India - Seventh Industrial Imports Project

RESTRICTED CIRCULATING COPY Report No. P-1073 TO BE RETURNED TO REPORTS DESK FlLECOPY This report is for official use only by the Bank Group and specificaDly authorized organizations or persons, It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO INDIA FOR THE SEVENTH INDUSTRIAL IMPORT PROJECT May 17, 1972  CURRENCY EQUIVALENTS 1 Indian Rupee = US$0.14 1 US$ = Rs. 7.28 (All conversions in this report have been made at the parities in force prior to December 31, 1971, when US$1 = Rs. 7.5, as the effect of the revaluation of currencies bas been too difficult to determine.) All units are expressed in the Metric System. The Indian financial year runs from April 1 to March 31. FY 1972 means the period running from April 1, 1971 to March 31, 1972. ABBREVIATIONS GOI - Government of India FY - Fiscal Year  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO INDIA FOR THE SEVENTH INDUSTRIAL IMPORTS PROJECT 1. I submit the following report and recommendation on a proposed credit to India in an amount equivalent to US$75 million on standard IDA terms for the Seventh Industrial Imports Project. PART I - INTRODUCTION 2. Since 1964, the Association has made six credits to India for industrial imports for a-total of US$605 million. These credits have provided foreign exchange to pay for imported materials and components required by selected groups of industrial firms. 3. An appraisal mission visited India in November/December 1971 and negotiations took place in Washington, D.C. in April 1972. The Borrower was represented at the negotiations by Dr. A. K. Ghosh, Economic Adviser, Ministry of Industrial Development, and Mr. V. N. Rajagopalan, Deputy Secretary, Department of Economic Affairs, Ministry of Finance. 4. Since 1949, the Bank has made 40 loans amounting to US$1,111 million and the Association 42 development credits amounting to US$1,740 million (both net of cancellations) to India. Of these amounts, US$410 million has been repaid and US$,670 mrillion is still undisbursed. A sunmary statement of loans and credits as of April 30, 1972 is in Annex 1 together with comments on the status of disbursements of effective loans and credits. 5. Sinc,e 1957, IFC has made 13 commitments in India totalling US$42.3 million, of which US$3.7 million has been repaid, US$5.9 million sold, and US$6.3 million cancelled. Of the balance of US$26.4 million, US$18.2 million represents loans and US$8.2 million equity. A summary statement of IFC loans as of April 30, 1972 is also in Annex 1. 6. The Bank Group's lending to India is primarily for agriculture, which is expected to account for about 40 percent of lending between FY 1972 and FY 1976. Other major areas for lending are transportation, power, telecommunications, ana also industry either throagh DFCs or directly for such industries as fertilizers. The nature of many of these projects, especially in the case of agriculture, has resulted in a rather slower transfer of resources than India could currently absorb effectively. It is,therefore,intended to complement the program by lending for industrial imports which will assure an accelerated transfer of resources.  - 2 - 7. I expect to present for your consideration before.the end of this fiscal year one other project, a population project to be.implemented .in the States of Mysore and Uttar Pradesh and to be financed jointly with the Swedish International Development Agency; the IDA contribution will be US$23 million. Early in the new fiscal year I expect to present a pro- posed credit to the Industrial Development Bank of India (US$25,Oillion) which will be directed towards assisting small firms. PART II - THE ECONOMY The Economny and the Plan 8. During FY 1972, India's resources, physical as well as fiscal, were greatly strained by developments in Pakistan, the influx of nearly ten million refugees, and the outbreak of hostilities in December 1971. The economy responded well to this challenge; -the increased fiscal burden was largely met, the real resources required for refugee rSelief and defense were mobilized in time, and prices and balance of payments wer,e kept under reasonable control. 9. The economy continued to grow during FY 19.72,.but.at;a pace slower than envisaged in the Fourth Five-Year Plan. The growth of national income in FY 1970 came to somewhat less than the Plan target of 5.5 percent and, in the following year, the rate of growth is estimated to be a little less than 5 percent. Indications, in regard to FY 19.72, are that the rate of growth will be of the :order of 4 percent. Sectorial contributions to the growth of-national income are not proceeding according to the pattern envisaged by the Plan. While the output of foodgrains has been increasing sharply, the industrial sector of the economy appears to have stagnated (see paras 35 to 37). 10. The two.most recent economic reports,"Current Economic Situation and Prospects of Indiat' (Reports No. SA-25a of.May 7, 1971 and SA-32a of May 10, 1972), reviewed the Fourth Plan in detail and found that its objectives were reasonable. The Plan emphasizes, as it should do, growth and effi- ciency based upon the maximization of additional output from existing capacity and new investment in-agriculture and industry, while taking account of the social aspect of development by promoting small industrial firms, expanding bank services in rural areas, improving employment, and aiding backward areas. The Plan is realistic in aiming to.add only US$10 to per capita income over the five-year period. Savings and Investments 11. Despite all the difficulties faced in BY 197.2, India was able to maintain the pace of public sector investments in financial terms at about the planned level, and this with only moderate inflation. But satisfaction over this achievement has to be tempered, since it was accompanied by a continuing low level of investment in private industry. For the first three years of the Plan, domestic resources mobilized by the..Center and the States are now estimated at only 50 percent of what was...planned ini-  3- tially for the five years, and would be even less if compared at constant prices. This result has been due more to the unexpected increases in non- development expenditures and current development expenditures outside the Plan, especially by State governments, than to lack of effort in raising current revenues and mobilizing and transferring of private savings. 