India - Cotton and textile industries : reforming to compete (Vol. 2 of 2) : Annexes

Report No. 18857-IN India Cotton and Textile Industries Reforming to Compete (in Two Volumes) Volume II: Annexes January 14, 1999 Rural Development Sector Unit South Asia Region Document of the World Bank  Abbreviations andAcronyms AICCIP All India Cotton Coordinated improvement Project AMPA Agricultural Product Markets Act ATC Agreement on Textiles and Clothing BIFR Board for Industrial and Financial Reconstruction CACP Commission for Agricultural Costs and Prices CCI Cotton Corporation of India CIB Central insecticides Board CICR Central Institute for Cotton Research CIRCOT Central Research on Cotton Technology CV Coefficient of Variation EC Act Essential Commodities Act ELS Extra-Long Staple EOUs Export Oriented units EPCG Export Promotion Capital Good Scheme FAO Fair Average Quality FC(R)A Forward Contracts (Regulation) Act GATT General Agreement on Tariffs and Trade GOI Government of India HYO Hank yarn Obligation ICDP Intensive Cotton Development Program ICMF Indian Cotton Mills Federation IPM Integrated pest Management ITMF International Textile Manufacturers Federation IPR Intellectual Property Rights MSCCGMF Maharashtra State Cotton Cooperative Growers' Marketing Federation MCPS Maharashtra Cotton Procurement Scheme MEP Minimum Export Price MFA Multi-Fiber Agreement MMF Man Made Fibers MOA Ministry of Agriculture MODVAT Modified Value Added Tax MSP Minimum Support Price NPC Nominal Protection Coefficient NTC National Textile Corporation NTSD Non-transferable Specific Delivery Cotton Contracts OGL Open General License OTC Office of the Textile Commissioner QRs Quantitative Restrictions RBI Reserve Bank of India SITRA South Indian Textile Research Association VABAL Value Added Based Advanced License Weights and Measures qtl - quintal (100 kg) kg - kilogram bale - 170kgs ha - hectare mt - metric ton Vice President: Mieko Nishimizu Director: Edwin Lim Sector Unit Leaders: Ridwan Ali/Michael Baxter Staff Members: Benoit BlarellDina Umali-Deininger  INDIA COTTON AND TEXTILE INDUSTRIES: REFORMING TO COMPETE Volume II Table of Contents Annex 1: Textile Industry Policy A. Evolution of India's Cotton Textile Policy .................................................................. 1 B. Textile Industry: Historical Perspective 1950s to 1985 ................................................. 1 C. Towards Liberalization: 1985-97 ..................................................................5 D. External Trade Reforms ..................................................................9 B. Appendix Tables ................................................................. 14 Annex 2: Cotton Sector Policy A. Cotton Production Policies ..................................................................1 B. Input Policies ................................................................. 3 C. Cotton Trade and Processing Regulations ..................................................................5 D. Risk Management ..................................................................8 E. External Trade Policies ..................................................................8 F. Appendix Tables .............. 10 Annex 3: Structure and Performance of the Textile Industry A. Introduction ..................................................................1 B. Structure of the Textile Industry ..................................................................1 C. Export Performance ..................................................................2 D. Domestic Demand for Textile Products ..................................................................4 E. Performance of the Spinning Industry ..................................................................6 F. Man-Made Fiber Products ................................................................. 14 G. Performance of the Weaving Sector .................................... ............................. 15 H. Handloom Sector ................................................................. 19 I. Structure and Performance of the Apparel Industry .......................................... ............. 19 J. Appendix Tables & Figures ................................................................. 25 Annex 4: Cotton Production Performance and Prospects A. Introduction ..................................................................1 B. Cotton Production Performance ..................................................................1 C. Technical Constraints to Future Productivity Growth .................................................... 6 D. Changing Composition of Cotton Output ................................................................. 12 E. Appendix Tables .15  Annex 5: Structure and Performance of Cotton Markets A. Introduction ..................................................................1 B. Marketing of Seed Cotton and Cotton Lint ................................................................. 1I C. Cotton Ginning and Pressing Industry ..................................................................7 D. Cotton Grading and Classification ................................................................. 10 E. International Marketing of Cotton ................................................................. 13 F. Cotton Market Performance ................................................................. 19 G. Risk Management in the Cotton Sector ................................................................. 22 H. Appendix Tables & Figures ................................................................. 28 Annex 6: MFA Phaseout and the Cotton and Textile Policies A. Introduction ..................................................................1 B. Overview of the Indian Cotton Textile Industry ............................................................ I C. MFA and Its Implications for India ..................................................................2 D. Methodology ..................................................................4 E. Policy Reform Simulations ..................................................................6 F. Economic Impact of Policy Reforms ..................................................................9 G. Summary and Conclusions ................................................................. 