India - Ninth Industrial Imports Project

tILE COPY DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1436-IN REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR THE NINTH INDUSTRIAL IMPORTS PROJECT May 7, 1974 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 It may not be published, quoted or' cited without Bank Group authorization.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 April 19, 1974) US$1.00 Rs. 7.96 Rs. 1.00 = US$0.126 Rs 1 million US$126,000 (The Rupee is officially valued at a fixed Pound Sterling rate. As the Pound is now floating relative to the US Dollar, the US Dollar/Rupee exchange rate is subject to change.) FISCAL YEAR April 1 - March 31  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE GOVERNMENT OF INDIA FOR THE NINTH INDUSTRIAL IMPORTS PROJECT 1. I submit the following report and recommendation on a proposed credit to India in an amount equivalent to US$150 million on standard IDA terms for the Ninth Industrial Imports Project. PART I - THE ECONOMY 2. An economic report, "Economic Situation and Prospects of India" is tc be distributed shortly to the Executive Directors. A country data sheet is attached as Annex I. Background 3. In 1972, India experienced a severe drought and total foodgrain production dropped by 8 percent. This followed a decline of 4 percent in foodgrain production in 1971 when the weather was unfavorable in large parts of Western and Northwestern India. The scarcity of food during 1972 and 1973 resulted in dramatic price increases adding further to inflation which has affected India over the last two years. Real income and demand were consequently affected and contributed in part to stagnation in_industrial ouRtput. At the same time, the huget was severely comstrained through the ~ ~ drought relief, while the balance of paymnts has hado.t accommodate large-scale imports of foodgrain. To these difficulties, there has now been added more recently the impcts of essent nial ipart.ed .dities, in particular foodgrain, oil and fertilizer. It is this current situation which is especially relevant to the consideration of the proposed credit. But, first, developments during 1973/74 1/ require some explanation. The Economy in 1973/74 4. At the beginning of 1973/74,-the prospects were for a year of modest growth. Weather conditions were expected to be favorable to agri- culture; industrial output was set to continue expanding, albeit at a somewhat lower rate than the previous year; and the balance of payments was forecast to include provision for increased imports of essential raw materials. Thanks to the weather, agricultural production has indeed improved, and foodgrains from the sum-mer (harifr) crop reached record levels. While winter (rabi) output is now forecast to fall short of the target, total foodgrain production may approach somewhere near the record output of 108 1/ Indian Fiscal Years, Aprill-March 31.  -2- million tons achiieved in 1970/71. However, this levejof-production will not permit_the_replepnjhment of nor meet the demand,_of the.rising_poplation withkout a,rdshipunles.siiports-arearranged. At the same time, industrial p.L oducnt.-o_ as_hown little nogrowth. Indeed, over the first six months of 1973, the index showed a decline, which is disappointing andl in many ways perplexing; this is examined in Part III. Exports have shown a very respectable increase of 19 percent. But the balance of payments is now undler strain as a result of the worldwide rise in commodity prices which took place during 1973/74. S5. It is is last.mentioned development which has overshadowed everything else. The originally projected trade ba aIcefor 1SL7L7 Lw as a deficit of USS$j40..million; the current estimate is a deficit of US$655 million. This serious deterioration is attributable to three factqMs, offset only in small part by somewhat better than forEcast export performance. First, substantial imports of foodgrain were re- quired; then petroleum prices started their spectacular increase during the latter part of the year; and finally, the cost of fertilizer has risen partly on account of scarcity and partly on account of rising feedstock costs. Other commodities have also risen in price as shown below but, as the import bill for these has been kept at the 1972/73 level, their volume thas had to be severely reduced. Average Prices of Selected Imports (c & f) (US$ per ton) 1972/73 /1 January 1974 /2 Percentage Increase Whueat 125 250 99 *Urea 69 260 275 SulDhur 32 70 119 Steel sheets 204 340 67 Steel wire rods 216 335 55 Copper 1103 2230 102 Zinc 351 1140 225 'Phosphate 18 85 372 /1 Customs data /2 Based on contracts entered into in January 1974. Source: Government of India 6. There have also been increases in the prices of some of India's exports; prices of oilcakes have gone up by a spectacular 90 percent, leather products by as much as 75 percent, cotton textiles by 30 percent:, coffee by 40 percent. Towards the end of the year, some upward movement began to take place in the prices of jute, tea and iron ore. But, during 1973/74 these were not nearly so dramatic as the increases in import prices. 