12. In aggregate terms, there has been a slight decline in the rate of overall savings to NDP during the first three years of the Plan (8.4 percent of NDP in FY 1969 against an estimated 8.2 percent in FY 1972), on account of the poor savings in the public sector. Pablic sector outlays have, therefore, been met by a larger than expected draft on private savings. 13. The Central government budget for FY 1973 estimates a rise in tax revenue by almost 10 percent over the revised estimates for FY 1972, largely because of the measures taken in that year, which should produce Rs. 5 billion a year (equivalent to 1.5 percent of NDP at factor costs), to which should be added Rs. 1.8 billion in fresh taxation introduced in the FY 1973 budget. As a result of this increase in revenues, a slower rise of current expenditures (down to 4.2 percent over FY 1972) and no rise at all in defense expenditures, whicb should level off at Rs. 14 billion (about 4.4 percent of NDP at factor costs), Central government Plan expenditure is expected to increase by 26.4 percent to 23.7 billion in FY 1973 compared with the previous year. Plan expenditure of the States is estimated to rise by 15.4 percent to Rs. 16 billion. Prospects for reaching the five-year target of Rs. 159 billion, of which Rs. 22 billion is net aid transfer, now look favorable, but that is in current prices; in real terms there would be a shortfall estimated at about 12 percent. 14. Thanks to better performance of public sector savings, the Government of India expects domestic savings to increase to 9.5 percent of NDP in FY 1973 and 10.2 percent in FY 1974. Net transfers from abroad are expected to decline slightly from 1.0 percent to 0.8 percent of NDP during the two remaining years of the Fourth Plan. It is, therefore, expected that in the fifth year of the Plan total investment would be about 11 percent of NDP as compared to about 13 percent postulated when the Flan was drawn. Contribution of net foreign assistance to total investment would be 7.2 percent in FY 1974 against over 20 percent in FY 1969, the year before the Fourth Plan started. Balance of Payments 15. India's foreign exchange position has shown a marked improvement in recent years, largely on account of the sharp reduction in the trade deficit from just over US$1 billion annually between FY 1965 and FY 1968, and US$735 million in FY 1969 to less than US$300 million in FY 1970 and FY 1971 (Annex 7). A sigpificant part of this improvement was derived from lower imports. In particular, foodgrain requirements were very much reduced due to India's growing self-sufficiency in food, although in FY 1970 there was also a large drop in non-food imports, and while they were 10 percent higher in FY 1971, they were still well below the level reached in FY 1969 (Annex 4).  -4- 16. In an economy in which imports are subject to licensing, it is, difficult to explain to what extent changes in imports are due to. demand factors or to supply factors arising from the Government's import policy which only permits essential imports that are not available, domestically., In the immediate post-devaluation pefiod (1966), import licenses.,were issued quite liberally. Maintenance-imports increased by 16 percent over- the period FY 1967 - FY 1969, but as industrial production rose by only 7 percent, this increase was considered to be excessive. 'As- a result, GOI became much more cautious in issuing import licenses. Maintenance imports declined by 18 percent in FY 1970 over FY 1969 to a level.below. that of three. years previously. 17. In spite of' a marked improvement during the last four-years, India's exports, over the last decade, have increased by only 3.4 percent per annum in dollar terms. The main reason for this modest,increase has been the decline in earnings from the three major i-tems of.InbiA!s "traditional" exports, e.g., tea, jute manufactures and cotton piece goods. In BY 1961, the combined value of these three exports.'amounted to US$665 million-but by FY 1971 earnings had fallen to US$552. million. In FY 1972, earnings from tea and jute manufactures improvedrbut this change may only be shortlived, especially in the latter, which benefited from the temporary disruption of Bangladesh's trade. 18. On the other hand, India has seized a number of opportunities for the export of other goods. Large quantities of iron ore were supplied to Japan's rapidly growing industry, and earnings from this item went up from US$36 million in FY 1961 to US$156 million in FY 1971. A significant contribution was also made by engineering goods, earnings from which increased from US$18 million in FY'1961 to US$180 million in-FY 1972. Chemical exports have also increased quite rapidly, and amount now to over US$80 million a year if items derived from natural and mineral products requiring extensive chemical treatment for conversion, such as tires and tubes are included. 19. In the face of declining net aid transfers (to which reference is made in Part III) and slow growth in export earnings, GOI planned to. improve its reserve position. It sought to achieve this by cautious management of foreign exchange especially in relation to imports. By the end of 1967, net official reserves were at their lowest point of US$206 million or less than one month's imports. By March 1972, they had reached US$1,265 million or about 30 percent of annual imports and debt service payments. This marked improvement is attributable in part to the allo- cations of SDRs worth US$334 million. 1/ "Maintenance imports" are a frequently usea but not very well defined concept. Broadly speaking, they-refer to all imports except. consumer goods and capital goods. This, however, does not imply that;maintenance imports are not used for investment. For instance, steel plate imported by'a machine tool manufacturer is clearly going fully to.inyestment, yet it is called "maintenance import".  - 5 - 20. The Foreign Exchange Gap. Despite the recent improvements in the trade account and India's reserve position, the prospect for further improvement in India's balance of payments is only fair: indeed, fore- casts for the next three years indicate a sharp increase in the trade deficit. As regards imports, the outstanding feature in recent years has been the decline in imports of foodgrains - from a peak of 10 million tons in FY 1967 to about 2 million tons in FY 1972. Unless there are two bad monsoons in a row, very few foodgrain imports will be necessary in the next two years. Imports in FY 1972 are estimated to have increased by about 11.7 percent to US$2,600 million (including US$160 million for Banglaaesh refugees). Non-feodgrain imports have risen rather sharply (probably by about 17 percent). An approximate 40 percent increase in steel imports (in volume) was necessary to ease the steel supply situation. There were also substantial increases in imports of non-ferrous metals and fertili.ers. Imports of POL were considerably higher in volume terms, but were very much more so in termt of value owing to international price increases last year. 21. The Government continued with a liberal approach to imports and licensing during FY 1972, which have been running at somewhat above the rate for FY 1971 and a further increase in maintenance imports of 18 percent is expected in FY 1973. In these circumstances, the increased availability of imported raw material anu components should now enable industrial pro- duction to improve. Import projections in Annex 4 are based upon the assumptions (i) that foodgrain imports will not be more than US$40 million up to FY 1975 ana (ii) that maintenance,. imports will increase by about 9 percent a year between FY 1973 and FY 1975 on the assumption that industrial production will increase by 6.0 to 6.5 percent a year. 22. Despite the exceptional circumstances which existed at the end of 1971, exports for FY 1972 are expected to show an increase of 10 percent. A good deal of the export growth this year (over 60 percent) is attributable to jute which enjoyed higher prices (+20 percent or more) and volume because supplies to major world markets from Bangladesh were interrupted. Engineer- ing exports continued to expand substantially with an increase of 16 percent expected in FY 1972, while tea exports are expected to be 15 percent higher. On the other hand, cotton textile exports are expecteu to be lower and steel exports very much more so on account of the domestic raw material problems. Judging from the recent trend and the good performance of engineering exports, it may not be unreasonable to assume an average annual growth rate of 5 percent for India in thb coming two or three years. 23. The above import anu export projections, with all the uncertainties and reservations, indicate that the trade deficit which is estimated at about US$300 million for FY 1972, excluding the effect of refugee imports, could well grow to about US$700 million in FY 1975. With US$657 million debt  - 6 - service is expected to reach its peak in FY 1973 and may decline slightly thereafter. All in all the gross external gap, including the iequirements for debt service payments, which is necessary to ensure a modest growth of both investment and industrial production, could well increase from US$1.1 billion in FY 1972 (excluding the effect of the refugees) to abbut.US$1.4 billion in FY 1975. Unless this gap is financed by external aid, it will have to be reduced by cutting development expenditures and by restraining growth. 24. In view of its present level of external reserves and the new allocation of SDRs, it could be argued that India should perhaps utilize some of its reserves to finance the external gap. Indeed, GOI should allow as. much as possible in the way of non-fdod' imports to maintain a satisfactory level of domestic economic activity and the recen't hoire liberal use of import licenses to ease the raw materials sitiuation will result in some use of India's foreign exchange holdings during FY 1973. However, the foreign exchange resources available to India W-iI1 still be inadequate to support a level of inaustrial raw material imports consistent with growth targets of both production anu investment, bearing' iin mind that India always has to take into account uncertainties relating t6 external aid commitments. PART III - EXTERNAL ASSISTANCE TO INDIA Availability of External Assistance 25. India does not resort to suppliers' credits in any significant way, nor does fresh transfer of private capital more than marginally exceed capital repatriation and dividend remittances. Therefore, to finance its foreign exchange gap, India relies mostly on official aid. In recent years, there have been significant changes in the official aid picture: a shai-p rise in debt service payments has coincided with a decline in gross aid inflow and resulted in a significant decline in net aid receipts. In the middle of the 1960's, gross aid disbursements reached a peak of over US$1.5 billion a year, and as debt service payments were still at a relatively low level, the net transfer of aid amounted to an average of'over US$1.1billion a year. Subsequently, gross aid disbursements began.to decline and as debt service continued to mount, net aid transfers were reduced rapidly from US$1.3 billion in FY 1966 to US$496 million in FY 1971. In Fy 1972', the maintenance at about the same level of` net aid transfers was almost entirely the result of an acceleration in the drawdown of the non-project pipeline. from US$580 million to an estimated US$349 million (including US$87 million of USAID on which disbursements have been suspended) over the course of the year (see Annex 5).  -7- 26. The decline of net transfer over the past few years is both the result of the sharp reduction in food aid, which is also a quick- disbursing form of assititance, as a consequence of the improvement in foodgrain production and the increasing debt service payments. In the future, the amount of external aid will depend upon the rate at which the existing credits are drawn down, and the amount of new commitments. On the commitment side, the picture is mixed. Project aid commitments increased very substantially in FY 1972 largely on account of increased commitments made by the Association in anticipation of the Third IDA replenishment; but this increase was offset in part by the decline in commitments of non-project assistance which dropped by half. Total com- mitments at about US$1.2 billion were about US$300 million higher than in FY 1971,entirely on account of additional project aid commitments - but as project aid tends .to be slow disbursing, it