15 H. Appendix: Structural Specifications of the GTAP Model ............................................. 17 Annex 7 Policy Options for Liberalizing the Cotton Textile Industry A. Introduction .................................................................1I B. Methodology .................................................................1I C. Income Distribution Impacts of Cotton Textile Liberalization ....................................... 5 D. Summary and Conclusions .7 E. Appendix: Simulation Model for the Cotton Sector Liberalization in India ................ 10 List of Tables Annex 1 Table A 1.1 Policy Environment in the Textile Industry, 1997 .6 Table Al.2 Excise Duties for Cotton Textile Products, 1997 .8 Table Al.3 Government Programs to Assist Handlooms .9 Table A 1.4 Import Tariffs on Cotton and Man-Made Products .13 Appendix Table Al.1 Textile Exports, Rs million ...................................................................... 14 Appendix Table A1.2 Inia's Commitments on Textile Imports under the Agreement with the USA &EU .................................. . ................ 15 Appendix Table A 1.3 Effective Rates of Excise Duties on Man-Made Staple Fibres Rs per Kg .................................................... 16 Annex 2 Table A2. 1 Average Annual Rate of Yield Growth of ICDP and Non-ICDP Districts in Haryana and Maharashtra......................................................... 3  Table A2.2 Annual Growth Rates in Ginning and Pressing Charges in Real Terms in Selected States .......................................................................7 Table A2.3 Cotton Production and Export Quotas ........................................................ 9 Appendix Table A2.1 Minimum Support Price of Seed Cotton of Fair Average Quality, 1990-91 to 1994-95, Rs per quintal ............................................................. 10 Appendix Table A2.2 GOI Expenditures under the Intensive Cotton Development Program, Rs million ...................................................................... 10 Appendix Table A2.3 Cotton Yields in ICDP and Other Districts in Haryana and Maharashtra ...................................................................... 11 Appendix Table A2.4 Ginning Fees in Selected States, 1990 rupees ............................................. 11 Appendix Table A2.5 Pressing Fees in Selected States, 1990 rupees ................. ........................... 12 Appendix Table A2.6 Selective Credit Control against Cotton Lint and Seed Cotton, 1975 to 1994 ...................................................................... 13 Annex 3 Table A3.1 Exports of Cotton Textile Products, $ million (1994/95 dollars) .3 Table A3.2 Direction of Export Trade in Cotton Textiles: 1987-94. 4 Table A3.3 Per Capita Household Consumption of Textiles at Different Income Levels, 1992 .4 Table A3.4 Spinning Capacity and Production Share by Ownership. 6 Table A3.5 Cotton Yarn Exports by Count .....................................................7 Table A3.6 Evolution of the Index of Modernization, 1983-95. 7 Table A3.7 Output to Installed Spindleage .8 Table A3.8 Output per Spindle by Category of Spinning Mills, 1994. 8 Table A3.9 Delay Analysis of Spinning Mills .9 Table A3.10 Productivity Range by Class of Spinning Mills Adjusted to 40s Count, 1994 .9 Table A3.11 Mill Age and Productivity .10 Table A3.12 Cotton Yarn Production and Hank Yarn Deliveries .10 Table A3.13 Hank Yarn Obligation Transfer Prices .10 Table A3.14 Index of Manufacturing Cost Component of Spinning Mills Using Thailand as Reference .12 Table A3.15 Capacity and Production by Firm Type and Yarn Count .13 Table A3.16 Effective Protection of Cotton Spinning Mills by Yarn Count and Type of Firms, 1995 .13 Table A3.17 Competitiveness of Different Categories of Mills by Yarn Counts at Domestic Cotton and Yarn Prices, Rs/kg .13 Table A3.18 Competitiveness of Different Categories of Mills by Yarn Counts at International Cotton Prices, Rs./kg .13 Table A3.19 Impact of Excise Duties on Market Prices for Different Yarn Types .15 Table A3.20 Comparison of Cost of Production of Gray Cloth, $US/Yard of 63 Inch-Wide Cloth, 1993 .17 Table A3.21 Public Textile Enterprises: Net Profit and Losses, Million Rupees, Net Worth and Number of Employees .18 Table A3.22 Apparel Manufactures by Type and Location .19  Table A3.23 Index of Apparel Productivity Using Hong Kong as Reference ................... 20 Table A3.24 Cost per Standard Minute Produced of a Standard Clothing Item, Selected Countries, 1995 .20 Table A3.25 Machinery and Investment Levels by Apparel Export Firms in Selected Countries (No. of Units) .21 Table A3.26 Number of Machinery Installed by Type in Apparel Export Firms, Number of Units .................................................... 21 Appendix Table A3.1 Per Capita Consumption and Percentage Share in Private Final Consumption, Expenditure of Textiles in Selected Countries And Regions, 1993 ...................................................................... 25 Appendix Table A3.2 Per Capita Cloth Consumption and Real GDP And Mid Year population in India .............................................................. 25 Appendix Table A3.3 Percentage Share of Purchases of Selected Man-Made Fiber Products by Income Groups .............................................................. 26 Appendix Table A3.4 Cotton Textile Exports, $Million, Constant 1994/95 Dollars ..................... 26 Appendix Table A3.5 Percentage Share of Apparel Exports by Fiber Type .................................. 26 Appendix Table A3.6 Yarn Production by Count, Million Kgs ..................................................... 27 Appendix Table A3.7 ITMF Computation of manufacturing Costs for 30s Combed Ring Spun Cotton Yarn at March 1995 Prices, US Cents/Kg ............................. 