7. Another significant trend has been the rapid ise inldomestic prices. Food items alone, on the wholesale price index, have risen by 27 percent over the year February 1973 to February 1974, while t.he index  -3- for all commodities has also gone up by the same amount. This contrasts with rises of 8 percent or so in 1972/73, and an average of around 4 percent in the three preceding years. Part of the explanation has been shortage of domestic products, especially food and foodgrains, and of course the world- wide increases in the price of raw materials and goods generally. But even with more plentiful supplies of foodgrain becoming available during the latter part of 1973, the index has failed to register any decline. A factor has been the difficult conditions created in 1973 following the Government takeover of the wholesale wheat trade and the setting of low procurement prices which undoubtedly led farmers to withhold supplies from the market. In addition, the expansion of money supply, especially credit to the Govern- ment sector, has added greatly to the inflationary forces. Prospects for 1974/75 8. The prospects for 1974/75 cannot be described as anything other than pgrim. India enters this year with food stocks well below the mninimtum safety level to deal with even a slight shortfall in production, severe constraints on development expenditures, continuing inflation and an impending import bill of barely manageable proportions. This is the first year of the Fifth Plan period, but events have invalidated many of the assumptions upon which the Plan had been drafted. 9. The Government is taking various measures to deal with the situation. It has already negotiated with the USSR for the import of 2 mil- lion tons of wheat of which 1 million tons has been delivered. A further two million tons are expected to be required during the course of 1974. Provided imports can be arranged in a timely manner, the Government should have sufficient supplies to maintain a reasonable level of distribution (throughout the year. At the same time, the Government recently decided ( that the private sector may again operate in the wholesale wheat trade. In the budget presented at the end of February, GOI planned to.reduce deficit financing and reassessedpriorities for developmentexpenditures. The former has been achieved by limiting the increase in development expendit.ures to only 7 percent which is likely to mean-a_decline-in_real=terms. However, within this relatively modest allocation for_development, certain vital sectors have received substantial increment4. Tha caion for- 3coal mining has quadrupled, for railways it has gone up 80 percent, and for fertilizer it has been raised by 75 percent. The reassessment of prior- ities underlying these increases has led to most of the burden of financial stringency being placed upon the social sectors. 10. Recent experience has shown that the deficits projected in the budgetprove inpractice to be much larger partly on account of requirements for unf eres.engyvents-such-as-droughts. For instance, in 1973/74 the deficit was budgeted to be US$113 million but is likely to end up at around US$870 million. The results for 1974/75 may also be worse than estimated but for the somewhat different reason that the 12 percent increase in tax revenue is expected largely to come through higher yields from existing taxes based on the assumption of some recovery of the economy. Circumstances are not propitious for such a recovery and so if events should prove the projection wrong, then another year of heavy deficit financing is likely to occur.  -4- Consequently, the curbs on the expansion of money supply imposed by the Reserve Bank of India (RBI) would be vitiated. In any case, even if the RBI is successful in reducing the rate of expansion, the best that can be hoped for is some decline in the rate of inflation through greater availability of domestic foodstuffs. II. The p,>o_s.fp.t-eL--crs-brtealuw&-oLp_ayme*s__Ane V x, -e blek 1The balance o - aggravated by the need for additional food imports, rising commodity prices as mentioned in paragraph 5, and a staggering bill for petroleum. Demand for petroleum products has been growing consistently at about 9 percent per annum over the last decade. Imports, which account for about two-thirds of India's total petroleum consumption, have been growing at about 6 percent per annum over the same decade to reach US$265 million in 1972/7:3 or 10 percent of India's total imports. The recent price _ifc, ag