is the drop in non- project commitments which is of immediate concern, a concern shared by the Indian Consortium at its meeting last year. 27. In FY 1973 the foreign exchange gap is expected to increase by US$100 million to US$1,200 million (Annex 7). Disbursements of project aid are estimated at near US$500 million (Annex 5) and US$100 million could perhaps be drawn from reserves, leaving a gap of over US$600 million. If this were to be met by debt relief to the extent of (say) US$200 million, there would remain a gap to be met from non-project aid of US$400 million. Given the specific disbursement pattern of newly committed non-project aid. and of the existing pipeline, this would mean that non-project commitments (excluding debt relief) would have to increase from US$250 million for FY 1972 to US$500 million for FY 1973. Under the present circumstances prospects of such commitments being made are not good. This has prompted the Bank to ask Dr. Coombs, former Governor of the Reserve Bank of Australia, to try to find ways in which members of the India Consortium could in a con- certed manner help India. A Working Party of the Consortium was held in Paris on April 24, 1972 and Dr. Coombs is presently visiting all the capitals of members' countries to discuss debt and aid. Characteristics of External Assistance 28. The resource and foreign exchange gaps analyzed above indicate the magnitude of India's requirement for external aid in supporting its moderate growth targets. The next question is in what form external assistance should be transferred to India, taking into account that nearly a third of export earnings is preempted by debt servicing; that a large part of the remainder serves to finance thowe essential require- ments for running the economy which are ineligible for one reason or another for external assistance such as PM and raw materials available only in developing countries. 29. Moreover, the production and import structure of the Indian economy has changed to such an extent that financing the traditional type of project will not enable sufficient and timely transfer to be made. India has been successful in developing its capital goods industry ana can now produce a wide range of machinery and -equipment, given proper  8 inputs. As a result, her imports of complete machinery and equipment have declined to the low level of 12 percent or so of total imports, against 30 percent in the late 1950's. Since project aid normally finances imports of capital goods related to specific investment projects, its role in India is bound to be relatively smaller than. in many other developing countries. Difficulty in transferring funds by means of project aid should not come as a surprise. India imports only 5 percent of its GNP .and by further concentrating its ipuport financing to a very small sector of the economy, project aid could lead, in aggregate terms, to financing more imports for it than are needed. It does not appear, therefore, that India could absorb much more than US$350-400 million of capital goods per year over the next three years (Annex 4). As disbursements are projected to reach this level in FY 1973, there is no scope for further increase in project aid involving capital goods imports. 30. Although project aid in the form of imports of capi-tal goods may have distinct limitations, these limitations could be circumvented if local cost were financed. However, of the various aid donors, IDA is the only one which presently offers any significant amount of local cost financing. Moreover, IDA only restarted to make significant com- mitments, including those involving local cost financing, in FY 1969 and actual disbursements against local costs in FY 1972 will probably only be about US$5 million, which has to be compared with US$220 million of com- mitments in this period (FY 1969 - FY 1972) covering local costs. The amount will increase, but in the immediate future the impact of IDA-local cost financing will be small because so much project aid is slow dis- bursing. 31. Another problem is the inflexibility of much bilateral aid resulting from various conditions and restrictions. Most of the external aid is tied to certain designated sources of supply or certain purposes. In FY 1971, for instance, about 50 percent of imports came in under tied arrangements, the rigidity of which serves to emphasize the extreme difficulty of managing India's foreign exchange. Since, as indicated in para. 28, a large part of free foreign exchange is preempted for debt servicing and import of vital items, Indian licensing authorities have to resort to rather complicated devices: advance licensing against aid pledged but not authorized, splitting imports requirements of an individual importer into many different sources of procurement, trying to take into account importer's needs and availability of finance, etc. The pool of free foreign exchange left to the licensing authorities' discretion is usually too small to allow much flexibility. Conclusion 32. India's need for external assiitance is well established, as even with reasonable domestic savings and export promotion, India will face difficulty in achieving a modest rate of development. The shortage of resources has, of course, been of long standing but more recently the  -9- situation hbs been exacerbated by the marked decline in the net external assistance. The prospects for any substantial increase in this assistance are limited, and hence, it is imperativeto ensure that external resources are made available in a manner best calculated to meet the most pressing needs. 33. Project assistance largely comprises machinery and equipment for which India's requirements are much reduced on account of the develop- ment of the domestic capital goods industry and the widespread underutil- ization of industrial-capacity. Furthermore, project assistance is often slow disbursing, whereas India needs the transfer of resources to take place now in a form which will enable imports of raw materials and com- ponents to be increased. Therefore, India's more pressing needs can be met only through non-project lending. 