27 Appendix Table A3.8 Production of Man-Made Fibers in India, OOOmt .27 Appendix Table A3.9 Installed Capacity for Man-Made Staple Fiber Production, OOOmt 28 Appendix Table A3.10 Production of Man-Made Filament Yarn, OOOmt .28 Appendix Table A3.11 Installed Capacity for Man-Made Filament yarn Production, OOOmt .29 Appendix Table A3.12 Public Textile Enterprises: Net Profit and Losses, Constant 1993/94 Million Dollars and Number of Employees .29 Appendix Table A3.13 Effective Protection of Yarn Exporting Firms, 1994/95 .30 Appendix Table A3.14a Production Cost of 20s Count Yarn, Rs/Kg . ............................................... 30 Appendix Table A3.14bProduction Cost of 30s Count Yarn, Rs/Kg . ............................................... 30 Appendix Table A3.14c Production Cost of 40s Count yarn, Rs/Kg . ................................................ 31 Appendix Table A3.15 Yarn Exports by Count, OOOmt . .................................................................. 31 Appendix Table A3.16 Total Apparel Export Firms and their Percentage Distribution by Region ...................................................................... 31 Appendix Table A3.17 Prices of Yarn and Filaments, Rs/Kg .......................................................... 32 Appendix Table A3.18 Productivity Levels of Apparel Firms ......................................................... 32 Annex 4 Table A4.1 Source of Cotton Output Growth by Region and All India. 3 Table A4.2 Outbreaks of Major Pests by Year and State. 6 Table A4.3 Crop-wise Consumption of Pesticides in India .6 Table A4.4 Total Requirement and Supply of Quality Seeds, 1994/95, 100 Percent Replacement Rate .11 Table A4.5 Cotton Production, Area and Yield Instability .12 Table A4.6 Production of Cotton by Staple, Region and State, 1991-92 .13 Appendix Table A4.1 Trend Growth Rates of Production of Major Crop Groups, Pre- and Post-Green Revolution, percent per year .15 Appendix Table A4.2 Cotton Area, Production and Yield by Region and All India ..................... 16 Appendix Table A4.3 Selected Cotton Variety Characteristics .17  Appendix Table A4.4 Irrigated Area under Cotton Cultivation by State, 000 ha and Percentage Share of Total Cultivated Area (values in parenthesis) ............ 19 Appendix Table A4.5 Integrated Post Management Approaches for Cotton in Selected Countries ..................................................... 20 Annex 5 Table A5.1 Markets Cess on Kapas in Selected States .................................................. 3 Table A5.2 Percent Distribution By Grade Cotton Procured by GSCCGMF ................ 6 Table A5.3 Cotton Ginning and Pressing Factories in India, 1995 ................................ 8 Table A5.4 Degree of Cotton Contamination in Selected Countries ............................. 8 Table A5.5 Typical Set of Specifications of Different Grades of a Variety .................. 11 Table A5.6 Agency-wise Pattern of Cotton Exports, 000 bales, 1988/89 to 1993/94 .15 Table A5.7 Farmer's Share of the Final Price of Cotton Lint and Cotton Seed under Different Marketing Systems .20 Table A5.8 Percentage Seasonal Price Increase of Selected Cotton Varieties ................ 21 Table A5.9 Cotton Associations Permitted to Trade Cotton NTSD Contracts, 1995 .23 Table A5.10 The Correlation of Monthly Average Spot Prices for Main Cotton Varieties, 1984-1995 .25 Appendix Table A5.1 Cotton Procurement by Different Agencies, 10,000 bale of 100kg .28 Appendix Table A5.2 Minimum Support Price of Seed Cotton of Fair Average Quality, 1990- 91 to 1994-95, Rs per Quintal .28 Appendix Table A5.3 Profits and Losses of CCI, 1978-79 to 1993-94 (Rs. Million) .................... 30 Appendix Table A5.4 CCI Statewise Purchases and Buyer-wise Sales (Bales of 170kg) ............. 31 Appendix Table A5.Sa Ginning Fees in Selected States, Rs/bale of 170kg ..................................... 31 Appendix Table A5.5b Pressing Fees om Selected States. Rs/bale of 170kb .................................. 31 Appendix Table A5.6 Farmers' Share in Gross Income Earned by Cotton Corporation of India and Maharashtra Monopoly Procurement Scheme, Rs million .................. 32 Annex 6 Table A6.1 Commodity Aggregation in the GTAP Model .5 Table A6.2 Experimental Design and Specification of the Shocks. 6 Table A6.3 Assumptions Used in the Projections: Cumulative Percentage Growth Rates over the Period 1992-2005 .8 Table A6.4 Change in Composition of GDP, Exports, Imports and the Trade Balance for India: 1992-2005 .9 Table A6.5 Impact of Domestic Reforms on Indian Output, Exports, and Imports in the Year 2005 .11 Table A6.6 Impact of Removing Cotton Export Tax on Indian Output, Exports, and Imports in the Year 2005 .12 Table A6.7 Impact of Removing Cotton Textile Export Tax on Indian Output, Exports, and Imports in the Year 2005 .13 Table A6.8 Impact of Removing the Hank Yarn Obligation on Indian Output, Exports, and Import in the Year 2005 .13 Table A6.9 Impact of Increased Productivity of Apparel on Indian Output, Exports, and Imports in the Year 2005 .14  Table A6. 10 Impact of Domestic Reforms on India's Welfare in Year 2005 (1992 $U S m ill) .................................................... 15 Table A6. 11 Impact of Indo-US and-EU Agreement on Indian Output Exports, and Imports in the Year 2005 ...................................................................... 16 Appendix Table A6.1 Shares Used in Splitting the Cotton/Textile/Wearing Apparel Factors ...... 19 Annex 7 Table A7. 1 Initial Values for Simulation .2 Table A7.2 Price Elasticities .3 Table A7.3 Summary of Policy Reform Scenarios. 5 Table A7.4 Changes in Net Income & Export Values. 6 Table A7.5 Changes in Net Income & Export Values. 7 Appendix Table A7.1 Initial Value Table for Simulations .13 Appendix Table A7.2 Elasticity Table for Base Simulation Case .................................................. 13 Appendix Table A7.3 Different Sets Elasticities Used for Sensitivity Analysis ............................ 14 List of Figures Annex 1 Figure A1.1 Expanding Share of Powerlooms in Cloth Production in India. 2 Figure Al.2 Increasing Share in Spinning Capacity of the Independent Mill Sector .4 Figure A1.3 Cotton Yarn Exports Exceed Export Ceilings .10 Annex 2 Figure A2.1 GOI Expenditures on ICDP .2 Annex 3 Figure A3.1 Structure of the Cotton Textile Industry. 2 Figure A3.2 Indian Cotton Apparel, Fabric and Yarn Exports by Volume. 3 Figure A3.3 Per Capita Availability of Cloth, Sq.M per Capita. 