) IBRD/IDA Expenditure Category General Imports 500 500 TOTAL 500 500 5. Use of Bank Resources Mission Data No. of No. of Staff Date of Month/Year Weeks Persons Weeks Report Preparation July/August 1991 2 4 8 September 6, 1991 (IM) Appraisal Sept./Oct. 1991 2 5 10 November 12,1991 (PR) Supervision I January 1992 1 2 2 February 13, 1992 Supervision II May 1992 1 4 4 June 18, 1992 Completion Not applicable June 30, 1993    IMAGING Report No: 14582 Type: PCR