India - Eighth Industrial Imports Project

DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSO Not For Public Use Report No. P-1268-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR THE EIGHTH INDUSTRIAL IMPORTS PROJECT May 24, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization.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.  CURRENCY EQUIVALENTS (As at May 11, 1973) US$1.00 Rupees (Rs) 7.6* Rs 1.00 US$0.13 Rs 1 million US$132,000 India has not yet declared a new par value following the devaluation of the dollar. The Rupee is officially valued at a fixed Pound Sterling rate; and, as the Pound is now floating relative to the US Dollar, the US Dollar/Rupee exchange rate is subject to change. Conversions in this report have been made at Rs 7.7 to US$1 unless otherwise stated. FISCAL YEAR April 1 - M4arch 31  INLLRNATIONAL DEVW,LO?Mi1ENT ASSOCIATION REPORT AND RECQ`ENDATION OF THE PRESIDENT TO THE EXLCLUTIVE DIhERCTORS ON A PROPOSED CREDIT TO THE GOVEH NMENT OF INDIA FOR THE EIGHTH INDUSTRIAL -IMPORTS PROJECT" 1. I submit the following report and recommendation on a proposed credit to India in an amount equivalent to US$100 million on standard IDA terms fo:r the Eighth Industrial Imports Project. PART I - THE ECONOMY 2. The latest economic report "Economic Situation and Prospects of India" (SA-32a, dated May 10, 1972) was distributed to the Executive Directors as R72-133 on June 2, 1972. A new report commenting on more recent developments is about to be circulated. The following summarizes the main conclusions of the forthcoming report. A country data sheet is attached as Annex I. Background 3. The most notable feature of the past decade has been the rapid decline in net external assistance to India. Nonetheless, over this period the Indian economy has been substantially strengthened by the expansion and deepening of the industrial structure and by a large increase in agricultural production through basic technological improve- ment in cultivation, especially in the wheat growing areas of Northern India. The technical development in wheat, with considerable promise for similar innovations in rice and other crops in the near future, has been perhaps the outstanding advance in the Indian economy since the mid-sixties. Even so, growth in the economy over the decade has not averaged more than 3.5 percent per annum; and this has not had much impact on per capita income as the population has grown by about 2 percent per annum. In the distribution of gains there has been little improvement for the vast numbers of very poor Indians living in rural areas of deficient or unre- liable rainfall or in overcrowded urban slums beyond the reach of new employment opportunities. 4. In contrast to agriculture, industry has lagged, especially since the mid-sixties. There have been constraints on output arising from short- ages of foreign exchange for import-ed raw materials and from shortfalls in production of local materials, some periodic like cotton, jute, sugar and oilseeds, and others of a more persistent nature such as steel. Shortage of power, especially recently, has also affected industry. Then, there have been serious labor problems especially in Eastern India, and technical management has often proved inadequate for the construction and operation of large new projects. These physical constraints have been aggravated by the fact that the structure of demand and of production have often been ill- matched, especially in the case of capital goods where there has been a  -2- .-;c -Da_aria e between capacity and the courntry's savings performance. Also9 consumrtion demand is poorly distributed and slow growing, wnile exports have rot been effectively developed to supplement domestic industrial demand. 5. The bottlenecks and imbalances which have arisen could have been alleviated by massive amounts of foreign assistance but these were not forthcoming. instead, the solution had to be found within the limits set by the balance of payments. As a result, India has had to content herself with relieving only certain specific bottlenecks through the import of the more urgent raw materials such as steel and fertilizer. This has left much under-utilized industrial capacity, especially in sectors producing investment goods, but also in some consumer industries relying heavily uponiimported or locally produced agricultural inputs. Recent Developments 6. The current economic scene is one of more than usual difficulty because of the adverse food situation. Foodgrain production in the crop year July 1972 to June 1973 will be only about 100 million tons compared with about 108 million tons in the peak year 1970/71 and just under 105 million tons last year. Serious shortages have been alleviated in many areas through the use of the buffer stock which was accumulated during the favorable harvest years and which amounted to about 9 million tons in the middle of 1972. But there are areas of acute suffering, for lack of drinking water as well as of food, mainly in the arid inland regions of West and Central India. About 2 million tons of foodgrains are being imported to meet basic needs until the collection of this year's spring harvest. So for the first time in several years, food imports will add substantially to the foreiga exchange burden. In addition, public relief and crash crop production expenditures amounting to about Rs 2.5 billion have been approved thus far in 1972/73. And the tight supplies of food and other agricultural crops have been mainly responsible for the sharp increase in the average wholesale price index so far this year (April-December) of about 8 percent or twice the rate of previous years. Further imports of 2 to 3 million tons may be required during the rest of 1973 depending upon the outcome of procurement from the 1973 spring harvest. Also as India has now been left without buffer stocks, their replenishment could add further to foreign exchange needs of the current and coming years. 