4 Figure A3.4 Consumption Shares of Different Textile Fibers in Selected Countries, 1992 .5 Figure A3.5 Spindle Capacity in India .6 Figure A3.6 Production of Yarn by Count in India. 7 Figure A3.7 Nominal Protection Coefficients of Yarn for Selected Counts .12 Figure A3.8 Expanding Share of Powerlooms in Cotton Fabric Production in India .15 Figure A3 .9 Fabric Exports by Subsector .16 Figure A3.10 Rapid Growth in India's Apparel Exports .22 Appendix Figure A3. 1 Wholesale Price indexes for Textiles, Manufactured Products and Primary Articles, 1981/82=1 00.33 Appendix Figure A3.2 Value of Consumption of Cloth per Person for a Period of 30 Days for Each Fractile Group .33  Appendix Figure A3.3.. Average Price Paid for Cloth by Different Income Groups, Rs per Meter .................................................... 34 Appendix Figure A3.4.. Production of Blended yams and 100% non Cotton and Man-Made Filament Yams .................................................... 34 Annex 4 Figure A4.1 Cotton Lint Production in India, 1974-75 to 1996-97, million mt .............. 1 Figure A4.2 Cotton Lint Production by Region .....................................................2 Figure A4.3 Cotton Lint Yields by Region and All India, kg/ha ..................................... 3 Figure A4.4 Cultivated Area under Hybrid Cotton in Selected States, 1979-93 and Percent Share of Hybrid Area in Total Area in 1992-93. 4 Figure A4.5 Relative Share of Irrigated and Rainfed Cotton Areas in the Different Regions in India, 1981/82 to 1991/92 .4 Figure A4.6 Average Cotton Lint Yields in Selected Countries and Indian Regions, 1992-94 .5 Figure A4.7 Cotton Lint Production and Area of Selected Major Cotton Producers in the World, TE94 ..................................................... 5 Figure A4.8 Staple Length and Final Output .................................................... 12 Figure A4.9 Cotton Output by Staple Length .................................................... 13 Figure A4. 10 How does Indian Staple Standards Compare to International Norms ......... 14 Annex 5 Figure A5.1 Private Traders Dominate Cotton Seed Procurement, TE 1993-94 ............ 1 Figure A5.2 Quality Premium between J-34 Superior Grade Purchased by an EOU and the Average Market Price .................................................... 12 Figure A5.3 Indian Cotton Exports, Volume and Value, 1984/85 to 1993/94 ................ 15 Figure A5.4 Cotton Exports are Generally Below Export Quotas ................... ............... 15 Figure A5.5 Nominal Protection Coefficients for MCU-5, S-4 and J-34 Cotton Lint (Exportable Hypothesis) ...................... .............................. 16 Figure A5.6 Percentage Share of Cotton Seed Oil in Edible Oil Market, 1990-94 ........ 16 Figure A5.7 Nominal Protection Coefficients for Cotton Seed (Importable Hypothesis) .17 Figure A5.8 Nominal Protection Coefficient for Seed Cotton (Exportable Hypothesis) .................................................... 17 Figure A5.9 Cotton Import, Volume and Value .................................................... 18 Figure A5.10 Gross Processing Margins for J-34 and F-414 ............................................ 19 Figure A5.11 Seasonal Price Indexes of Selected Cotton Varieties .................................. 21 Figure A5.12 Inter-annual Price Volatility for Selected Cotton Varieties, 1983-94 ......... 22 Figure AS.13 Seasonal Variation for Selected Cotton Varieties (% of the average crop- year price) .22 Appendix Figure A5.1 Ration of the Wholesale Price Index of Seed Cotton to the Wholesale Price Index of Oilseeds, Cotton, Pulses, and Sugar, Khandasari and Gur ........... 33 Appendix Figure A5.2 All India Oil cake and Cotton Oil Cake Exports and Domestic Cotton Oil Cake Production .34  Annex 7 Figure A7. 1 Simplified Commodity Flows in the Cotton-Textiles Industry 2 List of Boxes Annex 1 Box A1.1 Main Features of Bilateral US and EU Agreements ................................... 11 Box A1.2 The Agreement on Textiles and Clothing and the Phase-out of the MFA .................................................... 12 Annex 4 Box A4. 1 Cotton Production Data in India: Which Estimate is Best? ....................... 2 Box A4.2 Cotton Research and Extension in India ..................................................... 8 Box A4.3 Cotton: Marketing and Distribution of Improved Seeds ............................ 10 Annex 5 Box A5. 1 Agricultural Product Markets Act and Mandi Operations .......................... 2 Box A5.2 Expenditures Financed by Market Cess Levied on Market Yards in the State of Andhra Pradesh .....................................................3 Box A5.3 Cotton Grading in Other Cotton Producing Countries ................................ 14 Box A5.4 Mexico's Cotton Price Support Scheme .................................................... 27  Annex 1 Textile Industry Policy A. Evolution of India's Cotton Textile Policy AL.1 The textile industry is one of the largest and most important sectors in the economy in terms of output, foreign exchange earnings and employment in India. The textile industry includes all subsectors--spinning, weaving, knitting and garmenting and uses different raw materials--cotton, jute, wool, silk, man-made and synthetic fibers. In 1995/96, the textile industry accounted for about one-fifth of total industrial output, about 7 percent of GDP and more than a quarter (US$9 billion) of total commodity exports. Although the share of the man-made fiber subsector is growing, cotton still captures about 66 percent of the raw material mix in the industry--the target material mix of the Ministry of Textiles is a 55 percent cotton/45 percent man-made fibers. Cotton-based textile exports -- fabrics, yarn, garments and made-ups-- accounted for 20 percent of total export value ($6 billion). Made-ups consist of non-apparel textile based products such as carpets, bedspreads, blankets, towels, curtain materials, etc. In the last five years, cotton-based exports increased at a rate of 13 percent per year in real terms (Appendix Table A3.4). The textile industry is also one of the biggest employers in the economy, employing nearly 38 million people. A1.2 Past government emphasis on import substitution and the protection of labor interests