34. It is recommended that the proposed credit should be for US$75 million which is the same amount as the previous credit. While India's requirement for non-project assistance is in excess of this amount, it will, nonetheless, make an important contribution to India's industry by providing speedy delivery from the cheapest sources of the most urgently needed raw materials and supplies. PART IV - THE PROPOSED CREDIT The Industrial Scene 35. Over the period 1951 to 1960, industrial production increased quite steadily at about 7 percent per annum (Annex 8). From 1960 to 1965, the rate of increase accelerated to 9 percent per annum but then the disastrous drought years of 1965 and 1966 intervened and caused a recession which lasted until 1968 as shown below: Percentage ChanRes in Industrial Production for Major Categories of Products (on the basis of production index) Pre-recession Recession Post-recession 1964 1965 1966 1967 1968 1969 1970 Mining and quarrying -3.1 10.3 3.3 -0.2 6.2 2.2 1.0 Consumer goods 7.4 7.5 3.0 -4.3 4.9 10.2 6.5 Intermediate goods 21.2 6.0 -0.2 2.2 6.1 4.2 2.9 Capital goods 21.2 18.5 -14.0 -2.3 2.4 1.7 5.5 Electricity generated 15.0 10.0 8.9 11.0 15.6 12.9 10.9 All industries 8.6 9.1 -0.8 -0.8 6.4 7.1 4.8  - 10 - 36. Prior to the recession, capital goods were the leading product reflecting the large public sector program and considerable confid,ence on the part of private industrialists. In 1968 and 1969, a recovery got underway led by a resurgence of consumer demand, while capital,goods production remained depressed, partly because government was atill short of resources and partly because private sector confidence took some time to be restored. Then in 1970, a reversal of the trend took place with a slowdown in the rate-of increase in consumer goods and inte.rmRdiate goods; capital goods output meanwhile started to improve. The down trend in industrial production appears to have continued during 1971 and a growth rate of about 3-4 percent is now expected. The recovery in capital goods outputs-has been slow and is especially disappointing. Much of-this is attributable to the only very modest increase in public sector-investment which is still, in percentage terms of GNP, below that reached;in the pre- recession years. At the same time, the private sector has been slow in bringing forward its investments. It is these circumstances, *combined with shortage of raw materials referred to below, which expIains the lack of improvement compared with the pre-recession period. 37. The shortage of raw materials has been most pronounced in cotton and steel, both of which are domestically produced. Outpu,t in the textile industry was severely affected and as ,it has a signi.ficant weigbhting in the index (21 percent), the drop in textile production explains part of the decline in growth rate of the industrial index and most of the decline in the con- sumer goods sector. The effect of the shortage of steel which followed shortfalls in production of Indian steel mills is less evident. The high priority inuustries, in general, received adequate supplies because their allocations from domestic production wer,e assured, but with steel,,avail- ability almost static over the last three years, the requirements of the priority industries could be met only at the expense of other *industrial activity. Steel shortage became evident at the end of 1969 ,and some addi- tional imports were allowed during the first half of 1970. 'Put it was not before September 1970 that significant imports of steel were authorized. Unfortunately, the time lags are -such in the import system that the inflow of imports did not begin to materialize in any quantity until mid-1971. Previous Industrial Imports Credits 38. Since 1964, IUA has approved six industrial import credits to India amounting to US$605 million. The proceeds of the First Credit (Credit 52-IN of 1964 for US$90 million) were made available to manu- facturers of commercial vehicles and automotive components, machine and cutting tools, electrical equipment and construction equipment. Imports of raw materials, components, spare parts and balancing equipment,were financed. The Second Credit (Credit 78-IN of 1965 of US$100 million) was expanded to include financing for imports required by the electric cable and wire industry. In the Third and Fourth,Credits (Credits 92 and 97-IN of 1965 for US$150 and US$65 million) construction equipment was dropped at the request of the GOI, as a U.S. bilateral credit covering this category appeared to eliminate the need for IDA financing. But, other sectors were  added, including agricultural tractors, industrial machinery (for the textile, sugar, cement and mining industries), ball and roller bearings, fertilizers and pesticides, non-ferrous metals (including aluminum, lead, zinc and antimony), abrasives and synthetic rubber to cover a wider spectrum of industrial activities consistent with the policy then adopted in India for liberalizing imports required by all "priority" industries. 39. The Fifth Credit (Credit'138-IN of 1969 for US$125 million) maintained the broadened list of eligible industries. Under the most recent and smaller Sixth Credit (Credit 182-IN of 1970 for US$75 million) the number of eligible induutries was reduced to six; namely, commercial vehicles, agricultural tractors, automotive ancillaries, machine tools, cutting and small tools, abrasives, electric motors, and fertilizers and pesticides. Under the Sixth Credit approved in April 1970, it was expected that the amount would be fully disbursed by March 31, 1971. In the event full disbursement took place nine months later, because of the cautious import policy followed by the government during that period. 40. Actual disbursement between the various sectors took place as shown below: Projected ana Actual Disbursements - Sixth Credit (US$ millions) Sector Projected Actual Commercial Vehicles 14.0 10.4 Agricultural Tractors 4.8 2.6 Automotive Ancillaries 27.0 26.6 Machine and Cutting Tools 12.7 16.9 Electric Motors 1.5 3.4 Fertilizers and Pesticides 15.0 15.0 Total 75.0 75.0 A limit was set on the amount eligible for withdrawal in respect of fertilizers and pesticides but no limits were set for the remaining sectors. The variations between the projections and actual figures are a result of the balance struck for individual industries between their allocations of other lines of credit, free foreign exchange and MA funds. One of the main advantages of the DA credit is the flex- ibility it offers in a situation in which imports financed by bilateral aid have to be obtained under a host of conditions, specifications and delivery times.  - 12 - 41. Procurement under the six credits to date has spread over 54 countries (Annex 10) and the sources of supply have become pr'og- ressively diversified. The purpose of all these credits has been to assist selected industries in making better use of their already' installed capacity. Along with reforms introduced into the import, system at the time of the devaluation in 1966, these addition-s to India's foreign exchange not only help provide more resources to increase production of essential goods, but also increase competitti've- ness among firms in India; as a result, large sectors of thelindustry are now internationally competitive, as shown by industrial export results. Production in Individual Sectors 42. The proceeds of the Sixth Industrial Imports Credit' *'r'e made available for FY 1971 to six sectors, whose products were of High prior'ity to India's development program. They received preferential trb,atment for the supply of raw materials, especially imported P'aw materials'` cnd, they have consistently out-performed other industrial sectors (Annx'8): and; especially during FY 1971, as can be seen below: Percentage Increases in Production FY 1971 over FY 197Q Commercial Vehicles + 16% Agricultural Tractors + 18% Automotive Ancilliaries + lo% Machine tools, cutting and small tools + 18% Electric motors + 14% Fertilizers + 15% Pesticides + 25% 43. Commercial Vehicles. Trucks and buses account for abou't 85 percent of production by value in the sector. Capacity utilization averaged 70 percent during the last two years', because as a result of import liberalization regarding intermediate inputs, purchasers could buy the local make of their choice and there was little demand for the products of some firms. The three major manufacturers produce high quality vehicles for which the demand is good; they, are worki-ng at full capacity and at present have a backlog of orders equivalent to about 6 months' production. A promising start has been made in exporting; four years ago exports were negligible, largely because of restrictions imposed by the sponsoring foreign firms and pressure from the domestic market, whereas they are expected to have amounted to- US$23 million in FY 1972.  - 13 - 44. Agricultural Tractors. The number of tractors in India increased from 54,000 in FY 1967 to an estimated 160,000 in FY 1971. This increase was met partly through imports and partly through domestic assembly and manufacture, which increased from 9,000 in FY 1967 to around 20,000 in FY 1971. The government has recently granted a price increase which should raise the margin for local manufacturers by around 10 percent. The increase is part of a major change in the pricing which resulted from GATT granting India's request to remove tractors from the zero tariff list and may reduce demand somewhat over the short term but without creating any serious marketing problems for domestic manufacturers of the popular makes. 45. Automotive Ancillary Industry. Production of automobile com- ponents and parts rose at an average annual rate of 16 percent from FY 1965 to FY 1971. Output in FY 1972 is expected to reach the equivalent of US$192 million, a further 11.5 percent increase over FY 1971. The industry has also contributed to export earnings which rose from less than US$1 million in FY 1965 to about US$9 million in FY 1972. Production of tires rose from 3.85 million in FY 1969 to L4.6 million in FY 1972 while exports doubled between FY 1969 to FY 1972 from US$4 to US$8 million, largely to replacement markets in Africa and Middle East. Special sizes of truck and cycle tires are also exported to the U.S. market. The output of storage batteries has been stimulated not only by the growth of the automobile industry but also by electronics and communication requirements. Capacity utilization exceeded 100 percent of two shifts in FY 1972. 46. Electric Motors. After having recorded a steady growth from FY 1969. (2.2 million H.P.) to FY 1971 (3.2 million H.P.) production of 1 H.P. and above motors is expected to be just below 3 million H.P. in FY 1972. Growth to date has relied heavily upon demand from the agri- culture sector. 47. Machine Tools, Cutting and Small Tools. During the past three years, output of machine tools grew by about 30 percent per annum, while the growth of cutting tools, small tools and abrasives was 16 percent. The stimulus behind this growth has been the rapid development of the transportation and agricultural equipment industries, as well as the growing need for consumer durable products. The machine tool industry operated at about 60 percent of capacity and exports have been rising at an annual rate of 35 percent to reach about US$4 million in FY 1971. In the cutting tools and allied groups, exports expanded rapidly and reached just under US$6 million by FY 1971. This expansion has been accompanied by a marked improvement in quality and India is now capable of meeting international standards; a commendable achievement which has been brought about in part through improvements in management, and also through close collaboration with foreign firms. Foreign collaborators are now permitting Indian producers to use their brand names, and they have also occasionally shifted orders received at corporate headquarters to Indian factories.  - 14 - 48. Fertilizers. Consumption of fertilizer increased at rates of 30 percent up to FY 1968, but since then the rate of growth has dropped to 17 percent for nitrogen and slightly higher for phosphate. In.volume, however, increase in consumption was substantial and rose from 1,035 thousand tons in FY 1968 to over 1,800 thousand tons in FY 1972.opr nitrogen and from 300 thousand tons in BY 1968 to 850 thousand:itQns in FY 1972 for phosphate. During the period of high growth, 30 percent of nitrogeneous fertilizers supplies were produced domestically, and this percentage has since risen to slightly over 50 percent. The balance of the supplies was met by imports. Capacity utilization of all p1-ants has .av.eraged only 60 percent of installed capacity, since many new plants are coming into production and it takes some time before they work.at full capacity. 