7. Industrial produclion however began to stage a recovery from late 1971 with a probable growth rate of about 7 percent in 1972 compared with only 3 percent in 1971. But even with this encouraging development, the setback to the economy of two successive drought years has been severe. As a result, economic growth over B971/72 and 1972/73 is now expected to have averaged oniy 2 percent per aanum. Anc this low growth rate has been associated with budgetary aind balance of payments difficulties. The deficit to be financed through the banking system for 1972/73 is now forecast at Rs 5.5 billion, or double the original estimate, despite tax receipts well in excess of budget estimates. The principal factor has been the large amount of additional expenditure by the States which has been met by the Central Government. But, rises in defence costs and such other items as drought-related expenditures have also 'been contributory factors. The  - 3 - recently passed budget for 1973/74 plans further mobilization of domestic resources through a 13 percent increase in tax revenues. The amount of the increase in expenditures is also to be curbed in an effort to reduce this year's deficit to about half that of last year. 8. The difficulties encountered in the balance of payments stem principally from the continued decline in net transfers of aid, which were expected to be only US$215 million in 1972/73 compared with US$443 million in 1971/72 and the peak figure of US$1.3 billion in 1965/66. Thus, even with exports showing a reasonable increase and with a drawdc'wn of reserves, the total foreign exchange resources were only sufficient to finance imports in 1972/73 at about US$160 million below the level of the previous year. 9. Once again, therefore, as has so often been the case, economic activity is being cramped by the irregularities of the weather and by balance of payments difficulties. Weather conditions will determine economic prospects for the latter part of 1973 and for 1974. Assuming reason- able monsoons, the economy should be capable of expanding quite rapidly. An important constraint upon realizing this potential is likely to be shortage of foreign exchange in general and, more specifically, a shortage of foreign exchange for industrial raw material imports. India's Overall Resource Position 10. India is confronted with enormous social and administrative problems in mobilizing resources in face of extensive poverty. The recession of 1966 and 1967 compounded these difficulties to the extent that domestic savings as a percentage of NDP went down from around 10 percent in the early 1960s to 7.4 percent in 1967/68. Since then the percentage has risen steadily to reach 10 percent in 1971/72, but this level is still inadequate to sustain satisfactory growth in the economy. Furthermore, despite the efforts proposed in 1973/74 to mobilize addtional resources, the 1972 drought is bound to have a depressing effect upon domestic savings over the short term. So even with maximum feasible efforts in increasing domestic savings, the rate oL growth of the economy will be constrained unless additional resources can be made available from abroad. 11. The prospects for obtaining additional resources from abroad to finance imports will depend upon export potential, the extent to which foreign reserves can be drawn down, and the quantum as well as the form of foreign assistance. Export earnings have shown a decidedly upward trend over the past two years, but the increase acnieved in 1972r7~ w-ii; be difuf lc_ _'t to maintain as much of the improvement reflects the recovery of the cotton textile industry from raw cotton shortages of 1971, and the particularly favorable markets for Indian jute in the adverse circumstances o' Bangladesh jute textile production. Engineering goods exports, which did so well in previous years, slowed down in 1972/73 as a result of increased domestic demand for new investment. The problem of how to achieve more dynamic export expansion as a means of improving India's import capability can be solved only over the long term.  '' Fo-^e-a exchange resources to finance a higher level of industrial a-)o-rcs could De supplemented by drawing down reserves but, over the short i.. .tce scope fo:r this is very limited. in any case by March 1973, foreign c ange reserves are exoected to be US$33 million below the level of March -y.!2, and to represent just under 35 percent of imports and debt service -aymnent. W'ith nayments of about US$140 million for foodgrains still to be a