primarily shaped the structure of textile industry. The general economic policy of self reliance dating to the 1950s extended to the textile industry. Exports were treated as a marginal outlet for surpluses. Government concern for adequate access by the poor to their "preferred" cotton clothing--synthetic clothing was the rich person's apparel --also shaped tariff and fiscal policies which discriminated against the increased domestic use of synthetic fibers. The large labor base in the textile industry and the GOI's strong concern for employment produced several pieces of legislation which imposed restrictions on the operations of the large composite mills to protect the operations of the labor-intensive handloom industry. In the face of changing technologies, markets and competitive advantages, these regulations are imposing serious employment and operational rigidities in the composite mills, while leaving the backdoor open for the growth of the decentralized small-scale enterprise sector (powerlooms and knitting, yarn and fabric processing units). Beginning in the mid- 1980s, expanding international market opportunities brought a relaxation of some of the domestic industrial regulations, fiscal policies, and trade policies. A1.3 This Annex briefly reviews the policy instruments governing the cotton textile industry in India and their evolution through time. The next section traces how key policies from the 1950s to 1985 shaped the present structure of the textile industry. The third section summarizes the recent policy reforms (1985-1997) affecting domestic textile enterprise operations and trade. The last section reviews the progress achieved in external trade reform. B. Textile Industry: Historical Perspective 1950s to 1985 Decline of the Composite Mills, Rise of Powerlooms Al.4 Policies designed to promote the unorganized sector and protect the welfare of poor consumers led to the decline of the composite mills. Unlike the trend in most textile producing countries, the output of vertically integrated composite mills in India steadily declined over time,  Annex I Page 2 of 16 both in absolute terms and in shares of the market (Figure Al. 1.). This decline is due to a package of policies which affected all aspects of mill operations from pricing, employment to technology modernization. These are described below. A1.5 Restrictions on loom capacity Figure Al.1: Expanding Share of Powerlooms in Cloth expansion and automatic loom installation Production in India were imposed on composite mills in the 35 l950s. These were designed to protect 30 employment within the mill sector as well as a 25 promote greater employment in the 1520 handloom sector. Restrictions on capacity 10 - expansion were only relaxed under the 1985 5 new Textile Policy (see page 5). The 0 restriction on the installation of automatic looms was finally lifted in 1977. Its major 00 ? impact is that up to the present, only 30 n Mill a3 Pow erloom percent of the looms in India is automatic-- 0 Handloom * Knitting the lowest in the world, in contrast to the Source: Office of the Textile Commissioner, Compendium of Textile world average of 80 percent. Statistics, Various Issues; ICMF, Handbook of Statistics of the Cotton Textile lnd2ustiy, various issues. A1.6 A multitude of labor regulations under the Factories Act of 1948, which governed labor relations in the organized sector, discriminated against the mill sector. The Factories Act is applicable to all establishments employing 10 or more workers in processes which use power or 20 or more workers in processes which do not use power. Subsumed under this Act are several employment regulations, it includes the Payment of Wages Act, 1936; Minimum Wages Act, 1948; Workmen's Compensation Act, 1946; Employees' State Insurance Act, 1948; Employees' Provident Pension Fund and Miscellaneous Provisions Act, 1952; Employees' Pension Scheme, 1971; Maternity Benefit Act, 1961; Payment of Gratuity Act, 1972; Trade Union Act, 1926; Industrial Employment (Standing Orders) Act, 1946; Employment Exchanges (Compulsory Notification of Vacancies) Act, 1959; Apprentices Act, 1961; Contract Labor (Regulation and Abolition) Act, 1970; Equal Remuneration Act, 1976; and Inter-State Migrant Workmen (Regulation of Employment Conditions of Service) Act, 1979. Among others, these regulations vested strong powers on labor unions and fostered employment rigidities that discouraged investments in more efficient, but more capital intensive technologies. They increased labor costs significantly in the mill sector-- the difference in wages between the organized and unorganized sectors range from 50 to 60 percent.' This inability to modernize hampered the composite mill sector's ability to effectively compete with the fast growing, low cost powerlooms (see below). A1.7 The GOI introduced price controls and later dual pricing, as a means of ensuring low priced clothing to poor consumers. Composite mills were directed to produce coarse cloth at statutory prices. This policy, implemented in varying intensities between 1965 and 1978, imposed a serious financial burden on weaker mills and was a key factor in what is now known as the "sick mill problem."2 The increasing number of sick mills coupled with strong pressure from unionized labor were major factors contributing to the government take-over of many bankrupt I P. Anubhai and V.L. Mote, 1994,"India's Textile Industry: A Case Study of Subsectoral Restructuring," in S. Meyanathan (ed.), Managing Restructuring in the Textile and Garmnent Subsector, Examples form Asia; Washington, D.C.: EDI. 2 D. Mazumdar, 1981, "The Development of the Indian Textile Industry and Its Three Sectors," Studies in Employment and Rural Development Series, No. 76, World Bank, Washington, D.C.  