49. Pesticides. After a period of considerable growth,, consumption levelled off in FY 1969, mainly because of the withdrawal of the_subsidy. previously offered to farmers. However, at the same time, manufacturers were allowed to take. part in marketing, whereas before this hadJbeen handled mainly by State Governments. This change, coupled. withb.expanded governmental plant protection programs, raised conbumption'in FY.1971, so that production increased from 19,000 tons in FY 1969 to 3fJ,,000 tons -in FY 1971 and an estimated amount of 35,000 tons in FY 1972. U.tilization of capacity also improved to 79 percent in- FY 19.71 compared with 50 percent in FY 1968. The Proposed Seventh *Credit 50. An appraisal report "Seventh Industr.ial Import. Project" (PI-19 dated May 3, 1972) is being distributed separately. As seen in the table below, the Seventh Credit would meet less than 30 percent of import require- ments of the sectors covered by the credit: Proposed Credit - Indicative Allocations by Sector Total IDA %. of Total Import Need Allocation Import Need ($ m-illion8s) ($ millions) Tractors and Power Till'ers 13 3 23 Fertilizers* 63 14 22 Pesticides* 10 4 40 Electric Motors, Transformers, Switchgear and Magnetic and Steel Stampings 30 7 23 Aluminum Smelting 10 3 30 Commercial Vehicles 42 11 26 Automotive Ancillaries 54 20 37 Machine, Cutting and Small Tools, and Abrasives, Ball and Roller Bearings 36 13 36 Total 258 75 29 * In the case of fertilizers sand pesticides, the indicative ,allocation would be the ceiling on withdrawal, as.was :the case in the previous..credit.  - 15 - 51. Compared with the Sixth Credit, the eligible sectors have been somewhat redefined but in each case in a form closely related to one of the sectors previously selected. The detailed reasons for making these changes can be summarized as follows. Power tillers are a logical com- plement to tractors. Ball and roller bearings are essential for a wide range of transportation and industrial equipment and as India is virtually self-sufficient, there is a need for specialized imported materials. Electric transformers and switchgear requirements will be restricted to below 33Kv, thereby supporting the rural electrification program. Finally, aluminum smelted from domestic bauxite is enabling India to use aluminum instead of imported copper in electric cables. 52. One of the major changes introduced in the import policy since the Sixth Credit is the canalization through one of the three State trading corporations of a growing number of bulk import items, such as non-ferrous metals, raw materials for fertilizer production, and finished and semi- finished items such as steel products, fertilizers, etc. The main rationale behind this canalization is the improved bargaining power that State trading corporations command in negotiating large orders and in entering into long- term contracts. 53. As has been the practice in the past, the firms entitled to assist- ance under this credit will be those large and medium scale firms registered with the Directorate General of Technical Development. For non-canalized imports, firms would not be subject to any special procurement procedures. As with previous credits the recipients of IDA funds can be relied upon to make the best use of this flexibility in procurement. For canalized imports, users will place their orders through the appropriate State trading corpora- tions, and it is proposed that these imports will be reimbursable under the credit on the same basis as imports ordered directly. 54. Canalized imports are usually purchased in bulk, and where such orders exceed US$100,000, international bidding procedures will be used. This procedure will also be applied to orders submitted voluntarily by industrialists for handling by State trading corporations. It is, therefore, expected that US$40 to US$50 million of the proposed credit will be used in this way. As all purchases by canalizing agencies have been and will continue to be evaluated on a c.i.f. basis, this will eliminate about two-thirds of the credit from any bias which could conceivably arise from existing British Commonwealth tariff preferences. Of the US$25 to US$35 million remaining, US$10 million covers items for which there are no preferential tariffs.. Of the US$15 to US$25 million, the larger part ccnsists of com- ponents and spares already "locked in" to foreign collaborating companies, and there is little freedom of choice as to country of origin. Therefore, it is estimated that at most some US$5 to US$10 million of the total US$75 million might be affected by preference tariffs. 55. The Association will pursue studies of the subsectors involved in the proposed credit and during 1972, the tractor and commercial vehicles subsectors will be looked at in some detail. The GOI will keep the Association informed at regular intervals on the amount of IDA licenses outstanding and  - 16 - more generally will keep the Association informed of future progress made on the computerized information system on import licensing. Similarly, the GOI has agreed to forward aata on the margin and fees charged by the import canalizing agencies of the public sector to the users so that the Association can keep under review the pricing policies of these corporations. 56. The credit would be made to GOI on the usual IDA terms. The GOI would make the foreign exchange proceeds of the credit available through the Reserve Bank of India to the specified beneficiaries who would purchase the foreign exchange with rupee funds through authorized banks. The credit would not involve any financing of beneficiary firms. Disbursement under the proposed creait would be restricted to the actual foreign exchange cost of imports, for payments coming due after approval by the Executive Directors. While the target date agreed for withdrawal of the credit is 12 months, the closing date will be set for S.eptember 30, 1973 to allow for contingencies. PART V - LEGAL INSTRUMENTS AND AUTHORITY 57. The draft Development Credit Agreement between India and the Association the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement, and the Text of a draft Resolution approving the Credit, are being distributed to the Executive Directors separately. No special conditions of effectiveness are proposed. 58. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association. PART VI - RECOMENDATION 59. I recommend that the Executive Dimctors approve the proposed Credit. Robert S. McNamara President Attachments  List of Annexes Annex 1 - The Status of Bank Group Operations in India. Annex 2 - Country Data. Annex 3 - Summary of Proposed Credit. Annex 4 - Major Categories of Imports 1966/67 - 1974/75. Annex 5 - Foreign Assistance 1967/68 - 1972/73. Annex 6 - Non-Project Aid by Sources 1966/67 - 1971/72. Annex 7 - Balance of Payments 1966/67 - 1974/75. Annex 8 - Annual Growth Rates of Different Industries 1951 - 1970. Annex 9 - Annual Production of IDA Sector Industries 1965/66 - 1972/73. Annex 10 - IDA Industrial Imports Credit I - VI Sources of Procurement. Annex 11 - Foreign Ehcchange Requirements of IDA Sector Industries 1968/69 - 1972/73. Annex 12 - Disbursements by Category in the Six Previous Industrial Imports Credits. Annex 13 - Import Licenses Issued to IDA Sectors 1969/70 - September 1971. Map - Location of Major Industries and Industrial Centers  Annex I Page 1 THE STATUS OF BANK GROUP OPERATIONS IN INDIA A. STATEMENT OF BANK LOANS AND IDA CREDITS (As of April 30, 1972) (US $ million) Loan or Undis- Credit No. Year Borrower Purpose Bank IDA bursed Loans/Credits fully disbursed 876.4 1,115.6 307-IN 1961 IISCO Coal Mining 19.5 2.2 414-IN 1965 ICICI Industry DFC VI 49.8 4.0 89-IN 1966 India Beas Equipment 23.0 7.0 515-IN 1967 ICICI Industry DFC VII 25.0 3.5 61)4-IN 1969 India Tarai Seeds 13.0 10.5 61 5-IN 1969 India Telecommunications III 27.5 14.2 153-IN 1969 India Telecomnmnications III 27.5 o.4 176-IN 1970 India Kadana Irrigation 35.0 29.6 683-IN 1970 ICICI Industries DFC VIII 40.0 19.6 191-IN 1970 India Gujarat Agric. Credit 35.0 32.8 203-IN 1970 India Punjab Agric. Credit 27.5 27.5 226-IN 1971 India Andhra Pradesh 24.4 23.3 230-IN 1971 India Agro-Aviation 6.0 6.0 241-IT 1971 India Telecommunications IV 78.0 78.0 242-IN 1971 India Power Transmission II 75.0 75.0 249-IN 1971 India Haryana Agric. Credit 25.0 24.8 250-IN 1971 India Tamil Nadu Agric. Credit 35.0 35.0 264-IN 1971 India Cochin II Fertilizer 20.0 19.6 267-IN 1971 India Wheat Storage 5.0 5.0* 268-IN 1971 India Pochampad Irrigation 39.0 35.2 789-IN 1971 ICICI Industry DFC IX 60.0 58.6 278-IN 1971 India Mysore Agric. Credit 40.0 40.0*) 279-IN 1971 India Gorakhpur Fertilizer 10.0 10.0 280-IN 1971 India Railwayx XI 75.0 63.7 293-IN 1972 India Maharashtra Agric. Credit 30.0 30.0*- 294-IN 1972 India Bihar Agric. Markets 14.0 14.0* Total (less cancellation) 1,111.2 1,740.0 670.2 of which has been repaid 410.6 .7 Total now outstanding 700.6 1,739.3 Amount sold 110.2 of which has been repaid 108.8 1.4 Total now held by Bank and IDA 699.2 1,739.3 Total undisbursed 112.6 557.6 670.2 4 Not effective as of April 30, 1972  Anme.x I. Page 2 B. STATEMENT OF IFC INVESTMENTS (As of April 30, 1972) Amount [lb Year Company Loan $ _1.!Lt TUotal 1959 Republic Forge Company Ltd. 1.5 1.5 1959 Kirloskar Oil Engines Ltd. 0.9 0.9 1960 Assam Sillimanite Ltd. 1X4 - 1.4 1961 K.S.B. Pumps Ltd. 0.2 - 0.2 1963-66 Precision Bearings India Ltd. 0.7 0.3. 1.0 1964 Fort Gloster Industries Ltd. 0.8 0.)O 1.2 1964 Mahindra Ugine Steel Co. Ltd. 2.3 1.0 3.3 1964 Lakshmi Machine Works Ltd. 1.0 0.3 1.3 1967 Jayshree Chemicals Ltd. 1.0 0.1 1.1 1967 Indian Explosives Ltd. 8.6 2.9 11.5 1969-70 Zuari Agro-Chemical Ltd. 15.1 3.8 18.9 TOTAL 33.5 8.8 42.3 Less sold, repaid and cancelled 15.5 0.6 16.1 Now held 18AO J.2 _6_2 Undisbursed 5.1  Annex I Page 3 C. PROJECTS IN EXECUTION 1. Of the undisbursed loans, the longest outstanding is Loan 307-lN of 1961 to the Indian Iron Steel Corporation (IISCO) for the development of its collieries. A memorandum to the Executive Directors of July 9, 1970 (R70-135) proposing to postpone the closing date to June 30, 1974 explained the technical and other problems which beset this project. It is anticipated that disbursements will be completed by the revised closing date of June 30, 1974. 2. It was agreed in 1970 that the balance of Credit 89-IN (Beas Equipment Project) should be allocated to Stage II of the project and major purchases will be made later this year. As to the Tarai Seeds Project (614-IN), technical considerations regarding required machinery caused some delay but tenders have now been offered and disbursements should now accelerate. 3. Under the Kadana Irrigation Project (176-IN), requests for reimbursement of civil works expenditures are now being received more regularly since work on the dam resumed with departmental force account labor following suspension of the main contractor. Disburse- ments of the Bank's recent loans to ICICI (683-IN and 789-IN) have not kept up with original forecasts and closing dates have had to be postponed. These loans were affected by the 1966-68 recession which lengthened the intervals between ICICI's approval of sub-projects and actual commitment of disbursement of Bank's fundso More rapid dis- bursement is now expected. 4. Of the seven agricultural projects so far approved, Gujarat (Credit 191-IN), Punjab (Credit 203-IN) and Andhra Pradesh (Credit 226-IN) are showing slower progress than anticipated. However, there has been a recent acceleration in disbursements in respect of the minor irriga- tion components of all but the two most recently approved of these projects. This trend is expected to continue. A major cause of delay results from tractor procurement problems. Finally, for the Agro- Aviation Project (230-IN), disbursements are about nine months behind scehdule, as prequalification of aircraft supplies is still outstanding.  Annex 2 COUNTRf DATA CAlfR India 2 AREAI 3,268,580 kK2 POP1LATION 560 milliOn 1972 (mid-year) DOSIETI 172 pareone/Ic2 Rate of grovth 2.25;C 1961 - 1971 POPUIATION CARM.CTERISTICS: Crude birth rate (per 1,000) (eat.) 38 1971 PIAT^l Crude death rate (per 1,000) (eat.) 17 1971 Population per physician (eat.) 4,000 1971 Infant mortality (per 1,000 (eat.) 100-120 1971 Population per hospital bed 1,826 1968/69 live birtba) NUTRITION: EDUCATION: Caloric intake as 7. of requirenents 83 1960 - 1969 Adult literacy rate (M) (eat.) 41#/ Per capita protein intake (gram. par day) 55 1960 - 1969 Primary school enrol mt (1) 1969/70 CROSS NATIONAL PROYJCT 1970/71: Us M Rte of roth (, volume) CNP at market prices 52,770 100.0 1961T62 - 1965666 16566 -1969/70 1970/71 Groas investment 7,520 14.3 Gross national eavinga 6,480 12.3 2 . 5 2 , 9 4 . 7 Resource Gap 680 1.3 OUTPUT, LABOR FORCE AND Value Added