Annex I Page 3 of 16 mills, and used them to produce the bulk of the cheap mill cloth for sale. As a result, public sector units increased from 24 in 1967 to 176 in 1985. With the elimination of the dual pricing policy, the public mills took up the exclusive responsibility for production of cheap cloths. A1.8 Differential taxation across sectors increased costs for the mill sector. The mill sector was subject to excise duties, while the handloom and powerloom sectors (until 1974) were exempted from paying any duties. For example, for "Medium A" cloth produced by mills in 1974, the excise duty was Rs 0.179 per sqm. In contrast, powerlooms paid Rs 0.0452 per sqm for units with less than 5 looms and Rs 0.0565 per sqm for units employing 25-49 looms.3 In addition, the mill sector was subject to "progressive" taxation, whereby higher taxes were levied on finer varieties of mill cloth. A 1.9 The GOI imposed artificial compartmentalization of the textile industry. There were five categories of production, based on the raw material used: (i) made wholly or in part of cotton, including cotton yarn, hosiery or rope; (ii) made wholly or in part of jute, including jute, twine and rope; (iii) made wholly or in part of wool, including wool tops, woolen yarn, hosiery, carpets, and druggets; (iv) made wholly or in part of silk, including silk yarn and hosiery, and (v) made wholly or in part of synthetic, artificial (man-made) fibers. Although consumer preference began shifting towards synthetics or mixed blends, the compartmentalization of the industry prevented enterprises from adequately responding to the new demands in the market. A1.10 In contrast, unfettered by the policies and regulations burdening the composite mill sector, powerlooms posted exceptional growth. Powerlooms, by design or default, were exempted from many of the regulations and obligations which handicapped the mill sector. Being small and scattered, they were not subject to the Factories Act and thus were able to keep wages and overheads low. Until 1985, they benefited from lower excise taxes, lower power tariffs and, reportedly, lower power tariff collection rates. The net effect of these exemptions was to lower powerloom costs by about 8-10 percent over the mills. The textile industry strike in Bombay in 1982 also opened an important window of opportunity for the powerloom sector. Lasting about 15 months, it created a sudden vacuum in the supply of fabrics which the powerlooms quickly filled. The cost advantages afforded by the various exemptions and the greater flexibility of operations enabled powerlooms to out-compete the mills. As a result, by 1985, powerlooms had cornered nearly half of the fabric market (Figure Al.1) Sustained Protection of the Handloom Industry Al.11 The physical restriction of mill sector output and differential taxation were two instruments used to protect the handloom industry. Highly labor intensive by nature and characterized by strong traditional cultural underpinnings, the interests of the handloom sector are a major driving force shaping textile policies. There are various estimates of the number of people employed in the handloom sector. The most recent estimate from the Textile Commissioner's office (1997) is 12.4 million people employed in 3.8 million handloom units. Due to its labor intensity and the government's continued concern for both employment generation and the protection of labor, many of the restrictions imposed on the composite mill sector, and later expanded to the powerloom sector, are designed to protect the handloom industry. Restrictions on capacity expansion and the installation of automatic looms by composite mills were intended for the protection of the handloom sector. A1.12 The rationale for the Hank Yarn Obligation of 1974 was to ensure an adequate supply of reasonably priced yarn to the handloom industry. The Hank Yarn Obligation requires spinning 3 Ibid.  Annex I Page 4 of 16 mills to process 50 percent of their deliveries in hank form, with at most 85 percent in counts of 40s and below. Although the hank yarn obligation is exclusively intended for the handloom industry, leakages of between 15 to 25 percent to powerlooms have been reported. On a cost basis, it is less costly for powerlooms to use dyed hank yarn than dyed cone yarn. In addition, cotton and yarn export restrictions were imposed to ensure adequate domestic supply and keep the domestic prices of cotton and yarn, including hank yarn, at reasonable levels. The handloom sector also benefited from excise duty concessions. Rapid Growth in the Less Constrained Spinning Industry A1.13 A less constrained economic environment promoted the growth and modernization of the spinning industry. Inherently capital intensive4 and producing an intermediate product, the spinning industry was less targeted and less affected by the strict labor laws, strong labor unions, and other operational restrictions (e.g. price controls). Unlike weaving, where the addition of loomage was restricted at some point, no such restriction was placed on the spinning industry. It was allowed to grow and modernize, generally tailoring to the needs of the growing powerloom market. Government priority to value addition, however, translated into restrictions on yarn exports. To ensure an adequate supply of yarn to the weaving sector, especially the powerlooms and handlooms, and to check price increases in the domestic market, cotton yarn exports were and remain controlled (see page 9). Cotton yarn is defined as yarn containing more than 90 percent cotton by weight. Blended yarns are exempted from export controls, since they contain less than 90 percent cotton. A1.14 Despite the hankyarn obligation and restrictions onyarn exports, rapid demand growth from the weaving sector attracted the entry of new firms and capacity into the spinning industry. Between 1951 and 1985/86, spindlage Figure Al.2: Increasing Share in Spinning Capacity of the more than doubled from 11 million Independent Mill Sector, 1951 to 1995/96 (spindles) spindles to 26 million spindles. This 25 growth was largely driven by 20 r - - - - independent mills, whose capacity , 15 expanded by nearly a magnitude of ten j10 10 . -- from 1.84 million spindles in 1951 to r 13.4 million in 1985/86. This dramatic change in the structure of the spinning E industry continued till the 1990s (Figure E 4 ' A 2 Al.2). co IR m Independent -0- Conrposite Discrimination Against Man-Made S,ource: ICMF, Handbook of Statistics on Cotton Textile Fibers Industy, various issues. A1.15 The policy bias against the man-made fibers industry arose from two major GOI concerns. On the demand side, the prevailing view in government was that man-made fibers were preferred by rich consumers and thus its taxation would not affect poorer consumers who preferred cotton products. On the supply side, there was the apprehension during the initial years that man-made products could disrupt the cotton economy in many states. For these reasons, man-made products were subject to higher excise duties relative the similar cotton-based products (fibers, yarns, fabrics). This raised their prices relative to cotton products, depressing demand. Another factor increasing the local costs of manufacturing synthetic fiber and filament 4 The ratio of capital to labor cost in the spinning industry is estimated at 10:1 (ICCI and R. Jaikumar, 1995, "Beyond the Multifiber Agreement, Strategies for the Indian Apparel Industry").  Annex I Page 5 of 16 yarn was the uneconomic plant sizes, in part due to the licensing regime which limited entry and compartmentalized the industry by type of fiber. C. Towards Liberalization: 1985-97 A1.16 The last decade is characterized by the progressive relaxation of policies imposed on the textile industry and a greater emphasis on improving efficiency and competition. An important turning point in the development of the textile industry is the Textile Policy of 1985 which began to relax some of the restrictive policies handicapping the textile industry. A second milestone is the far-reaching economic liberalization program of the GOI beginning in 1991, which placed major emphasis on export-led growth. In line with the general policy of liberalization, several measures were undertaken to eliminate/reduce controls and bring about greater transparency in the textile sector. The textile industry was de-licensed as per the Statement of Industrial Policy, 1991 and the Textile (Development and Regulation) Order, 1992. Further reforms were also pursued on the fiscal front. The tax differentials between and within the weaving sectors and between cotton and man-made fibers were reduced. Table Al.1 summarizes the policy framework governing the textile industry as of 1997. A1.17 India's signing of the General Agreement on Tariffs and Trade (GATT) in 1995 prompted greater liberalization on the external front. The Agreement on Textiles and Clothing (ATC) included as part of the final act of the GATT provides for a dismantling of the discriminatory quota regime practiced under the Multi-Fiber Agreement (MFA) within ten years, creating new windows of opportunities for increase textile exports. It also prompted the opening of Indian markets to textile product imports. (See Annex 6 for detailed analysis of the impact of MFA phase-out on the Indian textile industry). Trade policy continues to be revised to make it more consistent with GATT commitments. These reforms were also driven by changing consumer preferences in the domestic and world markets. Recently completed bilateral agreements between India and the US and India and the EU also spell out the program for increased entry of Indian textile products into these countries and of increased entry of imports from these countries into India. The following section describes the major policy developments during this period. Textile Policy of 1985 A1.18 The GOI 1985 Textile Policy reversed some of the major restrictions on the textile industry. Based on the recommendations of the Expert Committee on Textiles, the main elements of the Textile Policy included: (i) dismantling the sector approach to the industry, retaining a special role for non-power technology; (ii) adopting a multi-fiber orientation and fiber flexibility; (iii) providing adequate raw materials at reasonable and stable prices; (iv) reducing the level of duties on synthetic raw materials; (v) removing entry and exit barriers; (vi) emphasizing modernization and technology and machinery imports at international prices; and (vii) making Indian textiles more competitive in the world market.5 5 P. Anubhai and V.L. Mote, 1994, "India's Textile Industry: A Case Study of Subsectoral Restructuring," in S.D. Meyanathan (ed.), Managing Restructuring in the Textile and Garment Subsector, Examples From Asia, Washington, D.C.: EDI, World Bank.  Annex I Page 6 of 16 TableA1.1: Poliy pnvironment in the Textile Industry, 1997 Domesbic Regulations S Textile (Development and Weaving Min. of Industry Removed licensing requirement. Regulation) Order, 1992 Spinning * The Factories Act, 1948/Labor Weaving Min. of bndustry, State No clear "exiutrpolicy Policies Spinning govt. * Small-scale Reservation, 1977 Garment Min. of Industry Ceiling recently raised from Rs 6 to 30 million KniAing son fPxed ivestment on garent m r * Tax Pol icy Spinning Min. of Finance Differential taxation between cone & d ank yat , Weaving handlooms and powerlooms/mills, coEC on and MMF MMF * Hank Yar Obligation, 1974 Spinning Min. of Textiles Except yae for expoi hosiery yan, >60 counts, blended & industrial yarm * Handlooms (Reservation of Handloom Min. of Textiles Covers 22 products Articles of Production) 1985 * Janata Cloth Subsidy Scheme Handloom Min. of Textiles Subsidy financed by addl. 15% duty on textile F products Trade PoTicies * Export Quotas Apparel Apparel Export Yarn counts > 40s, EOU and EPCG yarn, Fabrics Promotion Council, Min. processed yam, & bilateral ya i exports Yarn of Textiles exempted, Fabric and garment export quotas under ATC and bilateral agreements allocated by OTC based on pre-set criteria a Import restrictions Apparel Min. of Commerce EOUs and EPCGs exempted Fabric __ S Import Tariffs Apparel Min. of Commerce Reduction subject to US and EU bilateral Fabri agreements A1.19 Thea 985 Textile Policyr illustrated GOI's initial attempts to relaxtheregulatoryeburden on the composite mill sector. These included the elimination of the compartmentalization of the industry, the lifting of restrictions on composite mill loom capacity expansion, and the equalization of taxation among composite mills, powerlooms and independent processing units. At thssstnea time, the GOI supported, with limited success, the structural adjust1,ent of poor performing goveenment-owned mills and the exit of non-viable units. The Board for Industrial and Financial Reconstruction (BIFR) was constituted under the Sick Industrial Companies Special Provisions Act, 1985 to decide on the fate of sick enterprises--liquidation or rehabilitation. A sick enterprise is defined as a company that has been registered for 5 years and has negative net worth (accumulated losses exceeding equity plus reserves). A Textile Moderfization Fund Scheme was created by the Industrial Development Bank of India (IDBI) in 1986 to meet the modednization needs of ailing textile mills. This involved modenization assistance at concessional interest rates. Prior to its discontinuation in August 1991, Rs 8.8 billion had been disbursed to assist 307 mills. A Textile Worker's Rehabilitation Fund Scheme (TWVRFS) was established to provide a safety net for workers affected by the closure of mills. A1.20 ThzeTextile Policy of 1985 also marked th2ebeginning of the reduction of thehbias against man-made fibers. The 1985 Textile Policy included the flexibility to reduce fiscal levies on man- made fibers and yarns and intermediates used as inputs for their production. This was intended to facilitate the increased absorption of man-made and blended fabrics for which consumer's displayed increasing preference (See Annex 3). A1.21 In 1991, recognizing that the restructuring of public sector enterprises under structural adjustment would be accompanied by redundancy and unemployment, the GOI established a National Renewal Fund (NRF). The NRF consists of three funding instruments: (i) financing of voluntary retirement schemes (VRS), (ii) designing and implementing retraining projects to impart new skills to workers to reduce the period of involuntary unemployment, and (iii) for initiating unemployment insurance. According to VRS guidelines, money from the NRF is meant  Annex I Page 7 of 16 to finance 45 days pay for every year of completed service evaluated at the latest salary (private sector schemes are often more generous). Under the NRF scheme for retraining and redeployment, a worker is provided a Rs 40 per day stipend for fifty days while attending vocational training programs (appliance repair, plumbing, auto repair, carpentry, welding, tailoring, driving, etc.). Easing Firm Entry A1.22 The Statement of Industrial Policy, 1991 and the Textile (Development and Regulation) Order, 1992 eased entry into the spinning and weaving industry. The Statement of Industrial Policy 1991 eliminated the need to obtain licenses for new capacity in the mill sector. It also removed the restrictions on large companies coming under the Monopolies and Restrictive Prevention Act to make new investments and provided for some automatic clearances for foreign investment proposals. Under the Textile (Development and Regulation) Order 1992, certification of powerlooms became automatic, except for units which did not come under the small scale industry category and which were proposed to be located within 25 km of a city with a population exceeding 1 million. Similarly, units putting up new spindlage required only a submission of an information memorandum with the Textile Commissioner, unless the unit was not small-scale and is located within 25 km from the periphery of standard urban limits. A1.23 The knitting and apparel industries remain reserved for small-scale enterprises. In the case of the apparel industry, GOI recently raised the ceiling on fixed assets in plant and machinery from Rs 6 million to Rs 30 million,6 subject to the acceptance of an export obligation of 50 percent of new or additional production annually to be achieved within a period of three years, and not less than 50 percent of this obligation is to be achieved by way of non-quota exports. Large scale enterprises (investments greater than Rs 30 million) are required to assume an export obligation of 50 percent of new or additional production to be achieved within three years.7 The stringent export obligations impose an additional burden on large enterprises and make entry more difficult. Discriminatory Tax Policy Against Man-Made Fibers Improving A1.24 The last 5 years was marked by increasing rationalization of the tax policy in the textile industry. The excise duty differentials between cotton fiber and man-made staple fibers and between cotton yarn and man-made yarn were reduced. In July 1996, tax reforms included: (i) the reduction of the excise burden on polyester fiber yarn by 10 percentage points to 40 percent, (ii) merging of excise rates of synthetic filament yarns at 20 percent, (iii) merging of excise duties on cotton, man-made staple, and man-made filament fabrics (with some exemptions) at 10 percent; (iv) the Textiles and Textile Articles Act which provided for an ad valorem 15 percent duty was repealed; and (v) merging of the existing additional excise duty in lieu of sales tax of fabrics ranging from 5 to 20 percent to 10 percent. The modified VAT (MODVAT) scheme, a rebate scheme for taxes paid on inputs introduced in 1986/87, has also been extended to cover the fabric stage. The credit of duty paid on yarn would be available on a notional basis and the credit of duty paid on other inputs along with capital goods would be available on the basis of duty paying documents. In February 1997, additional tax reductions were introduced. These included the further reduction of excise duties on polyester filament yam from 40 to 30 percent and the reduction of the mean excise duty on blended synthetic yarn to 18 percent. 6 Small scale investment ceiling excludes land and building costs. 7 The export requirement was reduced from 75% to 50% in 1997. ICICI and R. Jaikumar, 1995.  Annex I Page 8 of 16 A1.25 Although these reforms will ease the price disparities between cotton and man-made products, existing duty levels continue to hinder the industry's flexibility to respond to-changing domestic and international trends in consumer preferences (Annex 3). Implementation of More Scale-Neutral Taxation A1.26 The elimination of lower tax privileges by small-scale enterprises using cotton yarn and texturized man-made yarn as of February 1997 works toward creating a more level playingfield between mills and powerlooms. In the past, this policy served to discriminate against the mill sector, making mill-made products less competitive. Table Al.2: Excise Duties for Cotton Textile Products, February 1997. Cotton lint - o | 2%